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Portfolio Management Meaning and Important Concepts

It is essential for individuals to invest wisely for the rainy days and to make their future secure.

What is a Portfolio ?

A portfolio refers to a collection of investment tools such as stocks, shares, mutual funds, bonds, cash and so on depending on the investor’s income, budget and convenient time frame.

Following are the two types of Portfolio:

  • 1. Market Portfolio

  • 2. Zero Investment Portfolio

What is Portfolio Management ?

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

Portfolio management refers to managing an individual’s investments in the form of bonds, shares, cash, mutual funds etc so that he earns the maximum profits within the stipulated time frame.

Portfolio management refers to managing money of an individual under the expert guidance of portfolio managers.

In a layman’s language, the art of managing an individual’s investment is called as portfolio management.

Need for Portfolio Management

Portfolio management presents the best investment plan to the individuals as per their income, budget, age and ability to undertake risks.

Portfolio management minimizes the risks involved in investing and also increases the chance of making profits.

Portfolio managers understand the client’s financial needs and suggest the best and unique investment policy for them with minimum risks involved.

Portfolio management enables the portfolio managers to provide customized investment solutions to clients as per their needs and requirements.

Types of Portfolio Management

Portfolio Management is further of the following types:

Active Portfolio Management: As the name suggests, in an active

portfolio management service, the portfolio managers are actively involved in buying and selling of securities to ensure maximum profits to individuals. Passive Portfolio Management: In a passive portfolio management, the portfolio manager deals with a fixed portfolio designed to match the current market scenario.

Discretionary Portfolio management services: In Discretionary portfolio management services, an individual authorizes a portfolio manager to take care of his financial needs on his behalf. The individual issues money to the portfolio manager who in turn takes care of all his investment needs, paper work, documentation, filing and so on. In discretionary portfolio management, the portfolio manager has full rights to take decisions on his client’s behalf.

Non-Discretionary

Portfolio

management

services:

In

non

discretionary portfolio management services, the portfolio manager can merely advise the client what is good and bad for him but the client

reserves full right to take his own decisions.

Who is 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.

A portfolio manager counsels the clients and advises him the best possible investment plan which would guarantee maximum returns to the individual.

A portfolio manager must understand the client’s financial goals and objectives and offer a tailor made investment solution to him. No two clients can have the same financial needs.

Financial Investment - Meaning, its Need and Different Types of Investments

It is human nature to plan for rainy days. An individual must plan and keep aside some amount of money for any unavoidable circumstance which might arise in days to come.

Future is uncertain and one must invest wisely to avoid financial crisis in any point of time.

Let us first understand what is investment ?

Investment is nothing but goods or commodities purchased today to be used in future or at the times of crisis. An individual must plan his future well to ensure happiness for himself as well as his immediate family members. Consuming everything today and saving nothing

for the future is foolish. Not everyday is a bed of roses, you never know what your future has in store for you.

What is Financial Investment ?

Financial investment refers to putting aside a fixed amount of money and expecting some kind of gain out of it within a stipulated time frame.

What is Important in Financial Investment ?

Planning plays a pivotal role in Financial Investment. Don’t just invest just for the sake of investing. Understand why you really need to invest money? Investing just because your friend has said you to do so is foolish. Careful analysis and focused approach are mandatory before investing.

Explore all the investment plans available in the market. Go through the pros and cons of each plan in detail. Analyze the risk factors carefully before finalizing the plan. Invest in something which will give you the maximum return.

Appoint a good financial planning manager who takes care of all your investment needs. He must understand your requirement, family income, stability etc to decide the best plan for you.

One needs to be a little careful and sensible while investing. An individual must read the documents carefully before investing.

Types of Financial Investment

An individual can invest in any of the following:

Mutual Funds

Fixed Deposits

Bonds

Stock

Equities

Real Estate (Residential/Commercial Property)

Gold /Silver

Precious stones

Need for Financial Investment

Financial Investment ensures all your dreams turn real and you enjoy life to the fullest without actually worrying about the future.

