15.3 Phases of portfolio management

Portfolio Management

There are five phases that can be identified in this process:

  1. Security analysis
  2. Portfolio analysis
  3. Portfolio selection
  4. Portfolio revision
  5. Portfolio evaluation

Security Analysis

Security analysis stands for the proposition that a well-disciplined investor can determine a rough value for a company from all of its financial statements, make purchases when the market inevitably under-prices some of them, earn a satisfactory return, and never be in real danger of permanent loss. This has already been explained in Module 2.

Portfolio Analysis

A portfolio is a group of assets held together as an investment. Investors invest their funds in a portfolio of securities rather than in a single security because they are risk-averse. By constructing a portfolio, investors attempt to spread risk by not putting all their eggs in one basket. The analysis phase of portfolio management consists of identifying the range of possible portfolios that can be constituted from a given set of securities and calculating their return and risk for further analysis. What decides a portfolio?

  1. Age of the investor
  2. Risk-bearing capacity
  3. Attitude towards risk
  4. Family responsibilities
  5. Education background
  6. Liquidity needs
  7. Tax saving needs
  8. Time span for investment

Portfolio Selection

The proper goal of portfolio construction is to generate a portfolio that provides the highest returns at a given level of risk. A portfolio having this characteristic is known as an efficient portfolio. The inputs from portfolio analysis can be used to identify the set of efficient portfolios. From this set of efficient portfolios, the optimal portfolio has to be selected for investment. Harry Markowitz’s portfolio theory provides both the conceptual framework and analytical tools for determining the optimal portfolio in a disciplined and objective way.

Depending upon your priorities, you may select the option best suited for your objectives. Please remember that for any investments you plan to make, there are three important criterions to evaluate each investment option. This is clubbed as LSR.

  1. Liquidity
  2. Safety
  3. Return

Portfolio Revision

Having constructed the optimal portfolio, the investor has to constantly monitor the portfolio to ensure that it continues to be optimal. As time passes, a security which was attractive may cease to be so. New securities of high return and low risk may emerge. Portfolio revision is as important as portfolio analysis and selection.

Portfolio Evaluation

It is the process which is concerned with assessing the performance of the portfolio over a selected period of time in terms of returns and risk. This involves quantitative measurement of actual returns realized and the risk borne by the portfolio over the period of investment. It provides a feedback mechanism for improving the entire portfolio management process. The portfolio management process is an ongoing process. It starts with security analysis, proceeds to portfolio construction and continues with portfolio revision and evaluation. The evaluation provides the necessary feedback for designing a better portfolio next time.

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