Portfolio Management

Definition

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. 

Or

Portfolio Management is the planning and devising strategies for the implementation of an individual or a business goal and seeing the implementation of such strategies.It is the management of financial responsibilities (upon investment) at the same time of risks while working on the possible outcome (which the investor always hopes as positive and favorable) of his investment.

Or

Portfolio management is the process of building, managing and assessing an inventory of company products and projects

Or

The aim of Portfolio Management is to achieve the maximum return from a portfolio which has been delegated to be managed by an individual manager or financial institution. The manager has to balance the parameters which define a good investment i.e. security, liquidity and return. The goal is to obtain the highest return for the client of the managed portfolio.

1.INTRODUCTION:-Stock exchange operations are peculiar in nature and most of the Investors feel insecure in managing their investment on the stock market because it is difficult for an individual to identify companies which have growth prospects for investment. Further due to volatile nature of the markets, its require constant reshuffling of portfolios to capitalized on the growth opportunities. Even after identifying the growth oriented companies and their securities, the trading practices are also complicated, making it a difficult task for investors to trade in all the exchange and follow up on post trading formalities. That is why professional investment advice through portfolio management service can help the investors to make an intelligent and informed choice between alternative investments opportunities without the worry of loosing their invested money.Hence this is very much important to the stock dealers specially who are new to the market.

2.MEANING OF PORTFOLIO MANAGEMENT:-

Portfolio management in common parlance refers to the selection of securities and their continuous shifting in the portfolio to optimize returns to suit the objectives of an investor. In India, as well as in a number of western countries, portfolio management service has assumed the role of a specialized service now a days and a number of professional merchant bankers compete aggressively to provide the best to high networth clients, who have little time to manage their investments. The idea is catching on with the boom in the capital market and an increasing number of people are inclined to make profits out of their hard-earned savings.Portfolio management service is one of the merchant banking activities recognized by Securities and Exchange Board of India(SEBI). The service can be rendered either by merchant bankers or portfolio managers or discretionary portfolio manager as define in clause (e) and (f) of Rule 2 of Securities and Exchang Board of India(Portfolio Managers)Rules, 1993 and their functioning are guided by sebi.

3. OBJECTIVES OF PORTFOLIO MANAGEMENT:-

The major objectives of portfolio management are summarized as below:-

i. Keep the security, safety of Principal sum intact both in terms of money as well as its purchasing power.ii. Stability of the flow of income so as to facilitate planning more accurately and systematically the re-investment or consumption of income.iii. To attain capital growth by re-investing in growth securities or through purchase of growth securities.iv. Marketability of the security which is essential for providing flexibility to investment portfolio.v. Liquidity i.e.nearness to money which is desirable for the investor so as to take advantage of attractive opportunities upcoming in the market.vi. Diversification: The basic objective of building a portfolio is to reduce the risk of loss of capital and income by investing in various types of securities and over a wide range of industries.vii. Favourable tax status : The effective yield an investor gets from his investment depends on tax to which it is subject. By minimizing the tax burden, yield can be effectively improved.

4. BASIC PRINCIPLES OF PORTFOLIO MANAGEMENT:-There are two basic principles for effective portfolio management which are given below:-1. Effective investment planning for the investment in securities by considering the following factors-a. Fiscal,financial and monetary policies of the Govt.of India and theReserve Bank of India.b. Industrial and economic environment and its impact on industryProspect in terms of prospective technological changes, competition in the market, capacity utilization with industry and demand prospects etc.II. Constant review of investment: Its require to review the investment in securities and to continue the selling and purchasing of investment in more profitable manner. For this purpose they have to carry the following analysis:a. To assess the quality of the management of the companies in which investment has been made or proposed to be made.b. To assess the financial and trend analysis of companies balance sheet and profit&loss Accounts to identify the optimum capital structure and better performance for the purpose of withholding the investment from poor companies.c. To analysis the security market and its trend in continuous basis to arrive at a conclusion as to whether the securities already in possession should be disinvested and new securities be purchased. If so the timing for investment or dis-investment is also revealed.

5. ACTIVITIES IN PORTFOLIO MANAGEMENT:-A. There are three major activities involved in an efficient portfolio management which are as follows:-a. Identification of assets or securities, allocation of investment and also identifying the classes of assets for the purpose of investment.b. They have to decide the major weights, proportion of different assets in the portfolio by taking in to consideration the related risk factors.c. Finally they select the security within the asset classes as identify.The above activities are directed to achieve the sole purpose to maximize return and minimize risk in the investment even if there are unlimited risk in the market.

Let us have a look on the composite risk involve in the market during operation:-

I. Interest rate risk: This arises due to variability in the interest rates from time to time. A changes in the interest rates establishes an inverse relationship in the price of the security i.e. price of securities trends to move inversely with change in rate of interest. Long term securities shows greater variability in compare to short term securities by this risk.II. Purchasing power risk: It is also known as inflation risk and the inflation affect the purchasing

power adversely. Inflation rates vary over time and changes unexpectedly causing erosion in the value of real return and expected return. Thus purchasing power risk is more in inflationary conditions especially in respect of bond and fixed income securities. It is not desirable to invest in such securities during inflationary situations. Purchasing power risk is however less in flexible income securities like equity shares or common stock where rise in dividend income off-sets increase in the rate of inflation and provides advantage of capital gain.

III. Business risk: Business risk arises from sale and purchase of securities affected by business cycles, technological changes etc. Business cycles affect all types of securities viz. there is cheerful movement in boom due to bullish trend in stock price where as bearish trend in depression brings down fall in the prices of all types of securities. Therefore securities bearing flexible income affected more than the fixed rated securities during depression due to decline in their market price

IV. Financial Risk: This arises due to changes in the capital structure of the company. It is also known as leveraged risk and expressed in the terms of debt-equity ratio. Excess of debt over equity in the capital structure of a company indicates that the company is highly geared even if the per capital earnings(EPS) of such company may be more. Because highly dependence on borrowings exposes to the risk of winding up for its inability to honour its commitments towards lenders and creditors. So the investors should be aware of this risk and portfolio manager should also very care full

.By taking in to accounts of all the above factors, investment decision in portfolio management are taken as followings:

B. INVESTMENT DECISION:

By a certain sum of funds, the investment decision are basically depends upon the following factors:-I. Objectives of investment portfolio: This is a crucial point which a Finance Manager must consider. There can be many objectives of making an investment. The manager of a provident fund portfolio has to look for security and may be satisfied with none too high a return, where as an aggressive investment company be willing to take high risk in order to have high capital appreciation.How the objectives can affect in investment decision can be seen from the fact that the Unit Trust of India has two major schemes : Its “capital units” are meant for those who wish to have a good capital appreciation and a moderate return, where as the ordinary unit are meant to provide a steady return only. The investment manager under both the scheme will invest the money of

the Trust in different kinds of shares and securities. So it is obvious that the objectives must be clearly defined before an investment decision is taken.

II. Selection of investment: Having defined the objectives of the investment, the next decision is to decide the kind of investment to be selected. The decision what to buy has to be seen in the context of the following:-

a. There is a wide variety of investments available in market i.e. Equity shares, preference share, debentures, convertible bond, Govt.securities and bond, capital units etc. Out of these what types of securities to be purchased .

b. What should be the proportion of investment in fixed interest dividend securities and variable dividend bearing securities. The fixed one ensure a definite return and thus a lower risk but the return is usually not as higher as that from the variable dividend bearing shares.

c. If the investment is decided in shares or debentures, then the industries showed a potential in growth should be taken in first line. Industry-wise-analysis is important since various industries are not at the same level from the investment point of view. It is important to recognized that at a particular point of time, a particular industry may have a better growth potential than other industries. For example, there was a time when jute industry was in great favour because of its growth potential and high profitability ,the industry is no longer at this point of time as a growth oriented industry.

d. Once industries with high growth potential have been identified, the next step is to select the particular companies, in whose shares or securities investments are to be made.To identify the industries, which have a high growth potential the following techniques/approaches may be taken in to consideration:-

a. Statistical analysis of past performance: A statistical analysis of the immediate past performance of the share price indices of various industries and changes there in related to the general price index of shares of all industries should be made. The Reserve Bank of India index numbers of security prices published every month in its bulletin may be taken to represent the behaviour of share prices of various industries in the last fiew years. The related changes in the price index of each industry as compare with the changes in the average price index of the shares of all industries would show those industries which are having a higher growth potential in the past fiew years. It may be noted that a Industry may not remaining a growth Industry for all the time. So we have to make an assessment of the various Industries keeping in view the present potentiality also to finalized the list of Industries in which we will try to spread our investment.

b. Assessing the intrinsic value of an Industry/Company:-

After identifying the Industry, we have to assess the various factors which influence the value of a particular share. Those factors generally relate to the strengths and weaknesses of the company under consideration, Characteristics of the industry within which the company fails and the national and international economic scene. The major objective of the analysis is to determine the relative quality and the quantity of the security. It is also to be seen that the security is good at current market prices. This approach is known as intrinsic value approach.Industry analysis can help to assess the nature of demand of a particular product, Cost structure of the industry and other economic and Govt. constraints on the same. An appraisal of the particular industries prospect is essential and the basic profitability of any company is depends upon the economic prospect of the industry to which it belongs. The following factors are important in this regards:-

a. Demand and Supply pattern for the industries products and its growth potential: The management expert identify fives stages in the life of an industry. These are “ Introduction, development, rapid growth, maturity and decline”. If an industry has already reached the maturity or decline stage, its future demand potential is not likely to be high.b. Profitability : It is a vital consideration for the investors as profit is the measures of performance and a source of earning for him. So the cost structure of the industry as related to its sale price is an important consideration. The other point to be considered is the ratio analysis, specially return on investment, gross profit and net profit ratio of the existing companies in the industry.c. Particular characteristics of the industry: Each industry has its own characteristics, which must be studied in depth in order to understand their impact on the working of the industry. Because the industry having a fast changing technology become obsolete at a faster rate. Similarly, many industries are characterized by high rate of profits and losses in alternate years. Such fluctuations in earnings must be carefully examine.

d. Labour management relations in the industry: The state of labour-management relationship in the particular industry also has a great deal of influence on the future profitability of the industry. So it is vital to see that the industry under analysis has been maintaining a cordial relationship between labour and management.

e. Company Analysis: To select a company for investment a number of qualitative factors have to be seen to visualize the performance of the company in future by analyzing its past performance such as :-

1. Size and ranking: In this regard the net capital employed, the net profits,the return on investment and the sales volume of the company under consideration may be compared with similar data of other company in the same industry group to assess the risk associated with the company.2. Growth record: Three growth indicators may be looked in to i.e.Price earnings ratio, Percentage growth rate of earnings per annum and Percentage growth rate of net block of the company in the past fiew years should be examined.3. Financial analysis: By the help of Financial analysis we can understandthe financial solvency and liquidity, the efficiency, the profitability and the financial and operating leverage of the company in which the fund are used.

4. Pattern of existing stock holding: This analysis would show the stake ofVarious parties associate with the company. An interesting case in this regard is that of the Panjab National Bank in which the L.I.C. and other financial institutions had substantial holdings. When the bank was nationalized, the residual company proposed a scheme whereby those shareholders, who wish to opt out, could received a certain amount as compensation in cash. It was only at the instant and bargaining strength of institutional investors that the compensation offered to the shareholders, who wish to opt out of the company, was raised considerably.

5. Marketability of the shares: Mere listing of a share on the stock exchange doesnot automatically mean that the share can be sold and purchase. There may be inactive shares with no transaction for long period. So we have to examined the speculative interest of such scrip, extent of public holding and the particular stock exchange where it is traded.Fundamental analysis thus is basically an examination of the economics and financial aspects of a company with the aim of estimating future earnings and dividend prospect. So after having analysed of all the relevant information we have to decide whether we should buy or sell the securities.

II. Timing of Purchases:-

The timing of dealings in the securities, specially shares is of crucialimportance, because after correctly identifying the companies one may losemoney if the timing is bad due to wide fluctuation in the price of shares ofthat companies.