Financial investment ensures you save for rainy days. Careful investment makes your future secure.

Financial investment controls an individual’s spending pattern. It decides how and what amount one should spend so that he has sufficient money for future.

Tips for Financial investment

Don’t just blindly trust your financial advisor. Read the terms and conditions and go through all the related documents carefully before signing. Check out risk factors, tenure, clauses etc before selecting the plan.

Avoid cash transactions. It is always advisable to issue an account payee cheque in favour of the company rather than giving cash to your advisor. You never know when he disappears with all your hard earned money.

Carefully staple all the related documents and put it in a folder. Keep it at a proper and safe place. Loosing even a single paper might land you in trouble later on.

Make sure your investment plan is the best in the market and guarantees sufficient return in future.

If you plan to invest in property, ensure it is at a prime location and would have takers in the near future. Investing in non approved properties is worthless.

What is a Financial Market ?

A market is a place where two parties are involved in transaction of goods and services in exchange of money. The two parties involved are:

Buyer

Seller

In a market the buyer and seller comes on a common platform, where buyer purchases goods and services from the seller in exchange of money.

What is a Financial Market ?

A place where individuals are involved in any kind of financial transaction refers to financial market. Financial market is a platform where buyers and sellers are involved in sale and purchase of financial products like shares, mutual funds, bonds and so on.

Let us go through the various types of financial market:

Capital Market

A market where individuals invest for a longer duration i.e. more than a year is called as capital market. In a capital market various financial institutions raise money from individuals and invest it for a longer period.

Capital Market is further divided into:

  • i. Primary Market: Primary Market is a form of capital market where various companies issue new stock, shares and bonds to investors in the form of IPO’s (Initial Public Offering). Primary Market is a form of market where stocks and securities are issued for the first time by organizations. ii. Secondary Market: Secondary market is a form of capital market where stocks and securities which have been previously issued are bought and sold.

Types of Capital Market

  • 1. Stock Markets: Stock Market is a type of Capital market which deals with the issuance and trading of shares and stocks at a certain price.

  • 2. Bond Markets: Bond Market is a form of capital market where buyers and sellers are involved in the trading of bonds.

  • 3. Commodity Market: A market which facilitates the sale and purchase of raw goods is called a commodity market. Commodity market like any other market includes a buyer and a seller. In such a market buyer purchases raw products like rice, wheat, grain, cattle and so on from the seller at a mutually agreed rate.

  • 4. Market:

Money

As

the

name

suggests,

money market involves

individuals who deal with the lending and borrowing of money for a short time frame.

  • 5. The

Derivatives

Market:

market

which

deals

with

the

trading

of

contracts which are derived from any other asset is called as derivative market.

  • 6. Future Market: Future market is a type of financial market which deals with the trading of financial instruments at a specific rate where in the delivery takes place in future.

  • 7. Insurance Market: Insurance market deals with the trading of insurance products. Insurance companies pay a certain amount to the immediate family members of owner of the policy in case of his untimely death.

  • 8. Foreign Exchange Market: Foreign exchange market is a globally operating market dealing in the sale and purchase of foreign currencies.

  • 9. Private Market: Private market is a form of market where transaction of financial products takes place between two parties directly.

10.Mortgage Market: A type of market where various financial organizations are involved in providing loans to individuals on various residential and commercial properties for a specific duration is called a mortgage market. The payment is made to the individual concerned on submitting certain necessary documents and fulfilling certain basic criteria.

Shares and Stock Market - An Overview

An organization in order to raise money divides its entire capital into small units of equal value. Each unit is called a share.

A share is nothing but an indivisible unit of a company’s capital to be sold among individuals to increase profit of the organization.

Shareholder

An individual owning one or more than one share of an organization is called a shareholder. In simpler words, an individual purchasing one or more than one share from any private or public organization is called a shareholder.

A shareholder can sell his shares anytime depending on the current value

of the share. He/she can purchase any new share issued by any other or same organization.

