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PROJECT

INVESTMENT MANAGEMENT
On

“PORTFOLIO CONSTRUCTION”

JAIPURIA INSTITUTE OF MANAGEMENT,


LUCKNOW

Submitted to:-
Prof. Saima Rizvi

Submitted by:-
Divyank Gupta (PGDM-051)
Deepak Awasthi (PGDM-046)
ACKNOWLEDGMENT

We want to place on record my gratitude to the COMPANY and its people


whose generous help and support enabled us to complete this project within
the stipulated time period.
Our special thanks to our project guide, Mrs.Saima Rizvi for her active help,
guidance and support in accomplishment of the report.
We are greatly indebted to all those people who have helped us in some way
or other in the completion of the project. We are also grateful to the
management and the staff members of the company for their support and
co-operation
The Faculty of our institute deserves the praise for their role in shaping this
project.
A special thanks to our parents who encourage us a lot during my project
session.
We once again thank all those who extended their support and co-operation
in bringing out this project work successfully.
WHAT IS PORTFOLIO?

In finance, a portfolio is an appropriate mix or collection of investments


held by an institution or an individual.

Holding a portfolio is a part of an investment and risk-limiting strategy


called diversification. By owning several assets, certain types of risk (in
particular specific risk) can be reduced. The assets in the portfolio could
include Bank accounts; stocks, bonds, options, warrants, gold certificates,
real estate, futures contracts, production facilities, or any other item that is
expected to retain its value.

In building up an investment portfolio a financial institution will typically


conduct its own investment analysis, whilst a private individual may make
use of the services of a financial advisor or a financial institution which
offers portfolio management services.

WHAT IS PORTFOLIO INVESTMENT?

The purchase of stocks, bonds, and money market instruments by foreigners


for the purpose of realizing a financial return, which does not result in
foreign management, ownership, or legal control.

Some examples of portfolio investment are:

• purchase of shares in a foreign company.


• purchase of bonds issued by a foreign government.
• acquisition of assets in a foreign country.
• purchase of stocks in a foreign company.

Factors affecting international portfolio investment:

• tax rates on interest or dividends (investors will normally prefer


countries where the tax rates are relatively low)
• interest rates (money tends to flow to countries with high interest
rates)
• exchange rates (foreign investors may be attracted if the local
currency is expected to strengthen)
Portfolio investment is part of the capital account on the balance of
payments statistics.

WHAT IS PORTFOLIO MANAGEMENT?


Portfolio Management is used to select a portfolio of new product
development projects to achieve the following goals:

• Maximize the profitability or value of the portfolio


• Provide balance
• Support the strategy of the enterprise

Portfolio Management is the responsibility of the senior management team


of an organization or business unit. This team, which might be called the
Product Committee, meets regularly to manage the product pipeline and
make decisions about the product portfolio. Often, this is the same group
that conducts the stage-gate reviews in the organization.

A logical starting point is to create a product strategy - markets, customers,


products, strategy approach, competitive emphasis, etc. The second step is to
understand the budget or resources available to balance the portfolio against.
Third, each project must be assessed for profitability (rewards), investment
requirements (resources), risks, and other appropriate factors.

The weighting of the goals in making decisions about products varies from
company. But organizations must balance these goals: risk vs. profitability,
new products vs. improvements, strategy fit vs. reward, market vs. product
line, long-term vs. short-term. Several types of techniques have been used to
support the portfolio management process:

• Heuristic models
• Scoring techniques
• Visual or mapping techniques

The earliest Portfolio Management techniques optimized projects'


profitability or financial returns using heuristic or mathematical models.
However, this approach paid little attention to balance or aligning the
portfolio to the organization's strategy. Scoring techniques weight and score
criteria to take into account investment requirements, profitability, risk and
strategic alignment. The shortcoming with this approach can be an over
emphasis on financial measures and an inability to optimize the mix of
projects. Mapping techniques use graphical presentation to visualize a
portfolio's balance. These are typically presented in the form of a two-
dimensional graph that shows the trade-off's or balance between two factors
such as risks vs. profitability, marketplace fit vs. product line coverage,
financial return vs. probability of success, etc.