The decision regarding timing of purchases is particularly difficult becauseof certain psychological factors. It is obvious that if a person wishes tomake any gains, he should buy cheap and sell dear, i.e. buy when the share are selling at a low

price and sell when they are at a higher price. But in practical it is a difficult task. When the prices are rising in the market i.e. there is bull phase, everybody joins in buying without any delay because every day the prices touch a new high. Later when the bear face starts, prices tumble down everyday and everybody starts counting the losses. The ordinary investor regretted such situation by thinking why he did not sell his shares in previous day and ultimately sell at a lower price. This kind of investment decision is entirely devoid of any sense of timing.

There are various theories and technique to deal with the portfolio management, some of their concept are discuss shortly hereunder:-

Dow Jones theory: According to this theory of Charles H. Dow , purchase should be made when bull trend started i.e. when price of the share are on the rise and sells them when they are on the fall i.e. at the time when bearish trend started.

Randam walk theory: Basically stock prices can never be predicted because they are not a result of any underlying factors but are mere statistical ups and downs. This hypothesis is known as Randam walk hypothesis. In the Layman’s language it may be said that prices on the stock exchange behave exactly the way a drunk would behave while walking in a blind lane, i.e. up and down, with an unsteady way going in any direction he likes, bending on the side once and on the other side the second time.

Capital Assets Pricing Model(CAPM): CAPM provides a conceptual framework for evaluating any investment decision. It is used to estimate the expected return of any portfolio with the following formula:

E(Rp) = Rf+Bp(E(Rm)-Rf)

Where,E(Rp) = Expected return of the portfolio

Rf = Risk free rate of return

Bp = Beta portfolio i.e. market sensitivity index

E(Rm)= Expected return on market portfolio

(E(Rm)-Rf)= Market risk premium

The above model of portfolio management can be used effectively to:-*Estimate the required rate of return to investors on company’s common stock.**Evalute risky investment projects involving real Assets.***Explain why the use of borrowed fund increases the risk and increases the rate of return.****Reduce the risk of the firm by diversifying its project portfolio.Moving Average: It refers to the mean of the closing price which changes constantly and moves ahead in time, there by encompasses the most recent days and deletes the old one.

CONCLUSION

From the above discussion it is clear that portfolio functioning is based on market risk, so one can get the help from the professional portfolio manager or the Merchant banker if required before investment. Because applicability of practical knowledge through technical analysis can help an investor to reduce risk. In other words Security prices are determined by money manager and home managers, students and strikers, doctors and dog catchers, lawyers and landscapers, the wealthy and the wanting. This breadth of market participants guarantees an element of unpredictability and excitement. If we were all totally logical and could separate our emotions from our investment decisions then, the determination of price based on future earnings would work magnificently. And since we would all have the same completely logical expectations, price would only change when quarterly reports or relevant news was released.“I believe the future is only the past again, entered through another gate” –Sir Arthur wing Pinero. 1893.

If price are based on investors expectations, then knowing what a security should sell for become less important than knowing what other investors expect it to sell for. “ There are two times of a man’s life when he should not speculate; when he can’t afford it and when he can” – Mark Twin,1897.

A Casino make money on a roulette wheel , not by knowing what number will come up next, but by slightly improving their odds with the addition of a “0” and “00”. Yet many investors buy securities without attempting to control the odds. If we believe that this dealings is not a ‘Gambling” we have to start up it with intelligent way. Through it is basically a future estimation or expectation , one should know the standard norms and related rules for lowering the risk.

So you've established an asset allocation strategy that is right for you, but at the end of the year, you find that the weighting of each asset class in your portfolio has changed! What happened? Over the course of the year, the market value of each security within your portfolio earned a different return, resulting in a weighting change. Portfolio rebalancing is like a tune-up for your car: it allows individuals to keep their risk level in check and minimize risk.

What Is Rebalancing? 

Rebalancing is the process of buying and selling portions of your portfolio in order to set the weight of each asset class back to its original state. In addition, if an investor's investment strategy or tolerance for risk has changed, he or she can use rebalancing to readjust the weightings of each security or asset class in the portfolio to fulfill a newly devised asset allocation. 

Blown Out of Proportion

 The asset mix originally created by an investor inevitably changes as a result of differing returns among various securities and asset classes. As a result, the percentage that you've allocated to different asset classes will change. This change may increase or decrease the risk of your portfolio, so let's compare a rebalanced portfolio to one in which changes were ignored, and then we'll look at the potential consequences of neglected allocations in a portfolio. 

Let's run through a simple example. Bob has $100,000 to invest. He decides to invest 50% in a bond fund, 10% in a Treasury fund and 40% in an equity fund. 

At the end of the year, Bob finds that the equity portion of his portfolio has dramatically outperformed the bond and Treasury portions. This has caused a change in his allocation of assets,  increasing the percentage that he has in the equity fund while decreasing the amount invested in the Treasury and bond funds. 

More specifically, the above chart shows that Bob's $40,000 investment in the equity fund has grown to $55,000, an increase of 37%! Conversely, the bond fund suffered, realizing a loss of 5%, but the Treasury fund realized a modest increase of 4%. The overall return on Bob's portfolio was 12.9%, but now there is more weight on equities than on bonds. Bob might be willing to leave the asset mix as is for the time being, but leaving it too long could result in an overweighting in the equity fund, which is more risky than the bond and Treasury fund. (Learn more about the relative risk of various investments in Determining Risk And The Risk Pyramid.)

The Consequences Imbalance

A popular belief among many investors is that if an investment has performed well over the last year, it should perform well over the next year. Unfortunately, past performance is not always an indication of future performance - this is a fact many mutual funds disclose. Many investors, however, remain heavily invested in last year's "winning" fund and may drop their portfolio weighting in last year's "losing" fixed-income fund. Remember, equities are more volatile than fixed-income securities, so last year's  large gains   may   translate   into   losses   over   the   next   year. 

Let's continue with Bob's portfolio and compare the values of his rebalanced portfolio with the portfolio left unchanged. 

At the end of the second year, the equity fund performs poorly, losing 7%. At the same time the bond fund performs well, appreciating 15%, and Treasuries remain relatively stable with a 2% increase. If Bob had rebalanced his portfolio the previous year, his total portfolio value would be $118,500, an increase of 5%. If Bob had left his portfolio alone with the skewed weightings, his total portfolio value would be $116,858, an increase of only 3.5%. In this case, rebalancing is the optimal strategy. 

However, if the stock market rallies again throughout the second year, the equity fund would appreciate more and the ignored portfolio may realize a greater appreciation in value than the bond fund. Just as with many hedging strategies, upside potential may be limited, but, by rebalancing, you are nevertheless adhering to your risk-return tolerance level. Risk-loving investors are able to tolerate the gains and losses associated with a heavy weighting in an equity fund, and risk-averse investors, who choose the safety offered in Treasury and fixed-income funds, are willing to accept limited upside potential in exchange for greater investment security. (Determine your risk tolerance in Personalizing Risk Tolerance.)

How to Rebalance Your Portfolio 

The optimal frequency of portfolio rebalancing depends on your transaction costs, personal preferences and tax considerations, including what type of account you are selling from and whether your capital gains or losses will be taxed at a short-term versus long-term rate. Usually about once a year is sufficient; however, if some assets in your portfolio haven't experienced a large appreciation within the year, longer time periods may also be appropriate. Additionally, changes in an investor's lifestyle may warrant a change to his or her asset-allocation strategy. Whatever your preference, the following guideline provides the basic steps for rebalancing your portfolio:

1. Record - If you have recently decided on an asset-allocation strategy perfect for you and purchased the appropriate securities in each asset class, keep a record of the total cost of each security at that time, as well as the total cost of your portfolio. These numbers will provide you with historical data of your portfolio, so at a future date you can compare them to current values. 

2. Compare - On a chosen future date, review the current value of your portfolio and of each asset class. Calculate the weightings of each fund in your portfolio by dividing the current value of each asset class by the total current portfolio value. Compare this figure to the original weightings. Are there any significant changes? If not, and if you have no need to liquidate your portfolio in the short term, it may be better to remainpassive. 

3. Adjust - If you find that changes in your asset class weightings have distorted the portfolio's exposure to risk, take the current total value of your portfolio and multiply it by each of the (percentage) weightings originally assigned to each asset class. The figures you calculate will be the amounts that should be invested in each asset class in order to maintain your original asset allocation. You may want to sell securities from asset classes whose weights are too high, and purchase additional securities in asset classes whose weights have declined. However, when selling assets to rebalance your portfolio, take a moment to consider the tax implications of readjusting your portfolio. In some cases, it might be more beneficial to simply not contribute any new funds to the asset class that is

overweighted while continuing to contribute to other asset classes that are underweighted. Your portfolio will rebalance over time without you incurring capital gains taxes.

Conclusion Rebalancing your portfolio will help you maintain your original asset-allocation strategy and allow you to implement any changes you make to your investing style. Essentially, rebalancing will help you stick to your investing plan regardless of what the market does. (To learn more, read Achieving Optimal Asset Allocation.) 

To see more of The Manila Times, or to subscribe to the newspaper, go to http://www.manilatimes.net. Copyright (c) 2009, The Manila Times, Philippines Distributed by McClatchy-Tribune Information Services. For reprints, email [email protected], call 800-374-7985 or 847-635-6550, send a fax to 847-635-6968, or write to The Permissions Group Inc., 1247 Milwaukee Ave., Suite 303, Glenview, IL 60025, USA.

Nov. 13--FOREIGNERS were net investors in Philippine financial assets last month but in August, they were reluctant to pour money into establishing or expanding businesses in the country, based on data from the Bangko Sentral ng Pilipinas (BSP).

In a statement, the BSP said foreign direct investment (FDI) inflows fell 29 percent in August to $36 million. Despite the decline, the end-August tally still was 30-percent higher year-on-year at $1.275 billion because of FDI inflows in the previous months.

The BSP projected FDI to register a net inflow of $1.5 billion this year, supporting the surplus in the country's capital and financial account and allowing the balance of payments (BOP) to post a surplus of $4 billion to $5 billion.

BSP Governor Amando Tetangco Jr. said the country has sustained equity capital inflows and higher reinvested earnings despite challenging global economic conditions.

Gross equity capital placements reached $53 million in August consisting largely of capital infused by a Japanese firm in a local corporation. This, however, was lower than the $326 million in July.

At end-August, gross equity capital placements grew by 24.8 year-on-year to $1.4 billion. The investments came from the US, Japan, Hong Kong and The Netherlands. Recipient sectors included manufacturing, real estate, construction, services, financial intermediation, mining and trade/commerce.

Reinvested earnings also increased by 87.5 percent to $30 million as investors opted to retain profits in local enterprises. These amounted to $104 million for the first eight months, a turnaround from the $76 million net outflow recorded during the same period last year.

The other capital account, consisting mainly of intercompany borrowing/lending between foreign direct investors and their subsidiaries/affiliates in the Philippines, reversed to a net outflow of $162 million from a net inflow of $52 million during the comparable period last year.

The outflows were due primarily to the intercompany loan repayments to foreign direct investors and higher trade credits extended to parent companies abroad.

In a separate statement, the BSP said foreign portfolio investments (FPI) recorded net inflows in the first 10 months as a result of investor optimism on the sustained growth in remittances and reserves.

The BSP said net FPI surged by 175 percent to $129.16 million in October.

Year-to-date, net FPI inflows rose to $358 million from a $1.3 billion outflow last year when the global financial crisis turned for the worse following the collapse of Lehman Brothers in late September.

Also called "hot money," FPI represents foreign placements in the country's stocks, bonds and other peso-denominated financial assets.

"Foreign investors remained upbeat on the Philippine market on account of the sustained growth in overseas Filipino remittances and gross international reserves, as well as stable prices and interest rates, which overshadowed the impact of the deterioration in the country's fiscal position and drop in export receipts," Tetangco said.

The top five investor countries were the US, the United Kingdom, Singapore, Japan, and Luxembourg, all of which contributed 81 percent of total registered investments.

About 67 percent was invested in Philippine Stock Exchange (PSE)--listed shares while the balance pertained to peso-denominated government securities.

In October alone, the US, UK and Singapore were the top investor countries.

