Comprehensive Portfolio Analysis and Management

This presentation provides a comprehensive overview of portfolio theory and management principles for students and finance professionals. It begins by defining what a portfolio is, exploring the components and significance of portfolio management in achieving optimal investment outcomes. Practical insights on portfolio risk and return, the effects of combining securities, and strategies for risk-adjusted performance are discussed.

1. PORTFOLIO ANALYSIS BY Dr M Priyanghaa Assistant Professor Department of Commerce (A&F) SRM -Institute of Science & Technology, FSH Ramapuram Campus, Chennai- 600 089

2. WHAT IS A PORTFOLIO? Portfolios are a combination of securities such as stocks, bonds, and money market instruments. WHAT IS PORTFOLIO MANAGEMENT? Portfolio management is the art of selecting the right investment policy for individuals in terms of minimum risk and maximum return. In simple terms, it is managing the money of an individual under the expert guidance of portfolio managers.

3. ACTIVE PORTFOLIO MANAGEMENT As the name suggests, in active portfolio management services, the portfolio managers are actively involved in buying and selling securities to ensure maximum profits for individuals. The aim of active portfolio management is to outperform the benchmark (For example, BSE-SENSEX, NSE-NIFTY50, etc.).

4. PASSIVE PORTFOLIO MANAGEMENT In passive portfolio management, the portfolio manager deals with a fixed portfolio designed to match the current market scenario. In discretionary portfolio management services, an individual authorizes a portfolio manager to take care of his/her financial needs on his/her behalf. The individual issues money to the portfolio manager, who in turn takes care of all his investment needs, paperwork, documentation, filing, and so on. In discretionary portfolio management, the portfolio manager has full rights to make decisions on his client’s behalf. In nondiscretionary portfolio management services, the portfolio manager can merely advise the client on what is good and bad for him, but the client reserves the full right to make his own decisions.

5. OBJECTIVES OF PORTFOLIO MANAGEMENT The key objectives of portfolio management are as follows: MAXIMIZING RETURNS: THE FUNDAMENTAL AIM IS TO ACHIEVE THE HIGHEST POSSIBLE RETURN ON INVESTMENT BY CAREFULLY SELECTING A MIX OF ASSETS THAT SUIT THE INVESTOR’S GOALS AND MARKET OUTLOOK. 1 REGULAR INCOME GENERATION: SOME PORTFOLIOS ARE STRUCTURED TO PROVIDE CONSISTENT CASH FLOW THROUGH INTEREST, DIVIDENDS, OR OTHER INCOME-GENERATING INSTRUMENTS, SUITABLE FOR RETIREES OR THOSE SEEKING STEADY INCOME. 5 RISK MANAGEMENT: PORTFOLIO MANAGEMENT SEEKS TO MINIMIZE RISK THROUGH DIVERSIFICATION AND STRATEGIC ASSET ALLOCATION, SPREADING INVESTMENTS ACROSS DIFFERENT ASSET CLASSES, SECTORS, AND GEOGRAPHIES SO THAT POOR PERFORMANCE IN ONE AREA DOES NOT SEVERELY IMPACT THE TOTAL PORTFOLIO. 2 LIQUIDITY MANAGEMENT: ENSURING THAT A PORTION OF THE PORTFOLIO CAN BE QUICKLY AND EASILY CONVERTED INTO CASH TO MEET SHORT-TERM NEEDS OR EMERGENCIES WITHOUT INCURRING SIGNIFICANT LOSSES. REGULAR MONITORING AND REBALANCING: CONTINUOUS TRACKING AND ADJUSTING OF THE PORTFOLIO TO ENSURE THAT IT REMAINS ALIGNED WITH INVESTMENT GOALS, RISK TOLERANCE, AND CHANGING MARKET CONDITIONS. 9 6 BENEFITS OF PORTFOLIO MANAGEMENT: CAPITAL APPRECIATION: IT WORKS TOWARDS INCREASING THE VALUE OF THE PORTFOLIO OVER TIME FOR LONG-TERM WEALTH CREATION BY INVESTING IN GROWTH-ORIENTED AND APPRECIATING ASSETS. PORTFOLIO MANAGEMENT PRESENTS THE BEST INVESTMENT PLAN TO INDIVIDUALS AS PER THEIR NEEDS AND REQUIREMENTS IN TERMS OF INCOME, BUDGET, AGE, AND ABILITY TO UNDERTAKE RISKS. TAX EFFICIENCY: STRUCTURING THE PORTFOLIO TO OPTIMIZE POST-TAX RETURNS BY UTILIZING TAX-ADVANTAGED ACCOUNTS, TAX-EFFICIENT INSTRUMENTS, AND SUITABLE ASSET ALLOCATION. 3 PORTFOLIO MANAGEMENT MINIMIZES THE RISKS INVOLVED IN INVESTING AND ALSO INCREASES THE RETURNS WITHIN A STIPULATED TIME PERIOD. 7 DIVERSIFICATION OF ONE’S HOLDINGS IS INTENDED TO REDUCE RISK IN AN ECONOMY. 1 MOST INVESTORS HOPE THAT IF THEY HOLD SEVERAL ASSETS, EVEN IF ONE GOES BAD, THE OTHERS WILL PROVIDE SOME PROTECTION FROM AN EXTREME LOSS. CAPITAL PRESERVATION: PROTECTING THE PRINCIPAL INVESTMENT AMOUNT AGAINST MARKET DOWNTURNS AND INFLATION, WHICH IS ESPECIALLY IMPORTANT FOR CONSERVATIVE INVESTORS. 2 GOAL-BASED ALIGNMENT: CUSTOMIZING PORTFOLIO STRATEGIES TO MEET SPECIFIC INVESTOR GOALS, SUCH AS RETIREMENT, EDUCATION, OR MAJOR PURCHASES, CONSIDERING TIME HORIZON AND RISK APPETITE. 3 4 4 8