A shareholder has the right to declared dividend.

Dividend

Why do people invest in shares ?

An organization pays the shareholders for investing in their company’s shares. The income earned by an individual by investing in an organization’s share (private or public) is called as dividend.

What is Retained Earnings ?

The profit earned by an organization is put into use in the following two ways:

It is paid to the shareholders as dividend.

The profit earned by the organization

is not distributed amongst the

shareholders but is retained and reinvested in the organization. This

portion of the income is called retained earnings.

What is a Share Certificate ?

When an individual purchases shares from any organization, he/she is issued a certificate as a proof of his investment. Such a certificate issued by an organization to the shareholders is called a share certificate.

Types of Shares

  • 1. Equity Shares

Equity shares also called as ordinary shares are the shares where the payment of dividend is directly proportional to the profits earned by the organization. Higher the profits earned, higher the dividend, lower the profits, and lower the dividend. In an equity share, dividends are paid at a fluctuating/floating rate.

Shares which enjoy preference over payment of dividends are called preference shares. Shareholders enjoy fixed rate of dividends in case of preference shares.

3.

Founder Shares

Shares held by the management or founders of the organization are called as founder shares.

4.

Bonus Shares

Bonus shares are often issued to the shareholders when the organization earns surplus profits. The company officials may decide to pay the extra profits to the shareholders either as cash (dividend) or issue a bonus share to them.

Bonus shares are often issued by organizations to the shareholders free of charge as a gift in proportion to their existing shares with the organization.

How to buy shares ?

Find a good broker for yourself. Make sure he has good knowledge about

the share market and can guide you properly. To invest in shares one needs to open a DEMAT Account for online trading. A DEMAT Account is mandatory for sale and purchase of shares anytime and anywhere.

An individual needs to have his PAN Card, a bank account, other necessary Identity proofs, address proofs and so on.

What is a Stock Market ?

A stock market is a platform for trading of company’s shares at an agreed rate.

Portfolio Management Models

Portfolio management refers to the art of managing various financial products and assets to help an individual earn maximum revenues with minimum risks involved in the long run. Portfolio management helps an individual to decide where and how to invest his hard earned money for guaranteed returns in the future.

Portfolio Management Models

1.

Capital Asset Pricing Model

Capital Asset Pricing Model also abbreviated as CAPM was proposed by Jack Treynor, William Sharpe, John Lintner and Jan Mossin.

When an asset needs to be added to an already well diversified portfolio, Capital Asset Pricing Model is used to calculate the asset’s rate of profit or rate of return (ROI).

In Capital Asset Pricing Model, the asset responds only to:

Market risks or non diversifiable risks often represented by beta

Expected return of the market

Expected rate of return of an asset with no risks involved

What are Non Diversifiable Risks ?

Risks which are similar to the entire range of assets and liabilities are called non diversifiable risks.

Where is Capital Asset Pricing Model Used ?

Capital Asset Pricing Model is used to determine the price of an individual security through security market line (SML) and how it is related to systematic risks.

What is Security Market Line ?

Security Market Line is nothing but the graphical representation of capital asset pricing model to determine the rate of return of an asset sensitive to non diversifiable risk (Beta).

In Capital Asset Pricing Model, the asset responds only to:  Market risks or non diversifiable
  • 2. Arbitrage Pricing Theory Stephen Ross proposed the Arbitrage Pricing Theory in 1976. Arbitrage Pricing Theory highlights the relationship between an asset and several similar market risk factors. According to Arbitrage Pricing Theory, the value of an asset is dependent on macro and company specific factors.

  • 3. Modern Portfolio Theory Modern Portfolio Theory was introduced by Harry Markowitz. According to Modern Portfolio Theory, while designing a portfolio, the ratio of each asset must be chosen and combined carefully in a portfolio for maximum returns and minimum risks. In Modern Portfolio Theory emphasis is not laid on a single asset in a portfolio, but how each asset changes in relation to the other asset in the portfolio with reference to fluctuations in the price.

