basics of portfolio management

7/31/2019 Basics of Portfolio Management

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BASICS OF

PORTFOLIOMANAGEMENT


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Phases Of Portfolio Management

SPECIFICATION OF INVESTMENT

OBJECTIVES AND CONSTRAINTS

CHOICE OF ASSET MIX

FORMULATION OF PORTFOLIO

STRATEGY

SELECTION OF SECURITIES

PORTFOLIO EXECUTION

PORTFOLIO REVISION

PORTFOLIO EVALUATION


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Specification Of Investment Objectives

The commonly stated investment goals are : income,growth, and stability

Since income and growth represent two ways bywhich return is generated and stability implies

containment of risk, investment objectives may be

expressed more succinctly in terms of return and risk.


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A Risk Tolerance Questionnaire

To assess your risk tolerance, seven questions are given below. Each

question is followed by three possible answers. Circle the letter that

corresponds to your answer.

1. Just six weeks after you invested in a stock, its price declines by 20

percent. If the fundamentals of the stock have not changed, what

would you do?

a. Sellb. Do nothingc. Buy more

2. Consider the previous question another way. Your stock dropped 20

percent, but it is part of a portfolio designed to meet investment goals

with three different time horizons.(i) What would you do if your goal were five years away?



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(ii) What would you do if the goal were 15 years away?


(iii) What would you do if the goal were 30 years away?


3. You have bought a stock as part of your retirement portfolio. It pricerises by 25 percent after one month. If the fundamentals of the stock

have not changed, what would you do?

a. Sellb. Do nothing

c. Buy more

4. You are investing for retirement which is 15 years away. What would

you do?

a. Invest in money market mutual fund or a guaranteed

investment contract


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b. Invest in a balanced mutual fund that has a stock : bond mix

of 50 : 50

c. Invest in an aggressive growth mutual fund

5. As a prize winner, you have been given some choice. Which one wouldyou choose?

a. Rs 50,000 in cashb. A 50 percent chance to get Rs 125,000c. A 20 percent chance to get Rs 375,000

6. A good investment opportunity has come your way. To participatein it you have to borrow money. Would you take a loan?

a. Nob. Perhapsc. Yes

7. Your company, which is planning to go public after three years, is

offering stock to its employees. Until it goes public, you cantsell yourshares. Your investment, however, has the potential of multiplying 10times when the company goes public. How much money would youinvest?


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a. Nothing

b. Three months salaryc. Six months salary

Your risk tolerance score is:

Number of (a) answers x 1

+ Number of (b) answers x 2

+ Number of (c) answers x 3


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Your Risk Appetite

Ifyour score is You may be a

914 points Conservative investor

1521 points Moderate investor

2227 points Aggressive investor


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Constraints

LIQUIDITY

TAXES

TIME HORIZON

UNIQUE PREFERENCES & CIRCUMSTANCES


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Selection Of Asset Mix

Should the long-term stock-bond mix be 50 : 50 or

75 : 25 or 25 : 75 or any other ?

Referred to as the strategic asset-mix decision (orpolicy asset-mix decision), this is by far the most

important decision by the investor. Empirical studies

have shown that nearly 90 percent of the variance of

the portfolio return is explained by its asset mix.


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Selection Of Asset Mix

CONVENTIONAL WISDOM

1. GREATER RISK TOLERANCE STOCKS2. LONGER INVESTMENT HORIZON STOCKS

RISK-RETURN RELATIONSHIP FOR VARIOUS TYPES

OF BONDS AND STOCKS

RETURN

RISK

BANK

DEPOSITS

PUBLIC

SECTOR

BONDS

INCOME/GROWTH

ORIENTED UNITS

NCDs OF PRIVATE

SECTOR

DEFENSIVE

SHARES

BLUE CHIP

SHARES

SPECULATIVE

SHARES

GROWTHSHARES


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Range Of Return On Common Stocks

60%

50%

40%

30%

20%

10%

0%

-10%

-20%

-30%

1-year 5-year 10-year 15-year 20-year 25-year

periods periods periods periods periods periods

High +52.6% +23.9% +19.3% +16.4% +13.4% +10.3%

Average +13.0% +10.4% + 9.5% + 9.3% + 9.4% + 9.4%

Low -26.5% - 2.4% + 1.2% + 4.3% + 6.5% + 8.4%


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Enduring Relation

J.H.LORIE : THE MOST ENDURING RELATION IN ALLFINANCE PERHAPS IS THE RELATIONSHIP BETWEEN

RETURNS ON EQUITIES (OR STOCKS) AND RETURNS

ON BONDS. IN ALL PERIODS OF AMERICAN HISTORY,BRITISH HISTORY, AND GERMAN HISTORY, EQUITIES

(STOCKS) HAVE PROVIDED HIGHER RETURNS THAN

BONDS A SIMILAR OBSERVN CAN BE MADE WHEN WE

LOOK AT THE RETURNS ON STOCKS AND BONDS IN

INDIA FOR THE LAST TWO DECADES


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Appropriate Percentage Allocation

RISK TOLERANCE

TIME HORIZON

LOW MODERATE HIGH

SHORT 0 25 50

MEDIUM 25 50 75

LONG 50 75 100


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Resurrection Of Time Diversification

