 Portfolio Management.

 Meaning and Definition.

The word "Portfolio" refers to a set of several assets
made by individuals or institutions to reduce investment risk.
Stocks of various firms, bonds, real estate, and other investments are examples of
different investments. The process of holding different types of investment at the
same time is called diversification.

Portfolio Management is an essential skill for planning and managing investments

effectively.

When an investor holds a single security, he is not diversifying his investment. It

means if the security price fall, all of his investment will go down in vain. On the
other hand, holding a lot of securities reduce risk because some securities will fall
while others will rise with the passage of time.
There is a famous quote, "Do not put all your eggs into a single basket”.
 Portfolio Management: An overview.
Always remember portfolio
diversification is hedge against market risk in normal market conditions. In an era of
market turmoil, generally all securities prices fall. This phenomenon is called
contagion.
An investor must try to hold the securities with the highest negative correlation. "-1"
is the ideal correlation for portfolio diversification. If two securities have a -1
correlation, it means they move in the opposite direction and it’s a 100% hedge
against risk.
Investors should focus on the correlation between the securities within a portfolio
because the correlation can change over time.

 Portfolio Management Process Steps:

The portfolio management process has three steps;
1. Planning
2. Execution
3. Feedback
These three are discussed further below.

1. Planning:
 In this step we analyze the client’s investment goal, time horizon, risk
tolerance, liquidity needs, tax and other obligations and other circumstances which
can affect his investment.
After the analysis we write IPS (Investment Policy Statement). IPS contains
investment objectives, constraints and a related benchmark to compare portfolio’s
performance. This statement can be and should be updated as soon as the investor’s
circumstances change.
2. Execution:
In this step we do these processes; Asset allocation, security analysis and
construct portfolio according to IPS. It means we (as an analyst) analyze risk and
return characteristics of different securities and allocate the client’s funds and develop
a portfolio.
The resultant portfolio must match the risk tolerance and return goals of the investor.
The analyst uses top-down analysis for the asset allocation. It may include over all the
macroeconomic conditions like GDP growth rate, inflation rate, interest rate, etc.
Following that, bottom-up analysis is carried out by looking at appealing and
undervalued assets. We can develop portfolio containing stocks, fixed income private
and government securities.

3. Feedback:
Once the portfolio is developed, it must be monitored and rebalanced at
intervals or whenever the investors or overall macroeconomic circumstances change.
For example, if a security’s risk characteristics increase, we should eliminate and
replace it with another security with a lower risk characteristic. The portfolio must be
monitored, evaluated with respect to the benchmark, and reported to the client.

 Types of Investors:
The need and characteristics of every investor can vary but
we can group them into two broad categories: Individual investors and institutional
investors.

1. Individual Investors:
Individual investors can have short-term or long-term goals.
For example, a plan to buy a house or fund a child’s education can be a short-term
goal, while a plan for a retirement pension is a long-term goal.

Some individual investors look for fixed income-generating opportunities, while

others want capital appreciation and/or deferment of taxes. Some individual investors
are retail investors, while others can be "high-net-worth" investors.
Their investment goals can also depend on their financial position, employment, and
other obligations, as does their risk tolerance.
 2. Institutional Investors:
An Institutional Investor is a legal entity that gathers
funds from a number of investors in order to invest in a variety of financial
instruments and earn from the process.
Long-term and short-term investing goals are both possible for institutional investors.

Usually, institutional investors are the major participants in the financial market.
Institutional Investors can be following.
i. Banks:
Usually, Banks have short-term investment goals. They want to earn
extra on excessive reserves. They usually invest in liquid assets like money market
instruments, so they can quickly withdraw funds to fulfill depositors’ claims.
ii. Insurance Companies:
Insurance Companies sell insurance products and
receive premiums. They need to invest so that they have sufficient funds to
fulfill insurance claims. Some insurance companies like life- Insurance have
long-term objectives while property and loss insurance companies have
shorter time horizons.

iii. Investment Companies:

Investment companies need to invest a pool of funds
in different securities in order to earn money for their financiers. The time
horizons of different investment companies differ with respect to their
investment goals. Some companies use an aggressive investment approach to
earn extra.

iv. Endowment Funds:

Endowment Funds can invest in a way to maintain the
principal amount (inflation adjusted) while earning a rate of return to fund
some ongoing projects like educational and or general welfare projects.
Usually, the same the time horizon of these funds is longer.

v. Foundations:
Foundations are charitable institutions that are established for the
welfare of a particular region, its people, or to support other welfare projects
like creating a vaccine for a specific disease. The investment time horizon of a
foundation can be the same as an endowment fund because it also has to save
the original amount (inflation adjusted) while funding some ongoing project.
Usually, the time horizon of a foundation is longer.

vi. Sovereign Investment Fund:

 It is the investment company owned by the
government of a country. These funds invest excessive government funds to
earn and to maintain the principal amount (Inflation adjusted).

vii. International Investment Corporations:

International funds and global funds are both types of funds that
invest in foreign stocks. A growing number of foreign investment enterprises
are entering the local market, offering both domestic and worldwide products.

viii. The Pension Fund:

It's the total amount of money received from employees while
they're on the job. These funds are meant to assist the individual after he or
she retires. Defined contribution and defined pension plans are the two types
of pension plans.

ix. The Hedge Fund:

A hedge fund is a pooled investment fund that trades in a
diversified portfolio and can make extensive use of advanced trading, portfolio
design, and risk management techniques, among other things.
 The Purpose of Portfolio Management:
The goal of portfolio management is to achieve the following:
Every man's life is a diary in which he intends to write one narrative but ends up
writing another; and his humblest hour is when he compares the volume as it is with
the volume he swore to make.

