Portfolio Management
UNIT 5 PORTFOLIO MANAGEMENT
INTRODUCTION
Portfolio management refers to the process of managing an individual's or institution's investment
portfolio in order to achieve specific financial objectives while considering risk tolerance,
investment constraints, and market conditions it involves the selection, allocation, and monitoring
of a mix of assets to achieve the desired return with minimal risk.
Meaning of Portfolio Management
Portfolio management is managing a client's investment by selecting the right investment tools in
the right proportion; it focuses on maintaining a balance of risk and helping clients maximize their
earnings over a period.
A portfolio manager can manage stocks, bonds, real estate, mutual funds and other financial assets,
these managers focus on matching goals to outcomes. Some of the objectives portfolio
management are,
• Ensuring capital appreciation
• Optimizing risk
• Allocating resources optimally
• Ensuring flexibility of portfolio
• Protecting capital against potential market risk
• Improving the proficiency of the portfolio
OBJECTIVES OF PORTFOLIO MANAGEMENT
Attaining Long-term Financial Goals: An investor always invests with a motive to secure the
future by earning a high return, keeping this in mind Portfolio Management works with the
objective to fulfill the long-term financial goals of the investors by recommending the most
profitable portfolio, overseeing and rebalancing it from time to time to ensure high return with
minimum risk appetite.
Capital Appreciation: Capital appreciation means an increase in the value of an asset over a time
period. Portfolio Management intends to make the portfolio of the investor grow, so the market
value of the investment rises within the given timeline, in comparison to its purchase value. Capital
appreciation is the main source of investors' earnings.
Maximizing Return on Investment: Return on Investment shows the earning from the
investment in relation to the expenditure made in such investment. Portfolio Management aims to
maximize the ROI by analyzing the market before selecting the right investment mix Other factors
like time period, inflation, Legal restrictions, and economic conditions are also considered.
Achieving Asset Allocation: The primary objective of Portfolio Management is to allocate assets
across different investment classes, such as equities, fixed income, and alternative investments in
such a way that the asset allocation goes with the investor's risk profile and investment goals.
Risk Management: Investment and risk are something that goes side by side and hence is a major
concern of the investors. Portfolio Management minimizes the degree of risk associated with the
investment by using the concept of diversified investment.
Diversification; spreading investment across different areas or various asset classes sectors, and
geographical to reduce overall risk and volatility.
Rebalancing and Monitoring the Portfolio: Portfolio Management aims to regularly monitor
and adjust the portfolio by rebalancing the portfolio, adding or removing assets, or changing
investment strategies so, it remains consistent with the investor's risk profile and investment goals.
TYPES OF PORTFOLIO MANAGEMENT
Portfolio Management can be classified into:
1. Active Portfolio Management: In active portfolio management, a portfolio manager is
continuously involved in the activity of trading securities to outperform the market and
achieve specific financial goals. They basically aim at buying unvalued securities and then
selling them at a high price to earn a profit. Active portfolio management is characterized
by higher fees and commissions.
2. Passive Portfolio Management: Passive portfolio management is based on the theory of
invest-and-forget strategy. Under this, investments are made into a portfolio of index funds
to replicate the performance of a particular market index like an exchange-traded fund
(ETF), a mutual fund, a unit investment trust, and other low-cost index funds.
3. Dynamic Portfolio Management: Dynamic portfolio management can be understood as
hybrid portfolio management as it includes features of both active and passive portfolio
management. Under this, Portfolio Managers implement long-term investment strategies
while making tactical adjustments and rebalancing in response to market changes.
4. Discretionary Portfolio Management: Discretionary portfolio management forms
authorize managers and financial experts to make all the financial decisions on behalf of
their clients without seeking any separate approval each time.
5. Non-discretionary Portfolio Management: Under a Non-discretionary portfolio
management system, a manager act just as an adviser to the client. The manager helps with
the allocation of assets, selecting investment strategies, and suggesting investment moves
to the clients.
