A Study On Portfolio Management As An Investment Strategy

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Chandrabhan Sharma College of Arts, Science and Commerce
Adi Shankar Acharya Marg, Powai Vihar Complex,
Powai, Mumbai -400076
“A STUDY ON PORTFOLIO MANAGEMENT AS AN INVESTMENT STRATEGY”
A Project submitted to
University of Mumbai for partial completion of the degree of
Bachelor of Management Studies
Under the Faculty of Commerce
Submitted by
‘JOEL NELSON CASTELINO’
Under the guidance of
‘ARPITA ATIBUDHI’
Academic Year: 2019 – 2020

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Chandrabhan Sharma College of Arts, Science and Commerce
“A STUDY ON PORTFOLIO MANAGEMENT AS AN INVESTMENT STRATEGY”
A Project submitted to
University of Mumbai for partial completion of the degree of
Bachelor of Management Studies
Under the Faculty of Commerce
Submitted by
‘JOEL NELSON CASTELINO’
Under the guidance of
‘ARPITA ATIBUDHI’
Academic Year: 2019 – 2020

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CHANDRABHAN SHARMA COLLEGE OF ARTS, SCIENCE AND COMMERCE
CERTIFICATE
This is to certify that Ms./Mr. JOEL NELSON CASTELINOhas worked and duly
completed her/his Project Work for the degree of Bachelor of Management Studies under the
Faculty of Commerce and her/his project is entitled, “A STUDY ON PORTFOLIO
MANAGEMENT AS AN INVESTMENT STRATEGY” under the supervision of
ARPITA ATIBUDHI. The information contained in this Project Work is true and original to
the best of our knowledge and belief.
Signature of Project Guide Signature of Principal
Signature of Course Coordinator Signature of Examiner

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DECLARATION
I, the undersigned JOEL NELSON CASTELINOof CHANDRABHAN SHARMA

COLLEGE OF ARTS, SCIENCE & COMMERCE, T.Y.B.M.S., Semester – VI (2019-2020),
hereby declare that the work embodied in this project work titled “A STUDY ON
PORTFOLIO MANAGEMENT AS AN INVESTMENT STRATEGY”, forms my own
contribution to the research work carried out under the guidance of ARPITA ATIBUDHI is
a result of my own research work and has not been previously submitted to any other
University for any other Degree/ Diploma to this or any other University.
Wherever reference has been made to previous works of others, it has been clearly indicated
as such and included in the bibliography.
I, here by further declare that all information of this document has been obtained and
presented in accordance with academic rules and ethical conduct.
Place: Mumbai
Date: Signature of the Student

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ACKNOWLEDGEMENT
To list who all have helped me is difficult because they are so numerous and the depth is so
enormous.
I would like to acknowledge the following as being idealistic channels and fresh dimensions
in the completion of this project.
I take this opportunity to thank the University of Mumbai for giving me chance to do this
project.
I would like to thank my Principal, Dr. Pratima Singh for providing the necessary facilities
required for completion of this project.
I take this opportunity to thank our Coordinator, Ms. Arpita Atibudhi, for her moral
support and guidance.
I would also like to express my sincere gratitude towards my project guide, ‘ARPITA
ATIBUDHI’ whose guidance and care made the project successful.
I would like to thank my College Library, for having provided various reference books and
magazines related to my project.
Lastly, I would like to thank each and every person who directly or indirectly helped me in
the completion of the project especially my Parents and Peers who supported me
throughout my project.
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Sr. No Particulars Pg. No
Introduction 7
What is Portfolio Management (Definition) 8
1
Types of Portfolio Management 10
Examples of Portfolio Management 12
Research & Methodology 14
Scope of Portfolio Management 16
2
Objective of Portfolio Management 17
Drawbacks of Portfolio management 18
Literature Review
19
Markowitz Portfolio Theory.
19
Role of Portfolio Management in an efficient market.
24
Risk and Return in Portfolio Investments.
31
Portfolio Revision Strategies in Invest Portfolio Management.
40
Diversification of Securities in Portfolio Investment.
3 54
Arbitrage Pricing Theory (APT)
58
Security Analysis Phase in Invest Portfolio Management.
60
Approaches of Investment Portfolio management.
63
Different Types of Investment Portfolio.
64
General Obligations and Responsibilities of Portfolio
66
Management
4 Data Analysis Interpretation 74
5 Conclusion & Suggestion 85
6 Reference 86
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Chapter No .1 Introduction
Portfolio management is the key skill that one requires for managing investment effectively.
Then whether he is an individual or HNI or a big MNC. Where HNI stands for High Net
Worth Individual and MNC stands for Multinational Company. Different attributes
of investment alternatives are analyzed and the objective of investment guides where and
how much money to allocate to each of the alternatives. Investing in more and more assets,
with different attributes, diversifies the risk of a portfolio and thereby increases reasonable
assurance of the returns.
For understanding portfolio management (PM), it is important to understand the term

‘portfolio’, the meaning of PM, who is a portfolio manager, what does PM service involve,
classification of PM services, objectives, and importance of PM.
WHAT IS PORTFOLIO AND PORTFOLIO MANAGEMENT

(DEFINITION)?
The portfolio is a collection of investment instruments like shares, mutual funds, bonds, FDs
and other cash equivalents, etc. Portfolio management is the art of selecting the right
investment tools in the right proportion to generate optimum returns with a balance of risk
from the investment made.
In other words, a portfolio is a group of assets. The portfolio gives an opportunity to diversify
risk. Diversification of risk does not mean that there will be an elimination of risk. With every
asset, there is an attachment of two types of risk;
diversifiable/unique/unexplained/unsystematic risk and undiversifiable/ market risk /
explained /systematic risk. Even an optimum portfolio cannot eliminate market risk, but can
only reduce or eliminate the diversifiable risk. As soon as risk reduces, the variability of
return reduces.
Best portfolio management practice runs on the principle of minimum risk and maximum
return within a given time frame. A portfolio is built based on investor’s income, investment
budget and risk appetite keeping the expected rate of return in mind.
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WHO IS A PORTFOLIO MANAGER?

Portfolio Manager is a person who understands his client’s investment needs and suggests a
suitable investment mix to meet his client’s investment objectives. This tailor-made
investment plan is recommended keeping in mind the Risk-Return balance.
PROCESS IN PORTFOLIO MANAGEMENT

Portfolio management process is not a one-time activity. The portfolio manager manages the
portfolio on a regular basis and keeps his client updated with the changes. It involves the
following tasks:
▪ Understanding the client’s investment objectives and availability of funds

▪ Matching investment to these objectives
▪ Recommending an investment policy
▪ Balancing risk and studying the portfolio performance from time to time
▪ Taking a decision on the investment strategy based on discussion with the client
▪ Changing asset allocation from time to time-based on portfolio performance.
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WHY IS PORTFOLIO MANAGEMENT IMPORTANT?

It is important due to the following reasons:
PM is a perfect way to select the “Best Investment Strategy” based on age, income, risk
taking the capacity of the individual and investment budget.
It helps to keep a gauge on the risk taken as the process of PM keeps “Risk Minimization” as
the focus.
“Customization” is possible because an individual’s needs and choices are kept in mind i.e.
when the person needs the return, how much return expectation a person has and how
much investment period an individual select.
Taking into account changes in tax laws, investments can be made.
When investment is made in fixed income security like preference share or debenture or
any other such security, then in that case investor is exposed to interest rate risk and price
risk of security. PM can take help of duration or convexity to immunize the portfolio.
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TYPES OF PORTFOLIO MANAGEMENT

Portfolio Management Services are classified into two broad categories
ACTIVE & PASSIVE PORTFOLIO MANAGEMENT

Active PM refers to the service when there is active involvement of portfolio managers in
buy-sell transactions for securities. It ensures meeting the investment objectives of the
investor. Whereas Passive PM refers to managing a fixed portfolio where the portfolio
performance is matched to the market index. (i.e. market)
On the basis of discretionary powers allowed to Portfolio Manager i.e.
DISCRETIONARY & NON-DISCRETIONARY PORTFOLIO

MANAGEMENT
Discretionary PM refers to the process where portfolio management has the authority to
make financial decisions. It makes those decisions for the invested funds on the basis of
investor’s investment needs. Apart from that, he also does the entire documentary work
and filing too. Non-Discretionary PM refers to the process where a portfolio manager acts
just as an advisor for which investments are good and unprofitable. And the investor takes
the decisions.
Benefits & Drawbacks of Portfolio Management

One of the biggest challenges faced by individuals & institutions is to decide how to invest
for future needs. For individuals, the goal might be to fund retirement needs. For
institutions such as insurance companies, the goal is to fund future liabilities in the form of
insurance claims. Regardless of the ultimate goal, all face the same challenges. To an
investor, the question is “should I analyze and invest in each security in isolation or take a
portfolio approach”. By portfolio approach, we mean evaluating individual securities in
relation to their contribution to the whole portfolio.
OPTIMAL ALLOCATION OF FUNDS

Any investor has limited funds to invest and would like to maximize the returns on his
investment. Portfolio management aides in maximizing these returns. A haphazard
investment methodology – buying a few stocks here, some bonds there, some gold
somewhere, is actually not a good investor behavior. Portfolio management theory gives
investors a proper framework & many different calculation models to exactly decide how
much returns they want, and how to get it. This structured approach makes it easy to
allocate the limited funds availability & put it to optimum use.
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Who would opt for Portfolio management?

• Limited knowledge: It is opted by someone who would like to invest in different investment
avenues like stocks, metals, other commodities but does not have the knowledge of doing it.
• Limitation of time: People who would be from a different work profile may not have the
time to set and track their portfolio and hence would hand it over to learn and experienced
hands.
How Portfolio Management takes place practically?

The actual method of Portfolio Management is different from that we do it academically.
The investors carry out a market survey in terms of the different schemes and their
performances in the past, the fund managers involved their experiences and risk-reward
ratio and accordingly select the fund in which they would chip in their money.
• It is initiated with a contract between the investor and the company that would have
different portfolio schemes. These could be purely stock/shares oriented or may have a
blend of different investment avenues.
• Once the contract is in place, verifying the fee structure, time frame, risk exposure and the
kind whether discretionary or nondiscretionary is decided.
• After all this is in place, the fund manager plays his role. The portfolio is structured on the
basis of the agreed terms and then churns the portfolio at regular intervals.
• The report of the performance of the portfolio is periodically sent to the investors.
• There are certain computer-software that are usedby the managers to keep a track of the
developments in the portfolio.
• The fund manager takes decisions on the basis of the hardcore research that is company
specific as well as market-related done by the team of the portfolio managers.
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Example of Portfolio Management

Say the investor has Rupees 1,00,000 to start with and the manager has to distribute this
across the different investment options. So the portfolio manager according to the risk-
taking capacity and the kind of returns calculated provides a portfolio structured in tandem
with that.
So for example, the portfolio could include real estate, fixed deposits with banks, mutual
funds, shares, and bonds. There shall be bifurcation across these five units of the total
corpus provided.
Thereby, depending on the security and the return from these avenues the bifurcation is
done.
On the other hand, the portfolio could be stock specific as well. Thereby, the bifurcation is
done across researched stocks in the markets.
Hence, depending on the requirements of the investors, the fund manager takes
appropriate decisions and allocates the funds.
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Career as a Portfolio Manager

An individual who understands the client’s financial needs and designs a suitable investment
plan as per his income and risk-taking abilities is called a portfolio manager. A portfolio
manager is one who invests on behalf of the client. After understanding the financial goals
and objectives of an investor, the portfolio manager provides the appropriate investment
solution. The role played by the portfolio manager is indeed a challenging, responsible and
answerable one. That is the reason why with the hierarchy across the portfolio management
team, the responsibility, as well as the remuneration, is decently high. The more
experienced the fund manager the more is the weight given to these managers and
accordingly place them in a good demanding position in terms of salaries. If to scale it, these
run from lakhs to crores as per the market and individual experience. All the pay packages
totally depend on the experience and the returns earned for the investors in good or bad
times.
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Chapter No.2 Research Methodology
The efficient market hypothesis. (EMH)
(1). Stock prices follow a random walk.

