Portfolio Management: Concept, Objectives, Process and Types

Before learning how to manage your Portfolio, understanding what Portfolio Investment is, becomes essential. Let’s understand it in the easiest language. Portfolio Investment can be understood as a bunch of different financial securities (including assets, stocks, government bonds, corporate bonds, mutual funds, other money market instruments, cash and cash equivalents, cryptocurrencies, commodities, and bank certificates of deposit.), bought with an expectation to gain either in the form of return or increased value, or both. So, the art of constructing and managing these portfolio investments is known as Portfolio Management. 

Portfolio Management aims to meet the long-term financial objectives of the investors within the given timeline while minimizing the degree of market risk. Such management services are provided by professionals, known as Portfolio Managers, who have knowledge of building portfolios, prevailing market situations and future expectations, understanding of risk appetite, and diversified investment. However, individuals with such knowledge can manage and oversee the portfolio on their own.

Portfolio Management is not a one-time activity but a continuous process of building and maintaining the portfolio investment with the intention to earn maximum gain within the given time frame. It can be understood as a continuous cycle of security allocation, diversification, supervision, and reconstruction of the appropriate portfolio. It is based on SWOT Analysis as the Portfolio Managers identify and analyze strengths and weaknesses of various investment plans and examines the market opportunities and threats associated with such investment plans to achieve the investor’s financial objectives.

Objectives of Portfolio Management

The basic objective of Portfolio Management is to earn a high return at minimum risk. However, some of the objectives of Portfolio Management are listed below:

1. Attaining Long-term Financial Goals: An investor always invests with a motive to secure the future by earning a high return, keeping this in mind Portfolio Management works with the objective to fulfil the long-term financial goals of the investors by recommending the most profitable portfolio, overseeing and rebalancing it from time to time to ensure high return with minimum risk appetite.

2. Capital Appreciation: Capital appreciation means an increase in the value of an asset over a time period. Portfolio Management intends to make the portfolio of the investor grow, so the market value of the investment rises within the given timeline, in comparison to its purchase value. Capital appreciation is the main source of investors’ earnings.

3. Maximizing Return on Investment: Return on Investment shows the earning from the investment in relation to the expenditure made in such investment.  Portfolio Management aims to maximize the ROI by analyzing the market before selecting the right investment mix. Other factors like time period, inflation, Legal restrictions, and economic conditions are also considered.

4. Achieving Asset Allocation: The primary objective of Portfolio Management is to allocate assets across different investment classes, such as equities, fixed income, and alternative investments in such a way that the asset allocation goes with the investor’s risk profile and investment goals.

5. Risk Management: Investment and risk are something that goes side by side and hence is a major concern of the investors. Portfolio Management minimizes the degree of risk associated with the investment by using the concept of diversified investment. Under this, investment is not made in a single category of an asset or the same industry, rather the investment is scattered into various investment classes or different industries, so even if any of the categories or industries so a downfall the other can overcome it by experiencing the rise.

6. Rebalancing and Monitoring the Portfolio: Portfolio Management aims to regularly monitor and adjust the portfolio by rebalancing the portfolio, adding or removing assets, or changing investment strategies so, it remains consistent with the investor’s risk profile and investment goals.

Who should opt for Portfolio Management?

Portfolio management can benefit a wide range of investors, from individuals to institutional investors, and shall be preferred by the following investors:

1. Less Investment Knowledge: A lack of investment knowledge is like a terrorist in the world of investment. New investors with no or less knowledge shall prefer portfolio investment and seek the service of portfolio management to earn a high return from their expertise. 

2. Busy Professionals: Investors who do not have the time to manage and oversee their own investments opt for Portfolio management services. Portfolio managers take care of their portfolios, giving them enough time to focus on their job and personal activities.

3. High Net Worth Individuals: High net worth individuals having significant assets and investments to manage, seek the help of professionals to achieve their financial goals. Such individuals are benefited from the expertise and knowledge of the Portfolio managers.

4. Corporate Institutions: Corporate bodies that deal in provident funds, pension funds, endowments, gratitudes, and foundations shall enjoy the benefits of portfolio management to achieve their long-term investment objectives and to meet their obligations towards such funds and foundations.

5. Investors with Complex Financial Needs: Investors who want the benefits from all classes of assets and securities go for a diversified investment plan and no one other than Portfolio managers and experts can manage such diversified portfolios in an optimum manner.

