Question

question

The procedure of managing an investment portfolio never stops. Explain the procedures involves in handling investment portfolio.

NB it is a 10 marks question so I need good answer

Answer 1

Here we have to explain what is investment portfolio and procedures for handling it , as below ,

Investment process

• When we speak of investment, I am sure most of you would think of investing in some fixed deposit or a property or some of you would even buy gold.
• But there is much more to investing. An investment is the purchase of an asset with an expectation to receive return or some other income on that asset in future.
• The process of investment involves careful study and analysis of the various classes of assets and the risk-return ratio attached to it.
• An investment process is a set of guidelines that govern the behaviour of investors in a way which allows them to remain faithful to the tenets of their investment strategy, that is the key principles which they hope to facilitate outperformance.

Meaning of investment Portfolio

• Portfolio investments are investments in the form of a group (portfolio) of assets, including transactions in equity, securities, such as common stock, and debt securities, such as banknotes, bonds, and debentures.

• Portfolio investments are passive investments, as they do not entail active management or control of the issuing company.

• The foreign investors have a relatively short-term interest in the ownership of these passive investments such as bonds and stocks.

• Rather, the purpose of the investment is solely financial gain, in contrast to foreign direct investment (FDI), which allows an investor to exercise a certain degree of managerial control over a company.

• For international transactions, equity investments where the owner holds less than 10% of a company's shares are classified as portfolio investments.

• These transactions are also referred to as "portfolio flows" and are recorded in the financial account of a country's balance of payments.

There are 5 investment process steps that help you in selecting and investing in the best asset class according to your needs and preferences. Are as follows :

Step 1- Understanding the client

• The first and the foremost step of investment process is to understand the client or the investor his/her needs, his risk taking capacity and his tax status.
• After getting an insight of the goals and restraints of the client, it is important to set a benchmark for the client’s portfolio management process which will help in evaluating the performance and check whether the client’s objectives are achieved.

Step 2- Asset allocation decision

• This step involves decision on how to allocate the investment across different asset classes, i.e. fixed income securities, equity, real estate etc.
• It also involves decision of whether to invest in domestic assets or in foreign assets.
• The investor will make this decision after considering the macroeconomic conditions and overall market status.

Step 3- Portfolio strategy selection

• Third step in the investment process is to select the proper strategy of portfolio creation.
• Choosing the right strategy for portfolio creation is very important as it forms the basis of selecting the assets that will be added in the portfolio management process.
• The strategy that conforms to the investment policies and investment objectives should be selected.
• There are two types of portfolio strategy-
• 1.Active Management
• 2.Passive Management

• Active portfolio management process refers to a strategy where the objective of investing is to outperform the market return compared to a specific benchmark by either buying securities that are undervalued or by short selling securities that are overvalued. In this strategy, risk and return both are high. This strategy is a proactive strategy it requires close attention by the investor or the fund manager.

• Passive portfolio management process refers to the strategy where the purpose is to generate returns equal to that of the market. It is a reactive strategy as the fund manager or the investor reacts after the market has responded.

Step 4- Asset selection decision

• The investor needs to select the assets to be placed in the portfolio management process in the fourth step.

• Within each asset class, there are different sub asset-classes. For example, in equity, which stocks should be chosen?

• Within the fixed income securities class, which bonds should be chosen?

• Also, the investment objectives should conform to the investment policies because otherwise the main purpose of investment management process would become meaningless.

Step 5- Evaluating portfolio performance

• This is the final step in the investment process which evaluates the portfolio management performance.
• This is an important step as it measures the performance of the investment with respect to a benchmark, in both absolute and relative terms.
• The investor would determine whether his objectives are being achieved or not.

Conclusion

• After all the above points have been followed, the investor needs to keep monitoring the portfolio management performance at an appropriate interval.
• If the investor finds that any asset is not performing well, he/she should ‘re balance’ the portfolio. Re balancing means adding or removing (or better call it adjusting) some assets from the portfolio to maintain the target level.
• Re balancing helps the investor to maintain his/her level of risk and return.

