Portfolio Management

Portfolio Diversification with a Number of Securities

The benefits from diversification increase, as more and more securities with less than perfectly positively correlated returns are included in the portfolio. As the number of securities added to a portfolio increases, the standard deviation of the portfolio becomes smaller and smaller. Hence an investor can make the portfolio risk arbitrarily small by including a large number of securities with negative or zero correlation in the portfolio.

But in reality, no securities show negative or even zero correlation. Typically, securities show some positive correlation, which is above zero but less than the perfectly positive value (+1). As a result, diversification (that is, adding securities to a portfolio) results in some reduction in total portfolio risk but not in complete elimination of risk.… Read the rest

Abey Francis

Naïve Diversification of Investment Portfolio

Portfolios may be diversified in a naïve manner, without really applying the principles of Markowitz diversification, which is discussed at length in the next paragraph. Naïve diversification, where securities are selected on a random basis only reduces the risk of a portfolio to a limited extent. When the securities included in such a portfolio number around ten to twelve, the portfolio risk decreases to the level of the systematic risk in the market. It may also be noted that beyond fifteen shares, there is no decrease in the total risk of a portfolio.

Before discussing about portfolio diversification process, what the researches of investors and investment analysts have found is to be set out briefly.… Read the rest

Abey Francis

The Process of Diversification of Investment Portfolio

The process of diversification  of investment portfolio has various phases involving investment into various classes of assets like equity shares, preference shares, money market instruments like commercial paper, inter-corporate investments, certificate of deposits etc. Within each class of assets, there is further possibility of diversification into various industries, different companies etc. The proportion of funds invested into various classes of assets, instruments, industries and companies would depend upon the objectives of investor, under portfolio management and his asset preferences, income and asset requirements.

A portfolio with the objective of regular income would invest a proportion of funds in bonds, debentures and fixed deposits.… Read the rest

Abey Francis

Diversification of Securities in Portfolio Investments

Reduction of Risk through Diversification of Securities

The process of combining securities in an investment portfolio is known as diversification. The aim of diversification of securities is to reduce total risk without sacrificing portfolio return. To understand the mechanism and power of diversification, it is necessary to consider the impact of co-variance or correlation on portfolio risk more closely. We shall examine three cases: (1) when security returns are perfectly positively correlated, (2) when security returns are perfectly negatively correlated and (3) when security returns are not correlated.

Diversification means, investment of funds in more than one risky asset with the basic objective of risk reduction.… Read the rest

Abey Francis

Risk-Return relationship in investments

The entire scenario of security analysis is built on two concepts of security: Return and risk. The risk and return constitute the framework for taking investment decision. Return from equity comprises dividend and capital appreciation. To earn return on investment, that is, to earn dividend and to get capital appreciation, investment has to be made for some period which in turn implies passage of time. Dealing with the return to be achieved requires estimated of the return on investment over the time period. Risk denotes deviation of actual return from the estimated return. This deviation of actual return from expected return may be on either side — both above and below the expected return.… Read the rest

Abey Francis

Risk and Return in Portfolio Investments

Risk in Portfolio Investments

The Webster’s New Collegiate Dictionary definition of risk includes the following meanings: “……. Possibility of loss or injury ….. the degree or probability of such loss”. This conforms to the connotations put on the term by most investors. Professional often speaks of “downside risk” and “upside potential”. The idea is straightforward enough: Risk has to do with bad outcomes, potential with good ones.

In considering economic and political factors, investors commonly identify five kinds of hazards to which their investments are exposed. The following are different  components of risks associated with portfolio investments:

A. Systematic Risk

Systematic risk refers to the portion of total variability in return caused by factors affecting the prices of all securities.… Read the rest

Abey Francis