When researchers have examined stock prices movement for quoted companies they have
observed that the price movements seem to follow a random pattern. In other words, stock
price movements cannot be predicted.
From their observations, a hypothesis was developed which stated that stock prices are
fairly valued on the basis of all existing information and stock prices quickly react to any new
information. Being fairly valued means that expected returns equal required returns, taking
into account the level of risk. This is referred to as an efficient capital market.
This would be expected given the large number of profit seeking investors analyzing stocks
independently of one another. In may be referred to as the fair game model .
(2). Stock prices respond to new information.

Stock prices will move new when new information is received and will fairly reflect that new
information since new information must, by definition, be unpredictable and random
(otherwise it would not be new information), it follows that stock price movements will also
be random. Stock prices adjust rapidly to new information according to the efficient market
hypothesis (EMH).
This is referred to as informational efficiency.
(3). Assumptions underlying efficient capital markets.

The premises underlying the hypothesis that prices adjust rapidly to reflect all information
are as follows,
1. A large number of market participants are competing to analyze and value securities
in order to make profits.
2. Information comes to the market in a random fashion. Timing of an announcement
is independent of other announcements.
3. Competing investors quickly react to this new information in setting stock prices. The
reaction may be imperfect, leading to an over or under-reaction to the new
information. However, there is no bias in one direction.
Generally, efficient capital markets therefore imply a minimum number of investors and a
high degree of trading.
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(4). The three forms of the EMH.

1. To what information do stock prices respond? Various levels of the EMH have been
developed which state that markets take accounts of different levels. These are usually
referred to as the weak. Semi strong and strong forms of the EMH.
2. Weak from of the EMH.The weak form of the EMH stats that all securities market
information has already been incorporated into the current stock price. Market information
includes share price movements, volumes, the nature of buyers and selves, etc.
What this implies is that it is impossible to use past stock price movements and other
historic market information to predict future price movements.
This form of the EMH directly contradicts technical analysis assumptions implicitly, technical
analysts believe that markets are not efficient, since they are using market information to
make investment decisions.
(3). Semi-strong from of the EMH.
The semi-strong form of the EMH stats that current stock prices not only reflect the market
information referred to In the weak form but also rapidly move to incorporate any non-
market information that has been published about a company, i.e. the price reflects all
public information.
For example, Release of preliminary figures by the company constitutes new information
and the stock price will move to reflect this. Other public information is incorporated in
ratios such as price to book value, P/E ratios. Ext.
This suggests that investors who base investment decisions on information after the
information has been made public will not make excess returns on average.
(4). Strong form of the EMH

The strong form of the EMH stats that, in addition to published information, a company’s
stock price reflects all information that can be gleaned about the company itself, its markets
and general economic factors. It includes those facts that are meant to be secret and
confidential to the company itself.
Effectively, the strong form extends the efficient market to encompass the perfect market,
where information is freely available to all investors at no cost and at the same time.
This form of the EMH is very extreme and few people actually believe that it applies in
practice. The very fact that stock prices move when previously confidential information is
published indicates that it is not the case.
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Scope of Portfolio Management

Portfolio management is a continuous process. It is a dynamic activity. The following are the basic
operations of a portfolio management.
1. Monitoring the performance of portfolio by incorporating the latest market conditions.

2. Identification of the investor’s objective, constraints and preferences.
3. Making an evaluation of portfolio income (comparison with targets and achievement).
4. Making revision in the portfolio.
Implementation of the strategies in tune with investment objectives.

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Objectives of Portfolio Management
The objective of portfolio management is to invest in securities is securities in such a

way that one maximizes one’s returns and minimizes risks in order to achieve one’s
investment objective.
A good portfolio should have multiple objectives and achieve a sound balance
among them. Any one objective should not be given undue importance at the cost of
others. Presented below are some important objectives of portfolio management .
• Stable Current Return: Once investment safety is guaranteed, the

portfolio should yield a steady current income. The current returns should at
least match the opportunity cost of the funds of the investor. What we are
referring to current income by way of interest of dividends, not capital gains.
• Marketability: A good portfolio consists of investment, which can be
marketed without difficulty. If there are too many unlisted or inactive shares
in your portfolio, you will face problems in encasing them, and switching
from one investment to another. It is desirable to invest in companies listed
on major stock exchanges, which are actively traded.
• Tax Planning: Since taxation is an important variable in total planning, a
good portfolio should enable its owner to enjoy a favorable tax shelter. The
portfolio should be developed considering not only income tax, but capital
gains tax, and gift tax, as well. What a good portfolio aims at is tax planning,
not tax evasion or tax avoidance.
• Appreciation in the value of capital: A good portfolio should
appreciate in value in order to protect the investor from any erosion in
purchasing power due to inflation. In other words, a balanced portfolio must
consist of certain investments, which tend to appreciate in real value after
adjusting for inflation.
• Liquidity: The portfolio should ensure that there are enough funds available
at short notice to take care of the investor’s liquidity requirements. It is
desirable to keep a line of credit from a bank for use in case it becomes
necessary to participate in right issues, or for any other personal needs.
• Safety of the investment: The first important objective of a portfolio, no
matter who owns it, is to ensure that the investment is absolutely safe. Other
considerations like income, growth, etc., only come into the picture after the
safety of your investment is ensured. Investment safety or minimization of
risks is one of the important objectives of portfolio management. There are
many types of risks, which are associated with investment in equity
stocks, including super stocks. Bear in mind that there is no such thing as a
zero risk investment. Moreover, relatively low risk investment gives
correspondingly lower returns. You can try and minimize the overall risk or
bring it to an acceptable level by developing a balanced and efficient
portfolio. A good portfolio of growth stocks satisfies the entire objectives
outline above.
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DRAWBACKS OF PORTFOLIO MANAGEMENT

NO DOWNSIDE PROTECTION
We must understand that even though portfolio management does help in reducing
downside risk, it doesn’t provide complete downside protection. When we select
investments to create a portfolio, we choose in a manner that there is structured
classification. We will invest in different asset classes, even within asset classes we
will select different sectors as per our goals. For example, sometimes a subset of
assets will go up in value at the same time that another will go down in value. An
investor will select from both the subsets to reduce risk. But there will be times, such
as the great meltdown of 2009, when the market crashes and the entire portfolio
will result in negative returns. There is no method in portfolio management to avoid
such a scenario. Thus we can say that portfolio management is a good tool when
used in normal or growing market, but during downfall or crash it becomes a little
obsolete.
RISK OF OVER-DIVERSIFICATION
Over-diversification occurs when the number of investments in a portfolio exceeds
the point where the marginal loss of expected return is greater than the marginal
benefit of reduced risk. In other words, when adding individual investments to a
portfolio, each additional investment lowers risk but also lowers the expected
return. Any portfolio must only be diversified until a point where unsystematic risk
becomes minimum. This is usually a matter of judgment of the investors, and many
times investors fall in the risk of over-diversification. This leads to lower returns for
the invested money. This pitfall in portfolio management actually erodes investor
returns.
There are always going to be some drawbacks to every theory & model. It is
important to assess that even with the drawbacks, how much a tool does helps us.
Top of Form Portfolio management has been used since 1930’s and has given such
good results over years & has become so common that even a layman understands
when we talk about “portfolio”. Portfolio management is the base on which an
investment strategy is built 1& the method is widely accepted by expert investment
analysts, portfolio managers, fund managers & the likes.
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Chapter No.3 Literature Review

Markowitz Portfolio Theory
Harry Markowitz developed a theory, also known as Modern Portfolio Theory
(MPT) according to which we can balance our investment by combining different
securities, illustrating how well selected shares portfolio can result in maximum
profit with minimum risk. He proved that investors who take a higher risk can also
achieve higher profit. The central measure of success or failure is the relative
portfolio gain, i.e. gain compared to the selected benchmark.
Modern portfolio theory is based on three assumptions about the behavior of investors
who:
• wish to maximize their utility function and who are risk averse,
• choose their portfolio based on the mean value and return variance,
• have a single-period time horizon.
Markowitz portfolio theory is based on several very important assumptions. Under

these assumptions a portfolio is considered to be efficient if no other portfolio offers
a higher expected return with the same or lower risk.
1. Investors view the mean of the distribution of potential outcomes as the

expected return of an investment.
2. Investors view the variability of potential outcomes about the mean as the
risk of an investment. Variability is measured by variance or standard
deviation.
3. Investors all have the same holding period. This eliminates time horizon risk.
4. Investors base all their decisions on expected return and risk. By connecting
all the points of equal utility, a series of curves called the investor’s
indifference or utility map is created.
5. For a given risk level, investors prefer higher returns to lower returns, or for a
given return level, investors prefer less risk to more risk.
By using risk (standard deviation – σ) and the expected return (Rp) in a two-
dimensional space, following figure presents portfolio combinations available to the
investor. Thus, each point within the space enclosed by points XYZ, represents a
certain portfolio.
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By analyzing the figure, the conclusion can be drawn that in a new combination of
securities the portfolio can be moved:
• upwards – which would imply higher returns with the same level of risk or
• to the left – this implies higher returns with less risk.
It can be noticed that the portfolios below the XY curve, unlike the portfolios on the
curve, offer the investor the same return with a higher level of risk or a higher risk
with less return, which is not acceptable to the investor. Investors tend to select the
combination of shares that would position their portfolio on the XY curve, called the
efficient frontier. If the portfolio does not belong to the frontier, the investor can
improve the situation by changing the structure of the portfolio, i.e. by changing its
content.
Investors will opt for the portfolio that best corresponds to their risk attitude. Those
who are more risk inclined will select the portfolio on the efficient frontier, closer to
point X, whereas the more risk averse will select the portfolio closer to point Y. It can
be said that the Markowitz portfolio theory helps investors in the selection of the set
of shares that will ensure a higher portfolio return with the desired level of risk (the
tendency is to minimize risk and maximize return on investment).
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The Efficient Frontier

Markowitz constructed what is called the efficient frontier. First, he combined all the
stocks in the universe together into “two stock” portfolios. He observed that the risk-
return line of each of the two stock combinations bent backwards toward the return
(Y) axis. He then built “two portfolios” portfolios out of all the “two stock” portfolios.
The risk-return line of these combination portfolios bent even further back toward
the return (Y) axis. He kept combining stocks and portfolios composed of different
weightings until he discovered at some point you get no more benefits from
diversification. He called this final or “optimal” bent line the efficient frontier. The
efficient frontier represents the set of portfolios that will give you the highest return
at each level of risk.
The efficient frontier has a curvilinear shape because if the set of possible portfolios
of assets is not perfectly correlated the set of relations will not be a straight line, but
is curved depending on the correlation. The lower the correlation the more curved.
Investor’s Utility Curves or Indifference Curves

The utility curves for an individual specify the trade-offs he/she is willing to make
between expected return and risk. These utility curves are used in conjunction with
the efficient frontier to determine which particular efficient portfolio is the best for a
particular investor. Two investors will not choose the same portfolio from the
efficient set unless their utility curves are identical. In the following picture, l1 and l2
denotes investors utility curves.
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Investor’s utility curves are important because they indicate the desired tradeoff by
investors between risk and return. Given the efficient frontier, they indicate which
portfolio is preferable for the given investor. Notably, because utility curves differ
one should expect different investors to select different portfolios on the efficient
frontier.
Efficient frontier and Capital Market Line (CML)