Registration of inward foreign investments with the BSP, which is voluntary, entitles the foreign investor to buy foreign exchange from authorized agent banks or their subsidiary/affiliate foreign exchange corporations for repatriation of capital and remittance of dividends/profits/earnings that accrue on the investment.

Credit: The Manila Times, Philippines

INTRODUCTION TO PORTFOLIOMANAGEMENTWe all dream of beating the market and being super investors and spend an inordinate amount of time and resources in this endeavor. Consequently, we are easy prey for the magic bullets and the

secret formulae offered by eager salespeople pushing their stuff. In spite of our best efforts, most of us fail in our attempts to be more than average investors. Nonetheless, we keep trying, hoping that we can be more like the investing legends – another Warren Buffett or Peter Lynch. We read the words written by and about successful investors, hoping to find in them the key to their stock-picking abilities, so that we can replicate them and become wealthy quickly. Investing in shares and debentures is profitable as well as exiting. It is indeed rewarding, but involves a great deal of risk and calls for scientific knowledge and forecasting skill. In such investments, both rational as well as emotional responses are involved. Investing in securities is considered as one of the best avenues to invest ones savings while it is acknowledged to be one of the most risky avenues of investment.It is unusual to find investors investing their entire money in one single security. Instead, they tend to invest in a group of securities. Such a group of securities is called a portfolio. Creation of a portfolio helps to reduce risks without sacrificing returns. Portfolio management deals with the analysis of individual securities as well as with the theory and practice of optimally combining securities into portfolios. An investor who understands the fundamental principals and analytical aspects of portfolio management has a better chance of success.

WHAT IS PORTFOLIO MANAGEMENT?An investor considering investment in securities is faced with the problem of choosing from among a large number of securities. His choice depends 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 security to hold and how much to invest in each. The investor faces an innumerable number of possible portfolios or group of securities. The risk and return characteristics of portfolios differ from those of individual securities combining to form a portfolio. The investor tries to choose the optimal portfolio taking into consideration the risk return characteristics of all possible portfolios. As the economic and financial environment keeps changing the risk and return characteristics of individual securities as well as portfolios also change. This calls for periodic review of and revision of investment portfolios of investors. An investor invests his funds in a portfolio expecting to get good return consistent with the risks that he has to bear. Thereturn realized from the portfolio has to be measured and the performance of the portfolio has to be evaluated. It is evident that rational investment activity involves creation of an investment portfolio. Portfolio management comprises all the processes involved in the creation and maintenance of an investment portfolio. It deals specifically with security analysis, portfolio analysis, portfolio selection, portfolio revision and portfolio evaluation. Portfolio management makes use of analytical techniques of analysis and conceptual theories regarding rational allocation of funds. Portfolio management is a complex process, which tries to make investment activity more rewarding and less risky.

OBJECTIVES OF PORTFOLIO MANAGEMENT

·Security/Safety of Principal: Security not only involves keeping the principal sum intact but also keeping intact its purchasing power.

· Stability of Income: Stability of income so as to facilitate planning more accurately and systematically the reinvestment or consumption of income.

· Capital Growth: Capital growth which can be attained by reinvesting in growth securities or through purchase of growth securities.

· Marketability: The case with which a security can be bought or sold. This isessential for providing flexibility to investment portfolio.· Liquidity: Liquidity i.e. nearness to money. It is desirable for the investor so as totake advantage of attractive opportunities upcoming in the market.· Diversification: The basic objective of building a portfolio is to reduce the risk ofloss of capital and income by investing in various types of securities and over a widerange of industries.· Favourable Tax Status: The effective yield an investor gets from his investmentdepends on tax to which it is subject. By minimizing the tax burden, yield can beeffectively improved.BASIC PRINCIPLES OF PORTFOLIO MANAGEMENTThere are two basic principles for effective Portfolio Management:1) Effective investment planning for the investment in securities by considering thefollowing factors:a) Fiscal, financial and monetary policies of the Government of India andthe Reserve Bank of India.b) Industrial and Economic environment and its impact on industryprospects in terms of prospective technological changes, competition in themarket, capacity utilization with industry and demand prospects etc.2) Constant review of investment: Portfolio managers are required to review theirinvestment in securities and continue selling and purchasing their investment in moreprofitable avenues. For this purpose they will have to carry the following analysis:a) Assessment of quality of management of the companies in whichinvestment has already been made or is proposed to be made.b) Financial and Trend analysis of companies, Balance Sheet/Profitand Loss accounts to identify sound companies with optimum capitalstructure and better performance and to disinvest the holding of thosecompanies whose performance is found to be slackening.c) The analysis of securities market and its trend is to be done on acontinuous basis.The above analysis will help to arrive at a conclusion as to whether the securitiesalready in possession should be disinvested and new securities be purchased. If so, thetiming for investment or dis-investment is also revealed.ACTIVITIES IN PORTFOLIO MANAGEMENTThe following three major activities are involved in an efficient portfolio management:a) Identification of assets or securities, Allocation of investments andidentifying asset classes.b) Deciding about major weights/proportion of differentassets/securities in the portfolio.

c) Security selection within the asset classes as identified earlier.The above activities are directed to achieve the sole purpose to maximize return andminimize risk in the investments. This will however be depending upon the class ofassets chosen for investment.The class of assets/securities varies according to the degree of risk. It is well interpretedthat higher the risk, higher will be the returns and vice versa. The portfolio managerforesees the balancing of risk and return in a portfolio investment. The composite risksinvolving the different risks are as indicated:1) Interest Rate Risk: This arises due to variability in the interest rates from time totime. A change in the interest rates establishes an inverse relationship in the price ofsecurity i.e. price of securities tend to move inversely with change in rate of interest, longterm securities show greater variability in the price with respect to interest rate changesthan short term securities. Interest rate risk vulnerability for different securities is asunder:TYPES RISK EXTENTCash equivalentLess vulnerable to interest raterisk.Long term bondsMore vulnerable to interest raterisk.2) Purchasing Power Risk: It is also known as inflation risk also emanates from thevery fact that inflation affects the purchasing power adversely. Nominal return containsboth the real return component and an inflation premium in a transaction involving risk tocompensate for inflation over an investment holding period. Inflation rates vary over timeand investors are caught unaware when rate of inflation changes unexpectedly causingerosion in the value of realized rate of return and expected return. Purchasing power riskis more in inflationary conditions especially in respect of bonds and fixed incomesecurities. It is not desirable to invest in such securities during inflationary periods.Purchasing power risk is however, less in flexible income securities like equity share orcommon stock where rise in dividend income off-sets increase in the rate of inflation andprovides advantage of capital gains.3) Business Risk: Business risk emanates from sale and purchase of securities affectedby business cycles, technological changes, etc. Business cycle affect all types ofsecurities viz. there is cheerful movement in boom due to bullish trend in stock priceswhereas bearish trend in depression brings down fall in the prices of all types ofsecurities. Flexible income securities are more affected than fixed rate securities duringdepression due to decline in their market price.4) Financial Risk: It arises due to changes in the capital structure of the company. It isalso known as leveraged risk and expressed in terms of debt-equity ratio. Excess of debtequity in the capital structure indicates that the company is highly geared. Although aleveraged company’s earnings per share are more but dependence on borrowings exposesit to the risk of winding-up for its inability to honor its commitments towardslenders/creditors. This risk is known as leveraged or financial risk of which investorsshould be aware and portfolio managers should be vary careful.Chapter II

INTRODUCTION TO PORTFOLIO MANAGERIn view of peculiar nature of stock exchange operations most of the investors feelinsecure in managing their investment on the stock market because it is difficult for anindividual to identify companies which have growth prospects conducive for investment.This is further complicated by the volatile nature of the markets, which demands constantreshuffling of portfolios to capitalize on the growth opportunities.Even if the investor is able to identify growth oriented companies and their securities, thetrading practices are complicated, making it a difficult task for investors to trade in all theexchanges and follow-up on post trading formalities. That is why professional investmentadvice through Portfolio Management Services (PMS) can help the investor to make anintelligent and informed choice between alternative investment opportunities without theworry of post trading hassles.DEFINITION OF PORTFOLIO / PORTFOLIO MANAGER:Portfolio means the total holdings of securities belonging to any person. Portfoliomanager means any person who enters into a contract or agreement with a client.Pursuant to such agreements he advices the clients or undertakes on behalf of such clientmanagement or administration of a portfolio of securities or invests and manages theclient’s funds.Two Types of Portfolio ManagersDiscretionary Non- DiscretionaryPortfolio Manager Portfolio Manager

1. Discretionary Portfolio Manager:

A discretionary portfolio manager means a portfolio manager who exercises or may,under a contract relating to portfolio management, exercises any degree of discretionin respect of the investments or management of the portfolio of securities or the fundsof the clients, as the case may be. He shall individually and independently manage thefunds of each client in accordance with the needs of the client in a manner which doesnot resemble a mutual fund.

2. Non-Discretionary Portfolio Manager:

A Non-Discretionary Portfolio Manager shall manage the funds of each client inaccordance with the directions of the client.A portfolio manager, by the virtue of his knowledge, background andexperience is expected to study the various avenues available for profitableinvestment and advise his client to enable the latter to maximize the return on hisinvestment and at the same time safeguard the funds invested.NEED FOR AND ROLE OF PORTFOLIO MANAGER:

With the development of the Indian securities market and with the appreciation in themarket price of equity shares of profit-making companies, investment in securities ofsuch companies has become quite attractive. At same time, the stock market becomingvolatile n account of various factors, a layman is puzzled as to how to make hisinvestments without losing the same. He has felt the need of expert’s guidance n thisrespect. Similarly Non-resident are eager to make their investments in Indian companies.They have also to comply with the conditions specified by the Reserve Bank of India

under various schemes for investment by the non-resident. The Portfolio Manager, withhis background and expertise, meets the needs of such investors by rendering service inhelping them to invest their funds profitably.FUNCTIONS OF PORTFOLIO MANGERS:Portfolio mangers rendering the services of portfolio management to their clients indifferent categories, viz. individuals, resident Indians and non-resident Indians, firms,association of persons like Joint Hindu Family, Trust, Society, Corporate EnterprisesProvident Fund Trustees etc. have to enquire of their individual objectives, need patternfor funds, perspective towards growth and attitude towards risk before counseling themon the subject and acceptance of the assignment. Nevertheless, portfolio managers in thewake of rendering their services perform following set of functions:· They study economic environment affecting the capital market and clientsinvestment.· They study securities market and evaluate price trend of shares and securities inwhich investment is to be made.· They maintain complete and updated financial performance data of Blue-Chipand other companies.· They keep a track on latest policies and guidelines of Government of India, RBIand Stock Exchanges.· They study problems of industry affecting securities market and the attitude ofinvestors.· They study the financial behaviour of development financial institutions andother players in the capital market to find out sentiments in the capital market.· They counsel the prospective investors on share market and suggest investmentsin certain assured securities.· They carry out investments in securities or sale or purchase of securities onbehalf of the clients to attain maximum return at lesser risk.CODE OF CONDUCT - PORTFOLIO MANAGERS:· A portfolio manager shall, in the conduct of his business, observe high standardsof integrity and fairness in all his dealings with his clients and other portfoliomanagers.· The money received by a portfolio manager from a client for an investmentpurpose should be deployed by the portfolio manager as soon as possible for thatpurpose and money due and payable to a client should be paid forthwith.· A portfolio manager shall render at all time high standards of services exercisedue diligence, ensure proper care and exercise independent professionaljudgment. The portfolio manager shall either avoid any conflict of interest in hisinvestment or disinvestments decision, or where any conflict of interest arises;ensure fair treatment to all his customers. He shall disclose to the clients, possiblesources of conflict of duties and interest, while providing unbiased services. Aportfolio manager shall not place his interest above those of his clients.· A portfolio manager shall not make any statement or become privy to any act,practice or unfair competition, which is likely to be harmful to the interests ofother portfolio managers or it likely to place such other portfolio managers in adisadvantageous position in relation to the portfolio manager himself, whilecompeting for or executing any assignment.

