PORTFOLIO MANAGEMENT

Introduction to portfolio management

Investing in securities such as shares, debentures and bonds is profitable as well as exciting. It is indeed rewarding, but involves a great deal of risk and calls for scientific knowledge as well as artistic skill. In such investments, both rational as well as emotional responses are involved. Investing in financial securities is now considered to be one of the best avenues for investing one’s savings while it is acknowledge to be one of the most risky avenues of investment.

It is rare to find investors investing their entire savings in a single security. Instead, they tend to invest in a group of securities. Such a group of security is called a portfolio. Creation of portfolio helps to reduce risk without sacrificing returns. Portfolio management deals with the analysis of individual securities as well as with the theory and practices of optimally combining securities into portfolios. As investor who understand the fundamental principles and analytical aspects of portfolio manangmement has better chance of success.

What is portfolio Management?

►an investor considering investment in securities is faced with the problem of choosing form among a large number of securities. His choice depends up on the risk return characteristics of individual securities. He would attempt to choose the most desirable securities and like to allocate his funds over this group of securities. Again he is faced with the problem of deciding which securiteies to hold and how much to invest in each.
► the investor faces an infinite number of possible protorlios or groups of securities. The risk and return characteristics of portofolios differ from those of individual securities combining to form a portfolio.The investor choose the optimal portfolio taking in to consideration the risk return characteristics of all possible portfolios.
► As the economic and financial environment keeps changing, risk return characteristics of individual securities as well as portfolios also change. This requires periodic review and revision of investment portfolios of investors.
►Portfolio management comprises all the processes involved in the creation and maintenance of an investment portfolio. It deals specicically with security analysis, portfolio analysis, portfolio selection, portfolio revision and portfolio evaluation.
►Portfolio management is a complex process which tries to make investment activity more rewarding and less risky.

Phases of Portfolio Management.
It is a process encompassing many activities aimed at optimising the investment of one’s funds. Five phases can be identified in this process.

1 Security analysis.

►Security available to an investor for investment are numerous and of various types. Shares of 7000 companies listed in stock market.

Traditionally, the securities were classified in to ownership securities such as equity and preference shares and creditorship securities such as debentures and bonds.
Recently a number of new securities with innovative features are being issued by companies to raise funds for their projects. Convertible debentures, deep discount bonds, zero coupon bond, flexi bonds, floating rate bonds, globle depository receipts, euro currency bonds, etc..
From this vast group of securities the investor has to choose those securities which he considers worthwhile to be included in his investment portfolio.

Security analysis os the initial phase of portfolio management process. This step consist of examining the risk return characteristics of individual securities. The basic strategy is to buy at underprice and to sell it on over poriced. But the problem is how to find under price and over price.

Two main approach to security analysis
1 fundamental approach
Concentrate on fundamental factors affecting the company such as EPS of the company, dividend pay out ratio, competition faced by the company, market share, quality of management etc…
2 technical approach
Technical analyst believes that share price movement are systematic and exhibit certain consistent patterns. There fore studies past movements in the pirces of share to identify trends and patterns. He then tries to predict the future movements. The current market price is compared with the future predicted price to determine the extent of mispircing.
More recent approach to security analysis is the efficient market hypothesis. According to this the financial market is efficient in pricing securities. The efficient market hypothesis holds that market prices instantaneously and fully reflect all relevant available information it means that the market prices of securities will always equal their intrinsic values. As a result fundamental analysis which tries to identify undervalued or overvalued securities is said to be a furtile exercise
The efficient market hypothesis further holds that share price movements are eandom and not systematic.
Efficient market hypothesis is a direct repudiation of both fundamental analysis and technical analysis. An investor can not consistently earn abnormal returns by undertaking fundamental analysis or technical analysis.

Portfolio analysis

A portfolio is a group of suecurities held together as investment. Incestors invest their funds in a portfolio o securities tather than in a single security because they are risk averse. By construing a portfolio, investors attempts to sparead risk by not putting all their eggs in to one basket. Thus diversification of one’s holding is intended to reduce risk in investment.
Security analysis provides a set of worthwhile or desirable securities.
Thus portfolio analysis phase of portfolio management consists of identifying the range of possible portfolios that can be constituted from a given set of securities and calculating their return and risk for further analysis.

Portfolio selection

Portfolio analysis provides the input for the next phase in portfolio mgt. which is portfolio selection. The goal of portfolio construction is to generate a portfolio that provides the highest returns at a given level of risk. A portfolio having such characteristic is known as an efficient portfolio.

Portfolio Revision

Having constructed the optimal portfolio, the investor has to constantly monitor the portfolio to ensure that it continues to be optimal. As the economy and financial markets are dynamic, changes take place almost daily. As time passes, securities which were once attractive may cease to be so. New securities with promises of high returns and low risk may emerge. The investor now has to revise his portfolio in the light of the developments in the market. This revision leads to purchase of some new securities and sale of some of the existing securities form the portfolio. The mix of securities and their proportion in the portfolio changes as a result of the revision.
Portfolio revision may also be necessitated by some investor-related changes such as availability of additional funds, changes in risk attitude, need of cash for other alternative use, etc..
Whatever be the reason for portfolio revision, it has to be done scientifically and objectively so as to ensure the optimality of the revised portfolio.

Portfolio evaluation.

The objective of constructing a portfolio and revision it periodically is to earn maximum returns with minimum risk. Portfolio evaluation is the process which is concerned with assessing the performance of the portfolio over a selected period of time in terms of return and risk. This involves quantitative measurement of actual return and the risk born by the portfolio over the period of investment. These have to be compared with objective norms to assess the relative performance of the portfolio.
Portfolio evaluation is useful in yet another way. It provides a mechanism for identifying weaknesses in the investment process and for improving these deficient areas.

Thus portfolio management process is an ongoing process. It starts with security analysis, proceeds to portfolio construction, and continues with portfolio revision and evaluation. The evaluation provides the necessary feedback for designing a better portfolio next time.