Portfolio Management: Meaning, Types and Approach

You have learned all about fundamental analysis and reached the final step of the process, which is portfolio management. In this chapter, we’ll dive into the details of portfolio management and also look at how you can select a good professional portfolio manager. 

Portfolio management refers to the art and science of making investment decisions across various asset classes to achieve specific investment goals. It involves creating a diversified portfolio aligned to an investor's risk appetite and expected returns and managing it actively through changing market conditions to optimise returns. This process requires assessing financial goals, designing tailored investment strategies, selecting securities, balancing risks and regularly tracking performance.

Effective portfolio management is key for investors seeking to grow wealth by leveraging market opportunities while insulating capital against volatility. This comprehensive guide explores portfolio investment approaches, strategies, regulatory landscape and best practices for creating balanced, high-performing investment portfolios.

What Is Portfolio Investment?

Portfolio investment refers to owning a basket or collection of securities like stocks, bonds, real estate and other asset classes rather than a single security. It provides exposure across multiple investments, asset types, sectors, regions, etc., to spread out risks. 

The objective is to hold assets expected to offer favourable risk-adjusted returns or capital growth over time. Portfolio creation aligns investments to financial goals like retirement planning or children's education while considering parameters like investment horizon, liquidity needs and risk appetite.

Professional portfolio managers design and manage tailored portfolios suitable to an investor's unique requirements. However, today's DIY investment platforms also enable self-directed portfolio management.

Types of Portfolio Investments  

Investment portfolios can span various asset classes catering to different investment styles and financial goals.

1. Equities 

Investing in stocks or shares of publicly listed companies provides exposure to equity markets. Concentrated equity portfolios holding stocks of few companies carry higher risks, while broader market-based equity portfolios mitigate risks through diversification.

2. Fixed Income  

Fixed-income securities like bonds, fixed deposits, and debentures provide regular income. Government and corporate bonds offer low-to-medium risks and returns.

3. Cash and Cash Equivalents 

Cash equivalents like savings accounts, CDs, and T-bills offer easy liquidity and capital preservation despite low returns. Every portfolio holds some cash to meet liquidity needs.

4. Alternative Investments  

Alternative investments like gold, real estate, private equity, venture capital funds, antiques and cryptocurrencies can enhance portfolio diversification. Underlying assets drive risk-return profiles.

5. Mutual Funds

Mutual funds offer professionally managed portfolios investing across equities, fixed income, etc. Index funds track market indexes, while active funds aim to outperform.

6. ETFs  

Exchange-traded funds trade on exchanges like stocks but hold underlying assets to track indexes, sectors, themes, etc. They provide diversified exposure at low costs.

Portfolio Investment Approaches  

Strategic approaches for portfolio investments focus on optimal asset allocation, continuous tracking and balancing to achieve investment objectives over the long term.

• Strategic asset allocation 

This involves assigning specific asset class weights within a portfolio in line with financial goals and risk profiles. Asset types, regions, sectors and market caps should be adequately represented.  

• Aligning with financial goals

Portfolio construction factors include investment horizon, liquidity needs and risk appetite linked to financial goals and life stage. For instance, millennial portfolios tolerate more risk than pre-retirees.

• Diversification 

Allocating capital across diverse, non-correlated asset classes and securities insulates against market swings in any single asset. Broad diversification underpins risk mitigation.

• Regular rebalancing  

As market movements skew asset allocations over time, portfolios need rebalancing back to original targets for optimal asset allocation. Rebalancing also takes evolving life circumstances into account.

• Performance monitoring and tracking

Investors can gauge progress towards financial objectives and make enhancements by regularly assessing portfolio returns versus appropriate benchmarks.

• Risk management

Portfolio risk management tools like asset allocation, security selection, diversification, liquidity planning, personal insurance cover, hedging and loss harvesting help mitigate overall investment portfolio risks. 

Active vs Passive Portfolio Management  

Investors can choose between active and passive portfolio management approaches based on their inclination toward monitoring investments and their ability to take risks.

