Portfolio Investment Process

The ultimate aim of the portfolio manager is to reduce the risk and increase the return to the investor in order to reach the investment objectives of an investor. The manager must be aware of the portfolio investment process. The process of portfolio management involves many logical steps like portfolio planning, portfolio implementation and monitoring. The portfolio investment process applies to different situation. Portfolio is owned by different individuals and organizations with different requirements. Investors should buy when prices are very low and sell when prices rise to levels higher that their normal fluctuation.

Portfolio Investment Process

Portfolio investment process is an important step to meet the needs and convenience of investors. The portfolio investment process involves the following steps:

  1. Planning of portfolio.
  2. Implementation of portfolio plan.
  3. Monitoring the performance of portfolio.

Portfolio Investment Process

1. Planning of Portfolio

Planning is the most important element in a proper portfolio management. The success of the portfolio management will depend upon the careful planning. While making the plan, due consideration will be given to the investor’s financial capability and current capital market situation. After taking into consideration a set of investment and speculative policies will be prepared in the written form. It is called as statement of investment policy. The document must contain (1) The portfolio objective (2) Applicable strategies (3) Investment and speculative constraints. The planning document must clearly define the asset allocation. It means an optimal combination of various assets in an efficient market. The portfolio manager must keep in mind about the difference between basic pure investment portfolio and actual portfolio returns. The statement of investment policy may contain these elements. The portfolio planning comprises the following situation for its better performance:

(A) Investor Conditions: – The first question which must be answered is this – “What is the purpose of the security portfolio?” While this question might seem obvious, it is too often overlooked, giving way instead to the excitement of selecting the securities which are to be held. Understanding the purpose for trading in financial securities will help to: (1) define the expected portfolio liquidation, (2) aid in determining an acceptable level or risk, and (3) indicate whether future consumption (liability needs) are to be paid in nominal or real money, etc. For example: a 60 year old woman with small to moderate saving probably (1) has a short investment horizon, (2) can accept little investment risk, and (3) needs protection against short term inflation. In contrast, a young couple investing couple investing for retirement in 30 years has (1) a very long investment horizon, (2) an ability to accept moderate to large investment risk because they can diversify over time, and (3)  a need for protection against long-term inflation. This suggests that the 60 year old woman should invest solely in low-default risk money market securities. The young couple could invest in many other asset classes for investment diversification and accept greater investment risks. In short, knowing the eventual purpose of the portfolio investment makes it possible to begin sketching out appropriate investment / speculative policies.

(B) Market Condition: – The portfolio owner must known the latest developments in the market. He may be in a position to assess the potential of future return on various capital market instruments. The investors’ expectation may be two types, long term expectations and short term expectations. The most important investment decision in portfolio construction is asset allocation. Asset allocation means the investment in different financial instruments at a percentage in portfolio. Some investment strategies are static. The portfolio requires changes according to investor’s needs and knowledge. A continues changes in portfolio leads to higher operating cost. Generally the potential volatility of equity and debt market is 2 to 3 years. The another type of re-balancing strategy focuses on the level of prices of a given financial asset.

(C) Speculative Policies: – The portfolio owner may accept the speculative strategies in order to reach his goals of earning to maximum extant. If no speculative strategies are used the management of the portfolio is relatively easy. Speculative strategies may be categorized as asset allocation timing decision or security selection decision. Small investors can do by purchasing mutual funds which are indexed to a stock. Organization with large capital can employ investment management firms to make their speculative trading decisions.

(D) Strategic Asset Allocation: – The most important investment decision which the owner of a portfolio must make is the portfolio’s asset allocation. Asset allocation refers to the percentage invested in various security classes. Security classes are simply the type of securities: (1) Money Market Investment; (2) Fixed Income obligations; (3) Equity Shares; (4) Real Estate Investment; (5) International securities.

Strategic asset allocation represents the asset allocation which would be optimal for the investor if all security prices trade at their long-term equilibrium values that is, if the markets are efficiency priced.

2. Implementation of Portfolio Plan

In the implementation stage, three decisions to be made, if the percentage holdings of various assets classes are currently different from the desired holdings as in the SIP, the portfolio should be re-balances to the desired SAA (Strategic Asset Allocation). If the statement of investment policy requires a pure investment strategy, this is the only thing, which is done in the implementation stage. However, many portfolio owners engage in speculative transaction in the belief that such transactions will generate excess risk-adjusted returns. Such speculative transactions are usually classified as “timing” or “selection” decisions. Timing decisions over or under weight various assets classes, industries, or economic sectors from the strategic asset allocation. Such timing decision deal with securities within a given asset class, industry group, or economic sector and attempt to determine which securities should be over or under-weighted.

(A) Tactical Asset Allocation: – If one believes that the price levels of certain asset classes, industry, or economic sectors are temporarily too high or too low, actual portfolio holdings should depart from the asset mix called for in the strategic asset allocation. Such timing decision is preferred to as tactical asset allocation. As noted, SAA decisions could be made across aggregate asset classes, industry classifications (steel, food), or various broad economic sectors (basic manufacturing, interest-sensitive, consumer durables).

Traditionally, most tactical assets allocation has involved timing across aggregate asset classes. For example, if equity prices are believes to be too high, one would reduce the portfolio’s equity allocation and increase allocation to, say, risk-free securities. If one is indeed successful at tactical asset allocation, the abnormal returns, which would be earned, are certainly entering.

(B) Security Selection: – The second type of active speculation involves the selection of securities within a given assets class, industry, or economic sector. The strategic asset allocation policy would call for broad diversification through an indexed holding of virtually all securities in the asset in the class. For example, if the total market value of HPS Corporation share currently represents 1% of all issued equity capital, than 1% of the investor’s portfolio allocated to equity would be held in HPS corporation shares. The only reason to overweight or underweight particular securities in the strategic asset allocation would be to off set risks the investors’ faces in other assets and liabilities outside the marketable security portfolio. Security selection, however, actively overweight and underweight holding of particular securities in the belief that they are temporarily mispriced.

3. Monitoring the Performance of Portfolio

Portfolio performance monitoring is a continuous and on going assessment of present investment portfolio and the portfolio manger shall incorporate the latest development which occurred in capital market. The portfolio manager should take into consideration of investor’s preferences, capital market condition and expectations. Monitoring the portfolio performance is up-grading activity in asset composition to take the advantage of economic, industry and market conditions. The market conditions are depending upon the Government policy. Any change in Government policy would reflect the stock market, which in turn affects the portfolio. The continues revision of a portfolio depends upon the following factors:

  1. Change in Government policy.
  2. Shifting from one industry to other
  3. Shifting from one company scrip to another company scrip.
  4. Shifting from one financial instrument to another.
  5. The half yearly / yearly results of the corporate sector

Risk reduction is an important factor in portfolio. It will be achieved by a diversification of the portfolio, changes in market prices may have necessitated in asset composition. The composition has to be changed to maximize the returns to reach the goals of investor.

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