Portfolio Management: Definition, Types, Importance & Process (2024)

Portfolio management is the process of managing a portfolio of investment mix that includes Stocks, Bonds, Mutual fund, FD and RD. In general a portfolio manager is appointed to manage a portfolio and its performance.

• It primarily aims at guiding an organization or an Individual to make sound decisions
• It ensures that the risk appetite of the investor does not affect him.
• The key factors involved in portfolio management include risk, decision making and control.
• Portfolio management ensures flexibility of an individual’s and companies Portfolio.
• Portfoliomanagementmaximizesthereturnoninvestment.

As the figure above illustrates, there are 4 kinds of portfolio management.

1. Active

Active portfolio management needs a greater level of market knowledge. The fund manager who aims at using an active strategy expects a market return. The active strategy requires a constant evaluation and quantitative analysis of the market. Furthermore, it requires a clear understanding of the business cycle.

• Active portfolio management ensures a greater level of market returns
• Another benefit of active portfolio management is that the fund manager has better flexibility.
• Active strategies are suitable for investors with great market knowledge and experience. It is suitable for an investor with a greater risk appetite.

2. Passive

Passive portfolio management is not concerned about beating the market because the proponent subscribe to the efficient market hypothesis

• Investors who seek to reduce risk often prefer passive portfolio management.
• Passive strategy is one of the low-cost strategies to execute.
• These strategies provide better gains in the long term.

3. Discretionary

The fund manager takes complete discretion in investment decisions for the customer. The investment manager takes all the buy and sale decision and use them to make the best out of it. This strategy can be offered by only experts who possess a great level of knowledge in this field.

• One of the biggest advantages of this type of portfolio management is that they make our lives in terms of investment decision.
• All the burden and hassle of decision making is transferred to an expert.

4. Non-discretionary

Non-discretionary portfolio management is a type of asset management. Here, the manager acts as a financial adviser for the individual. The manager states the advantages and disadvantages of the options. Finally, the individual owns the discretion.

• The merit of this type of portfolio management is that the manager gives you the choices and individuals get to choose their decisions.

1. Investment decisions

A portfolio manager ensures that clients make the best decisions regarding their investment. For this purpose, the portfolio manager is expected to understand the client’s profile. The client profile involves knowing about the customer’s age category, income level and risk appetite. Uncertain situations arise at any point in one’s life, keeping aside a sum for investment would be the best option and that action could be carried out with the help of portfolio management. The Portfolio Manager will also provide investment advice to his clients.

2. Investment tools

The prime responsibility of the portfolio manager is to ensure that the clients are aware of the several investment tools that are available in the market. The manager should further take another step and explain the benefits and drawbacks of those tools and assess them for risk and returns.

The manager should also consider the financial position of the client while carrying out the duty. After analysis of the option, the manager should give the client the option that is suitable.

3. Customization of plan

Portfolio management requires a clear understanding of the customer’s needs and his problem. The conundrum in such a field begins with understanding the client’s dynamics. Since every client’s needs and different, it is not easy to carry out such a duty.

Thus, the portfolio manager’s key role is to understand and plan a customized strategy. This consists of factors like risk, return and market conditions. The plan should consider the financial stability and risk appetite of the customers.

4. Unbiased service and professionalism

A portfolio manager should treat all his clients equally and prioritize the needs of the clients. He should ensure that client’s needs and expectations are satisfied with his/her service. In simple words, he/she should put the satisfaction first rather than escaping the
Responsibilities.

Moreover, his relationship with the client has to be highly professional. It should ensure that the client’s financial details and information are safe and secure.

5. Decision making & communication

A portfolio manager is expected to make a quick and prompt decision. For instance, after making an investment decision the customer expects high asset performance. There is always a probability factor that is tied up with the investment performance.

Let’s consider an investment is not performing well due to market condition. Then, the manager should step in and make decisions relating to asset withdrawal and asset reinvestment. Communication is essential for the relationship that the client and the manager have. It helps to understand the perspective of the client. The manager should ensure that he updates the client about the performance of the asset.