Process of Portfolio Management

Like any management process, Portfolio Management also includes steps like planning, execution, and evaluation. Let’s understand the process of managing a portfolio in detail:

1. Understanding Financial Objectives: The first and foremost step is to determine and understand the short-term and long-term financial objectives of the investor. This also includes understanding the risk appetite and time horizon of the investor to make the best decision.

2. Asset Selection and Allocation: Once the goals the fixed, it is important to walk on the right path to achieve those goals. So, the next step is to perform research on different asset classes to analyse the risk associated with each asset class to ensure security and minimise the risk. Once the analysis and research are done, asset allocation is done to meet the investor’s objectives and risk tolerance.

3. Portfolio Construction: As mentioned above, a portfolio is a bunch of assets belonging to different asset classes. Once the risk analysis and security check are done, the portfolio is constructed as per the financial goal, timeline, and risk tolerance of the investor. This is followed by the optimal weightings of each security in the portfolio.

4. Portfolio Overseeing and Rebalancing: After creating a suitable portfolio and investing in it, it becomes necessary to monitor and rebalance the portfolio from time to time. Overseeing helps to minimise the risk factor and rebalancing is important to stay confined to the financial goals and risk appetite.

5. Performance Evaluation: Last but the most important step of the management process is to conduct a performance evaluation to judge the growth and take necessary corrective steps to grow further. This involves comparing the portfolio’s returns to its benchmark and assessing its risk-adjusted performance. Evaluation is important to know whether the investing goals have been accomplished or not.

Types of Portfolio Management

Portfolio Management can be classified into: 

1. Active Portfolio Management:  In active portfolio management, a portfolio manager is continuously involved in the activity of trading securities to outperform the market and achieve specific financial goals. They basically aim at buying unvalued securities and then selling them at a high price to earn a profit. Active portfolio management is characterized by higher fees and commissions.

2. Passive Portfolio Management: Passive portfolio management is based on the theory of invest-and-forget strategy. Under this, investments are made into a portfolio of index funds to replicate the performance of a particular market index like an exchange-traded fund (ETF), a mutual fund, a unit investment trust, and other low-cost index funds. These generally offer lower returns but are profitable in the long term. The management fee is comparatively lower under this category.

3. Dynamic Portfolio Management: Dynamic portfolio management can be understood as hybrid portfolio management as it includes features of both active and passive portfolio management. Under this, Portfolio Managers implement long-term investment strategies while making tactical adjustments and rebalancing in response to market changes.

4. Discretionary Portfolio Management: Discretionary portfolio management forms authorize managers and financial experts to make all the financial decisions on behalf of their clients without seeking any separate approval each time. However, paperwork and filing are done initially to avoid any conflict and confusion between the manager and their clients. A portfolio manager has full control over investment decisions, while the investor provides only general guidelines and objectives.

5. Non-discretionary Portfolio Management: Under a Non-discretionary portfolio management system, a manager act just as an adviser to the client. The manager helps with the allocation of assets, selecting investment strategies, and suggesting investment moves to the clients. The manager is not in the capacity to make any investment decision without seeking the approval of the client.

Ways of Portfolio Management

The way to manage a portfolio highly depends on the investor’s financial goal and risk appetite. However, some of the ways of Portfolio Management include:

1. Asset Allocation: Asset Allocation strategy help the investor or portfolio manager to select the asset class (i.e.stocks, bonds, cash, etc.) to be invested in. Such allocation shall be compatible with the financial goal and risk-bearing of the investor. A young investor can bear more risk and hence can allocate the investment to a riskier class such as equity, whereas a person closer to retirement is in a position to bear the low risk and opt for a safer asset class like bonds/ debenture.

2. Diversification: Diversification is an integral part of portfolio management. Portfolio managers use a diversification strategy of investment to minimize the risk factor. The basic feature of diversified investment is that the profit made by one asset class can easily offset the losses incurred by another class. In the long run, diversified investment yields high returns at minimum risk of loss.

3. Rebalancing: Rebalancing is a process of adjusting the asset allocation of the portfolio by selling and buying the assets. Rebalancing becomes important to overcome the threats of the financial market and minimize the risk. It is basically a process of selling assets whose value has increased and buying the assets that have been undervalued in order to stay confined to the investor’s goals.

4. Tax Management: Tax management way of overseeing the portfolio is linked to the asset location i.e. investing either in a taxable investment account or a tax-friendly investment account. Investing in tax-efficient investments, harvesting tax losses, and maximizing tax-deferred investment accounts help in optimizing the taxes to get the maximum benefit out of the investment.