Investment Meaning, Nature and Scope:

Investment
In finance, the purchase of a financial product or other item of value with an expectation of
favorable future returns. In general terms, investment means the use money in the hope of
making more money

Objective of SAPM

To improve decision-making skills in management of investment

through better understanding of modern theories on portfolio management and functioning of

capital market.

To get better return on portfolio with lesser risk

Nature and Scope of Investment Decision

To understand various investment decision rules.

To know what are the good investments decisions rules.

To know the category of investment decision rules.

You can take investment decision only after analyzing entire process of investment that starts
with funds contribution and ends with getting expectations fulfilled.

The investment decision rules allow you to formalize the process and specify what condition
or conditions need to be met to accept the project.

You will take decision only after ensuring that the required expectations in terms of returns are
ensured at any cost.

Decision Process
Understand characteristics of good investment decision rules.

Decide basis of calculation of return based on required condition.

Use constrain to eliminate investment alternatives.

Follow decision rules to accept or reject investment opportunity.

Characteristics of Good Investment Decision Rules
It should maintain a fair balance between allowing manager to analyze the project and bring-in
subjective assessment into the decision and ensuring that different projects are judged
consistently.

It must maximize the value of the firm and minimize risk.

It should work across a variety of investments.

Category of Investment Decision Rules

Accounting Income-based decision rule

Return on Capital

Return on Equity

Cash flow-based decision rule

Cash Return on capital

Cash Return on Equity

SECURITY ANALYSIS & PORTFOLIO MANAGEMENT

SECURITY

:- Investments in capital markets is in various financial instruments, which are all claims on
money. These instruments may be of various categories with different characteristics. These are
called ‘Securities’ in market place.

Securities Contracts Regulation Act, 1956 has defined the security as inclusive of shares,
scrips, stocks, bonds, debenture stock or any other markatable instruments of a like nature in or
of any debentures of a company or body corporate, the government and semi-government body
etc. It includes all rights & interests in them including warrants and loyalty coupons etc., issued
by any of the bodies, organisations or the government. The derivatives of securities and Security
Index are also included as securities.

SECURITY ANALYSIS
 :- Security Analysis involves the projection of future dividend or earnings flows, forecast of the
share price in the future and estimating the intrinsic value of a security based on forecast of
earnings or dividends. Modern Security Analysis relies on the fundamental analysis of the
security, leading to it’s intrinsic worth and also risk-return analysis depending on the variability
of the returns, covariance, safety of funds and the projections of the future returns.

•PORTFOLIO

:- A combination of securities with different risk-return profile will constitute the portfolio of
the investor. Thus portfolio is a combination of assets and/or instruments of investments. The
combination may have different features of risk & return, separate from those of components.

PORTFOLIO MANAGEMENT

:- Security Analysis is only a tool for efficient portfolio management. Traditional Portfolio
theory aims at the selection of such securities that would fit in well with the asset preferences,
needs and choices of the investor. Modern Portfolio theory postulates that maximisation of
return and/or minimisation of risk will yield optimal returns and the choice and attitudes of
investors are only a starting point for investment decision and that vigrous risk return analysis is
necessary for optimisation of returns.

INVESTMENT SCENARIO

Investment activity involves the use of funds or savings for acquisition of assets & further
creation of assets.

INVESTMENT VS. SPECULATION

An investment is a commitment of funds made in the expectation of some positive rate of
return commensurate with the risk profile of the investment. The true investor is interested in a
good rate of return, earned on a consistent basis for relatively long period of time.

The speculator seeks opportunities promising very large returns, earned quickly. Speculator is
less interested in consistent performance than is the investor & is more interested in the
abnormal, extremely high rate of return than the normal moderate rate. Furthermore, the
speculator wants to get these returns in a short span of time & switchover to other opportunities.

Speculator adds to the market’s liquidity as he is frequently turning over his portfolio. Thus,
the presence of speculator provides a market for securities, the much required depth & breadth
for expansion of capital markets.
INVESTMENT CATEGORIES

Investments generally involve – A) Real Assets (Physical Assets)

:- They are tangible, material things such as buildings, automobiles, plant and machinery etc.
B) Financial Assets

:- These are pieces of paper representing an indirect claim to real assets held by someone
else.One of the distinguishing features of Real Assets & Financial Assets is the degree of
liquidity. Liquidity refers to the ease of converting an asset into money quickly, conveniently and
at little exchange cost. Real Assets are less liquid than financial assets, largely because real
assets are more heterogeneous, often peculiarly adapted to a specific use, and yield benefits only
in co-operation with other productive factors. In addition to it the returns of real assets are
frequently more difficult to measure accurately, owing to absence of broad, ready, and active
markets.

FINANCIAL ASSETS

Financial Assets can be categorised according to their source of issuance (public or private)
and the nature of the buyer’s commitment (creditor or owner). Accordingly different financial
assets are –

DEBT INSTRUMENTS

These are issued by government, corporations and individuals & represent money loaned
rather than ownership to the investor. They call for fixed periodic payments, called interest and
eventual repayment of the amount borrowed, called the principal. The interest payment stated as
a percentage of the face value or maturity value is referred to as the nominal or coupon rate.

Institutional Deposits & Contracts

:- Demand & Time deposits, Certificate of Deposits, Life Insurance policies, Contributions to
Pension Funds. Title can’t be transferred to a third party.

Government Debt Securities

:- These are the safest and most liquid securities. The short-term securities have maturities of one
year or less and include Treasury Bills with maturities of 91 days to one year.
Long term securities include Treasury Notes (one to ten year maturity) and Treasury Bonds
(maturities of ten to thirty years), which bear interest.

Private Issues

:- Private debt issues are offered by corporations engaged in mining, manufacturing,

merchandising and service activities. The most common short-term privately issued debt
securities are Commercial Paper. CP is unsecured promissory note from 30 to 270 days maturity.
These securities are issued to suppliment bank credit and are sold by companies of prime credit
standing. Banker’s acceptances are issued in international trade. They are of high quality having
maturities from ninety days to one year. The long-term debt contracts cosist of two basic
promises- i) To pay regular interest ii) To redeem the principal at maturity.The long-term
debts are in the form of bonds, Debentures, Convertible bonds, Mortgage Bonds, Collateral Trust
Bonds.International Bonds-International domestic bonds are sold by an issuer within the country
of issue in that country’s currency- e.g. Sony Corp selling yen-denominated bonds in Tokyo

Foreign bonds are issued in the currency of the country where they are sold but sold by a
borrower of different nationality. E.g. A dollar denominated bond sold in Newyork by Sony
Corp is called Yankee bond. Yen denominate bond sold by IBM in Tokyo is called Samurai
bond.

