Meaning of Portfolio Management
Portfolio management is defined as the process of managing individual investments for maximizing the overall returns within a given time frame. It is simply the art of choosing the best investment policy for investors in respect of maximum return and minimum risk. This investment approach works on performing a 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 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 the lowest risk level. These managers hold a specialized license in the investment field and are highly knowledgeable about various instruments of the market. The portfolio managers provide clients with customized investment solutions considering their needs and requirements by employing the technique of portfolio management.
Types of Portfolio Management
Various types of portfolio management are as follows: –
Active Portfolio Management
Active portfolio management is a type of management where the manager is more focused on generating maximum returns for investors. Portfolio managers are actively involved in securities trading where they put a significant part of their resources. They usually buy stocks when their value is low and sell them off as the value increases.
Passive Portfolio Management
This type of portfolio management is one where managers are concerned with a fixed portfolio that is constructed in alignment with current trends of the market. Portfolio managers invest more in index funds which carry steady return although it is low but may turn out to be profitable in the future.
Discretionary Portfolio Management
Discretionary portfolio management is a type where investor place funds with portfolio managers and entrust them with the authority of doing investments on their behalf. It is the responsibility of the manager to look after all investment needs, and documentation and choose suitable strategies of investment as per investor goal and risk appetite.
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 belong to the investor himself and the service provider (portfolio managers) gets consideration for rendering services in form of fees.
Objective of Portfolio Management
The key elements of portfolio management are discussed in the points given below: –
Proper asset Allocation
The right long-term mix of assets is key to effective portfolio management. This means stock, bond, commodities, derivatives, cash, and cash equivalents all of which differ from each other in volatility terms and do not move in the same direction. Asset allocation is basically concerned with choosing an appropriate mix of these assets which provide the right balance and security against risk. It is more about managing the overall risk as numerous studies have shown asset allocation to be the key determinant of both returns as well as the volatility of the portfolio.
Asset allocation, therefore, focuses on optimizing the overall risk/return of investors via selecting a mix of assets that have a low correlation to one another. Individuals having aggressive profiles can weigh their portfolio towards more volatile securities whereas one having a conservative profile towards conservative securities.
Predicting the winner or losers in the world of investment is quite an impossible thing. There are lots of fluctuations going on at every point in time across distinct investments trading in the market. The prudent approach to deal with such a high-risk environment is to hold a basket of investments that provide broad exposure within the 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 one type. Knowing which particular subset of the 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. Proper diversification is created across multiple classes of securities, sectors of the economy, and geographical regions.
Rebalancing and Restructuring
Rebalancing and restructuring mean 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 the investor. For an instance, a portfolio that 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 investors can tolerate which is now returned to its original position via rebalancing.
Rebalancing generally leads to the 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 investors in capturing gains and opens opportunities for growth in high-potential sectors while keeping them aligned with their respective risk/return profiles.