Needs of portfolio management
1. Risk management: one of the primary need of PM is the management of risk. Investor
faces various types of risk, including market risk, Credit risk, liquidity risks etc... By
managing risk effectively, investors can protect their portfolios from potential losses.
2. Achieving financial goals PM Strategies help investors achieve specific financial goals,
such as retirement Savings, wealth accumulation generating regular Income.
3. Asset allocation It determines the optimal distribution of investment across various asset
Classes such as Stocks, bonds, & cash to achieve a balanced-risk-reward.
4. Return maximization PM aims to maximize returns while considering an investors risk-
tolerance & investment goals. Through Strategic asset allocation and active management
Strategies.
5. Tax Efficiency PM includes Strategies to minimize liabilities through tax efficient
investing, tax planning, tax minimizing etc..
6. Tailored Investment Solutions: Portfolio management provides tailored investment
solutions that align with investors' unique financial goals, time horizons, and risk
preferences. Whether an investor is seeking capital appreciation, income generation, or
wealth preservation, portfolio managers design customized investment portfolios to meet
these specific objectives.
7. Professional Expertise: Many investors lack the time, resources, or expertise to manage
their investment portfolios effectively. Portfolio management offers access to professional
expertise and experienced investment professionals who can navigate complex financial
markets, conduct in-depth research, and make informed investment decisions on behalf of
clients.
PROCESS OF PORTFOLIO MANAGEMENT
1. Setting Objectives and Constraints The first step in portfolio management is defining
investment objectives and constraints. Objectives could include capital appreciation,
income generation, or a combination of both. Constraints may involve factors such as time
horizon, risk tolerance, liquidity needs, and regulatory considerations. Clear objectives and
constraints provide a foundation for constructing a portfolio tailored to the investor's
unique circumstances.
2. Asset Allocation Asset allocation is a strategic decision that involves determining the mix
of asset classes (e.g., stocks, bonds, cash, real estate) within the portfolio. This decision is
crucial as it significantly influences the portfolio's risk and return profile.
3. Security Selection Once the asset allocation is determined, the next step is selecting
specific securities or Investments within each asset class. This involves analyzing
individual stocks, bonds, or other financial instruments to build a well-diversified portfolio.
Fundamental analysis, technical analysis, and other evaluation methods are employed to
identify securities that align with the investor's goals.
4. Risk Management Managing risk is an integral part of portfolio management. Techniques
such as diversification, hedging, and the use of risk-adjusted metrics help control and mitigate portfolio risk. Understanding the correlation between different assets and
incorporating risk management strategies are essential for constructing a resilient portfolio.
5. Portfolio Construction Portfolio construction involves combining the selected securities
in the desired proportions based on the asset allocation. The goal is to create a balanced
and diversified portfolio that aligns with the investor's risk-return profile. Attention is given
to factors such as sector exposure, geographic considerations, and market capitalization to
ensure a well-rounded Investment mix.
6. Monitoring and Rebalancing Once the portfolio is constructed, continuous monitoring is
essential. Market conditions, economic factors, and changes in the investor's financial
situation may necessitate adjustments. Rebalancing involves periodically reviewing the
portfolio's asset allocation and making adjustments to bring it back in line with the original
strategic plan.
7. Performance Evaluation Regular performance evaluation helps assess how well the
portfolio is meeting its objectives. Key performance metrics, such as return on investment,
risk-adjusted return, and portfolio volatility, are analyzed. This evaluation provides
insights into the effectiveness of the chosen strategy and helps investors make informed
decisions about the portfolio's future direction.
8. Adaptation to Changing Market Conditions Portfolio management is not a static
process; it requires adaptability to changing market conditions. Economic shifts,
geopolitical events, and fluctuations in interest rates can impact the performance of
different asset classes. Portfolio managers must stay informed about market trends and be
prepared to adjust the portfolio strategy accordingly
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