UNIT– 05

PORTFOLIO MANAGEMENT
MEANING :-
Portfolio management is a technique of managing individual investments in the form of bonds, shares, cash,
and mutual funds etc so that maximum returns can be earned within the pre specified period of time.
Or
It is a process of selecting of securities and frequently shifting of portfolios in the light of altering
attractiveness of the essentials of portfolio. It is the preference of selecting and revising range of securities
with in the characteristics of an investor.
Or
Portfolio management is a technique for selecting the appropriate policy for investing the money of
individuals in terms of minimum risk and maximum return

WHO SHOULD OPT FOR PORTFOLIO MANAGEMENT :-

Portfolio management can benefit a wide range of investors, from individuals to institutional investors, and
shall be preferred by the following investors:

1.Less Investment Knowledge: A lack of investment knowledge is like a terrorist in the world of
investment. New investors with no or less knowledge shall prefer portfolio investment and seek the service
of portfolio management to earn a high return from their expertise.
2.Busy Professionals: Investors who do not have the time to manage and oversee their own investments opt
for Portfolio management services. Portfolio managers take care of their portfolios, giving them enough time
to focus on their job and personal activities.
3. High Net Worth Individuals: High net worth individuals having significant assets and investments to
manage, seek the help of professionals to achieve their financial goals. Such individuals are benefited from
the expertise and knowledge of the Portfolio managers.
4. Corporate Institutions: Corporate bodies that deal in provident funds, pension funds, endowments,
gratitudes, and foundations shall enjoy the benefits of portfolio management to achieve their long-term
investment objectives and to meet their obligations towards such funds and foundations.
5. Investors with Complex Financial Needs: Investors who want the benefits from all classes of assets and
securities go for a diversified investment plan and no one other than Portfolio managers and experts can
manage such diversified portfolios in an optimum manner.
TYPES OF PORTFOLIO MANAGEMENT
Portfolio Management can be classified into:
1. Active Portfolio Management: In active portfolio management, a portfolio manager is continuously
involved in the activity of trading securities to outperform the market and achieve specific financial goals.
They basically aim at buying unvalued securities and then selling them at a high price to earn a profit. Active
portfolio management is characterized by higher fees and commissions.
2. Passive Portfolio Management: Passive portfolio management is based on the theory of invest-and-
forget strategy. Under this, investments are made into a portfolio of index funds to replicate the performance
of a particular market index like an exchange-traded fund (ETF), a mutual fund, a unit investment trust, and
other low-cost index funds. These generally offer lower returns but are profitable in the long term. The
management fee is comparatively lower under this category.
3. Dynamic Portfolio Management: Dynamic portfolio management can be understood as hybrid portfolio
management as it includes features of both active and passive portfolio management. Under this, Portfolio
Managers implement long-term investment strategies while making tactical adjustments and rebalancing in
response to market changes.
4. Discretionary Portfolio Management: Discretionary portfolio management forms authorize managers
and financial experts to make all the financial decisions on behalf of their clients without seeking any
separate approval each time. However, paperwork and filing are done initially to avoid any conflict and
confusion between the manager and their clients. A portfolio manager has full control over investment
decisions, while the investor provides only general guidelines and objectives.
5. Non-discretionary Portfolio Management: Under a Non-discretionary portfolio management system, a
manager act just as an adviser to the client. The manager helps with the allocation of assets, selecting
investment strategies, and suggesting investment moves to the clients. The manager is not in the capacity to
make any investment decision without seeking the approval of the client.

BENEFITS OF PORTFOLIO MANAGEMENT :-

1. Helps make the right investment choice: Portfolio management is a strategic investment strategy that
helps an investor choose the right portfolio of assets. It helps in making mors informed investment decisions
regarding the investment plan. These strategies quide investors to invest in stocks, bonds and other financial
securities according to their investment goals and objectives.
2. Ensures higher returns: Without investing, it is impossible to grow an investor's capital. Maximising the
retum is one of the most critical works of portfolio management. It provides a structured framework for
analysis and helps the investor select the best assets that offer higher retums. Portfolio managers can help
clients earn higher returns, even with limited funds.
3. Helps manage liquidity: Portfolio management encourages investors to structure their investments. A
portfolio manager makes investment decisions so the investors can sell some of their funds in an emergency.
These professionals ensure investors can convert assets, including stocks and bonds, into cash without
affecting the market price.
4. Reduces risk: Investment in securities and stocks is risky because of market volatility. This can increase
the chances of incurring a loss. Portfolio management can help in reducing risks through portfolio
diversification. This primarily means investing in over one financial asset, like stocks or bonds.
5. Improves financial understanding: Portfolio management improves the financial knowledge of
investors. While managing their portfolio, investors can come across many financial concepts and learn how
a financial market works. This can be useful in making intelligent investment decisions and enhancing
overall financial understanding.