1. THERE IS SOME EVIDENCE THAT STOCK RETURNS

ARE NOT SERIALLY INDEPENDENT BUT TEND TOMEAN - REVERT OVER LONG INTERVALS .. THE

DISPERSION OF TERMINAL WEALTH INCREASES -

AT A SLOWER RATE THAN WHAT IS IMPLIED BY

SERIALLY INDEPENDENT RETURNS

2. YOU MAY BE MORE INCLINED TO ACCEPT MORE

RISK OVER A LONGER HORIZON AS YOU HAVE

GREATER SCOPE TO ADJUST YOUR CONSUMPTION

AND WORK HABITS


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Some Specialized Concepts

Growth Stocks

Value Stocks

Asset Rich Stocks

Technology Stocks

Cyclical Stocks

Momentum Stocks


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Two Popular Management StylesValue Management & Growth Management

Value Stocks

Low earnings per share

growth

Low price - earning ratio

Low price book ratio

High dividend yield

Betas tend to be less than

one Out of favor

Growth Stocks

High earnings per share

growth

High price - earning ratio

High price book ratio

Low dividend yield

Betas tend to be more than

one Popular


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Market Timing

WHILE REVIEWING MARKET FLUCTNS, ANY ONE WILLGET TEMPTED TO PLAY GAME OF MARKET TIMING

A CAREFUL STUDY OF MARKET TIMING SUGGESTS

- A FUND MANAGER SHOULD CORRECTLY FORECAST AT

LEAST 75% TIMES JUST TO BREAK-EVEN.

FISHER BLACK SAYS :

THE MARKET DOES JUST AS WELL, ON AVERAGE, WHEN

THE INVESTOR IS OUT OF THE MARKET AS IT DOES WHENHE IS IN. SO HE LOSES MONEY, RELATIVE TO A SIMPLE BUY-

AND-HOLD STRATEGY, BY BEING OUT OF THE MARKET

PART OF THE TIME


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Passive Strategy

ACTIVE STRATEGY IS BASED ON PREMISE THAT THERE ARE

INEFFICIENCIES IN THE MARKET WHICH SHOULD BE

EXPLOITED

PASSIVE STRATEGY RESTS ON THE TENET THAT MARKET

IS FAIRLY EFFICIENT WITH RESPECT TO AVAILABLE

INFORN

1. CREATE A WELL-DIVERSIFIED PORTFOLIO AT A

PRE-DETERMINED LEVEL OF RISK

2. HOLD THE PORTFOLIO RELATIVELY UNCHANGED

OVER TIME, UNLESS IT BECOMES INADEQUATELY

DIVERSIFIED OR INCONSISTENT WITH THE

INVESTORS RISK-RETURN PREFERENCES

P f li S Mi


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Portfolio Strategy Mix

ABILITY TO SELECT ABILITY TO FORECAST OVERALL MARKET

UNDERVALUED GOOD BAD

SECURITIES

1. CONCENTRATE 1. CONCENTRATE

GOOD 2. SHIFT BETA 2. KEEP BETA STABLE

1. DIVERSIFY 1. DIVERSIFY

BAD 2. SHIFT BETA 2. KEEP BETA STABLE

S l i Of S i i


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Selection Of Securities

SELECTION OF BONDS

YTM

DEFAULT RISK

TAX SHIELD

LIQUIDITY

DURATION

SELECTION OF STOCKS

TECHNICAL ANALYSIS

FUNDAMENTAL ANALYSIS

RANDOM ANALYSIS

M k Effi i A d S i S l i


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Market Efficiency And Security Selection

LEVEL OF APPROACH TECHNICAL FUNDAMENTAL RANDOM

EFFICIENCY ANALYSIS ANALYSIS SELECTION

INEFFICIENCY BEST POOR POOR

WEAK-FORM POOR BEST POOR

EFFICIENCY

SEMI-STRONG-FORM

EFFICIENCY POOR GOOD FAIR

STRONG-FORM

EFFICIENCY POOR FAIR BEST


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The Efficient Market Hypothesis

The weak form of the EMH says that past

prices, volume, and other market statistics

provide no information that can be used topredict future prices.

The semi-strong form says that prices fully

reflect all publicly available information and

expectations about the future.

The strong form says that prices fully reflect all

information, whether publicly available or not.

P tf li E ti T di G


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Portfolio Execution Trading Game

BUSINESS TRANSACTION SECURITY TRANSACTION

MOTIVE AND IDENTITY OF MOTIVE AND IDENTITYTHE COUNTERPARTY OF THE COUNTERPARTY

KNOWN NOT KNOWN

CONSTRUCTIVE MOTIVES ZERO SUM GAME

+ SUM GAME

MOTIVES FOR TRADE

COGNITIVE

EMOTIONAL


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Key Players Value Based Transactors (VBT)

Information Based Transactors (IBT)

Liquidity Based Transactors (LBT)

Pseudo Information Based Transactors

(PIBT)

Dealers

T di M ti ti Ti H i A d Ti /


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Trading Motivations, Time Horizons, And Time v/s

Price Preferences

TRANSACTOR MOTIVATION TIME TIME v/s PRICEHORIZON PREFERENCE

VBT DISCREPANCY WEEKS TO PRICE

BETWEEN VALUE MONTHS

AND PRICE

IBT NEW INFORMATION HOURS TO TIME

DAYS

LBT RELEASE OR ABSORB HOURS TO TIME

CASH DAYS

PIBT APPARENTLY NEW HOURS TO TIME

INFORMATION DAYS

DEALER ACCOMODATION MINUTES TO INDIFFERENT

HOURS

f l


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Portfolio Revision

NEED

PORTFOLIO REBALANCING

BUY AND HOLD POLICY CONSTANT MIX POLICY

PORFOLIO INSURANCE POLICY

PORTFOLIO UPGRADING

basics of portfolio management

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