FRAMEWORK
The Grand Design
OUTLINE
• Phases of Portfolio Management
• Specification of Investment Objectives and Constraints
• Choice of Asset Mix
• Formulation of Portfolio Strategy
• Selection of Securities
• Portfolio Execution
• Portfolio Revision
• Portfolio Evaluation
PHASES OF PORTFOLIO MANAGEMENT
SPECIFICATION OF INVESTMENT
OBJECTIVES AND CONSTRAINTS
FORMULATION OF PORTFOLIO
STRATEGY
SELECTION OF SECURITIES
PORTFOLIO EXECUTION
PORTFOLIO REVISION
PORTFOLIO EVALUAYION
Investment Policy Worksheet
1. Executive Summary
2. Investment Objectives
3. Investment Philosophy
4. Investment Selection Criteria
5. Monitoring Procedures
SPECIFICATION OF INVESTMENT OBJECTIVES
• The commonly stated investment goals are :
Income – To provide steady stream of income through
regular interest/dividend payment
Growth – To increase the value of the principal
amount through capital appreciation
Stability – To protect the principal amount invested
from the risk of loss.
• Since income and growth represent two ways by which
return is generated and stability implies containment of
risk, investment objectives may be expressed more
succinctly in terms of return and risk.
Investment Goals
As in investor you would primarily be
interested in a higher return (in the form of
income and/or capital appreciation) and a
lower level of risk.
How much risk you would be willing to
bear to seek a higher return, depends on
your risk disposition.
Your investment objective should state your
preference for return relative to your
distaste for risk.
Specification of investment
objective
Maximize the expected return, subject to the
risk exposure being held within a certain
limit (the risk tolerance level)
Minimize the risk exposure, without
sacrificing a certain expected rate of return
(the target rate of return)
Temperament.
Bonds
Stocks
Real Estate
Precious Metals
Others
Note the following:
The first important investment decision for
most individual is concerned with their
education meant to build their human capital.
Growth Shares
Blue-chip Shares
Cyclical Shares
Speculative Shares……etc
Savings Bonds
Bank Deposits
Schemes…………etc
ENDURING RELATION
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
RISK TOLERANCE
TIME HORIZON
LOW MODERATE HIGH
SHORT 0 25 50
MEDIUM 25 50 75
LONG 50 75 100
A popular rule of thumb for asset allocation says that the percentage allocation to
debt must be equal to the age of the individual.
Contd…
For the sake of simplicity, we assumed that there is single
investment horizon.
In reality, an investor may have multiple investment horizons
corresponding to varied needs.
For eg, the investment horizons corresponding to various goals
sought by an investor may be as follows:
“…..it gives the investor the feeling that he is at least making some moves in
response to market developments; more important of all, it will restrain
him from being drawn more and more heavily into common stocks as the
market rises to more and more dizzy heights!”
John Bogle on Asset Allocation
Balanced Asset Allocation Model
Investment Goal
FORMULATION OF PORTFOLIO
STRATEGY
Sector Rotation
Security Selection
• ACTIVE
• PASSIVE
Value stocks
Technology Stocks
Growth Management
SELECTION OF BONDS
• YTM
• DEFAULT RISK
• TAX SHIELD
• LIQUIDITY
• DURATION
SELECTION OF STOCKS
• TECHNICAL ANALYSIS
• FUNDAMENTAL ANALYSIS
• RANDOM ANALYSIS
MARKET EFFICIENCY AND
SECURITY SELECTION
SEMI-STRONG-FORM
EFFICIENCY POOR GOOD FAIR
STRONG-FORM
EFFICIENCY POOR FAIR BEST
PORTFOLIO EXECUTION
TRADING GAME
pressure
Volume that can be traded without pushing
operators
Degree of market resilience.
inferior returns
You may forego opportunities of making promising
investments.
……….
Learn to weight the opportunity cost of non-
trading against the explicit costs of trading.
Key Dimensions
PERFORMANCE EVALUATION RATE OF RETURN
1. ARITHMETIC MEAN 2. IRR 3. GEOMETRIC MEAN
RATE OF RETURN DATA
Year Market value of Dividend and Rate of return
the portfolio interest income
(Rs) (Rs)
0 100,000
17,160
A : 10,000 = r = 19.72%
(1+r)3
8,000 0 4680
B : 10,000 = + + r = 15.27%
(1+r) (1+r)2 (1+r)3
IRR REFLECTS INVESTMENT PERFORMANCE AS WELL AS THE EFFECT OF CONTRIBUTIONS AND
WITHDRAWALS .. TOTAL EXPERIENCE OF A FUND (a) INVESTMENET PERFORMANCE & (b) CASH
FLOWS.
G.M : [(1.10) (1.30) (1.20)] 1/3 - 1 = 0.1972 OR 19.72%
RISK
d n
• Standard Deviation
• Beta
PERFORMANCE MEASURE
Rp - Rf
TREYNOR MEASURE :
p
Rp - Rf
SHARPE MEASURE :
p
decision.
It has promoted the cult of market timing.
……..
It must be recognized that it is not feasible
to evaluate the ability of a money manager
over a short period of one to three years
when it should be appraised over a period of
five to seven years.
“For accuracy of computations,
performance should be computed as
often as practical, but results should not
be taken as significant by the investor or
the investment manager until a
reasonable period of time, such as a
market cycle for equities or an interest
rate cycle for fixed income securities,
has elapsed”
THE END