BASICS OF PORTFOLIO MANAGEMENT

Phases Of Portfolio Management

SPECIFICATION OF INVESTMENT OBJECTIVES AND CONSTRAINTS

CHOICE OF ASSET MIX

FORMULATION OF PORTFOLIO STRATEGY SELECTION OF SECURITIES PORTFOLIO EXECUTION

PORTFOLIO REVISION
PORTFOLIO EVALUATION

Specification Of Investment Objectives

The commonly stated investment goals are : income, growth, and stability Since income and growth represent two ways by which return is generated and stability implies containment of risk, investment objectives may be expressed more succinctly in terms of return and risk.

A Risk Tolerance Questionnaire

To assess your risk tolerance, seven questions are given below. Each question is followed by three possible answers. Circle the letter that corresponds to your answer. 1. Just six weeks after you invested in a stock, its price declines by 20 percent. If the fundamentals of the stock have not changed, what would you do? a. Sell b. Do nothing c. Buy more 2. Consider the previous question another way. Your stock dropped 20 percent, but it is part of a portfolio designed to meet investment goals with three different time horizons. (i) What would you do if your goal were five years away? a. Sell b. Do nothing c. Buy more

(ii) What would you do if the goal were 15 years away?

a. b. c. a. b. c. 3. Sell Do nothing Buy more Sell Do nothing Buy more

(iii) What would you do if the goal were 30 years away?

You have bought a stock as part of your retirement portfolio. It price rises by 25 percent after one month. If the fundamentals of the stock have not changed, what would you do? a. b. c. Sell Do nothing Buy more

4.

You are investing for retirement which is 15 years away. What would you do?
a. Invest in money market mutual fund or a guaranteed investment contract

b. Invest in a balanced mutual fund that has a stock : bond mix of 50 : 50 c. Invest in an aggressive growth mutual fund 5. As a prize winner, you have been given some choice. Which one would you choose?

a. Rs 50,000 in cash b. A 50 percent chance to get Rs 125,000 c. A 20 percent chance to get Rs 375,000

6. A good investment opportunity has come your way. To participate in it you have to borrow money. Would you take a loan?
a. No b. Perhaps c. Yes 7. Your company, which is planning to go public after three years, is offering stock to its employees. Until it goes public, you cant sell your shares. Your investment, however, has the potential of multiplying 10 times when the company goes public. How much money would you invest?

a. Nothing b. Three months salary c. Six months salary

Your risk tolerance score is: Number of (a) answers x 1

+ Number of (b) answers x 2

+ Number of (c) answers x 3

Your Risk Appetite If your score is You may be a

914 points
1521 points 2227 points

Conservative investor
Moderate investor Aggressive investor

Constraints
LIQUIDITY

TAXES

TIME HORIZON UNIQUE PREFERENCES & CIRCUMSTANCES

Selection Of Asset Mix

Should the long-term stock-bond mix be 50 : 50 or 75 : 25 or 25 : 75 or any other ? Referred to as the strategic asset-mix decision (or policy asset-mix decision), this is by far the most important decision by the investor. Empirical studies have shown that nearly 90 percent of the variance of the portfolio return is explained by its asset mix.

Selection Of Asset Mix

CONVENTIONAL WISDOM
1. GREATER RISK TOLERANCE 2. LONGER INVESTMENT HORIZON STOCKS STOCKS

RISK-RETURN RELATIONSHIP FOR VARIOUS TYPES OF BONDS AND STOCKS

RETURN
BLUE CHIP SHARES PUBLIC SECTOR BONDS NCDs OF PRIVATE SECTOR GROWTH SHARES DEFENSIVE SHARES BANK DEPOSITS INCOME/GROWTH ORIENTED UNITS SPECULATIVE SHARES

RISK

Range Of Return On Common Stocks

60% 50% 40% 30% 20% 10% 0% -10% -20% -30%

1-year periods High Average +52.6% +13.0%

5-year periods +23.9% +10.4%

10-year periods +19.3% + 9.5%

15-year periods +16.4% + 9.3%

20-year periods +13.4% + 9.4%

25-year periods +10.3% + 9.4%

Low

-26.5%

- 2.4%

+ 1.2%

+ 4.3%

+ 6.5%

+ 8.4%

Enduring Relation
J.H.LORIE : THE MOST ENDURING RELATION IN ALL FINANCE PERHAPS IS THE RELATIONSHIP BETWEEN RETURNS ON EQUITIES (OR STOCKS) AND RETURNS ON BONDS. IN ALL PERIODS OF AMERICAN HISTORY, BRITISH HISTORY, AND GERMAN HISTORY, EQUITIES (STOCKS) HAVE PROVIDED HIGHER RETURNS THAN BONDS A SIMILAR OBSERVN CAN BE MADE WHEN WE LOOK AT THE RETURNS ON STOCKS AND BONDS IN INDIA FOR THE LAST TWO DECADES

Appropriate Percentage Allocation

RISK TOLERANCE TIME HORIZON LOW SHORT MEDIUM LONG 0 25 50 MODERATE 25 50 75 HIGH 50 75 100

Resurrection Of Time Diversification

1. THERE ARE IS SOME EVIDENCE THAT STOCK RETURNS NOT SERIALLY INDEPENDENT BUT TEND TO MEAN - REVERT OVER LONG INTERVALS .. THE DISPERSION OF TERMINAL WEALTH INCREASES AT A SLOWER RATE THAN WHAT IS IMPLIED BY SERIALLY INDEPENDENT RETURNS YOU MAY BE RISK OVER A GREATER SCOPE AND WORK HABITS MORE INCLINED TO ACCEPT MORE LONGER HORIZON AS YOU HAVE TO ADJUST YOUR CONSUMPTION

2.

