PORTFOLIO MANAGEMENT
FRAMEWORK
Phases Of Portfolio Management
SPECIFICATION OF INVESTMENT
OBJECTIVES AND CONSTRAINTS
CHOICE OF ASSET MIX
FORMULATION OF PORTFOLIO
STRATEGY
SELECTION OF SECURITIES
PORTFOLIO EXECUTION
PORTFOLIO REVISION
PORTFOLIO EVALUAYION
Specification Of Investment Objectives
• The commonly stated investment goals are :
income, growth, and stability
• Since income and growth represent two ways by
which return is generated and stability implies
containment of risk, investment objectives may
be expressed more succinctly in terms of return
and risk.
A Risk Tolerance Questionnaire
To assess your risk tolerance, seven questions are given below.
Each question is followed by three possible answers. Circle the
letter that corresponds to your answer.
1. Just six weeks after you invested in a stock, its price declines by
20 percent. If the fundamentals of the stock have not changed,
what would you do?
a. Sell
b. Do nothing
c. Buy more
2. Consider the previous question another way. Your stock dropped
20 percent, but it is part of a portfolio designed to meet
investment goals with three different time horizons.
(i) What would you do if your goal were five years away?
a. Sell
b. Do nothing
c. Buy more
(ii) What would you do if the goal were 15 years away?
a. Sell
b. Do nothing
c. Buy more
(iii) What would you do if the goal were 30 years away?
a. Sell
b. Do nothing
c. Buy more
3. You have bought a stock as part of your retirement portfolio. It
price rises by 25 percent after one month. If the fundamentals of
the stock have not changed, what would you do?
a. Sell
b. Do nothing
c. Buy more
4. You are investing for retirement which is 15 years away. What
would you do?
a. Invest in money market mutual fund or a guaranteed
investment contract
b. Invest in a balanced mutual fund that has a stock :
bond mix of 50 : 50
c. Invest in an aggressive growth mutual fund
5. As a prize winner, you have been given some choice. Which one
would you choose?
a. Rs 50,000 in cash
b. A 50 percent chance to get Rs 125,000
c. A 20 percent chance to get Rs 375,000
6. A good investment opportunity has come your way. To
participate in it you have to borrow money. Would you take a
loan?
a. No
b. Perhaps
c. Yes
7. Your company, which is planning to go public after three years, is
offering stock to its employees. Until it goes public, you
can’t sell your shares. Your investment, however, has the
potential of multiplying 10 times when the company goes
public. How much money would you invest?
a. Nothing
b. Three months’ salary
c. Six months’ salary
Your risk tolerance score is:
Number of (a) answers x 1
+ Number of (b) answers x 2
+ Number of (c) answers x 3
If your score is … You may be a …
9–14 points Conservative investor
15–21 points Moderate investor
22–27 points Aggressive investor
Adapted from a risk tolerance questionnaire developed by Dow
Jones & Company Inc.
Constraints
• LIQUIDITY
• TAXES
• TIME HORIZON
• UNIQUE PREFERENCES &
• CIRCUMSTANCES
Selection Of Asset Mix
•Should the long-term stock-bond mix be 50 : 50 or
75 : 25 or 25 : 75 or any other ?
• Referred to as the strategic asset-mix decision (or
policy asset-mix decision), this is by far the most
important ecision by the investor. Empirical studies
have shown that nearly 90 percent of the variance
of the portfolio return is explained by its asset mix.