Active portfolio management 

In active management, portfolio managers actively track markets to identify mispriced assets and exploit short-term opportunities through tactical asset allocation. They assemble concentrated portfolios of selected well-researched stocks aiming to outperform the broader market. 

Actively managed mutual funds and alternative investment portfolios fall under this style, charging higher fees. However, Outperformance is not guaranteed as active decisions could underperform too. Investors must closely track fund performance against benchmarks.

Passive portfolio management  

Passive portfolios aim to generate market-equivalent returns by simply mirroring the performance of a market index like BSE Sensex or Nifty 50 without attempting to beat it. Index investing via index mutual funds and exchange-traded funds helps create diversified portfolios at minimal costs.

As no stock selection or market timing decision-making is involved, passive portfolios offer simplicity for hands-off investors despite potential underperformance compared to active selections.  

Optimal Portfolio Construction Approaches

• Factor investing portfolio  

This framework identifies factors like value, growth, quality, volatility, etc., that drive a company's share price irrespective of its sector. Portfolios are built with a mix of stocks exhibiting specific factors like high growth or low volatility.

• Core-satellite portfolio   

This has twin components – core holdings tracking market indexes through index funds or ETFs providing broad diversification, while satellite holdings comprising actively managed funds, sector funds, or selected stocks to enhance returns. The core mitigates portfolio risk.

• Bucket portfolio 

This tailors asset classes to investment horizons - short-term, medium-term and long-term needs are mapped to suitable securities. For instance, current income needs depend on cash, while retirement corpus should emphasise equities for growth. This balances liquidity, income and growth.

Types of Portfolio Risk

Investment portfolios carry inherent risks arising from external market conditions as well as internal selections. Understanding risk types is key to portfolio construction.

• Systematic risk  

These are market-related risks arising from economic, political or social events affecting entire asset classes. Investors cannot avoid systematic risks but can insulate against them via diversification.

• Unsystematic risk

Also called idiosyncratic risk, this relates to industry/company-specific events like financial issues, lawsuits, etc. Impacting just single assets. Diversifying across sectors, regions, and companies helps mitigate unsystematic risks.

• Interest rate risk

For fixed-income assets like bonds, rate hikes directly lower their market values and portfolio returns as new bonds offer higher yields. Bond portfolio durations and yield curve alignments help manage such risk.

• Credit risk  

This refers to the risk of default by bond issuers or counterparties in derivatives, etc. Rating downgrades also impact valuations. Careful credit assessment during security selection and diversification across issuers can alleviate this risk.

• Liquidity risk

This affects the ability to sell assets without significant price discounts and convert them to cash to meet funding needs. Holding cash buffers as well as liquid assets like large-cap equities can help address unexpected liquidity pressures.  

• Currency risk

For offshore investments or multi-currency portfolios, exchange rate fluctuations alter returns for Indian investors. Currency hedging using derivatives, multi-currency funds or assets with negative currency correlation can help offset such risks.

• Geopolitical risks  

Cross-border investments expose portfolios to geopolitical events like policy changes, sanctions, etc, materially impacting returns. Diversifying across geographies helps cushion country-specific impacts.  

Risk Profiling in Portfolio Management  

As risks directly impact portfolio returns and the ability to achieve financial goals, assessing risk appetite is crucial before building investment portfolios. SEBI-registered portfolio advisors follow a systematic risk profiling process encompassing the following:

• Understanding investors' financial needs, goals, and timeframes.
• Analysing income, saving and spending patterns to gauge the investible surplus.  
• Evaluating existing investment exposures across assets.
• Ascertaining life stage needs, responsibilities and liquidity needs impacting investment horizon.
• Conducting a formal risk assessment questionnaire to determine risk tolerance. Conservative, moderate or aggressive risk attitude is identified based on the investor’s willingness and ability to tolerate volatility, losses and fluctuations across market cycles.  

The interplay between return expectations and risk appetite needs alignment. This ultimately guides optimal asset allocation between equities, fixed income and cash for balanced portfolios. Younger investors with longer investment horizons and a focus on wealth creation can target higher equity exposure compared to older pre-retirees prioritising capital preservation.

