Introduction to Portfolio Management

Introduction

Security analysis is a pre-requisite for making investments. In the present day financial
markets, investment has become complicated. One makes investments for a return
higher than what he can get by keeping the money in a commercial or cooperative bank
or even in an investment bank. Financial  markets  have  the  basic  function  of 
mobilizing  the investments needed by corporate entities. 

Investment - Meaning

Investment may be defined as an activity that commits funds in any financial/physical

form in the present with an expectation of receiving additional  return  in  the  future. 
The expectation brings  with  it  a probability that the quantum of return may vary from a
minimum to a maximum. This possibility of variation in the actual return is known as
investment risk. Thus every investment involves a return and risk. Investment  is  an 
activity  that  is  undertaken  by  those  who  have savings.

Elements of Investment

(a) Return:

Investors buy or sell financial instruments in order to earn return on them. The return on
investment is the reward to the investors. 

(b) Risk:

Risk is the chance of loss due to variability of returns on an investment. In case of every
investment, there is chance of loss. 

(c) Time:

Time is an important factor in investment. It offers several different courses of action.

Time period depends on the attitude of the investors who follows a ‘buy and hold’
policy. 

(d) Safety:

The safety of investment is identified with the certainty of return of capital without loss
of money or time. Safety is another feature that an investor desires from investments. 

(e) Liquidity:
An investment that is easily saleable or marketable without loss  of  money and  without 
loss  of  time  is  said  to  possess  the characteristic  of  liquidity.  An investor  tends  to 
prefer  maximization  of  expected  return, minimization of risk, safety of funds, and
liquidity of investments.

Objectives of Investment

1. Maximizing return. (Yield of the investors)

2. Minimizing risk. (Risk can be minimized but cannot be eliminated)

3. Maintaining liquidity. (Marketability)

4. Hedging against inflation. (Rate of return should be higher than rate of inflation)
5. Increasing safety. (Different types of risks affect the returns of the investment)
6. Saving tax.

Portfolio - Meaning

Portfolio means combined holding of many kinds of financial security that is shares,
debentures, government bonds, units and other financial assets. The term investment
portfolio refers to the various assets of an investor which are to be considered as a unit. 

Portfolio Management - Meaning

Portfolio management means selection of securities and constant shifting of the

portfolios in the light of varying attractiveness of the constituents of the portfolio. It is a
choice of selecting and revising spectrum of securities to it in which the characteristics of
an investor. Markowitz analyzed the implications of the fact that the investors, although
seeking high expected returns, generally wish to avoid risk. 

The art of selecting the right investment policy for the individuals or companies in terms
of minimum risk and maximum return is called as portfolio management.

Harry Markowitz - Father of Modern Portfolio Theory: Modern portfolio theory

(MPT) is a theory on how risk-averse investors can construct portfolios to optimize or
maximize expected return based on a given level of market risk.

Objectives of Portfolio Management

The basic objective of portfolio management is to maximize yield and minimize risk. The
other

objectives are as follows:

 (a) Stability of income

(b)  Capital growth

(c) Liquidity

(d) Safety

(e) Tax incentives

Significance of Investment

The financial system enables lenders and borrowers to exchange funds. India has a
financial system that is controlled by independent regulators in the  sectors of insurance,
banking, capital markets and various services sectors.

Thus, a financial system can be said to play a significant role in the economic  growth of
a country by mobilizing the surplus funds and utilizing them effectively for productive
purposes.

1.      It plays a vital role in economic development of a country.

2.      It encourages both savings and investment.

3.      It links savers and investors.

4.      It helps in capital formation.

5.      It helps in allocation of risk.

6.      It facilitates expansion of financial market.

7.      It facilitates the expansion of financial institutions and markets

8.      It is also concerned with the Provision of funds

Difference between Investment, Speculation & Gambling

Basis Investment Speculation Gambling

Time horizon Longer period(1 year to Short period (few days Very short term
few years) to months) (within a day)
Risk Moderate risk Willing to take high Very high risk
risk
     
 
Return Moderate return Likes to have a high Very high return
 return

 
Decision Considers fundamental Considers inside --
factors & evaluates the information & market
performance of the behavior.
investment.
 
 
Funds Uses own Funds Mostly uses funds Uses own as well as
borrowed from others. borrowed funds.

   

Process of Portfolio investment - Step by Step

Portfolio management means selection of securities and constant shifting of the

portfolios in the light of varying attractiveness of the constituents of the portfolio. It is a
choice of selecting and revising spectrum of securities to it in which the characteristics of
an investor. Markowitz analyzed the implications of the fact that the investors, although
seeking high expected returns, generally wish to avoid risk. A professional, who manages
other people’s or institution’s investment portfolio with the object of profitability, growth
and risk minimization is known as portfolio manager. He is expected to manage the
investors assets prudently and choose particular investment avenues appropriate for
particular times aiming at maximization of profit. Portfolio management includes
portfolio planning, selection and construction, review and evaluation of securities. The
skill in portfolio management lies in achieving a sound balance between the objectives
of safety, liquidity and profitability.

The following are the essential steps involved in the process of Portfolio Management

Step 1: Specification of objectives.

Step 2: Specification of Portfolio.

Step 3: Choice of asset mix.

Step 4: Formation of portfolio strategy.

Step 5: Portfolio analysis (EIC Analysis)

Step 6: Selection of securities or portfolio securities.

Step 7: Portfolio Execution.

Step 8: Portfolio Revision.

Step 9: Portfolio Evaluation.