An efficient portfolio is one that produces the highest expected return for any given
level of risk. Markowitz showed how to find the frontier of risk and returns for
stocks. Only portfolios on the frontier are efficient. Sharpe added the riskless asset
return and noted that returns on a line connecting r rf and the tangency point on the
efficient frontier was also “feasible” in the sense that portfolios consisting of some of
the riskless asset and some of the market portfolio could be developed.
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The introduction of a risk-free asset in the portfolio changes the Markowitz efficient
frontier into a straight line. He called that straight efficient frontier line the Capital
Market Line (CML), and he used indifference curves to show how investors with
different degrees of risk aversion would choose portfolios with different mixes of
stocks and the riskless asset. Investors who are not at all averse to risk could borrow
and buy stocks on margin, and thus move out the CML beyond the tangency
point. Since the line is straight, the math implies that any two assets falling on this
line will be perfectly positively correlated with each other.
The optimal portfolio for an investor is the point where the new CML is tangent to
the old efficient frontier when only risky securities were graphed. This optimal
portfolio is normally known as the market portfolio.
Two rational investors could hold portfolios at different points on the CML. An
extremely risk averse investor could hold only riskless assets, while someone who is
not at all sensitive to risk but who wants to maximize expected returns could move
on out the CML by buying stock on margin.
Note, though, that all rational investors would have a portfolio that is on the CML.
So, a highly risk adverse investor would not load up on low-risk stock, nor would a
“risk taker” load up on highly risky stocks. Both would invest in the market portfolio
and then increase or decrease risk by either buying the riskless asset or borrowing to
buy more of the market portfolio.
The Role of Portfolio Management in an Efficient Market
You have learned that a basic principle in portfolio management is the diversification
of securities. Even if all stocks are priced fairly, each still poses firm-specific risk that
can be eliminated through diversification. Therefore, rational security selection, even
in an efficient market, calls for the selection of a well-diversified portfolio, providing
the systematic risk level that the investor wants. Even in an efficient market investor
must choose the risk-return profiles they deem appropriate.
The efficient market hypothesis (EMH) states that a market is efficient if security
prices immediately and fully reflect all available relevant information. If the market
fully reflects information, the knowledge of that information would not allow an
investor to profit from the information because stock prices already incorporate the
information. In an efficient market, no securities are consistently over-priced or
underpriced. While some securities will turn out after any investment period to
have provided positive alphas (i.e., risk-adjusted abnormal returns) and some
negative alphas, these past returns are not predictive of future returns.
Proponents of the efficient market hypothesis believe that active management is

largely wasted effort and unlikely to justify the expenses incurred. Therefore, they
advocate a passive investment strategy that makes no attempt to outsmart the
market. A passive strategy aims only at establishing a well-diversified portfolio of
securities without attempting to find under or overvalued stocks. Passive
management is usually characterized by a buy-and-hold strategy. Because
the efficient market theory indicates that stock prices are at fair levels, given all
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available information, it makes no sense to buy and sell securities frequently, which
generates large brokerage fees without increasing expected performance.
Rational investment policy also requires that tax considerations be reflected in

security choices. High-tax-bracket investors generally will not want the same
securities that low-tax-bracket investors find favorable. At an obvious level, high-
bracket investors find it advantageous to buy tax-exempt municipal bonds despite
their relatively low pre-tax yields, whereas those same bonds are unattractive to
low-bracket or tax-exempt investors. At subtler level, high-bracket investors might
want to tilt their portfolios in the direction of capital gains as opposed to interest
income, because capital gains are taxed less heavily and because the option to defer
the realization of capital gains income is more valuable the higher the current tax
bracket. They also will be more attracted to investment opportunities for which
returns are sensitive to tax benefits, such as real estate ventures.
A third argument for rational portfolio management relates to the particular risk
profile of the investors. For example, a Toyota executive whose annual bonus
depends on Toyota’s profits generally should not invest additional amounts in auto
stocks. To the extent that his or her compensation already depends on Toyota’s well-
being, the executive is already over-invested in Toyota and should not exacerbate
the lack of diversification.
In conclusion, there is a role for portfolio management even in an efficient market.

Investors optimal positions will vary according to factors such as age, tax bracket,
risk-aversion, and employment. The role of portfolio management in an efficient
market is to tailor the portfolio to these needs, rather than to attempt to beat the
market, which requires identifying the client’s return requirements and risk
tolerance. Rational portfolio management also requires examining the investor’s
constraints, including liquidity, time horizon, laws and regulations, taxes, and unique
preferences and circumstances such as age and employment.
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Portfolio Construction Phase in Investment Portfolio Management
Investment portfolio construction refers to the allocation of funds among a variety of

financial assets open for investment. Portfolio theory concerns itself with the
principles governing such allocation. The objective of the theory is to elaborate the
principles in which the risk can be minimized subject to desired level of return on the
portfolio or maximize the return, subject to the constraint of a tolerate level of risk.
Thus, the basic objective of portfolio management is to maximize yield and minimize
risk. The other ancillary objectives are as per the needs of investors, namely:
• Safety of the investment

• Stable current returns
• Appreciation in the value of capital
• Marketability and Liquidity
• Minimizing of tax liability.
In pursuit of these objectives, the portfolio manager has to set out all the various
alternative investment along with their projected return and risk and choose
investment with safety the requirement of the individual investor and cater to his
preferences. The manager has to keep a list of such investment avenues along with
return-risk profile, tax implications, yield and other return such as convertible options,
bonus, rights etc. A ready reckoned giving out the analysis of the risk involved in
each investment and the corresponding return should be kept.
The investment portfolio construction, as referred to earlier, be made on the basis of

the investment strategy, set out for each investor. Through choice of asset classes,
instrument of investment and the specific scripts, save of bond or equity of different
risk and return characteristics, the choice of tax characteristics, risk level and other
feature of investment, are decided upon.
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Three Types of Portfolio Investments

Portfolio management is a process encompassing many activities of investment in
assets and securities. It is a dynamic and flexible concept and involves regular and
systematic analysis, judgment and action. The objective of this service is to help the
unknown and investors with the expertise of professionals in investment portfolio
management. It involves construction of a portfolio based upon the investor’s
objectives, constraints, preferences for risk and returns and tax liability. The portfolio
is reviewed and adjusted from time to time in tune with the market conditions.
The evaluation of portfolio is to be done in terms of targets set for risk and returns.
The changes in the portfolio are to be effected to meet the changing condition.
Portfolio construction refers to the allocation of surplus funds in hand among a variety
of financial assets open for investment. Portfolio theory concerns itself with the
principles governing such allocation. The modern view of investment is oriented more
go towards the assembly of proper combination of individual securities to form
investment portfolio. A combination of securities held together will give a beneficial
result if they grouped in a manner to secure higher returns after taking into
consideration the risk elements. The modern theory is the view that by diversification
risk can be reduced. Diversification can be made by the investor either by having a
large number of shares of companies in different regions, in different industries or
those producing different types of product lines. Modern theory believes in the
perspective of combination of securities under constraints of risk and returns.
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Types of Portfolio Investments

When it comes to investing there are many options available to individuals. A person
can invest in stocks, bonds, mutual funds, etc. Once a person invests in multiple
products their performance needs to be tracked and strategies made to ensure the
investor reaps the most profit possible. This is where the investment portfolio comes
into play. According to Investor Awareness, it is a term that describes all investments
owned. To take this definition a little farther, an investment portfolio is a significant
aspect in diversification. Maintaining a diverse portfolio helps to mitigate loss
because the investor has not placed all of their eggs in one basket. There are different
types of investment portfolios. Perhaps the most common type’s individuals are
exposed to are: Conservative, Balanced and Aggressive Growth.
A portfolio is a combination of different investment assets mixed and matched for the
purpose of achieving an investor’s goals. Items that are considered a part of Investors
portfolio can include any asset that they own – from real items such as art and real
estate, to equities, fixed-income instruments and their cash and equivalents. For the
purpose of this section, Investors will focus on the most liquid asset types: equities,
fixed-income securities and cash and equivalents. The asset mix they choose
according to their aims and strategy will determine the risk and expected return of
their portfolio.
1. Aggressive Investment Portfolio

In general, aggressive investment strategies – those that shoot for the highest possible
return – are most appropriate for investors who, for the sake of this potential high
return, have a high risk tolerance and a longer time horizon. Aggressive portfolios
generally have a higher investment in equities. Aggressive investment portfolios are
for investors not afraid of high risk. This type of portfolio may incorporate mutual
funds that aim for high capital gain, equities, stocks, bonds, cash and maybe some
commodities. In the short-term, growth will be very small and some loss will be
observed. As a result, aggressive portfolios perform better in the long term – about
five years or longer. An actively traded aggressive portfolio will typically gain
maximum returns for the investor. The loss factor is why only individuals who are
willing to take a high financial risk should seek an aggressive investment portfolio.
An aggressive portfolio contains high growth investments that will hopefully

appreciate in value. This strategy attempts to achieve high long-term growth by
investing in often risky but profitable, short-term stocks. Under normal market
conditions, the Aggressive Growth Portfolio will invest approximately 100% of its
total assets in equity securities. The Aggressive Growth Portfolio can invest up to
100% of its total assets in equity securities and up to 25% of its total assets in fixed
income securities.
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2. Balanced or Moderate Investment Portfolio
A moderately aggressive portfolio is meant for individuals with a longer time horizon
and an average risk tolerance. Investors who find these types of portfolios attractive
are seeking to balance the amount of risk and return contained within the fund. The
portfolio would consist of approximately 50-55% equities, 35-40% bonds, 5-10%
cash and equivalents.
The Moderate Portfolio’s primary investment objective is to seek long-term capital

appreciation and also the Moderate Portfolio seeks current income.
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3. Conservative Investment Portfolio

The conservative investment strategies, which put safety at a high priority, are most
appropriate for investors who are risk averse and have a shorter time horizon.
Conservative portfolios will generally consist mainly of cash and cash equivalents, or
high-quality fixed-income instruments. The main goal of a conservative portfolio
strategy is to maintain the real value of the portfolio, or to protect the value of the
portfolio against inflation. The portfolio shown below would yield a high amount of
current income from the bonds and would also yield long-term capital growth
potential from the investment in high quality equities.
The conservative investment portfolio is geared towards preserving capital. A

minimal risk investment strategy is used. This type of portfolio is ideal for retirees
who are focused more on having assets available than a stream of income from
interest. Since the primary goal is to preserve capital, investors can dip into their
principal to supplement living expenses instead of relying on the portfolio’s earned
income. The Conservative Portfolio’s primary investment objective is to seek
preservation of capital and current income. The Conservative Portfolio also seeks
capital appreciation. Under normal market conditions, the Conservative Portfolio will
invest approximately 65% of its total assets in fixed income securities and cash and
approximately 35% of its total assets in equity securities. The Conservative Portfolio
can invest up to 100% of its total assets in fixed income securities and or some time
up to 20% of its total assets in equity securities.
Investors can further break down the above asset classes into subclasses, which also
have different risks and potential returns. For example, an investor might divide the
equity portion between large companies, small companies and international firms. The
bond portion might be allocated between those that are short-term and long-term,
government versus corporate debt, and so forth. More advanced investors might also
have some of the alternative assets such as options and futures in the mix. As, the
number of possible asset allocations is practically unlimited.
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Risk and Return in Portfolio Investments
The Webster’s New Collegiate Dictionary definition of risk includes the following
meanings: “……. Possibility of loss or injury …. the degree or probability of such
loss”. This conforms to the connotations put on the term by most investors.
Professional often speaks of “downside risk” and “upside potential”. The idea is
straightforward enough: Risk has to do with bad outcomes, potential with good ones.
In considering economic and political factors, investors commonly identify five kinds
of hazards to which their investments are exposed. The following are
different components of risks associated with portfolio investments:
A. Systematic Risk
Systematic risk refers to the portion of total variability in return caused by factors
affecting the prices of all securities. Economic, Political and Sociological changes are
sources of systematic risk. Their effect is to cause prices of nearly all individual
common stocks or security to move together in the same manner. For example; if the
Economy is moving toward a recession and corporate profits shift downward, stock
prices may decline across a broad front. Nearly all stocks listed on the BSE / NSE
move in the same direction as the BSE / NSE index.
Systematic risk is also called non-diversified risk. If is unavoidable. In short, the

variability in a securities total return in directly associated with the overall movements
in the general market or Economy is called systematic risk. Systematic risk covers
market risk, Interest rate risk and Purchasing power risk
1. Market Risk
Market risk is referred to as stock/security variability due to changes in investor’s
reaction towards tangible and intangible events is the chief cause affecting market
risk. The first set that is the tangible events, has a real basis but the intangible events
are based on psychological basis.
Here, real events, comprising of political, social or economic reason. Intangible

events are related to psychology of investors or say emotional intangibility of
investors. The initial decline or rise in market price will create an emotional instability
of investors and cause a fear of loss or create an undue confidence, relating possibility
of profit. The reaction to loss will reduce selling & purchasing prices down & the
reaction to gain will bring in the activity of active buying of securities.
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2. Interest Rate Risk

