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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

EXECUTIVE SUMMARY

Managing an investment portfolio in todays dynamic environment is a challenge for every individual, who works hard to reach the ultimate goal of preserving and generating wealth. Global financial markets are complex and diverse enough that money can be made in any investment environment. The greatest challenge in making an investment portfolio work is knowing exactly where to invest and what to do when. One of the safest ways an investment portfolio generates money is through fixed income investments. These are usually in the form of stock & bonds issued by corporations or governments or from dividends paid to shareholders by a corporation. Issues effecting fixed income are the credit worthiness, or default risk, of the issuer, and the yield earned by the bondholder. Safer lenders, such as those of governments or blue-chip companies, typically pay a lower yield--at times, so low that the real return after inflation is at or below zero! On the other hand, a company or government that goes bankrupt will be unable to pay its high dividends or service its debt. To do this successfully, however, requires patience, discipline and a deep knowledge of macroeconomic trends. In an environment when an economy is growing, most assets will tend to rise in value, making capital gains relatively easy to come by. Asset allocation is much more difficult and crucial in a period of stagnant or contracting growth. During these times, investors will have to monitor capital flows to know which assets can maintain their value or appreciate while others decline. Capital gains can be realized over a very long period of time, which is recommended for most novice investors, or over a very short period of time, as little as a few minutes or hours for risktaking day traders.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

To mitigate the risks of asset allocation within a portfolio, holdings should be diversified. If done correctly, diversification will vastly reduce risk while preserving growth potential. Investments, though a source of gain to generate wealth out of the existing wealth, is accompanied by various risks. Awareness about the various types of risks one might face, making choices about the risks one is willing to take, and an understanding of how to build and balance ones portfolio to offset potential problems, one can manage investment risks to their advantage.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

OBJECTIVES OF PROJECT:

1)To understand various investment opportunities comprising of Portfolio like combination of stocks ,bonds ,options considering the risk and the return factors, also investments in mutual funds and the insurance. 2) To evaluate the risks associated with the investments and the return opportunities from the same. 3) To understand the functions of the portfolio Manager and activities involved in Portfolio Management.. 4) To study the various theories related to the Portfolio Management like Markowitz Theory, CAPM, SML, Arbitrage Pricing Theory. 5) To understand the main objectives and guide the investors while framing the portfolio. 6) To design a suitable portfolio which is well diversified depending upon the investors risk and the return profiles.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

INTROUDUCTION

Portfolio management is the professional management of various securities (shares, bonds etc) assets (e.g. real estate), to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or private investors (both directly via investment contracts and more commonly via collective investment schemes e.g. mutual funds) . The term asset management is often used to refer to the portfolio management of collective investments, whilst the more generic fund management may refer to all forms of institutional investment as well as investment management for private investors. Investment managers who specialize in advisory or discretionary management on behalf of (normally wealthy) private investors may often refer to their services as wealth management or portfolio management often within the context of so-called "private banking". The provision of 'portfolio management services' includes elements of financial analysis, asset selection, stock selection, plan implementation and ongoing monitoring of investments. Portfolio management is a large and important global industry in its own right responsible for caretaking of trillions of dollars, euro, pounds and yen. Coming under the remit of financial services many of the world's largest companies are at least in part investment managers and employ millions of staff and create billions in revenue. Portfolio Management Services (PMS) is an investment portfolio in stocks, fixed income, debt, cash, structured products and other individual securities, managed by a professional money manager that can potentially be tailored to meet specific investment objectives.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

When you invest in PMS, you own individual securities unlike a mutual fund investor, who owns units of the entire fund. You have the freedom and flexibility to tailor your portfolio to address personal preferences and financial goals. Although portfolio managers may oversee hundreds of portfolio, your account may be unique.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

WHY IS PORTFOLIO MANAGEMENT REQUIRED?

A vast majority of investors are often left with questions like: 1. Where should I invest right now? 2. What's the next booming trend? 3. Where and how can I minimize risk? 4. What's safe to invest in now? 5. Why is there so much confusing and conflicting information? To answer some of these questions, a study of the investment options available for small investors is essential. In a current scenario, a large amount of investment options are available, which have their respective benefits & risks associated to them. Absence of adequate information & expertise can lead to investors losing confidence in the these investment options, even though they may be quite promising. As in the current scenario the effectiveness of PMS is required. As the PMS gives investors periodically review their asset allocation across different assets as the portfolio can get skewed over a period of time. This can be largely due to appreciation / depreciation in the value of the investments. As the financial goals are diverse, the investment choices also need to be different to meet those needs. No single investment is likely to meet all the needs, so one should keep some money in bank deposits and / liquid funds to meet any urgent need for cash and keep the balance in other investment products/ schemes that would maximize the return and minimize the risk. Investment allocation can also change depending on one's risk-return profile. That is precisely why
Portfolio Management Services are require in todays scenario where investors are exposed to various asset classes and they desire to achieve a maximum return on their portfolio with minimum amount of risk.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

OBJECTIVES OF PORTFOLIO MANAGEMENT SERVICES 1. Safety Of Fund: The investment should be preserved, not be lost, and should remain in the returnable position in cash or kind. 2. Minimize risk: Risk avoidance and minimization of risk are important objective of portfolio management. Portfolio managers achieve these objectives by effective investment planning and periodical review of market, situation and economic environment affecting the financial market 3. Liquidity: The portfolio must consist of such securities, which could be en-cashed without any difficulty or involvement of time to meet urgent need for funds. Marketability ensures liquidity to the portfolio. 4. Reasonable return: The investment should earn a reasonable return to upkeep the declining value of money and be compatible with opportunity cost of the money in terms of current income in the form of interest or dividend. 5. Appreciation in Capital: The money invested in portfolio should grow and result into capital gains. 6. Tax planning: Efficient portfolio management is concerned with composite tax planning covering income tax, capital gain tax, wealth tax and gift tax.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

FUNCTIONS OF PORTFOLIO MANAGER:

Portfolio Manager renders the service of portfolio management to the clients in the different categories viz. individuals ,residents and Non residents Indian, firms associations of persons, joint Hindu family ,trust, society, enterprises, provident fund have to inquire about the respective individuals objectives and the goals, need pattern for the funds, the clients perspective towards the growth and the objectives towards the risk and thus need to give him proper counseling on the subject and the acceptance of the matter. In the wake of rendering services the portfolio managers perform the following functions: a) Portfolio managers study the economic environment affecting the capital markets and also the factors affecting the clients investments. b) They study the securities markets. c) They evaluate the price trend in the shares and the securities in which the investments are to be made. d) They maintain a complete and updated financial performance data of the blue chips and the other companies. e) They keep a track of the latest policies and the guidelines of the SEBI. Govt of India, RBI and the stock exchanges. f) They study the problems of the industry affecting the securities market and the attitude of the investors.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

g) They also study the financial behavior of the development financial institutions and the other players in the capital markets to find out the sentiments of the investors and the capital market h) They counsel the prospective investors on the share markets and suggest investments in the assured securities i) They carry out investments in the securities or the sale or the purchase of securities on behalf of the client to attain the maximize return at lesser risk. The services of portfolio managers may be discretionary or non-discretionary, depending on whether the investor decides to leave all investment decisions in professional hands or whether he takes the final decision himself.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