Company Deposits – Large corporate time deposits in commercial banks are often of certain
minimum amounts for a specified time period. Unlike time deposits of individuals, these CDs are
negotiable; i.e. They can be sold to & redeemed by third parties.

EQUITY INSTRUMENTS

These instruments are divided into two categories – one representing indirect equity investment
through institutions and the other representing direct equity investment through the capital
markets.Investment Through Institutions

:- These investments involve a commitment of funds to an institution of some sort that in return
manages the investment for the investor. Direct Equity Investments

:- Equity investments are either in common stock or preferred stock. The holders of common
stock are the owners of the firm, have the voting power, can elect the BOD and carry right to the
earnings of the firm after all expenses & obligations have been paid and also carry a risk of
losing earnings in case of losses.

Common stock holders receive a return based on two sources- Dividends & Capital Gains.
Preferred stock is called a ‘hybrid security’ because it has features of both common stock &
bonds.
 In the event of liquidation, preferred stockholders get their stated dividends before common
stockholders. International Equities

:- Foreign Stocks offer diversification possibilities because correlation with domestic stocks is
much lower in case of foreign stocks than any other domestic stock. These could be acquired
directly at foreign stock exchanges by purchase of depository receipts ( ADRs, GDRs ).
International equities face the same currency risks as in foreign bonds.

OPTIONS & FUTURES

These instruments of investment derive their value from an underlying security (stock, bond or
basket of securities). Thus they are so called as derivatives. An option agreement is a contract in
which the writer of the option grants the buyer of the option the right to purchase from or sell

to the writer a designated instrument at a specified price (or receive a cash settlement) within a
specified period of time. Call options are options to buy & put options are options to sell.

Financial futures represent a firm legal commitment between a buyer and seller, where they
agree to exchange something at a specified price at the end of a designated period of time. The
buyer agrees to take delivery and the seller agrees to make delivery. Futures are available either
on stocks (stock futures) or basket of stocks (index futures). Futures on fixed-income securities
(e.g. Treasury Bonds) are called interest-rate futures.

REAL ESTATE

Investments in real estate can be direct one as a owner or indirect as a creditor. Debt
participation is also offered by direct acquisition of mortgages or the indirect purchase of
mortgage backed securities. Real estate pools that are similar to mutual funds are called Real
Estate Investment Trusts (REITs). They are available for diversified debt & equity ownership in
pools of property of various types.

RISK & RETURN

Risk in holding securities is generally associated with the possibility that realised returns will be
less than that were expected. Some risks are external to the firm & can’t be controlled, thus
affect large number of securities (Systematic Risk). Other influences are internal to the firm &
are controllable to a large degree (Unsystematic Risk).
Systematic Risk refers to that portion of total variability in return caused by factors affecting
the prices of all securities. Economic, Political and sociological changes are the sources of
systematic risk.

Unsystematic Risk is the portion of total risk that is unique to a firm or industry. E.g. Factors
such as management capability, consumer preferences, labour strikes etc.SYSTEMATIC RISK

Market Risk

:- This risk is caused due to changes in the attitudes of investors toward equities in general, or
toward certain types or groups of securities in particular. Market risk is caused by investor
reaction to tangible as well as intangible events. The tangible events include political, social and
economic environment.

Intangible events are related to market psychology. Market risk is usually touched off by a
reaction to real events leading to emotional instability of investors.

Interest-Rate Risk :-

It refers to the uncertainty of future market values and of the size of future income, caused by
fluctuations in the general level of interest rates. The root cause of interest rate risk is fluctuating
yield on government securities.

Purchasing-Power Risk

:- Purchasing power risk refers to the impact of inflation or deflation on an investment. Rising
prices of goods & services are associated with inflation & that falling with deflation

UNSYSTEMATIC RISK

Unsystematic risk is that portion of total risk that is unique or peculiar to a firm or industry.
Factors such as management capability, consumer preferences and labour strikes can cause
unsystematic variability of returns for a company’s stock.

Business Risk

:- This risk is a function of the operating conditions faced by a firm and the variability these
conditions inject into the operating income and expected dividends. Business risk can be divided
into two broad categories- external & internal.

Internal Business Risk

:- This risk is largely associated with the efficiency with which a firm conducts it’s operations
within the broader operating environment imposed upon it.

External Business Risk

:- It is the result of operating conditions imposed upon the firm by circumstances beyond it’s
control. Govt. policies with regard to monetary & fiscal matters can affect revenues thro’ the
effect on the cost & availability of funds.Financial Risk

:- This risk is associated with the way in which a company finances it’s activities. The
substantial debt funds, preference shares in the capital structure of the firm creates high fixed-
cost commitments for it. This causes the amount of residual earnings available for common-stock
dividends more stressed.

RETURN

Investors want to maximise expected returns subject to their tolerance for risk. It is the
motivating force and the principal reward in the investment process.

Realised Return

:- It is the return which is actually earned.

Expected Return

:- It is the return from an asset that investors anticipate they will earn over some future
period.Return in a typical investment consists of two components. The basic component is the
periodic cash receipt on the investment, either in the form of interest or dividends. The second
component is the change in the price of the asset – commonly called capital gains or loss. This
element of return is the difference between the purchase price and the price at which the asset
can be sold.Total Return = Income + Price Change = Cash payments received + Price
change over the period

Purchase price of assetTotal return can be either positive or

negative.

BETA

Beta is a measure of non-diversifiable risk. It shows how the price of a security responds to
market forces. In effect, the more responsive the price of a security is to changes in the market,
the higher will be it’s beta.
It is calculated by relating the returns on a security with the returns for the market. Market
return is measured by the average return of a large sample of stocks, such as stock index. The
beta for overall market is equal to 1.00 and other betas are viewed in relation to this value.

Measure of beta is helpful in assessing systematic risk and understanding the impact market
movements can have on the return expected from a share of stock. Decreases in the market
returns are translated into decreasing security returns. Stocks having beta more than one will be
more responsive & that less than one will be less responsive to the market movements.

Measure of Beta = % Price change of a scrip return

% Price change of the Market Index Return

INTRODUCTION

PORTFOLIO MANAGEMENT SERVICES

As per definition of SEBI Portfolio means “a collection of securities owned by an

investor”. It represents the total holdings of securities belonging to any person". It
comprises of different types of assets and securities. Portfolio management refers to
the management or administration of a portfolio of securities to protect and enhance
the value of the underlying investment. It is the management of various securities
(shares, bonds etc) and other assets (e.g. real estate), to meet specified investment
goals for the benefit of the investors. It helps to reduce risk without sacrificing returns.
It involves a proper investment decision with regards to what to buy and sell. It
involves proper money management. It is also known as Investment Management.
Portfolio Management Services, called, as PMS are the advisory services provided by
corporate financial intermediaries. It enables investors to promote and protect their
investments that help them to generate higher returns. It devotes sufficient time in
reshuffling the investments on hand in line with the changing dynamics. It provides the
skill and expertise to steer through these complex, volatile and dynamic times. It is a
choice of selecting and revising spectrum of securities to it with the characteristics of an
investor. It prevents holding of stocks of depreciating-value. It acts as a financial
intermediary and is subject to regulatory control of SEBI.