OBJECTIVE OF MANAGING PORTFOLIO ON AN


INVESTOR:
1 . Safety Of Fund: -
The investment should be preserved, not be lost, and should remain in the
returnable position in cash or kind.
2 . Marketability: -
The investment made in securities should be marketable that means, the
securities must be listed and traded in stock exchange so as to avoid
difficulty in their
encashment.
3. Liquidity: -
The portfolio must consist of such securities, which could be en-cashed
without any difficulty or involvement of time to meet urgent need for funds.
Marketability ensures liquidity to the portfolio.
4. Reasonable return: -
The investment should earn a reasonable return to upkeep the declining
value of money and be compatible with opportunity cost of the money in
terms of current income in the form of interest or dividend.
5. Appreciation in Capital: -
The money invested in portfolio should grow and result into capital gains.
6. Tax planning: -
Efficient portfolio management is concerned with composite tax planning
covering income tax, capital gain tax, wealth tax and gift tax.
7. Minimize risk: -
Risk avoidance and minimization of risk are important objective of
portfoliomanagement. Portfolio managers achieve these objectives by
effective investment
ISSUES RELATED TO PORTFOLIO CONSTRUCTION:
 Know that the broader your investment portfolio, the less vulnerable it is
to the ups and downs of individual companies or industries.
 Consider investing in mutual funds if you don't have time or money to
invest in a broad mix of individual stocks.
 Understand that mutual funds generally buy the stocks of many
companies, freeing you of the need to keep track of dozens of individual
stocks.
 Evaluate mutual funds by looking at their total returns over the past three
to five years. How do they compare with the market as a whole?
 Find out how much the funds charge in annual management fees. The
fees will take a toll on your return.
 Invest in a mix of mutual funds. Some focus on hot-growth companies,
others are more conservative. Some invest in bonds, others buy only stocks.
 Choose a mix of investments that matches your goals. If you are 55 and
saving for retirement, your goals and your portfolio won't match those of a
22-year-old who is saving for a new boat.

 Update your portfolio as your goals change and as the market

PORTFOLIO CONSTRUCTION:
The Portfolio Construction of Rational investors wish to maximize the
returns on their funds for a given level of risk. All investments possess
varying degrees of risk. Returns come in the form of income, such as interest
or dividends, or through growth in capital values (i.e. capital gains).The
portfolio construction process can be broadly characterized as comprising
the following steps:
1. Setting objectives .
The first step in building a portfolio is to determine the main objectives of
the fund given the constraints (i.e. tax and liquidity requirements) that may
apply. Each investor has different objectives, time horizons and attitude
towards risk. Pension funds have long-term obligations and, as a result,
invest for the long term. Their objective may be to maximize total returns in
excess of the inflation rate. A charity might wish to generate the highest
level of income whilst maintaining the value of its capital received from
bequests. An individual may have certain liabilities and wish to match them
at a future date. Assessing a client’s risk tolerance can be difficult. The
concepts of efficient portfolios and diversification must also be considered
when setting up the investment objectives.
2. Defining Policy:
Once the objectives have been set, a suitable investment policy must be
established. The standard procedure is for the money manager to ask clients
to select their preferred mix of assets, for example equities and bonds, to
provide an idea of the normal mix desired. Clients are then asked to specify
limits or maximum and minimum amounts they will allow to be invested
in the different assets available. The main asset classes are cash, equities,
gilts/bonds and other debt instruments, derivatives, property and overseas
assets. Alternative investments, such as private equity, are also growing in
popularity, and will be discussed in a later chapter. Attaining the optimal
asset mix over time is one of the key factors of successful investing.
3. Applying portfolio strategy.
At either end of the portfolio management spectrum of strategies are active
and passive strategies. An active strategy involves predicting trends and
changing expectations about the
likely future performance of the various asset classes and actively dealing in
and out of investments to seek a better performance. For example, if the
manager expects interest rates to rise, bond prices are likely to fall and so
bonds should be sold, unless this expectation is already factored into bond
prices. At this stage, the active fund manager should also determine the style
of the portfolio. For example, will the fund invest primarily in companies
with large market capitalizations, in shares of companies expected to
generate high growth rates, or in companies whose valuations are low? A
passive strategy usually involves buying securities to match a preselected
market index. Alternatively, a portfolio can be set up to match the investor’s
choice of tailor-made index. Passive strategies rely on diversification to
reduce risk. Out performance versus the chosen index is not expected. This
strategy requires minimum input from the portfolio manager. In practice,
many active funds are managed somewhere between the active and passive
extremes, the core holdings of the fund being passively managed and the
balance being actively managed.

4. Asset selections :

Once the strategy is decided, the fund manager must select individual assets
in which to invest. Usually a systematic procedure known as an investment
process is established, which sets guidelines or criteria for asset selection.
Active strategies require that the fund managers.

5. Performance assessments :

In order to assess the success of the fund manager, the performance of the
fund is periodically measured against a pre-agreed benchmark – perhaps a
suitable stock exchange index or against a group of similar portfolios (peer
group comparison). The portfolio construction process is continuously
iterative, reflecting changes internally and externally. For example, expected
movements in exchange rates may make overseas investment more
attractive,
leading to changes in asset allocation. Or, if many large-scale investors
simultaneously decide to switch from passive to more active strategies,
pressure will be put on the fund managers to offer more active funds. Poor
performance of a fund may lead to modifications in individual asset
holdings or, as an extreme measure; the manager of the fund may be
changed altogether.
TYPES OF PORTFOLIO:
The different types of Portfolio which is carried by any Fund Manager to
maximize profit and minimize losses are different as per their objectives:
Aggressive Portfolio:
Objective: Growth. This strategy might be appropriate for investors who
seek High growth and who can tolerate wide fluctuations in market values,
over the short term.