RISK Risk can be classified into 2 broad categories in the purview of Portfolio Management: 1. Systematic Risk 2. Unsystematic Risk Systematic Risk : Systematic risk is also known as market risk and relates to factors that affect the overall economy or securities markets. Systematic risk affects all companies, regardless of the company's financial condition, management, or capital structure, and, depending on the investment, can involve international as well as domestic factors. Beta is a measure of systematic risk. Some of the most common systematic risks: i. Interest-rate risk describes the risk that the value of a security will go down because of changes in interest rates. ii. Inflation risk describes the risk that increases in the prices of goods and services, and therefore the cost of living, will reduce the purchasing power iii. Currency risk occurs because many world currencies float against each other. If money needs to be converted to a different currency to make an investment, any change in the exchange rate between that currency and domestic currency can increase or reduce the investment return. This risk usually only impacts in case of international securities or funds that invest in international securities. iv. Liquidity risk is the risk that one might not be able to buy or sell investments quickly for a price that is close to the true underlying value of the asset. Sometimes one may not be able to sell the investment at all if there are no buyers for it. v. Sociopolitical risk is the possibility that instability or unrest in one or more regions of the world will affect investment markets.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

Unsystematic Risk : Unsystematic risk, in contrast to systematic risk, affects a much smaller number of companies or investments and is associated with investing in a particular product, company, or industry sector. Some examples of unsystematic risk: i. Management risk, also known as company risk, refers to the impact that bad management decisions, other internal missteps, or even external situations can have on a company's performance and, as a consequence, on the value of investments in that company. ii. Credit risk, also called default risk, is the possibility that a bond issuer won't pay interest as scheduled or repay the principal at maturity. Market rewards for Unsystematic Risk as Systematic risk can be done away with.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

ASSESSING RISK It's one thing to know that there are risks in investing. But how do you figure out ahead of time what those risks might be, which ones you are willing to take, and which ones may never be worth taking? There are three basic steps to assessing risk:
1. 2. 3.

Understanding the risk posed by certain categories of investments Determining the kind of risk you are comfortable taking Evaluating specific investments

You can follow this path on your own or with the help of one or more investment professionals, including stockbrokers, registered investment advisers, and financial planners with expertise in these areas.
1.

Determine the Risk of an asset class The first step in assessing investment risk is to understand the types of risk a

particular category or group of investmentscalled an asset classmight expose you to. For example, stock, bonds, and cash are considered separate asset classes because each of them puts your money to work in different ways: Stocks, don't have a fixed value but reflect changing investor demand, one of the greatest risks you face when you invest in stock is volatility, or significant price changes in relatively rapid succession. Bonds face a risk of default on the part of the bond issuer and a risk of change in the market price of bonds due to upward or downward movement in interest rates

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

Cash investments like treasury bills and money market mutual funds though highly liquid pose a risk of losing ground to inflation. Other assets classes, including real estate, pose their own risks, while investment products, such as annuities or mutual funds that invest in a specific asset class, tend to share the risks of that class. However ,if one understands what those risks are, one can generally take steps to offset those risks.
2.

Selecting Risk

The second step is to determine the kinds of risk you are comfortable taking at a particular point in time. Since it's rarely possible to avoid investment risk entirely, the goal of this step is to determine the level of risk that is appropriate for you and your situation. Your decision will be driven in large part by:
A. Your age B. Your goals and your timeline for meeting them C. Your financial responsibilities D. Your other financial resources 3.

Evaluating Specific Investments

The third step is evaluating specific investments that you are considering within an asset class. There are tools you can use to evaluate the risk of a particular investmenta process that makes a lot of sense to follow both before you make a new purchase and as part of a regular reassessment of your portfolio. It's important to remember that part of managing investment risk is not only deciding what to buy and when to buy it, but also what to sell and when to sell it.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

For stocks and bonds, the place to start is with information about the issuer, since the value of the investment is directly linked to the strength of the companyor in the case of certain bonds, the government or government agencybehind them. One should take a note of the issuing companys documents like: o Audited Financial Statements, o Prospectus in case of initial public offer, o Credit ratings given by independent rating agencies like ICRA, CARE, CIRSIL etc. The higher the letter grade a rating company assigns, the lower the risk you are taking. But remember that ratings aren't perfect and can't tell you whether or not your investment will go up or down in value. Research companies also rate or rank stocks and mutual funds based on specific sets of criteria.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

DIVERSIFY OR PUT ALL EGGS IN ONE BASKET A risk management technique that mixes a wide variety of investments within a portfolio is diversification. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

Investing all the resources or funds in one particular asset which is likely to generate most favourable returns in an asset class is the general human psyche. However, market movements are uncertain and do not necessarily result in the expected manner. This makes the expected returns on the investments dubious. Market movements are based on expectations of all the market participants, which may not be the same, thereby making the movements favorable to some and unfavorable to others. Diversification, with its emphasis on variety, allows one to manage unsystematic risk by tapping into the potential strength of different subclasses, which, like the larger asset classes, tend to do better in some periods than in others. For example, there are times when the performance of small company stock outpaces the performance of larger, more stable companies. And there are times when small company stock falters However, an individual can expect a certain gain on invested assets, if he chooses to divide the money allocated to a particular asset class into sub classes depending upon different market capitalisations. Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated. Diversification is all about reducing risk and increasing returns in your portfolio and finding the right balance.
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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

HOW MUCH DIVERSIFICATION?

In general, this decision will depend on how closely the investments track one another's returnsa concept called correlation. For example, if Stock A always goes up and down the same amount as Stock B, they are said to be perfectly correlated. If Stock A always goes up the same amount that Stock B goes down, they are said to be negatively correlated. In the real world, securities often are positively correlated with one another to varying degrees. The less positively correlated your investments are with one another, the better diversified you are.

Building a diversified portfolio is one of the reasons many investors turn to pooled investmentsincluding mutual funds, exchange traded funds, and the investment portfolios of variable annuities. Pooled investments typically include a larger number and variety of underlying investments than you are likely to assemble on your own, so they help spread out your risk. You do have to make sure, however, that even the pooled investments you own are diversifiedfor example, owning two mutual funds that invest in the same subclass of stocks won't help you to diversify.

