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The process of portfolio management
The document outlines the process of portfolio management across four parts. It discusses establishing investment objectives and policies, constructing a portfolio using diversification and asset allocation strategies, maintaining the portfolio through active or passive management, and protecting it through hedging strategies and derivatives. Performance is evaluated based on return and risk metrics to ensure objectives are met. Fiduciary duties require managers to act in clients' best interests when overseeing their money and investments. The portfolio process aims to balance risks and returns through various economic conditions.
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The process of portfolio management
- 1. 1 The Process ofPortfolio Management
- 2. 2 The Life ofevery man is a diary in which he means to write one story, and writes another; and his humblest hour is when he compares the volume as it is with what he vowed to make it. - J.M. Barrie
- 3. 3 Outline Introduction Part one: Background,Basic Principles, and Investment Policy Part two: Portfolio construction Part three: Portfolio management Part four: Portfolio protection and contemporary issues
- 4. 4 Introduction Investments Security analysis Portfolio management Purposeof portfolio management Low risk vs. high risk investments The portfolio manager’s job The six steps of portfolio management
- 5. 5 Investments Traditional investments covers: •Security analysis – Involves estimating the merits of individual investments • Portfolio management – Deals with the construction and maintenance of a collection of investments
- 6. 6 Security Analysis Athree-step process 1) The analyst considers prospects for the economy, given the state of the business cycle 2) The analyst determines which industries are likely to fare well in the forecasted economic conditions 3) The analyst chooses particular companies within the favored industries • EIC analysis (a top-down approach)
- 7. 7 Portfolio Management Literaturesupports the efficient markets paradigm • On a well-developed securities exchange, asset prices accurately reflect the tradeoff between relative risk and potential returns of a security – Efforts to identify undervalued undervalued securities are fruitless – Free lunches are difficult to find
- 8. 8 Portfolio Management (cont’d) Market efficiency and portfolio management • A properly constructed portfolio achieves a given level of expected return with the least possible risk – Portfolio managers have a duty to create the best possible collection of investments for each customer’s unique needs and circumstances
- 9. 9 Purpose of Portfolio Management Portfolio management primarily involves reducing risk rather than increasing return • Consider two $10,000 investments: 1) Earns 10% per year for each of ten years (low risk) 2) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, - 12%, and 10% in the ten years, respectively (high risk)
- 10. 10 Low Risk vs.High Risk Investments $25,937 $10,000 $23,642 $0 $10,000 $20,000 $30,000 '92 '94 '96 '98 '00 '02 Low Risk High Risk
- 11. 11 Low Risk vs.High Risk Investments (cont’d) 1) Earns 10% per year for each of ten years (low risk) • Terminal value is $25,937 2) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%, and 10% in the ten years, respectively (high risk) • Terminal value is $23,642 The lower the dispersion of returns, the greater the terminal value of equal investments
- 12. 12 The Portfolio Manager’sJob Begins with a statement of investment policy, which outlines: • Return requirements • Investor’s risk tolerance • Constraints under which the portfolio must operate
- 13. 13 The Six Stepsof Portfolio Management 1) Learn the basic principles of finance 2) Set portfolio objectives 3) Formulate an investment strategy 4) Have a game plan for portfolio revision 5) Evaluate performance 6) Protect the portfolio when appropriate
- 14. 14 The Six Stepsof Portfolio Management (cont’d) Learn the Basic Principles of Finance (Chapters 1 – 3) Set Portfolio Objectives (Chapters 4 – 5) Formulate an Investment Strategy (Chapters 6 – 14) Have a Game Plan for Portfolio Revision (Chapters 15 – 18) Protect the Portfolio When Appropriate (Chapters 21 – 25) Evaluate Performance (Chapters 19 - 20)
- 15. 15 Overview of theText PART ONE: Background, Basic Principles, and Investment Policy PART TWO: Portfolio Construction PART THREE:Portfolio Management PART FOUR: Portfolio Protection and Contemporary Issues
- 16. 16 PART ONE Background, BasicPrinciples, and Investment Policy A person cannot be an effective portfolio manager without a solid grounding in the basic principles of finance Egos sometimes get involved • Take time to review “simple” material • Fluff and bluster have no place in the formation of investment policy or strategy
