Project Portfolio Management | A Defined Tutorial for Beginners
Last updated on 24th Aug 2022, Blog, Tutorials
Functions of Portfolio Management:
Portfolio management is the key skill that one needs for managing investment effectively.Irrespective of whether they are an individual or HNI (High Net Worth Individual) or a large MNC (Multinational Company).various attributes of investment alternatives are analyzed, and the objective of investment rules where and how much money to allocate to each of the alternatives.Investing in more and more assets with various attributes diversifies the risk of a portfolio, thereby increasing the reasonable assurance of the returns.Understanding portfolio management (PM), it is important to understand the term ‘portfolio,’ the meaning of PM, who is a portfolio manager, what PM service involves the classification of PM services, objectives, and the importance of PM.
What is Portfolio and Portfolio Management (Definition)?
The portfolio is a gathering of investment instruments like shares, mutual funds, bonds, FDs, other cash equivalents, etc.Portfolio management is the art of selecting the right investment tools in the right proportion to create optimum returns with a balance of risk from the investment made.In other words, a portfolio is a group of an assets. The portfolio gives an opportunity to diversify risk.Diversification of risk does not mean that there will be a removal of risk.With every asset, there is an attachment of 2 types of risk; diversifiable/unique/unexplained/unsystematic risk and undiversifiable/market risk/explained/systematic risk.Even an optimum portfolio cannot eliminate the market risk but can only deduce or eliminate the diversifiable risk. As soon as risk reduces, the variability of the return reduces.Best PM practice runs on the principle of minimum risk and maximum return within a given time frame.A portfolio is build based on an investor’s income, investment budget, and risk appetite maintaining the expected rate of return in mind.
Objectives of Portfolio Management:
A portfolio manager should keep the following objectives of investments in mind while building a portfolio based on an single expectation.The choice of one or more of these depends on the investor’s personal preference.
- 1. Capital growth
- 2. Security of principal amount invested
- 3. Liquidity
- 4. Marketability of securities invested in
- 5. Diversification of risk
- 6. Consistent returns
- 7. Tax planning
Investors hire portfolio managers and avail of professional services to maintain portfolios by paying a pre-decided fee for these services.
Who is a Portfolio Manager?
A portfolio manager is a person who understands the client’s investment needs and suggests a suitable investment mix to meet the client’s investment objectives.This tailor-made investment plan is recommended for keeping in mind the risk-return trade-off.
Types of Portfolio Manager:
A portfolio manager can choose to serve the individual or an institution.The following are the prominent kind of portfolio managers:
1. Stock Portfolio Manager: These managers are stock market experts and help clients to allocate the funds in a basket of diversified securities.
2. The selection is based on the client’s crucial palate.
3. Growth Portfolio Manager: Such experts actively put funds into assets having a more growth rate. However, they work for clients with a broader risk-taking ability and aim to multiply their money quickly.
4. The growth rate reflects improved market risks as well.
5. Income Portfolio Manager: More clients want to play safe and derive a regular income from their investments in the long run.
6. Such clients avail the services of an income of portfolio manager.All the above-mentioned managers for the following investment approaches:
Active Approach – A manager with an active approach will be aggressive and attempt to beat the market returns.
Passive Approach – A manager with a passive approach will usually prefer to buy stocks that reflect the market performance,
i.e., market index. When such an approach is followed, investors expect a return equivalent to that of the market index.
Process in Portfolio Management:
The portfolio management process is not a one-time activity.The portfolio manager maintains the portfolio regularly and keeps the client updated with the changes. It involves the following tasks:
- 1.Understanding the client’s investment objectives and the availability of funds.
- 2.Matching investment to those objectives.
- 3.Recommending an investment policy.
- 4.Balancing risk and studying the portfolio performance from the time to time.
- 5.Taking a decision on the portfolio investment strategy based on the discussion with a client.
- 6.Changing asset allocation from time to time based on the portfolio performance.
Why is Portfolio Management Important?
- It is important due to the following reasons:
- PM is a perfect way to select the “Best Investment Strategy” based on age, income, the capacity for risk-taking of the single and investment budget.
- It helps to gauge the risk taken as the process of PM maintains “Risk Minimization” as the focus.
- “Customization” is possible because an individual’s needs and choices are kept in mind, i.e., when the person want to return, how much return expectation a person has, and how much investment period an individual selects.
- Taking into account changes in tax laws, investments can be made.
- When investment is made in fixed income security like preference share or debenture or any other such security, then that investor is exposed to interest rate risk and price risk of the security.
- PM can take the help of duration or convexity to immunize the portfolio.
Functions of Portfolio and Management: The objective of portfolio management is to develop a portfolio that has a maximum return at whatever the level of risk the investor deems appropriate.
