In: Finance
Explain the 2-step portfolio construction process and briefly discuss its implications for the investment management industry.
here , explains the portfolio construction process and its implications for the investment management industry.
Portfolio meaning :
Portfolio is termed as a grouping of financial assets such as bonds , stocks , currencies , commodities and other cash equivalents , then mutual , exchange traded and closed funds .
it also includes , non publically tradable securities like art , real estate , private investments ..etc.
These are directly managed by financial professionals and money managers.
Time and risk tolerance are considered when choosing investments to set up a portfolio .
Risk tolerance impact on portfolio allocation are as follows :
A conservative investor will take portfolio with large cap stocks , high grade cash equivalents , broad based market index funds , investment grade bonds...and position in liquid .whether , a risk tolerant investor take small cap stocks to an aggressive , high yield bonds , international and other alternative investing opportunities to built up their portfolio .
Time horizon impact in portfolio allocation as follows :
An investor who saves for retirement , may plans to leave the workforce in during years example , in 5 years .then despite their comfort level investing in stocks and risky securities .then large portion will invest in conservative items such as cash , bonds ..etc., which protect them .
In an investor just enter into portfolio making , they will invest mostly in stocks , and take the ability to ride out market's short term volatility .
Meaning of portfolio construction is ,
Portfolio construction termed as a process of choosing optimum mix of securities needed for the achievement of maximum return by minimum risks.
Step 1 = assessment of current situation.
While we takes for future planning , firstly needed to know about investor's current situationin relation to where they want to be .
For that purposes, we needs assessment of current assets and liabilities, cash flow and others of investors most important goals .when there is clear defining of goals , it will help to know whether there any gap between current investment strategy and goal.
Thus , in first step says that , needs of good discussion about investor's beliefs , values , and other priorities , all which helps to develop investment strategy .
Step 2 = establishing investment objectives .,
Step 3 = determining asset allocation :
Step 4 = selecting investment options :
Step 5 = monitor , measure and rebalancing :
Its implications for investment management industry:
Diversification is ne way to reduce risk by allocating in different financial instruments .
Its aim is to make maximum return with less risk.
Investor faces two type risks as below :
1. Systematic or market risk = this risk is undiversifiable .it is related with every company , which includes inflation rates , political instability , exchange rates , interest rates..etc.they are not specific to a particular company , so not solved through diversification..
2. Unsystematic or diversifiable risk = its specific to a particular company , market or economy .can reduce through diversification. It includes financial risk and business risk .
So , you will diversify across the board , not only different types of companies , but also various types of industries .because more uncorrelated your stocks , are the better .
Active and passive portfolio management :
Investors have two choices of investment strategies to generate return on their investment are as follows
In active portfolio management focuses on outperforming the market in compare to specific benchmark as Sand P 500 index .
The main objective of actively managed portfolio , is to beat the market .by taking greater market risk than passive.
Passive management portfolio or index fund management , has the purpose of generating return that is the same as the chosen index ..
Thus ,
Portfolio construction means a process of understanding how various financial assets , funds and weightings impacting each other .and also their performance , risk level and decisions which attain the investor's objectives .
And understood its implications for invesment management industry
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