Portfolio management

The art and science of making decisions about investment mix and policy,
matching investments to objectives, asset allocation for individuals and
institutions, and balancing risk against. Performance.
Portfolio management is all about strengths, weaknesses, opportunities and threats
in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and
many other tradeoffs encountered in the attempt to maximize return at a given
appetite for risk.

Investopedia explains Portfolio

Management
In the case of mutual and exchange-traded funds (ETFs), there are two forms of
portfolio management: passive and active. Passive management simply tracks a
market index, commonly referred to as indexing or index investing. Active
management involves a single manager, co-managers, or a team of managers who
attempt to beat the market return by actively managing a fund's portfolio through
investment decisions based on research and decisions on individual holdings.
Closed-end funds are generally actively managed.

Why we use portfolio management?

Portfolio Management is used to select a portfolio of new product development
projects to achieve the following goals:

 Maximize the profitability or value of the portfolio

 Provide balance
 Support the strategy of the enterprise

Portfolio Management is the responsibility of the senior management team of an

organization or business unit. This team, which might be called the Product
Committee, meets regularly to manage the product pipeline and make decisions
about the product portfolio. Often, this is the same group that conducts the stage-
gate reviews in the organization.

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A logical starting point is to create a product strategy - markets, customers,
products, strategy approach, competitive emphasis, etc. The second step is to
understand the budget or resources available to balance the portfolio against. Third,
each project must be assessed for profitability (rewards), investment requirements
(resources), risks, and other appropriate factors.

The weighting of the goals in making decisions about products varies from
company. But organizations must balance these goals: risk vs. profitability, new
products vs. improvements, strategy fit vs. reward, market vs. product line, long-
term vs. short-term. Several types of techniques have been used to support the
portfolio management process:

 Heuristic models
 Scoring techniques
 Visual or mapping techniques

The earliest Portfolio Management techniques optimized projects' profitability or

financial returns using heuristic or mathematical models. However, this approach
paid little attention to balance or aligning the portfolio to the organization's
strategy. Scoring techniques weight and score criteria to take into account
investment requirements, profitability, risk and strategic alignment. The
shortcoming with this approach can be an over emphasis on financial measures and
an inability to optimize the mix of projects. Mapping techniques use graphical
presentation to visualize a portfolio's balance.

These are typically presented in the form of a two-dimensional graph that shows
the trade-off's or balance between two factors such as risks vs. profitability,
marketplace fit vs. product line coverage, financial return vs. probability of
success, etc.

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The chart shown above provides a graphical view of the project portfolio risk-
reward balance. It is used to assure balance in the portfolio of projects - neither too
risky or conservative and appropriate levels of reward for the risk involved. The
horizontal axis is Net Present Value, the vertical axis is Probability of Success. The
size of the bubble is proportional to the total revenue generated over the lifetime
sales of the product.

While this visual presentation is useful, it can't prioritize projects. Therefore, some
mix of these techniques is appropriate to support the Portfolio Management
Process. This mix is often dependent upon the priority of the goals.

Simplest steps of successful portfolio management

Portfolio management is challenging, but it's also exciting. Some people prefer to
have their portfolios managed by a professional. However, it's not impossible to
manage your own portfolio. It just takes time and a basic understanding of the
process.

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Portfolio management involves 6 steps in an ongoing process:
1. Determine Objectives/Constraints
2. Formulate a Strategy
3. Design an Investment Policy
4. Implement Asset Allocation
5. Monitor Performance
6. Evaluate Performance

As an ongoing process, it is the responsibility of the portfolio manager (whether

that's you or a professional) to go through the process (beginning at "Determine
Objectives and Constraints") and upon reaching the "Evaluate Performance" stage,
start again.

Why is it an ongoing process? Because life is not static. People move, they change
jobs, they get married, they get divorced, they get remarried, they have children,
they make large purchases, they make wise decisions, they make unwise decisions,
they are faced with windfalls and tragedies. Each of those (and many, many other)
events will affect how they manage their portfolio.

Every individual has different needs and wants. The first step to successfully
manage your investment needs is to identify them by drafting an investment plan.
This plan should state your goals. It is simply a mission statement of what you
endeavor to achieve. Be as specific as you can, so that you can determine what to
invest in, and how your portfolio will be structured to realise your dream.

Knowing yourself is critical to creating and managing a portfolio that will do what
you want it to do. This knowledge will help you set realistic future financial goals
and will help you to decide how much risk to include in your investment strategy

There are several constraints that may work against your desire to build up a
healthy nest egg. These are all challenges of having money. Unfortunately, many
of them are unavoidable… but that doesn't mean that they're not manageable. The
best thing to do is know that they exist and develop strategies to help you over
come them. Some of the considerations include evaluating your Risk & Return
Profile, Investment Time Horizon, Liquidity Requirement, Legal and Taxation

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Structure, etc.