· A portfolio manager shall not make any exaggerated statement, whether oral orwritten, to the client either about the qualification or the capability to rendercertain services or his achievements in regard to services rendered to otherclients.· At the time of entering into a contract, the portfolio manager shall obtain inwriting from the client, his interest in various corporate bodies, which enableshim to obtain unpublished price-sensitive information of the body corporate.· A portfolio manager shall not disclose to any clients or press any confidentialinformation about his clients, which has come to his knowledge.· The portfolio manager shall where necessary and in the interest of the client takeadequate steps for registration of the transfer of the client’s securities and forclaiming and receiving dividend, interest payment and other rights accruing tothe client. He shall also take necessary action for conversion of securities andsubscription of/or rights in accordance with the client’s instruction.· Portfolio manager shall ensure that the investors are provided with true andadequate information without making any misguiding or exaggerated claims andare made aware of attendant risks before they take any investment decision.· He should render the best possible advice to the client having regard to theclient’s needs and the environment, and his own professional skills.· Ensure that all professional dealings are affected in a prompt, efficient and costeffective manner.

PORTFOLIO REVISIONIn portfolio management, the maximum emphasis is placed on portfolio analysisand selection which lads to the construction of the optimal portfolio. Very littlediscussion is seen on portfolio revision which is as important as portfolio analysis orselection.The financial markets are continually changing. In this dynamic environment, a portfoliothat was optimal when constructed may not be so with the passage of time. It may have tobe revised periodically so as to ensure that it remains optimal.NEED FOR REVISIONThe primary factor necessitating portfolio revision is changes in the financialmarkets since the creation of the portfolio. The need for portfolio revision may arisebecause of some investor related factors also. These factors may be listed as:· Availability of additional funds for investment.· Change in risk tolerance· Change in investment goals· Need to liquidate a part of the portfolio to provide funds for some alternative use.The portfolio needs to be revised to accommodate the changes in the investor’s position.Thus the need for portfolio revision may arise from changes in the financial market orchanges in the investor’s position, namely, his financial status and preferences..MEANING OF PORTFOLIO REVISIONA portfolio is a mix of securities selected from a vast universe of securities. Twovariables determine the composition of a portfolio; the first is the securities included inthe portfolio and the second is the proportion of total funds invested in each security.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 alteringthe proportion of funds invested in the securities. New securities may be added to theNotes Compiled by Prof.V.S.Gopalportfolio or some of the existing securities may be removed from the portfolio. Portfoliorevision thus leads to the purchases and sales of the securities. The objective of portfoliorevision is the same as selection i.e. maximization of returns for a given level of risk orminimizing the risk for a given level of return. The ultimate aim of portfolio revision ismaximization of returns and minimization of risk.CONSTRAINTS IN PORTFOLIO REVISIONPortfolio revision is the process of adjusting the existing portfolio in accordancewith the changes in the financial markets and the investor’s position so as to ensuremaximum return from the portfolio with the minimum of risk. Portfolio revisionnecessitates purchase and sale of securities. The practice of portfolio adjustmentinvolving purchase and sale of securities gives rise to certain problems which act asconstraints in portfolio revision. Some of these are discussed below:· Transaction cost: Buying and selling of securities involve transaction costs suchas commission and brokerage. Frequent buying and selling of securities forportfolio revision may push up transaction costs thereby reducing the gains fromportfolio revision. Hence, the transaction costs involved in portfolio revision mayact as a constraint to timely revision of portfolios.· Taxes: Tax is payable on the capital gains arising from sale of securities. Usually,long-term capital gains are taxed at a lower rate than short-term capital gains. Toqualify as long-term capital gain, a security must be held by an investor for aperiod of not less than 12 months before sale. Frequent sale of securities in thecourse of periodic portfolio revision or adjustment will result in short-term capitalgains, which would be taxed at a higher rate compared to long-term capital gains.The higher tax of short-term capital gains may act as a constraint to frequentportfolio revisions.Notes Compiled by Prof.V.S.Gopal· Statutory stipulations: The large portfolios in every country are managed byinvestment companies and mutual funds. These institutional investors arenormally governed by certain statutory stipulations regarding their investmentactivity. These stipulations often act as constraints in timely portfolio revision.· Intrinsic difficulty: Portfolio revision is a difficult and a time consumingexercise. The methodology to be followed for portfolio revision is also not clearlyestablished. Different approaches may be adopted for the purpose. The difficultyof carrying out portfolio revision itself may act as a constraint to portfoliorevision.

PORTFOLIO REVISION STRATEGIESTwo different strategies may be adopted for portfolio revision, namely, an activerevision strategy and a passive revision strategy. The choice of the strategy woulddepend on the investors objectives, skills, resources and time.

Active revision strategy involves frequent and sometimes substantial adjustmentsto the portfolio. Investors who take active revision strategy believe that the securitiesmarkets are not continuously efficient. They believe that the securities can be mispricedat times giving an opportunity for earning excess returns through trading in them.Moreover, they believe that different investors have divergent expectations regarding therisk and return of the securities in the market. The practitioners of the active revisionstrategy are confident of developing a better estimate of the true risk and return of thesecurity than the rest of the market. They hope to use their better estimated to generateexcess returns. Thus the objective of active revision strategy is to beat the market.Portfolio revision strategy, in contrast, involves only minor and infrequentadjustments to the portfolio over time. The practitioners of passive revision strategybelieve in market efficiency and homogeneity of expectation among investors. They findlittle incentive for actively trading and revising portfolios practically.Under passive revision strategy, adjustment to the portfolio is carried outaccording to certain predetermined rules and procedures designated as Formula Plans.Notes Compiled by Prof.V.S.GopalThese Formula Plans help the investor to adjust his portfolio according to changes in thesecurities market.FORMULA PLANS:In the market the prices of securities fluctuate. Ideally, investors should buy when pricesare low and sell when prices are high. If portfolio revision is done according to thisprinciple, investors would be able to benefit from the price fluctuations in the securitiesmarket. But investors are hesitant to buy when prices are low either expecting the pricesto fall further or fearing that the prices would not move further up again. Similarly, whenprices are high, investors hesitate to sell because they feel that the prices will fall furtherand they may realize larger profits.Thus, left to themselves, investors will not be acting in a way required to benefitfrom price fluctuations. Hence certain mechanical revision techniques have beendeveloped to enable the investor to take advantage of the price fluctuations in the market.The technique is referred as Formula Plans.Formula plans represent an attempt to exploit the price fluctuations in the marketand make them a source of profit to the investor. They make the decisions on the timingof buying and selling securities automatically and eliminate the emotions surrounding thetiming decisions. Formula plans consist of predetermined rules regarding when to buy orsell and how much to buy and sell. These predetermined rules call for specific actionswhen there are changes in the securities market.There are different formula plans for implementing passive portfolio revision.Some of them are enumerated below: -Constant Rupee Value Plan:This is one of the most commonly used formula plans. In this plan the investor constructstwo portfolios, one aggressive consisting of equity shares and the other one defensiveconsisting of bonds and debentures. The purpose of this plan is to keep the value of theaggressive portfolio constant, i.e. at the original amount invested in the aggressiveportfolio.Notes Compiled by Prof.V.S.GopalAs share prices fluctuate, the value of the aggressive portfolio keeps changing. When

share prices are increasing, the total value of the aggressive portfolio increases. Theinvestor has to sell some of his shares from his portfolio to bring down the total value ofthe aggressive portfolio to the level of his original investment in it. The sale proceeds willbe invested I the defensive portfolio by buying bonds and debenturesOn the contrary, when share prices are falling, the total value of the aggressive portfoliowould also decline. To keep the total value of the aggressive portfolio at its original level,the investor has to buy some shares from the market to be included in his portfolio. Forthis purpose, a part of the defensive portfolio will be liquidated to raise the money neededto buy additional shares.Under this plan, the investor is effectively transferring funds from the aggressiveportfolio to the defensive portfolio and thereby booking profit when share prices areincreasing. Funds are transferred from the defensive portfolio to the aggressive portfoliowhen share prices are low. Thus the plan helps the investor to buy shares when theirprices are low and sell them when their prices are high.In order to implement this plan, the investor has to decide the action points, i.e., when heshould make the transfer of funds to keep the rupee value of the aggressive portfolioconstant. These action points, or revision points, should be predetermined and should bechosen carefully. The revision points have a significant effect on the returns of theinvestor. For instance, the revision points may be predetermined as 10 per cent, 15 percent, 20 per cent etc. above or below the original investment in the aggressive portfolio.If the revision points are too close, the number of transactions would be more and thetransaction costs would increase reducing the benefits of revision. If the revision pointsare set too far apart, it may not be possible to profit from the price fluctuations occurringbetween these revision points.Example: We can understand the working of the “constant rupee value plan” byconsidering an example. Let us consider an investor who has Rs. 1,00,000 for investment.He decides to invest Rs. 50,000 in an aggressive portfolio of equity shares and theNotes Compiled by Prof.V.S.Gopalremaining Rs. 50,000 in a defensive portfolio of bonds and debentures. He purchases1250 shares selling at Rs. 40 per share for his aggressive portfolio. The revision pointsare fixed as 20 per cent above or below the original investment of Rs. 50,000.After the construction of the portfolios, the share price will fluctuate. If the price of theshare increases to Rs. 45, the value of the aggressive portfolio increases to Rs. 56,250(that is, 1250 x Rs. 45). Since the revision points are fixed at 20 per cent above or belowthe original investment, the investor will act only when the value of the aggressiveportfolio increases to Rs. 60,000 or falls to Rs. 40,000. If the price of the share increasesto Rs. 48 or above, the value of the aggressive portfolio will exceed Rs. 60,000. Let ussuppose that the price of the share increases to Rs. 50, the value of the aggressiveportfolio will be Rs. 62,500. The investor will sell shares worth Rs. 12,500 (that is 250shares at Rs. 50 per share) and transfer the amount to the defensive portfolio by buyingbonds for Rs. 12,500. The value of the aggressive and defensive portfolios would now beRs. 50,000 and Rs. 62,500 respectively. The aggressive portfolio now has only 1000shares valued at Rs. 50 per share.Let us now suppose that the share price falls to Rs. 40 per share. The value of theaggressive portfolio would then be Rs. 40,000 (i.e., 1000 shares x Rs. 40) which is 20 percent less than the original investment. The investor now has to buy shares worth Rs.

