Professional Documents
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Portfolio Evaluation and Revision
Portfolio Evaluation and Revision
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INDEX
Sr. No.
PARTICULARS
Page No.
Executive Summary
Introduction
Portfolio Management
10
11
12
13
24
10
25
11
27
12
31
13
Conclusion
34
14
Bibliography
35
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EXECUTIVE SUMMARY
SCOPE OF THE STUDY:
The management of portfolio has many aspects. The portfolio theory relates to efficient
portfolio investment in financial and physical assets. The portfolio of individual and
corporate unit is consisting of securities and investments in assets. Such investment is results
of individual preferences and decisions of holders, regarding risk, return and number of other
decisions.
OBJECTIVES OF THE STUDY:
The objective of doing this project is to relate the bookish theories with the actual
Portfolio management.
METHODOLOGY:
Reference books
Internet
Limitation of time
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INTRODUCTION
In India, Portfolio Management is still in its infancy. Barring a few Indian banks, and foreign
banks and UTI, no other agency had professional Portfolio management until 1987. After the
success of Mutual Funds in Mutual Funds, since / 1987, Professional Portfolio Management,
backed by competent research staff became the order of the day. After the success of Mutual
Funds in Portfolio Management, a number of brokers and Investment Consultants some of
whom are also professionally qualified have become Portfolio Managers. They have managed
the funds of clients on both discretionary and nondiscretionary basis. It was fou:1d that many
of them, including Mutual Funds have guaranteed a minimum return or capital appreciation
and adopted all kinds of incentives which are now prohibited by SEB!. They resorted to
speculative over trading and insider trading, discounts, etc., to achieve their targeted returns
to the clients, which are also prohibited by SEBI. The recent CBI probe into the operations of
many market dealers has revealed the unscrupulous practices by banks, dealers and brokers in
their Portfolio Operations. The SEBI has then imposed stricter rules, which included their
registration, a code of conduct and minimum infrastructure, experience and expertise etc. It is
no longer possible for. Any unemployed youth, or retired person or self-styled consultant to
engage in Portfolio Management without the SEBIs license. The guidelines of SEBI are in
the direction of making Portfolio Management a responsible professional service to be
rendered by experts in the field.
Basically Portfolio Management involves
a. A proper investment decision-making of what to buy and sell;
b. Proper money management in terms of investment in a basket of assets so as to satisfy the
asset preferences of investors;
c. Reduce the risk and increase returns
Portfolio Management Service As per the SEBI norms, it refers to professional services
rendered for manage-ment of Portfolio of others, namely, clients or customers with the help
of experts in Invesm1cnt Advisory Services. The latter involves the advice regarding the
worthwhileness of any particular investment or advice of what to .buy and sell. Investment
management on the other hand involves continuing relationship with client to manage
investments with or without discretion for the client as per his requirements.
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Portfolio Management
Portfolio management refers to the management or administration of a portfolio of securities
to protect and enhance the value of the underlying investment. It is the management of
various securities (shares, bonds etc.) and other assets (e.g. real estate), to meet specified
investment goals for the benefit of the investors. It helps to reduce risk without sacrificing
returns. It involves a proper investment decision with regards to what to buy and sell. It
involves proper money management. It is also known as Investment Management
Portfolio management involves deciding what assets to include in the portfolio, given the
goals of the portfolio owner and changing economic conditions. Selection involves deciding
what assets to purchase, how many to purchase, when to purchase them, and what assets to
divest. These decisions always involve some sort of performance measurement, most
typically expected return on the portfolio, and the risk associated with this return (i.e. the
standard deviation of the return). Typically the expected return from portfolios of different
asset bundles is compared.
The unique goals and circumstances of the investor must also be considered. Some investors
are more risk averse than others.
Mutual funds have developed particular techniques to optimize their portfolio holdings.
The art and science of making decisions about investment mix and policy, matching
investments to objectives, asset allocation for individuals and institutions, and balancing risk
against performance .
Portfolio management is all about strengths, weaknesses, opportunities and threats in the
choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other
tradeoffs encountered in the attempt to maximize return at a given appetite for risk.
Portfolio management involves maintaining a proper combination of securities which
comprise the investors portfolio in a manner that they give maximum return with minimum
risk. This requires framing of proper investment policy. Investment policy means formation
of guidelines for allocation of available funds among the various types of securities including
variation in such proportion under changing environment. This requires proper mix between
different securities in a manner that it can maximize the return with minimum risk to the
investor. Broadly speaking investors are those individuals who save money and invest in the
market in order to get return over it. They are not much educated, expert and they do not have
time to carry out detailed study. They have their business life, family life as well as social life
and the time left out is very much limited to study for investment purpose. On the other hand
institutional investors are companies, mutual funds, banks and insurance company who have
surplus fund which needs to be invested profitably. These investors have time and resources
to carry out detailed research for the purpose of investing.