ROLE OF PORTFOLIO MANAGEMENT

In the beginning of the nineties India embarked on a programme of economic

liberalization and globalization. This reform process has made the Indian capital
markets active. The Indian stock markets are steadily moving towards capital
efficiency, with rapid computerization, increasing market transparency, better
infrastructure, better customer service, closer integration and higher volumes. Large
institutional investors with their diversified portfolios dominate the markets. A large
number of mutual funds have been set up in the country since 1987. With this
development, investment securities have gained considerable momentum.
Along with the spread of securities investment among ordinary investors, the
acceptance of quantitative techniques by the investment community changed the
investment scenario in India. Professional portfolio management, backed by competent
research, began to be practiced by mutual funds, investment consultants and big
brokers. The Securities and Exchange Board of India, the stock market regulatory body
in India, is supervising the whole process with a view to making portfolio management
a responsible professional service to be rendered by experts in the field. With the
advent of computers the whole process of portfolio management has become quite
easy. The computer can absorb large volumes of data, perform the computations
accurately and quickly give out the results in a desired form.
The trend towards liberalization and globalization of the economy has promoted free
flow capital across international borders. Portfolios now include not only domestic
securities but also foreign securities. Diversification has become international.
Another significant development in the field of portfolio management is the introduction
of derivatives securities such as options and futures. The trading in derivative
securities, their valuation, etc. has broadened the scope of portfolio management.
Portfolio management is a dynamic concept, having systematic approach that helps it
to achieve efficiency in investment.

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:

Ø Monitoring the performance of portfolio by incorporating the latest market conditions.

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

ELEMENTS OF PORTFOLIO MANAGEMENT

Portfolio management is an on-going process involving the following basic tasks:

ü Identification of the investor’s objectives, constraints and preferences, which will help
formulate the investment policy.
ü Strategies are to be developed and implemented in tune with the investment policy
formulated. This will help the selection of asset classes and securities in each class
depending upon their risk-return attributes.
ü Review and monitoring of the performance of the portfolio by continuous overview of
the market conditions, companies performance and investor’s circumstances.
ü Finally, the evaluation of the portfolio for the results to compare with the targets and
needed adjustments have to be made in the portfolio to the emerging conditions and to
make up for any shortfalls in achievement vis-à-vis targets.

The collection of data on the investor’s preferences, objectives, etc., is the foundation
of portfolio management. This gives an idea of channels of investment in terms of asset
classes to be selected and securities to be chosen based upon the liquidity
requirements, time horizon, taxes, asset preferences of investors, etc. these are the
building blocks for the construction of a portfolio.
According to these objectives and constraints, the investment policy can be formulated.
The policy will lay down the weights to be given to different asset classes of investment
such as equity share, preference shares, debentures, company deposits, etc., and the
proportion of funds to be invested in each class and selection of assets and securities in
each class are made on this basis. The next stage is to formulate the investment
strategy for a time horizon for income and capital appreciation and for a level of risk
tolerance. The investment strategies developed by the portfolio managers have to be
correlated with their expectation of the capital market and the individual sectors of
industry. Then a particular combination of assets is chosen on the basis of investment
strategy and managers expectations of the market.

OBJECTIVES OF PORTFOLIO MANAGEMENT

The objective of portfolio management is to maximize the return and minimize the risk.
These objectives are categorized into:
1. Basic Objectives.
2. Subsidiary Objectives.

1. Basic Objectives
The basic objectives of a portfolio management are further divided into two kinds viz.,
(a) maximize yield (b) minimize risk. The aim of the portfolio management is to
enhance the return for the level of risk to the portfolio owner. A desired return for a
given risk level is being started. The level of risk of a portfolio depends upon many
factors. The investor, who invests the savings in the financial asset, requires a regular
return and capital appreciation.

2. Subsidiary Objectives
The subsidiary objectives of a portfolio management are expecting a reasonable
income, appreciation of capital at the time of disposal, safety of the investment and
liquidity etc. The objective of investor is to get a reasonable return on his investment
without any risk. Any investor desires regularity of income at a consistent rate.
However, it may not always be possible to get such income. Every investor has to
dispose his holding after a stipulated period of time for a capital appreciation. Capital
appreciation of a financial asset is highly influenced by a strong brand image, market
leadership, guaranteed sales, financial strength, large pool of reverses, retained
earnings and accumulated profits of the company. The idea of growth stocks is the right
issue in the right industry, bought at the right time. A portfolio management desires the
safety of the investment. The portfolio objective is to take the precautionary measures
about the safety of the principal even by diversification process. The safety of the
investment calls for careful review of economic and industry trends. Liquidity of the
investment is most important, which may not be neglected by any investor/portfolio
manager. An investment is to be liquid, it must have “termination and marketable”
facility at any time.

PORTFOLIO MANAGER

Ø Portfolio Manager is a professional who manages the portfolio of an investor with the
objective of profitability, growth and risk minimization.
Ø According to SEBI, Any person who pursuant to a contract or arrangement with a
client, advises or directs or undertakes on behalf of the client the management or
administration of a portfolio of securities or the funds of the client, as the case may be
is a portfolio manager.
Ø He is expected to manage the investor’s assets prudently and choose particular
investment avenues appropriate for particular times aiming at maximization of profit.
He tracks and monitors all your investments, cash flow and assets, through live price
updates.
Ø The manager has to balance the parameters which defines a good investment i.e.
security, liquidity and return. The goal is to obtain the highest return for the client of
the managed portfolio.
Ø There are two types of portfolio manager known as Discretionary Portfolio Manager
and Non Discretionary Portfolio Manager. Discretionary portfolio manager is the one
who individually and independently manages the funds of each client in accordance with
the needs of the client and non-discretionary portfolio manager is the one who
manages the funds in accordance with the directions of the client.