Selection Of Asset Mis
CONVENTIONAL WISDOM
1. GREATER RISK TOLERANCE STOCKS
2. LONGER INVESTMENT HORIZON STOCKS
RISK-RETURN RELATIONSHIP FOR VARIOUS TYPES
OF BONDS AND STOCKS
SPECULATIVE
RETURN SHARES
BLUE CHIP
SHARES
NCDs OF PRIVATE
PUBLIC SECTOR
SECTOR
BONDS GROWTH
SHARES
DEFENSIVE
SHARES
BANK INCOME/GROWTH
DEPOSITS ORIENTED UNITS
RISK
Range Of Return On Common Stocks
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
1-year 5-year 10-year 15-year 20-year 25-year
periods periods periods periods periods periods
High +52.6% +23.9% +19.3% +16.4% +13.4% +10.3%
Average +13.0% +10.4% + 9.5% + 9.3% + 9.4% + 9.4%
Low -26.5% - 2.4% + 1.2% + 4.3% + 6.5% + 8.4%
Appropriate Percentage Allocation
RISK TOLERANCE
TIME HORIZON
LOW MODERATE HIGH
SHORT 0 25 50
MEDIUM 25 50 75
LONG 50 75 100
Portfolio Strategy
• ACTIVE
• PASSIVE
HIGHLY ACTIVE HIGHLY PASSIVE
MARKET TIMING | …………………………………………… |
SECTOR ROTATION | …………………………………………… |
SECURITY SELECTION | …………………………………………… |
USE OF A SPECIALISED | …………………………………………… |
CONCEPT
Use Of A Specialised Concept
CHARLES .D. ELLIS … A POSSIBLE WAY TO ENHANCE
RETURNS
• GROWTH STOCKS
• NEGLECTED OR ‘OUT OF FAVOUR’ STOCKS
• ASSET-RICH STOCKS
• TECHNOLOGY STOCKS
• CYCLICAL STOCKS
PROS CONS
FOCUS OBSOLETE
MASTERY INERTIA
Selection Of Securities
SELECTION OF BONDS
• YTM
• DEFAULT RISK
• TAX SHIELD
• LIQUIDITY
• DURATION
SELECTION OF STOCKS
• TECHNICAL ANALYSIS
• FUNDAMENTAL ANALYSIS
• RANDOM ANALYSIS
Portfolio Revision
• NEED
• PORTFOLIO REBALANCING
• BUY AND HOLD POLICY
• CONSTANT MIX POLICY
• PORFOLIO INSRANCE POLICY
• PORTFOLIO UPGRADING
Performance Measure
Rp - Rf
TREYNOR MEASURE :
p
Rp - Rf
SHARPE MEASURE :
p
JENSEN MEASURE : Rp - [Rf + p (RM - Rf)]
Annual Returns For Three Mutual Funds And A Market
Index
PERIOD FUND A FUND B FUND C RETURN ON RISK-FREE
MARKET RETURN
1 - 38.7 -16 -33 -26 7.9
2 39.6 39.4 30 36.9 5.8
3 11.1 34.3 18.2 23.6 5.0
4 12.7 -6.9 -7.3 -7.2 5.3
5 20.9 3.2 4.9 6.4 7.2
6 35.5 28.9 30.9 18.2 10
7 57.6 24.1 34.7 31.5 11.5
8 -7.8 0.0 6.0 -4.8 14.1
9 22.8 23.4 33.0 20.4 10.7
Mean: Rp 17.1 14.5 13.0 11 8.6
Standard
Deviation: σp 28.1 19.7 22.8 20.5 _
Beta: βp 1.20 0.92 1.04 1.00 _
Performance Evaluation Of The Three Funds
Rp - Rf
TREYNOR MEASURE :
p
17.1 - 8.6
FUND A : = 7.1
1.20
14.5 - 8.6
FUND B : = 4.9
0.92
13.0 - 8.6
FUND C : = 4.8
1.04
11.0 - 8.6
MARKET INDEX : = 2.4
1.0
Rp - Rf
SHARPE MEASURE :
p
17.1 - 8.6
FUND A : = 0.302
28.1
14.5 - 8.6
FUND B : = 0.299
19.7
13.0 - 8.6
FUND C : = 0.193
22.8
11.0 - 8.6
MARKET INDEX : = 0.117
20.5
JENSEN MEASURE : Rp - [Rf + p (RM - Rf )]
FUND A : 17.1 - [8.6 + 1.20 (2.4)] = 5.62
FUND B : 14.5 - [8.6 + 0.92 (2.4)] = 3.69
FUND C : 13.0 - [8.6 + 1.04 (2.4)] = 1.90
MARKET INDEX : O (BY DEFINITION)
SUMMING UP
• Portfolio management is a complex process or activity that may
be divided into seven broad phases.
• Investment objectives are expressed in terms of return and risk.
• The strategic asset-mix decision (or policy asset-mix decision) is
the most important decision made by the investor.
• Investors with greater tolerance for risk and longer investment
horizon should tilt the asset mix in favour of stocks
• The four principal vectors of an active portfolio strategy are :
market timing, sector rotation, security selection, and the use of
a specialised concept.
• A passive portfolio strategy calls for creating a well-diversified
portfolio at a pre-determined level of risk and holding it
relatively unchanged over time.
• The factors commonly considered in selecting bonds are : yield
to maturity, risk of default, tax shield, liquidity, and duration.
• Three broad approaches are employed for stock selection :
technical analysis, fundamental analysis, and random selection.
• Motives of trading are cognitive and emotional.
• Portfolio revision involves portfolio rebalancing and portfolio
upgrading
• The key dimensions of performance evaluation are rate of
return and risk.
• Treynor measure, Sharpe measure, and Jensen measure are
three popularly employed performance measures.