10,000 (that is, 250 shares at Rs. 40 per share) to bring the value of the aggressiveportfolio to its original level of Rs. 50,000. The money required for buying the shares willbe raised by selling bonds from the defensive portfolio.The two portfolios now will have values of Rs. 50,000 (aggressive) and Rs. 52,500 (i.e.,Rs. 62,500 - Rs. 10,000) (defensive), aggregating to Rs. 1,02,500. It may be recalled thatthe investor started with Rs. 1,00,000 as investment in the two portfolios. Thus, when the`constant rupee value plan' is being implemented, funds will be transferred from oneportfolio to the other, whenever the value of the aggressive portfolio increases or declinesto the predetermined levels.Notes Compiled by Prof.V.S.GopalConstant Ratio PlanThis is a variation of the constant rupee value plan. Here again the investor wouldconstruct two portfolios, one aggressive and the other defensive with his investmentfunds. The ratio between the investments in the aggressive portfolio and the defensiveportfolio would be predetermined such as 1:1 or 1.5:1 etc. The purpose of this plan is tokeep this ratio constant by readjusting the two portfolios when share prices fluctuate fromtime to time. For this purpose, a revision point will also have to be predetermined. Therevision points may be fixed as ± 0.10 for example. This means that when the ratiobetween the values of the aggressive portfolio and the defensive portfolio moves up by0.10 points or moves down by 0.10 points, the portfolios would be adjusted by transfer offunds from one to the other.Let us assume that an investor starts with Rs. 20,000, investing Rs. 10,000 each in theaggressive portfolio and the defensive portfolio. The initial ratio is then 1:1. He haspredetermined the revision points as ± 0.20. As share price increases the value of theaggressive portfolio would rise. When the value of the aggressive portfolio rises to Rs.12,000, the ratio becomes 1.2:1 (i.e., Rs. 12,000: Rs. 10,000). Shares worth Rs. 1,000 willbe sold and the amount transferred to the defensive portfolio by buying bonds. Now thevalue of both the portfolios would be Rs. 11,000 and the ratio would become 1:1.Now let us assume that the share prices are falling. The value of the aggressive portfoliowould start declining. If, for instance, the value declines to Rs. 8,500, the ratio becomes0.77:1 (i.e., Rs. 8.500: Rs. 1,000). The ratio has declined by more than 0.20 points. Theinvestor now has to make the value of both portfolios equal. He has to buy shares worthRs. 1,250 by selling bonds for an equivalent amount from his defensive portfolio. Nowthe value of the aggressive portfolio increases by Rs. 1.250 and that of the defensiveportfolio decreases by Rs. 1,250. The values of both portfolios become Rs. 9,750 and theratio becomes 1:1.The adjustment of portfolios is done periodically in this manner.Notes Compiled by Prof.V.S.GopalDollar Cost AveragingThis is another method of passive portfolio revision. This is, however, different from thetwo Formula Plans discussed above. All Formula Plans assume that stock prices fluctuateup and down in cycles. Dollar cost averaging utilizes this cyclic movement in shareprices to construct a portfolio at low cost.The Plan stipulates that the investor invest a constant sum, such as Rs. 5,000, Rs. 10,000,etc, in a specified share or portfolio of shares regularly at periodical intervals, such as amonth, two months, a quarter, etc. regardless of the price of the shares at the time ofinvestment. This periodic investment is to be continued over a fairly long period to cover

a complete cycle of share price movements.If the Plan is implemented over a complete cycle of stock prices, the investor will obtainhis shares at a lower average cost per share than the average price prevailing in themarket over the period. This occurs because more shares would be purchased at lowerprices than at higher prices.The Dollar Cost Averaging is really a technique of building up a portfolio over a periodof time. The Plan does not envisage withdrawal of funds from the portfolio in between.When a large portfolio has been built up over a complete cycle of share price movements,the investor may switch over to one of the other formula plans for its subsequent revision.The “dollar cost averaging” is specially suited to investors who have periodic sums toinvest.The various formula plans attempt to make portfolio revision a simple and almostmechanical exercise enabling the investor to automatically buy shares when their pricesare low and sell them when their prices are high. But formula plans have their limitations.By their very nature they are inflexible. Further, these plans do not indicate whichsecurities from the portfolio are to be sold and which securities are to be bought to beincluded in the portfolio. Only active portfolio revision can provide answers to thesequestions

PORTFOLIO SELECTIONThe objective of every investor is to maximize his returns and minimize his risk.Diversification is the method adopted to reduce the risk. It essentially results in theconstruction of portfolios. The proper goal of construction of portfolios would be togenerate a portfolio that provides the highest return and lowest risk. Such a portfoliowould be an optimal portfolio. The process of finding the optimal portfolio is describedas portfolio selection.The conceptual framework and analytical tools for determining the optimalportfolio in disciplined and objective manner have been provided by Harry Markowitz inhis pioneering work on portfolio analysis described in his 1952 “ JOURNAL OFFINANCE” article and subsequent book in 1959. His method of portfolio selection iscome to be known as Markowitz model. In fact, Markowitz work marked the beginningof what is today the Modern Portfolio Theory.FEASIBLE SET OF PORTFOLIOSWith limited number of securities an investor can create a very large number ofportfolios by combining these securities in different proportions. These constitute thefeasible set of portfolios in which the investor can possibly invest. This is also known asthe portfolio opportunity set.Each portfolio in the opportunity set is characterized by an expected return and ameasure of risk, viz., and variance of the returns. Not every portfolio in the portfolioopportunity set is of interest to an investor. In an opportunity set some portfolios will bedominant over the others. A portfolio will dominate the other if it has either a lowervariance and the same expected return as the other, or a higher return and the samevariance as the other. Portfolios that are dominated by the others are called asinsufficient portfolios. An investor would not be interested in all the portfolios in theopportunity set. He would be interested only in the efficient portfolios.

Notes Compiled by Prof.V.S.GopalEFFICIENT SET OF PORTFOLIOSTo understand the concept of efficient portfolios, let us consider variouscombinations of securities and designate them as portfolios 1 to n. the expected returns ofthese portfolios may be worked out. The risk of these portfolios may be estimated bymeasuring the variance of the portfolio returns. The table below shows illustrative returnsand variance of some portfolios:Portfolio No. Expected Return(per cent)Variance(risk)1 5.6 4.52 7.8 5.83 9.2 7.64 10.5 8.15 11.7 8.16 12.4 9.37 13.5 9.58 13.5 11.39 15.7 12.710 16.8 12.9If we compare portfolios 4 and 5, for the same variance of 8.1 portfolio no. 5gives a higher expected return of 11.7, making it more efficient than portfolio no. 4.Again, if we compare portfolios 7 and 8 for the same expected return of 13.5%, thevariance is lower for portfolio no.7, making it more efficient than portfolio no. 8. Thusthe selection of the portfolios by the investor will be guided by two criteria:· Given two portfolios with the same expected return, the investor will prefer theone with the lower risk.· Given two portfolios with the same risk, the investor will prefer the one with thehigher expected returns.These criteria are based on the assumption that investors are rational and also risk averse.As they are rational they would prefer more returns to less returns. As they are riskaverse, they would prefer less risk to more risk.The concept of efficient sets can be illustrated with the help of a graph. Theexpected returns and the variance can be depicted on a XY graph, measuring the expectedNotes Compiled by Prof.V.S.Gopalreturns on the Y-axis and the variance on the X-axis. The figure below depicts such agraph.As a single point in the risk-return space would represent each possible portfolio in theopportunity set or the feasible set of portfolio enclosed within the two axes of the graph.The shaded area in the graph represents the set of all possible portfolios that can beconstructed from a given set of securities. This opportunity set of portfolios takes aconcave shape because it consists of portfolios containing securities that are less thanperfectly correlated with each other.Let us closely examine the diagram above. Consider portfolios F and E. Both theportfolios have the same expected return but portfolio E has less risk. Hence portfolio E

would be preferred to portfolio F. Now consider portfolios C and E. Both have the samerisk, but portfolio E offers more return for the same risk. Hence portfolio E would bepreferred to portfolio C. Thus for any point in the risk-return space, an investor wouldlike to move as far as possible in the direction of increasing returns and also as far asNotes Compiled by Prof.V.S.Gopalpossible in the direction of decreasing risk. Effectively, he would be moving towards theleft in search of decreasing risk and upwards in search of increasing returns.Let us consider portfolios C and A. Portfolio C would be preferred to portfolio A becauseit offers less risk for the same level of return. In the opportunity set of portfoliosrepresented in the diagram, portfolio C has the lowest risk compared to all otherportfolios. Here portfolio C in this diagram represents the Global Minimum VariancePortfolio.Comparing portfolios A and B, we find that portfolio B is preferable to portfolio Abecause it offers higher return for the same level of risk. In this diagram, point Brepresents the portfolio with the highest expected return among all the portfolios in thefeasible set.Thus we find that portfolios lying inthe North West boundary of the shadedarea are more efficient than all theportfolios in the interior of the shadedarea. This boundary of the shaded areais called the Efficient Frontier becauseit contains all the efficient portfolios inthe opportunity set. The set ofportfolios lying between the globalminimum variance portfolio and themaximum return portfolio on theefficient frontier represents the efficient set of portfolios. The efficient frontier is shownseparately in Fig.The efficient frontier is a concave curve in the risk-return space that extends from theminimum variance portfolio to the maximum return portfolio.Notes Compiled by Prof.V.S.GopalSELECTION OF OPTIMAL PORTFOLIOThe portfolio selection problem is really the process of delineating the efficient portfoliosand then selecting the best portfolio from the set.Rational investors will obviously prefer to invest in the efficient portfolios. The particularportfolio that an individual investor will select from the efficient frontier will depend onthat investor's degree of aversion to risk. A highly risk averse investor will hold aportfolio on the lower left hand segment of the efficient frontier, while an investor who isnot too risk averse will hold one on the upper portion of the efficient frontier.The selection of the optimal portfolio thus depends on the investor's risk aversion, orconversely on his risk tolerance. This can be graphically represented through a series ofrisk return utility curves or indifference curves. The indifference curves of an investor areshown in Fig. Each curve represents different combinations of risk and return all ofwhich are equally satisfactory to the concerned investor. The investor is indifferentbetween the successive points in the curve. Each successive curve moving upwards to the

left represents a higher level of satisfaction or utility. The investor's goal would be tomaximize his utility by moving up to the higher utility curve. The optimal portfolio for aninvestor would be the one at the point of tangency between the efficient frontier and hisrisk-return utility or indifference curve.This is shown in Fig. The point O' represents the optimal portfolio. Markowitz used thetechnique of quadratic programming to identify the efficient portfolios. Using theexpected return and risk of each security under consideration and the covarianceestimates for each pair of securities, he calculated risk and return for all possibleportfolios. Then, for any specific value of expected portfolio return, he determined theleast risk portfolio using quadratic programming. With another value of expectedportfolio return, a similar procedure again gives the minimum risk portfolio. The processis repeated with different values of expected return, the resulting minimum risk portfoliosconstitute the set of efficient portfolio

Bond Portfolio ManagementStrategiesStock market investors will choose a particular risk level on the SMLand invest at this point, choosing only those securities that lie on theSML (or above it). Stock investors have different levels of risk/returnrequirements Bond investors will do the same thing. A young,aggressive bond investor may choose a high risk bond & is willing torisk his principal investment. A retiree may not be willing to take arisky bond investment and may, instead invest in conservative bonds.Individual investors choose to invest in bonds. Also, pension plans,banks, insurance companies and other institutions invest in bonds. Atany rate, all investors are interested in a bond investment strategy.There are three major types of strategies:1. passive portfolio management strategies2. active portfolio management strategies3. matched-funding strategiesIn the 1950s the bond market was considered a safe, conservativeinvestment. At that time a buy-and-hold strategy was sufficient.However, times changed, in the 1960s inflation increased, and interestrates became more volatile. Thus, with more volatile interest rates,there was a great amount of profit potential with bonds. Also, in the1970s the Macauley duration measure was re-discovered.Not all investors viewed the rise in interest rate volatility as a goodthing. The pension fund and insurance companies that invest in bondfound their job much more difficult. Thus, strategies based on durationwere developed to aid pension fund managers to match their liabilitieswith properly constructed bond portfolios.Passive Bond Portfolio StrategiesThere are two major passive strategies:· buy-and-hold

· indexingBuy-and-hold StrategyThis strategy simply involves buying a bond and holding it untilmaturity. Bond investors would examine such factors as qualityratings, coupon levels, terms to maturity, call features and sinkingfunds. These investors do not trade actively to earn returns, ratherthey look for bonds with maturities or durations that match theirinvestment horizon.There is also a modified buy-and-hold strategy in which investors buybonds with the intention of holding them until maturity, but they stillactively look for opportunities to trade into more desirable positions.[However, if you modify this too much it turns into an active strategy.] While the buy-and-hold strategy is a passive strategy, it still involves agreat deal of work. Agency issues typically provide high quality bondsat a higher return than Treasury securities, callability affects theattractiveness of an issue, etc. Plus, you may want to develop aportfolio in which coupon payments are structured (and principalrepayments).Techniques, Vehicles and Costs: Only default-free or very highquality securities should be held. Also, those securities that arecallable by firm (allows the issuer to buy back the bond at a particularprice and time) or putable by holder (allows bondholder to sell thebond to issuer at a specified price and time) will introduce alterationsin the firm's cash flows, and probably should not be included in thebuy-and-hold strategy. Also, those investors seeking to lock in a rateof return may choose a zero-coupon bond--good strategy for collegetuition or retirement. The buy-and-hold strategy minimizes transactioncosts and, if implemented astutely, can be highly productive. Forexample, if interest rates are currently high and are expected toremain so for an extended period of time, the buy-and-hold strategywill do well.IndexingIndexing involves attempting to build a portfolio that will match theperformance of a selected bond portfolio index, such as the ShearsonLehman Hutton Government/Corporate Bond Index, Merrill LynchIndex, etc. This portfolio manager is judged on his ability to track theindex.Techniques, Vehicles and Costs: The fixed income market isbroader (in terms of security types) than the equity market. Also, eventhough the Shearson Lehman Hutton Corporate Bond Index has over4,000 securities, it only represents high quality corporate bond issues.Thus, a compromise must be made when selected among differentindexes. Also, the strategy of buying every bond in a market indexaccording to its weight in the index is not a practical one. However, arelevant subset is possible. We may choose to emulate a narrowerbond index.