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ASSET ALLOCATION ON THE BASIS OF THE RISK PROFILE

There are various Asset classes in which a potential client can invest depending upon his risk appetite. The various Asset classes are listed as under: A. Stocks & Bonds: Trading in stocks or making long term investments is fairly a complicated job, as choosing from innumerous company stocks of different industries and also of companies based in different countries is by far tedious and confusing for an individual. However an investor can make smart investments by taking care of the following guidelines before investing : Look for positive price momentum Diversify between industry groups Beware of stodgy stocks Weed out takeover situations Check out the chart (Technical Analysis) Other Criterion: Earnings Growth, market capitalizations, buy the price performers, and share price of the stock. (Fundamental Analysis)

B. Gold: As an asset class, gold has traditionally been an integral part of ones asset in the Indian household right through the ages. Apart from being one of the best hedging tools against inflation, gold traditionally has a negative correlation with other asset classes such as stocks, fixed income and commodities. A recent introduction to the Indian markets has been Gold Exchange Traded Funds or ETFs. These passively managed mutual funds invest in standard bullion gold (0.995 purity) an equivalent amount of which is placed in the physical form with a custodian. Units are allotted such that each unit corresponds to one gram of gold

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and the returns from each unit are tracked from the physical gold prices in the spot markets. Investment in Gold ETFs enable investors to benefit from the advantages gold provides, with the elimination of many drawbacks like storage costs, purity, liquidity; not to forget the tax advantages they offer over investing in physical gold.

C. Commodity trading : It can also be a very rewarding option and can provide the much needed diversification your portfolio needs. Commodity markets or exchanges are where raw and primary products such as agricultural products, metals, energy resources are traded by buying and selling of standardized contracts authorized by the exchange. There are two commodity exchanges in India; namely the MCX or Multi Commodity Exchange of India and the NCDEX or the National Commodity and Derivatives Exchange which facilitate trading in all commodities listed by the exchange in a regulated manner thereby reducing the market risk. Both the exchanges are pretty well developed facilitating trades in spot markets as well as futures markets. Commodity trading is definitely worth a second look considering the rapid and increasing consumption of agricultural goods and natural resources one is witnessing eventually widening the demand-supply gap which is fueling the price rise in all commodities. Some of the essential commodities like gold, silver, steel, cotton etc are actively traded across the exchange. D. Mutual Funds: There are investment options in the form of mutual funds that invest in companies that are closely associated with consumption and exploration of natural resources.

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Currently absent are commodity mutual funds which could potentially be excellent investment vehicles wherein investments would be made in mutual funds which invest in commodities. The offer documents are pending with the two regulatory authorities; SEBI and AMFI who are studying the ramifications and the wider impact these investments could potentially have. Besides being essential risk diversification tools and commodities markets not being as saturated as the capital and money markets, these funds could deliver high rates of returns to investors who are seeking the twin advantage of diversity and returns. Thus, till commodity funds are launched in India, the available funds provide investors a mechanism to participate in the upswing seen in several commodities lately. E. International Mututal Funds : Although there is no doubt in the India growth story, there are equally attractive investment opportunities in other countries; mainly in developing nations. Diversifying internationally allows an individual to build a portfolio that can capitalize on each countrys strength. Although investments in direct equities would not be a prudent option unless a thorough research methodology is applied, one can always invest via International mutual funds which invest in a basket of international securities in different countries. International mutual funds are offered by a majority of fund houses like Kotak, Birla Sun Life, Franklin etc and are usually close ended funds.

F. Real Estate : It has been the source of wealth accumulation even for most developed countries (the recent sub-prime crisis notwithstanding). With land increasingly getting scarce in a country like India, the value of real estate holdings is expected to boom further. As retail investors, it gets a tad too difficult to indulge in the property
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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

markets directly due to high transaction costs (stamp duties, registration, brokerages, etc) and the risks involved. On the other hand Real Estate Trusts and PMS provide the requisite diversification and risk mitigation for investing in real estate. Most of them currently have minimum commitments of Rs. 25 lakh or Rs. 50 lakh; but this is set to go down as and when SEBI clears the way for Mutual Funds to directly participate in real estate projects.Real Estate funds invest the corpus across a range of projects and cities; thus diversifying the risk by obtaining exposure to a broader range of investment options like residential properties, commercial premises, shopping malls and hospitality projects with more attractive returns as costs are much lower at initial stages of development. G. Contemporary Indian Art : It is finally making its presence felt as an attractive asset class. Contrary to the usual perception, investment in art is actually quite a profitable investment option with the Indian art market multiplying many folds over the last few years. This can be pictorially represented as under:
Real Estate 8% Emerging Market Equity 3% Internation al Equity 17% High Yield Debt 3%
Alternative Investment s 10%

Domestic Equity 38%

Fixed Income 21%

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

Asset Class

Risk

Return

Debt/ Fixed Income: Equity Hybrid Real Estate Precious Metal Art : : : : :

Low High Mild High High High

Low High Mild High High High

Depending on the Risk profile of the investor his entire wealth can be allocated to the various asset classes. An individuals risk profile is dependent on various factors like his age, his family background, his immediate needs, his wealth profile, etc. Thus the risk also differs from individual to individual. Some may want high returns but not willing to take risk, others may want high risk and high returns. Thus these characteristics are known as risk averse, risk neutral and risk seeker behavioral patterns. A risk averse person is who does not like to take risk. He wants optimized returns at a low level of risk. On an average every individual is risk averse by nature. A risk seeker on the other hand is willing to take high risk provided he is rewarded with higher returns.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

A tabular representation of the same may be as under:

Alternative Risk Profile Debt Equity Investments

Risk Averse

100%

0%

0%

Conservative

70%

20%

10%

Balanced

50%

35%

15%

Growth

30%

50%

20%

Aggressive

10%

65%

25%

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HOW TO CREATE AN INVESTMENT PORTFOLIO?

A high-performing portfolio is every investor's goal. First, you'll need to develop your own objectives and strategies.

Step1 :Determine what items or events you're saving for. These can be retirement, a new home, your children's education or anything else you choose. Step2 : Determine when you want to retire, purchase a home or send your children to college, to help you decide what percentage return you need to earn on your initial investment. Step3 :Decide how much money to invest. Invest what you can comfortably afford now, keeping in mind that you can change that amount later. Step4 : Determine how much risk you are willing to take. Many investments generate high returns and are riskier than others. Step5 : Once you decide the amount you are willing to invest, the returns you want to achieve, when you need the money and how much risk you are willing to accept, put together your investment portfolio. Step6 : An investment counselor or stockbroker is a good source of advice. Tell these advisers your objectives and ask them to suggest how to allocate your money. Step7 : Reevaluate your portfolio at least annually. Analyze each investment.