NEEDS OF PORTFOLIO MANAGEMENT

1. Risk Management: One of the primary needs of portfolio management is the management of risk.
Investors face various types of risk, including market risk, credit risk, liquidity risk, and geopolitical risk.
Portfolio management techniques such as diversification, asset allocation, and risk assessment help investors
mitigate these risks by spreading investments across different asset classes, industries, and geographic
regions. By managing risk effectively, investors can protect their portfolios from potential losses and
stabilize returns over the long term.
2. Return Maximization: Portfolio management aims to maximize returns while considering an investor's
risk tolerance and investment goals. Through strategic asset allocation and active management strategies,
portfolio managers seek to identify investment opportunities that offer attractive risk-adjusted returns. By
diversifying investments and actively monitoring market conditions, portfolio management helps investors
capture growth opportunities while minimizing downside risk, ultimately enhancing the overall performance
of the portfolio.
3. Wealth Preservation: Another critical need of portfolio management is wealth preservation. Investors
seek to safeguard their wealth and maintain its purchasing power over time, especially in the face of
inflation and economic uncertainties. Portfolio managers implement risk management strategies, such as
asset allocation, hedging, and downside protection, to preserve capital during market downturns and volatile
periods. By carefully managing risk and adopting conservative investment strategies, portfolio management
aims to safeguard investors' wealth and provide a stable source of income.
4. Tailored Investment Solutions: Portfolio management provides tailored investment solutions that align
with investors' unique financial goals, time horizons, and risk preferences. Whether an investor is seeking
capital appreciation, income generation, or wealth preservation, portfolio managers design customized
investment portfolios to meet these specific objectives. By understanding investors' individual needs and
constraints, portfolio management ensures that investment strategies are aligned with their long-term
financial goals, enhancing the likelihood of achieving desired outcomes.
5. Professional Expertise: Many investors lack the time, resources, or expertise to manage their investment
portfolios effectively. Portfolio management offers access to professional expertise and experienced
investment professionals who can navigate complex financial markets, conduct in-depth research, and make
informed investment decisions on behalf of clients. By leveraging the knowledge and skills of portfolio
managers, investors can benefit from disciplined investment processes, rigorous risk management practices,
and sophisticated investment strategies tailored to their unique needs and preferences.

OBJECTIVES OF PORTFOLIO MANAGEMENT :-

1.Security of Principal Investment: While investing the money, the main objective is safety of the amount
of every investor. Safety means protecting the investing amount not only from losses but also safeguarding
the same from frequent variations. Portfolio management not only helps in protecting the amount invested
but also assists in growth of its purchasing power over the period. In order to provide, careful analysis of the
trends in economic and industry should be required.
2. Consistency of Returns: Along with safety of principal consistency of returns is also required by the
investor. Thus can be achieved by reinvesting the interest in the diversified and profitable portfolios.
3. Capital Appreciation: Portfolio management ensures that the amount of investors must be invested in
growth securities. Team of portfolio management must keep in mind the principle of capital appreciation
while purchasing or re-investing in securities, A portfolio must comprise of those assets which will increase
in their value with the passage of time irrespective of market situation.
4. Marketability: Portfolio management must ensure that the portfolio must consist of active and listed
shares and other securities which can be easily marketed as and when required. Diversified securities which
are easily being traded can form the part of portfolios.
5. Liquidity: Portfolio must be comprised of securities which are highly liquid i.e. easy to transfer in to
money with in short span of time, only then the investor will avail the advantage of attractive opportunities
of the market.
6. Diversification of Portfolio: the main objective of making investment in Portfolios is to reduce the risk
of loss of capital and/or income by investing in varied types of securities available in a market. While
investing care should be taken as there is no such security which is pure risk averse. Also securities which
are less risky must also not give good return in exchange. So while formulating portfolios proper selection of
securities should be done.
7. Favorable Tax Status: Another main objective of portfolio management is to help the investors in
reducing the tax burden. Securities involved in portfolio should be planned in such a way so that the yield
from investment can be increased by minimizing the tax burden. A good portfolio should give a favorable
tax shelter to the investors. The portfolio should be assessed properly after taking into consideration income
tax, capital gains tax, and other taxes.
These objectives of portfolio management are appropriate for all the financial portfolios. If portfolios are
framed after giving due weight-age to these objectives then this would lead to growth in financial returns of
the investor. Finally, a good portfolio of growth stocks often satisfies all objectives of portfolio management.

