OVERVIEW OF PORTFOLIO MANAGEMENT
Introduction
A
portfolio can be defined as basket of diversified investment instruments such
as stocks, shares, mutual funds, bonds, and cash in a certain ratio depending upon
the investor’s income level, budget, risk appetite and the holding period. In other words, a portfolio is a group of assets. The
portfolio gives an opportunity to diversify risk. Diversification of risk does not mean that risk is
completely eliminated. With every asset, there are two types of risk; unsystematic
risk (inherent to a specific company or industry) and market/ systematic risk.
Even an optimum portfolio cannot eliminate systematic risk, but can only reduce
or eliminate the element of unsystematic risk.
Meaning of Portfolio Management
Portfolio Management is the art of making decisions about the
investment mix for investors ensuring
maximum returns and minimum
risk within a given timeframe. In common terms, it refers to the selection of assets
and securities and their continuous churning in the portfolio to optimize the overall
returns. The riskiness of portfolios depends on the attributes of individual
assets, as well as the interrelationships among assets. Therefore, it is
primarily for this reason that portfolio management is desirable.
The theory of portfolio management describes the resulting risk and return of a
combination of individual assets and securities. One of the major objectives of
the theory is to identify combinations of assets and securities that are
efficient. Here, efficiency means the highest expected rate of return on an
investment for a given level of risk. The starting point for portfolio theory
requires an assumption that investors are risk averse. This means that for a
given level of return, investors prefer less risk to more risk.
Modern portfolio theory has been
largely defined by the work of Harry Markowitz in a series of articles published in the late 1950s. In 1952, Harry
Markowitz's article on "Portfolio selection" was published in which
he analyzed the implications of the fact that investors seeking high expected
returns generally wish to avoid risk. This is the basis of all scientific
portfolio management. Portfolio theory explains that
some sources of risk associated with individual assets can be eliminated, or
diversified away, by holding a proper combination of assets.
Objectives of
Portfolio Management
- Security/safety of principal:
Security
in this context implies keeping the principal amount secured. Safety means protection of
investment against loss and uncertainty. In order to ensure safety of
investment, a careful review of the underlying economic and industry
trends is necessary before selecting the investment avenue.
- Stability of income: To ensure a steady flow of income to
take care of financial needs of the family.
- Growth of capital: Investors seek appreciation in
capital and want their money to grow quickly.
- Liquidity:
This is one of the major objective of investors so that they can get the
money back when needed. It also helps them to
maintain the purchasing power.
- Diversification:
The basic objective of building a portfolio is to reduce risk of loss of
capital and / or income by investing in various types of securities and
over a wide range of industries.
Types of Portfolio Management
There are primarily two types of portfolio
management strategies:
·
Passive portfolio management: A passive strategy requires the investor to buy
and hold some replica of the market portfolio and accept an expected return
equal to the market.
·
Active portfolio management: In this strategy, specific
investments are made focusing on
outperforming an investment benchmark index or market return by
actively buying and selling securities.
Conclusion
To summarize, portfolio management is
a process to manage investment in assets and securities as per the income,
budget and risk appetite of the investors. It is a dynamic concept and involves
regular and systematic analysis, judgment and action. Further, it is quite relevant
as it helps investors in effective and efficient management of their investments
to achieve their overall financial goals over a period of time.