The price of all securities rise or fall depending on the change in interest rate, Interest
rate risk is the difference between the expected interest rates & the current market
interest rate. The markets will have different interest rate fluctuations, according to
market situation, supply and demand position of cash or credit. The degree of interest
rate risk is related to the length of time to maturity of the security. If the maturity
period is long, the market value of the security may fluctuate widely. Further, the
market activity & investor perceptions change with the change in the interest rates &
interest rates also depend upon the nature of instruments such as bonds, debentures,
loans and maturity period, credit worthiness of the security issues.
3. Purchasing Power Risk

Purchasing power risk is also known as inflation risk. This risks arises out of change
in the prices of goods & services and technically it covers both inflation and deflation
period. Purchasing power risk is more relevant in case of fixed income securities;
shares are regarded as hedge against inflation. There is always a chance that the
purchasing power of invested money will decline or the real return will decline due to
inflation.
The behavior of purchasing power risk can in some way be compared to interest rate
risk. They have a systematic influence on the prices of both stocks & bonds. If the
consumer price index in a country shows a constant increase of 4% & suddenly jump
to 5% in the next. Year, the required rate of return will have to be adjusted with
upward revision. Such a change in process will affect government securities,
corporate bonds & common stocks.
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B. Unsystematic Risk
The risk arises out of the uncertainty surrounding a particular firm or industry due to
factors like labor strike, consumer preference & management policies are called
Unsystematic risk. These uncertainties directly affect the financing & operating
environment of the firm. Unsystematic risk is also called “Diversifiable risk”. It is
avoidable. Unsystematic risk can be minimized or eliminated through diversification
of security holding. Unsystematic risk covers Business risk and Financial risk
1. Business Risk
Business risk arises due to the uncertainty of return which depend upon the nature of
business. It relates to the variability of the business, sales, income, expenses & profits.
It depends upon the market conditions for the product mix, input supplies, strength of
the competitor etc. The business risk may be classified into two kind viz. internal risk
and External risk.
• Internal risk is related to the operating efficiency of the firm. This is

manageable by the firm. Interest Business risk loads to fall in revenue & profit
of the companies.
• External risk refers to the policies of government or strategic of competitors
or unforeseen situation in market. This risk may not be controlled & corrected
by the firm.
2. Financial Risk
Financial risk is associated with the way in which a company finances its activities.
Generally, financial risk is related to capital structure of a firm. The presence of
borrowed money or debt in capital structure creates fixed payments in the form of
interest that must be sustained by the firm. The presence of these interest
commitments – fixed interest payments due to debt or fixed dividend payments on
preference share – causes the amount of retained earning availability for equity share
dividends to be more variable than if no interest payments were required. Financial
risk is avoidable risk to the extent that management has the freedom to decline to
borrow or not to borrow funds. A firm with no debt financing has no financial risk.
One positive point for using debt instruments is that it provides a low cost source of
funds to a company at the same time providing financial leverage for the equity
shareholders & as long as the earning of company are higher than cost of borrowed
funds, the earning per share of equity share are increased.
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Return in Portfolio Investments

The typical objective of investment is to make current income from the investment in
the form of dividends and interest income. Suitable securities are those whose prices
are relatively stable but still pay reasonable dividends or interest, such as blue chip
companies. The investment should earn reasonable and expected return on the
investments. Before the selection of investment the investor should keep in mind that
certain investment like, Bank deposits, Public deposits, Debenture, Bonds, etc. will
carry fixed rate of return payable periodically. On investments made in shares of
companies, the periodical payments are not assured but it may ensure higher returns
from fixed income securities. But these instruments carry higher risk than fixed
income instruments.
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Portfolio Investment Process

The ultimate aim of the portfolio manager is to reduce the risk and increase the
return to the investor in order to reach the investment objectives of an investor. The
manager must be aware of the portfolio investment process. The process of portfolio
management involves many logical steps like portfolio planning, portfolio
implementation and monitoring. The portfolio investment process applies to different
situation. Portfolio is owned by different individuals and organizations with different
requirements. Investors should buy when prices are very low and sell when prices rise
to levels higher that their normal fluctuation.
Portfolio Investment Process
Portfolio investment process is an important step to meet the needs and convenience
of investors. The portfolio investment process involves the following steps:
1. Planning of portfolio.
2. Implementation of portfolio plan.
3. Monitoring the performance of portfolio.

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1. Planning of Portfolio
Planning is the most important element in a proper portfolio management. The
success of the portfolio management will depend upon the careful planning. While
making the plan, due consideration will be given to the investor’s financial
capability and current capital market situation. After taking into consideration a
set of investment and speculative policies will be prepared in the written form. It
is called as statement of investment policy. The document must contain (1) The
portfolio objective (2) Applicable strategies (3) Investment and speculative
constraints. The planning document must clearly define the asset allocation. It
means an optimal combination of various assets in an efficient market. The
portfolio manager must keep in mind about the difference between basic pure
investment portfolio and actual portfolio returns. The statement of investment
policy may contain these elements. The portfolio planning comprises the
following situation for its better performance.
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(A) Investor Conditions: – The first question which must be answered is

this – “What is the purpose of the security portfolio?” While this question might
seem obvious, it is too often overlooked, giving way instead to the excitement of
selecting the securities which are to be held. Understanding the purpose for
trading in financial securities will help to: (1) define the expected portfolio
liquidation, (2) aid in determining an acceptable level or risk, and (3) indicate
whether future consumption (liability needs) are to be paid in nominal or real
money, etc. For example: a 60 year old woman with small to moderate saving
probably (1) has a short investment horizon, (2) can accept little investment risk,
and (3) needs protection against short term inflation. In contrast, a young couple
investing couple investing for retirement in 30 years has (1) a very long
investment horizon, (2) an ability to accept moderate to large investment risk
because they can diversify over time, and (3) a need for protection against long-
term inflation. This suggests that the 60 year old woman should invest solely in
low-default risk money market securities. The young couple could invest in many
other asset classes for investment diversification and accept greater investment
risks. In short, knowing the eventual purpose of the portfolio investment makes it
possible to begin sketching out appropriate investment / speculative policies.
(B) Market Condition: – The portfolio owner must know the latest
developments in the market. He may be in a position to assess the potential of
future return on various capital market instruments. The investors’ expectation
may be two types, long term expectations and short term expectations. The most
important investment decision in portfolio construction is asset allocation. Asset
allocation means the investment in different financial instruments at a percentage
in portfolio. Some investment strategies are static. The portfolio requires changes
according to investor’s needs and knowledge. A continues changes in portfolio
leads to higher operating cost. Generally, the potential volatility of equity and debt
market is 2 to 3 years. The another type of re-balancing strategy focuses on the
level of prices of a given financial asset.
(C) Speculative Policies: – The portfolio owner may accept the speculative
strategies in order to reach his goals of earning to maximum extant. If no
speculative strategies are used the management of the portfolio is relatively easy.
Speculative strategies may be categorized as asset allocation timing decision or
security selection decision. Small investors can do by purchasing mutual funds
which are indexed to a stock. Organization with large capital can employ
investment management firms to make their speculative trading decisions.
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(D) Strategic Asset Allocation: – The most important investment decision

which the owner of a portfolio must make is the portfolio’s asset allocation. Asset
allocation refers to the percentage invested in various security classes. Security
classes are simply the type of securities: (1) Money Market Investment; (2) Fixed
Income obligations; (3) Equity Shares; (4) Real Estate Investment; (5) securities.
Strategic asset allocation represents the asset allocation which would be optimal
for the investor if all security prices trade at their long-term equilibrium values
that is, if the markets are efficiency priced.
2. Implementation of Portfolio Plan
In the implementation stage, three decisions to be made, if the percentage holdings

of various assets classes are currently different from the desired holdings as in the
SIP, the portfolio should be re-balances to the desired SAA (Strategic Asset
Allocation). If the statement of investment policy requires a pure investment
strategy, this is the only thing, which is done in the implementation stage.
However, many portfolio owners engage in speculative transaction in the belief
that such transactions will generate excess risk-adjusted returns. Such speculative
transactions are usually classified as “timing” or “selection” decisions. Timing
decisions over or under weight various assets classes, industries, or economic
sectors from the strategic asset allocation. Such timing decision deal with
securities within a given asset class, industry group, or economic sector and
attempt to determine which securities should be over or under-weighted.
(A) Tactical Asset Allocation: – If one believes that the price levels of
certain asset classes, industry, or economic sectors are temporarily too high or too
low, actual portfolio holdings should depart from the asset mix called for in the
strategic asset allocation. Such timing decision is preferred to as tactical asset
allocation. As noted, SAA decisions could be made across aggregate asset classes,
industry classifications (steel, food), or various broad economic sectors (basic
manufacturing, interest-sensitive, consumer durables).
Traditionally, most tactical assets allocation has involved timing across aggregate
asset classes. For example, if equity prices are believing to be too high, one would
reduce the portfolio’s equity allocation and increase allocation to, say, risk-free
securities. If one is indeed successful at tactical asset allocation, the abnormal
returns, which would be earned, are certainly entering.
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(B) Security Selection: – The second type of active speculation involves the
selection of securities within a given assets class, industry, or economic sector.
The strategic asset allocation policy would call for broad diversification through
an indexed holding of virtually all securities in the asset in the class. For example,
if the total market value of HPS Corporation share currently represents 1% of all
issued equity capital, then 1% of the investor’s portfolio allocated to equity would
be held in HPS corporation shares. The only reason to overweight or underweight
particular securities in the strategic asset allocation would be to offset risks the
investors’ faces in other assets and liabilities outside the marketable security
portfolio. Security selection, however, actively overweight and underweight
holding of particular securities in the belief that they are temporarily mispriced.
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3. Monitoring the Performance of Portfolio

Portfolio performance monitoring is a continuous and ongoing assessment of
present investment portfolio and the portfolio manager shall incorporate the latest
development which occurred in capital market. The portfolio manager should take
into consideration of investor’s preferences, capital market condition and
expectations. Monitoring the portfolio performance is up-grading activity in asset
composition to take the advantage of economic, industry and market conditions.
The market conditions are depending upon the Government policy. Any change in
Government policy would reflect the stock market, which in turn affects the
portfolio. The continues revision of a portfolio depends upon the following
factors:
1. Change in Government policy.
2. Shifting from one industry to other
3. Shifting from one company scrip to another company scrip.
4. Shifting from one financial instrument to another.
5. The half yearly / yearly results of the corporate sector
Risk reduction is an important factor in portfolio. It will be achieved by

a diversification of the portfolio, changes in market prices may have necessitated in
asset composition. The composition has to be changed to maximize the returns to
reach the goals of investor.
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Portfolio Revision Strategies in Investment Portfolio Management
Meaning of Portfolio Revision

A portfolio is a mix of securities selected from a vast universe of securities. Two
variables determine the composition of a portfolio; the first is the securities included
in the portfolio and the second is the proportion of total funds invested in each
security.
Portfolio revision involves changing the existing mix of securities. This may be
effected either by changing the securities currently included in the portfolio or by
altering the proportion of funds invested in the securities. New securities may be
added to the portfolio or some of the existing securities may be removed from the
portfolio. Portfolio revision thus leads to purchases and sales of securities. The
objective of portfolio revision is the same as the objective of portfolio selection, i.e.
maximizing the return for a given level of risk or minimizing the risk for a given level
of return. The ultimate aim of portfolio revision is maximization of returns and
minimization of risk.
Constraints in Portfolio Revision:

Portfolio revision is the process of adjusting the existing portfolio in accordance with
the changes in financial markets and the investor ‘s position so as to ensure maximum
return from the portfolio with the minimum of risk. Portfolio revision or adjustment
necessitates purchase and sale of securities. The practice of portfolio adjustment
involving purchase and sale of securities gives rise to certain problems which act as
constraints in portfolio revision. Some of these areas under:
1. Transaction cost: Buying and selling of securities involve transaction costs

such as commission and brokerage. Frequent buying and selling of securities for
portfolio revision may push up transaction costs thereby reducing the gains from
portfolio revision. Hence, the transaction costs involved in portfolio revision
may act as a constraint to timely revision of portfolio.
2. Taxes: Tax is payable on the capital gains arising from sale of securities.
Usually, long-term capital gains are taxed at a lower rate than short-term capital
gains. To qualify as long-term capital gain, a security must be held by an
investor for a period of not less than 12 months before sale. Frequent sales of
securities in the course of periodic portfolio revision or adjustment will result in
short-term capital gains which would be taxed at a higher rate compared to long-
term capital gains. The higher tax on short-term capital gains may act as a
constraint to frequent portfolio revision.
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3. Statutory stipulations: The largest portfolios in every country are managed

by investment companies and mutual funds. These institutional investors are
normally governed by certain statutory stipulations regarding their investment
activity. These stipulations often act as constraints in timely portfolio revision.
4. Intrinsic difficulty: Portfolio revision is a difficult and time consuming

exercise. The methodology to be followed for portfolio revision is also not
clearly established. Different approaches may be adopted for the purpose. The
difficulty of carrying out portfolio revision itself may act as a constraint to
portfolio revision.
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Portfolio Revision Strategies

Two different strategies may be adopted for portfolio revision, namely an
active revision strategy and a passive revision strategy. The choice of the
strategy would depend on the investor ‘s objectives, skill, resources and time.
Active revision strategy involves frequent and sometimes substantial

adjustments to the portfolio. Investors who undertake active revision strategy
believe that security markets are not continuously efficient. They believe that
securities can be mispriced at times giving an opportunity for earning excess
returns through trading in them. Moreover, they believe that different investors
have divergent or heterogeneous expectations regarding the risk and return of
securities in the market. The practitioners of active revision strategy are
confident of developing better estimates of the true risk and return of securities
than the rest of the market. They hope to use their better estimates to generate
excess returns. Thus, the objective of active revision strategy is to beat the
market.
Active portfolio revision is essentially carrying out portfolio analysis and

portfolio selection all over again. It is based on an analysis of the fundamental
factors affecting the economy, industry and company as also the technical
factors like demand and supply. Consequently, the time, skill and resources
required for implementing active revision strategy will be much higher. The
frequency of trading is likely to be much higher under active revision strategy
resulting in higher transaction costs.
Passive revision strategy, in contrast, involves only minor and infrequent

adjustment to the portfolio over time. The practitioners of passive revision
strategy believe in market efficiency and homogeneity of expectation among
investors. They find little incentive for actively trading and revising portfolios
periodically.
Under passive revision strategy, adjustment to the portfolio is carried out

according to certain predetermined rules and procedures designated as formula
plans. These formula plans help the investor to adjust his portfolio according
to changes in the securities market.
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Formula Plans in Passive Revision Strategy

In the market, the prices of securities fluctuate. Ideally, investors should buy when
prices are low and sell when prices are high. If portfolio revision is done according to
this principle, investors would be able to benefit from the price fluctuations in the
securities market. But investors are hesitant to buy when prices are low either
expecting that prices will fall further lower or fearing that prices would not move
upwards again. Similarly, when prices are high, investors hesitate to sell because they
feel that prices may rise further and they may be able to realize larger profits.
Thus, left to themselves, investors would not be acting in the way required to benefit
from price fluctuations. Hence, certain mechanical revision techniques or procedures
have been developed to enable the investors to benefit from price fluctuations in the
market by buying stocks when prices are low and selling them when prices are high.
These techniques are referred to as formula plans.
Formula plans represent an attempt to exploit the price fluctuations in the market and
make them a source of profit to the investor. They make the decisions on timings of
buying and selling securities automatic and eliminate the emotions surrounding the
timing decisions. Formula plans consist of predetermined rules regarding when to buy
or sell and how much to buy and sell. These predetermined rules call for specified
actions when there are changes in the securities market.
The use of formula plans demands that the investor divide his investment funds into
two portfolios, one aggressive and the other conservative or defensive. The aggressive
portfolio usually consists of equity shares while the defensive portfolio consists of
bonds and debentures. The formula plans specify predetermined rules for the transfer
of funds from the aggressive portfolio to the defensive portfolio and vice versa. These
rules enable the investor to automatically sell shares when their prices are rising and
buy shares when their prices are falling.
There are different formula plans for implementing passive portfolio revision; some
of them are as under
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1. Constant Rupee Value Plan:

This is one of the most popular or commonly used formula plans. In this plan, the
investor constructs two portfolios, one aggressive, consisting of equity shares and the
other, defensive, consisting of bonds and debentures. The purpose of this plan is to
keep the value of the aggressive portfolio constant, i.e. at the original amount invested
in the aggressive portfolio.
As share prices fluctuate, the value of the aggressive portfolio keeps changing. When
share prices are increasing, the total value of the aggressive portfolio increases. The
investor has to sell some of the shares from his portfolio to bring down the total value
of the aggressive portfolio to the level of his original investment in it. The sale
proceeds will be invested in the defensive portfolio by buying bonds and debentures.
On the contrary, when share prices are falling, the total value of the aggressive
portfolio would also decline. To keep the total value of the aggressive portfolio at its
original level, the investor has to buy some shares from the market to be included in
his portfolio. For this purpose, a part of the defensive portfolio will be liquidated to
raise the money needed to buy additional shares.
Under this plan, the investor is effectively transferring funds from the aggressive
portfolio to the defensive portfolio and thereby booking profit when share prices are
increasing. Funds are transferred from the defensive portfolio to the aggressive
portfolio when share prices are low. Thus, the plan helps the investor to buy shares
when their prices are low and sell them when their prices are high
In order to implement this plan, the investor has to decide the action points, i.e. when
he should make the transfer of funds to keep the rupee value of the aggressive
portfolio constant. These action points, or revision points, should be predetermined
and should be chosen carefully. The revision points have a significant effect on the
returns of the investor. For instance, the revision points may be predetermined as 10
per cent, 15 per cent, 20 per cent, etc. above or below the original investment in the
aggressive portfolio. If the revision points are too close, the number of transactions
would be more and the transaction costs would increase reducing the benefits of
revision. If the revision points are set too far apart, it may not be possible to profit
from the price fluctuations occurring between these revision points.
Example: Let us consider an investor who has Rs. 1,00,000 for investment. He
decides to invest Rupees. 50,000 in an aggressive portfolio of equity shares and the
remaining Rs. 50,000 in a defensive portfolio of bonds and debentures. He purchases
1250 shares selling at Rs. 40 per share for his aggressive portfolio. The revision points
are fixed as 20 per cent above or below the original investment of Rs. 50,000.
After the construction of the portfolios, the share price will fluctuate. If the price of
the share increases to Rs. 45, the value of the aggressive portfolio increases to Rs.
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56,250 (1250 * Rs. 45). Since the revision points are fixed to 20 per cent above or
below the original investment, the investor will act only when the value of the
aggressive portfolio increases to Rs. 60,000 or falls to Rs. 40,000. If the price of the
share increases to Rs. 48 or above, the value of the aggressive portfolio will exceed
Rs. 60,000. Let us suppose that the price of the share increases to Rs. 50, the value of
the aggressive portfolio will be Rs. 62,500. The investor will sell shares worth Rs.
12,500 (250 * Rs. 50) and transfer the amount to the defensive portfolio by buying
bonds for Rs. 12,500. The value of the aggressive and defensive portfolios would now
be Rs. 50,000 and Rs. 62,500 respectively. The aggressive portfolio now has only
1000 shares valued at Rs. 50 per share.
Let us now suppose that the share price falls to Rs. 40 per share. The value of the
aggressive portfolio would then be Rs. 40,000 (1000 * Rs. 40) which is 20 per cent
less than the original investment. The investor now has to buy shares worth Rs.
10,000 (250* Rs. 40) to bring the value of the aggressive portfolio to its original level
of Rs. 50,000. The money required for buying the shares will be raised by selling
bonds from the defensive portfolio. The two portfolios now will have values of Rs.
50,000 (aggressive) and Rs. 52,500 (i.e. Rs. 62,500 – Rs. 10,000) (defensive),
aggregating to Rs. 1,02,500. It may be recalled that the investor started with Rs.
1,00,000 as investment in two portfolios.
Thus, when the ‘constant rupee value plan’ is being implemented, funds will be
transferred from one portfolio to the other, whenever the value of the aggressive
portfolio increases or declines to the predetermined levels.
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2. Constant Ratio plan

This is a variation of the constant rupee value plan. Here again the investor would
construct two portfolios, one aggressive and the other defensive with his investment
funds. The ratio between the investments in aggressive portfolio and the defensive
portfolio would be predetermined such as 1:1 or 1.5:1 etc. The purpose of this plan is
to keep this ratio constant by readjusting the two portfolios when share prices
fluctuate from time to time. For this purpose, a revision point will also have to be
predetermined.
Suppose the revision points may be fixed as +/- 0.10. This means that when the ratio
between the values of the aggressive portfolio and the defensive portfolio moves up
by 0.10 points or moves down by 0.10 points, the portfolios would be adjusted by
transfer of funds from one to the other.
Let us assume that an investor starts with Rs. 20,000, investing Rs. 10,000 each in the
aggressive portfolio and the defensive portfolio. The initial ratio is then 1:1. He has
predetermined the revision points as + 0.20. As share price increases the value of the
aggressive portfolio would rise. When the value of the aggressive portfolio rises to
Rs. 12,000, the ratio becomes 1.2:1 (i.e. Rs. 12,000: Rs. 10,000). Shares worth Rs.
1,000 will be sold and the amount transferred to the defensive portfolio by buying
bonds.
Now, the value of both the portfolios would be Rs. 11,000 and the ratio would
become 1:1. Now let us assume that the share prices are falling. The value of the
aggressive portfolio would start declining. If, for instance, the value declines to Rs.
8,500, the ratio becomes 0.77:1 (i.e. Rs. 8,500: Rs, 11,000). The ratio has declined by
more than 0.20 points. The investor now has to make the value of both portfolios
equal. He has to buy shares worth Rs. 1,250 by selling bonds for an equivalent
amount from his defensive portfolio. Now the value of the aggressive portfolio
increases by Rs. 1,250 and that of the defensive portfolio decreases by Rs. 1,250. The
values of both portfolios become Rs. 9,750 and the ratio becomes 1:1. The adjustment
of portfolios is done periodically in this manner.
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3. Dollar cost averaging

This is another method of passive portfolio revision. All formula plans assume that
stock prices fluctuate up and down in cycles. Dollar cost averaging utilizes this cyclic
movement in share prices to construct a portfolio at low cost.
The plan stipulates that the investor invest a constant sum, such as Rs. 5,000, Rs.
10,000, etc. in a specified share or portfolio of shares regularly at periodical intervals,
such as a month, two months, a quarter, etc. regardless of the price of the shares at the
time of investment. This periodic investment is to be continued over a fairly long
period to cover a complete cycle of share price movements.
If the plan is implemented over a complete cycle of stock prices, the investor will
obtain his shares at a lower average cost per share than the average price prevailing in
the market over the period. This occurs because more shares would be purchased at
lower prices than at higher prices.
The dollar cost averaging is really a technique of building up a portfolio over a period
of time. The plan does not envisage withdrawal of funds from the portfolio in
between. When a large portfolio has been built up over a complete cycle of share
price movements, the investor may switch over to one of the other formula plans for
its subsequent revision. The dollar cost averaging is especially suited to investors who
have periodic sums to invest. All formula plans have their limitations. By their very
nature they are inflexible.
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Diversification of Securities in Portfolio Investments