Alternative Vehicles: We may choose to randomly select bonds fromthe universe of bonds, or, we may choose the stratified approach(segmenting the index into components from which individualsecurities are chosen). When choosing the indexing option, bondportfolio management cannot be considered entirely passive. Also,there will be transaction costs associated with (1) purchasing theissues used to construct the index; and (2) reinvesting cash paymentsfrom coupon and principal repayments; and (3) rebalancing of portfolioif the composition of your target index changes. Whereas fullreplication of the target index would work best, this is impractical. Ifyou choose the stratified method, your performance will probably notmirror your target index.How many securities should you have in your portfolio if you use therandom sampling approach? McEnally and Boardman (1979) havefound that, once an index is selected, close replication is possible withperhaps 40 bonds (for the long term).Stratified Approach: Consists of analyzing the index to determinevarious stratification levels (what portion of securities that make upindex are Treasury, Aaa Industrial, Baa Financial, of X years tomaturity, of X% coupon rate, etc.). The next step is to select thesecurities for your portfolio. Typically, at selection and at therebalancing period (usually once a month) one security is chosen fromeach category (there could be 40 categories). There's no requirementas to which security is selected from each class.Active Management StrategiesThese strategies require major adjustments to portfolios, trading totake advantage of interest rate fluctuations, etc. There are five majoractive bond portfolio management strategies:1. Interest rate anticipation2. Valuation analysis3. Credit analysis4. Yield spread analysis5. bond swapsIn each strategy, the manager hops to outperform the buy-and-holdpolicy by using acumen, skill, etc.Interest Rate AnticipationThis is the riskiest strategy because the investor must act on uncertainforecasts of future interest rates. The strategy is designed to preservecapital (lose as little as possible) when interest rates rise (and bondprices drop) and to receive as much capital appreciation as possiblewhen interest rates drop (and bond prices rise).These objectives can be obtained by altering the maturity or durationof their portfolios. Longer maturity, or longer duration, portfolios willbenefit the most from an interest rate decrease and vice versa. Thus,if a manager expects an increase in interest rates, they wouldstructure portfolio to have the lowest possible duration.

The problem faced with this type of strategy is the risk of misestimatinginterest rate movements. It is difficult (EXTREMELY) topredict (with accuracy) interest rate movements.However, if this is your strategy, you should be concerned with:· direction of the change in interest rates· the magnitude of the change across maturities, and· the timing of the change.How your bond will be affected by changes in interest rates can usuallybe directly related to the security's duration. Thus, if you expect IR todrop, you should shift to high duration securities. Also, the timing as towhen you expect the interest rate shift is important. You don't want toshift too early, because you may compromise some return. Obviously,you don't want to wait too late.Scenario Analysis: Say, "what if" interest rates rise/fall by this muchover the next month/year/etc. Analyze the individual bonds withinyour portfolio under each scenario and see how the returns areaffected under each scenario. [See p. 8-30] The scenario analysisleads us to further analysis.Relative Return Value Analysis: We can calculate the overallexpected return for each bond in our scenario (expected return undereach interest rate scenario weighted by the probability of that scenariooccurring) and the current duration of each bond in our portfolio andgraph the relationship. Those bonds falling above a regression line(showing the general relationship) would be doing ok!Strategic Frontier Analysis: We can graph the bonds in our portfoliowith the best case scenario (an interest rate decrease) on the verticalaxis and the worst case scenario on the horizontal axis, as shownbelow:Those securities which fall into Quadrant I represent aggressivesecurities--if the best case happens, they will do well; however if theworst case happens they will be the worst performers. Those securitiesfalling into Quadrant II are superior securities--they will perform wellregardless of which scenario occurs. Quadrant III represents defensivesecurities--they will do well under the worst case scenario, but performpoorly if the best case occurs. Quadrant IV securities are inferior asthey will perform poorly regardless of the scenario. You should sellsecurities falling into Quadrant IV. Normally a few securities would fallinto Quadrants II and IV, with most falling into Quadrants I and III.Valuation AnalysisThe portfolio manager looks for undervalued bonds--those bonds thathave a computed value (according to the portfolio manager) higherthan the current market price). This also translates to those bondswhose expected YTM is lower than the current YTM. This strategyrequires lots of analysis (continuous evaluations) and lots of tradingbased on the analysis. Based on your confidence in your analysis, youwould buy undervalued bonds and sell overvalued bonds (or ignore

them if they are not in your portfolio).Valuation Analysis: We can examine the term structure of purediscount bonds (zero coupon) and thus determine the value of USTreasuries, thus we can determine the default free characteristics ofany other type of bond. Then we can attempt to determine the otherfactors that will affect bond yield by using multiple factor regressionanalysis (looking at things such as: quality rating, coupon effect,sector effect, call provision, sinking fund attributes, etc.) Using thisfactor analysis, we can determine the expected yield for the security (ifthe expected yield < current YTM then buy). However, there is somesubjectivity in factor analysis. For instance, if there is some "eventrisk" (something affecting the financial stability of firm) missing fromthe analysis, or if there is any anticipation of a market upgrade...Credit AnalysisCredit analysis involves examining bond issuers to determine if anychanges in the firm's default risk can be identified. We try todetermine if the bond rating agencies are going to change the firm'srating. Rating changes are prompted by internal changes within thefirm as well as external changes. Various factors examined includefinancial ratios, GNP, inflation, etc.Many more downgradings occur during economic contractions[However from 1985-1990 downgradings increased substantiallydespite an economic expansion.]. To be successful in utilizing bondrating changes, you must accurately predict when the bond ratingchange will occur and take action prior to the change. The market doesreact to unexpected bond rating changes, however, it reacts quickly.Credit Analysis of High-Yield Junk Bonds. Junk bonds have a widespread over bonds rated BBB and higher. Also, these yield spreadswiden over time (during poor economic times the spread widens).Altman and Nammacher point out that the net return of junk bonds(average gross return minus losses from bonds that defaulted) hasbeen superior to higher-rated debt [Of course, they're of higher risk.]Other points to note: Even though the rating categories have notchanged, the quality of bonds today that fall into, let's say, the Acategory, has lessened over time. "Specifically, the average values ofthe financial ratios that determine whether bonds are included in the Bor CCC rating classes have declined over time."Thus, bond portfolio managers will have to involved themselves indetailed credit analysis to determine those bonds that will not default.Credit Analysis: The assessment of default risk. Default risk has bothsystematic and unsystematic elements. First, individual bond issuersmay experience difficulty in meeting their debt obligations. This couldbe an isolated incident, and can be diversified away (or eliminated byeffective credit analysis). However, if default risk is precipitated byadverse general business conditions, then this would require moremacro-oriented analysis. Many fixed-income investors complement the

bond ratings providing by bond agencies (Fitch's, Moody's, Duff &Phelps, S&P's) with their own credit analysis, citing reasons such as:more accurate, comprehensive, and timely analyses andrecommendations.Yield Spread AnalysisA portfolio manager would monitor the yield relationships betweenvarious types of bonds and look for abnormalities. If a spread werethought to be abnormally high, you would trade to take advantage of areturn to a normal spread. Thus, you need to know what the "normal"spread is, and you need the liquidity to make trades quickly to takeadvantage of temporary spread abnormalities.Spread Analysis: Involves anticipating changes in sectoralrelationships. For example, prices and yields on lower investmentgrade bonds tend to move together (identifiable classes of securitiesare referred to as sectors). Changes in relative yields (or the spread)may occur due to:· altered perceptions of the creditworthiness of asector of the market's sensitivity to default risk· changes in the market's valuation of some attributeor characteristic of the securities in the sector (such as azero coupon feature); or· changes in supply/demand conditions.The objective is to invest in the sector or sectors that will display thestrongest relative price movements. Brokerage firms maintainhistorical records of yield spreads and are able to conduct specializedanalyses for clients, such as measurement of the historical average,maximum, and minimum spread among sectors.Potential drawbacks of this method include the need to makenumerous trades, the possibility of poor timing (how long will it takefor the market to realize the abnormal spread), and the danger thatoverall changes in interest rates will dwarf these efforts.Matched-Funding TechniquesThe matched-funding techniques incorporates the passive buy-andholdstrategy and active management strategies. The manager tries tomatch specific liability obligations due at specific times to a portfolio ofbonds in a way that minimizes the portfolio's exposure to interest raterisk (the uncertainty of returns due to possible changes in interestrates over time). These techniques are meant to avoid or offset risk,and they typically require constant monitoring and many transactionsto achieve the intended goal.Many of these techniques were developed in the 1980s (due to highlyvolatile interest rates) for pension funds (known obligations),individual retirement planning, college education, etc. These investorsneeded $x at x date. With interest rates that were highly volatile, atthe needed date, bond prices could be down (substantially below theneeded amount). Thus, many investors wanted techniques that would

help them match future liability streams with bond portfolios thatwould provide the required funds without having to worry about whereinterest rates would be at the time.Dedicated PortfoliosPure Cash-matched dedicated portfolio: most conservative method.Construct a bond portfolio with a stream of payments, sinking funds,and maturing principal payments to exactly match specific liabilityschedule. This requires estimating your future obligations (pensionfund payouts, college tuition, etc.) You could choose zero-couponbonds that had maturity dates exactly when you needed the funds.This is an entirely passive portfolio that requires no reinvestment (zerocoupon bonds pay no cash coupon payment and matures the day youneed the funds, so as soon as you receive your maturity payment, youwould payout your pension money). Technically it is difficult todetermine exactly WHEN your cash flow payouts will be due, so it isbest to apply a somewhat conservative approach.Dedicated Cash-matched portfolio with reinvestment: Assumes thatcash flows don't always come when needed (may come earlier) andwill be reinvested. Therefore, will require smaller sums of initial fundsto meet future goals.Portfolio ImmunizationAttempts to enable one to "lock-in" going interest rates and not haveto worry about interest rate shifts. Developed by Fisher and Weil in1971.Components of Interest Rate Risk: One of the major problems facedby bond portfolio managers is having the needed amount of funds at aspecific date (the ending wealth requirement) -- your investmenthorizon. If interest rates never changed during your investmenthorizon, you could reinvest your coupon payments at the stableinterest rate and earn the promised YTM. However, in reality, the yieldcurve is not flat and interest rates do change. Consequently, investorsface interest rate risk. There are two components of interest rate risk:· Price risk: if interest rates change before the end ofyour investment horizon and the bond is sold prior tomaturity (you would "win" with an interest rate decreaseand "lose" with an interest rate increase.· Coupon reinvestment risk: The promised YTMassumes that all coupon payments are reinvested at thepromised YTM. If interest rates change, this cannot beaccomplished. You will "win" with an increase in IR andvice versa.Immunization and Interest Rate Risk: Note that the "win" situationunder price risk is exactly opposite the "win" situation under couponreinvestment risk. Bond portfolio managers would like to eliminatethese two interest rate risks. Fisher and Weil (because of the opposingeffects of IR on price and coupon reinvestment risk) developed a

precise immunization process to eliminate IR risk. Fisher and Weilargue that a portfolio has been immunized if its value at the end of theperiod is the same (or higher) than what it would have been if interestrates had not changed during the investment horizon. They assumethat IR changes will affect all rates by the same amount (i.e. all rateswill rise by .005 or fall by .005--long term bonds won't rise by .007and short term by .005, both will rise by .005). If this is the case, thenportfolio immunization can be achieved by holding a portfolio of bondswith a modified duration equal to the remaining investment horizon."To obtain a given portfolio duration, you set the value-weightedaverage modified duration of the portfolio at the investment horizonand keep it equal to the remaining horizon value over time."There are two strategies for portfolio immunization:1. the maturity strategy (term to maturity equal toinvestment horizon); and2. the duration strategy (set modified duration equal toinvestment horizon).Implementing Immunization. While on the surface the immunizationstrategy may seem simple, even passive, in reality it is not (exceptzero coupon bonds face no coupon reinvestment risk or price risk--asits duration is its term to maturity). Most portfolios (non-zero-couponportfolios) require frequent rebalancing to maintain the modifiedduration/investment horizon matching. You cannot initially set themequal and then ignore them after that. Duration is positively affectedby term to maturity, so, as time passes as your investment horizonshortens, so does the duration of the bond portfolio (assuming nothingelse has changed). However, duration changes at a slower pace thanterm to maturity. Also, duration is affected by changes in interestrates, etc. So, it takes constant rebalancing to keep track of durationmatching immunization strategy.