Portfolio Optimisation Techniques  

Portfolio optimisation aims to construct optimal portfolios offering the highest returns for the given risk tolerance while minimising risks for the expected return level. Mathematical models guide security selection and asset allocation.

Harry Markowitz pioneered the Modern Portfolio Theory underlying such optimisation. It quantifies the relationship between portfolio risk & returns to identify an ‘efficient frontier’ spectrum depicting optimal portfolio combinations for which:

• Returns are maximised for any given risk level  
• Risks are minimised for any given return requirement

Using historical return data, covariances between assets and risk-free rates, efficient frontiers can be mapped, showing curved optimal portfolios. Practical challenges, however, constrain the realisation of theoretical projections. Still, optimisation provides a principled portfolio creation approach.

Key optimisation inputs are:

• Expected returns for each asset based on fundamentals 
• Volatilities reflecting portfolio risks 
• Correlations between asset class movements

By maximising the portfolio Sharpe ratio, assets are allocated for optimum return per unit of risk taken. As higher stock allocation enhances returns but also risks, optimisation provides the most efficient risk-adjusted allocation.

Main Types of Portfolio Strategies

Investment portfolio strategies range from aggressive accumulation to defensive preservation across investor risk appetites and market cycles.

• Growth portfolio  

Growth portfolios target wealth creation over the long term, like 20-30 years for retirement or children’s goals. By overweighting equities of firms with strong growth prospects, tolerant investors get significantly higher return potential despite short-term volatility. Concentrated bets on emerging themes, markets and small-caps can enhance rewards.

• Income Portfolio   

Income portfolios emphasise assets generating regular cash flows like bonds, rental yields, annuities and dividends from mature companies. Conservative investors, retirees or those seeking supplementary earnings rely on such portfolios, parking limited capital in modest but stable return assets.  

• Balanced portfolio   

For moderate risk appetites, balanced portfolios provide the best of both worlds by allocating between equities and fixed income across market caps, categories and geographies. Built to weather volatility through diversification, balanced portfolios enable participating in the upside while limiting downsides akin to hybrid mutual funds. Rebalancing helps maintain stability.

• Market cycle portfolio  

Tactical market timers alter their asset mix, allowing greater flexibility across market cycles. When markets peak, assets shift towards fixed income or cash to preserve gains until equities become attractive again after corrections to re-enter. This active approach relies strongly on reading macroeconomic trends and sentiment shifts correctly.

• Factor-based portfolio  

Spanning market segments, this targets consistent horses for courses like concentrated value picks or diversified low volatility shares rather than chasing recent top performers. By focusing on fundamentals rather than emotions, such portfolios improve investing consistency. However, strict rules need compliance.  

• ESG portfolio  

Values-based investing portfolios apply environmental, social and governance filters to align investments with personal beliefs or ethics. ESG factors take precedence over raw returns, which are constrained to sustainable, responsible assets. However, variety limits flexibility in small markets like India currently.

Common Portfolio Management Strategies 

• Rupee Cost Averaging  

By investing fixed amounts at regular intervals, investors benefit from volatility by purchasing more assets when prices drop and fewer when they rise. Over time, costs average out, enhancing returns. SIP investments employ this time-tested approach, allowing budgeting small sums like Rs.5000 monthly rather than large lump sums.

• Rebalancing

Recalibrating portfolios back to original allocations helps lock investment gains and enforce discipline to adhere to predefined risk levels essential for financial goals. Rebalancing also accounts for life-stage priorities and market cycles.

• Loss Harvesting   

Booking losses by selling off underperforming investments offset capital gains taxes liability while redirecting freed-up capital into better-performing assets, improving overall returns. However, loss selling should factor in long-run potential, too.

• Churning   

Portfolio churning completely realigns existing holdings to preferred assets periodically to capitalise on emerging segments and fund manager styles while cutting losses. But churning also exposes to transaction costs and taxes.

