Portfolio management is the key skill required for effective investment management whether it for an individual or HNI (High Net Worth Individual) or a big MNC (Multinational Company). Different attributes of investment alternatives are analyzed and the objective of investment guides where and how much money to allocate to each of the alternatives. Investing in more and more assets, with different attributes, diversifies the risk of a portfolio and thereby increases reasonable assurance of the returns.
For understanding portfolio management (PM), it is important to understand the term ‘portfolio’, the meaning of PM, who is a portfolio manager, what does PM service involve, classification of PM services, objectives and an importance of PM.
Table of Contents
- 1 What is Portfolio and Portfolio Management (Definition)?
- 2 Objectives of Portfolio Management
- 3 Who is a Portfolio Manager?
- 4 Process in Portfolio Management
- 5 Why is Portfolio Management Important?
- 6 Types of Portfolio Management
- 7 Active & Passive Portfolio Management
- 8 Discretionary & Non-Discretionary Portfolio Management
What is Portfolio and Portfolio Management (Definition)?
The portfolio is a collection of investment instruments like shares, mutual funds, bonds, fixed deposits and other cash equivalents etc. Portfolio management is the art of selecting the right investment tools in the right proportion to generate optimum returns with balance of risk from the investment made.
In other words, a portfolio is a group of assets. Portfolio gives an opportunity to diversify risk. Diversification of risk does not mean that risk will be eliminated. With every asset, two types of risk are attached, diversifiable / unique/ unexplained / unsystematic risk and undiverifiable/ market risk / expalined /systematic risk. Even an optimum portfolio cannot eliminate market risk, but can only reduce or eliminate the diversifiable risk. As soon as risk reduces, the variability of return reduces.
Best portfolio management practice runs on the principle of minimum risk and maximum return within a given time frame. A portfolio is built based on investor’s income, investment budget and risk appetite keeping the expected rate of return in mind.
Objectives of Portfolio Management
When a portfolio is built, following objectives are to be kept in mind by the portfolio manager based on an individual’s expectation. The choice of one or more of these depends on the investor’s personal preference.
- Capital Growth
- Security of Principal Amount Invested
- Marketability of Securities Invested in
- Diversification of Risk
- Consistent Returns
- Tax Planning
Investors hire portfolio managers and avail professional services for the management of portfolio by as paying a pre-decided fee for these services. Let us understanding who is a portfolio manager and tasks involved in the management of a portfolio.
Who is a Portfolio Manager?
Portfolio Manager is a person who understands his client’s investment needs and suggests a suitable investment mix to meet his client’s investment objectives. This tailor-made investment plan is recommended keeping in mind the risk-return balance.
Process in Portfolio Management
Portfolio management process is not a one-time activity. The portfolio manager manages the portfolio on a regular basis and keeps his client updated with the changes. The tasks involved in it are stated below:
- Understanding the client’s investment objectives and availability of funds
- Matching investment to these objectives
- Recommending an investment policy
- Balancing risk and studying the portfolio performance from time to time
- Taking decision on the investment strategy based on discussion with the client
- Changing asset allocation from time to time-based on portfolio performance
Why is Portfolio Management Important?
It is important due to the following reasons:
- PM is a perfect way to select the “Best Investment Strategy” based on age, income, risk taking the capacity of the individual and investment budget.
- It helps to keep a gauge on the risk taken as the process of PM keeps “Risk Minimization” as the focus.
- “Customization” is possible because individual’s needs and choices are kept in mind i.e. when the person needs the return, how much return expectation a person has and how much investment period an individual selects.
- Taking into account changes in tax laws, investments can be made.
- When investment is made in fixed income security like preference share or debenture or any other such security, then in that case investor is exposed to interest rate risk and price risk of security. PM can take help of duration or convexity to immunize the portfolio.
Types of Portfolio Management
Portfolio Management Services are classified into two broad categories:
On the basis of a level of activity viz.
Active & Passive Portfolio Management
Active PM refers to the service when there is active involvement of portfolio managers in buy-sell transactions for securities to ensure meeting the investment objectives of the investor whereas Passive PM refers to managing a fixed portfolio where the portfolio performance is matched to the market index (i.e. market)
On the basis of discretionary powers allowed to Portfolio Manager i.e.
Discretionary & Non-Discretionary Portfolio Management
Discretionary PM refers to the process where portfolio management is authorized to make financial decisions for the funds invested based on investment needs of the investor. Apart from that, he also does the entire documentary work and filing too. Non-Discretionary PM refers to the process where portfolio manager acts just as an advisor for which investments are good and which are not lucrative and the decision is taken by the investor.Last updated on : October 15th, 2018