Modern Portfolio theory proposes that a portfolio manager must carefully choose various assets while designing a portfolio for maximum guaranteed returns in the future.

  • 4. Value at Risk Model Value at Risk Model was proposed to calculate the risk involved in financial market. Financial markets are characterized by risks and uncertainty over the returns earned in future on various investment products. Market conditions can fluctuate anytime giving rise to major crisis. The potential risk involved and the potential loss in value of a portfolio over a certain period of time is defined as value at risk model. Value at Risk model is used by financial experts to estimate the risk involved in any financial portfolio over a given period of time.

  • 5. Jensen’s Performance Index Jensen’s Performance Index was proposed by Michael Jensen in 1968. Jensen’s Performance Index is used to calculate the abnormal return of any financial asset (bonds, shares, securities) as compared to its expected return in any portfolio. Also called Jensen’s alpha, investors prefer portfolio with abnormal returns or positive alpha. Jensen’s alpha = Portfolio Return – [Risk Free Rate + Portfolio Beta * (Market Return – Risk Free Rate)

Modern Portfolio theory proposes that a portfolio manager must carefully choose various assets while designing a
  • 6. Treynor Index Treynor Index model named after Jack.L Treynor is used to calculate the excess return earned which could otherwise have been earned in a portfolio with minimum or no risk factors involved. Where T-Treynor ratio

Modern Portfolio theory proposes that a portfolio manager must carefully choose various assets while designing a

Roles and Responsibilities of a Portfolio Manager

A portfolio manager is one who helps an individual invest in the best available investment

plans for guaranteed returns in the future.

Let us go through some roles and responsibilities of a Portfolio manager:

A portfolio manager plays a pivotal role in deciding the best investment plan for an individual as per his income, age as well as ability to undertake risks. Investment is essential for every earning individual. One must keep aside some amount of his/her income for tough times. Unavoidable circumstances might arise anytime and one needs to have sufficient funds to overcome the same.

A portfolio manager is responsible for making an individual aware of the various

investment tools available in the market and benefits associated with each plan. Make an individual realize why he actually needs to invest and which plan would be the best for him.

A portfolio manager is responsible for designing customized investment solutions for the clients. No two individuals can have the same financial needs. It is essential for the portfolio manager to first analyze the background of his client. Know an individual’s earnings and his capacity to invest. Sit with your client and understand his financial needs and requirement.

A portfolio manager must keep himself abreast with the latest changes in the

financial market. Suggest the best plan for your client with minimum risks involved and maximum returns. Make him understand the investment plans and the risks involved with each plan in a jargon free language. A portfolio manager must be transparent with individuals. Read out the terms and conditions and never hide anything from any of your clients. Be honest to your client for a long term relationship.

A portfolio manager ought to be unbiased and a thorough professional. Don’t always look for your commissions or money. It is your responsibility to guide your client and help him choose the best investment plan. A portfolio manager must design tailor made investment solutions for individuals which guarantee maximum returns and benefits within a stipulated time frame. It is the portfolio manager’s duty to suggest the individual where to invest and where not to invest? Keep a check on the market fluctuations and guide the individual accordingly.

A portfolio manager needs to be a good decision maker. He should be prompt enough to finalize the best financial plan for an individual and invest on his behalf.

Communicate with your client on a regular basis. A portfolio manager plays a major role in setting financial goal of an individual. Be accessible to your clients. Never ignore them. Remember you have the responsibility of putting their hard earned money into something which would benefit them in the long run.

Be patient with your clients. You might need to meet them twice or even thrice to explain them all the investment plans, benefits, maturity period, terms and conditions, risks involved and so on. Don’t ever get hyper with them.

Never sign any important document on your client’s behalf. Never pressurize your client for any plan. It is his money and he has all the rights to select the best plan for himself.

Selecting the right Portfolio Manager

What is Investment ?

It is essential for every individual to keep aside some amount of his income for a secure future. The art of assigning some amount of money into something, which would benefit the individual concerned in the near future, is called as investment.