PROCESS OF PORTFOLIO MANAGEMENT

1. Setting Objectives and Constraints : The first step in portfolio management is defining investment
objectives and constraints. Objectives could include capital appreciation, income generation, or a
combination of both. Constraints may involve factors such as time horizon, risk tolerance, liquidity needs,
and regulatory considerations. Clear objectives and constraints provide a foundation for constructing a
portfolio tailored to the investor's unique circumstances.
2. Asset Allocation : Asset allocation is a strategic decision that involves determining the mix of asset
classes (e.g., stocks, bonds, cash, real estate) within the portfolio. This decision is crucial as it significantly
influences the portfolio's risk and return profile. Modern Portfolio Theory suggests that diversification
across different asset classes can enhance returns for a given level of risk.
3. Security Selection : Once the asset allocation is determined, the next step is selecting specific securities
or investments within each asset class. This involves analyzing individual stocks, bonds, or other financial
instruments to build a well-diversified portfolio. Fundamental analysis, technical analysis, and other
evaluation methods are employed to identify securities that align with the investor's goals.
4. Risk Management : Managing risk is an integral part of portfolio management. Techniques such as
diversification, hedging, and the use of risk-adjusted metrics help control and mitigate portfolio risk.
Understanding the correlation between different assets and incorporating risk management strategies are
essential for constructing a resilient portfolio.
5. Portfolio Construction : Portfolio construction involves combining the selected securities in the desired
proportions based on the asset allocation. The goal is to create a balanced and diversified portfolio that
aligns with the investor's risk-return profile. Attention is given to factors such as sector exposure, geographic
considerations, and market capitalization to ensure a well-rounded investment mix.
6. Monitoring and Rebalancing : Once the portfolio is constructed, continuous monitoring is essential.
Market conditions, economic factors, and changes in the investor's financial situation may necessitate .
adjustments. Rebalancing involves periodically reviewing the portfolio's asset allocation and making
adjustments to bring it back in line with the original strategic plan. This ensures that the portfolio remains
aligned with the investor's goals.
7. Performance Evaluation : Regular performance evaluation helps assess how well the portfolio is
meeting its objectives. Key performance metrics, such as return on investment, risk-adjusted return, and
portfolio volatility, are analyzed. This evaluation provides insights into the effectiveness of the chosen
strategy and helps investors make informed decisions about the portfolio's future direction.
8. Adaptation to Changing Market Conditions : Portfolio management is not a static process; it requires
adaptability to changing market conditions. Economic shifts, geopolitical events, and fluctuations in interest
rates can impact the performance of different asset classes. Portfolio managers must stay informed about
market trends and be prepared to adjust the portfolio strategy accordingly.

SELECTION OF SECURITIES
Meaning :-
Stock selection is a process within the investment strategy where investors and portfolio managers study the
market and select certain stocks in their portfolios.

CRITERIA OF SELECTION OF SECURITIES

1. Quality Rating For Assets: According to popular investor Benjamin Graham, the company's rating is
vital. Thus, companies with good ratings have a higher value. And to check its quality, S&P (Standard and
Poor) rating is the best metric. Therefore, Graham suggested a rating of B or more (A).
2. Consistent Earnings And Dividends: Before selecting any stock, the financials of that company play an
important role. For example, a firm with good year-on-year growth for five years depicts a growing
company. As a result, it becomes easy for them to create reserves for shareholders. Thus, firms can distribute
excess as dividends, creating a passive income source.
3. Company Size: Graham suggests that a company's size and structure also affect the stock selection
decision. As per Benjamin Graham, large companies are more successful as they do not over or
underperform. Also, they are less volatile to market sentiments. Thus, large caps should be on the checklist
before picking the stocks.
4. Healthy Current Ratio: Another important criterion for picking stocks depends on the company's
liquidity ratio. If the company's debt is more, it indicates a near-to-bankruptcy situation. Therefore, it is
necessary to have a current ratio of more than 1.5 times.