6. Tracking performance

Tracking the performance of the asset is another vital role of the portfolio manager. After understanding the client’s status and guiding them to invest in certain assets the manager should make sure that assets are performing according to the standards.

The manager generally uses an optimization tool to evaluate the performance of the asset. In case if the assets do not perform well, it is the duty of the manager to communicate them to the client and suggest ideas for reinvestment. The Portfolio manager performs frequent portfolio analysis to track the performance of his investments.

7. Other responsibilities

The manager should explain all the financial information to the client. The client trusts the portfolio manager and hands over the money to invest. Hence, the investor should receive every update about the investment and its performance.

Moreover, the manager should ensure that the client is not neglected, due to adverse work condition. The portfolio manager shouldn’t ignore any client queries.

1. Allocation of funds

A good portfolio management aims at allocating the funds in the most profitable way by considering factors such as market returns , risk appetite etc.

2. Reduces risk

Portfolio management ensures that the risk factor is reduced by adjusting the The risk that an individual is taking on a specific percentage of the capital.

3. Diversification

Diversification is nothing but allocating the funds in various financial instruments, the objective here is to one asset is protected against the risk.

4.Tax planning

portfolio management is helpful to a great extent in terms of tax planning Because having a portfolio of investments helps to reduce the tax burden. Tax planning can be done as a part of portfolio management. Investing in financial instruments such as PPF & PF etc. Are brilliant way of saving tax.

5.Managing adverse conditions

A good portfolio management includes investment made in
Liquid instruments and also cash balances. During times of adverse condition they can withdraw funds from assets with poor performance and invest them in a suitable financial instrument that gives a better return.

1. To make the right investment

People generally acquire assets or make investments indecisively or for the purpose of investing money. Portfolio gives an individual an overall view of their assets and bridges the gaps financially. Furthermore, they help an individual to be sure of their financial objectives. Thus, portfolio helps the people to make right choices in terms of investment decision.

2. Track performance

By consolidation of your investment in a portfolio could help an individual to understand the performance of particular assets and compare it with the performance of other assets. If a particular does not perform as you expected or if the asset is under performing the funds from that particular asset can be withdrawn and be reinvested in some other asset that has a better performance level. Thus, portfolio can help to track the performance of an asset and could help to save a lot of money by reinvesting.

3. Invest in regular and disciplined manner

The primary goal of portfolio management is maximization of returns. For instance, if an individual wants to invest on a regular basis, but does not have a big sum of money, he or she could invest in a systematic investment plan in a mutual fund. By doing this, one can invest a small sum every month and practice the habit of regular investment. Moreover, disciplined investment will increase the speed of growth of the fund.

4. Manage your liquidity

The neediest for funds are not predictable and highly uncertain. One requires funds for various reasons due to his/her commitments, but the need might be an emergency as well. Thus a portfolio management can help you plan your investment in a way where assets could be sold without any hassle.
For instance, portfolio manager keeps a certain amount of liquid funds which can be easily sold without any problem.

5. Balance risk award

There are various kinds of assets based on risk and returns. There are assets that can be very risky to buy, but the returns from such assets are high (for example: equities) on the other hand, there are assets that are very safe but the returns are
Underwhelming. Thus, portfolio management helps to differentiate between various kinds of asset and strikes a balance depending on the needs of the customers.

6. Readjust your investment with time

Managing your portfolio ensures efficiency, it helps you to stay true to your goals.
For instance, if your portfolio consists of 60% of equity and 40% of debt and over the year the equity performs well, so it increases to 70 % of equity and 30 % of debt, which means there is a need to readjust the ratio back to 60:40, for this reason managing your portfolio is highly important.

7. Improve your financial understanding

Portfolio management feeds an individual’s mind with financial knowledge. When an individual is in conversation with the portfolio manager, he engages in conversation relating to the market situation, eventually such engagements exposes people to the financial world and improves their financial understanding.

