Portfolio Management: Meaning, Types, Elements, Process and Importance


Portfolio management is defined as process of managing individual investments for maximizing the overall returns within given time frame. It is simply the art of choosing best investment policy for investors in respect of maximum return and minimum risk. This investment approach works on performing SWOT analysis of distinct investment avenues considering the goals of investors at specified risk appetite. Portfolio management enables people to know the right plan of doing investment according to their risk potential, income, age and budget. The money of people is invested under the supervision of experts i.e., portfolio managers whose main focus is on earning maximum profits at lowest risk level. These managers hold specialized license in investment field and are highly knowledgeable about various instruments of market. The portfolio managers provide clients with customized investment solutions considering their need and requirements by employing the technique of portfolio management.

The multiple investment avenues are managed by portfolio management under an overall umbrella referred to as portfolio. A portfolio is a mix of stocks, commodities, bonds, real state, cash as well as cash equivalents.  It is collection of overall financial investments held by individual for making profits. 

Types of Portfolio Management

Various types of portfolio management are as follows: – 

  1. Active Portfolio Management: Active portfolio management is type of management where manager is more focused on generating maximum returns for investor. Portfolio managers are actively involved in securities trading where they put significant part of resources. They usually buy stocks when their value is low and sell them off as the value increases.
  2. Passive Portfolio Management: This type of portfolio management is one where managers are concerned with fixed portfolio that is constructed in alignment with current trends of market. Portfolio managers invests more in index funds which carry steady return although it is low but may turn out to be profitable in future.
  3. Discretionary Portfolio Management: Discretionary portfolio management is a type where investor place funds with portfolio managers and entrust them with authority of doing investments on their behalf. It is responsibility of manager to look after all investment needs, documentation and choose suitable strategy of investment as per investor goal and risk appetite.
  4. Non-discretionary Portfolio Management: Under this type of portfolio management, investors get advice from portfolio managers on investment choices. It is up to the client or investor to either accept or reject the expert advice. All outcomes of investment be it profit or loss belongs to investor himself and service provider (portfolio managers) gets consideration for rendering services in form of fees.

Elements of Portfolio Management

The key elements of portfolio management are discussed in points given below: – 

  1. Proper asset allocation: The right long-term mix of assets is a key to effective portfolio management. This mean stock, bond, commodities, derivatives, cash and cash equivalents all of which differs from each other in volatility terms and does not move in same direction. Asset allocation is basically concerned with choosing appropriate mix of these assets which provide right balance and security against risk. It is more about managing the overall risk as numerous studies have shown asset allocation to be key determinant of both return as well as volatility of portfolio.
    Asset allocation therefore focuses on optimizing the overall risk/return of investor via selecting such mix of assets that have low correlation to one another. Individuals having aggressive profile can weigh their portfolio towards more volatile securities whereas one having conservative profile towards conservative securities.   
  2. Diversification: Predicting the winner or losers in world of investment is quite impossible thing. There are lots of fluctuations going at every point of time across distinct investments trading in market. The prudent approach to deal with such high risky environment is to hold a basket of investment which provide broad exposure within asset class. Diversification is all about spreading the overall risk and return within asset class by holding multiple types of securities instead of going for only type. Knowing which particular subset of asset class is going to outperform is difficult therefore diversification aims at getting returns of all sectors over time along with less volatility at any time period. A proper diversification is created across multiple classes of securities, sectors of economy and geographical regions.    
  1. Rebalancing and Restructing: Rebalancing and restructing means bringing back the portfolio to its original target allocation at regular intervals which usually take place on annual basis. It is mainly done in order to retain the original asset mix which reflects the risk/return profile of investor. For an instance, a portfolio which was originally formed with 70% equity and 30% fixed income allocation may shift to 80/20 allocation due to external market movements. The portfolio gets exposed to high-risk value as compared to what investor can tolerate which is now returned to its original position via rebalancing. Rebalancing generally leads to selling of high-priced/low value investments and putting the money recovered back into low-priced/high value investments. This practice carried out on annual basis helps investor in capturing gains and opens opportunities for growth in high potential sectors while keeping them aligned with their respective risk/return profile. 

Process of Portfolio management

There is a complex process involved in portfolio management, therefore, following steps need to followed in careful manner. 

