Portfolio
It is the combination of securities such as stocks, shares, mutual funds, and cash and so on depending on the investor’s income, budget and convenient time frame. It is constructed in such a manner to meet the investor goals & objective. An investor should decide how caused to reach the goals with the securities available the investor tries to attain maximum with minimum risks towards this end he diversifies his portfolio and allocated funds along the securities. Following are the two types of Portfolios:
- Market Portfolio
- Zero Investment Portfolios
Meaning of Portfolio Management
Investment in the securities such as bonds, debentures and shares etc. is lucrative as well as exciting for the investors. Though investment in these securities may be rewarding, it is also fraught with risk. Therefore, investment in these securities requires a good amount of scientific and analytical skill. As per the famous principle of not putting all eggs in the same basket, an investor never invests his entire investable funds in one security. He invests in a well - diversified portfolio of a number of securities which will optimize the overall risk-return profile.
Investment in a portfolio can reduce risk without diluting the returns. An investor, who is expert in portfolio analysis, may be able to generate trading profits on a sustained basis.
Every investment is characterized by return and risk. The concept of risk is intuitively understood by investors. In general, it refers to the possibility of the rate of return from a security or a portfolio of securities deviating from the corresponding expected/ average rate and can be measured by the standard deviation/variance of the rate of return.
- Portfolio management refers to managing an individual’s investments in the form of bonds, shares, cash, mutual funds etc so that he earns the maximum profits within the stipulated time frame. The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against Performance. It is an art of selecting the right investment policy for the individuals in terms of minimum risk and maximum return.
- Portfolio management refers to managing money of an individual under the expert guidance of portfolio managers. It is all about strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other trade-offs encountered in the attempt to maximize return at a given appetite for risk. For example, Consider Mr. John has $100,000 and wants to invest his money in the financial market other than real estate investments. Here, the rational objective of the investor (Mr. John) is to earn a considerable rate of return with less possible risk.
|
No. |
Investor’s
portfolio |
Investment |
Percentage |
Security |
Returns |
|
1. |
Government Bonds |
$25,000 |
25% |
High |
Low |
|
2. |
Bank’s Fixed Deposits |
$ 15,000 |
15% |
High |
Average |
|
3. |
Shares |
$ 35,000 |
35% |
Low |
High |
|
4. |
Mutual Funds |
$25,000 |
25% |
Average |
Average |
Note that: The above table is just an example and may not be taken as a standard for the portfolio management.
Need for 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.
Types of Portfolio Management
- Active Portfolio Management: As the name suggests, in an active portfolio management service, the portfolio managers are actively involved in buying and selling of securities to ensure maximum profits to individuals.
- Passive Portfolio Management: In a passive portfolio management, the portfolio manager deals with a fixed portfolio designed to match the current market scenario.
- 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.
Portfolio Management steps
- Investment Process - The investment process is a systematic approach of identifying objectives, analyzing securities, selecting investments, and monitoring performance. For Example: An investor decides to invest for retirement, studies mutual funds, selects suitable funds, and reviews returns yearly.
- Portfolio (Combination of Securities) - A portfolio is a collection of different financial securities held together to reduce risk. For Example: Holding shares of IT companies, bank stocks, bonds, and mutual funds together.
- Construction of Portfolio - Portfolio construction involves selecting and allocating securities based on risk tolerance and investment goals. For Example: Investing 50% in equities, 30% in bonds, and 20% in gold for balanced risk.
- Securities Available in the Market - These are financial instruments in which investors can invest to earn returns. For Example: Equity shares, debentures, bonds, mutual funds, derivatives, and government securities.
- Optimum Portfolio - An optimum portfolio offers the maximum possible return for a given level of risk. For Example: A mix of blue-chip stocks and bonds that gives higher returns with controlled risk.
- Security Analysis - Security analysis is the evaluation of financial instruments to assess their value and risk. For Example: Analyzing a company’s balance sheet and profit trends before buying its shares.
- Relation Between Risk and Return - Higher risk is associated with higher expected returns, and lower risk gives lower returns. For Example: Equity shares are riskier but give higher returns than fixed deposits.
- Portfolio Evaluation - Portfolio evaluation measures the performance of a portfolio in terms of return and risk. For Example: Comparing a portfolio’s return with a benchmark index like Sensex.
Objectives of Portfolio management
- Security of Principal Investment: Investment safety or minimization of risks is one of the most important objectives of portfolio management. Portfolio management not only involves keeping the investment intact but also contributes towards the growth of its purchasing power over the period. The motive of a financial portfolio management is to ensure that the investment is absolutely safe. Other factors such as income, growth, etc., are considered only after the safety of investment is ensured.
- Consistency of Returns: Portfolio management also ensures to provide the stability of returns by reinvesting the same earned returns in profitable and good portfolios. The portfolio helps to yield steady returns. The earned returns should compensate the opportunity cost of the funds invested.
- Capital Growth: Portfolio management guarantees the growth of capital by reinvesting in growth securities or by the purchase of the growth securities. A portfolio shall appreciate in value, in order to safeguard the investor from any erosion in purchasing power due to inflation and other economic factors. A portfolio must consist of those investments, which tend to appreciate in real value after adjusting for inflation.
- Marketability: Portfolio management ensures the flexibility to the investment portfolio. A portfolio consists of such investment, which can be marketed and traded. Suppose, if your portfolio contains too many unlisted or inactive shares, then there would be problems to do trading like switching from one investment to another. It is always recommended to invest only in those shares and securities which are listed on major stock exchanges, and also, which are actively traded.
- Liquidity: Portfolio management is planned in such a way that it facilitates to take maximum advantage of various good opportunities upcoming in the market. The portfolio should always ensure that there are enough funds available at short notice to take care of the investor’s liquidity requirements.
- Diversification of Portfolio: Portfolio management is purposely designed to reduce the risk of loss of capital and/or income by investing in different types of securities available in a wide range of industries. The investors shall be aware of the fact that there is no such thing as a zero-risk investment. More over relatively low risk investment give correspondingly a lower return to their financial portfolio.
- Favorable Tax Status: Portfolio management is planned in such a way to increase the effective yield an investor gets from his surplus invested funds. By minimizing the tax burden, yield can be effectively improved. A good portfolio should give a favorable tax shelter to the investors. The portfolio should be evaluated after considering income tax, capital gains tax, and other taxes.
The objectives of portfolio management are applicable to all financial portfolios. These objectives, if considered, results in a proper analytical approach towards the growth of the portfolio. Furthermore, overall risk needs to be maintained at the acceptable level by developing a balanced and efficient portfolio. Finally, a good portfolio of growth stocks often satisfies all objectives of portfolio management.
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