GENERAL RESPONSIBILITIES OF A PORTFOLIO MANAGER

Following are some of the responsibilities of a Portfolio Manager:

Ø The portfolio manager shall act in a fiduciary capacity with regard to the client's
funds.
Ø The portfolio manager shall transact the securities within the limitations placed by the
client.
Ø The portfolio manager shall not derive any direct or indirect benefit out of the client's
funds or securities.
Ø The portfolio manager shall not borrow funds or securities on behalf of the client.
Ø The portfolio manager shall ensure proper and timely handling of complaints from his
clients and take appropriate action immediately
Ø The portfolio manager shall not lend securities held on behalf of clients to a third
person except as provided under these regulations.
CODE OF CONDUCT OF A PORTFOLIO MANAGER

Every portfolio manager in India as per the regulation 13 of SEBI shall follow the
following Code of Conduct:
1. A portfolio manager shall maintain a high standard of integrity fairness.
2. The client’s funds should be deployed as soon as he receives.
3. A portfolio manager shall render all times high standards and unbiased service.
4. A portfolio manager shall not make any statement that is likely to be harmful to the
integration of other portfolio manager.
5. A portfolio manager shall not make any exaggerated statement.
6. A portfolio manager shall not disclose to any client or press any confidential
information about his client, which has come to his knowledge.
7. A portfolio manager shall always provide true and adequate information.
8. A portfolio manager should render the best pose advice to the client.

SEBI GUIDELINES TO PORTFOLIO MANAGEMENT

SEBI has issued detailed guidelines for portfolio management services. The guidelines
have been made to protect the interest of investors. The salient features of these
guidelines are:

Ø The nature of portfolio management service shall be investment consultant.

Ø The portfolio manager shall not guarantee any return to his client.
Ø Client’s funds will be kept in a separate bank account.
Ø The portfolio manager shall act as trustee of client’s funds.
Ø The portfolio manager can invest in money or capital market.
Ø Purchase and sale of securities will be at a prevailing market price.

POWERS OF SEBI

The Securities and Exchange Board of India has the following powers to control and
manage the portfolio managers:

1. The portfolio manager shall submit to SEBI such reports, returns and documents as
may be prescribed.
2. SEBI may investigate the affairs of a portfolio manager such as inspection of books
of accounts, records, etc.,
3. SEBI has full authority in the event of violation of any provision to suspend or cancel
the license.
4. No exemptions will be given under any circumstances to portfolio manager.
OBJECTIVES OF INVESTORS

Following are the objectives of the investors:

1. Safety of their investment.
2. Maximum regulation return.
3. Liquidity.
4. Minimization of risk.
An investor may decide on the basis of a detailed study of marketing information that
the shares he has sold earlier are worth buying again. The current prices may be higher
than the price at which he has relinquished them. It is better to buy shares in a rising
market than to hold on to shares in a falling market. The growth potential of a company
may improve due to the rising trend in sales or profits, modernization and expansion
changes in government policies and other such factors.

INVESTORS ALERT

Do’s:
ü Only intermediaries having specific SEBI registration for rendering Portfolio
management services can offer portfolio management services.
ü Investors should make sure that they are dealing with SEBI authorized portfolio
manager.
ü Investors must obtain a disclosure document from the portfolio manager broadly
covering manner and quantum of fee payable by the clients, portfolio risks,
performance of the portfolio manager etc.
ü Investors must check whether the portfolio manager has a necessary infrastructure to
effectively service their requirements.
ü Investors must enter into an agreement with the portfolio manager.
ü Investors should make sure that they receive a periodical report on their portfolio as
per the agreed terms.
ü Investors must make sure that portfolio manager has got the respective portfolio
account by an independent charted accountant every year and that the certificate given
by the charted accountant is given to an investor by the portfolio manager.
ü In case of complaints, the investors must approach the authorities for redressal in a
timely manner.

Don’ts:
ü Investors should not deal with unregistered portfolio managers.
ü They should not hesitate to approach the authorities for redressal of the grievances.
ü They should not invest unless they have understood the details of the scheme
including risks involved.
ü They should not invest without verifying the background and performance of the
portfolio manager.
ü The promise of guaranteed returns should not influence the investors.

TYPES OF RISK IN PORTFOLIO MANGEMENT

Each and every investor has to face risk while investing. What is Risk? Risk is the
uncertainty of income/capital appreciation or loss of both. Risk is classified into:
Systematic risk or Market related risk and Unsystematic risk or Company related risk.

· Systematic risk refers to that portion of variation in return caused by factors that
affect the price of all securities. It cannot be avoided. It relates to economic trends with
effect to the whole market. This is further divided into the following:

ü Market risks: A variation in price sparked off due to real, social political and
economical events is referred as market risks.

ü Interest rate risks: Uncertainties of future market values and the size of future
incomes, caused by fluctuations in the general level of interest is referred to as interest
rate risk. Here price of securities tend to move inversely with the change in rate of
interest.

ü Inflation risks: Uncertainties in purchasing power is said to be inflation risk.

· Unsystematic risk refers to that portion of risk that is caused due to factors
related to a firm or industry. This is further divided into:

ü Business risk: Business risk arises due to changes in operating conditions caused by
conditions that thrust upon the firm which are beyond its control such as business
cycles, government controls, etc.

ü Internal risk: Internal risk is associated with the efficiency with which a firm
conducts its operations within the broader environment imposed upon it.

ü Financial risk: Financial risk is associated with the capital structure of a firm. A firm
with no debt financing has no financial risk. The extends depends upon the leverage of
the firms capital structure.

DIFFERENCE BETWEEN PORTFOLIO MANAGEMENT SERVICES

(PMS) AND MUTUAL FUNDS

While the concept of Portfolio Management Services and Mutual Funds remains the
same of collecting money from investors, pooling them and investing the funds in
various securities. There are some differences between them described as follows:
ü In the case of portfolio management, the target investors are high net-worth
investors, while in the case of mutual funds the target investors include the retail
investors.
ü In case of portfolio management, the investments of each investor are managed
separately, while in the case of MFs the funds collected under a scheme are pooled and
the returns are distributed in the same proportion, in which the investors/ unit holders
make the investments.
ü The investments in portfolio management are managed taking the risk profile of
individuals into account. In mutual fund, the risk is pooled depending on the objective
of a scheme.
In case of portfolio management, the investors are offered the advantage of
personalized service to try to meet each individual client’s investment objectives
separately while in case of mutual funds investors are not offered any such advantage
of personalized services.

