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Portfolio Management
Dr S.M.Tariq Zafar
M.Com, PGDMM, PhD (Social Sector Investment)
[email protected],
[email protected]
Introduction
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Introduction to Portfolio:
Portfolio management
Security analysis
Fundamental Analysis &Technical Analysis
Portfolio analysis
Portfolio selection
Portfolio revision
Portfolio evaluation
Purpose of portfolio management
Low risk vs. high risk investments
Introduction to Portfolio:
The developments in the capital market and the new financial avenues, new
challenges, risk & return management, performance evaluation in turbulent,
unpredictable and volatile traditional financial environment have made the life
challenging for the investors, financial economists, leaders of financial services
entities. To reduce the complexity of investment, risk, return and to assess and
evaluate the performance of securities the financial economists develop and
adopted portfolio management as an effective and efficient tool and technique.
With acquired knowledge and skills it regularly update financial purchases and
comparative analyze prevailing market condition. It measure the market
movement, sentiment, emotion and impacts and determines the virtual strengths
and opportunities for sale and purchase of the security. It minutely evaluate the
risk and return factors of security market and of respective securities of portfolio
in order to protect the investment and to generate growth and improvement in
future return
What is ‘‘Portfolio?
•Selection of different securities with different risk factors and maturity as a one unit is called
a portfolio. It is simply a collection or a group of securities considered in total as a single
investment unit. The term portfolio refers to any collection of financial assets such as cash. It
can be defined very broadly as it include property, antiques, works of arts, bullion,
commodities financial securities such as stocks, bonds, cash equivalents and money market
instruments.
•Creation of portfolio reduce the risk factor without sacrificing returns.
•Portfolios are held directly by investors or are managed by financial professionals,
hedge funds, banks and other financial institutions
•It is generally accepted principle that a portfolio is designed according to the investor's
risk tolerance, time frame and investment objectives.
Example: You can not construct your home on one pillar. You need numbers of pillar to
construct your home. These pillars are required to distribute the balance and weight, risk of
weight get distributed and home become safe. Similarly putting entire savings in a single
security is risky and to reduce the risk investment is done in group of securities. Such group
of securities is called a Portfolio.
What is 'Portfolio Management?'
•Portfolio management is a dynamic function of evaluating and revising the
portfolio in terms of stated investors objectives. It is concerned with efficient
management of investment in securities. it is an 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.
•Portfolio management deals with the process of selection of securities from
number of opportunities available with different expected returns and carrying
different expected levels of risk. And the selection of securities is made with a
view to provide the investors the maximum yield for a given level of risk or
ensure minimum risk for a good level of return.
Passive and Active Portfolio Management
•In general 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.
Phases of Portfolio Management:
Portfolio management is process encompassing many activities aimed at optimising the
investment of one’s funds. It is primarily concerned with efficient management of
investment in the securities. Out of many phases five are identified as a significant in this
process.
1. Security analysis
2. Portfolio analysis
3. Portfolio selection
4. Portfolio revision
5. Portfolio evaluation
Security Analysis:
•What is a Security ?
•Securities that have return and Risk characteristics of their own and have some financial
value are called securities.
•The entire process of estimating return & risk for individual securities is known
securities analysis.
•Method of Securities analysis are classified under the two head
•(1) Fundamental Analysis
• (2) Technical Analysis
•Characteristics of Securities
•Securities are tradable and represent a financial value.
•Securities are fungible.
•Classification of Securities:
•Debt Securities: Tradable assets which have clearly defined terms and conditions
are called debt securities. Financial instruments sold and purchased between parties
with clearly mentioned interest rate, principal amount, maturity date as well as rate
of returns are called debt securities.
•Equity Securities: Financial instruments signifying the ownership of an
individual in an organization are called equity securities. An individual buying
equities has an ownership in the company’s profits and assets.
•Derivatives: Derivatives are financial instruments with specific conditions under
which payments need to be made between two parties.
What is Security Analysis ?
The analysis of various tradable financial instruments is called security analysis. Security
analysis helps a financial expert or a security analyst to determine the value of assets in a
portfolio.
Why Security Analysis ?
Security analysis is a method which helps to calculate the value of various assets and also
find out the effect of various market fluctuations on the value of tradable financial
instruments (also called securities).
