Portfolio Management
May 28, 2021
What is “Portfolio Management”?
Portfolio management relates to the processes of selecting investments, their ongoing monitoring and making changes where required. During that process, there are some key decisions to be made – what would be the optimal exposure in terms of asset classes, regions, style, market capitalization and product. In order to make an informed and rational decision, investors also need to assess various factors such as: time horizon, level of risk, objectives or ethical preferences, which will help them build and execute the desired strategy.
Individual investors could dedicate their money to be managed by professionals in the form of different collective products or on a discretionary basis or may prefer to run their own portfolio themselves.
Key Learning Points
- Portfolio management involves investment selection, asset allocation and ongoing monitoring and making changes where required
- Investors could trust their money to professional portfolio managers or run their own portfolio
- There are two major types of portfolio management – active and passive
- In order to create the optimal portfolio, investors need to determine what is their time horizon, risk appetite, specific needs or requirements
Asset Allocation and Investment Selection
Asset Allocation and Investment Selection are the fundamentals of portfolio management. Determining the right mix of assets in the portfolio is based on the principle of diversification – offsetting specific risks in an attempt to achieve the optimal return adjusted for the risk involved. Through allocating funds to different asset classes, for example, equities, bonds, property, or commodities, investors will set up the framework for their strategy. On the other hand, the selection process involves defining the best security or product that will help to get the desired exposure. That may be either individual securities such as equities or bonds, or investment products that invest in those types of securities such as mutual funds, investment trusts or exchange traded funds.
Active Vs. Passive Management
When it comes to selecting investment products, there are two major types of management – active and passive. Generally, active managers are trying to outperform a particular market index over a specific time frame, where passive managers aim at replicating as closely as possible the returns of the index. In the first instance, an individual runs a strategy and makes decisions according to his/her views, where the latter offers pure market exposure generated through automated methods.
Rebalancing
After periods of potential gains or losses of its underlying holdings, a portfolio might have shifted from its initial framework and will need to be rebalanced in order to continue serving its specific purposes. This involves selling a proportion of the investments that became larger than the target framework and allocating the proceeds to other areas where the portfolio is currently underweight. For example, if a portfolio has 60% equities and 40% fixed income as its target allocation and after an extended stock rally it shifted to 75% equities and 25% bonds, it means the investor has experienced good returns but as a result the portfolio’s risk level also increase over time. Selling some of the equities and putting the proceeds into the bond holdings will rebalance the portfolio to its original merits.