Growth Portfolio:
Objective: Growth. This strategy might be appropriate for investors who
have a preference for growth and who can withstand significant fluctuations
in market value.

Balanced Portfolio:
Objective: Capital appreciation and income. This strategy might be
appropriate for investors who want the potential for capital appreciation and
some growth, and who can withstand moderate fluctuations in market values
Conservative Portfolio:
Objective: Income and capital appreciation. This strategy may be
appropriate for investors who want to preserve their capital and minimize
fluctuations in market value.
WHY DIVIDENDS FROM A PORTFOLIO?
An equity portfolio has its own set of risks: non-guaranteed dividends and
economic risks. Suppose that instead of investing in a portfolio of bonds, as
in the previous example, you invested in healthy dividend-paying equities
with a 4% yield. These equities should grow their dividend payout at least
3% annually, which would cover the inflation rate, and would likely grow at
5% annually through that same 12 years. If the latter happened, the $50,000-
income stream would grow to almost $90,000 annually. In today's dollars
that same $90,000 would be worth around $62,000, at the same 3% inflation
rate. After the 15% tax on dividends, (also not guaranteed in the future) that
$62,000 would be worth about $53,000 in today's dollars. That's more than
double the return provided by our interest bearing portfolio of CDs and
bonds. (For related reading, see The Power Of Dividend Growh.)

A portfolio that combines the two methods has both the ability to withstand
inflation and the ability to withstand market fluctuations. The time-tested
method of putting half of your portfolio into stocks and half into bonds has
merit, and should be considered. As an investor grows older, his or her time
horizon shortens and the need to beat inflation diminishes. In this case, a
heavier bond weighting is acceptable, but for a younger investor with
another 30 or 40 years before retirement, inflation risk must be confronted or
it will eat away earning power. (To learn more, read All About Inflation)

A great income portfolio, or any portfolio for that matter, takes time to build.
Therefore, unless you find stocks at the bottom of a bear market, there is
probably only a handful of worthy income stocks to buy at any given time. If
it takes five years of shopping to find these winners, that's okay. (What
should you invest in.
FINAL CONCLUSION:
1. Diversify
Diversify among at least 25-30 good stocks.
Remember, you are investing for your future income needs - not trying to
turn your money into King Solomon's fortune; therefore, leave the ultra-
focused portfolio stuff to the guys who eat and breathe their stocks.
Receiving dividends should be a main focus - not just growth. You don't
need to take company risk, so don't.

Diversify among 5-7 industries.


Having 10 oil companies looks nice - unless oil falls to $10 a barrel.
Dividend stability and growth is the main priority, so you'll want to avoid a
dividend cut. If your dividends do get cut, make sure that it's not an industry-
wide problem that hits all of your holdings at once.

2. Choose financial stability over growth.


Having both is best, but if in doubt, having more financial wherewithal is
better than having more growth in your portfolio. This can be measured by a
company's credit ratings. Also, the Value Line Investment Survey ranks all
of its stocks from A++ to a D. Focus on the 'As' for the least risk. (To learn
more, check out What Is A Corporate Credit Rating?)

3. Find companies with modest payout ratios (dividends as a percentage


of earnings).
A payout ratio of 60% or less is best to allow for wiggle room in case of
unforeseen company trouble.

4. Find companies with a long history of raising the dividend.


Bank of America's dividend yield was only 4.2% in early 1995 when it paid
out $0.47 per share. However, based on a purchase made that year at
~$11.20 per share and the 2006 dividend of $2.12, the yield that an investor
would have earned for that year based on the stock's original purchase price
would be 18.9% in 2006! That's how it's supposed to work. (To read more,
check out How And Why Do Companies Pay Dividends?)

Good places to start looking for portfolio candidates that have increased
their dividends every year are the S&P's "Dividend Aristocrats" (25 years) &
Mergent's "Dividend Achievers" (10 years). The Value Line Investment
Survey is also useful in identifying potential dividend stocks. Companies
that have raised their dividends steadily over time tend to continue doing so
in the future, assuming that the business continues to be healthy.

5. Reinvest the Dividends


If you start investing for income well in advance of when you need the
money, reinvest the dividend. This one action can add a surprising amount
of growth to your portfolio with minimal effort. (To read more about this,
see The Perks Of Dividend Reinvestment Plans)

Conclusion
While not perfect, the dividend approach gives us a greater opportunity to
beat inflation, over time, than a bond-only portfolio. If you have both, that is
best. The investor who expects a safe 5% return without any risk is asking
for the impossible. It's similar to trying to find an insurance policy that
protects you no matter what happens - it doesn't exist. Even hiding cash in
the mattress won't work due to low, but constant, inflation. Investors have to
take risk whether they like it or not, because the risk of inflation is already
here, and growth is the only way to beat it.