Classification of Security Analysis:
Security Analysis is broadly classified into three categories:
Fundamental Analysis
Technical Analysis
Quantitative Analysis
What is Fundamental Analysis ?
•Fundamental analysis is all about doing Qualitative and Quantitative Analysis about basic
details of a business such as Revenue Expenses, Assets, Liabilities and other Functional
aspects of the company.
•It estimate real worth of the stock, considering the potential of a company which depend on
investment environment and factors relating to specific industry, competitiveness, quality of
management, operational efficiency, profitability, capital structure and dividend policy. It
evaluate securities with the help of certain fundamental business factors such as financial
statements, current interest rates as well as competitor’s products and financial market.
•It is a method of evaluating a security that entails attempting to measure its intrinsic Value
by examining related economic, financial and other qualitative and quantitative factors.
Fundamental analysts attempt to study everything that can affect the security's value,
including macroeconomics factors (like the overall economy and industry conditions) and
company-specific factors (like financial condition and management).
•The end goal of performing fundamental analysis is to produce a value that an investor can
compare with the security's current price, with the aim of figuring out what sort of position
to take with that security (underpriced = buy, overpriced = sell or short).
Continued:
•This method of security analysis is considered to be the opposite of Technical analysis.
•Fundamental analysis is about using real data to evaluate a security's value. Although
most analysts use fundamental analysis to value stocks, this method of valuation can be
used for just about any type of security.
•Fundamental analysis includes: Economic analysis, Industry analysis, Company analysis
Why use fundamental analysis?
Fundamental analysis is built on the idea that the stock market may price a company
wrong from time to time. Profits can be made by finding underpriced stocks and
waiting for the market to adjust the valuation of the company. By analyzing the
financial reports from companies you will get an understanding of the value of
different companies and understand the pricing in the stock market.
After analyzing these factors you have a better understanding of whether the price of
the stock is undervalued or overvalued at the current market price. Fundamental
analysis can also be performed on a sectors basis and in the economy as a whole.
Interpretation:
Most fundamental information focuses on economic, industry, and company statistics.
The typical approach to analyzing a company involves four basic steps:
•Determine the condition of the general economy.
•Determine the condition of the industry.
•Determine the condition of the company.
•Determine the value of the company's stock.
Strength of Fundamental Analysis:
Long term Trend
Value Spotting
Business Acumen
Knowing Who is Who
Weakness of Fundamental Analysis:
Time Constraint
Industry / Company Specific
Subjectivity
Analysis Bias
Definition of fair value
Kind of Fundamental Analysis:
1. Quantitative Analysis:
•Quantitative analysis is based on numerical terms and factor like operational efficiency,
profitability, capital stricture and dividend policy
•The Quantitative factors are those which can be obtained from the financial statements.
•The factor like revenue, expenses, profit, defined revenue, capital structure, working
Capital
Ratios Used in Qualitative Analysis:
Return on Investment (ROI)
Price Earning Ratio (PE Ratio)
Earning Per Share (EPS)
Book Value (BV)
Debt Equity Ratio
Dividend Payout Ratio
Dividend Yield
Dividend Cover
Interest Cover
What is Technical Analysis:
Technical analysis is the future forecasting of financial price movement based on
examination of past price movement. A method of evaluating securities by analyzing
statistics generated by market activity, such as past prices and volume. Technical
analysts do not attempt to measure a security's intrinsic value, but instead use charts and
other tools to identify patterns that can suggest future activity. Technical analysts believe
that the historical performance of stocks and markets are indications of future
performance.
Assumptions of Technical Analysis:
•The assumption of technical analysis is that the price of stocks depends on Supply and
Demand in the market place.
•It has little correlation with its Intrinsic Value
•All financial data and market information of given stock is already reflected in its
market price.
•Charts are drawn to identify price movement pattern to predict future movement of the
stock.
•Technical Theory attempts to predict whether a trend is deceivable, if so then whether it
will continue or reverse.
•Mood of investors in unpredictable thus excessive reliance on technical indicators can
be disastrous for investors
•Past prices of share price may or may not predict the future behavior,
Assumption Continued:
•A best share price movements coupled with historical data may help in predicting
probabilities but not the exact cause of future events.