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PORTFOLIO MANAGEMENT - A TOOL FOR OPTIMIZING INVESTORS WEALTH

PORTFOLIO CONSTRUCTION

The Portfolio Construction of Rational investors wish to maximize the returns on their funds for a given level of risk. All investments possess varying degrees of risk. Returns come in the form of income, such as interest or dividends, or through growth in capital values (i.e. capital gains).

The portfolio construction process can be broadly characterized as comprising the following steps:

1. Setting objectives.

The first step in building a portfolio is to determine the main objectives of the fund given the constraints (i.e. tax and liquidity requirements) that may apply. Each investor has different objectives, time horizons and attitude towards risk. Pension funds have longterm obligations and, as a result, invest for the long term. Their objective may be to maximize total returns in excess of the inflation rate. A charity might wish to generate the highest level of income whilst maintaining the value of its capital received from bequests. An individual may have certain liabilities and wish to match them at a future date. Assessing a client's risk tolerance can be difficult. The concepts of efficient portfolios and diversification must also be considered when setting up the investment objectives.

2. Defining Policy.

Once the objectives have been set, a suitable investment policy must be established. The

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standard procedure is for the money manager to ask clients to select their preferred mix of assets, for example equities and bonds, to provide an idea of the normal mix desire.

Clients are then asked to specify limits or maximum and minimum amounts they will allow to be invested in the different assets available. The main asset classes are cash, equities, gilts/bonds and other debt instruments, derivatives, property and overseas assets. Alternative investments, such as private equity, are also growing in popularity, and will be discussed in a later chapter. Attaining the optimal asset mix over time is one of the key factors of successful investing.

3. Applying portfolio strategy.

At either end of the portfolio management spectrum of strategies are active and passive strategies. An active strategy involves predicting trends and changing expectations about the likely future performance of the various asset classes and actively dealing in and out of investments to seek a better performance. For example, if the manager expects interest rates to rise, bond prices are likely to fall and so bonds should be sold, unless this expectation is already factored into bond prices. At this stage, the active fund manager should also determine the style of the portfolio. For example, will the fund invest primarily in companies with large market capitalizations, in shares of companies expected to generate high growth rates, or in companies whose valuations are low? A passive strategy usually involves buying securities to match a preselected market index. Alternatively, a portfolio can be set up to match the investor's choice of tailor-made index. Passive strategies rely on diversification to reduce risk. Outperformance versus the chosen index is not expected. This strategy requires minimum input from the portfolio manager. In practice, many active funds are managed somewhere between the active and passive extremes, the core holdings of the fund being passively managed and the balance being actively managed.

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4. Asset selections.

Once the strategy is decided, the fund manager must select individual assets in which to invest. Usually a systematic procedure known as an investment process is established, which sets guidelines or criteria for asset selection. Active strategies require that the fund managers apply analytical skills and judgment for asset selection in order to identify undervalued assets and to try to generate superior performance.

5. Performance assessments.

In order to assess the success of the fund manager, the performance of the fund is periodically measured against a pre-agreed benchmark - perhaps a suitable stock exchange index or against a group of similar portfolios (peer group comparison). The portfolio construction process is continuously iterative, reflecting changes internally and externally. For example, expected movements in exchange rates may make overseas investment more attractive, leading to changes in asset allocation. Or, if many large-scale investors simultaneously decide to switch from passive to more active strategies, pressure will be put on the fund managers to offer more active funds. Poor performance of a fund may lead to modifications in individual asset holdings or, as an extreme measure; the manager of the fund may be changed altogether.

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SOME USEFUL CONCEPTS IN PORTFOLIO MANAGEMENT

1. INDIFFERENCE CURVES:

Suppose the following situation exists Plan Expected Return Risk(Standard Deviation) Investment A Investment B 10% 20% 5% 10%

The question to ask here is, does the extra 10% return compensate for the extra risk? There is no right answer, as the decision would depend on the particular investor's attitude to risk. A particular investor's indifference curve can be ascertained by plotting what rate of return the investor would require for each level of risk to be indifferent amongst all of the investments.

For example, there may be an investor who can obtain a return of 50% with zero risk and a return of 55 %with a risk or standard deviation of 5% who will be indifferent between the two investments. If further investments were considered, each with a higher degree of risk, the investor would require still higher returns to make all of the investments equally attractive. The investor being discussed could present the following as the indifference curve shown in Figure.

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Indifference Curve

RETURNS A

RETURNS B

RETURNS C

RISK

50% 55% 70% 100% 120% 230%

90% 95% 110% 140% 160% 270%

120% 125% 140% 170% 190% 300%

0% 5% 10% 15% 18% 25%

Indifference Curves
1000%

800%
Axis Title 600% 400% 200% 0% 0% 5% 10% 15% 18% 25% Portfolio 3 Portfolio 2 Returns

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UTILITY:
At this stage the concept of utility scores can be introduced. These can be seen as a way of ranking competing portfolios based on the expected return and risk of those portfolios. Thus if a fund manager had to determine which investment a particular investor would prefer, i.e. Investment A equaling a return of 10% for a risk of 5% or Investment B equaling a return of 20% for a risk of 10%, the manager would create indifference curves for that particular investor and look at the utility scores. Higher utility scores are assigned to portfolios or investments with more attractive risk-return profiles. Although several scoring systems are legitimate, one function that is commonly employed assigns a portfolio or investment with expected return or value EV and variance of returns 2the following utility value: Utility is enhanced by high expected returns and diminished by high risk. Investors choosing amongst competing investment portfolios will select the one providing the highest utility value.

