Question

Briefly discuss the three major steps in Portfolio Management Process with your own examples when necessary.

Answer 1

Solution:

Portfolio Management process is the process the investor takes to help him meeting his investment goals,

Major Steps in Portfolio Management Process are 1) Plannning 2) Execution and 3) Feedback.

Planning: Planning involves understanding the needs of the customer. It involves analysing the investor’s objectives and constraints, and creating an Investment Policy Statement . Without really understanding investor’s objectives for investing and the constraints they have, it is difficult for an investment manager to come up with a suitable investment plan. The Investment Policy Statement is a written document that officially documents the objectives and constrains for each investor and that needs to be followed for making the investments. The investment manager will typically review the Investment Policy Statement every few months or on the occurrence of a specific event and make any necessary revision

For eg: an IPS generally states reporting requirements, rebalancing guidelines, frequency and format of investment communication, manager fees, investment strategy, and the desired investment style or styles of investment managers.

Execution: The next step is to actually make the investments. This starts by first deciding on how we will allocate the funds between different asset classes. This is called asset allocation. The major asset classes include equities, fixed income, commodities, and real estate. After asset allocation, we need to analyse the individual securities for possible investment. Finally the portfolio manager will construct the portfolio by considering all the information he has including the investment policy statement, asset allocation, and security analysis. While constructing the portfolio the portfolio manager has to make many decisions including weights for different asset classes, weights for assets within an asset class, security selection, etc. This step also involves trading in the financial markets as the manager will have to actually purchase the required securities for the required amounts.

For Eg: the asset allocation might change to reflect an investor’s current circumstances that are different from normal. The temporary allocation may remain in place until circumstances return to those described in the IPS and reflected in the strategic asset allocation.

Feedback: Last step is the continual monitoring of the investor's needs, capital market conditions, and, when necessary, updating the policy statement. One component of the monitoring process is evaluating a portfolio's performance and comparing the relative results to the expectations and requirements listed in the policy statement. Some rebalancing may be required.

For eg:, if the original plan was to invest 80% in equities and 20% in fixed income, and equities have done really well, then with the new prices, the proportion would have changed and equity portion would have become higher (e.g., 85:15). In this case the portfolio manager will rebalance the portfolio by selling some equity (mostly the ones not performing well) to bring the balance back to 80%:20%. The portfolio manager depending on his style will monitor and rebalance the portfolio from time to time.