The process of portfolio management Robert A. Strong.pdf

Chapter 1 portfolio construction Robert A. Strong

1. The Process of
Portfolio Management
Chapter 1

2. Intro :-
•The traditional investments course covers two principal topics: security analysis and portfolio
management.
•Security analysis involves estimating the merits of individual investments, many people call this
procedure EIC analysis for economy, industry, and company.
•while portfolio management deals with the construction and maintenance of a collection of
investments.
•Most of the academic literature from the last two decades generally supports the efficient markets
paradigm. Market efficiency means that on a well-developed securities exchange, asset prices
accurately reflect the trade-off between the relative risk and potential return associated with the
security.

3. Intro :-
•Portfolio management primarily involves reducing risk rather than increasing
return By reducing the dispersion of an investment’s returns while holding
the mean return constant, the investor fares better.
•Before the portfolio manager can do the job, however, there needs to be a
statement of investment policy. This outlines the return requirements, the
investor’s risk tolerance, and the constraints under which the portfolio must
operate.

5. Step 1 : Learn the basic principles of finance
•The two key concepts in finance are
(1) a dollar today is worth more than a dollar tomorrow and
(2) a safe dollar is worth more than a risky dollar.
These two ideas form the basis for all aspects of financial management.
•The whole point of investment management is to get more of what you like and get rid of what you
dislike.
•The goal is to get as much of the “good” while suffering as little of the “bad” as possible.
•All of finance stems from the basic concepts of the risk/return trade-off and the time value of money.
•A good company is not necessarily a good investment.
•Talk is cheap in the investment business, People can say that they know how to do something, but in the
final analysis, it is deeds, not dialogue, that count.

6. Step 2 : Set portfolio objectives
•According to an old saying, “It is difficult to accomplish your objectives until
you know what it is you want to accomplish.”
•Setting objectives and determining investment policy.
•Portfolio objectives : people think they understand words such as growth or
income, but these terms often mean different things to different people. the
difficulty people have in finding a balance between risk and expected return
and provides a framework for determining portfolio objectives.

7. Step 2 : Set portfolio objectives
•A formal statement of investment policy is a very useful tool. This document
clearly outlines responsibilities and procedures. It is an important part of the
investment process to make sure such a document exists.
•The separation of investment policy from investment management is a
fundamental tenet of institutional money management.
•One group of people, such as a board of directors or an investment policy
committee, establishes the rules of the game and hires someone to play the
game. These people establish policy. The investment manager is the person
who implements the plan. It is a mistake (sometimes very serious one) and
possibly a breach of legal duty.

8. Step 3: Formulate an investment strategy
•This involves more than simply buying a handful of securities so that all your eggs
are not in one proverbial basket. There are many different things to consider and to
monitor.
•Portfolio managers need to understand the basic elements of capital market theory.
The mathematical relationships underlying portfolio theory, risk reduction benefits,
international investment, emerging markets, the implications of this to the investor
and the portfolio manager & beta statistic .
•Security screening : Managers need a logical protocol to reduce the total to a
workable number for closer investigation. We call such a technique a screen.

9. Step 3: Formulate an investment strategy
•“Bond Pricing and Selection,” reviews basic principles regarding the pricing of debt
securities. In addition, it introduces the concept of duration, which enables the
portfolio manager to alter the risk of the fixed-income component of a portfolio
quickly and efficiently without having to perform complex calculations or trial-and-
error iterations.
•The set of investment possibilities includes assets other than stocks and bonds.
Pension funds pay attention to gold and timberland; these are examples of real
assets.
•Alternative investments, this asset class includes a variety of esoteric investment
vehicles including infrastructure (like bridges, toll roads, and parking garages), hedge
funds, and private equity.

10. Step 4: Have a game plan for portfolio revision.
•Having formed a portfolio, an investor should not normally leave it untended.
Conditions change, and portfolios need maintenance. Developing a game plan for
updating the portfolio is the fourth step of portfolio management.
•An investor can manage a portfolio passively or actively.
•Passive management involves letting the chips fall where they may, either by doing
nothing or by following a predetermined investment strategy that is invariant to
market conditions.
•Active management requires the periodic changing of the portfolio components as
the manager’s outlook for the market changes.

11. Step 4: Have a game plan for portfolio revision.
•manager should understand the basic principles of options and option
pricing. This includes an understanding of where options come from, why
they are a good idea, and what basic strategies portfolio managers might use.
•Option overwriting is a popular activity designed to increase the yield on a
given portfolio and to improve performance in a flat market.

12. Step 5: Evaluate the performance

13. Step 6: Protect the portfolio when appropriate
•Portfolio protection is a powerful managerial tool designed to reduce the
likelihood that a portfolio will fall in value below a predetermined minimum
level.
•Protecting the portfolio when appropriate is the final aspect of the portfolio
management process.