Portfolio Management Process

The Processes On Demand portfolio management process is a best practice for management of the projects and programs of the portfolio. The portfolio management process steps include:

1. Portfolio Management Process1. Identification

2. Categorization

3. Evaluation

4. Selection

5. Prioritization

6. Balancing

7. Authorization

8. Review and Reporting

9. Strategic Change

2. Governance Process

1. Consultation

2. Preparation

3. Selection

3. Portfolio Management Dashboards

1. Status Summary View

2. Gantt View

3. Cost View

4. Risk view

Portfolio Management is used to select a portfolio of new product development projects to achieve th following goals:

4. Maximize the profitability or value of the portfolio5. Provide balance

6. Support the strategy of the enterprise

Portfolio Management is the responsibility of the senior management team of an organization or business unit. This team, which might be called the Product Committee, meets regularly to manage the product pipeline and make decisions about the product portfolio. Often, this is the same group that conducts the stage-gate reviews in the organization.

A logical starting point is to create a product strategy - markets, customers, products, strategy approach, competitive emphasis, etc. The second step is to understand the budget or resources available to balance the portfolio against. Third, each project must be assessed for profitability (rewards), investment requirements (resources), risks, and other appropriate factors.

The weighting of the goals in making decisions about products varies from company. But organizations must balance these goals: risk vs. profitability, new products vs. improvements, strategy fit vs. reward, market vs. product line, long-term vs. short-term. Several types of techniques have been used to support the portfolio management process:

3. Heuristic models

4. Scoring techniques

5. Visual or mapping techniques

The earliest Portfolio Management techniques optimized projects' profitability or financial returns using heuristic or mathematical models. However, this approach paid little attention to balance or aligning the portfolio to the organization's strategy. Scoring techniques weight and score criteria to take into account investment requirements, profitability, risk and strategic alignment. The shortcoming with this approach can be an over emphasis on financial measures and an inability to optimize the mix of projects. Mapping techniques use graphical presentation to visualize a portfolio's balance. These are typically presented in the form of a two-dimensional graph that shows the trade-off's or balance between two factors such as risks vs. profitability, marketplace fit vs. product line coverage, financial return vs. probability of success, etc.

The chart shown above provides a graphical view of the project portfolio risk-reward balance. It is used to assure balance in the portfolio of projects - neither too risky or conservative and appropriate levels of reward for the risk involved. The horizontal axis is Net Present Value, the vertical axis is Probability of Success. The size of the bubble is proportional to the total revenue generated over the lifetime sales of the product.

While this visual presentation is useful, it can't prioritize projects. Therefore, some mix of these techniques is appropriate to support the Portfolio Management Process. This mix is often dependent upon the priority of the goals.

Our recommended approach is to start with the overall business plan that should define the planned level of R&:D investment, resources (e.g., headcount, etc.), and related sales expected from new products. With multiple business units, product lines or types of development, we recommend a strategic allocation process based on the business plan. This strategic allocation should apportion the planned R&D investment into business units, product lines, markets, geographic areas, etc. It may also breakdown the R&D investment into types of development, e.g., technology development, platform development, new products, and upgrades/enhancements/line extensions, etc.

Once this is done, then a portfolio listing can be developed including the relevant portfolio data. We favor use of the development productivity index (DPI) or scores from the scoring method. The development productivity index is calculated as follows: (Net Present Value x Probability of Success) / Development Cost Remaining. It factors the NPV by the probability of both technical and commercial success. By dividing this result by the development cost remaining, it places more weight on projects nearer completion and with lower uncommitted costs. The scoring method uses a set of criertia (potentially different for each stage of the project) as a basis for scoring or evaluating each project. An example of this scoring method is shown with the worksheet below.

Weighting factors can be set for each criteria. The evaluators on a Product Committee score projects (1 to 10, where 10 is best). The worksheet computes the average scores and applies the weighting factors to compute the overall score. The maximum weighted score for a project is 100.

This portfolio list can then be ranked by either the development priority index or the score. An example of the portfolio list is shown below and the second illustration shows the category summary for the scoring method.

Once the organization has its prioritized list of projects, it then needs to determine where the cutoff is based on the business plan and the planned level of investment of the resources avaialable. This subset of the high priority projects then needs to be further analyzed and checked. The first step is to check that the prioritized list reflects the planned breakdown of projects based on the strategic allocation of the business plan. Pie charts such as the one below can be used for this purpose.

Other factors can also be checked using bubble charts. For example, the risk-reward balance is commonly checked using the bubble chart shown earlier. A final check is to analyze product and technology roadmaps for project relationships. For example, if a lower priority platform project was omitted from the protfolio priority list, the subsequent higher priority projects that depend on that platform or platform technology would be impossible to execute unless that platform project were included in the portfolio priority list. An example of a roadmap is shown below.

This overall portfolio management process is shown in the following diagram.

Finally, this balanced portfolio that has been developed is checked against the business plan as shown below to see if the plan goals have been achieved - projects within the planned R&D investment and resource levels and sales that have met the goals.

With the significant investments required to develop new products and the risks involved, Portfolio Management is becoming an increasingly important tool to make strategic decisions about product development and the investment of company resources. In many companies, current year revenues are increasingly based on new products developed in the last one to three years. Therefore, these portfolio decisions are the basis of a company's profitability and even its continued existencPortfolio Management and Risk Management Process

This section deals with the internalization of the internalization of the on-going capability to make and implement portfolio management and risk management decisions in a consistent and disciplined manner.

Overview

Over the past 20 years, we have been engaged by and have worked with over 300 institutional clients in evaluating, developing, implementing, and managing a variety of portfolio management and risk management programs.

The types of institutional clients include financial intermediaries, energy companies, agricultural concerns, government entities, consumer finance corporations, and regulatory agencies.The management activities involved in these engagements include asset/liability management, interest rate risk management, portfolio management, currency risk management, and commodity price risk management.

The primary focus of these engagements has been the internalization of the on-going capability to make and implement portfolio management and risk management decisions in a consistent and disciplined manner. This focus is driven by a commitment to a sound personal and portfolio management and risk management philosophy. This philosophy is maintained within a framework of proven principles that is constantly being adapted to ensure suitability in contemporary applications.

The following comments on developing and implementing a portfolio management and risk management process are a direct result of the experiences gained from these engagements. The comments are organized in the following sections:

Performance Profile - The driving force of any effort to develop and implement an internalized portfolio management and risk management process. Basic Elements of Portfolio & Risk Management Process - There are five basic elements every portfolio management and risk management program needs to include.

Performance Profile

The driving force of any effort to develop and implement an internalized portfolio management and risk management process is the conscious decision, by management, to proactively manage the performance profile created by the underlying business and/or portfolio.

Performance profile, simply defined, is a graph depicting how the value, gain/loss, income, or cost of a business activity or portfolio changes as a result of changes in the associated price, interest rate, or exchange rate. This is usually done with the size of the business activity or portfolio remaining constant.

The techniques employed to create performance profile graphs are very similar regardless of the underlying business or portfolio. However, each type of business or portfolio tend to have a unique set of values for three main variables:

1. Size of business activity or portfolio balances.

2. Price, interest rate, or exchange rate associated with the business activity or portfolio.

3. Resulting value, gain/loss, income, or expense created by relating Item 1 with Item 2.

(JDH Note: I am in the process of modifying a series of performance profile charts related to businesses in each of the main global economic drivers. These performance profile charts will include; interest rates; fixed income portfolios; equity portfolios; energy related production, marketing, and consumption profiles; currency; and, various commodity profiles. Modifications to these profiles will be completed within the next few weeks. In the interim, I would appreciate your comments regarding the profiles in which you have the most interest.)

Creating a graph of the "as is" performance profile can be as simple as creating a graph of a single security portfolio, or as complex as executing a series of sophisticated balance sheet, cash flow, income statement, and econometric models representing the relationships of a myriad of interrelated business activities or portfolio holdings. Regardless of how simple or complex the effort, an "as is" profile can, and must, be produced before developing and implementing strategies to alter the profile. The reasons for this are fairly straightforward:

• Without an understanding of the "as is" profile, it is difficult, if not impossible, to evaluate the effectiveness of any strategy implemented to alter the "as is" profile.

• Regardless of how well intentioned management's risk management efforts might be, without an understanding of the "as is" profile, many risk management strategies actually end up exacerbating risk exposure as opposed to managing it towards the desired profile.

From any given point in time, there are three basic alternative shapes the "as is" performance profile can be managed toward:

1. Increased risk.

2. Decreased risk.

3. Unchanged risk.

Regardless of the desired shape, and regardless of why that shape is desired, the key objective is to develop an explicit expression of the potential consequences our actions will have on the risks inherent in the resulting performance profile.

Basic Elements of Portfolio & Risk Management Process

There are five basic elements every portfolio management and risk management program needs to include. Furthermore, all of these issues will need to be addressed rather intensely in the initial development stages, and then to varying degrees on an on-going basis. These five main elements are:

1. Start-up, Documentation, and Approval.

2. Risk Analysis and Quantification.

3. Strategy Development.

4. Strategy Implementation and Management.

5. Accounting, Recordkeeping, and Reporting.

The primary challenge in virtually every portfolio management and risk management engagement has been to clearly identify how management is currently managing risk. Once this step is accomplished, a project plan can be developed to facilitate the integration of these five elements into the dynamics of the existing portfolio management and risk management process (regardless of management's sophistication level).

Start-up, Documentation, and Approval

The focus of this element is to educate staff, management and board, along with enhancing internal policies and procedures to a level, wherein, portfolio management and risk management

decisions can be made and implemented on a consistent and disciplined basis. The important subsets of this element include:

Current Management Practices

Identify portfolio management and risk management practices currently employed. The three main categories include:

1. Policy decisions.

2. Cash market transactions.

3. Forwards, futures, options, and other derivatives.

Internal Training

Conduct internal training for staff, management and board. Given that most staff, management, and board members are well up the experience curve on the effect policy decisions and cash market transactions have on their performance profile, the focus of this training tends to evolve around the application of important derivatives instruments, concepts, and techniques to the portfolio management and risk management practices already being employed. In addition to defining what derivatives are, the important derivatives concepts that usually need to be covered include (refer to Glossary):

• Underlying instrument.

• Exchange traded instruments vs. over-the-counter (OTC) instruments.

• Future/forward pricing structure.

• Volatility.

• Time decay.

• Convergence (as it applies to both price and volatility).

• Exercise (strike) price vs. current price:

• Out of the money (OTM).

• At the money (ATM).

• In the money (ITM).

Policies and Procedures

Develop written portfolio management and risk management policies and procedures that are consistent with the existing management policies and procedures framework. In addition to being integrated with existing policies and procedures, explicit provisions should be made for:

• Assignment of functional responsibilities for management and staff.

• Evaluation and selection of firms through, and with, whom portfolio management and risk management strategies will be implemented.

• Securing management and board approval of both the overall process and the implementation of the process.