Things for handling Investment Portfolio Are as follows :

1.Insist Upon a Margin of Safety

• Benjamin Graham, the father of modern security analysis, taught that building a margin of safety into your investments is the single most important thing you can do to protect your portfolio.
• There are two ways you can incorporate this principle into your investment selection process.
• First, be conservative In your valuation assumptions. As a class, investors have a peculiar habit of extrapolating recent events into the future.
• When times are good, they become overly optimistic about the prospects of their enterprises.
• As Graham pointed out in his landmark investment book The Intelligent Investor, the chief risk is not overpaying for excellent businesses but rather paying too much for mediocre businesses during generally prosperous times.
• To avoid this situation, err on the side of caution, especially in the area of estimating future growth rates when valuing a business to determine the potential return.
• For an investor with a 15% required rate of return, a business that generates $1 per share in profitis worth $14.29 if the business is expected to grow at 8%. With an expected growth rate of 14%, however, the estimated intrinsic value per share is $100, or seven times as much.
• Second, only purchase assets trading near (in the case of excellent businesses) or substantially below (in the case of other businesses) your estimate of intrinsic value.
• Once you’ve conservatively estimated the intrinsic value of a stock or private business, such as a car wash held through a limited liability company, make sure you are getting a fair deal.
• How much you are willing to pay depends on a variety of factors, but that price will determine your rate of return.

• In the case of an exceptional enterprise—the type of company with huge competitive advantages, economies of scale, brand name protection, mouthwatering returns on capital, and a strong balance sheet, income statement, and cash flow statement—paying a full price, and regularly buying additional shares through new purchases and reinvesting your dividends, can be rational.

• Those types of businesses are rare. Most fall into the territory or secondary or tertiary quality.

• When dealing with these sorts of firms, it is wise to demand an additional margin of safety by tempering earnings through cyclical adjustments and/or only paying a price that approximates no more than 66% or your estimated intrinsic value, which you will get from time to time.

• It's the nature of the stock market. In fact, historically, drops in quoted market value of 33% or more are fairly common every few years.

• Building upon our prior example of a company with an estimated intrinsic value of $14.29, this means you wouldn’t want to purchase the stock if it was trading at $12.86 because that is only a 10% margin of safety.

• Instead, you’d want to wait for it to fall to around $9.57. It would allow you to have additional downside protection in the event of another Great Depression or 1973–1974 collapse.

2.Invest In Assets You Understand

• How can you estimate the future earnings per share of a company?
• In the case of a major beverage company, for example, you could look at per-capita product consumption by various countries in the world, input costs such as sugar prices, management’s history for allocating capital, and a whole list of things.
• You'd build spreadsheets, run scenarios, and come up with a range of future projections based on different confidence levels. All of this requires understanding how businesses make their money.
• Shockingly, many investors ignore this common sense and invest in companies that operate outside of their knowledge base.
• Unless you understand the economics of an industry and can forecast where a business will be within five to ten years with reasonable certainty, do not purchase the stock. In most cases, your actions are driven by a fear of being left out of a “sure thing” or forgoing the potential of a huge payoff. If that describes you, you’ll take comfort to know that following the invention of the car, television, the computer, and the internet, there were thousands of companies that came into existence, only to go bust in the end.
• From a societal standpoint, these technological advances were major accomplishments.
• As investments, a vast majority fizzled. The key is to avoid seduction by excitement. The money spends the same, regardless of whether you are selling hot dogs or microchips. Forget this, and you can lose everything.
• To be a successful investor, you don’t have to understand convertible arbitrage, esoteric fixed-income trading strategies, stock optionvaluation, or even advanced accounting.
• These things expand the potential area of investment available to you—valuable, yet not critical to achieving your financial dreams.
• Many investors are unwilling to put some opportunities under the “too difficult” pile, though, reluctant to admit they are not up to the task. Even billionaire Warren Buffett, renowned for his vast knowledge of business, finance, accounting, tax law, and management, admits his shortcomings.