And also, do you remember the popular saying, "Don't put all your eggs in
one basket" ? The reason why you should achieve diversification in your portfolio
is that the value of different asset classes tends to behave and perform very
differently. Some assets move in tandem or in a similar direction with each other,
while others move in opposite directions. What may surprise you is that for the
same rate of return, you can actually combine different asset classes to achieve this
expected return. Thus the secret to successful portfolio management is to create a
portfolio by investing in different types of asset classes, that generate the lowest
risk factor to achieve your investment objectives.

8 Steps to Portfolio Management

1. Standardize and automate the governance processes.
Define multiple workflows to subject each project to the appropriate governance
controls throughout its life cycle — from proposal to post-implementation —
resulting in lowered costs, faster cycle times, and increased quality. 

 2. Capture all investments within a central repository.

Consolidate business and information technology (IT) investments within an
enterprise repository to improve visibility, insight, and control. Implement
repeatable processes as templates to standardize and streamline data collection
across the organization. Centralized data facilitates cross project analysis of
finances, resources, schedules as well as other data trends and status for
informative reports. 

3. Objectively prioritize business strategy and competing

investments. 
Employ proven techniques to define and prioritize your organization’s business
strategy for the upcoming planning period, and automatically derive objective
prioritization scores to effectively evaluate the competing investments from
multiple dimensions.
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4. Align the selected portfolios with the business strategy. 
Run optimization what-if scenarios to identify tradeoffs and select the optimal
portfolio under varying budgetary and business constraints that best align with
your organization’s business strategy. Take advantage of advanced portfolio
analytical techniques to identify and break the constraints prohibiting the portfolio
from reaching the Efficient Frontier.

5. Effectively manage resources

Without understanding long-term workloads and capacity, companies can
experience inefficient hire-fire cycles, resulting in higher overhead, lost
knowledge, and poor employee morale. By providing visibility into overall work
commitments, actual timesheets, and resource capabilities, create resource plans to
align your strategic recruiting and outsourcing with your long-term business
objectives.

6. Collaborate and coordinate easily

Helping to ensure that teams share common goals and work together effectively
becomes more vital as organizations become more geographically and culturally
diverse. Web-based access to timely, business-critical project information means
teams can share knowledge, collaborate smoothly to complete tasks and
deliverables, and adjust activities quickly to accommodate project changes and
updates.

7. Measure and track portfolio performance

Effectively measure and track projects, programs, and applications throughout their
life cycle, giving you the visibility to proactively identify potential issues, make
decisions, and help ensure that your portfolios maximize return on investment
(ROI) and improve operational efficiencies.

8. Quickly realize a return on investment.

By enabling increased employee productivity, faster cycle times, reduced costs,
and improved time management, portfolio management solutions provide a
positive and sustainable return on investment. In IT portfolio management,
software can cut costs 2-5 percent, improve productivity 20-25 percent and shift

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10-15 percent of budgets to more strategic projects. In developing and bringing
new products to market, the best performers — those who have applied rigorous
process and technology to their research and development and go-to-market
activities — can reduce time to market by more than 30 percent.

Whole Portfolio Process Overview

A complete portfolio management process life cycle consists of four major
sequential phases or activities. These are: Prepare; Plan; Execute; and Harvest.
There are several things worth noting about this sequence

 Firstly, unlike a project that has a life span that is often misnamed life cycle
(a project doesn't "cycle", it starts and it finishes), a project portfolio is an
entity that does have a true life cycle. That's because the portfolio does get
reviewed and its process repeated throughout the year and certainly on an
annual basis.
 Secondly, project practitioners will be familiar with the sequence: Prepare;
Plan; Execute (and deliver) as it applies to a single project. However,
portfolio management starts much earlier in the game and, downstream, must
actively deploy project outcomes and rigorously garner the expected
improvements.
 Thirdly, the outcomes of portfolio projects are not just deliverables, they are
enablers - enablers of future benefits derived through "harvesting".
 Fourthly, the harvesting activity includes the reaping of the benefits,
gathering data on the actual benefits realized, assessing value and feeding the
findings back into the preparation phase of the portfolio process. All of this is
to establish continuous improvement, and thus completing the portfolio
cycle.

 Fifthly, not many organizations conduct this entire process as just described,
especially including rigorous harvesting. This is simply because of the
difficulties of managing across major organizational boundaries in traditional
"stovepipe" structures.