Risk Diversification: An essential function of portfolio management is spread risk to investment of assets. Diversification could take place across various securities and across various industries. Is an effective way of diversifying the risk in an investment. Simple diversification decrease risk within categories of stocks that all have the same quality rating.
The Allocation of Assets: Asset allocation is a crucial part of every portfolio manager’s duties. It deals with attaining the operational proportions of investments from asset categories. Portfolio managers basically aim to stock-bond mix. For this purpose, equally weighted categories of assets are used.
Bets Estimation: Another important function of a portfolio manager is to make an estimate of best coefficient. It measures and ranks the systematic risk of various assets. Best coefficient is an index of the systematic risk. This is useful in making the ultimate selection of securities for investment by investment by the portfolio manager.
E-Balancing Portfolios: Rebalancing of portfolios involved the process of periodically adjusting the portfolios to keep the original conditions of the portfolio. The adjustment may be made either the way of ‘Constant proportion portfolio or by way of Constant best portfolio’. In the Constant proportion portfolio, adjustments are made in such a way as to keep the relative weighting in portfolio components according to the modification in prices. Under the constant beta portfolio, adjustments are made to use the values of component betas in the portfolio.
When managing a portfolio, a manager may use any of the following tactics:
Buy and Hold Strategy: Under the buy, and the portfolio hold ‘manager built strate portfolio of stock which is not disturbed at all for a long duration of time.Indexing Another strategy employed by portfolio managers is an indexing’. Indexing attempt to replicate an investment characteristics of a famous measure of the bond market.Securities that are held in best-known bond indexes are basically more grade issues.
Laddered Portfolio: Under the laddered portfolio, bonds are selected in such a way as that the maturities are spread uniformly over a long duration of time. This way a portfolio manager aims at distributing the funds throughout the curve.
Barbell Portfolio: Under the laddered portfolio, bonds are selected in such a way as that the maturities are spread uniformly over a long duration of time. This way a portfolio manager aims at distributing the funds throughout the curve can also benefit from the lower transaction costs because of their better liquidity
- On the basis of discretionary powers permitted to portfolio managers- discretionary & non-discretionary
- Discretionary & Non-Discretionary Portfolio Management
- Discretionary Portfolio Management refers to the process where PM has the authority to made financial decisions.
- It makes those decisions for the invested funds on the basis of the investor’s investment requirement.
- Apart from that, also does the full documentary work and filing.
- Non-discretionary PM refers to the process where a portfolio manager acts just as an advisor for which investments are good and unprofitable. And the investor takes the decisions.
Advantage of Portfolio Management:
Makes Right Investment Choice: Portfolio management is a tool that helps investors in choosing the right portfolio of assets.It enables making more informed decisions regarding investment plans in accordance with the goals and objectives.
Maximizes Return: Maximizing the return is one of the most important roles played by portfolio investment.It offers a structured framework for analyses and selecting the best class of assets.Investors are able to earn great returns with limited funds.
Avoids Disaster: Portfolio management avoids the disaster of facing large risks by investors.It guides in investing among various classes of assets instead of investing only in one type of asset.If an investor invests in only one type of security and supposes it fails, then the investor will suffer large losses which could be avoided if he might have invested among various assets.
Track Performance: Portfolio management helps management in tracing the performance of the portfolio of investments.A consolidated investment held within the portfolio can be evaluated in a better way and any of its failures can be simply detected.
Manages Liquidity: Portfolio management enables investors to assemble their investment in a systematic manner. Investors can choose assets in such a pattern where they can sell some of them simply whenever they need funds.
Avoids Risk: Investment in securities is quite crucial due to the volatility of the security market which increases the chance of losses.Portfolio management helps in deducing the risk through the diversification of risk among more peoples.
Improves Financial Understanding: It helps in improving the financial knowledge of an investor.While managing the portfolio I came across numerous financial concepts and learned how a financial market works which will enhance the overall financial understanding.
disAdvantage of Portfolio Management:
Risk Of Over Diversification: Sometimes portfolio managers invest funds among big categories of assets whose control becomes impossible.In his efforts to diversify the risk it goes beyond the limit to manage effectively.Loss arising in such situations is more and can bring serious repercussions.
No Downside Protection Portfolio management only reduces the risk through diversification but does not offer a full protection.At times of market crash, the concept of portfolio management becomes obsolete.
Faulty Forecasting: Portfolio management uses historical data for calculating the returns of securities for investment purposes.Sometimes the historical data gathered is incorrect or unreliable which leads to wrong forecasts.
Portfolio Management is an important exercise in today’s times.In today’s times’ asset managers, mutual funds, pension funds, insurance companies, and even corporations use different theories and a mix of them to manage the quantum of funds available to them.Obviously, the idea is to make handsome returns in line with the stated objectives.Modern theories impressed upon the earning a return with a given amount of risk.And there, they all would like to excel compared to the competitors in terms of generating better than market/alpha returns.
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