ROLE OF MERCHANT BANKERS IN RESPECT TO PORTFOLIO

MANAGEMENT

Merchant Banking is the institution, which covers a wide range of activities such as
customer services, portfolio management, credit syndication, insurance, etc. Merchant
bankers are the persons who are engaged in business of issue management by making
arrangements regarding selling, buying or subscribing securities as a manager,
consultant, and advisor or by rendering corporate advisory services.
Let us have a look on the role played by Merchant bankers in relation to Portfolio
Management:
Portfolio refers to investment in different kinds of securities such as shares, debentures,
etc. it is not merely a collection of un-related assets but a carefully blended asset
combination within a unified framework. Portfolio management refers to maintaining
proper combination of securities in a manner that they give maximum return with
minimum risk.
Merchant Bankers provide portfolio management services to their clients. Today the
investor is very prudent and he is interested in safety, liquidity, and profitability of his
investment, but he cannot study and choose the appropriate securities, he requires
expert guidance. Merchant bankers have a role to play in this regard. They have to
conduct regular market and economic surveys to know the following needs:
ü Monetary and fiscal policies of the government.
ü Financial statements of various corporate sectors in which the investments have to be
made by the investors.
ü Secondary market position i.e., how the share market is moving.
ü Changing pattern of the industry.
ü The competition faced by the industry with similar type of industries.
The Merchant bankers have to analyze the surveys and help the prospective investors
in choosing the shares. The portfolio managers will generally have to classify the
investors based on capacity and risk they can take and arrange appropriate investment.
Thus portfolio management plans successful investment strategies for investors.
Merchant bankers also help NRI-Non Resident Indians in selecting right type of
securities and offering expertise guidance in fulfilling government regulations. By this
service to NRI account holders, Merchant bankers can mobilize more resources for the
corporate sector.

PORTFOLIO MANAGEMENT BY CORPORATES

Investors, whose objective is maximization of their wealth, own Corporates. Corporate

ownership pattern in India shows that the bulk owners are the financial institutions and
mutual funds, LIC, GIC, and other corporates, leaving aside, the FFIs, FIIs and NRIs.
The ownership of individual shareholders does not exceed an average to 20-30%. The
interest of financial and non-financial institutions and corporates do not coincide with
that of individual shareholders who are the true savers of the household sectors while
the former categories are only intermediaries.
Corporate Managers secure funds from banks, and financial institutions, next only to
promoters and hence their interest stands prominent in the minds of the portfolio
managers in the corporate business. In case of listed corporate securities, there is no
direct dialogue between Corporate Managers and the individual investors, except
through the daily price quotation of the scrip on the exchanges. The share price reflects
the investor’s perception of that company, relative to others in the field.
The companies generally keep continuous contact and dialogue with financing bankers
and financial institutions and not with other categories of investors, in matter of
operations. The role of individual investors and remaining categories of investors can
have their say only in the Annual general body meetings or other extra ordinary general
body meetings, called by the corporate management.
The Government and SEBI regulations, the Company law and the Listing Agreement
with the Stock Exchange also guide the performance of corporates and their operations.
The prudential norms for raising resources, allocation of funds and declaration of
dividends, etc., are governed by the Law and Government notifications from time-to-
time.

PORTFOLIO INVESTMENT BY FOREIGN INSTITUTIONAL INVESTORS

A country with a developing economy cannot depend exclusively on its own domestic
savings to propel its economy's rapid growth. The domestic savings of India presently
are 25% of its GDP. But this can provide only a 2 to 3% growth of its economy on
annual basis. The country has to maintain an 8 to 10% growth for a period of two
decades to reach the level of advanced nations and to wipe out widespread poverty of
its people. The gap is to be covered by inflow of foreign investment along with
advanced technology. As per the Development Goals and Strategy of the 10th Plan,
which is currently under implementation:
"The strategy to achieve a high annual growth target of 8.00% combines accelerated
capital accumulation to raise the average investment rate from 24.23% to 28.41% with
an increase in capital-use efficiency to reduce the ratio of incremental capital to output
from 4.00 to about 3.55. Private sector development, infrastructure development, and
increased foreign investment and trade are key to increasing efficiency"
The regular inflow of external capital investment is indispensable to sustain our
economic growth at the planned level and this is well recognized by the plan document
itself. When remittances are made by Foreign Institutional Investors for portfolio
investments, such remittances are on trading account, as securities can be bought, as
well as sold back through approved stock exchanges. This may be trading transaction,
but net amount at any time (purchases minus sales) is a significant figure and this adds
to the foreign exchange reserves of the country.
MANAGEMENT OF INVESTMENT PORTFOLIOS

Investment Management or Portfolio Management deals with the manner in which

investors analyze, select and evaluate investments in terms of their risks and expected
returns. It is both an art and a science.
The art aspect derives from the notion that some investors, by whatever means, have
the ability to consistently pick up investments that outperform other investments on a
risk/expected-return basis. Although many techniques have been developed to assist
investors in the selection of investments, the concept of market efficiency maintains
that for most investors, the ability to consistently select high-return/low risk
investments may be difficult to do. An efficient market is one where prices reflect a
given body of information. In such a situation, one investment should not persistently
dominate another in terms of risk and expected return. In other words, markets are
said to be efficient if there is a free flow of information and market absorbs this
information quickly. James Lorie has defined the efficient security market as, “the
ability of the capital market to function, so that the prices of securities react rapidly to
new information. Such efficiency will produce prices that are appropriate in terms of
current knowledge, and investors will be less likely to make unwise investments.”
This brings to the science aspect of portfolio/investment management. If markets are
reasonably efficient in a risk/expected-return sense, investor’s objective should be to
choose their preferred levels of risk and expected return and to diversify as easily as
possible to meet their investment goal. As a consequence, portfolio management has
become very analytical. Various techniques are today available which enable investors
to identify the diversified portfolio that has the highest expected return at their
preferred level of risk.

PORTFOLIO MANAGEMENT FRAMEWORK

Investment management, also referred to as portfolio management, is a complex and a
dynamic process or activity that may be divided into various phases as described as
follows:

PORTFOLIO MANAGEMENT PROCESS

INTER RELATIONSHIP AMONG VARIOUS PHASES OF PORTFOLIO MANAGEMENT

1. SPECIFICATION OF INVESTMENT OBJECTIVES AND

CONSTRAINTS:
The first step in the portfolio management process is to specify the investment policy
that consists of investment objectives, constraints and preferences of investor. The
investment policy can be explained as follows:

· OBJECTIVES
ü Return requirements: Return is the primary motive that drives investment. It is the
reward for undertaking the investment. The commonly stated investment goals are
income, growth and stability. Since income and growth represent two ways through
which income is generated and stability implies containment or elimination of risk. But
investment objectives may be more clearly expressed in terms of returns and risk.
However, return and risk go hand in hand. An investor would primarily be interested in
a higher return (in the form of income or capital appreciation) and lower level of risk.
So he has to bear higher level of risk in order to earn high return. How much risk he
would be willing to bear to earn a high return depends on his risk disposition. The
investment objective should state the investor the preference of return in relation to
risk.