Portfolio Strategy
ACTIVE PASSIVE
MARKET TIMING SECTOR ROTATION SECURITY SELECTION USE OF A SPECIALISED CONCEPT HIGHLY ACTIVE HIGHLY PASSIVE | | | | | | | |

Some Specialized Concepts

Growth Stocks Value Stocks Asset Rich Stocks Technology Stocks Cyclical Stocks Momentum Stocks

Two Popular Management Styles

Value Management & Growth Management
Value Stocks Low earnings per share growth Low price - earning ratio Low price book ratio High dividend yield Betas tend to be less than one Out of favor Growth Stocks High earnings per share growth High price - earning ratio High price book ratio Low dividend yield Betas tend to be more than one Popular

Market Timing
WHILE REVIEWING MARKET FLUCTNS, ANY ONE WILL GET TEMPTED TO PLAY GAME OF MARKET TIMING

A CAREFUL STUDY OF MARKET TIMING SUGGESTS - A FUND MANAGER SHOULD CORRECTLY FORECAST AT LEAST 75% TIMES JUST TO BREAK-EVEN. FISHER BLACK SAYS :
THE MARKET DOES JUST AS WELL, ON AVERAGE, WHEN THE INVESTOR IS OUT OF THE MARKET AS IT DOES WHEN HE IS IN. SO HE LOSES MONEY, RELATIVE TO A SIMPLE BUYAND-HOLD STRATEGY, BY BEING OUT OF THE MARKET PART OF THE TIME

Passive Strategy
ACTIVE STRATEGY IS BASED ON PREMISE THAT THERE ARE INEFFICIENCIES IN THE MARKET WHICH SHOULD BE EXPLOITED PASSIVE STRATEGY RESTS ON THE TENET THAT MARKET IS FAIRLY EFFICIENT WITH RESPECT TO AVAILABLE INFORN 1. CREATE A WELL-DIVERSIFIED PORTFOLIO AT A PRE-DETERMINED LEVEL OF RISK
2. HOLD THE PORTFOLIO RELATIVELY UNCHANGED OVER TIME, UNLESS IT BECOMES INADEQUATELY DIVERSIFIED OR INCONSISTENT WITH THE INVESTORS RISK-RETURN PREFERENCES

Portfolio Strategy Mix

ABILITY TO SELECT UNDERVALUED SECURITIES 1. CONCENTRATE GOOD 2. SHIFT BETA 1. CONCENTRATE 2. KEEP BETA STABLE ABILITY TO FORECAST OVERALL MARKET GOOD BAD

1. DIVERSIFY BAD 2. SHIFT BETA

1. DIVERSIFY 2. KEEP BETA STABLE

Selection Of Securities
SELECTION OF BONDS YTM DEFAULT RISK

TAX SHIELD
LIQUIDITY DURATION SELECTION OF STOCKS TECHNICAL ANALYSIS FUNDAMENTAL ANALYSIS RANDOM ANALYSIS

Market Efficiency And Security Selection

LEVEL OF APPROACH EFFICIENCY INEFFICIENCY WEAK-FORM EFFICIENCY SEMI-STRONG-FORM EFFICIENCY STRONG-FORM EFFICIENCY TECHNICAL FUNDAMENTAL ANALYSIS ANALYSIS BEST POOR POOR BEST RANDOM SELECTION POOR POOR

POOR POOR

GOOD FAIR

FAIR BEST

The Efficient Market Hypothesis

The weak form of the EMH says that past prices, volume, and other market statistics provide no information that can be used to predict future prices. The semi-strong form says that prices fully reflect all publicly available information and expectations about the future. The strong form says that prices fully reflect all information, whether publicly available or not.

Portfolio Execution Trading Game

BUSINESS TRANSACTION MOTIVE AND IDENTITY OF THE COUNTERPARTY KNOWN CONSTRUCTIVE MOTIVES + SUM GAME SECURITY TRANSACTION MOTIVE AND IDENTITY OF THE COUNTERPARTY NOT KNOWN ZERO SUM GAME

MOTIVES FOR TRADE COGNITIVE EMOTIONAL

Key Players

Value Based Transactors (VBT) Information Based Transactors (IBT) Liquidity Based Transactors (LBT) Pseudo Information Based Transactors (PIBT) Dealers

Trading Motivations, Time Horizons, And Time v/s Price Preferences

TRANSACTOR VBT MOTIVATION DISCREPANCY BETWEEN VALUE AND PRICE NEW INFORMATION RELEASE OR ABSORB CASH TIME HORIZON WEEKS TO MONTHS HOURS TO DAYS HOURS TO DAYS TIME v/s PRICE PREFERENCE PRICE

IBT LBT

TIME TIME

PIBT
DEALER

APPARENTLY NEW INFORMATION

ACCOMODATION

HOURS TO DAYS
MINUTES TO HOURS

TIME
INDIFFERENT

Portfolio Revision NEED

PORTFOLIO REBALANCING
BUY AND HOLD POLICY CONSTANT MIX POLICY PORFOLIO INSURANCE POLICY PORTFOLIO UPGRADING