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2. Subsidiary Objectives
The subsidiary objectives of a portfolio management are expecting a reasonable income,
appreciation of capital at the time of disposal, safety of the investment and liquidity etc. The
objective of investor is to get a reasonable return on his investment without any risk. Any
investor desires regularity of income at a consistent rate. However, it may not always be
possible to get such income. Every investor has to dispose his holding after a stipulated
period of time for a capital appreciation. Capital appreciation of a financial asset is highly
influenced by a strong brand image, market leadership, guaranteed sales, financial strength,
and large pool of reverses, retained earnings and accumulated profits of the company. The
idea of growth stocks is the right issue in the right industry, bought at the right time. A
portfolio management desires the safety of the investment. The portfolio objective is to take
the precautionary measures about the safety of the principal even by diversification process.
The safety of the investment calls for careful review of economic and industry trends.
Liquidity of the investment is most important, which may not be neglected by any
investor/portfolio manager.
An investment is to be liquid, it must has termination and marketable facility any time.
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Portfolio management is a continuous process. It is a dynamic activity. The following are the
basic operations of a portfolio management:
1. monitoring the performance of portfolio by incorporating the latest market conditions.
2. Identification of the investors objective, constraints and preferences.
3. Making an evaluation of portfolio income (comparison with targets and achievements).
4. Making revision in the portfolio.
5. Implementation of strategies in tune with the investment objectives.
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PROCESS/STEPS OF PORTFOLIO
Specification of Investment objective and
Constraints
Formulation of Portfolio
Strategy
Selection of Securities
Portfolio Execution
Portfolio Revision
Portfolio Evaluation
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1.
The first step in the portfolio management process is to specify the investment policy that
consists of investment objectives, constraints and preferences of investor. The investment
policy can be explained as follows:
Specification of investment objectives can be done in following two ways:
Maximize the expected rate of return, subject to the risk exposure being held
within a certain limit (the risk tolerance level).
Minimize the risk exposure, without sacrificing a certain expected rate of return
(the target rate of return).
An investor should start by defining how much risk he can bear or how much he can
afford to lose, rather than specifying how much money he wants to make. The risk he
wants to bear depends on two factors:
a) Financial situation
b) Temperament
To assess financial situation one must take into consideration position of the wealth,
major expenses, earning capacity, etc. and a careful and realistic appraisal of the assets,
expenses and earnings forms a base to define the risk tolerance.
After appraisal of the financial situation assess the temperamental tolerance of risk. Risk
tolerance level is set either by ones financial situation or financial temperament
whichever is lower, so it is necessary to understand financial temperament objectively.
One must realize that risk tolerance cannot be defined too rigorously or precisely. For
practical purposes it is enough to define it as low, medium or high. This will serve as a
valuable guide in taking an investment decision. It will provide a useful perspective and
will prevent from being a victim of the waves and manias that tend to sweep the market
from time to time.
Constraints and Preferences:
Liquidity:
Liquidity refers to the speed with which an asset can be sold, without suffering any
loss to its actual market price. For example, money market instruments are the most
liquid assets, whereas antiques are among the least liquid.
Investment horizon:
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The investment horizon is the time when the investment or part of it is planned to
liquidate to meet a specific need. For example, the investment horizon for ten years to
fund the childs college education. The investment horizon has an important bearing
on the choice of assets.
Taxes:
The post tax return from an investment matters a lot. Tax considerations therefore
have an important bearing on investment decisions. So, it is very important to review
the tax shelters available and to incorporate the same in the investment decisions.
Regulations:
While individual investors are generally not constrained much by laws and
regulations, institutional investors have to conform to various regulations. For
example, mutual funds in India are not allowed to hold more than 10 percent of equity
shares of a public limited company.
Unique circumstances:
Almost every investor faces unique circumstances. For example, an endowment fund
may be prevented from investing in the securities of companies making alcoholic and
tobacco products.
Bonds:
Bonds or debentures represent long-term debt instruments. They are generally of
private sector companies, public sector bonds, gilt-edged securities, RBI saving
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bonds, national saving certificates, Kisan Vikas Patras, bank deposits, public
provident fund, post office savings, etc.
