Portfolio

Management
Dr Rishi Manrai
Assistant Professor
 Why Portfolio ???
A portfolio can be simply understood as a group of assets, or a
basket of securities.
An old investment wisdom says “don’t keep all eggs in one basket”.
Investment in only a single asset/stock results in the investor
being exposed to the total risk which consists of
 Unsystematic risk or diversifiable risk – Induced by factors relating
to a single firm and which are mainly attributable to fundamental
factors
 Systematic risk or non diversifiable risk – Induced by factors not
limited to single stock, but which affects the whole market.
By investing in a well diversified portfolio we can minimize the
impact of unsystematic risk factors
 Portfolio Management
A process of creating and maintaining a portfolio for
achievement of investment objectives.
The art of selecting the right investment policy in terms
of minimum risk and maximum return.
The art and science of making decisions about
Investment mix and policy
Matching investments to objectives
Asset allocation for individuals and institutions
Balancing risk against performance.
Fundamental Principles/Notions of Portfolio
Management
Notion of Diversification
The portfolio should contain large number of securities
which should be manageable.
Inclusion of more number of securities spreads the risks
associated to a large number of assets
Notion of Negative Correlation
This will ensure that the bad performance of one or
more securities will be taken care of by good
performance of other securities.
Meaning and Necessity of Investment Policy
Statement (IPS)
This is a statement providing the general investment
goals and objectives of a client and it describes the
strategies that the manager should employ to meet these
objectives.
Specific information on matters such as asset allocation,
risk tolerance, and liquidity requirements would also be
included in an IPS.
Creating an Investment Policy Statement forces an
investor to put the investment strategy in writing and
commit to a disciplined investment plan.
It's both a blueprint and a report card.
 Inputs to policy statement
The Executive Summary
 Provides an overview of your current situation and what you expect
from your portfolio. It's a snapshot in time. Update your Executive
Summary whenever you rebalance your portfolio.
Here are the questions to answer:
 What are the current assets of my portfolio today?
 How much do I plan to invest each month?
 How many years will I be investing?
 How much do I expect my portfolio to return each year over inflation?
 How much of a loss can I accept over a three-month period, a one-
year period, and a five-year period?
 What is my target asset allocation?
 What are my benchmarks for my portfolio?
Inputs to policy statement
The Investment Objectives
Details of what you're trying to achieve with this portfolio
and in what time frame.
Answer the following questions:
What is my financial goal?
How long will I be funding this goal?
How much will this goal cost every year?
 Inputs to policy statement
The Investment Philosophy
 In this section, the investor articulates what's important as an
investor. These are the theories you believe in and plan to
follow.
Here are some questions to consider:
 What's my philosophy about risk?
 What's my philosophy about core versus noncore investments?
 What's my philosophy about diversification?
 What's my philosophy about trading?
 What's my philosophy about costs?
 What's my philosophy about taxes?
 Inputs to Policy Statement
 The Investment Selection Criteria
 Section of your Investment Policy Statement includes your rules for
choosing investments. To determine what qualities an investment must
have before joining your portfolio, consider reviewing some of the classes
in the Mutual Funds and Stocks tracks of the Investing Classroom.
 Some criteria to consider for mutual funds:
 Minimum category rating
 Minimum total return % category rank over various periods
 Maximum percentage of assets in top-10 holdings
 Maximum percentage of assets in any one sector
 Some criteria to consider for stocks:
 Maximum price for each stock
 Minimum return on equity
 Minimum free cash flow
 Minimum forecasted five-year earnings-growth rate
 Inputs to Policy Statement
The Monitoring Procedures
 Details the investor’s plan for keeping tabs on their investments.
 It's their blueprint for rebalancing, and for determining what
investments, if any, they should sell.
Answer the following questions:
 How often will I monitor my portfolio?
 How will I determine how well my individual investments are
doing?
 How will I determine how well my overall portfolio is doing?
 How will I determine if my portfolio is meeting my expected
return?
 How will I determine whether losses fall within my accepted range?
 Need of Portfolio Management
Portfolio management presents the best investment
plan to the individuals as per their income, budget, age
and ability to undertake risks.
Portfolio management minimizes the risks involved in
investing and also increases the chance of making profits.
Portfolio managers understand the client’s financial needs
and suggest the best and unique investment policy for
them with minimum risks involved.
Portfolio management enables the portfolio managers
to provide customized investment solutions to clients
as per their needs and requirements.
 Portfolio Theories
Traditional Theory
Only considers the risk and return of different securities
Does not considers the correlation between securities
Individual analysis of securities
The risk is considered in totality
Selection of securities by matching risk and return
Diversification on the basis of classes such as equity or debt,
maturity of bond, different industries etc.
Portfolio Management Process
Deciding investment objectives
Deciding investment constraints
Asset Mix Decision
Formulation of portfolio Strategy
Selection of securities
Portfolio execution
Portfolio revision and alignment
Portfolio performance evaluation
Investment Motives or Goals
Safety of the invested money
Certainty & Regularity of Income
Chances of capital appreciation
Tax savings and tax free income
Liquidity/ Marketability
Opportunities of speculative gains
Hedging the risk
Arbitrage opportunities
Investment Constraints
Disposable Income
Return requirements
Liquidity preference
Tax considerations
Time horizon
 Asset Mix
Depends upon the risk tolerance and investment horizon
In case of low risk tolerance the investment in shares
should be limited to 20% - 50% of the corpus
In case of medium risk tolerance the limit can be
increased to 35% - 70% of the corpus
An investor having high risk tolerance can load 50% -
90% of the corpus by shares.
Increase in length of investment period reduces the risk
of investing in shares due to time diversification.
 Portfolio strategy
Active strategy
Changing the investment pattern according to the
changes in market
Riding the market swings
Switching the sectors
Combining fundamental and technical analysis
Passive strategy
Sticking to the original asset allocation till the time of
review
The strategy rests on the assumption of efficiency in
market making the possibility of abnormal returns on
the basis of information differentials, difficult.
 Security Selection
For equity on the basis of market efficiency
Fundamental analysis – Weak Form
Technical analysis - Inefficient
Random selection – Strong Form
For bonds on the basis of
YTM
Risk of default
Tax shield
Liquidity
Portfolio Execution & Revision
Placing of the order
Periodic reviews for watching whether the prevailing
portfolio has become inconsistent with the original
investment philosophy and objectives and revising it.
Performance evaluation
Calculation of Holding period returns (HPY)
Calculation of average returns over longer time
periods
Calculation of total risk of portfolio in terms of
variance/ standard deviation
Calculation of portfolio Beta for systematic risk.
Types of portfolio management
Discretionary Portfolio management services: In
Discretionary portfolio management services, an individual
authorizes a portfolio manager to take care of his financial
needs on his behalf. The individual issues money to the
portfolio manager who in turn takes care of all his investment
needs, paper work, documentation, filing and so on. In
discretionary portfolio management, the portfolio manager has
full rights to take decisions on his client’s behalf.
Non-Discretionary Portfolio management services: In non
discretionary portfolio management services, the portfolio
manager can merely advise the client what is good and bad for
him but the client reserves full right to take his own decisions.
THANK YOU