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THEORIES OF PORTFOLIO MANAGEMENT


Portfolios of Assets Typically, the answer to the investment problem is not the selection of one asset above all others, but the construction of a portfolio of assets, i.e. diversification across a number of different securities. The key to diversification is the correlation across securities. The correlation coefficient is a value between -1 and 1, and measures the degree of co-movement between two random variables, in this case stock returns. It is calculated as:

Where the sigma AB is the covariance of the two securities. Here is how to use correlation in the context of portfolio construction. Consider two securities, A and B. Security A has a mean of 10% and an STD of 15%. Security B has a mean of 20% and an STD of 30%. We can calculate the standard deviation of a portfolio composed of different mixtures of A & B using this equation:

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The mean return is not as complicated. It is a simple weighted average of the means of the two assets:

mean p = W A RA + W B R B. Notice that a portfolio will typically have a weight of one, so usually, W A + W B = 1. What if the correlation of A&B = 0 ? Notice that a portfolio of 80% A and 20% B has a standard deviation of: sqrt(.82*.152+.22.32+2*0*.8*.2*.15*.3) = 13.4 %

In other words, a mixture of 20% of the MORE RISKY SECURITY actually decreases the volatility of the portfolio! This is a remarkable result. It means you can reduce risk and increase return by diversifying across assets. What if the correlation of A&B = 1 ? In this case, the perfect correlation between the two assets means there is no diversification. The portfolio std of of the 80/20 mix is 18%. this is equal to a linear combination of the standard deviations: (.8)(.15)+(.2)(.30) = 18% What if the correlation of A&B = -1 ? This is an unusual case, because it means that when A moves up, B always moves down. Take a mixture of .665 A and (1-.665) B. sqrt(.6652*.152+(1-.665)2.32+2*0*(.665)*(1-.665)*.15*.3) = .075%, Which is very close to zero. In other words, A is nearly a perfect hedge for B. One of the few real-life negative correlations you will find is a short position in a stock offsetting the long position. In this case, since the mean returns are also the same, the expected return will be zero. These extremes of correlation values allow us to describe an envelope within which all combinations of two assets will lie, regardless of their correlations.

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MARKOWITZ THEORY OF EFFICIENT FRONTIER

The first efficient frontier was created by Harry Markowitz, using a handful of stocks from the New York Stock Exchange. Markowitz showed that the variance of the rate of return was a maeanigful measuer of portfolio risk under a reasonable set of assumptions, and he derived the formula for computing the variance of the portfolio. This portfolio variance formula not only indicated the importance of diversifying investments to reduce the total risk of the portfolio but also showed how to effectively diversify. The Markowitz model is based on several assumptions regarding investors behavior:

1. Investors consider each investment alternative as being represented by a probability distribution of expected returns over some holding period. 2. Investors maximize one-period expected utility, and their utility curves demonstrate diminishing marginal utility of wealth. 3. Investors estimate the risk of the portfolio on the basis of the variability of expected returns. 4. Investors base decision solely ion expected return and risk, so their utility curves are a function of expected return and expected variance(or standard deviation) of returns only 5. For a given risk level, investors prefer high returns to a lower returns. Similarly, for a given level of expected return investors prefer less risk to more risk.

Under these assumptions, a single asset or portfolio of assets is considered to be efficient if no other asset or portfolio of asset offer a higher expected return with the same (or lower) risk or lower risk with the same( or higher) expected return.

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CAPITAL ASSET PRICING MODEL


Because the CAPM is a theory, we must assume for argument that 1. All assets in the world are traded. 2. All assets are infinitely divisible. 3. All investors in the world collectively hold all assets. 4. For every borrower, there is a lender. 5. There is a riskless security in the world. 6. All investors borrow and lend at the riskless rate . 7. Everyone agrees on the inputs to the Mean-STD picture . 8. Preferences are well-described by simple utility functions. 9. Security distributions are normal, or at least well described by two parameters. 10. There are only two periods of time in our world.

This is a long list of requirements, and together they describe the capitalist's ideal world. Everything may be bought and sold in perfectly liquid fractional amounts -even human capital! There is a perfect, safe haven for risk-averse investors i.e. the riskless asset. This means that everyone is an equally good credit risk! No one has any informational advantage in the CAPM world. Everyone has already generously shared all of their knowledge about the future risk and return of the securities, so no one disagrees about expected returns. All customer preferences are an open book -- risk attitudes are well described by a simple utility function. There is no mystery about the shape of the future return distributions. Last but not least, decisions are not complicated by the ability to change your mind through time. You invest irrevocably at one point, and reap the rewards of your investment in the next period -- at which time you and the investment problem cease to exist. Terminal wealth is measured at that time. I.e. he who

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dies with the most toys wins! The technical name for this setting is "A frictionless oneperiod, multi-asset economy with no asymmetric information."

The CAPM argues that these assumptions imply that the tangency portfolio will be a value-weighted mix of all the assets in the world

The proof is actually an elegant equilibrium argument. It begins with the assertion that all risky assets in the world may be regarded as "slices" of a global wealth portfolio. We may graphically represent this as a large, square "cake," sliced horizontally in varying widths. The widths are proportional to the size of each company. Size in this case is determined by the number of shares times the price per share.

Here is the equilibrium part of the argument: Assume that all investors in the world collectively hold all the assets in the world, and that, for every borrower at the riskless rate there is a lender. This last condition is needed so that we can claim that the positions in the riskless asset "net-out" across all investors.

From the two-fund separation picture above, we already know that all investors will

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hold the same portfolio of risky assets, i.e. that the weights for each risky asset j will be the same across all investor portfolios. This knowledge allows us to cut the cake in another direction: vertically. As with companies, we vary the width of the slice according to the wealth of the individual.

Notice that each vertical "slice" is a portfolio, and the weights are given by the relative asset values of the companies. We can calculate what the weights are exactly: weight on asset i = [price i x shares i] / world wealth Each investor's portfolio weight is exactly proportional to the percentage that the firm represents of the world's assets. There you have it: the tangency portfolio is a capitalweighted portfolio of all the world's assets. The equation of CAPM is as follows:

E(R)= Rfr+(Rm-Rfr)

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Investment Implications of CAPM:

The CAPM tells us that all investors will want to hold "capital-weighted" portfolios of global wealth. In the 1960's when the CAPM was developed, this solution looked a lot like a portfolio that was already familiar to many people: the S&P 500. The S&P 500 is a capital-weighted portfolio of most of the U.S.'s largest stocks. At that time, the U.S. was the world's largest market, and thus, it seemed to be a fair approximation to the "cake." Amazingly, the answer was right under our noses -- the tangency portfolio must be something like the S&P 500! Not co-incidentally, widespread use of index funds began about this time. Index funds are mutual funds and/or money managers who simply match the performance of the S&P. Many institutions and individuals discovered the virtues of indexing. Trading costs were minimal in this strategy: capital-weighted portfolios automatically adjust to changes in value when stocks grow, so that investors need not change their weights all the time -- it is a "buy-and-hold" portfolio. There was also little evidence at the time that active portfolio management beat the S&P index -- so why not? Is the CAPM true?

Any theory is only strictly valid if its assumptions are true. There are a few nettlesome issues that call into question the validity of the CAPM: Is the world in equilibrium? Do you hold the value-weighted world wealth portfolio? Can you even come close? What about "human capital?"