Stocks:
Stocks include equity shares and units/shares of equity schemes of mutual funds. It
includes income shares, growth shares, blue chip shares, etc.
Real estate:
The most important asset for individual investors is generally a residential house. In
addition to this, the more affluent investors are likely to be interested in other types of
real estate, like commercial property, agricultural land, semi-urban land, etc.
Precious objects are items that are generally small in size but highly valuable in monetary
terms. It includes gold and silver, precious stones, art objects, etc. Other assets includes
like that of financial derivatives, insurance, etc.
3. FORMULATION OF PORTFOLIO STRATEGY:
After selection of asset mix, formulation of appropriate portfolio strategy is required.
There are two types of portfolio strategies, active portfolio strategy and passive portfolio
strategy.
Active vs. passive
Strategic vs. tactical asset allocation.
Most investment professionals follow an active portfolio strategy and aggressive investors
who strive to earn superior returns after adjustment for risk. The four principal vectors of
an active strategy are:
1. Market Timing
2. Sector Rotation
3. Security Selection
4. Use of a specialized concept
1. Market timing:
Market timing is based on an explicit or implicit forecast of general market movements.
The advocates of market timing employ a variety of tools like business cycle analysis,
advance-decline analysis, moving average analysis, and econometric models. The forecast
of the general market movement derived with the help of one or more of these tools are
tempered by the subjective judgment of the investor. Often, of course, the investor may
go largely by his market sense.
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2. Sector Rotation:
The concept of sector rotation can be applied to stocks as well as bonds. It is however,
used more commonly with respect to stock component of portfolio where it essentially
involves shifting the weightings for various industrial sectors based on their assessed
outlook. For example if it is assumed that cement and pharmaceutical sectors would do
well compared to other sectors in the forthcoming period, one may overweight these
sectors, relative to their position in market portfolio. With respect to bonds, sector rotation
implies a shift in the composition of the bond portfolio in terms of quality, coupon rate,
term to maturity and so on. For example, if there is a rise in the interest rates, there may
be shift in long term bonds to medium term or even short-term bonds. But we should
remember that a long-term bond is more sensitive to interest rate variation compared to a
short-term bond.
3. Security Selection:
Security selection involves a search for underpriced securities. If an investor resort to
active stock selection, he may employ fundamental and or technical analysis to identify
stocks that seems to promise superior returns and overweight the stock component of his
portfolio on them. Likewise, stocks that are perceived to be unattractive will be under
weighted relative to their position in the market portfolio. As far as bonds are concerned,
security selection calls for choosing bonds that offer the highest yield to maturity at a
given level of risk.
4. Use of a specialized Investment Concept:
A fourth possible approach to achieve superior returns is to employ a specialized concept
or philosophy, particularly with respect to investment in stocks. As Charles D. Ellis words
says, a possible way to enhance returns is to develop a profound and valid insight into
the forces that drive a particular group of companies or industries and systematically
exploit that investment insight or concept
PASSIVE PORTFOLIO STRATEGY:
The passive strategy rests on the tenet that the capital market is fairly efficient with
respect to the available information. The passive strategy is implemented according to the
following two guidelines:
1. Create a well-diversified portfolio at a predetermined level of risk.
2. Hold the portfolio relatively unchanged over time, unless it becomes inadequately
diversified or inconsistent with the investors risk-return preferences.
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Generally, these weights are not changed over time. When market values
change, the investor may have to adjust the portfolio annually or after major market
moves to maintain the desired fixed-percentage allocation.
Tactical asset allocation produces temporary asset allocation weights that
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4. SELECTION OF SECURITIES:
The following factors should be taken into consideration while selecting the fixed
income avenues:
SELECTION OF BONDS (fixed income avenues)
Yield to maturity: The yield to maturity for a fixed income avenue represents the rate of
return earned by the investors if he invests in the fixed income avenue and holds it till its
maturity.
Risk of default:
To assess the risk of default on a bond, one may look at the credit rating of the bond. If
no credit rating is available, examine relevant financial ratios (like debt-to-equity ratio,
times interest earned ratio, and earning power) of the firm and assess the general
prospects of the industry to which the firm belongs
Tax Shield:
In yesteryears, several fixed income avenues offered tax shield, now very few do so.
Liquidity:
If the fixed income avenue can be converted wholly or substantially into cash at a fairly
short notice, it possesses liquidity of a high order.
SELECTION OF STOCK (Equity shares)
Three board approaches are employed for the selection of equity shares:
Technical analysis looks at price behavior and volume data to determine whether
the share will move up or down or remain trend less.
