Portfolio Management Strategies

Abstract

Introduction

I. INTRODUCTION

Before starting with portfolio, let us understand what is investments.

Investment means buying an asset for example stocks, real estate, bonds, mortgages which may provide a future income and increases its value.

Characteristics of Investments

• Risk
• Return
• Safety
• Liquidity
• Marketability
• Concealability
• Capital growth
• Stability of income
• Tax Benefits

Now let’s understand what is a portfolio, a portfolio is group of invested financial instruments. To maintain a healthy portfolio, we need to manage our portfolio. Portfolio Management is described as an integrated set of steps undertaken in a consistent manner to create and maintain an appropriate portfolio.

Portfolio Management is an ongoing process in which –

• Investment objectives and constraints are identified and specified
• Investment strategies are developed
• Portfolio composition is decided
• Portfolio performance is measured and monitored
• Any necessary rebalancing is implemented

A. Investment Objectives

The investor’s objectives are his or her investment goals expressed in terms of both risk and returns. The relationship between risk and returns requires that goals not to be expressed only in terms of returns. Expressing goals only in terms of returns can lead to in-appropriate investment practices.

For example – a person may have stated a goal such as “double my investment in 5 years”. Before that statement becomes part of the policy statement, he/she much be aware about the investment risks in the particular instrument.

B. Risk Objectives

In formulating a risk objective, the investor must arise the following questions.

1. How do I measure risk?
2. What is my willingness to take the risk?
3. What is my ability to take risk?
4. What are the specific risk objectives?

C. Return Objectives

The second element of the investment policy framework is the return objective, which must be consistent with the risk objectives. The following questions should arise.

1. How is return calculated?
2. How much return do I need?
3. What are the specific return objectives?

D. Portfolio Optimization

Stated at its simplest, portfolio construction involves selection of securities to be included in the portfolio and the determination of portfolio funds (weights) to be placed in each security. The Markowitz model provides the basis for a scientific portfolio construction resulting in efficient portfolios.

“An efficient portfolio is one with the highest level of expected return for a given level of risk, or the lowest risk for a given level of expected return”.

On a formal basis, the Markowitz model provides an organized framework for portfolio optimization, which allows investors to construct portfolio that are efficient.

The basic concepts pioneered by Markowitz are –

1. Monitoring market conditions.
2. Changes in investor’s circumstances
3. Change in wealth
4. Change in time horizon
5. Change in liquidity
6. Change in liquidity requirements
7. Change in tax circumstances
8. Change in legal or regulatory considerations
9. Change in unique needs.

E. Rebalancing Portfolio

Even the most carefully constructed portfolio is not intended to remain intact without change. The key is to know how and when to do such rebalancing because a trade-off is involved.

The cost of trading involves commissions, possible impact on the market price, and the time involved in deciding the trade. The cost of not trading involves holding positions that are not the best suited for the portfolio’s owner, holding asset allocation plan, holding a portfolio that is no longer adequately diversified and so forth.

Rebalancing reduces the risks of sharp losses in general, a rebalanced portfolio is less volatile than one that is not balanced. Investors should concentrate on keeping their chosen asset allocation percentages in line over the long run.

Rebalancing simply means periodically reviewing your portfolio to ensure that it is still fulfilling your investing goals.

F. Performance Management

The portfolio management process is designed to facilitate making investment decisions in an organised, systematic manner. Clearly it is important to evaluate the effectiveness of the overall decision-making process. The measurement of portfolio performance allows investors to determine the success of the portfolio management process.

II. LITERATURE REVIEW

Different strategies should be utilised for different market conditions, the time planning of an investment plays a significant role in the profitability of the strategy.

A. Jaroslaw Gruszka

Excess returns can be achieved by correctly timing changes in yields and yield spreads motivates active bond portfolio management strategies.

B. Naomi E. Boyd and Jeffrey M Mercer

The direct use of portfolio management tools in the market can cause sub-optimal solutions, so risk aversion constant of utility functions should be adopted.

C. Mete Emin Atmaca

Risk sensitive criterion amounts to maximising a portfolio’s risk adjusted growth rate.