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While these problems may violate the letter of the law, perhaps the spirit of the CAPM is correct. That is, the theory may me a good prescription for investment policy. It tells investors to choose a very reasonable, diversified and low cost portfolio. It also moves them into global assets, i.e. towards investments that are not too correlated with their personal human capital. In fact, even if the CAPM is approximately correct, it will have a major impact upon how investors regard individual securities. Why?

Portfolio Risk

Suppose you were a CAPM-style investor holding the world wealth portfolio, and someone offered you another stock to invest in. What rate of return would you demand to hold this stock? The answer before the CAPM might have depended upon the standard deviation of a stock's returns. After the CAPM, it is clear that you care about the effect of this stock on the TANGENCY portfolio. The diagram shows that the introduction of asset A into the portfolio will move the tangency portfolio from T(1) to T(2).

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The extent of this movement determines the price you are willing to pay (alternately, the return you demand) for holding asset A. The lower the average correlation A has with the rest of the assets in the portfolio, the more the frontier, and hence T, will move to the left. This is good news for the investor -- if A moves your portfolio left, you will demand lower expected return because it improves your portfolio risk-return profile. This is why the CAPM is called the "Capital Asset Pricing Model." It explains relative security prices in terms of a security's contribution to the risk of the whole portfolio, not its individual standard deviation.

Conclusion

The CAPM is a theoretical solution to the identity of the tangency portfolio. It uses some ideal assumptions about the economy to argue that the capital weighted world wealth portfolio is the tangency portfolio, and that every investor will hold this same portfolio of risky assets. Even though it is clear they do not, the CAPM is still a very useful tool. It has been taken as a prescription for the investment portfolio, as well as a tool for estimating an expected rate of return.

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THE ARBITRAGE PRICING THEORY

I. Holding the Security Market Line

No matter how theoretically appealing it may be, even the most ardent supporters of the Capital Asset Pricing Model admit the model does not quite fit reality. It is difficult to test the CAPM without data on the global wealth portfolio, and the S&P just won't do. We know that some of the most obvious implications of the CAPM are violated -for instance, we all hold different portfolios. We are still in the dark about the more fundamental implications, such as the question of whether only systematic risk is priced. In the 1970's, financial researchers took a different approach to the issue of identifying a discount rate for securities. This time, the security market line was the motivation for further theory.

Consider this -- even if the CAPM is untrue, the security market line STILL remains an appealing diagram. The SML diagram contains the seeds to a different asset pricing model, called the Arbitrage Pricing Theory. The APT was developed by Stephen Ross. Like the CAPM, it argues that discount rates are based upon the systematic risk exposure of the security, as opposed to the total risk. Unlike the CAPM, it does not require that all investors behave alike, nor does it claim that the capital-weighted market portfolio i.e. the tangency portfolio, it the only risky asset that will be held.

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Arbitrage in Expected Returns: An Example

Suppose you observed the following conditions: 1. Risk-free bonds may be purchased at a cost of $100 (or in fractions if required). They are known to pay off in one year $110 with certainty. 2. All investors can borrow and lend at the riskless rate. 3. Shares of the market portfolio may be purchased for $100 each. They are expected to pay off $120 at the end of the year, but there is uncertainty involved. Shares of the market may be purchased and shorted without transactions costs. 4. Shares of asset A may be purchased for $100 and they are expected by everyone to be worth $150 at the end of the year. Asset A has a beta of 1.3. As with the market, shares of A may be shorted and purchased without transactions costs. How would an investor proceed in an expectations arbitrage?

First, calculate the expected return of asset A, under linear pricing model assumptions: E[Ra = R f + a(E[Rm] - R f) where Rf = the riskfree rate E[Rm] = expected return on the market E[Ra] = expected return on asset A

This tells us that everyone should expect a share of A to be worth, at the end of the period:

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$100 x [(1+ .10 + 1.3 x .10] = $123

The expected return in this case yields an expected future value which is lower than $150. This is a logical inconsistency if the index model were true. In practical terms it is underpriced. To exploit this underpricing we take the following actions SYSTEMATIC RISK () 1.3

ACTION

POSITION

1) Buy one share of asset A, costing money 2) Short 1.3 shares of market portfolio, generating cash proceeds 3) Buy .3 bonds, costing money NET POSITION

-$100

$130

-1.3

-$30 $0

0 0.0

Now, what happens at the end of the period? The market has a realization, different from its expectation and asset A has a realization different from its expectation. This may be expressed as: Rm = E[Rm] + em Ra = E[Ra] + eA When things turn out exactly as expected, em and eA both equal zero. Thus, action (1)
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yields $150, action (2) yields -$156 and action (3) yields $33. This is a net gain of 183-156 = $27.

Now suppose the returns did not occur as expected, i.e. the errors were not zero, nor were they equal. You would receive: $27 + $100 + eA - $130 em

Sometimes this is negative, sometimes this is positive. It has a variance, and thus is risky. In other words, the "A" in the APT is not true arbitrage, but arbitrage in expectations.

IV. The Arbitrage Pricing Theory Argument

The APT argument is best understood from the arbitrage in expectations example presented above. To achieve "arbitrage" pricing, we must assume that: There exist some important systematic risks driving security returns in a linear fashion Investors perceive these risks and can estimate the sensitivity of the security to them Some investors are risk-takers in the economy These investors can and will exploit differences in expected return by undertaking risk arbitrage .Expected returns will be determined such that the expected returns of securities in the economy plot on or close to the security market line in as many dimensions of risk as there are factors.

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MARKET EFFICIENCY

Mispricing due to arrival of information:


One answer to these questions is provided by looking at how market participants react to news that is suddenly revealed to the public. Major corporate events can immediately change expected future cash flows. For instance, a major disaster such as the Bophol chemical spill immediately drove down the Union Carbide stock price. In fact, prices react within a matter of minutes to such news, and the reaction is over within the day! In empirical "event studies" which focus on corporate news releases, there is little evidence that you can make money by investing on yesterday's news. This means, for instance, that when you read in the Wall Street Journal that a company announced the discovery of a new cure for the common cold at a news conference yesterday, arbitrageurs have already bought the shares, and driven the price up.

Often there is major news about the discount rate used to discount the future cash flows in valuation. For instance, when the Federal Reserve cuts the discount rate, we expect the net present value of corporate securities to increase -- that is stocks should jump. When discount rate changes are announced, stock prices react that day, and not the next day. This empirical evidence strongly indicates that, at least in the highly liquid, open-information economy of the U.S. capital markets, stock prices are Efficient.

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Three Degrees of Market Efficiency:


What kind of information is impounded in the stock price? It turns out that there are lots of different levels of market efficiency, depending upon the source or the information being impounded. The best way to illustrate this is by example. Suppose you had a hyper-efficient market that impounded All private information. This means that even a personal note passed between the CEO and the CFO regarding a major financial decision would suddenly impact the stock price! If so, this is called StrongForm Efficiency. Few people believe that the market is strong-form efficient, but it is nice to have this benchmark!