Why Investment ?

Investment helps an individual to save money for the times when he would

no longer be able to earn. Investment makes an individual’s future secure and stable.

Where to Invest ?

An individual can invest in any of the following:

Gold/Silver Mutual

Funds

Shares Bonds Property (Residential as well as commercial)

and

Stocks

How to Invest ?

An individual should not invest just for the sake of investing. One should understand as to why he needs to invest? Don’t just invest in any plan available in the market. Decide the best plan for yourself as per your income, age and financial requirements. One must go through the terms and conditions before investing in any market plan.

Who decides where to invest ?

How would one come to know where to invest and where not to invest ?

How would an individual decide which organization’s share would yield him the best results in the near future and which should be sold off immediately ?

Here comes the role of a Portfolio Manager.

Who is a Portfolio Manager ?

An individual who understands the client’s financial needs and designs tailor made investment solutions with minimum risks involved and maximum profits is called a portfolio manager.

A portfolio manager invests money on behalf of the client in various investment tools such as mutual funds, bonds, shares and so on to ensure maximum profitability.

It is the responsibility of the portfolio manager to choose the best plan for his client as per his financial requirements, income and ability to undertake risks.

How to choose the right portfolio manager ?

Portfolio managers charge a good amount of money form their clients for their services. One must be careful while selecting the right portfolio manager.

Make sure the portfolio manager you choose has complete market

knowledge and knows about the existing investment plans and the various risks involved. Taking the assistance of someone who himself is not clear about the market policies does not make sense. A portfolio manager should be trustworthy. You will find all types of portfolio managers in the market - cheat, dishonest, unprofessional. An individual must hire the best portfolio manager who understands the market well and can guide him correctly. Don’t give money to someone who does not have a good background. You never know he might run away with all your hard earned money. Ask for his business card. Check his reputation in the market.

An individual must not blindly trust his portfolio manager. Make it a point to read the related documents carefully before investing. A/C payee cheques must be issued and one should never sign any blank document.

A good portfolio manager should be transparent with his client. One should not try to confuse his client by using complicated terminologies and professional jargons. The various plans must be explained to the client in the easiest possible way.

Select a portfolio manager who does not have any personal interests in your investing in any particular plan. He should be able to help you decide the best plan available in the market.

What are Bonds ?

Why Investment is Important ?

Every individual needs to put some part of his income into something which would benefit him in the long run. Investment is essential as unavoidable circumstances can arise anytime and anywhere. One needs to invest money into something which would guarantee maximum returns with minimum risks in future. Money saved now will help you overcome tough times in the best possible way.

What are Bonds ?

Bonds are issued by organizations generally for a period of more than one year to raise money by borrowing.

Organizations in order to raise capital issue bond to investors which is nothing but a financial contract, where the organization promises to pay the principal amount and interest (in the form of coupons) to the holder of the bond after a certain date. (Also called maturity date).Some Bonds do not pay interest to the investors, however it is mandatory for the issuers to pay the principal amount to the investors.

What is a Maturity Date ?

Maturity date refers to the final date for the payment of any financial product when the principal along with the interest needs to be paid to the investor by the issuer.

Characteristics of a Bond

A bond is generally a form of debt which the investors pay to the issuers

for a defined time frame. In a layman’s language, bond holders offer credit to the company issuing the bond. Bonds generally have a fixed maturity date.

All bonds repay the principal amount after the maturity date; however

some

bonds do

pay

the

interest along with the

principal to

the bond

holders.

Types of Bonds

Following are the types of bonds:

  • 1. Fixed Rate Bonds In Fixed Rate Bonds, the interest remains fixed through out the tenure of the bond. Owing to a constant interest rate, fixed rate bonds are resistant to changes and fluctuations in the market.

  • 2. Floating Rate Bonds

Floating rate bonds have a fluctuating interest rate (coupons) as per the current market reference rate.