D. Tomasz R. Bielecki and Stanley R. Pliska

Determining strategic positions in the balancing market and identifying corresponding economic in an analysis allows an economically starting optimal starting point for real-time balancing and create a marketplace for flexible capacity, that is more often than alternative marketplaces.

E. Christoph Moller

In testing the efficiency of the 1/n rule, the authors find that it outperforms the mean variance rule for individual small portfolios out of sample, but for large portfolios (i.e., institutional investors) the Markowitz strategy is superior. The advantage of the 1/n rule in the out-of-sample analysis is the absence of exposures to estimation errors.

F. Ran Duchin & Haim Levy

III. METHODOLOGY

The portfolio perspective refers to evaluating individual investments by their contribution to the risk and return of the investors portfolio. The alternative to taking a portfolio perspective is to examine the risk and return of the individual investments in isolation. An investor who holds all his wealth in a single stock, because he believes it to be the best stock available is not taking the portfolio perspective. His portfolio is risky compared to holding a diversified portfolio of stocks. Modern portfolio theory concludes that the extra risk from holding only a single security is not rewarded with high expected return. Conversely diversification allows an investor to reduce portfolio risk without necessarily reducing the portfolio’s expected return.

Before we start with the risk and return part, let us understand how to classify data.

A. Visualizing and Describing Data

The term data encompasses information in any form. Data can be classified into 3 different perspectives.

• Numerical and Categorical data
• Time-series and cross-sectional data
• Structured and un-structured data

Numerical data – Numerical data are the values that can be counted or measured. Numerical data can be DISCRETE or CONTINUOUS. Discrete data are countable, such as days, months, weeks, etc. . Continuous data can take fractional value, such as an annual return.

Categorical data – it consists of labels that can be used to classify set of data into groups. Categorical data can be nominal and ordinal, nominal data are labels that cannot be ranked in a logical order. Ordinal data are labels that can be ranked in a logical order.

Time-series data – it is a set of observation taken periodically most often at equal intervals over time.

Cross-sectional data – it is a set of comparable observations all taken at one specific point of time.

[Time-series data and Cross-sectional data may be combined to form a panel data]

Structured data – data that are structured in a defined way.

Un-structured data – refers to information that is presented in a form with no specific structure.

Data are typically organized into array for analysis. A time-series is an example of a one-dimensional array.

A frequency distribution is a tabular presentation of statistical data that aids the analysis of large data sets. Frequency distribution summarize statistical data by assigning them to specified groups or intervals.

Let us understand frequency distribution with an example

The annual returns of X, common stock.

Tally and interval count for returns data.

Relative Frequency is another useful way to present data, it is calculated by dividing the abs. freq. of each interval by the total number of observations.

References

[1] Jochen Felsenheimer, Philip Gizdakis, Michael Jeiser : A practical guide to credit risk management strategies. Wiley (2006) . https://www.google.co.in/books/edition/Active_Credit_Portfolio_Management/RcvnDwAAQBAJ?hl=en&gbpv=0 [2] Frank J Fabozzi, James L. Grant : Equity portfolio Management (2011) . https://www.researchgate.net/profile/James-Grant-11/publication/272091083_Equity_Portfolio_Management/links/54da6b5d0cf2ba88a68d3040/Equity-Portfolio-Management.pdf [3] Edward E. Qian : Quantitative equity Portfolio management(2007) .https://www.taylorfrancis.com/books/mono/10.1201/9781420010794/quantitative-equity-portfolio-management-edward-qian [4] Bruce M. Collins , Frank J Fanbozzi : Derivatives and equity portfolio management, Wiley (2006). https://www.google.co.in/books/edition/Derivatives_and_Equity_Portfolio_Managem/FZ3NrVOxiE8C?hl=en&gbpv=0 [5] Frank J Fanbozzi , Harry M. Markowitz : Equity Valuation and portfolio management, Wiley (2011). https://www.google.co.in/books/edition/Equity_Valuation_and_Portfolio_Managemen/s9Gaps-mKDAC?hl=en&gbpv=0 [6] Benjamin Graham : The Intelligent Investor .(2003) [7] Morgan Housel : The Pshycology of Money (Harriman House Ltd.)

Copyright

Copyright © 2022 Bishal Pal. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.