Fundamental analysis focuses on fundamental factors like the earnings level,
growth prospects, and risk exposure to establish the intrinsic value of a share. The
recommendation to buy, hold, or sell is based on a comparison of the intrinsic
value and the prevailing market price.
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Random selection approach is based on the premise that the market is efficient and
securities are properly priced.
5. PORTFOLIO EXECUTION:
The next step is to implement the portfolio plan by buying or selling specified securities in given
amounts. This is the phase of portfolio execution which is often glossed over in portfolio
management literature. However, it is an important practical step that has a significant bearing on
the investment results. In the execution stage, three decision need to be made, if the percentage
holdings of various asset classes are currently different from the desired holdings.
6. PORTFOLIO REVISION:
In the entire process of portfolio management, portfolio revision is as important stage as
portfolio selection. Portfolio revision involves changing the existing mix of securities.
This may be effected either by changing the securities currently included in the portfolio
or by altering the proportion of funds invested in the securities. New securities may be
added to the portfolio or some existing securities may be removed from the portfolio.
Thus it leads to purchase and sale of securities. The objective of portfolio revision is
similar to the objective of selection i.e. maximizing the return for a given level of risk or
minimizing the risk for a given level of return.
The need for portfolio revision has aroused due to changes in the financial markets since
creation of portfolio. It has aroused because of many factors like availability of additional
funds for investment, change in the risk attitude, change investment goals, the need to
liquidate a part of the portfolio to provide funds for some alternative uses. The portfolio
needs to be revised to accommodate the changes in the investors position.
Portfolio Revision basically involves two stages:
Portfolio Rebalancing:
Portfolio Rebalancing involves reviewing and revising the portfolio composition (i.e. the
stock- bond mix). There are three basic policies with respect to portfolio rebalancing: buy
and hold policy, constant mix policy, and the portfolio insurance policy.
Under a buy and hold policy, the initial portfolio is left undisturbed. It is essentially a
buy and hold policy. Irrespective of what happens to the relative values, no rebalancing
is done. For example, if the initial portfolio has a stock-bond mix of 50:50 and after six
months it happens to be say 70:50 because the stock component has appreciated and the
bond component has stagnated, than in such cases no changes are made.
The constant mix policy calls for maintaining the proportions of stocks and bonds in line
with their target value. For example, if the desired mix of stocks and bonds is say 50:50,
the constant mix calls for rebalancing the portfolio when relative value of its components
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Portfolio Upgrading:
While portfolio rebalancing involves shifting from stocks to bonds or vice versa,
portfolio-upgrading calls for re-assessing the risk return characteristics of various
securities (stocks as well as bonds), selling over-priced securities, and buying underpriced securities. It may also entail other changes the investor may consider necessary to
enhance the performance of the portfolio.
7. PORTFOLIO EVALUATION:
Portfolio evaluation is the last step in the process of portfolio management. It is the
process that is concerned with assessing the performance of the portfolio over a selected
period of time in terms of return and risk. Through portfolio evaluation the investor tries
to find out how well the portfolio has performed. The portfolio of securities held by an
investor is the result of his investment decisions. Portfolio evaluation is really a study of
the impact of such decisions. This involves quantitative measurement of actual return
realized and the risk born by the portfolio over the period of investment. It provides a
mechanism for identifying the weakness in the investment process and for improving
these deficient areas.
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SYSTEMATIC RISK
RISK
SYSTEMATIC
UNSYSTEMATIC RISK
1. Market Risk
2. Interest Rate Risk
3. Inflation Rate Risk
1. Business Risk
2. Internal Risk
3. Financial Risk
SYSTEMATIC RISK
Systematic risk refers to that portion of variation in return caused by factors that affect
the price of all securities. It cannot be avoided. It relates to economic trends with
effect to the whole market.
This is further divided into the following:
1. Market risks:
A variation in price sparked off due to real, social political and economic events is
referred as market risks.
2. Interest rate risks:
Uncertainties of future market values and the size of future incomes, caused by
fluctuations in the general level of interest are referred to as interest rate risk.
Here price of securities tend to move inversely with the change in rate of interest.
3. Inflation risks:
Uncertainties in purchasing power is said to be inflation risk.
UNSYSTEMATIC RISK
Unsystematic risk refers to that portion of risk that is caused due to factors related to a
firm or industry. This is further divided into:
1. Business risk:
Business risk arises due to changes in operating conditions caused by conditions that
thrust upon the firm which are beyond its control such as business cycles, government
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controls, etc.
2. Internal risk:
Internal risk is associated with the efficiency with which a firm conducts its
operations within the broader environment imposed upon it.