  1. Identification of objectives and constraints: Process of portfolio management initiates with the identification of objectives as well as constraints of investor. Investment objectives are outcomes in respect of return and risk which client desires to achieve whereas any limitations on investment decisions are constraints. The risk-bearing capacity of investor as well as his/her ability to withstand volatility should be well-know for effective portfolio management. Investors may be either willing to have maximum return at minimum risk or capital appreciation. 
  2. Selection of asset mix: The second major step involved in portfolio management process is identification of distinct assets which can be included in portfolio within the goals and risk appetite of investor. Relationship among the securities need to be clearly specified here in this step. A portfolio may be composed of mixture of equity shares, preference shares, bonds, debentures and many more. The proportion of various asset to be included in portfolio is determined as per the risk-bearing ability and investment limit of individual.  
  3. Portfolio strategy formulation: Once an appropriate asset mix is selected, then the next step in portfolio management process is forming right strategy of portfolio. There are 2 options available for appropriate portfolio strategy creation: active portfolio strategy and passive portfolio strategy. Active strategy of portfolio is one which seeks to make superior risk adjusted return via adopting as per the market timing. The strategy switches from one sector to another in accordance with scenario of market, security selection or mixture of all these. Whereas, passive strategy on other hand has pre-determined risk exposure level. There is broad diversification of portfolio that is strictly maintained. 
  4. Security analysis: Security analysis is step where investor for selecting securities involves himself actively. This step involves analysis of securities from risk and return perspective which is done with help of required information. Factors such as price, possible risk and return, growth potential and volatility are all evaluated of securities for portfolio. Risk and return are both co-related to one another such that for every amount of return, there is always risk associated with it. Security analysis enables in easy understanding of risk and return nature of specific security in market. There are basically two analysis which are done under security analysis which are micro analysis and macro analysis. Micro analysis is analysis of one script and analysis of market of securities of macro analysis. 
  1. Execution of portfolio: The execution of portfolio plan is next step in portfolio management process which is done once securities for investment are chosen. Portfolio plan executive relates to purchasing and selling of particular securities in given amounts. It is one of the crucial steps in portfolio management as it has direct influence on investment results. The transaction cost involved in portfolio execution can bring down the overall performance of portfolio. Various elements of transaction cost are explicit costs such as fees, commission, taxes etc. and implicit cost like opportunity cost, bid-ask spread, market price impacts etc. Therefore, it is must to ensure that portfolio executive is properly timed and well-managed. 
  2. Revision of portfolio: Portfolio revision is major step utilized by portfolio manager for keeping portfolio within the goals and objectives of investor. After an optimal portfolio is constructed, portfolio managers keep portfolio under their close supervision for making sure that portfolio remains optimal in coming time. Activities such as adding or removal of scripts, moving from one stock to another or from stock to bond and vice versa taking place under portfolio revision for earning good returns. 
  3. Evaluation of portfolio: Portfolio evaluation is phase where performance of portfolio is measured by portfolio manager. Manager over a selected time period need to be examine the portfolio performance. Examination of performance includes checking relative pros and cons of portfolio, risk and return factors, portfolio management adherence to publicly stated investment objectives or combination of all these. The actual amount of return earned and risk borne by portfolio over investment period is quantitively measured while assessing risk/return criterial. Portfolio evaluation is very useful step which helps in enhancing the portfolio management quality on continuous basis by providing feedback. 

Importance of Portfolio Management Process

The importance of portfolio management process can be well-understood from points given below: – 

  1. Security of principal invested: The first and primary role played by portfolio management is security of investor’s hard-earned money. Every individual investor their money with the aim of earning best return at lowest possible risk. There are lot of risky securities being traded in market which seems to be profitable and may result in loss of principal amount invested by individuals. Portfolio management assist in easy identification of risky and optimum assets so that investment can be made in assets which falls with risk/return appetite of individuals.   
  2. Allocation of funds for maximum returns: There are many factors for which portfolio management process is carried out such as desired return, risk-bearing potential etc. Active management of portfolio can ensure you maximum return at lowest risk on your hard-earned money. A good portfolio has potential of earning you good returns but its right management can bring bigger returns for you. Management of portfolio make sure that portfolio remain optimum at all point of time during investment period and going in the direction of investor goals. 
  3. Bring down overall risk: It is one of crucial benefit offered by process of portfolio management. Every investor wants to avoid every part of risk associated with his/her desired profit level. Portfolio management can help you a lot in adjusting risk you are taking on your capital for earning returns. It helps in doing easy distinction in between high-risk assets and low-risk assets so that investors can accordingly pick them as per their capabilities. Debt funds and fixed assets are some of the low-risk assets having less returns whereas equity markets are highly risky with potential of making good returns.
  4. Informed decision making: Portfolio management provides a sufficient amount of information regarding market assets which leads to informed decision making by investors. It provides greater insight into cost, risk, return, volatility, growth potential etc. of investment securities. When individuals are well-informative on all these crucial factors then they build portfolio out of optimum assets resulting in maximum return at low risk. 
  5. Diversification: An actively managed and well-balanced portfolio offers a great advantage of diversification to investors. Diversification stands for spreading your overall risk by doing investment in multiple class securities. It saves from encountering risk posed by single asset as when different types of assets are included in portfolio then loss by one asset is covered by profit generated by other assets. 
  6. Tax planning: Portfolio management results in efficient tax planning of investors. Individuals holding a portfolio of investments can have fewer tax obligations. It is possible to do tax planning as part of portfolio management. By doing investment of some amount of capital in instruments like PPF, PF, NPS, NSC etc., investors can save good amount of their money which they might have paid as tax payments.