Portfolio construction refers to the allocation of funds among a variety of financial assets open for investment. Portfolio theory concerns itself with the principles governing such allocation. The objective of the theory is to elaborate the principles in which the risk can be minimized subject to desired level of return on the portfolio or maximize the return, subject to the constraint of a tolerate level of risk.
Thus, the basic objective of portfolio management is to maximize yield and minimize risk. The other ancillary objectives are as per the needs of investors, namely:
- Safety of the investment
- Stable current Returns
- Appreciation in the value of capital
- Marketability and Liquidity
- Minimizing of tax liability.
In pursuit of these objectives, the portfolio manager has to set out all the various alternative investment along with their projected return and risk and choose investment with safety the requirement of the individual investor and cater to his preferences. The manager has to keep a list of such investment avenues along with return-risk profile, tax implications, yield and other return such as convertible options, bonus, rights etc. A ready reckoned giving out the analysis of the risk involved in each investment and the corresponding return should be kept.
The portfolio construction, as referred to earlier, be made on the basis of the investment strategy, set out for each investor. Through choice of asset classis, instrument of investment and the specific scripts, save of bond or equity of different risk and return characteristics, the choice of tax characteristics, risk level and other feature of investment, are decided upon.