In a sense, the four major phases of portfolio management described above may
be likened to four levels of organizational maturity. Only those organizations that
actually conduct all four phases successfully, and are truly effective in modifying
the input strategies as in "continuous learning", have reached the highest level of
project management organizational maturity

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The Portfolio Management Process
 Planning,
Which includes- Investment Objectives and Constraints, Formulating the
IPS (which includes making the investment strategy- active, passive or semi-
active), Perceiving the Capital Market Expectations, and Strategic Asset
Allocation.

 Execution
Selection of specific assets for the portfolio, interacts constantly with the
feedback step. Tactical Asset Allocation- Responding to changes in the short
term capital market expectations rather than to investor circumstances.
Transaction costs (both explicit and implicit) need to be taken into account).

 The Feedback Step

Includes Monitoring and Rebalancing and Performance Evaluation.

a. During monitoring, two types of factors are monitored: the investor’s

circumstances and the economic and market   input factors. We should manage
ongoing exposures to available investment opportunities in order to continually
satisfy the client’s current objectives and constraints. When asset price changes
occur, however, revisions can be required even without changes in expectations. 

b. Performance evaluation-Has three steps- Performance measurement (which can

be done through 3 sources- market timing, strategic asset allocation and security
selection. Port. management is often done against a benchmark. So, both absolute
and relative measurement are important), performance attribution (the source of the
port’s performance) and performance appraisal (evaluating if the manager did a
good job).  The applicability of the benchmark also should be assessed.

Different components of the Planning Step in details

1. Investment Objectives- Includes both risk and return objective. The investment
objectives are specific and measurable. Risk tolerance gives more of a range

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(below average, above average etc.) and risk objective quantifies the risk tolerance.
Risk can be measured by absolute methods such as Variance, Std. Deviation, VaR
or by relative methods such as Tracking Error. We need to synthesize both the
willingness and the ability of the investor to take on risk. Return Objective:
Specify a return measure such as total nominal return, determine the investor’s
stated return desire,  the investor’s RRR, and specify an objective in terms of the
return measure in the first step. Although an absolute return objective is sometimes
set (e.g.- 10%), the reality of the markets suggest that a relative return objective
may be more plausible. The investment constraints are limitations on the ability to
make use of particular investments.

They can be liquidity (need for cash in excess of new contributions), time horizon,
tax concerns, legal and regulatory factors and unique circumstances (ethical
objectives or social responsibility considerations, health needs, support of
dependents, avoidance of nondomestic shares etc.)

2. Investment Policy Statement- Is a written document that governs all investment

decisions for the client. It is specific to each client and integrates the needs,
preferences and circumstances of that client’s objectives and constraints.

It also involved the making of an investment strategy, which is the manager’s

approach to investment analysis and security selection. The strategy can either be
passive ( a portfolio indexed to a market index or a buy and hold strategy), active
(when the port. holdings differ from the port’s benchmark or comparison port, in
order to produce a positive alpha), or the semi active, risk-controlled active or the
enhanced index approach (a port. closely following an index strategy, but adding a
targeted amt of value by tilting the asset weights in a direction the manager
believes to be profitable).

3. Capital Market Expectations- Long run forecasts of risk and return

characteristics for various asset classes that form the basis for choosing portfolios.

Portfolio Management Theories

Risk Aversion
Risk aversion is an investor's general desire to avoid participation in "risky"
behavior or, in this case, risky investments. Investors typically wish to maximize
their return with the least amount of risk possible. When faced with two investment

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opportunities with similar returns, good investor will always choose the investment
with the least risk as there is no benefit to choosing a higher level of risk unless
there is also an increased level of return. 

Insurance is a great example of investors' risk aversion. Given the potential for a

car accident, an investor would rather pay for insurance and minimize the risk of a
huge outlay in the event of an accident.

Markowitz Portfolio Theory

Harry Markowitz developed the portfolio model. This model includes not only
expected return, but also includes the level of risk for a particular
return. Markowitz assumed the following about an individual's investment
behavior: 

Given the same level of expected return, an investor will choose the investment
with the lowest amount of risk.
Investors measure risk in terms of an investment's variance or standard deviation.
For each investment, the investor can quantify the investment's expected return and
the probability of those returns over a specified time horizon.
Investors seek to maximize their utility.
Investors make decision based on an investment's risk and return, therefore, an
investor's utility curve is based on risk and return.
The Efficient Frontier
Markowitz' work on an individual's investment behavior is important not only
when looking at individual investment, but also in the context of a portfolio. The
risk of a portfolio takes into account each investment's risk and return as well as
the investment's correlation with the other investments in the portfolio.

Risk of a portfolio is affected by the risk of each investment in the portfolio

relative to its return, as well as each investment's correlation with the other
investments in the portfolio.

4 A portfolio is considered efficient if it gives the investor a higher expected return

with the same or lower level of risk as compared to another investment.
The frontier’s simply a plot of those efficient portfolios, as illustrated below.

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