Risk Analysis And Quantification

The focus of this element is to establish a quantitatively based performance profile analysis methodology, the foundation of which is the measurement of the risk inherent in the basic business or portfolio being managed. This enables management to make conscious decisions and take deliberate actions to alter or maintain the "as is" performance profile. The important subsets of this issue include:

Type of Risk Exposure

Once the "as is" performance profile has been created and verified as accurately representing the underlying business activity or portfolio, it is fairly easy to identify the inherent type of risk exposure. Once the inherent risk exposure has been identified, three critical management events are enabled:

1. Management can objectively evaluate and express the acceptability of the inherent risk exposure.

2. Management can explicitly state their intent regarding the continued acceptance of, or alterations to, the inherent risk exposure relative to a commonly understood reference point.

3. Management can immediately separate the suitability of instruments, positions, strategies, and tactics into two main action groups:

• Pursue those alternatives that have performance profiles that, when added to the "as is" profile, produces the desired profile.

• Eliminate those alternatives that have performance profiles that, when added to the "as is" profile, would tend to exacerbate undesirable changes to the "as is" profile.

Performance Profile Objectives

Conscious and explicit statement of management's objectives regarding the "as is" performance profile. Generally speaking, management can choose to maintain, increase, or decrease the risk inherent in the "as is" profile through a variety of portfolio management and risk management strategies and tactics.

Strategy Development

The focus of this element is to ensure the suitability of portfolio management and risk management strategies and tactics to management's performance profile objectives and, in some cases, expected market conditions. Therefore it is assumed that steps have already been taken to properly analyze, quantify, and present the risks inherent in the "as is" performance profile. The important subsets of this element include:

Idealized Price, Interest rate, or Exchange Rate Movement Cycle. Identify the four basic phase of the idealized price, interest rate, or exchange rate movement cycle:

• Bottom.

• Rising.

• Top.

• Declining.

Alternative Risk Profile Management Methods

Review the three main alternative methods for managing the risk profile:

1. Policy decisions.

2. Cash market transactions.

3. Futures, options and other derivatives.

Strategy Matrix

Construct a 3D strategy matrix of the ideal strategies for each phase of the price, interest rate, or exchange rate movement cycle for each of the main alternative performance profile management methods.

(JDH Note: I am in the process of modifying a series of ideal strategy matrices related to businesses in each of the main global economic drivers. Modifications to these matrices will be completed within the next few weeks. In the interim, I would appreciate your comments regarding the matrices in which you have the most interest.)

Identify Current Cycle Phase

Identify the current phase of the price, interest rate, or exchange rate movement cycle and select the equivalent strategies from strategy matrix that are suitable to both the current cycle phase and management's performance profile objectives.

Performance Profile Modeling

Model the performance profiles of the equivalent strategies. Regardless of the degree of conviction we might have regarding the current price, interest rate, or exchange rate cycle phase, a serious effort should be made to evaluate the possible performance profile of each strategy in scenarios that are neutral, favorable and adverse to the underlying position. The main issues considered in this modeling effort include (email your comments to me if you think there is a need to develop the following points in greater detail):

• Time frame dynamics (static, collapsing or expanding);

• Beginning point.

• Ending point.

• Duration.

• Underlying risk position;

• Quantity.

• Pricing index.

• Price, interest rate, or exchange rate movement scenarios driven by volatility;

• Up.

• Down.

• Flat.

• Basis relationship between the pricing index influencing the underlying risk position and the pricing of the performance profile management position.

• Performance profile management position;

• Ratios.

• Contract month placement;

• Nearby stack and roll.

• Strip.

• Deferred stack and peel.

• Combination.

• Entry/exit method;

• All at once.

• Scale-in/out.

• Cash flow requirements.

• P&L impact.

• Presentation of modeling results;

• Tabular.

• Graphic.

Equivalent Strategy Comparison

Evaluate the suitability of the equivalent strategies by comparing the performance profiles and related reward/risk ratios of each strategy:

• Relative to each other.

• Relative to the desired changes in the underlying performance profile.

• Relative to the "as is" performance profile.

Suitable Strategy Selection

Select the most suitable strategy for implementation. This step is facilitated by seeking a balance between:

• Strategy costs;

• The imbedded costs of each strategy if prices, interest rates, or exchange rates go flat.

• The out-of-pocket loss that would be suffered on the underlying position if adverse price, interest rate, or exchange rate movement occurs, and the recovery potential afforded by implementing each strategy.

• The opportunity gain that would be realized on the underlying position if favorable price, interest rate, or exchange rate movement occurs, and the foregone opportunity caused by implementing each strategy.

• The consequences of maintaining the "as is" performance profile in favorable, adverse and flat price, interest rate, or exchange rate scenarios.

• The probabilities associated with each of the scenarios. An important aspect of this step includes an attempt to quantify and prepare for the risk of being wrong in the cycle phase assessment. This, in turn, includes the effort to identifying the appropriate measures to;

• Minimize the risk of foregoing opportunity gains from favorable movements on the underlying position.

• Maximize the opportunity to recover out-of-pocket losses from adverse price movements on the underlying position.

No Acceptable Alternative

Occasionally, management will be left with no alternative but to continue accepting the "as is" performance profile. This occurs when the performance profiles of all the alternative strategies have unacceptable reward/risk ratios.

Strategy Implementation and Management

The focus of this element is prompt implementation of strategies selected, and timely tactical adaptations to maintain the suitability of the strategies to management's performance profile objectives and current market conditions. The important subsets of this element include:

Position Entry

Range entry methodology:

• Percent of position.

• Timing.

Periodic Position Adjustments

Events necessitating periodic adjustments:

• Basis relationship changes.

• Time decay management.

Position Exit

Range exit methodology:

• Planned.

• Early.

Accounting, Recordkeeping and Reporting

The focus of this element is to ensure accurate accounting, recordkeeping and reporting of the results of all strategies and tactical adjustments. This will enable the objective evaluation of the results of the portfolio and risk management efforts. The important subsets of this element include:

GAAP and taxes

Ensure proper accounting treatment for GAAP and taxes.

Reconciliation

Systematically reconcile internal transaction records with brokerage firm records.

Reporting

Periodically report strategy performance to management and board.

Regardless of management's performance profile objectives, the foregoing five basic elements and related subsets need to be addressed on an on-going basis in order to develop, implement and maintain a disciplined portfolio management and risk management program.e over the next several years.

Stock and Share Portfolio Management: Taking Care of Your Money

Companies, mostly the big ones, create stocks and shares in the attempt to raise funds for the finances of their business. And once a person buys stocks and shares from them they become part owners of the corporation. It also means they are entitled to a certain portion of profits generated by the company which is in proportion to the number of stocks they hold. There are different types of stock and shares available and it is possible to avail of several of them. The aggregate of company shares is called a share portfolio. And a good stock share portfolio is important to achieve success in this type of financial endeavor. 

Stocks, shares, and stock market investment are considered to be capital investments. A person can possibly own a number of stocks at any given time. And this is made possible because of the vast financial market that we have today. In other countries, stocks and shares are similar to security bonds and other financial securities. 

There are different types of shares and stocks that you can possibly own. There are ordinary shares, preference shares, cumulative preference shares, and redeemable shares. The kind of portfolio of shares you own can be the determining factor of your financial success. It is then very important that you are well informed of to how to build your portfolio of stocks so you can effectively establish your fiscal stability.

Tips for Effectively Managing a Portfolio of Stocks

For you to successfully build a strong stocks portfolio and ensure effective share portfolio management here are good tips to follow on how you can go about it:

1. Know which type of stocks you'd like to buy. 

The stock market is very volatile. This is why your choice of shares must be analyzed very well. Common stocks are the type mostly traded in the market today. They come in several forms too, such as the speculative stocks, the growth stocks, and the blue-chip stocks, among others.

2. Strive to know all the things that pertain to your chosen stock. 

Accumulate accurate information. That's the very key to your success in building a share portfolio. Make it a point to know everything regarding the company that offers the stocks. Try to investigate the background of the company thoroughly. Make sure that you do that before you even consider investing with them. It is important that the company you plan to deal with is very stable.

Stock Portfolio Management: Saving Your Portfolio From Disaster With Trailing Stops“We are at the peak of most likely the greatest financial mania that will ever be seen in our lifetimes and quite possibly the greatest ever witnessed.”- January 2000 Oxford Club Communiqué cover story, by Dr. Steve SjuggerudI couldn’t have been clearer back in 2000 when I wrote that cover story. Unfortunately, I have a feeling that very few people took my advice to use a trailing stop in their stock portfolio management instead people just kept buying tech stocks.Since then, I don’t know how many people have said to me, “If I’d have just followed your advice, then I wouldn’t have lost all my money I would have sold with huge profits, and would be retired today.“ My advice to these folks then – and my advice to you today – involves using trailing stops, especially if you’re holding tech stocks, which may be riding a new bubble. Utilizing trailing stops in your stock portfolio management not only secures your profits, they protect your principal and using them will ensure that you never see catastrophic damage to your portfolio.The Stock Market Is Giving You Another ChanceThese days stock investors are partying like it’s 1999 all over again. Shares of Yahoo, for example, are up nearly 200% from their lows less than a year ago. The stock is extraordinarily expensive, trading at well over 100 times annual earnings. If Yahoo continued to make the same amount it’s making, that would mean it would take a private buyer over 100 years to recoup his investment in YahooHopefully you can see that your downside risk here is huge in comparison to the upside potential in a stock like Yahoo. There aren’t too many seasoned investors our there that would pay 100 times earnings. The only hope a buyer of Yahoo has today is that there is a less savvy investor out there, willing to take the shares off him at a higher price – just like in 1999.It’s not just Yahoo. Yahoo actually is cheaper than a basket of the major tech stocks The  Wall Street Journal reports today that the stocks that make up the Nasdaq 100 (the 100 largest tech-oriented companies) now trade at more than 200 times earnings. That doesn’t mean to me that Yahoo is cheap. It means that we’re back to the strange days of 1999-2000. So the market has given you a second chance to play your stock portfolio management the smart way. To pocket some profits instead of see them disappear. And the main key will be for you to use trailing stops. This way, you keep your upside unlimited (because we don’t know how long these less savvy investors will keep buying). And you keep your downside limited, to a 25% lossThe Secret of the Smart Investor’s Stock Portfolio Management: Exciting Stories Are Often The Big LosersI was reading Wired magazine today. Wired is a magazine for businessmen / techies who want to stay up on the latest in the high-tech world. It is extremely well written, and fun to read. You get

to learn about the “next big thing” here. The problem is, if there is any resounding lesson of the last few years, it is that the exciting futuristic companies are often the worst investments for your stock portfolio management “Pioneering don’t pay,” as Andrew Carnegie said.Wired magazine just updated its Wired Index of the 40 most “innovative thinking” companies. The index originally came out in 1998. Only 10 of the original 40 companies even exist today. If you had invested in the excitement, you could have made a lot of money – but only if you sold in time. And the best way to have sold in time would have been by using a 25% trailing stop.For example, Oxford Club readers at the time pocketed 900% gains in JDSU by using a trailing stop. If you didn’t use one and you had held until today, you’d have lost money on JDSU. In that case, a trailing stop made a 900% difference. I tell the full story of JDSU, including how trailing stops work, in E-Letter #118 (“Honey, What Happened To Our Retirement?”) I suggest reading it.Wired magazine’s new Wired 40 includes the following companies: Google, eBay, Amazon.com, Yahoo, Netflix, Nvidia, EMC, Comcast, JDSU, and some biotech companies, among others. Many of these are the trendy stocks that are up by triple digits in the last few months.My Advice for Your Stock PortfolioGood for those companies. And good for you if you own some of them. But don’t lose sight of what happened to three of the four Wired “innovators.” They’re gone. So my advice to you today is the same as it was back in 2000 don’t let hype get the better of you in the management of your stock portfolio.“As long as the mania continues, continue to hold and even buy the best participating companies.” But we’ll “always use trailing stops to get us out of losing positions ahead of the crowd and protect our principal. It’s a simple yet constantly understated strategy in any investor’s stock portfolio management If you have no exit plan, you have no system. And if you have no system, you won’t make money!”Ride this rally as long as it lasts, and use your trailing stops to get you out when the music stops. Tech stocks are priced like 1999-2000 all over again. And the fall could be just as brutal.Enjoy the ride up. And get out on the way down by sticking to your stops.Good Investing,