•Most analyst use charts at times as method of keeping track on the price movement of
particular shares or the market as a whole.
•In case of individual shares, charts can alert the analyst to any sharp upward or
downward movement or any persistent trend relative to the market
•The essence of Chartism is the is the belief that share prices trace out pattern over time.
These are reelection of investors behavior and it can be assumed that history trends to
repeat itself in the stock market.
Strength of Technical Analysis:
•Focus on Price
•Supply Demand and Price Action
•Pictorial Price History
•Asset with entry Point
Weakness of Technical Analysis:
•Analyst Bias
•Open Interpretation
•Too Late
•Always Another Level
•Traders Remorse
Approaches of Technical Analysis:
In general Technical Analysis adopt two approaches to analyse securities:
1. Market value is determined solely by the interaction of Supply and demand
2. Supply & demand are governed by many factors, both rational and irrational,
including fundamentalist as well as opinions, mood, guesses and blind necessities.
The market weighs all of these factor continually and automatically. Disregarding
minor fluctuations in the market security press tend to move in trends which persist
for an appreciable length time. Change is caused in trend by the shifts in supply and
demand relationships. These shifts no matter why they occur, can be detected sooner
or later in the action of the market itself.
Distinction Between Technical Analysts & Fundamental Analysis:
•Technical Analysts try to predict short term price movement, Where fundamental
analysts try to establish long term values.
•The focus of technical analysis is mainly on internal market date, particular price and
volume data, whereas the focus of Fundamental analysis is on the factor relating to
economy, industry and the company
•Speculators who want to make quick money mostly use results of technical analysis,
whereas investors who invest on long term basis use the results of fundamental analysis.
Portfolio Analysis:
A portfolio is a group of securities held together as investment. Investors invest their funds
in a portfolio of securities rather than in a single security because of risk factor. By
constructing a portfolio, investors attempt to spread risk by not putting all their eggs into
one basket. Thus diversification of investment tend to reduce risk by spreading risk over
many assets.
What is involved in Portfolio Analysis?
Portfolio analysis is broadly carried out for each asset at two levels:
Risk Aversion: This method analyzes the portfolio composition while considering the risk
appetite of an investor. Some investors may prefer to play safe and accept low profits
rather than invest in risky assets that can generate high returns. Each individual security
has its own risk- return characteristics which can be measured and expressed
quantitatively. Each portfolio constructed by combining the individual securities has its
own specific risk and return characteristics which are not just the aggregate of the
individual security characteristics. The return and risk of each portfolio has to be
calculated mathematically and expressed quantitatively.
Analyzing Returns: While performing portfolio analysis, prospective returns are
calculated through the average and compound return methods. An average return is simply
the arithmetic average of returns from individual assets. However, compound return is the
arithmetic mean that considers the cumulative effect on overall returns.
The next step in portfolio analysis involves determining dispersion of returns. It is the
measure of volatility or standard deviation of returns for a particular asset. Simply put,
dispersion refers is the difference between the real interest rate and the calculated average
return.
Benefits:
The Portfolio analysis can help you resist the urge to keep adding new products and services
before the previous ones have fulfilled their potential. The tool introduces logic to the
decision making process. Some organisations also use the tool very successfully to help
them gauge distance travelled – if you repeat the exercise every three or four years, you will
see how your organisation has shifted emphasis, adjusted to meet need or context and so on.
Limitations:
Portfolio analysis was developed with an assumption that long-term profitability is the
dominant goal, and responsibility to existing customers secondary - a balance of
assumptions which does not sit easily for the charities, social enterprises and others in the
voluntary and community sector. But provided one recognises this, it is still very useful,
primarily for products/offerings which break even or have the potential to break even.
Portfolio Selection:
Portfolio analysis provides the input for the next phase in portfolio
management which is portfolio selection. The goal of portfolio
construction is to generate a portfolio that provides the highest
returns at a given level of risk. A Portfolio having this characteristics
is known as an efficient portfolio. This inputs from portfolio analysis
can be used to identify the set of portfolio efficient portfolio. From
this set of efficient portfolio, the optimal portfolio has to be selected
for investment. The Harry Markowitz's portfolio theory provides
both the conceptual framework and the analytical tools for
determining the optimal portfolio in a disciplined and objective way
Portfolio Revision:
Having constructed the optimal portfolio, the investors has to constantly
monitor the portfolio to ensure that it continues to be optimal. As the economy
and financial markets are dynamics, changes take place almost daily. As time
passes, securities which were one attractive may cease to be so. New securities
with promises of high returns and low risk may emerge. The investors now has
to revise his portfolio in light of the developments in the market. This revision
leads to purchase of some new securities and sale of some of the existing
securities from the portfolio. The mix of securities and their proportion in the
portfolio changes as a result of the revision.