Reduction of Risk through Diversification of Securities
The process of combining securities in an investment portfolio is known as
diversification. The aim of diversification of securities is to reduce total risk without
sacrificing portfolio return. To understand the mechanism and power of
diversification, it is necessary to consider the impact of co-variance or correlation on
portfolio risk more closely. We shall examine three cases: (1) when security returns
are perfectly positively correlated, (2) when security returns are perfectly negatively
correlated and (3) when security returns are not correlated.
Diversification means, investment of funds in more than one risky asset with the basic
objective of risk reduction. The lay man can make good returns on his investment by
making use of technique of diversification.
Main forms of Diversification of Securities
1. Simple Diversification,
2. Over Diversification,
3. Efficient Diversification.
1. Simple Diversification
It involves a random selection of portfolio construction. The common man could
make better returns by making a random diversification of investments. It is the
process of altering the mix ratio of different components of a portfolio. The simple
diversification can reduce unsystematic risk. The research studies on portfolio found
that 10 to 15 securities in a portfolio will bring sufficient amount of returns. Further,
this concept reveals that the prediction should be based on a scientific method.
2. Over Diversification
Investors have the freedom to choose many investment alternatives to achieve the
desired profit on his portfolio. However, the investor shall have a great knowledge
regarding a large number of financial assets spreading different sectors, industries,
companies. The investors also more careful about the liquidity of each investment,
return, tax liability, the performance of the company etc. Investors find problems to
handle the large number of investments. It involves more transaction cost and more
money will be spent in managing over diversification. If any investor involves in over
diversification, there may be a chance either to get higher return or exposure to more
risk. All the problems involved in this process may result in inadequate return on the
portfolio.
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3. Efficient Diversification
Efficient diversification means a combination of low risk involved securities and high
risk instruments. The combination will only be finalized after considering the
expected return from an individual security and it does inter relationship with other
components in a portfolio. The securities shall have to be evaluated and thus
diversification to be restricted to some extent. Efficient diversification assures the
better return at an accepted level of risk.
Importance of Diversification of Securities

If you invest in a single security, your return will depend solely on that security; if
that security flops, your entire return will be severely affected. Clearly, held by itself,
the single security is highly risky. If you add nine other unrelated securities to that
single security portfolio, the possible outcome changes—if that security flops, your
entire return won’t be as badly hurt. By diversifying your investments, you have
substantially reduced the risk of the single security. However, that security’s return
will be the same whether held in isolation or in a portfolio.
Diversification substantially reduces your risk with little impact on potential returns.
The key involves investing in categories or securities that are dissimilar: Their returns
are affected by different factors and they face different kinds of risks. Diversification
should occur at all levels of investing. Diversification among the major asset
categories—stocks, fixed-income and money market investments—can help reduce
market risk, inflation risk and liquidity risk, since these categories are affected by
different market and economic factors.
Diversification within the major asset categories—for instance, among the various
kinds of stocks (international or domestic, for instance) or fixed-income products—
can help further reduce market and inflation risk.
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Diversification of Risk in Portfolio Management
Average investors are risk averse. Therefore, they will be ready to invest into
securities under the presumption of an adequate compensation for risk taking. The
compensation for the risk taken should be in the form of minimal rate of return for the
invested financial assets, and the rate is named the required rate of return. It has two
components:
• Delayed consumption compensation (investors could have purchased goods

and services with the assets they are to invest) and
• Risk acceptance compensation.
Diversification is used to stabilize the potential return, and thus increase the value of
the investment. Diversification stands for the investment of capital into several
different securities or projects, all together called the portfolio. Each security or
project entails certain risk; however, the only thing that matters to the investors who
diversify their investments is the total risk (portfolio risk) and the portfolio return.
There are two types of risks associated with portfolio investments:
• Systemic Risk – Risk that can be diversified and

• Non-systemic Risk – Risk that cannot be diversified.
It is a known fact that investments with a high level of portfolio diversification have
more stable and higher returns in comparison to investments that do not diversify their
portfolio. It should be mentioned that investments into securities entail both the
systemic and non-systemic risk.
Systemic risk cannot be suspended, i.e. it is always present, and at the securities
market it is manifested as the threat of recession, inflation, political turmoil, rise in
interest rates etc. Therefore, no matter how much investors may diversify their
investments, the systemic risk hazard is always present. The key to protection from
non-systemic risk lies in the diversification, and the investor must pay attention to the
fact that the security returns are in as little correlation as possible.
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By analyzing the above picture, the conclusion can be drawn that the increase the
number of different shares in the portfolio decreases the non-systemic risk, thereby
the total risk as well, while the systemic risk remains unchanged. On the other hand,
the total risk can never be completely eliminated.
For example, take an investor who has evenly arranged the investment of his financial
assets into 25 shares of different companies from different branches (business
activities) in order for the return on securities to be in as little correlation as possible.
One of the companies from his/her portfolio reports a poor financial result which
causes the company share to plunge by 50 %. It will be assumed that other shares
from his/her portfolio that day did not change significantly. Since the investor evenly
arranged the investment among 25 companies, the share of each company is 4 %,
including the company the value of which fell by 50 %. The investor has lost 2 % of
his/her investment.
The above example shows that diversification is desirable; however, when investing,
investors face the dilemma of how to diversify their assets, i.e. according to which
ratio to invest the total available financial assets into individual securities and/or
projects. The answer to the identified problem is given by the Markowitz Portfolio
Theory.
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Portfolio Diversification with a Number of Securities

The benefits from diversification increase, as more and more securities with less than
perfectly positively correlated returns are included in the portfolio. As the number of
securities added to a portfolio increases, the standard deviation of the portfolio
becomes smaller and smaller. Hence an investor can make the portfolio risk arbitrarily
small by including a large number of securities with negative or zero correlation in the
portfolio.
But in reality, no securities show negative or even zero correlation. Typically,

securities show some positive correlation, which is above zero but less than the
perfectly positive value (+1). As a result, diversification (that is, adding securities to a
portfolio) results in some reduction in total portfolio risk but not in complete
elimination of risk. Moreover, the effects of diversification are exhausted fairly
rapidly. That is, most of the reduction in portfolio standard deviation occurs by the
time the portfolio size increases to 25 or 30 securities. Adding securities beyond this
size brings about only marginal reduction in portfolio standard deviation.
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Adding securities to a portfolio reduces risk because securities are not perfectly
positively correlated. But the effects of diversification are exhausted rapidly because
the securities are still positively correlated to each other though not perfectly
correlated. Had they been negatively correlated, the portfolio risk would have
continued to decline as portfolio size increased. Thus, in practice, the benefits of
diversification are limited.
The total risk of an individual security comprises two components; the market related
risk called systematic risk and the unique risk of that particular security
called unsystematic risk. By combining securities into a portfolio the unsystematic
risk specific to different securities is cancelled out. Consequently, the risk of the
portfolio as a whole is reduced as the size of the portfolio increases. Ultimately when
the size of the portfolio reaches a certain limit, it will contain only the systematic risk
of securities included in the portfolio. The systematic risk, however, cannot be
eliminated. Thus a fairly large portfolio has only systematic risk and has relatively
little unsystematic risk. That is why there is no gain in adding securities to a portfolio
beyond a certain portfolio size.
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Arbitrage Pricing Theory (APT)
A substitute and concurrent theory to the Capital Asset Pricing Model (CAPM) is one
that incorporates multiple factors in explaining the movement of asset prices. The
arbitrage pricing model (APT) on the other hand approaches pricing from a different
aspect. It is rarely successful to analyze portfolio risks by assessing the weighted
sum of its components. Equity portfolios are far more diverse and enormously large
for separate component assessment, and the correlation existing between the elements
would make a calculation as such untrue. Rather, the portfolio’s risk should be
viewed as a single product’s innate risk. The APT represents portfolio risk by a factor
model that is linear, where returns are a sum of risk factor returns. Factors may range
from macroeconomic to fundamental market indices weighted by sensitivities to
changes in each factor. These sensitivities are called factor-specific beta coefficients
or more commonly, factor loadings. In addition, the firm-specific or idiosyncratic
return is added as a noise factor. This last part, as is the case with all econometric
models, is indispensable in explaining whatever the original factors failed to include.
In contrast with the CAPM, this is not an equilibrium model; it is not concerned with
the efficient portfolio of the investor. Rather, the APT model calculates asset pricing
using the different factors and assumes that in the case market pricing deviates from
the price suggested by the model, arbitrageurs will make use of the imbalance and
veer pricing back to equilibrium levels. At its simplest form, the arbitrage pricing
model can have one factor only, the market portfolio factor. This form will give
similar results to the Capital Asset Pricing Model (CAPM).
Stephen Ross, who initiated Arbitrage Pricing Theory (APT) in 1976, explained that
an asset’s price today should equal the sum of discounted future cash flows, where the
expected return of the asset is a linear function of the various factors. It is based on
the tenet that in a well-functioning security market no arbitrage opportunities
should exist.
The core idea of the APT is that only a small number of systematic influences affect
the long term average returns of securities. The first ingredient of Ross’s APT is a
factor model. Multi-factor models allow an asset to have not just one, but many
measures of systematic risk. Each measure captures the sensitivity of the asset to the
corresponding pervasive factor. If the factor model holds exactly and assets do not
have specific risk, then the law of one price implies that the expected return of any
asset is just a linear function of the other assets’ expected return. If this were not the
case, arbitrageurs would be able to create a long-short trading strategy that would
have no initial cost, but would give positive profits for sure.
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According to the above explanation, risky asset return will satisfy the following
equation:
E(rj) = rf + bj1RP1 + bj2RP2 + bj3RP3 + bj4RP4 + … + bjnRPn
Where E(rj) is the expected return of the asset, RPn the is risk premium of the
factor, if is the risk-free rate and bn is the sensitivity of the asset to factor n, also
known as factor loading.
Major assumptions of Arbitrage Pricing Theory (APT) are (1) returns can be
described by a factor model, (2) there are no arbitrage opportunities, (3) there are a
large number of securities so it is possible to form portfolios that diversify the firm-
specific risk of individual stocks and (4) the financial markets are friction-less.
Factors may be economic factors (such as interest rates, inflation, GDP) financial
factors (market indices, yield curves, exchange rates) fundamentals (like
price/earnings ratios, dividend yields), or statistical (e.g. principal component
analysis, factor analysis.) The factor model’s beta coefficients i.e. sensitivities may
be estimated using cross-sectional regression or time series techniques.
Relationship between Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing
Theory (APT)
The two models approach asset pricing from different aspects. The Arbitrage Pricing
Theory (APT) is less restrictive in its assumptions than the Capital Asset Pricing
Model (CAPM). It is a rather explanatory model as opposed to statistical. It assumes
investors will each hold a portfolio unique to their risk receptiveness with a unique
beta, as opposed to the identical market portfolio presumed by the CAPM.
Moreover, the Arbitrage Pricing Theory (APT) presumes an infinite number of