5. Good Financial Leverage: A good leverage indicates that the firm has more assets than the debt owed.
Therefore, Graham suggested stocks that have financial leverage (debt-to-current asset) of less than 1.1.

PORTFOLIO ANALYSIS
Portfolio analysis is a fundamental process in investment management that involves evaluating the
performance, risk, and composition of an investment portfolio. It encompasses a range of quantitative and
qualitative techniques to assess the strengths, weaknesses, opportunities, and threats associated with the
portfolio holdings. The primary objective of portfolio analysis is to optimize the risk-return profile of the
portfolio, align it with the investor's financial goals and risk tolerance, and make informed investment
decisions.

STEPS TO PORTFOLIO ANALYSIS

1. Understanding Investor Expectation and Market Characteristics : The first step before portfolio
analysis is to sync the investor expectation and the market in which such Assets will be invested. Proper
sync of the expectations of the investor vis-à-vis the risk and return and the market factors helps a long way
in meeting the portfolio objective. With a higher information ratio, fund manager B has delivered superior
performance.
2. Defining an Asset Allocation and Deployment Strategy : This is a scientific process with subjective
biases. It is imperative to define what type of assets the portfolio will invest, what tools will be used in
analyzing the portfolio, which type of benchmark the portfolio will be compared with, the frequency of such
performance measurement, and so on.
3. Evaluating Performance and Making Changes if Required : After a stated period as defined in the
previous step, portfolio performance will be analyzed and evaluated to determine whether the portfolio
attained stated objectives and the remedial actions, if any, required. Also, any changes in the investor
objectives are incorporated to ensure portfolio analysis is up to date and keeps the investor expectation in
check.

ADVANTAGES OF PORTFOLIO ANALYSIS

1. It helps investors to assess the performance periodically and make changes to their Investment strategies
if such analysis warrants.
2. This helps in comparing the portfolio against a benchmark for return perspective and understanding the
risk undertaken to earn such return, enabling investors to derive the risk- adjusted return.
3. It helps realign the investment strategies with the changing investment objective of the investor.
4. It helps in separating underperformance and outperformance, and accordingly, investments can be
allocated.

EVALUATION OF PORTFOLIO
Portfolio evaluation refers to the evaluation of the performance of the portfolio. It is essentially the process
of comparing the return earned on a portfolio with the return earned on one or more other portfolios or on a
benchmark portfolio.It is basically the study of the impact of investment decisions.
Need for Portfolio Evalution
1. Self-evaluation : Where individual investors undertake the investment activity on their own, the
investment decisions are taken by them. They construct and manage their own portfolio of securities. In such
a situation, an investor would like to evaluate the performance of his portfolio in order to identify the
mistakes committed by him. This self-evaluation will enable him to improve his skills and achieve better
performance in future.
2. Evaluation of portfolio managers : A mutual fund or investment company usually creates different
portfolios with different objectives aimed at different sets of investors. Each such portfolio may be entrusted
to different professional portfolio managers who are responsible for the investment decisions regarding the
portfolio entrusted to each of them. In such a situation, the organization would like to evaluate the
performance of each portfolio so as to compare the performance of different portfolio managers.
3.Evaluation of mutual funds : many mutual funds companies operating both in the public sector as well as
in the private sector. These compete with each other for mobilizing the investment funds with individual
investors and other organizations by offering attractive returns, minimum risk, high safety and prompt
liquidity. Investors and organizations desirous of placing their funds with these mutual funds would like to
know the comparative performance of each so as to select the best mutual fund or investment company. For
this, evaluation of the performance of mutual funds and their portfolios becomes necessary.
4. Evaluation perspective : A portfolio comprises several individual securities. In the building up of the
portfolio several transactions of purchase and sale of securities take place. Thus, several transactions in
several securities are needed to create and revise a portfolio of securities. Hence, the evaluation may be
carried out from different perspectives or viewpoints such a transactions view, security view or portfolio
view.
5. Transaction view : An investor may attempt to evaluate every transaction of purchase and sale of
securities. Whenever a security is bought or sold, the transaction is evaluated as regards its correctness and
profitability.
6. Security view : Each security included in the portfolio has been purchased at a particular price. At the end
of the holding period, the market price of the security may be higher or lower than its cost price or purchase
price. Further, during the holding period, interest or dividend might have been received in respect of the
security. Thus, it may be possible to evaluate the profitability of holding each security separately. This is
evaluation from the security viewpoint.
Portfolio Performance Evaluation Methods
The objective of modern portfolio theory is maximization of return or minimization of risk. In this context
the research studies have tried to evolve a composite index to measure risk based return. The credit for
evaluating the systematic, unsystematic and residual risk goes to Sharpe, Treynor and Jensen.
The portfolio performance evaluation can be made based on the following methods:
1. Sharpe’s Measure
2. Treynor’s Measure
3. Jensen’s Measure

