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Portfolio Management

Portfolio management is done in different steps to maintain combination of assets meet desired goals.

We should first make an investment policy statement that includes:

  • Time horizon of investment.
  • Liquidity needs.
  • Tax considerations.
  • Regulatory requirements.
  • Unique circumstances.

Portfolio management planning involves following steps:

  • Investment objectives and policies.
  • Capital market expectations.
  • Strategic allocations.

Capital market expectations concern the risk and return characteristics of stocks and bonds.

Investment Manager’s fees are usually based on a fixed percentage of the average amount of assets managed by the manager. It also depends upon the types of investments managed.

Size of a management firm depends upon the amount of assets managed by the firm.

Institutional investors are entities like pension funds, incurance companies and banks.

Investment advisors are usually oriented to serving high networth individuals. These advisors can incorporate a heavy personal financial planning emphasis in their services.

Investment management companies hire managers, analysts and traders. Portfolio managers of these companies use both outsdide and inside research.

The portfolio planning step involves following steps:

  • Identifying and specifying investors, objectives and constraints. Investment objectives are to get desired results from the investments. Constraints are limitations on taking a full or partial advantage of a specific investment.
  • Once a client has specified a set of objectives and constraints an investment policy is created. This policy would have following information:
  •  Description of client.
  • Reasons for developing guidelines.
  • Duties and responsibilities of parties involved.
  • Investment goals, objectives and constraints.
  • Review schedule of investment performance.
  • Benchmarks and measures used to evaluate performance.
  • Strategies used for asset allocation.
  • Guidelines for re-balancing of portfolio.

There are three strategies of investment:

  • Passive investment approach.
  • Active investment approach.
  • Semi active investment approach.

In a passive investment approach, portfolio composition does not react to capital market expectations. Indexing is the most common passive approach of investing. The other passive approach is strict buy and hold strategy.

In an active investment approach a portfolio manager will respond to changing capital market expectations. Portfolio manager in this approach would have a bench mark or a comparison portfolio for comparison. An active investment approach focuses on value or growth stocks. If portfolio manager’s expactations are correct, it may add value to portfolio.

Third approach is called semi active approach or enhanced index approach. This approach seeks a positive alpha (positive excess risk adjusted returns) while keeping a very tight control over risk.

A portfolio manager would form capital market expectations. This process includes long run forecasts of risk and return, maximizing return and minimizing risk.

Potfolio manager’s next task is the planning process in determining asset allocation. Once analysts have given their input, portfolio selection procedure starts. Portfolios are revised as investor’s circumstances or capital market expectations change. Portfolio managers may use optimization techniques for combining assets efficiently to achieve a set of return and risk objectives.

Portfolio implementation decision is a very important decision. Poor management of a portfolio results in higher transaction costs and reduced performance. Trading costs, transaction costs and missed trade opportunity costs are all part of transaction costs.

Monitoring and re-balancing of a portfolio is an ongoing process. A portfolio revision can be triggered due to following circumstances:

  • The termination of a pension plan or death of a spouse.
  • Changes in economic and market input factors.
  • A change in expectations.
  • Review period of a portfolio.

Investment performance must be evaluated periodically. Portfolios need to be evaluated for performance measurement (Portfolio rate of return), Performance attribution (Sources of portfolio’s performance), and performance appraisal (Evaluation of a manager to see how the portfolio did relative to a bench mark).

In a nutshell, portfolio management is an ongoing process in which:

  1. Investment objectives and constraints are identified and specified.
  2. Investment strategies are developed.
  3. Portfolio comparison is decided in detail.
  4. Portfolio decisions are initiated by portfolio managers and implemented by traders.
  5. Portfolio performance is measured and evaluated.
  6. Investor and market conditions are monitored.
  7. Any re-balancing is implemented.

 

 

Disclaimer:

This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.

References:

Managing Investment Portfolios a dynamic process by:

John L. Maginn, CFA

Donald L. Tuttle, CFA

Dennis W. Mcleavey, CFA

Jerald E. Pinto, CFA

Accountant

BSBA – EA – ICIA – RA

Tax for Canada and U.S.A

Web: www.theaccountingandtax.com and www.taxservicesguru.com

Blog: http://taxservicesguru.blogspot.ca

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