• Hedging 

Mitigating risks in turbulent times by using derivatives as portfolio insurance helps protect existing gains through covered calls, long puts, etc. Hedging should be judicious, not excessive, or profit potential gets curtailed.

Selecting Optimal Financial Assets for Portfolio Inclusion

While risk appetite guides allocating investments across stocks, bonds and cash, selecting specific assets calls for diligent scrutiny of some key parameters for shortlisting:

• Company Fundamentals 

Evaluating financial health, competitive strengths, governance standards, growth runways, profitability drivers, and capital efficiency is crucial while screening quality stocks with promising upside. Distribution channels, input costs and industry tailwinds also need accounting.

• Investment Attributes 

In addition to robust fundamentals, assessing key investment-specific aspects also helps determine asset selection. 

For stocks, it is earnings visibility, cash flows, ROCE, ROC, valuations, and price momentum.  

For mutual funds, it is consistent alphas over benchmarks, risk-adjusted returns, and AUM growth. 

For bonds, there are high ratings, coupon rates, liquidity, and duration risks.

• Macro Analysis  

To identify opportunities and risks, tracking economic growth, fiscal deficit trends, inflation, credit cycle, currency movements, commodity prices and monetary policies provides a top-down perspective on vulnerable sectors, attractive segments, etc. 

• Qualitative Analysis  

Reviewing historical price charts to uncover support-resistance levels, long-term trend direction, and trading volumes to supplement business analytics. Relative strength vs. benchmarks and sentiment trends also help time entries.

• Portfolio Fit  

Checking an asset's diversification benefits and portfolio fit in terms of return drivers, growth avenues, and correlations aids cohesiveness rather than disjointed portfolios. Too many overlaps get avoided. Option synergies and strategic alignments also support related holdings like insurers + hospitals.

Core Aspects of Risk Management in Portfolio Analysis

While portfolio expansion seeks higher returns, the critical flipside of chasing alpha is heightened risks. By incorporating safety nets, adverse black swan events get contained. Core risk considerations include:  

• Diversification 

Avoiding concentrated bets in limited assets, sectors, or geographies enhances risk-adjusted returns over market cycles through diversification across categories. Blend market caps, sectors, regions, and asset types.  

• Hedging 

Portfolio insurance via index put options, inverse ETFs or covered call writing partially compensates losses from market slides. But being over-hedged also cuts positive returns. Balance protection cost with buffer required. Know when to hedge.

• Liquidity   

Ensuring adequate cash reserves or quick-conversion assets like overnight funds, arbitrage funds or short-duration bonds ensures liquidity access to address emergencies without expensive distress selling of core holdings or portfolio disruption.

• Customization  

Aligning investments strictly as per designated goals, timeframes, and risk tolerance minimises the possibility of reactive mistakes, even in stressful situations. Customised portfolios aid discipline.

• Dynamic course correction 

Stay nimble by regularly reviewing portfolio structure, diversity and market alignment to economic fundamentals for proactively modifying compositions utilising loss harvesting, rebalancing, and churning strategies to improve return potential while mitigating emerging risks. 

Core Aspects of Risk Management in Portfolio Analysis

Ongoing portfolio assessments help measure progress toward targeted asset accumulation or wealth creation goals by employing specific quantitative return & risk gauges.

• Absolute returns

The actual portfolio gains or losses over a period. However, absolute returns vary widely across assets, so using norms aids comparability. 

• Risk-adjusted returns  

Performance ratios like Sharpe and Treynor determine returns earned per unit of risk taken, where higher values signify better. Helps compare uneven assets.

1. Alpha  

Returns generated by a portfolio over & above the benchmark returns due to savvy asset selection or market timing. Demonstrates outperformance vs. index.

• Beta

Beta indicates portfolio volatility in relation to overall markets. Higher beta portfolios carry higher systematic risk but also higher return potential if markets rise.  

• R-squared

It assesses diversification across assets whose price movements are not synchronised. Lower R-squared indicates assets are not moving in tandem. Better diversification should proportionately lower R-squared.

