WHAT IS A PORTFOLIO?

WHAT IS PORTFOLIO MANAGEMENT?

THE FOUR MAIN TYPES OF PORTFOLIO MANAGEMENT

  • Passive Portfolio Management: involves selecting a group of investment vehicles that usually only track and index. The goal is to mirror the returns of the market over time. Use Modern Portfolio Theory (MPT) to optimize the mix.
  • Discretionary Portfolio Management: Full control is given to PM to decide what to do with the investors cash
  • Non discretionary Portfolio Management: reduces a PM’s job to that of a financial advisor.

THE THREE MAIN ELEMENTS OF PORTFOLIO MANAGEMENT

  • Diversification: spreading risk and reward within an asset class. Made across various asset classes.
  • Rebalancing: Used to return a portfolio at regular intervals to its original target allocation. Used to help maintain the original asset mix.
An Example of one of my portfolios asset allocation into different investment vehicles

CHARACTERISTICS OF INVESTMENTS

  • Risk: Examples; loss of capital, delay in repayments, non payment of return, variability in repayment, and defaults. The higher risk the higher the expected return.
  • Security: certainty of return of (initial) capital without loss of time or money
  • Liquidity: how easily an investment can be sold

One primarily wants: High returns (more specifically yield which is the net returns), low risk, safe & secure funds, and high liquidity.

Secondarily one also wants: Tax minimization, hedging against inflation

TWO KINDS OF ASSETS

  • Financial Assets: Divisible. Piece of paper. eg. equity, fixed income (debt), credits, and derivatives

FINANCIAL ASSETS ARE FURTHER CLASSIFIED INTO:

  • Non marketable: are transacted between investor and issuer only. eg. Post office deposits, Company deposits, provident fund deposits, bank deposits

THREE KINDS OF INVESTORS

  • Moderate: Invest in cash, bonds, long term stocks, low risk real estate. Low risk investments
  • Aggressive: Invest mostly in the stock market and on high risk real estate. High risk investments

The kind of investor ultimately holds the level of risk tolerance they each possess.

THE 12 TYPES OF RISKS:

  1. Industry risk: danger of a specific industry performing poorly. Also can crossover to other industries
  2. Tax risk: rising taxes will make investments less attractive as they affect capital gains, dividends, and interest
  3. Political risk: government legislation can have an adverse effect on an investment
  4. Reinvestment risk: risk subject to dividend reinvestment plans. Danger of yielding lower returns than prior to reinvestment
  5. Exchange rate risk: danger of a nation’s currency losing value when exchanged for foreign currencies
  6. Inflation rate risk: when inflation rises, investments have less purchasing power
  7. Liquidity risk: no volume in the investment you are trying to sell which may lead to a loss in value
  8. Market risk: chance of the entire market to decline
  9. Management risk: danger of a management team that will run a company poorly causing it not to grow or delay or not to payout dividends.
  10. Tenure risk: danger of losing money whilst holding on to a security
  11. Timing risk: danger of buying the right security at the wrong time or selling the security at the wrong time.
Diversifying sector allocation mitigates industry risk

PORTFOLIO MANAGEMENT PROCESS:

  1. Analysis and evaluation of investment vehicles: select the investment vehicles that provide the best balance of diversification at a low cost
  2. Formation of diversified investments portfolio: using the Modern Portfolio Theory create portfolios matched to a range of risk tolerances
  3. Portfolio revision: understanding the risk preferences to finally agree on the suggested portfolio
  4. Measurement and evaluation of portfolio performance: monitor and rebalance portfolio to make sure it stays on track

ANALYSIS AND EVALUATION OF INVESTMENT VEHICLES

EXAMPLE OF ASSET ALLOCATION

Inherently contains the conscious effort to gain exposure to the desired level of risk.

Putting in mind capital market expectations, risk and return, and objectives and constraints.

CONCLUSION

An aspiring quant & writer at : www.ghannami.com

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