Specification of investment objectives can be done in following two ways:

Ø Maximize the expected rate of return, subject to the risk exposure being held within a
certain limit (the risk tolerance level).
Ø Minimize the risk exposure, with out sacrificing a certain expected rate of return (the
target rate of return).
An investor should start by defining how much risk he can bear or how much he can
afford to lose, rather than specifying how much money he wants to make. The risk he
wants to bear depends on two factors:
a) Financial situation
b) Temperament

To assess financial situation one must take into consideration: position of the wealth,
major expenses, earning capacity, etc and a careful and realistic appraisal of the
assets, expenses and earnings forms a base to define the risk tolerance.
After appraisal of the financial situation assess the temperamental tolerance of risk.
Risk tolerance level is set either by one’s financial situation or financial temperament
which ever is lower, so it is necessary to understand financial temperament objectively.
One must realize that risk tolerance cannot be defined too rigorously or precisely. For
practical purposes it is enough to define it as low, medium or high. This will serve as a
valuable guide in taking an investment decision. It will provide a useful perspective and
will prevent from being a victim of the waves and manias that tend to sweep the
market from time to time.

ü Risk tolerance: Risk refers to the possibility that the actual outcome of an investment
will differ from its expected outcome. More specifically, most of the investors are
concerned about the actual outcome being less than the expected outcome. The wider
the range of possible outcomes, the greater is the risk. It all depends on the investor,
how much risk he is able to bear. If he is willing to bear high risk, he is expected to get
high return and if he is willing to bear low risk, he will get low return.

· CONSTRAINTS AND PREFERENCES

ü Liquidity: Liquidity refers to the speed with which an asset can be sold, without
suffering any loss to its actual market price. For example, money market instruments
are the most liquid assets, whereas antiques are among the least liquid.
ü Investment horizon: the investment horizon is the time when the investment or
part of it is planned to liquidate to meet a specific need. For example, the investment
horizon for ten years to fund the child’s college education. The investment horizon has
an important bearing on the choice of assets.
ü Taxes: The post – tax return from an investment matters a lot. Tax considerations
therefore have an important bearing on investment decisions. So, it is very important
to review the tax shelters available and to incorporate the same in the investment
decisions.

ü Regulations: While individual investors are generally not constrained much by laws
and regulations, institutional investors have to conform to various regulations. For
example, mutual funds in India are not allowed to hold more than 10 percent of equity
shares of a public limited company.
ü Unique circumstances: Almost every investor faces unique circumstances. For
example, an endowment fund may be prevented from investing in the securities of
companies making alcoholic and tobacco products.

2. SELECTION OF ASSET MIX: Based on the objectives and constraints, selection

of assets is done. Selection of assets refers to the amount of portfolio to be invested in
each of the following asset categories:

ü Cash: The first major economic asset that an individual plan to invest in is his or her
own house. Their savings are likely to be in the form of bank deposits and money
market mutual fund schemes. Referred to broadly as ‘cash’, these instruments have
appeal, as they are safe and liquid.
ü Bonds: Bonds or debentures represent long-term debt instruments. They are
generally of private sector companies, public sector bonds, gilt-edged securities, RBI
saving bonds, national saving certificates, Kisan Vikas Patras, bank deposits, public
provident fund, post office savings, etc.
ü Stocks: Stocks include equity shares and units/shares of equity schemes of mutual
funds. It includes income shares, growth shares, blue chip shares, etc.
ü Real estate: The most important asset for individual investors is generally a
residential house. In addition to this, the more affluent investors are likely to be
interested in other types of real estate, like commercial property, agricultural land,
semi-urban land, etc.
ü Precious objects and others: Precious objects are items that are generally small in
size but highly valuable in monetary terms. It includes gold and silver, precious stones,
art objects, etc. Other assets includes like that of financial derivatives, insurance, etc.

· Conventional wisdom on Asset Mix: The conventional wisdom on the asset mix is
embodied in two propositions:
ü Other things being equal, an investor with greater tolerance for risk should tilt the
portfolio in favor of stocks, whereas an investor with lesser tolerance for risk should tilt
the portfolio in favor of bonds. This is because, in general, stocks are riskier than bonds
hence earn higher return than bonds.
ü Other things being equal, an investor with a longer investment horizon should tilt his
portfolio in favor of stocks whereas an investor with a shorter investment horizon
should tilt the portfolio in favor of bonds. This is because the expected rate of return
from stocks is very sensitive to the length of the investment period; the risk from stock
diminishes as investment period lengthens.

· The fallacy of Time Diversification: The notion or the idea of time diversification is
fallacious. Even though the uncertainty about the average rate of return diminishes
over a longer period, it also compounds over a longer time period. Unfortunately, the
latter effect dominates. Hence the total return becomes more uncertain as the
investment horizon lengthens.

3. FORMULATION OF PORTFOLIO STRATEGY: After selection of asset mix, formulation

of appropriate portfolio strategy is required. There are two types of portfolio strategies,
active portfolio strategy and passive portfolio strategy.
· ACTIVE PORTFOLIO STRATEGY: Most investment professionals follow an active
portfolio strategy and aggressive investors who strive to earn superior returns after
adjustment for risk. The four principal vectors of an active strategy are:
ü Market Timing
ü Sector Rotation
ü Security Selection
ü Use of a specialized concept
ü Market timing: This involves departing from the normal (or strategic or long run)
asset mix to reflect one’s assessment of the prospects of various assets in the near
future. Suppose an investor’s investible resources for financial assets are 100 and his
normal (or strategic) stock-bond mix is 50:50. In short and intermediate run however
he may be inclined to deviate from long-term asset mix. If he expects stocks to out
perform bonds, on a risk-adjusted basis, in the near future, he may perhaps step up
the stock component of his portfolio to say 60 to 70 percent. Such an action, of course,
would raise the beta of his portfolio. On the other hand, if he expects the bonds to
outperform stocks, on a risk-adjusted basis, in the near future, he may set up the bond
component of his portfolio to 60 to 70 percent. This will naturally lower the beta of his
portfolio. Market timing is based on an explicit or implicit forecast of general market
movements. The advocates of market timing employ a variety of tools like business
cycle analysis, advance-decline analysis, moving average analysis, and econometric
models. The forecast of the general market movement derived with the help of one or
more of these tools are tempered by the subjective judgment of the investor. Often, of
course, the investor may go largely by his market sense.

ü Sector Rotation: The concept of sector rotation can be applied to stocks as well as
bonds. It is however, used more commonly with respect to stock component of portfolio
where it essentially involves shifting the weightings for various industrial sectors based
on their assessed outlook. For example if it is assumed that cement and pharmaceutical
sectors would do well compared to other sectors in the forthcoming period, one may
overweight these sectors, relative to their position in market portfolio. With respect to
bonds, sector rotation implies a shift in the composition of the bond portfolio in terms of
quality, coupon rate, term to maturity and so on. For example, if there is a rise in the
interest rates, there may be shift in long term bonds to medium term or even short-
term bonds. But we should remember that a long-term bond is more sensitive to
interest rate variation compared to a short-term bond.

