Portfolio management is defined as a process at the corporate level for the successful delivery of the portfolio of an organization. This portfolio includes an entire set of projects and programs.
Portfolio management is a tool to determine opportunities, strengths, weaknesses, and threats so as to maximize the returns against risks. It has a simple principle of maximum returns with minimum risk within a specific time frame.
Table of Contents
Understanding portfolio management
Portfolio management is described as a continuous reviewing and monitoring process of previous and current performances, making decisions about policies and investment mix, asset allocation for institutions and individuals, matching investments to the objectives and balancing risk against performances.
Portfolio management deals in creating and later maintaining an investment account. It includes several professional services in order to handle company securities for instance bonds, mutual funds, stocks, shares, cash or even real estate. The portfolio management process takes into consideration diversification, level of risks, maturity and period of investment.
Key elements of portfolio management
The key elements of portfolio management are
1. Asset allocation
One of the main elements of portfolio management is asset allocation or a long-term mix of assets. It is described as an investment strategy that helps to balance rewards and risks. Some assets are more volatile than others and it is asset allocation that helps to maximize return with minimum risk by investing in several assets that do not have much correlation with each other.
If an investor prefers he can weigh his investment opportunities more towards aggressive profile or towards conservative profile as per his wishes.
A key element of portfolio management is diversification of assets. One of the hard facts of investment is that it is impossible to predict consistently about the investments that will yield either best or worst returns. The market has a way of surprising even the most experienced investor time and again. The best way to keep yourself safe is to diversify your investments into several asset classes.
This will offer broad exposure and help to spread both risks and return within the asset class. Proper diversification helps to capture returns from all the sectors over time but with less risk factor
Another key element of portfolio management is rebalancing. It is a process that nudges the portfolio towards its original objective at an annual interval. It includes making viable changes and retaining the asset mix that looks beneficial in the long run.
The process of rebalancing helps investors to expand growth opportunities and capture gains in sectors that show high potential.
Process of portfolio management
The portfolio management process involves several steps to ensure that a client’s investment objectives are met successfully. It includes
Stage 1 – Planning
The first step in the process of portfolio management is planning. It is considered the most important and crucial stage as it lays down the foundation for all the other steps that will be implemented. It includes
1. Identifying constraints and objectives
Identify the investment objectives or the desired outcomes of the investor and look for any constraints that include limitations regarding investment decisions. Both must be specific at this point in time so as to take further steps accordingly.
2. Investment policy statement
The next step in the portfolio management process is to create an investment policy statement. It is actually a roadmap where the investor is made aware of the investment goals and limitations. This statement should be reviewed regularly to make appropriate changes in time.
3. Capital market expectations
Forming expectations in regard to capital markets is the next step in the portfolio management process. Return and risk are forecasted to make choices between portfolios that will maximize the return but with certain risk or minimize the risk with less amount of expected return.
4. Asset allocation strategy
The fourth and final step of the planning process is asset allocation. It is a concept based on the fact that different assets have different marketplace performance. This step of asset allocation deals in investing in several assets.
- Tactical asset allocation – It is an investment strategy that deals with shifting asset allocation so as to take advantage of market inefficiencies.
- Strategic asset allocation – The capital market expectation and investment policy statement are both taken into account to assign weights to asset classes in the portfolio.
Stage 2 – Execution
The second stage of the portfolio management process is the execution of the planned portfolio. It includes
1. Portfolio selection
The investment allocation strategy that has been decided upon is integrated with capital market expectations and now particular assets are chosen so as to add them into the portfolio of the investor.
2. Portfolio implementation
After finalizing the composition of the portfolio now is the time for execution strategy. It is one of the most vital steps in the execution process because the high costs of the transaction can minimize portfolio performance.
The transaction costs in this scenario include implicit costs like market price impacts, opportunity costs, and bid-ask spread and explicit costs like commissions, fees, and taxes. The execution of portfolio management must be well-managed and timed to yield the best results.