investments, which in turn lead to the disappearance of firm-specific risk. It can be
viewed as a supply-side model, as its beta coefficients reflect sensitivity of the
underlying asset to the different factors. In this sense, factor changes will cause
sizable shifts in the asset’s expected returns. On the other hand, the CAPM is a
demand-side model. Its results arise from the investors’ utility function maximization
problem, and from the resultant market equilibrium. As investors can be considered
to be consumers of the asset, the demand approach is reasonable.
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Security Analysis Phase in Investment Portfolio Management
There are different types of securities are available to an investor for investment. In
Indian stock exchanges shares of more than 7000 companies are listed. Traditionally,
the securities were classified into ownership such as equity shares, preference shares,
and debt as a debenture bonds etc. Recently companies to raise funds for their projects
are issuing a number of new securities with innovative feature. Convertible debenture,
discount bonds, Zero coupon bonds, Flexi bond, floating rate bond, etc. are some of
these new securities. From these huge group of securities the investors has to choose
those securities, which he considers worthwhile to be included in his investment
portfolio. So for this detailed security analysis is most important.
The aim of the security analysis in portfolio management is to find out intrinsic value
of a security. The basic value is also called as the real value of a security is the true
economic worth of a financial asset. The real value of the security indicates whether
the present market price is overpriced or underpriced in order to make a right
investment decision. The actual price of the security is considered to be a function of
a set of anticipated capitalization rate. Price changes, as anticipation risk and return
change, which in turn change as a result of latest information.
Security analysis in portfolio management refers to analyzing the securities from the
point of view of the scrip prices, return and risks. The analysis will help in
understanding the behavior of security prices in the market for investment decision
making. If it is an analysis of securities and referred to as a macro analysis of the
behavior of the market. Security analysis entails in arriving at investment decisions
after collection and analysis of the requisite relevant information. To find out basic
value of a security “the potential price of that security and the future stream of cash
flows are to be forecast and then discounted back to the present value.” The basic
value of the security is to be compared with the current market price and a decision
may be taken for buying or selling the security. If the basic value is lower than the
market price, then the security is in the overbought position, hence it is to be sold. On
the other hand, if the basic value is higher than the market price the security’s worth is
not fully recognized by the market and it is in under bought position, hence it is to be
purchased to gain profit in the future.
here are mainly three alternative approaches to security analysis, namely fundamental
analysis, technical analysis and efficient market theory.
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1. Fundamental Analysis
The fundamental analysis allows for selection of securities of different sectors of the
economy that appear to offer profitable opportunities. The security analysis will help
to establish what type of investment should be undertaken among various alternatives
i.e. real estate, bonds, debentures, equity shares, fixed deposit, gold, jewelry etc.
Neither all industries grow at same rate nor do all companies. The growth rates of a
company depend basically on its ability to satisfy human desires through production
of goods or performance is important to analyze nation economy. It is very important
to predict the course of national economy because economic activity substantially
affects corporate profits, investors’ attitudes, expectations and ultimately security
price.
According to this approach, the share price of a company is determined by these

fundamental factors. The fundamental works out the compares this intrinsic value of a
security based on its fundamental; them compares this intrinsic value, the share is said
to be overpriced and vice versa. The mispricing security provides an opportunity to
the investor to those securities, which are underpriced and sell those securities, which
are overpriced. It is believed that the market will correct notable cases of mispricing
in future. The prices of undervalued shares will increase and those of overvalued will
decline. Fundamental analysis helps to identify fundamentally strong companies
whose shares are worthy to be included in the investor’s portfolio.
2. Technical Analysis
The second alternative of security analysis is technical analysis. The technical
analysis is the study of market action for the purpose of forecasting future price
trends. The term market action includes the three principal sources of information
available to the technician – price, value, and interest. Technical Analysis can be
frequently used to supplement the fundamental analysis. It discards the fundamental
approach to intrinsic value. Changes in price movements represent shifts in supply
and demand position. Technical Analysis is useful in timing a buy or sells order. The
technical analysis does not claim 100% of success in predictions. It helps to improve
the knowledge of the probability of price behavior and provides for investment. The
current market price is compared with the future predicted price to determine the
extent of mispricing. Technical analysis is an approach, which concentrates on price
movements and ignores the fundamentals of the shares.
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3. Efficient Market Theory

A more recent approach to security analysis is the efficient market
hypothesis/theory. According to this school of thought, the financial market is
efficient in pricing securities. The efficient market hypothesis holds that market prices
instantaneously and fully reflect all relevant available information. It means that the
market prices of securities will always equal its intrinsic value. As a result,
fundamental analysis, which tries to identify undervalued or overvalued securities, is
said to be a useless exercise.
Efficient market hypothesis is direct repudiation of both fundamental analysis and

technical analysis. An investor can’t consistently earn abnormal return by undertaking
fundamental analysis or technical analysis. According to efficient market hypothesis it
is possible for an investor to earn normal return by randomly choosing securities of a
given risk level.
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Approaches of Investment Portfolio Management
Different investors follow different approaches when they deal with portfolio
investments. Four basic approaches of investment portfolio management are
illustrated below, but there could be numerous variations.
1. The Holy-Cow Approach: These investors typically buy but never sell. He
treats his scrips like holy cows, which are never to be sold for slaughter. If you
can consistently find and then confine yourself to buying only prized bulls, this
holy cow approaches may pay well in the long run.
2. The Pig-Farmer Approach: The pig-farmer on the other hand, knows that
pigs are meant for slaughter. Similarly, an investor adopting this approach buys
and sells shares as fast as pigs are growth and slaughtered. Pigs become pork and
equity become hard cash.
3. The Rice-Miller Approach: The rice miller buys paddy feverishly in the
market during the season, then mills, hoards and sells the rice slowly over an
extended period depending on price movements. His success lies in his shills in
buying and selling, and his financial capacity to hold stocks. Similarly, an
investor following this approach grabs the share at the right price, takes a
position, holds on to it, and liquidates slowly.
4. The Woolen-Trader Approach: The woolen-trader buys woolen ever a

period of time but sells them quickly during the season. His success also lies in
his skill in buying and selling, and his ability to hold stocks. An investor
following this strategy over a period of time but sells quickly, and quits.
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Different Types of Investment Portfolios
The set of all securities held by an investor is called his investment portfolio.
The investment portfolio may contain just one security. However, since in general no
one puts all one’s eggs in one basket, it will contain several securities. Such
an investment portfolio is knows as a diversified portfolio.
An investment portfolio can be classified in the light of following factors such as

objectives, risk levels and the level of diversification.
Investment Portfolios based on Objectives
On the basis of objectives sought, a portfolio can be income portfolio, growth

portfolio, mixed portfolio, tax savings portfolio or liquidity portfolio.
1. Income portfolio: the objective is maximum current income. Small

investors, investor’s whose current income needs are high like pensioners and
unemployed persons, persons with lower tax brackets prefer income
portfolios. Here the portfolio generally consists of fixed income securities like
debenture/bonds/income mutual fund/equity with continuous dividend-record.
2. Growth portfolio: stress on capital gain. Big investors, high earning

professionals and persons in the higher tax brackets prefer this portfolio.
Growth mutual funds, growth shares, etc. are included in the portfolio.
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3. Mixed portfolio: give moderate preference for both return and growth.
Salaried persons and middle income investors prefer this portfolio. Here the
portfolio consists of securities like debentures/bonds, convertible debentures,
growth as well as income mutual funds, growth shares and on.
4. Liquidity portfolio: emphasis on easy offloading. Frequently traded

securities (with many quotations on a single day in stock exchanged), gilt-
edged securities, buy-back securities etc. are included in the portfolio
Investment Portfolios based on Risk Level

On the basis of level of risk portfolio may be aggressive (high risk), moderate
(medium risk) or conservative/ defensive (low risk).
1. Investor interested in assuming high risk go for aggressive portfolio. They may select
securities which are having positive correlations between them. The may be rewarded
in proportion to the risk they take. Aggressive portfolio has beta coefficients greater
than + 1 Beta coefficient is a measure of risk. Market folio (consisting of security of
majority of companies) is said to have a beta of 1. So a beta coefficient of more than
+1 means higher risk than the market.
2. Moderate portfolio has risk more or less equal to that of the market portfolio. The beta
of such portfolios is in between +1 and 0.
3. Conservative portfolio has far lesser risk than the market. Their beta coefficients are
close to zero, say +.05. Conservative portfolio will have a high load of risk free
investments like bank deposits, govt. bonds etc. Aggressive portfolios scantly include
the above and contain mostly equity and convertible debenture.
Investment Portfolios based on Diversification Level

On the basis of level of diversification, portfolio can be classified into highly
diversified, moderately diversified and lowly diversified.
1. High diversification may be taken to mean that the portfolio has over 20 different
securities in the kit.
2. Moderate diversification includes 10-20 securities in the kit and low diversification
means that less than 10 securities in the kit and
3. Low diversification means that less than 10 securities are in the kit.
High diversification, if properly done, reduces the un-systematic risk to zero. In

moderate diversification means substantial un-systematic risk is present in the
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portfolio. As number of securities increases, un-systematic risk reduces and hence

total risk reduces. Beyond 20 securities, risk remains the same, as the systematic risk
cannot be reduced. When you have more than say 25 securities, your portfolio is
called ‘superfluous’ portfolio, indicating that it is diversified more than enough.
General obligations and responsibilities of portfolio managers
1. Code of Conduct: -
A portfolio manager has to, in the conduct of business; observe high standards of
integrity and fairness in all his dealing with his clients and other portfolio
managers. The money received by him from a client for an investment purpose
should be deployed as soon as possible and money due and payable to a client
should be paid forthwith.
A portfolio manager has to render at all times high standards of services, exercise
due diligence, ensure proper-care and exercise independent professional judgment.
He should either avoid any conflict of interest in his investment or disinvestment
decision, or where any conflict of interest arises; ensure fair treatment of all his
customers. He must disclose to the client, possible sources of conflict of duties
and interest, while providing unbiased services. A portfolio manager should not
place his interest above those of his clients.
He should not make any statement or become privy to any act, practice or unfair
competition, which i! Likely to be harmful to the interest of other portfolio
managers or is likely to place them in a advantageous position in relation to the
portfolio manager himself, while competing for or executing any assignment.
Any exaggerated statement, whether oral or written, should not be made ‘by him
to client other about the qualification or the capability to- render certain services
or his achievements in regards to services n rendered to the other clients.
At the time of entering into contract, he should have been in writing from the
clients his interest in various corporate bodies which enable him to obtain
unpublished price-sensitive information of the, body corporate.
A portfolio manager should not disclose to any clients or press any confidential
information about his clients, which has come in his knowledge.
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Where necessary and in the interest of the clients, he should take adequate’ steps
for the registration of the transfer of the clients’ securities and for claiming and
receiving dividends, interest payment and other right accruing to the client. He
must also make necessary action for the conversion of securities and subscription/
renunciation of/or rights in accordance with the clients’ instruction.
• A portfolio manager has to endeavor to: -
a) Ensure that the investors are provided with true and adequate information
without making any misguiding or exaggerated claims and are made aware of
attendant risks before any investment decision is taken by them;
b) Render the best possible advice to the client having regards to the client’s needs
and the environment and his own professional skills;
c) Ensure that all professional dealing is affected in prompt, efficient and cost
effective manager.
• A portfolio manager should not be party to: -
a) Creation of false market in securities;
b) Price rigging or manipulation of securities;
c) Passing of price sensitive information to brokers, members of the stock COI

exchanges and any other intermediaries in the capital market or take any other
action which in prejudicial to the interest of the investors. No portfolio manager or
any of its directors, partners or managers should either on their respective
accounts or through their associates or family members, relatives enter into any
transaction in securities of the companies on the basis of published price sensitive
information obtained by them during the course of any professional assignment.
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Contract with Clients: -