ü Security Selection: Security selection involves a search for under priced securities.
If an investor resort to active stock selection, he may employ fundamental and or
technical analysis to identify stocks that seems to promise superior returns and
overweight the stock component of his portfolio on them. Likewise, stocks that are
perceived to be unattractive will be under weighted relative to their position in the
market portfolio. As far as bonds are concerned, security selection calls for choosing
bonds that offer the highest yield to maturity at a given level of risk.

ü Use of a specialized Investment Concept: A fourth possible approach to achieve

superior returns is to employ a specialized concept or philosophy, particularly with
respect to investment in stocks. As Charles D. Ellis words says, a possible way to
enhance returns “is to develop a profound and valid insight into the forces that drive a
particular group of companies or industries and systematically exploit that investment
insight or concept.” Some of the concepts of investment practitioners are as follows:
ü Growth stocks
ü Value stocks
ü Asset-rich stocks
ü Technology stocks
ü Cyclical stocks

The advantage of cultivating a specialized investment concept or philosophy is that it

will help you to:
a) Focus efforts on a certain kind of investment that reflects ones abilities and talents
b) Avoid the distractions of pursuing other alternatives
c) Master an approach through sustained practice and continual self-critique.
As against these merits, the great disadvantage of focusing on a specialized concept is
that it may become obsolete. The changes in market may cast a shadow over the
validity of the basic premise underlying the investment philosophy.

· PASSIVE PORTFOLIO STRATEGY: The passive strategy rests on the tenet that the
capital market is fairly efficient with respect to the available information. The passive
strategy is implemented according to the following two guidelines:
ü Create a well-diversified portfolio at a predetermined level of risk.
ü Hold the portfolio relatively unchanged over time, unless it becomes inadequately
diversified or inconsistent with the investor’s risk-return preferences.

4. SELECTION OF SECURITIES: The following factors should be taken into

consideration while selecting the fixed income avenues:
· SELECTION OF BONDS (fixed income avenues)
ü Yield to maturity: The yield to maturity for a fixed income avenue represents the rate
of return earned by the investors if he invests in the fixed income avenue and holds it
till its maturity.

ü Risk of default: To assess the risk of default on a bond, one may look at the credit
rating of the bond. If no credit rating is available, examine relevant financial ratios (like
debt-to-equity ratio, times interest earned ratio, and earning power) of the firm and
assess the general prospects of the industry to which the firm belongs.

ü Tax Shield: In yesteryears, several fixed income avenues offered tax shield, now very
few do so.

ü Liquidity: If the fixed income avenue can be converted wholly or substantially into
cash at a fairly short notice, it possesses liquidity of a high order.

· SELECTION OF STOCK (Equity shares)

Three board approaches are employed for the selection of equity shares:
ü Technical analysis
ü Fundamental analysis
ü Random selection
Technical analysis looks at price behavior and volume data to determine whether the
share will move up or down or remain trend less.
Fundamental analysis focuses on fundamental factors like the earnings level, growth
prospects, and risk exposure to establish the intrinsic value of a share. The
recommendation to buy, hold, or sell is based on a comparison of the intrinsic value
and the prevailing market price.
Random selection approach is based on the premise that the market is efficient and
securities are properly priced.

5. PORTFOLIO EXECUTION: The next step is to implement the portfolio plan by

buying or selling specified securities in given amounts. This is the phase of portfolio
execution which is often glossed over in portfolio management literature. However, it is
an important practical step that has a significant bearing on the investment results. In
the execution stage, three decision need to be made, if the percentage holdings of
various asset classes are currently different from the desired holdings.

6. PORTFOLIO REVISION: In the entire process of portfolio management, portfolio

revision is as important stage as portfolio selection. 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 existing securities may
be removed from the portfolio. Thus it leads to purchase and sale of securities. The
objective of portfolio revision is similar to the objective of selection i.e. maximizing the
return for a given level of risk or minimizing the risk for a given level of return.
The need for portfolio revision has aroused due to changes in the financial markets
since creation of portfolio. It has aroused because of many factors like availability of
additional funds for investment, change in the risk attitude, change investment goals,
the need to liquidate a part of the portfolio to provide funds for some alternative uses.
The portfolio needs to be revised to accommodate the changes in the investor’s
position.
Portfolio Revision basically involves two stages:
ü Portfolio Rebalancing: Portfolio Rebalancing involves reviewing and revising the
portfolio composition (i.e. the stock- bond mix). There are three basic policies with
respect to portfolio rebalancing: buy and hold policy, constant mix policy, and the
portfolio insurance policy.
Under a buy and hold policy, the initial portfolio is left undisturbed. It is essentially a
‘buy and hold’ policy. Irrespective of what happens to the relative values, no
rebalancing is done. For example, if the initial portfolio has a stock-bond mix of 50:50
and after six months it happens to be say 70:50 because the stock component has
appreciated and the bond component has stagnated, than in such cases no changes are
made.
The constant mix policy calls for maintaining the proportions of stocks and bonds in line
with their target value. For example, if the desired mix of stocks and bonds is say
50:50, the constant mix calls for rebalancing the portfolio when relative value of its
components change, so that the target proportions are maintained.
The portfolio insurance policy calls for increasing the exposure to stocks when the
portfolio appreciates in value and decreasing the exposure to stocks when the portfolio
depreciates in value. The basic idea is to ensure that the portfolio value does not fall
below a floor level.
ü Portfolio Upgrading: While portfolio rebalancing involves shifting from stocks to bonds
or vice versa, portfolio-upgrading calls for re-assessing the risk return characteristics of
various securities (stocks as well as bonds), selling over-priced securities, and buying
under-priced securities. It may also entail other changes the investor may consider
necessary to enhance the performance of the portfolio.

7. PORTFOLIO EVALUATION: Portfolio evaluation is the last step in the process of

portfolio management. It is the process that is concerned with assessing the
performance of the portfolio over a selected period of time in terms of return and risk.
Through portfolio evaluation the investor tries to find out how well the portfolio has
performed. The portfolio of securities held by an investor is the result of his investment
decisions. Portfolio evaluation is really a study of the impact of such decisions. This
involves quantitative measurement of actual return realized and the risk born by the
portfolio over the period of investment. It provides a mechanism for identifying the
weakness in the investment process and for improving these deficient areas. The
evaluation provides the necessary feedback for designing a better portfolio next time.