Rather of maximizing return, Portfolio management focuses on lowering risk.

Asset prices accurately reflect the tradeoff between relative risk and possible returns
of a security on a well-developed securities market.

A well-constructed portfolio achieves a certain level of projected return while posing

the least amount of risk. The profit will eventually rise.
 Portfolio Manager Duty:
Without a thorough understanding of the fundamentals
of finance, an individual cannot be a successful portfolio manager.

Portfolio managers have a responsibility to put together the greatest possible

investment portfolio for each customer's specific goals and circumstances. It entails
determining the worth of individual investments.
 Portfolio managers are responsible for the creation and upkeep of a collection of
various investments, such as cash, bonds, and stocks.

 Security Analysis:
Security Process involve in three steps.

1. The analyst evaluates the economy's prospects in light of the current state of
the economic cycle.

2. The analyst analyses which industries are likely to thrive in the future
economic environment.

3. Within the preferred industries, the analyst selects specific companies.

 Aspects of Asset Management Industry:

Asset management industry is a collection of all firms who deal with investment
assets. Asset management industry can include “Buy-Side and Sell-Side Firms, Active
or Passive managers” etc.

In an investing firm, the capital of multiple clients is pooled. Clients develop personal
contact with private management and consulting firms. A broad answer is provided by
an investment firm. Contract with a management and advice firm directly.

Invest a pool of funds from multiple people into a single portfolio security.
 Introduction to Risk Management:
Risk can be defined in a single word as
“uncertainty”. When the future outcome of an investment is not 100 percent certain, it
is called risky investment. The individual investors and institutions can reduce the risk
that is called risk management.

The institutes can reduce the risk by identifying the risk, calculating their risk,
calculating their risk tolerance, choosing which and how much risk they can take and
transferring to risk to another party.

Individuals can also reduce the risk by not investing in junk securities, diversifying
and using insurance products.

All those processes to reduce the risk is called Risk Management.

 Portfolio Risk and Return:
The total risk of our portfolio is not the sum of the
risks of individual securities as there is covariance involved. Total risk can be less
than or equal to the sum of the individual risks of the securities that comprise it.

If two securities have a 1 to 1 correlation (perfectly negative correlation) and their

proportion is the same in a portfolio, there would be zero investment risk. If one
security rises, the other will fall by the same proportion. If they are perfectly
positively correlated (+1 correlation coefficient), the total risk is simply the sum of the
individual risks of each security.

Having a correlation between +1 and -1 is called a less than perfect correlation. In this
case, the overall risk of a portfolio is less than the sum of the individual risks of each
security.
 Professional Asset Manager:
A professional asset manager can assist you in
determining your investing goals and developing a portfolio that meets them. To
avoid unsystematic risk, diversify your investments.

Maintain portfolio diversity and risk class preferences while allowing for flexibility in
switching between various investment instruments as needed.

Make an effort to outperform your relevant benchmark in terms of risk-adjusted

performance.

Administrate the account, maintain track of costs and transactions, offer accurate tax
information, and reinvest dividends if needed.

Maintain high ethical standards at all times.

 Financial Risks:
There are three categories of financial risks;
1. Market Risk
2. Credit Risk
3. Liquidity Risk
1. Market Risk:
The unfavorable movement of share prices, the downfall of the
overall market, changes in interest rates, etc.
2. Credit Risk:
Risk of default of counterparty.
3. Liquidity Risk:
The problem is that the company will be unable to sell an asset at a reasonable
price. This is more likely to happen in a volatile market or when the underlying asset
is less liquid.

 Non-Financial Risks:
Some of Non-Financial Risk are discussed below.

1) Legal Risk:
There's a chance your counterparty will bail you out.
2) Compliance Risk:
Risk that an organization will not meet the regulatory requirement.

3) Model Risk:
Risk of using un-appropriate model for security evaluation.

4) Tail Risk:
Risk that an extreme event will occur which will affect the
organization in a very bad way.
5) Solvency Risk:
Risk that the company will be defaulted.
6) Operational Risk:
The risk that the employees of an organization can make errors which
can cost the organization.
7) Political Risk:
Risk that the government’s policies will change.

All of the risks mentioned above interact with one another. It's possible that the total
risk is greater than the sum of these risks.

The end