How about all public information? That is, all information available in annual reports, news clippings, gossip columns and so on? If the market price impounds all of this information the market is called Semi-Strong Form Efficient. Most people believe that the U.S. equity markets by and large reflect publicly available information. But consider this -- is information put on the Internet public? Are government files available under the freedom of information act public? There must be subtle shades of semi-strong market efficiency, but they are not typically differentiated. Each new piece of information an analyst gathers should be carefully considered with regard to whether it is already impounded in the stock price. The easier it was to get, the more likely it is to have already been traded upon.

The final form of market efficiency is Weak Form Efficiency A weak-form efficient market is one in which past security prices are impounded into current prices. Since past prices are deemed public information, weak form efficiency implies semi-strong form efficiency and semi-strong form efficiency implies strong form efficiency.
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Weak form efficiency implies that you can't make excess profits by trading on past trends. Many people do that. They are called technical analysts, or chartists. Academics have been testing trading rules like this for forty years, and traders have been exploiting them for even longer. The concept behind the simple rule described above is momentum. Although it is a widely used concept for technical investing, there is no evidence that any short-term market-timing rule actually makes money. The reason for this is the following: What if everyone followed the same strategy? Wouldn't the opportunity go away? It turns out that daily to stocks are returns are weakly correlated (i.e. they have momentum, but the costs of exploiting this pattern are high. You have to buy and sell stocks every day, and in doing so, you have to pay brokerage fees. Thus, while major patterns in stock prices should not exist, weak patterns that are too costly to arbitrage may persist. If these simple trends are arbitraged away, then the market will follow a random walk, i.e. past deviation from expected returns tell you nothing about future deviations from expected returns.

Evidence For Market Efficiency

A simple test for Strong Form Efficiency is based upon price changes close to an event. Acts of nature may move prices, but if private information release does not, then we know that the information is already in the stock price. For example, consider a merger between two firms. Normally, a merger or an acquisition is known about by an "inner circle" of lawyers and investment bankers and firm managers before the public release of the information. When these insiders violate the law by trading on this private information, they may make money.

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Unfortunately, stock prices typically move up before a merger, indicating that someone is acting dishonestly. The early move indicates that the market has a tendency towards strong-form efficiency, i.e. even private information is incorporated into prices. However, the public announcement of a merger is typically met with a large price response, suggesting that the market it not strong-form efficient. Leakage, even if illegal, does occur, but it is not fully impounded in stock price. By the way, until recently, insider trading was legal in Switzerland.

Is the stock market semi-strong form efficient?

The most obvious indication that the market is not always and everywhere semi-strong form efficient is that money managers frequently use public information to take positions in stocks. While there is no evidence that they beat the market on a riskadjusted basis, it is hard to believe that an entire industry of information production and analysis is for naught. It seems likely that there is value to publicly available

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information, however there are probably degrees to which information really is public knowledge. What is surprising is that recent studies have shown some evidence that excess returns can be made by trading upon very public information. These tests usually take the form of "backtesting" trading strategies. That is, you play a "what-if" game with past stock prices, and pretend you followed some rule, using information available only at the time of the pretend trade. One common rule that seems to perform well historically is to buy stocks when the dividend yield is high. This apparently has made money in the past, even though the information about which stocks have high yields and which have low yields is widely available. Another rule that generates positive excess returns in back-tests is to buy stocks when the earnings announcement is higher than expected. This seems simple, since current announcements and even forecasts are widely available as well.

Is the stock market weak form efficient?

Weak form efficiency should be the simplest type of efficiency to prove, and for a time it was widely accepted that the U.S. stock market was at least weak form efficient. Recall that weak form efficiency only requires that you cannot make money using past price history of a stock (or index) to make excess profits. Recall the intuition that, if people know the price will rise tomorrow, then they will bid the price up today in order to capture the profit. Researchers have been testing weak form efficiency using daily information since the 1950's and typically they have found some daily price patterns, e.g. momentum. However, it appears difficult to exploit these short-term patterns to make money. Interestingly, as you increase the horizon of the return, there seems to be evidence of profits through trading. Buying stocks that went down over the last two weeks and shorting those that went up appears to have been profitable. When you really increase the horizons, stock returns look even more predictable. Eugene Fama
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and Ken French for instance, found some evidence that 4 year returns tend to revert towards the mean. Unfortunately, this is a difficult rule to trade on with any confidence, since the cycles are so long -- in fact, they are as long as the patterns conjectured by Charles Henry Dow some 100 years ago! Does this all lend credence to the chartists, who look for cryptic patterns in security prices -- perhaps. But in all likelihood there is no easy money in charting, either. Prices for widely trades securities are pretty close to a random walk, and if they were not, then they would quickly become so, as arbitrageurs moved in to buy the stock when it is underpriced and short it when it is overpriced. But who knows. Maybe a retired rocket scientist playing around with fractal geometry and artificial intelligence will hit upon something -- of course if he or she did, it wouldn't become common knowledge, at least for a while!

Conclusion

The efficient market theory is a good first approximation for characterizing how prices is a liquid and free market react to the disclosure of information. In a word, "Quickly!" If they did not, then the market is lacking in the opportunism we have come to expect from an economy with arbitrageurs constantly collecting, processing and trading upon information about individual firms. The fact that information is impounded quickly in stock prices and that windows of investment opportunity are fleeting is one of the best arguments for keeping the markets free of excessive trading costs, and for removing the penalties for honest speculation. Speculators keep market prices close to economic values, and this is good, not bad.

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CASE STUDY
We were approached by a Client working at a Senior management position with a Multinational company to review his Investment Portfolio. He was 56 years of age and planning to retire within 2 years. He didnt plan to carry on work in any professional capacity post retirement and wanted to be involved in a philanthropic or charitable cause. Clients Family Spouse was a housewife pursuing Fashion Designing as a hobby. Daughter aged 21yrs had completed her education Son aged 17 yrs pursuing his under-graduation & wishes to pursue higher studies abroad within the next 2 to 3 years. On detailed discussion with the Client and his spouse the following goals were identified: Setting aside a retirement corpus Making a provision for sons higher education; current cost of the desired education was Rs 50 Lacs Rs 35 Lacs as provision for daughters marriage Rs 15 Lacs p.a. as expenses for the charitable cause Rs 3 Lacs p.a. for a 10 to 15 day holiday, abroad.