6. NEED FOR PORTFOLIO MANAGEMENT 1 Portfolio management presents the best investment plan to individuals based on their income, budget, age, and ability to undertake risks. 3 Portfolio managers understand the client’s financial needs and can suggest the best and unique investment policy for them with minimum risks involved. 2 Portfolio management minimizes the risks involved in investing and also increases the chances of making profits. 4 Portfolio management enables portfolio managers to provide customized investment solutions to clients as per their needs and requirements.

7. PHASES OF PORTFOLIO MANAGEMENT SECURITY ANALYSIS This phase involves the examination of individual securities to assess their risk and return characteristics, using both fundamental and technical analysis. PORTFOLIO ANALYSIS Here, combinations of selected securities are analyzed for overall risk and return, considering various factors like diversification and investor’s risk tolerance. PORTFOLIO SELECTION The optimal portfolio is chosen from efficient portfolios, targeting the best risk-return balance suited to the investor's objectives. PORTFOLIO REVISION Portfolios are periodically monitored and adjusted to adapt to market changes and maintain optimal risk-return characteristics. PORTFOLIO EVALUATION The final phase measures the portfolio’s performance against benchmarks, assessing whether investment objectives have been achieved.

8. FACTORS FOR CONSTRUCTING A PORTFOLIO MODEL Investment Time Horizon: The duration for which investments will be held determines asset selection. Longer horizons can tolerate higher risk for potentially greater rewards, while shorter horizons may require safer, more liquid assets. Expected Rate of Return: The desired return level guides the choice and proportion of assets, balancing between high-return (usually high-risk) and stable-return (low-risk) investments. 1 Tax Implications: Selecting assets that offer tax advantages and structuring the portfolio for optimal post-tax returns ensures higher effective gains. 3 5 Liquidity and Marketability: Assets should be easily tradable and convertible into cash when needed, ensuring flexibility to meet unexpected financial needs or opportunities. 7 Risk Tolerance and Management: Each investor’s ability and willingness to withstand losses or volatility affects portfolio composition. Those with low risk tolerance favor conservative assets, whereas higher risk tolerance allows for more aggressive investments. Need for Diversification: Spreading investments across different assets, sectors, and geographies helps reduce unsystematic risks and enhance portfolio stability. Size of Investment Units: The amount allocated to each asset (unit size) impacts the degree of diversification and risk exposure. Proper allocation prevents over-concentration in any single asset. Security of Principal Invested: Prioritizing investments that protect the initial capital from erosion is especially important for risk-averse investors or those nearing their financial goals. 2 4 6 8