• Standard deviation 

Measuring dispersion of returns from the expected average, S.D conveys unpredictable variability where higher figures signal greater volatility risks likely.  

• Sharpe Ratio  

This crucial return-to-risk gauge indicates outperformance with respect to the risk-free rate. So, the Sharpe Ratio effectively determines excess returns achieved per unit of volatility risk taken by an investment portfolio.  

• Information ratio

Performance benchmarking metric quantifying a portfolio’s returns over the volatility of its returns vis-à-vis a benchmark. Positive information ratios suggest outperformance.

Investment Portfolio Reporting  

SEBI mandates detailed performance reporting by Portfolio Managers to investor clients, including:

• Policy statements mapping investments to goals 
• Returns reporting vs. benchmark comparison 
• Online account access
• Holistic comparison across financial assets held 
• Fee breakup across services
• Risk profile evolution 
• Performance attribution identifying key outperformers  
• Compliance declarations

Such transparency obligations foster trust between portfolio advisors and investors while ensuring visibility into portfolio holdings and risk exposures.

Regulations Governing Portfolio Management in India

SEBI (Securities & Exchange Board of India) regulates the portfolio management industry as portfolio managers handle sizeable public funds. Standardised practices safeguard small investors.

• SEBI Portfolio Manager Rules 2020

These rules govern portfolio manager eligibility, responsibilities and restrictions, including disclosure, reporting requirements and grievance handling.

• SEBI Prohibition of Fraudulent Trade Practices Rules 2003

These rules bar portfolio managers from making false statements, concealing information or spreading rumours to induce securities transactions.

• SEBI Depository Receipts Regulations 2021  

These rules regulate foreign companies accessing Indian securities markets for raising funds via depository receipts issuances and alignments. 

Eligibility Criteria for Portfolio Managers

• Net Worth Requirements 

Portfolio managers need a minimum net worth of Rs5 crore. Net worth represents owned capital funding operations, denoting capital adequacy.

• Form C certification  

Companies must secure an SEBI-registered ‘Certificate of Registration’ in Form C confirming compliance with eligibility prerequisites before commencing portfolio services.

• Key personnel standards 

Firms must appoint a principal officer designated as the compliance head responsible for monitoring enforcement. Specific qualifications apply for portfolio manager roles like MBA or professional certifications (CFA, FRM). 

Duties and Responsibilities of a Portfolio Manager

SEBI mandate certain legally binding duties for portfolio managers:

• Fiduciary responsibility   

This means portfolio managers must act solely in clients’ interests while managing investment decisions. No self-dealing is allowed. Setting service charges reasonably also comes under fiduciary duty.

• Capacity disclosure   

Managers must reveal their capacity in securities allotments during IPOs or offers specifying own/client allotments separately. 

• Segregating client assets   

Managers must keep client funds and securities demarked separately from their assets and other clients’ holdings. No pooling is allowed, which can lead to mis-utilisation risks.

• Transparency and disclosure   

Managers must share adequate information about portfolio strategies, structures, costs and risks through policy statements to help investors make informed decisions. Any conflicts of interest must also be disclosed formally.

How To Manage Your Portfolio on Angel One?

1. Open the Angel One app. Go to ‘PORTFOLIO’.
2. First, go to ‘Equity’. All the stocks and ETFs that are delivered to your demat account will be displayed here, along with your daily and overall gains/losses.
3. You can check the performance of your Mutual Funds and SGBs from their respective sections on the Portfolio page.
4. You can also click on ‘ANALYZE’ in order to use the Portfolio Analyzer to better understand your Portfolio. It will show how the different segments of your portfolio are performing.

Conclusion

Constructing profitable yet balanced portfolios for wealth creation rests on alignment, diversification and discipline. Dynamic course corrections guided by data-based analytics separate thriving portfolios from average performers. Ultimately, staying invested matters most, given equity markets reward long-term commitment despite inherent volatility. So, design sturdy portfolios customised to your needs and let compounding work magic!

With this, you are now ready to start building your own portfolio. In the upcoming chapter, we’ll learn how to monitor your portfolio and learn about rebalancing.