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The clients and his spouses combined Investment portfolio was valued at Rs.8crs~ and was invested as follows :
Cash&Cash Equivalent 0.40Cr, 5% Concentrated Holdings (ESOPs) 2.75Cr, 34% PPF 0.20Cr, 3% RBI Bonds 0.25Cr, 3%

Equity MF 2.25Cr, 28%

Real Estate 1.4Cr, (18%)

Fixed Deposit 0.75Cr, 9%

Investment Details Additionally, unexercised ESOPs were valued at Rs 75 lacs The Real estate investment was in a residential property valued at Rs 1.40 crs and earning a rental income of Rs 45,000 p.m. Expected Retirement Benefits of Rs 50 lacs in 2011 Protection Total sum assured of the Life Insurance policies held by the client was Rs 3 crs. Medical Insurance of Rs 10 lacs for the entire family was being provided by the clients employer

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Cash Flow Analysis An analysis of the cash flows indicated: Clients annual expenses were around Rs 18 lacs and investible surplus generated was around Rs 10 lacs p.a. The expenses included an EMI of Rs 55,000 p.m. towards the real estate investment. The loan repayment would be completed within 4 years Client also had an existing high cost car loan

One of the key objectives of the client was to ensure that his lifestyle was maintained post retirement. Therefore, we estimated the post retirement annual expenses up to the age of 75 by adjusting the current annual expenses for inflation to estimate the future expenses. Client would have an annual surplus of Rs.10lacs after meeting annual expenses for the next 2 yrs and rental income of Rs.5.4lacs p.a.

Financial Goals

Year

in

which

corpus

Amount required

required Annual Expenses Regular Rs.18 Lacs p.a., to grow at 6% p.a. Initial Outlay for charitable cause 2011 Rs.75 Lacs

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Annual Travel abroad

Regular

Rs.3 Lacs p.a. to grow at 6% p.a.

Annual

contribution

for

Regular from 2012

Rs.15 lacs p.a. to grow at 6% p.a.

charitable cause Sons education 2011

Rs.58 Lacs (Adjusted for inflation at 8% p.a.)

Daughters expenses

wedding

2013

Rs.35 Lacs

Suggested Asset Allocation Clients risk profile was assessed as Balanced Client had several objectives to be achieved over a 2-3 year horizon. There could have been uncertainty in achieving the objectives of the client based on

the current asset allocation which was overweight on Equities, given the high volatility of returns from Equities over a 1 to 2 year horizon. Since he was planning to retire within a couple of years, which would result in discontinuation of regular income flow and increased need for access to liquidity.

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Real Estate, 18%

Equities, 35%

Debt, 47%

Break-up of Recommended Asset Allocation


Short term Funds & Cash & Cash Equivalent Floaters PPF 1% 15% 3%

Capital Protected Structure 9% Gilt Funds 10% Income Funds 6%

RBI Bonds 3% Equities 30%

Real Estate 18%

Concentrated Holdings (ESOPs) 5%

Rebalancing Suggestions Since the client was due to retire within a couple of years and the post retirement expenses and financial goals would be met out of the Investments, it was considered essential to rebalance the asset allocation and reduce concentration to a single stock to increase the certainty of meeting the objectives. It was recommended to reduce the exposure to the stock from 60% of the Equity portfolio to 15%. The unexercised ESOPs were also exercised and exited. The exit was planned in a staggered manner keeping in mind the market reaction to a management executives sale of shares
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The funding for the purchase of the unexercised ESOPs was also arranged, in the form of a temporary loan, therefore avoiding a liquidation of other investments There was a post tax gain of Rs.35lacs from the exit of ESOPs which was reinvested in the portfolio. A Principal Protected Structured Product was recommended to the client partially out of the proceeds from exit of ESOPs. The Structured Product would protect the downside on the portfolio and at the same time give the client participation rights in the upside to the Equity markets. Typically, a contingency equal to 3-6 months expenses should be retained in the form of liquid/cash equivalent. Cash equivalent was being maintained at Rs.40 lacs, which was reduced to Rs.10 lacs. The remainder was deployed in other Debt instruments which would enhance the returns on the portfolio. Re-Balancing Suggestions & Implementation Recommendation Rationale Under performing funds Implementation

were recommended to be exited & client had exposure to sectoral & mid-cap funds Mutual balancing Fund Rewhere the volatility was very high Implemented recommendation as per

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Portion of Direct Equity to be exited & re-invested through Equity Advisory services From the point of view of time management & Implemented recommendation as per

Dynamic fund management Preferential rate applicable

Switch of existing high cost car loan to the Bank

to Wealth customers at that point of time Based on the view on

Implemented recommendation

as

per

Was not exited as client expressed retaining children's intention property of from future

Interest rates & since the Allocation to Debt in a mix of Long Term & Medium Term Debt Investment in Residential Property to be exited client did not have any immediate requirement of liquidity Rental yield on property was very low To invest the money in line Plan to invest Annual surplus & retrials due in 2012 No further investments in Alternate category with client Since the client was already invested in Real Estate achieving the

requirement point of view Plan was accepted by the client

investment objectives of the

Recommendation accepted by the client

was

Meeting Clients Objectives

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Clients objectives Rs.75lacs required for philanthropic cause Rs.18lacsp.a for Annual Expenses & Rs.3lacsp.a for Annual Travel

Year

To be met out of

2011

Investments in Debt

Regular Regular, starting

Returns on Portfolio

Rs.15lacsp.a for charitable purpose

from 2012

Regular Returns on Portfolio

Rs.58lacs~ for sons higher education

2011

Investments in Debt

Rs.35lacs for Daughters wedding

2013

Investments in Debt

The estimated corpus available at the age of 75 would be approximately Rs 50 crores after meeting all commitments. Since the client expressed his intention to be involved in a philanthropic causes post retirement, on discussion with our Business Solutions Group we referred the client to Birla Foundation which as a part of its Corporate Social Responsibility funds various projects of NGOs

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Other Recommendations The sum assured of Life Insurance policies held by the client of Rs 3 crores was considered to be sufficient. The policies would start maturing from 2013 and the proceeds would be re-invested as per the strategic asset allocation. Since home and jewelry are vulnerable to theft, fire among other things, insurance for these assets was recommended. A Personal Accident plan with a Sum Insured of Rs 2 crores. This was to provide for contingencies. Since the client was due to retire and the Mediclaim Insurance being provided by the employer wouldnt be available post retirement, a Family floater plan for Medical care was advised with a coverage of Rs 10 lacs. Portfolio to be monitored regularly to check if the recommended portfolio is aligned to the investment objectives, outlook on specific asset class, risk profile etc. Asset Allocation to be reviewed on meeting of Investment objectives

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BIBLIOGRAPHY:

www.wikipedia.org www.investopedia.com Reilly & Brown www.livemint.com www.google.com

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