1. Sharpe’s Measure
 Sharpe’s Index measure total risk by calculating standard deviation. The method adopted by Sharpe
is to rank all portfolios on the basis of evaluation measure.
 Reward is in the numerator as risk premium. Total risk is in the denominator as standard deviation of
its return.
 We will get a measure of portfolio’s total risk and variability of return in relation to the risk premium.
The measure of a portfolio can be done by the following formula:
SI = (Rt — Rf)/Std . Dev p
Where, • SI = Sharpe’s Index
• Rt = Average return on portfolio
• Rf = Risk free return
• Std. dev p - Standard deviation of the portfolio return.
2. Treynor’s Measure
 The Treynor’s measure related a portfolio’s excess return to non-diversifiable or systematic risk.
 The Treynor’s measure employs beta.
 The Treynor based his formula on the concept of characteristic line.
 It is the risk measure of standard deviation, namely the total risk of the portfolio is replaced by
beta.
 The equation can be presented as follow: • Tn = (Rn – Rf)/ β
Where, Tn = Treynor’s measure of performance
Rn = Return on the portfolio
Rf = Risk free rate of return
β = Beta of the portfolio ( A measure of systematic risk)
3. Jensen’s Measure
 Jensen attempts to construct a measure of absolute performance on a risk adjusted basis. This
measure is based on Capital Asset Pricing Model (CAPM) model
  It measures the portfolio manager’s predictive ability to achieve higher return than expected for
the accepted riskiness.
 The ability to earn returns through successful prediction of security prices on a standard
measurement.
 The Jensen measure of the performance of portfolio can be calculated by applying the following
formula: Rp = Rf + β (Rm — Rf) x βs
Where, • Rp = Return on portfolio
• Rm = Return on market index
• Rf = Risk free rate of return

Construction of optimal portfolio using Sharpe’s Single Index Model.

The Construction of an optimal portfolio using Sharpe’s Single Index Model is a systematic process that
aims to maximize returns for a given level of risk or minimize risk for a given level of return, by
carefully selecting securities that have the best risk-return trade-off as measured by their Sharpe ratio.
The Single Index Model (SIM) simplifies the process by using a single factor, typically the return on the
market portfolio, to describe the returns on a security.
Step 1: Understand the Single Index Model : The Single Index Model (SIM) posits that the return on
any given security (or asset) can be explained by the return on a common market index plus a security-
specific component.
Step 2: Calculate Expected Return, Beta, and Alpha for Each Security : Using historical data,
calculate the expected return, beta (β), and alpha (α) for each security in the universe of potential
investments. Beta represents the sensitivity of the security’s returns to the returns of the market
portfolio, while alpha represents the security’s ability to generate returns independent of the market’s
performance.
Step 3: Estimate the Risk-Free Rate and the Expected Market Return: Identify the current risk-
free rate of return, often represented by the yield on government securities, and the expected return on
the market portfolio. These figures are necessary for calculating the Sharpe ratio and for comparison
purposes in portfolio construction.
Step 4: Calculate the Expected Excess Return and Sharpe Ratio for Each Security: For each
security, calculate the expected excess return by subtracting the risk-free rate from the security’s
expected return. Then, calculate the Sharpe ratio for each security using the formula.
Step 5: Optimize the Portfolio : Using the Single Index Model, the optimization process involves
selecting a combination of securities that maximizes the portfolio’s expected return for a given level of
risk or minimizes risk for a given level of expected return.
Step 6: Construct the Portfolio : Based on the optimization results, construct the portfolio by
allocating capital to the selected securities in the proportions determined in the optimization process.
Step 7: Monitor and Rebalance : The constructed portfolio should be regularly monitored, and its
performance should be compared against the expected outcomes derived from the Single Index Model.