PORTFOLIO

MANAGEMNET
 PORTFOLIO CONSTRUCTION
 PORTFOLIO EVALUATION
 PORTFOLIO REVISION
WHAT IS PORTFOLIO MANAGEMENT?
 Portfolio refers to a combination of securities such as stocks, bonds and
money market instruments.

 Portfolio management is the art and science of making decisions about

investment mix and policy, matching investments to objectives, asset
allocation for individuals and balancing risk against performance.

 It is all about determining strengths, weakness, opportunities and threats in

the choice of debt vs. equity, domestic vs. international, growth vs. safety,
and much other trade offs encountered for maximize return at a given
appetite for risk.
PORTFOLIO MANAGEMNET BENEFITS

 Higher return on project investments

 Lower organizational risk
 Balanced project portfolio workload
 Increased project throughout
 Greater confidence of meeting customer commitments
 Shorter project cycle times
PORTFOLIO CONSTRUCTION

 The process of blending together the broad asset classes to yield optimum
return with minimum risk is called portfolio construction.

 Diversification of one’s investment helps to spread risk over many assets

and thus reduces unsystematic risk.
APPROACHES TO PORTFOLIO
CONSTRUCTION
 TRADITIONAL APPROACH: evaluates investor needs in terms of income and
capital appreciation and selects appropriate securities to meet the need
of the investors. Usually, in this approach, the entire financial plan of
individual is evaluated.

 MARKOWITZ APPROACH: portfolios are constructed to maximize the

expected return for a given level of risk as it views portfolio construction in
terms of expected return and risk associated.
TRADITIONAL APPROACH

It deals with two crucial decisions:

 Determining the objectives of the portfolio
 Selecting the securities to be included in portfolio
STEPS IN TRADITIONAL APPROACH

2)
1) Analysis of 3) Selection of
Determination
constraints protfolio
of objective

4) Assessment
5)
of risk and
Diversification
return
1. ANALYSIS OF CONSTRAINTS

 Income needs:
a) Need for current income
b) Need for constant income
 Liquidity
 Safety of the principal
 Tax consideration
 Time horizon
 Temperament
2. DETERMINATION OF OBJECTIVE

The objective of detailing a portfolio range from income to capital

appreciation. The common objective are as follows:
 Current income
 Growth in income
 Capital appreciation
 Preservation of capital
3. SELECTION OF PORTFOLIO

The selection of portfolio depends on the objectives of the investors which are
discussed below:
 Objectives and asset mix
 Growth of income and asset mix
 Capital appreciation and asset mix
 Safety of the principal and asset mix
4. RISK AND RETURN ANALYSIS

 Traditional approach, the investor has some basic assumptions like prefers
larger to smaller returns from securities which requires ability to assess risk
and take risks.
 These risks are interest rate risk, purchasing power risk, financial risk and
market risk.
 The ability to achieve higher return is dependent upon the ability to judge
risk and his ability to take specific risk.
5. DIVERSIFICATION

 Top quality bonds can minimized financial risk but are limited resistance to
inflation while stocks provide better inflation protection than bonds.
 Depending upon the investor’s need and his risk tolerance level
appropriate portfolio is selected.
STEPS IN PORTFOLIO DIVERSFICATION:

Selection of Selection of Determining

industries companies in the size of
the industry participation
MODERN APPRACCH (MARKOWITZ
MODEL)
 This approach places importance on the process of selecting portfolio and
can be applied better to selection of common stocks portfolio than bond
portfolios.
 On the basis of risk and return the selection of stocks is made.
 Return may be in the form of market return or dividend.
 The final step is the asset allocation process i.e., to choose a portfolio that
meet the requirements of the investors.
 Risk taker with higher probability of risk for expected return will choose high
risk portfolio and investor with lower tolerance of risk will go for low risk
portfolio.
PORTFOLIO REVISION

 The art of changing the mix of securities in a portfolio is called as portfolio

revision.
 The process of addition of more assets in an existing portfolio or changing
the ratio of funds invested is called as portfolio revision.
 The sale and purchase of assets in an existing portfolio over a certain period
of time to maximize returns and minimize risk is called as Portfolio revision.
NEED FOR PORTFOLIO REVISION