  • 3. Zero Interest Rate Bonds Zero Interest Rate Bonds do not pay any regular interest to the investors. In such types of bonds, issuers only pay the principal amount to the bond holders.

  • 4. Inflation Linked Bonds Bonds linked to inflation are called inflation linked bonds. The interest rate of Inflation linked bonds is generally lower than fixed rate bonds.

  • 5. Perpetual Bonds Bonds with no maturity dates are called perpetual bonds. Holders of perpetual bonds enjoy interest throughout.

  • 6. Subordinated Bonds Bonds which are given less priority as compared to other bonds of the company in cases of a close down are called subordinated bonds. In cases of liquidation, subordinated bonds are given less importance as compared to senior bonds which are paid first.

  • 7. Bearer Bonds

Bearer Bonds do not carry the name of the bond holder and anyone who possesses the bond certificate can claim the amount. If the bond certificate gets stolen or misplaced by the bond holder, anyone else with the paper can claim the bond amount.

  • 8. War Bonds War Bonds are issued by any government to raise funds in cases of war.

  • 9. Serial Bonds Bonds maturing over a period of time in installments are called serial bonds.

10.Climate Bonds

Climate Bonds are issued by any government to raise funds when the country concerned faces any adverse changes in climatic conditions.

Security

Analysis

Management

and

Portfolio

What is a Security ?

Assets with some financial value are called securities.

Characteristics of Securities

Securities are tradable and represent a financial value.

Securities are fungible.

Classification of Securities

Debt Securities: Tradable assets which have clearly defined terms and

conditions are called debt securities. Financial instruments sold and purchased between parties with clearly mentioned interest rate, principal amount, maturity date as well as rate of returns are called debt securities. Equity Securities: Financial instruments signifying the ownership of an individual in an organization are called equity securities. An individual buying equities has an ownership in the company’s profits and assets.

Derivatives: Derivatives are financial instruments with specific conditions under which payments need to be made between two parties.

What is Security Analysis ?

The analysis of various tradable financial instruments is called security analysis. Security analysis helps a financial expert or a security analyst to determine the value of assets in a portfolio.

Why Security Analysis ?

Security analysis is a method which helps to calculate the value of various assets and also find out the effect of various market fluctuations on the value of tradable financial instruments (also called securities).

Classification of Security Analysis

Security Analysis is broadly classified into three categories:

  • 1. Fundamental Analysis

  • 2. Technical Analysis

  • 3. Quantitative Analysis

What is Fundamental Analysis ?

Fundamental Analysis refers to the evaluation of securities with the help of certain fundamental business factors such as financial statements, current interest rates as well as competitor’s products and financial market.

What are Financial Statements ?

Financial statements are nothing but proofs or written records of various financial transactions of an investor or company.

Financial statements are used by financial experts to study and analyze the profits, liabilities, assets of an organization or an individual.

What is Technical Analysis ?

Technical analysis refers to the analysis of securities and helps the finance professionals to forecast the price trends through past price trends and market data.

What is Quantitative Analysis ?

Quantitative analysis refers to the analysis of securities using quantitative data.

Difference between Fundamental Analysis and Quantitative Analysis

Fundamental analysis is done with the help of financial statements, competitor’s market, market data and other relevant facts and figures whereas technical analysis is more to do with the price trends of securities.

What is Portfolio Management ?

The stream which deals with managing various securities and creating an investment objective for individuals is called portfolio management. Portfoilo management refers to the art of selecting the best investment plans for an individual concerned which guarantees maximum returns with minimum risks involved.

Portfolio management is generally done with the help of portfolio managers who after understanding the client’s requirements and his ability to undertake risks design a portfolio with a mix of financial instruments with maximum returns for a secure future.

Portfolio Theory

Portfolio theory was proposed by Harry M. Markowitz of University of Chicago. According to Markowitz’s portfolio theory, portfolio managers should carefully select and combine financial products on behalf of their clients for guaranteed maximum returns with minimum risks.

Portfolio theory helps portfolio managers to calculate the amount of return as well as risk for any investment portfolio.