- 17. 17 PART ONE Background, BasicPrinciples, and Investment Policy (cont’d) There is a distinction between “good companies” and “good investments” • The stock of a well-managed company may be too expensive • The stock of a poorly-run company can be a great investment if it is cheap enough
- 18. 18 PART ONE Background, BasicPrinciples, and Investment Policy (cont’d) The two key concepts in finance are: 1) A dollar today is worth more than a dollar tomorrow 2) A safe dollar is worth more than a risky dollar These two ideas form the basis for all aspects of financial management
- 19. 19 PART ONE Background, BasicPrinciples, and Investment Policy (cont’d) Other important concepts • The economic concept of utility • Return maximization
- 20. 20 PART ONE Background, BasicPrinciples, and Investment Policy (cont’d) Setting objectives • It is difficult to accomplish your objectives until you know what they are • Terms like growth or income may mean different things to different people
- 21. 21 PART ONE Background, BasicPrinciples, and Investment Policy (cont’d) Investment policy • The separation of investment policy from investment management is a fundamental tenet of institutional money management – Board of directors or investment policy committee establish policy – Investment manager implements policy
- 22. 22 PART TWO Portfolio Construction Formulate an investment strategy based on the investment policy statement • Portfolio managers must understand the basic elements of capital market theory – Informed diversification – Naïve diversification – Beta
- 23. 23 PART TWO Portfolio Construction(cont’d) International investment • Emerging markets carry special risk • Emerging markets may not be informationally efficient
- 24. 24 PART TWO Portfolio Construction(cont’d) Stock categories and security analysis • Preferred stock • Blue chips, defensive stocks, cyclical stocks Security screening • A screen is a logical protocol to reduce the total to a workable number for closer investigation
- 25. 25 PART TWO Portfolio Construction(cont’d) Debt securities • Pricing • Duration – Enables the portfolio manager to alter the risk of the fixed-income portfolio component • Bond diversification
- 26. 26 PART TWO Portfolio Construction(cont’d) Pension funds • Significant holdings in gold and timberland (real assets) • In many respects, timberland is an ideal investment for long-term investors with no liquidity problems
- 27. 27 PART THREE Portfolio Management Subsequent to portfolio construction: • Conditions change • Portfolios need maintenance
- 28. 28 PART THREE Portfolio Management(cont’d) Passive management has the following characteristics: • Follow a predetermined investment strategy that is invariant to market conditions or • Do nothing • Let the chips fall where they may
- 29. 29 PART THREE Portfolio Management(cont’d) Active management: • Requires the periodic changing of the portfolio components as the manager’s outlook for the market changes
- 30. 30 PART THREE Portfolio Management(cont’d) Options and option pricing • Black-Scholes Option Pricing model • Option overwriting – A popular activity designed to increase the yield on a portfolio in a flat market • Use of stock options under various portfolio scenarios
- 31. 31 PART THREE Portfolio Management(cont’d) Performance evaluation • Did the portfolio manager do what he or she was hired to do? – Someone needs to verify that the firm followed directions • Interpreting the numbers – How much did the portfolio earn? – How much risk did the portfolio bear? – Must consider return in conjunction with risk
- 32. 32 PART THREE Portfolio Management(cont’d) Performance evaluation (cont’d) • More complicated when there are cash deposits and/or withdrawals • More complicated when the manager uses options to enhance the portfolio yield Fiduciary duties • Responsibilities for looking after someone else’s money and having some discretion in its investment
- 33. 33 PART FOUR Portfolio Protectionand Contemporary Issues Portfolio protection • Called portfolio insurance prior to 1987 • A managerial tool to reduce the likelihood that a portfolio will fall in value below a predetermined level
- 34. 34 PART FOUR Portfolio Protectionand Contemporary Issues (cont’d) Futures • Related to options • Use of derivative assets to: – Generate additional income – Manage risk Interest rate risk • Duration
- 35. 35 PART FOUR Portfolio Protectionand Contemporary Issues (cont’d) Contemporary issues • Derivative securities • Tactical asset allocation • Program trading • Stock lending • CFA program
- 36. For details andbookings contact:- Parveen Kumar Chadha… THINK TANK (Founder and C.E.O of Saxbee Consultants & Other-Mother marketingandcommunicationconsultants.com) Email :[email protected] Mobile No. +91-9818308353 Address:-First Floor G-20(A), Kirti Nagar, New Delhi India Postal Code- 110015