BASICS OF PORTFOLIO MANAGEMENT IN INDIA

In India, Portfolio Management is still in its infancy. Barring a few Indian banks, and
foreign banks and UTI, no other agency had professional portfolio management until
1987. After the setting up of public sector mutual funds, since 1987, professional
portfolio management, backed by competent research staff became the order of the
day. After the success of the mutual funds in portfolio management, a number of
brokers and Investment consultants some of whom are professionally qualified have
become portfolio managers. They have managed the funds of the client on both
discretionary and non-discretionary basis. It was found that many of them, including
mutual funds have guaranteed a minimum return or capital appreciation and adopted
all kinds of incentives that are now prohibited by SEBI.
The recent CBI probe into the operations of many market dealers has revealed the
unscrupulous practices by banks, dealers and brokers in their portfolio operations. The
SEBI has then imposed stricter rules, which included their registration, a code of
conduct and minimum infrastructure, experience and expertise etc. it is no longer
possible for any unemployed youth, or retired person or self-styled consultant to
engage in portfolio management without the SEBI’s license. The guidelines of SEBI are
in the direction of making portfolio management a responsible professional service to
be rendered by the experts in the field.
ASPECTS OF PORTFOLIO MANAGEMENT

Basically, portfolio management involves:

ü A proper investment decision-making of what to buy and sell
ü Proper money management in terms of investment in a basket of assets to satisfy the
asset preferences of the investors.
ü Reduce the risk and increase the returns.

· Investment Strategy:
In India there are large number of savers, barring the 37% of population who are below
the poverty line. In a poor country like this, it is surprising that saving rate is high as
24% of GDP per annum and investment at 26% of GDP. But the return in the form of
output growth is as low as5 to 7% per annum. One may ask why is it that high levels of
investment could not generate comparable rates of growth of output? The answer is
poor investment strategy; involving high capital output ratios, low productivity of
capital, and high rates of obsolescence of capital. The use of capital in India is wasteful
and inefficient, despite the fact that India is labour rich and capital poor. Thus the
portfolio managers in India lack the expertise and experience, which will enable them to
have proper strategy for investment management.
Secondly, the average Indian household saves around 60% in the financial form and
40% in the physical form. Of those in the financial form, nearly 42% is held in cash and
bank deposits, as per RBI data and they have return less than inflation rates. Besides a
proportion of 35% of financial savings is held in the form of insurance, pension funds,
etc. while another 12% is in government instruments and certificates like post office
deposits, public provident fund, national saving scheme, etc. the real returns on
insurance and pension funds are low and many times lower than average inflation
rates. With the removal of many tax concessions from investments in Post Office
Savings, certificates, etc. they also become less attractive to small and medium
investors. The only investment, satisfying all their objectives is capital market
instruments. These objectives are income, capital appreciation, safety, liquidity, and
hedge against inflation and investment.

· Objectives of Investors:
The return on equity investments in the capital market particularly if proper investment
strategy is adopted would satisfy the above objectives and real returns would be higher
than any other saving instruments.
All investment involves risk taking. However, some risk free investments are available
like bank deposits or post-office deposits whose returns are called risk free returns of
about 5-12%. So, the returns on more risky investments are higher than that having
risk premium. Risk is variability of return and uncertainty of payment of interest and
repayment of principal. Risk is measured by standard deviation of the returns over the
mean for a given period. Risk varies directly with the return. The higher the risk taken,
the higher is the return, under normal market conditions.
· Risk and Beta:
Risk is of two components – systematic market related risk and unsystematic risk. The
former cannot be eliminated or managed with the help of Beta (β), which is explained
as follows:
β = % change of Scrip return
% change of Market return

If β = 1, the risk of the company is the same as that of the market and if β > 1, the
company’s risk is more than market risk and if β < 1, the reverse is the position.

· Time Value of Money:

In portfolio management and investment decision-making, time element and time value
of money are very relevant. Savings are automatic or induced. If induced, it requires a
return enough to induce to part with liquidity. Thus, the investors will part savings and
liquidity if only their time preference is satisfied by proper return.

· Compounding:
Future Value Factor (FVF) is (1+ r) ⁿ where (r) is the rate of interest required and (n) is
the period of years.

Fn = P (1+ r) ⁿ or Future value = present value x (Future Value Factor)

So, the return required by the savers is related to the waiting period, loss of
consumption at present, or liquidity and risk of loss of money or variance of returns.

· Discounting:
If the future flow of money is known as Cı, C2, C3, etc. what is the future value of them
and how much is he prepared to pay for them? If he deposits today Rs. 100 he gets Rs.
110 at the end of one year and Rs. 121 at the end of 2 years, if interest rate is Rs.
10%. This process of finding the present value for future money flow is called
discounting. Present value of future amounts is:
P = F (n) 1
(1+ r)n
The multiplier 1 is called PVF or Present Value Factor.
(1+ r)n
It is necessary to know the amounts of cash flows (Fn), number of years (n) and the
required rate of return (r).

· Perpetuity:
When we receive a fixed sum of money every year up to infinity, it is called Perpetuity.
Suppose, if a person wants to receive Rs. 1000 and the equation is
PV = a
r
where,
PV is the present value of perpetuity,
‘a’ is the fixed periodic cash flow and
‘r’ is the rate of interest.

· Annuity:
Annuity is the constant cash flow for a finite time period of say 5 years (n). Examples of
annuity are found in the case of lease rentals, loan repayments, recurring deposits, etc.

· Application to Portfolio Management:

Portfolio Management involves time element and time horizon. The present value of
future returns/cash flows by discounting is useful for share valuation and bond
valuation. The investment strategy in portfolio construction should have a time horizon;
say 3 to 5 years; to produce desired results of 20-30% return per annum.
Besides, Portfolio Management should also take into account tax benefits and
incentives. As the returns are taken by investors net of tax payments, and there is
always an element of inflation, returns net of taxation and inflation are more relevant to
tax paying investors. These are called net real rates of returns, which should be more
than other returns. They should encompass risk free returns plus a reasonable risk
premium, depending upon the risk taken on the instruments/ assets invested.

CONCLUSION

After the overall all study about each and every aspect of this topic it shows that
portfolio management is a dynamic and flexible concept which involves regular and
systematic analysis, proper management, judgment, and actions and also that the
service which was not so popular earlier as other services has become a booming sector
as on today and is yet to gain more importance and popularity in future as people are
slowly and steadily coming to know about this concept and its importance.
I also help both an individual the investor and FII to manage their portfolio by expert
portfolio mangers. It protects the investor’s portfolio of funds very crucially.
Portfolio management service is very important and effective investment tool as on
today for managing investible funds with a surety to secure it. As and how development
is done every sector will gain its place in this world of investment.
BIBLIOGRAPHY
REFERENCE BOOKS:
Ø PRASANNA CHANDRA → SECURITY ANLYSIS AND PORTFOLIO MANAGEMENT.

Ø V.A. AVADHANI → SECURITY ANLYSIS AND PORTFOLIO MANAGEMENT.

Ø S.KEVIN → SECURITY ANLYSIS AND PORTFOLIO MANAGEMENT.

Ø GORDON AND NATRAJAN → FINANCIAL SERVICES AND MARKETS.

Ø IGNOU → MBA COURSE MATERIAL