Every portfolio manager is required, before taking up an assignment of
management of portfolio on behalf of a client, is enter into an agreement with
such client clearly defining the inter se relationship, and setting out their mutual
rights, liabilities and obligation relating to the management of the portfolio of the
client. The contract should, inter alias, contain.
1. The investment objectives and the services to be provided
2. Areas of investment and restrictions, if any, imposed by the client with regards
to investment in a particular company or industry;
3. Attendant risks involved in the management of the portfolio;
4. Period of the contract and provision of early termination, if any;
5. Amount to be invested;
6. Procedure of setting the client’s accounts including the form of repayment on

maturity or early termination of contract;
7. Fee payable to the portfolio manager;
8. Custody of securities.
The funds of all clients must be placed by the portfolio manager in a separates
accounts to be maintained by him in a scheduled commercial bank. He can charge
an agreed fee from the client for rendering portfolio management services without
guaranteeing or assuring, either directly or indirectly, any return and such fee
should be independent of the returns to the clients and should not be on return
sharing basis.
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2. General Responsibilities; -
The discretionary portfolio manager should individually and independently

manage the funds of each client in accordance with the need of the client in a
manner, which does not partake the character of a mutual fund, whereas the non-
discretionary portfolio manager should manage the funds in accordance with the
direction of client. He should act in a fiduciary capacity with regard to the client
funds and transact in securities in within the limitation placed by the client himself
with regard to dealing to securities under the provisions of the reserve bank of
India act, 1934. He should not derive any direct or indirect benefit out of the client
funds or securities. he cannot pledge or give on loan securities held on behalf of
client to a third person, without obtaining a written permission from his client. He
should ensure proper timely handling of complaints from his client and take
appropriate action immediately.
3. Investment of clients’money: -
The portfolio manager should not accept money of securities from his client from
his client for a period of less than one year. Any renewal of portfolio funds the
maturity of the indicial period is deemed as a fresh placement for a minimum
period of one year. The portfolio funds can be withdrawn or taken back by the
portfolio client at his risk before the maturity date of the contract under the
following circumstances.
• Voluntary or compulsory termination of portfolio management service by the

portfolio manager.
• Suspension or termination of registration of portfolio manager by the SEBI.
• Bankruptcy or liquidation in case the portfolio manager is a body corporate.
• Permanent disability, lunacy or insolvency in case the portfolio manager is an

individual.
The portfolio manager can invest funds of his clients in money market instrument
or as specified in the contract, but not in bill discounting, bedlam financing or for
the purpose of lending or placement with corporate or non-corporate bodies.
While dealing with client’s funds, he should not indulge in speculative

transaction, that is, not enter into any transaction for the purchase or sale of any
securities in which transaction is periodically or ultimately settled otherwise than
by actual delivery or transfer of security. He may enter into transaction on behalf
66
of the client for the specific purpose of meeting margin requirements only if the
contract so provides and the client is made aware of, the attendant risk of such
transaction.
He should ordinarily purchase all sell securities separately for each client.
However, in the event of aggregation of purchase or sales for economy of scale,
inter se allocation should be done on a pro rata basis and at weighted average
price of the day’s transaction. The portfolio manager should not keep any position
open in respect of allocation of sales or purchase affected in a day.
Any transaction of purchase or sale including that between the portfolio managers
own account and client accounts or between two clients account should at the
prevailing market price. He should segregate each client’s fund and portfolio
securities and keep them separately from his own funds and securities and be
responsible for the safekeeping of clients fund and securities. He may hold the
belonging to the portfolio account in his own name on behalf of his client’s only
if, the contract so provides and in such an event his record and reports to the client
should clearly indicate that the securities are held by him on behalf of the portfolio
account.
67
4. Maintenance of book of accounts / records:
Every portfolio manager must keep am maintain the following book of accounts,
records and documents.
• A copy of balance sheet at the end of each accounting period.
• A copy of the profit and loss account for each accounting period.
• A copy of the auditor report on the account for each accounting period.
• A statement of financial position and
• Record in support of every investment transaction or recommendation which

indicate the data, fact and opinion leading to that investment decision.
After the end of each accounting period, copies of the balance sheet, profit and
loss account and such other documents for any other preceding five accounting
year when required must be submitted to the SEBI. Half yearly unedited financial
result, when required with a view to monitor the capital adequacy have to be
submitted to the SEBI the books of account and other record and document must
be preserved for a minimum period off five years.
68
5. Disclosure to SEBI:
A portfolio manager must disclose to SEBI a and when required the following
information.
• Particulars regarding the management of a portfolio.
• Any information or particulars previously furnished, which have a bearing on

the certificate granted to him.
• The name of the clients whose portfolio he has managed and
Particulars relating to the capital adequacy requirement.
Portfolio Management is used to select a portfolio of new product development

projects to achieve the following goals:
• Maximize the profitability or value of the portfolio
• Provide balance
• Support the strategy of the enterprise
Portfolio Management is the responsibility of the senior management team of an

organization or business unit. This team, which might be called the Product
Committee, meets regularly to manage the product pipeline and make decisions
about the product portfolio. Often, this is the same group that conducts the stage-
gate reviews in the organization.
A logical starting point is to create a product strategy – markets, customers,

products, strategy approach, competitive emphasis, etc. The second step is to
understand the budget or resources available to balance the portfolio against.
Third, each project must be assessed for profitability (rewards), investment
requirements (resources), risks, and other appropriate factors.
69
The weighting of the goals in making decisions about products varies from
company. But organizations must balance these goals: risk vs. profitability, new
products vs. improvements, strategy fit vs. reward, market vs. product line, long-
term vs. short-term. Several types of techniques have been used to support the
portfolio management process:
• Heuristic models
• Scoring techniques
• Visual or mapping techniques
The earliest Portfolio Management techniques optimized projects’ profitability or

financial returns using heuristic or mathematical models. However, this approach
paid little attention to balance or aligning the portfolio to the organization’s
strategy. Scoring techniques weight and score criteria to take into account
investment requirements, profitability, risk and strategic alignment. The
shortcoming with this approach can be an over emphasis on financial measures
and an inability to optimize the mix of projects. Mapping techniques use graphical
presentation to visualize a portfolio’s balance. These are typically presented in the
form of a two-dimensional graph that shows the trade-offs or balance between two
factors such as risks vs. profitability, marketplace fit vs. product line coverage,
financial return vs. probability of success, etc.
70
Chapter No.4 Data Analysis, Interpretation and Presentation

To know more about portfolio management, we did a survey to know about people's
knowledge
towards this topic.
Q1. OCCUPATION of the respondents.
Row labels Count of occupation
Other 4
Self employed 18
Service 20
Student 8
Grand total 50
TOTAL
Total
25
20
20
18
15
10
8
5
4
0
OTHERS SELF EMPLOYED SERVICE STUDENT
71
Q2. Professions of the respondents

Row labels Count of occupation
Student 8
Executive 25
Senior 12
Top 5
Grand total 50
TOTAL
Total
30
25
25
20
15
10 12
5 8
5
0
STUDENT EXCECUTIVE SENIOR TOP
In this question, a service person knows about portfolio management and students
who are currently studying it.
72
Q3. Age of the respondents
Row labels Age of the respondents
More then 35 9
31-35 15
26-31 14
Below 25 12
Grand Total 50
TOTAL
Total
16
14 15
14
12
12
10
8 9
0
MORE THEN 35 31-35 26-31 BELOW 25
In this context, between the age of 26-35. Group of people are more knowledgeable
about portfolio management.
73
Q4. Annual Income of the respondents
Row labels Annual Income of the respondents
1 lakh–3 lakh 20
3 lakh–5 lakh 10
Less than 1 8
More than 5 12
Grand Total 50
TOTAL
Total
25
20
20
15
10 12
10
8
5
0
1 LAKH–3 LAKH 3 LAKH–5 LAKH LESS THAN 1 MORE THAN 5
Interpretation: In this question, people who are earned more than 5 lakh rupees
know more about portfolio management as they are either self-employed or
businessmen/women.
74
Q5. Is there a need for portfolio management?
Row labels is there any need for portfolio management
No 10
Yes 40
Total 50
TOTAL
Total
45
40
40
35
30
25
20
15
10
10
5
0
YES NO
Interpretation: in this we get to know that 40% of respondents are aware of the need
for portfolio management
75
Q6. For achieving your portfolio goals, you invest the maximum in which mutual
funds
Row labels Which funds are more likely to be profitable
equity diversified 20
equity tax planning 14
industry specific 10
index based 6
Grand total 50
TOTAL
Total
25
20
20
15
14
10
10
5 6
0
EQUITY DIVERSIFIED EQUITY TAX INDUSTRY SPECIFIC INDEX BASED
PLANNING
Interpretation: in this we get to know which portfolios do the respondents prefer.

76
Q7. While undertaking portfolio selection which factor do you consider the most
Row labels While undertaking portfolio selection which factor do you
consider the most frequently
return on the portfolio with 30

the general index e.g.
Sensex/nifty
correlation among security 10
returns
return on the portfolio with 10

the world market indices
performance
Grand total 50
frequently
TOTAL
Total
35
30
30
25
20
15
10
10 10
5
0
RETURN ON THE PORTFOLIO CORRELATION AMONG RETURN ON THE PORTFOLIO
WITH THE GENERAL INDEX SECURITY RETURNS WITH THE WORLD MARKET
E.G. SENSEX/NIFTY INDICES PERFORMANCE
Interpretation: In this we get to understand where the respondents would consider the
factors most frequent.
77
Q8. Do you anticipate needing your invested monies in the next five years?
Row labels needing your invested monies in the next five years
No 10
Yes 40
Total 50
TOTAL
Total
45
40
40
35
30
25
20
15
10
10
5
0
YES NO
Interpretation: in this we get to know that 80% of the respondents want to get their monies
back in the next 5 years.
78
Q9. List any special preferences or requirements you feel are relevant in the
development and management of your portfolio. For example, are there any
companies or industry sectors that you do not want to invest in?
Row labels are there any companies or industry sectors that you do not want to
invest in?
Non listed companies 7
Hind Petrol 10
RACL geartech 8
Motilal and Oswal 20
HDFC Argo 5
Grand total 50
TOTAL
Total
25
20
20
15
10
10
5 7 8
5
0
NON LISTED HIND PETROL RACL MOTILAL AND HDFC ARGO
COMPANIES GEARTECH OSWAL
Interpretation: in this we get to know that the respondents prefer to invest in listed
companies with goodwill than non-listed companies.
79
FINDINGS:
• People who are doing jobs are more concerned towards stock markets, they
invest more than any other occupation.
In our data 40% people know about portfolio management
Self-employed people are 60% who investing in a stock market.

• Age of the respondents in our data, who are more active in investing in the
stock market.
Youth are more concerned for benefits and investment decisions.
People are mostly from (26-36) years.
Second is people form (31-36) years.
People who are investing in a share market are from big of earnings.
In our data, most of the people are form (1-3lakh).
It constitutes almost 40% data who are investing having a bracket of more
than 1-3 lakh rupees.
• People are investing for more than a period of (5) years, it means that people
gave a time spam to their investment to give them returns.
80
Chapter No.5 Conclusions and Suggestions
The objective of portfolio management services is to maximize returns in the

long run by investing in marketable securities such as equity, debt, cash, and
commodity etc. PMS help the client to reduce the risk through proper
diversification and provide customized solutions for achieving client’s goals.
Whenever we invest in something, there are two sides to the
investment, which are risk and return. Both are important, and if
anything, risk is even more important than return, although risk
doesn’t really get the attention it deserves, especially from individual
investors. There’s also the matter of efficiency, where even if a certain
strategy has produced good results over time, another strategy may be
more efficient and produce even better results. This is where looking to
manage returns well comes in, and our goal in portfolio management is
to at least seek out more efficiency, not just be satisfied with shooting for
positive returns that may turn out to be quite mediocre.
81
REFFRENCE
1.Bharti V. Pathak, “The Indian Financial System”, Pearson Education [India] Ltd.
2ndEdition, Year 2006.2.V. K. Bhalla, “Investment Management”, New-Delhi,

Sultanchand & SonsPublication, 10thEdition, Year 2004.
3.Prasanna Chandra, “Investment analysis & Portfolio Management”, New-Delhi,The

McGraw Hill Company Ltd. 6thedition, year 2006.
4.Gordon & Natarajan, “The Financial Markets & Services”, New-Delhi,

HimalyaPublishing House, year 2007.
5.Dr. G. Ramesh Babu, “The Financial services in India”, New-Delhi,

ConceptPublishing Company. Year 2005
6.B. S. Bhatia and G. S. Batra, “Management of Capital Markets, Financial

Servicesand Institutions”, New-Delhi, Deep & Deep Publication Pvt Ltd. Year 2001.
7.Dr. M. L. Varma, Foreign Trade Management In india, Vikas Publishing HousePvt.

Ltd. Year-1999.
8.Meir Kohn, Financial Institutions and Market, Tata MC Graw-Hill

Publication,Year-1999.
9.E. Philip Davis, Benn Steil, Institutional Investors, MIT Press, Year-2004.
10.Theodor Baums, Richard M. Buxbaum, Klaus J. Hopt, Walter de

GruyterInstitutionalinvestors and corporate governance, , 1994.
hthttps://www.edupristine.com/blog/all-about-portfolio-managementtp://professional-
edu.blogspot.com/2009/02/48-portfolio-management-efficient.html
https://www.investopedia.com/terms/p/portfoliomanagement.asp
https://www.managementstudyguide.com/portfolio-management.htm
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https://www.moneyworks4me.com/about-stock-market/portfolio-management

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