9. Aspect Traditional Analysis Modern Analysis Risk Focus Individual asset risk Portfolio-wide risk (variance, covariance) Diversification Minimal Central concept Asset Selection Basis Fundamental/Technical analysis Statistical models, Efficient Frontier Market Assumptions Inefficient markets Efficient markets Tools Used Simple calculations Advanced quantitative/statistical tools Success Means Lowest individual asset risk Optimized risk-return balance for the whole portfolio TRADITIONAL VS MODERN PORTFOLIO ANALYSIS

10. KEY COMPONENTS OF A PORTFOLIO SELECTION MODEL 1 Objective: Maximize portfolio value, minimize risk, and align investments with strategic financial goals and risk tolerance. 3 Risk-Return Analysis: Assess expected returns and risks (standard deviation/variance) for combinations of securities. Use of covariance and correlation to measure how assets interact together. 5 Constraints: Consider investor’s capital resources, time horizon, liquidity needs, and other limitations. 7 Optimization Techniques: Utilize mathematical/statistical models, including single-index, multi-index, or more advanced optimization methods to construct efficient portfolios. Example: Markowitz Model Markowitz’s Mean-Variance Model: • Developed by Harry Markowitz, this model finds the optimal portfolio by analyzing all possible combinations of assets and selecting those that lie on the “efficient frontier”—the set of portfolios offering the highest return for a given level of risk or the lowest risk for a given return. • Assumes risk is based on the variability (variance) of returns and that investors are rational and risk-averse. 2 4 Asset Allocation: Determine the proportion of different asset classes (e.g., stocks, bonds, cash) to achieve diversification and balance risk. Diversification: Select assets that do not move together (low or negative correlation) so that risk is reduced without sacrificing return. 6 Model Input: Use historical data, expected returns, beta values, and other statistics as model input for optimization.

11. PORTFOLIO SELECTION PROCESS 1 Identify potential assets: List all possible investment opportunities. 3 Optimize asset weights: Use quantitative models to select asset weights that maximize return for risk or minimize risk for required return. 5 Monitor and revise: Continuously track portfolio performance and rebalance as needed. 2 Evaluate expected returns and risk (variance/covariance): Calculate the expected return and risk for all combinations. 4 Apply constraints and adjust: Incorporate investor goals, risk tolerance, liquidity needs, and other specific requirements.

12. EFFECTS OF COMBINING SECURITIES Combining securities in a portfolio has several important effects, primarily related to risk reduction and return optimization through diversification: Risk Reduction: By holding a mix of different securities, the overall portfolio risk decreases because the poor performance of some assets may be offset by better performance of others. This reduces unsystematic risk, which is specific to individual securities or sectors. 1 Improved Risk-Adjusted Returns: Combining assets with different risk-return profiles enhances the risk-adjusted return of the portfolio, meaning investors receive better returns for each unit of risk taken. 3 Protection Against Market Volatility: When markets are volatile or downturns occur in certain sectors, diversified portfolios tend to experience less dramatic losses, helping to preserve capital. 5 Smoother Returns: Diversification leads to more consistent and stable returns over time, as fluctuations in one investment are counterbalanced by others. This lowers volatility in the portfolio’s overall value. Exposure to Opportunities: A diversified portfolio allows investors to participate in various sectors, geographies, and asset classes, potentially benefiting from different market cycles and growth trends. 2 4

13. PORTFOLIO RISK AND RETURN Portfolio risk and return refer to the expected performance and the uncertainty associated with the overall portfolio of investments. Return: The portfolio return is the weighted average of the expected returns of the individual securities within the portfolio. It represents the gain or loss generated by the portfolio over a period. Risk-Return Relationship: There is a fundamental tradeoff between risk and return in investing. Generally, higher expected returns come with higher risks, and investors have to balance their risk tolerance against their return expectations. 1 3 Measurement Metrics: ALPHA 1 Measures performance relative to a benchmark. Risk: Portfolio risk is the uncertainty or variability of returns. It is measured by the portfolio’s variance or standard deviation, which considers not only the individual risks of assets but also the correlations among them. BETA Diversification Effect: By combining securities that are not perfectly correlated, portfolio risk can be reduced without proportionally reducing expected returns. This is a core concept of modern portfolio theory (MPT). Measures sensitivity to market movements. 2 2 4 SHARPE RATIO Measures risk-adjusted returns. 3

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