3. Financial risk:
Financial risk is associated with the capital structure of a firm. A firm with no debt
financing has no financial risk.
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The investor over the time may change his/her investment objectives and in
Change in wealth
Change in time horizon
Change in liquidity requirements
Change in tax circumstances
Change in legal considerations
Change in other circumstances and investors needs.
Any changes identified must be assessed very carefully before usually they
generally are related with the noticeable changes in investors portfolio.
Rebalancing a portfolio
Rebalancing portfolio is the process of periodically adjusting it to maintain
certain original conditions. Rebalancing reduces the risks of losses in general, a
rebalanced portfolio is less volatile than one that is not rebalanced. Several methods of
rebalancing portfolios are used:
performed the best. This is very difficult to do for the investor psychologically. But the
investor should always consider this method of rebalancing as one
choice, but not necessarily the best one.
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Indexing.
These alternatives for rebalancing the portfolio are more frequently
used by institutional investors (often mutual funds), because their portfolios tend to be
large and the strategy of matching a market index are best applicable for them.
Managing index based portfolio investor (or portfolio manager) eliminates concern
about outperforming the market, because by design, it seeks to behave just like the
market averages. Investor attempts to maintain some predetermined characteristics of
the portfolio, such as Beta of 1,0. The extent to which such a portfolio deviates from
its intended behaviors called tracking error.
Revising a portfolio is not without costs for an individual investor. These
costs can be direct costs trading fees and commissions for the brokers who can
trade securities on the exchange. With the developing of alternative trading systems
(ATS) these costs can be decreased. It is important also, that the selling the securities
may have income tax implications which differ from country to country.
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Sharpes ratio;
Treynors ratio;
Jensens Alpha.
Sharpes ratio shows an excess a return over risk free rate, or risk premium, by
unit of total risk, measured by standard deviation:
Sharpes ratio = (p f) / p,
here: p - the average return for portfolio p during some period of time;
f - the average risk-free rate of return during the period;
p - standard deviation of returns for portfolio p during the period.
Treynors ratio shows an excess actual return over risk free rate, or risk
premium, by unit of systematic risk, measured by Beta:
Treynors ratio = (p f) / p,
here: p Beta, measure of systematic risk for the portfolio p.
Jensens Alpha shows excess actual return over required return and excess
of actual risk premium over required risk premium. This measure of the portfolio
managers performance is based on the CAPM
Jensens Alpha = (p f) p (m f),
here: m - the average return on the market in period t;
(m f) - the market risk premium during period t.
Treynors and Jensens measures can rank relatively undiversified portfolios much
higher than the Sharpe measure does. Since the Sharpe ratio uses total risk, both
systematic and unsystematic components are included.
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CONCLUSION
Investment is a financial activity that involves risk. It is the commitment of funds for a return
expected to be realized in the future. Investments may be made in financial assets or physical
assets. In either case there is the possibility that the actual return may vary from the expected
return. That possibility is the risk involved in the investment. Risk and Return are the two
most important characteristics of any investment. Safety and liquidity are also important for
an investor. The objective of an investor is specified as maximization of return and
minimization of risk. Investment is generally distinguished from speculation in terms of three
factors, namely risk, capital gains and time period. Gambling is the extreme form of
speculation. Investors may be individuals or institutions. Both types of investors combine to
make investment activity dynamic and profitable. The investors in the financial market have
different attitudes towards risk and varying levels of risk bearing capacity. Some investors are
risk averse, while some may have an affinity to risk. The risk bearing capacity of an investor,
on the other hand, is a function of his income. A person with higher income is assumed to
have a higher risk bearing capacity. Each investor tries to maximize his welfare by choosing
the optimum combination of risk and return in accordance with his preference and capacity.
After the overall all study about each and every aspect of this topic it shows that portfolio
management is a dynamic and flexible concept which involves regular and systematic
analysis, proper management, judgment, and actions and also that the service which was not
so popular earlier as other services has become a booming sector as on today and is yet to
gain more importance and popularity in future as people are slowly and steadily coming to
know about this concept and its importance.
It also helps both an individual the investor and FII to manage their portfolio by expert
portfolio managers. It protects the investors portfolio of funds very crucially.
Portfolio management service is very important and effective investment tool as on today for
managing investible funds with a surety to secure it. As and how development is done every
sector will gain its place in this world of investment.
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BIBLIOGRAPHY
E-BOOKS REFERRED:
1
WEB SITES:
1
www.investopedia.com
www.equitymaster.com
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