3.Measure Your Success by the Underlying Operating Performance of the Business, Not the Stock Price

• Unfortunately, many investors look to the current market price of an asset for validation and measurement, when in the long run it follows the underlying performance of the cash generated by the asset. The lesson? Underlying performance is what counts.
• One historical example: During the 1970s market crash, people sold fantastic long-term holdings that had fallen to 2x or 3x earnings, liquidating their stakes in hotels, restaurants, manufacturing plants, insurance companies, banks, candy makers, flour mills, pharmaceutical giants, and railroads all because they had lost 60% or 70% on paper.
• The underlying enterprises were fine, in many cases pumping out as much money as ever.
• Those with the discipline and foresight to sit at home and collect their dividends went on to compound their money at jaw-dropping rates over the subsequent 40 years despite inflation and deflation, war and peace, incredible technological changes, and several stock market bubbles and bursts.
• That fundamentals matter seems to be an impossible truth for a certain minority of investors with a penchant for gambling, to whom stocks are essentially magical lottery tickets.
• These types of speculators come and go, getting wiped out after nearly every collapse.
• The disciplined investor can avoid that cycle by acquiring assets that generate ever-growing sums of cash, holding them in the most tax-efficient way available, and letting time do the rest.
• Whether you're up 30% or 50% in any given year doesn't matter much as long as the profits and dividends keep growing skyward at a rate substantially in excess of inflation and that represents a good return on equity.

4.Be Rational About Price

• The higher a price you pay for an asset in relation to its earnings, the lower your return assuming a constant valuation multiple.
• The same stock that was a terrible investment at $40 per share may be a wonderful investment at $20.
• In the hustle and bustle of Wall Street, many people forget this basic premise and, sadly, pay for it with their pocketbooks.
• Imagine you purchased a new home in an excellent neighborhood for $500,000. A week later, someone knocks on your door and offers you $300,000 for the house. You would laugh in their face.
• In the stock market, you may be likely to panic and sell your proportional interest in the business simply because other people think it is worth less than you paid for it.
• If you’ve done your homework, provided an ample margin of safety, and are hopeful about the long-term economics of the business, you should view price declines as an opportunity to acquire more of a good thing.
• Instead, people tend to get excited about stocks that rapidly increase in price, a completely irrational position for those who were hoping to build a large position in the business.
• Would you want to buy more gas if per-gallon prices doubled? Why then should you view equity in a company differently?
• Investors who behave that way are more gambling than investing.

5.Minimize Costs, Expenses, and Fees

• Frequent trading can substantially lower your long-term results due to commissions,fees, ask/bid spreads, and taxes.
• Combined with understanding the time value of money, the results can be staggering when you start talking about 10-, 15-, 25-, and 50-year stretches.
• Imagine that in the 1960s, you are 21 years old. You plan to retire on your 65th birthday, giving you 44 financially productive years. Each year, you invest $10,000 for your future in small-capitalization stocks.
• Over that time, you would have earned a 12% rate of return. If you spent 2% on costs, you would end up with $6,526,408.
• It's certainly not chump change by anyone’s standards. Had you controlled frictional expenses, keeping most of that 2% in your portfolio compounding for your family, you'd have ended up with $12,118,125 by retirement, nearly twice as much capital.
• Although it seems counterintuitive, frequent activity is often the enemy of long-term superior results.

6. Keep Your Eyes Open for Opportunities

• Like all great investors, famed mutual fund manager Peter Lynch was always on the lookout for the next opportunity.
• During his tenure at Fidelity, he made no secret of his investigative homework: traveling the country, examining companies, testing products, visiting management, and quizzing his family about their shopping trips.
• It led him to discover some of the greatest growth stories of his day—long before Wall Street became aware they existed.
• The same holds true for your portfolio. By simply keeping your eyes open, you can stumble onto a profitable enterprise far easier than you can by scanning the pages of financial publications.

7.Allocate Capital By Opportunity Cost

• Should you pay off your debt or invest? Buy government bonds or common stock? Go with a fixed rate or interest-only mortgage?
• The answer to financial questions such as these should always be made based on your expected opportunity cost.
• Opportunity cost investing means looking at every potential use of cash and comparing it to the one that offers you the highest risk-adjusted return.
• It's about evaluating alternatives. Here's an example: Imagine your family owns a chain of successful craft stores.
• You are growing sales and profits at 30% as you expand across the country. It wouldn't make a lot of sense to buy real estate properties with 4% cap rates in San Francisco for the sake of diversifying your passive income.
• You'll end up far poorer than you otherwise would have been. Rather, you should consider opening another location, adding additional cash flow to your family treasury from doing what you know how to do best.

Thus we can conclude that , Handling of Investment portfolio is not a easy task. its time consuming . Shortly , Planning portfolio , implementation of portfolio plan and monitoring its performance are procedures of portfolio investment.

Hope you understand this procedures in detail. Comment me your reply please.