Portfolio Management – Meaning and Important Concepts!

What is a Portfolio?

A portfolio refers to a collection of investment tools such as stocks, shares, mutual funds, bonds and cash and so on depending on the investor’s income, budget and convenient time frame.

Following are the two types of Portfolio:

1. Market Portfolio
2. Zero Investment Portfolio

What is Portfolio Management?

The art of selecting the right investment policy for the individuals in terms of minimum risk and maximum return is called as portfolio management.

Portfolio management refers to managing money of an individual under the expert guidance of portfolio managers.

Need for Portfolio Management

Portfolio management presents the best investment plan to the individuals as per their income, budget, age and ability to undertake risks.

Portfolio management minimizes the risks involved in investing and also increases the chance of making profits.

Portfolio managers understand the client’s financial needs and suggest the best and unique investment policy for them with minimum risks involved.

Portfolio management enables the portfolio managers to provide customized investment solutions to clients as per their needs and requirements.

Types of Portfolio Management

Portfolio Management is further of the following types:

• Active Portfolio Management: As the name suggests, in an active portfolio management service, the portfolio managers are actively involved in buying and selling of securities to ensure maximum profits to individuals.
• Passive Portfolio Management: In a passive portfolio management, the portfolio manager deals with a fixed portfolio designed to match the current market scenario.
• Discretionary Portfolio management services: In Discretionary portfolio management services, an individual authorizes a portfolio manager to take care of his financial needs on his behalf. The individual issues money to the portfolio manager who in turn takes care of all his investment needs, paper work, documentation, filing and so on. In discretionary portfolio management, the portfolio manager has full rights to take decisions on his client’s behalf.
• Non-Discretionary Portfolio management services: In non-discretionary portfolio management services, the portfolio manager can merely advise the client what is good and bad for him but the client reserves full right to take his own decisions.

Who is a Portfolio Manager?

An individual who understands the client’s financial needs and designs a suitable investment plan as per his income and risk taking abilities is called a portfolio manager. A portfolio manager is one who invests on behalf of the client.

A portfolio manager counsels the clients and advises him the best possible investment plan which would guarantee maximum returns to the individual.

A portfolio manager must understand the client’s financial goals and objectives and offer a tailor made investment solution to him. No two clients can have the same financial needs.

OBJECTIVES OF PORTFOLIO MANAGEMENT

When the portfolio manager builds a portfolio, he should keep the following objectives in mind based on an individual’s expectation. The choice of one or more of these depends on the investor’s personal preference.

1. Capital Growth
2. Security of Principal Amount Invested
3. Liquidity
4. Marketability of Securities Invested
5. Diversification of Risk
6. Consistent Returns
7. 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.

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. It involves the following tasks:

• 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 a 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:

1.    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.

2.    It helps to keep a gauge on the risk taken as the process of PM keeps “Risk Minimization” as the focus.

3. “Customization” is possible because an 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 select.

4.    Taking into account changes in tax laws, investments can be made.

5.    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.

How Portfolio Management Works

Portfolio management includes a range of professional services to manage an individual’s and company’s securities, such as stocks and bonds, and other assets, such as real estate. The management is executed in accordance with a specific investment goal and investment profile and takes into consideration the level of risk, diversification, period of investment and maturity (i.e. when the returns are needed or desired) that the investor seeks.

In cases of sophisticated portfolio management, services may include research, financial analysis, and asset valuation, monitoring and reporting.

The fee for portfolio management services can vary widely among management companies. In terms of structure, fees may include an asset-based management fee, which is calculated on the basis of the asset valuation at the beginning of the service. Since this fee is guaranteed to the manager, it is typically a lower amount. Alternatively, the fee may be tied to profits earned by the portfolio manager for the owner. In such cases, the risk-based fee is usually much higher.