 An individual at certain point of time might feel the need to invest more.
The need for portfolio revision arises when an individual has some additional
money to invest.
 Change in investment goal also gives rise to revision in portfolio. Depending
on the cash flow, an individual can modify his financial goal, eventually
giving rise to changes in the portfolio i.e. portfolio revision.
 Financial market is subject to risks and uncertainty. An individual might sell
off some of his assets owing to fluctuations in the financial market.
PORTFOLIO REVISION STRATEGIES
There are two types of Portfolio Revision Strategies:
1. Active Revision Strategy
 Active Revision Strategy involves frequent changes in an existing portfolio
over a certain period of time for maximum returns and minimum risks.
 Active Revision Strategy helps a portfolio manager to sell and purchase
securities on a regular basis for portfolio revision.
2. Passive Revision Strategy
 Passive Revision Strategy involves rare changes in portfolio only under
certain predetermined rules. These predefined rules are known as formula
plans.
 According to passive revision strategy a portfolio manager can bring
changes in the portfolio as per the formula plans only.
FORMULA PLANS
 Formula Plans are certain predefined rules and regulations deciding when
and how much assets an individual can purchase or sell for portfolio
revision. Securities can be purchased and sold only when there are
changes or fluctuations in the financial market.
 With the help of formula plans an investor can divide his funds into
aggressive and defensive portfolio and easily transfer funds from one
portfolio to other.
 Aggressive Portfolio
It consists of funds that appreciate quickly and guarantee maximum returns to
the investor.
 Defensive Portfolio
It consists of securities that do not fluctuate much and remain constant over a
period of time.
PORTFOLIO REVISION TECHNIQUES
1. Rupee Cost averaging
 Stocks with good fundamentals and long term growth prospects should be
selected
 The investor should make a regular commitment of buying shares at regular
intervals
 Reduces the average cost per share and improves the possibility of gain over a
long period
2. Constant Rupee plan
 A fixed amount of money is invested in selected stocks and bonds.
 When the price of the stocks increases, the investor sells sufficient amount of
stocks to return to the original amount of the investment in stocks.
 The investor must choose action points or revaluation points.
 The action points are the times at which the investor has to readjust the values
of the stocks in the portfolio.
3. Constant Ratio Plan
 Constant ratio between the aggressive and conservative portfolio is
maintained
 The ratio is fixed by the investor
 The investor’s attitude towards risk and return plays a major role in fixing the
ratio
4. Variable Ratio Plan
 At varying levels of market price, the proportions of the stocks and bonds
change
 Whenever the price of the stock increases the stocks are sold and new ratio
is adopted by increasing the proportion of defensive or aggressive portfolio
 To adopt this plan, the investor is required to estimate a long term trend in
the price of the stocks
PORTFOLIO EVALUATION

 Portfolio manager evaluates his portfolio performance and identifies the

sources of strength and weakness.

 The evaluation of the portfolio provides a feed back about the

performance to evolve better management strategy.

 Evaluation of portfolio performance is considered to be the last stage of

investment process.
OBJECTIVES
 To understand NAV
 To assess the downside and upside potential of portfolio
 To measure the return in terms of the risk
 To evaluate the performance of the funds and portfolios
SHARPE’S PERFORMANCE INDEX
 Sharpe index measures the risk premium of the portfolio relative to the total
amount of risk in the portfolio
 Risk premium is the difference between the portfolio’s average rate of
return and the risk less rate of return.
FORMULA:
• Rp – Portfolio’s average rate of return
• Rf – Risk free rate of return
• σp - Standard deviation of the portfolio return
• The larger the St, better the fund has performed
TREYNOR’S PERFORMANCE INDEX
 The relationship between a given market return and the fund’s return is given by
the characteristic line.
 The fund’s performance is measured in relation to the market performance.
 The ideal fund’s return rises at a faster rate than the general market
performance when the market is moving upwards.
 Its rate of return declines slowly than the market return, in the decline.
FORMULA:
Rp = + βRm + ep
Rp = Portfolio return
Rm = The market return or index return
ep = The error term or the residual
α, β = Coefficients to be estimated

 Beta co-efficient is treated as a measure of un-diversifiable or systematic risk

JENSEN’S PERFORMANCE INDEX
 The absolute risk adjusted return measure was developed by Michael Jensen.
 It is mentioned as a measure of absolute performance because a definite
standard is set and against that the performance is measured.
 The standard is based on the manager’s predictive ability.
 The basic model of Jensen is:
Rp = + β (Rm – Rf)

Rp = average return of portfolio

Rf = riskless rate of interest
= the intercept
β = a measure of systematic risk
Rm = average market return
αp represents the forecasting ability of the manager. Then the equation
becomes

Rp – Rf = p + β(Rm – Rf)
or
Rp = p + Rf + β(Rm – Rf)