Stage 3 – Feedback
The responsibility of the portfolio manager does not end with the planning and execution of portfolio management. It needs to be monitored, rebalanced and evaluated regularly so that returns keep on coming as expected.
Feedback is important after planning and execution because it will help the portfolio manager to analyze the considerations of his actions. It has two steps
1. Monitoring and rebalancing
The product manager keeps a vigilant eye on the investor’s circumstances and market conditions. He monitors and assesses the portfolio’s risk exposure and makes a comparison with strategic asset allocation.
This step basically ensures that the investment objectives and constraints are achieved. Portfolio rebalancing includes considering transaction costs and taxes. In the absence of rebalancing the market movements can expose the portfolio to greater risks and reduced opportunities for returns.
2. Performance evaluation
It is imperative to evaluate the investment performance on a regular basis so as to measure the achievements of objectives as well as performances.
Objectives of portfolio management
The objectives of portfolio management are as follows-
- One of the objectives of portfolio management is the minimization of risk It helps to keep the investment absolutely safe irrespective of other factors.
- The objective of portfolio management is ensuring flexibility to the investment portfolio
- Portfolio management is designed with the objective of portfolio diversification
- An important objective of portfolio management is offering stable returns
- The portfolio management’s objective is buying or reinvesting of growth securities for capital growth.
- Portfolio management has the objective of assisting in taking the best possible advantage of good opportunities.
- Its objective is to minimize the tax burden that proves favourable tax shelter to the investor
Types of portfolio management
The different types of portfolio management are-
1. Active portfolio management
Active management is described as a process that actively manages a portfolio via investment decisions of individual holdings. The portfolio manager actively trades securities in order to earn a maximum return for the investor. He pays close attention to changes in the political landscape, shifts in the economy and market trends and uses the information to take advantage of market irregularities.
2. Passive portfolio management
Passive portfolio management is a process where the portfolio manager creates a fixed portfolio aligning it with current trends in the market. It is a long-term strategy for index investing whose purpose is to generate a return that equals the chosen index instead of outperforming it.
3. Discretionary portfolio management
Discretionary portfolio management is defined as a process where the funds of an investor are placed with the portfolio manager and it is the manager who has authorized powers to make and manage the investments as per his discretion on behalf of the investor.
4. Non-discretionary portfolio management
Non-discretionary portfolio management is a process where the portfolio manager offers investment advice to the investor, who either accepts or rejects it as per his discretion.
Why portfolio management is important?
Portfolio management is an important process because of the following reasons-
- The portfolio management is important because it is one of the best methods to identify, assess and select the best investment strategy. It can be based on income, age and the capacity of risk-taking of the investor and his investment budget
- It helps to minimize the risk factor that is involved in investment opportunities and maximizes the chance of expected returns or profits
- Portfolio management is a tool that is customized as per the preference and needs of an investor. How much is the expected return and what is the investment period are queries that can be answered via this process? It actually understands the financial need of an investor and suggests the best policy for him that involves the least risk factor
- The portfolio management process helps to keep an eye on risks taken and risk management.
- The portfolio management process is important because it takes into account tax laws and then suggests the likely investments that can turn profitable for the investor
Advantages of portfolio management
The advantages of portfolio management are-
- Avoids disasters – If an individual invests in a single security and it fails then it will have a very great impact on his investment. Portfolio management avoids disastrous outcomes by diversifying the investments
- Maximizing returns – Portfolio management offers a structured framework to the investor so that he can maximize the returns even with limited funds
- Avoids risks – The security market is very volatile and the chance of loss is great. One of the benefits of portfolio management is it reduces the downside risk via diversification, which absorbs the shock of a volatile market
Disadvantages of portfolio management
The disadvantages of portfolio management are as follows-
- Risk of over-diversification – Sometimes the portfolio manager becomes zealous in his efforts to diversify and the investments exceed beyond control. The expected loss in such cases becomes more than the expected profits and in case of a crash, it can cause serious repercussions.
- No downside protection – Even though portfolio management helps in reducing risks it cannot offer full protection and becomes obsolete during a crash
Liked this post? Check out the complete series on Management