Portfolio revision may also be necessitated by some by some investors related
changes such as availability of additional funds, change in risk attitude, need of
cash for the alternative use, etc.
Whatever be the reason for portfolio revision, it has to be done scientifically
and objectively so as to ensure the optimality of the revised portfolio. Portfolio
revision is not a casual process to be carried out without much care. In fact, in
the entire process of portfolio management, portfolio revision is an important as
portfolio analysis and selection.
Portfolio Evaluation:
The objective of constructing a portfolio and revising it periodically is to earn maximum returns
with minimum risk. Portfolio evaluation is the process which is concerned with assessing the
performance of the portfolio over a selected period of time in term of return and risk. This
involves quantitative measurement of actual return realized and the risk born by the portfolio
over the period of investment. These have to be compared with objective norms to asses the
relative performance of the portfolio. Alternative measures of performance evaluation have been
developed for use by investors and portfolio managers.
Portfolio evaluation is useful in yet another way. It provides a mechanism for identifying
weakness in the investment process and for improving these deficient areas. It provides a
feedback mechanism for improving the entire portfolio management process.
The portfolio management process is an ongoing process. It starts with security analysis,
proceeds to portfolio construction, and continues with portfolio revision and evaluation. The
evaluation provides the necessary feedback for designing a better portfolio next time Superior
performance is achieved through continual refinement of portfolio management skills.
What is the difference between portfolio management and financial planning:
Utilizing the expertise of a financial professional can be beneficial to an individual
wanting to reach an investment goal or other financial objective. However, it is
important to know which types of services are provided by the financial
professional. Although it is common to use the terms ‘Portfolio Management’ and
"financial planning" as synonyms, these staples of the financial services industry are
not the same. Portfolio management is the act of creating and maintaining an
investment account, while financial planning is the process of developing financial
goals and creating a plan of action to achieve them. Understanding the difference
between the two may help in selecting the most suitable financial professional.
Portfolio management is provided by financial professionals who hold certain ‘Finra
Series Licenses’ that allow them to create and recommend portfolios of stocks,
bonds, mutual funds, exchange-traded funds (ETFs) or alternative investments to
meet the investment objectives of a specific investor. Professionals who perform
portfolio management are focused on meeting the needs of investors through the
rate of return achieved within a portfolio, and they are often responsible for
rebalancing the account to remain in line with the investor's allocation preferences.
Continued:
Financial planning is a more comprehensive process than portfolio management, although the
financial professionals that perform this task can hold the same licenses as a portfolio manager.
Individuals going through the financial planning process often develop a plan aimed at meeting
short- and long-term financial objectives, including building an emergency fund, saving for a new
home or reducing debt, accumulating retirement assets and creating estate or tax efficiency.
Financial planning may also include a discussion about portfolio management, but it is focused
on what rate of return needs to be achieved to meet a specific goal or what allocation is most
appropriate for an investor's risk appetite.
Purpose of Portfolio Management:
Portfolio management primarily involves reducing
risk rather than increasing return
Consider two $10,000 investments:
1)
2)
Earns 10% per year for each of ten years (low risk)
Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%,
and 10% in the ten years, respectively (high risk)
Low Risk vs. High Risk Investments
$30,000
$25,937
$23,642
$20,000
$10,000
$10,000
$0
'92
'94
'96
'98
'00
'02
Low
Risk
High
Risk
Low Risk vs. High Risk Investments
1)
Earns 10% per year for each of ten years
(low risk)
Terminal value is $25,937
2) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%,
20%, -12%, and 10% in the ten years,
respectively (high risk)
Terminal value is $23,642
The lower the dispersion of returns, the greater
the terminal value of equal investments
THANKS FOR COOPERATION
Dr. S. M. TARIQ ZAFAR
[email protected],
[email protected]