1. Effective diversification

The traditional perspective of diversification inclines to emphasize the asset class. Even though holding various assets could help to meet diversity, they are futile. They do not provide any meaningful diversification benefits.

Implementation of effective portfolio management could stabilize your portfolio as well as minimize the overlap between stocks and bonds. Most of the companies are highly exposed to the performance of the company and the greatest risk is the level of inflation.

During the period of unexpected inflation equities and fixed income investment may lose the money and having an asset in the portfolio rising along inflation is a part of effective diversification.

2. Active management

According to research markets are relatively efficient, since most of the information was priced into the stock already it makes the situation cumbersome as the market or individual stocks are difficult to predict the short term.

According to Nobel Prize winning research, markets are predictable three to five year period. Another perspective to this scenario is a market that looks expensive in the present will perform badly compared to market that are cheaper today vice versa.

Analysis of global market would help the investor to avoid economic bubbles and make the best out of the available growth opportunities. The research emphasizes on patience, but this would not be the case all the time.

3. Cost Efficiency

An individual can himself manage an investment. The question of worth arises in the case of investment management done by a manager.

This process includes process such as advisory fees and custodial fees, investment expense ratio and transaction cost. If your fees cost more than 3% every year than it is a lot of money.

Advisors aim at adding value to the portfolio by developing a diversified portfolio, monitoring markets to avoid economic bubble, seize opportunities, minimizing the hidden cost embedded in the product.

To recapitulate it is important that the service provides a positive return by tackling the market risk.

4. Tax efficiency

The level of success can be measured by the amount of money you retain at the end and that’s when the concept of tax efficiency came into existence. There are various methods to attain tax efficiency,

One way is to use tax advantage vehicles and other one is asset location strategies to minimize tax by determining which asset type could use the best tax advantage

1. Planning

• Identification of objectives

The first step involved in the process of portfolio management involves knowing the primary goal which is also called as the objective. For this to happen understanding the customer’s thoughts, intentions and their needs.

The manager should focus on the customer’s expectation on the desired outcome plays an indispensable role in this process. After understanding the customer’s expectation, finding out the constraints it is essential. This step followed so that the manager can
Overcome the problem relating the constraints.

• Investment policy statement

After understanding the customer’s expectation and identifying the objectives that is expected to be accomplished, the investment policy statement is drafted. The policy statement consists of the following

• • Client description
  • Purpose
  • Review schedule
  • Constraints
  • Responsibilities and duties
  • Objectives
  • Instruction for adjustment

• Capital market expectation

The next step after drafting an investment policy statement is to form expectation about the capital market. After understanding the capital market, there are certain decisions taken in terms of risk and return.

Understanding the risk and return of various assets is an important factor one should have in mind while planning. Decisions relating to choices (i.e.) whether to maximize the returns for a certain level of risk or lower return to stay safe without any risk.

• Asset allocation strategy

  • Strategic asset allocation: –
    • This strategy of allocation involves combining investment policy statement and capital market expectation in order to determine the weights of the asset class for the long run.
  • Tactical asset allocation: –
    • Change in circ*mstances of investors and market creates a short term change in the portfolio strategy such changes are termed as tactical asset allocation. There are greater chances for these short term changes to become the new portfolio strategy if they are updated in the investment policy statement.

2. Execution

• Portfolio selection

In this step the capital market expectation is combined with the Investment allocation strategy to choose the assets of the investor’s portfolio. A portfolio optimization technique is used to complete this process.

• Portfolio implementation

This step involves implementation of the strategy and it’s considered really important as they involve transactional costs, thus the implementation should be properly managed and timed.

3. Feedback

• Monitoring

After the implementation of the strategy, it is essential that the portfolio manager monitors the risk factor and compare them with the strategic asset allocation. This step ensures that the investment objectives and constraints are accomplished. The manager also monitors the investor’s circ*mstances economically and the market conditions.

• Performance Evaluation

It is essential that the performance should be measured, timely in order to make sure the objectives are accomplished. The returns are the standards to measure the performance.