INTRODUCTION

Portfolio Management
A portfolio is a collection of securities since it is really desirable to invest the entire funds of
an individual or an institution or a single security, it is essential that every security be viewed
in a portfolio context. Thus it seems logical that the expected return of the portfolio. Portfolio
analysis considers the determining of future risk and return in holding various blends of
individual securities.

The term portfolio refers to any collection of financial assets such as stocks, bonds and cash.
Portfolios may be held by individual investors and managed by financial professionals, hedge
funds, banks and other financial institutions. It is a generally accepted principle that a
portfolio is designed according to the investor’s risk tolerance, time frame and investment
objectives. The euro amount of each asset may influence the risk/reward ratio of the portfolio
and is referred to as the asset allocation of the portfolio. When determining a proper asset
allocation aims at maximizing the expected return and minimizing the risk.

This is an example of multi-objective optimization problem: more “efficient solutions” are

available and the preferred solution must be selected by considering a tradeoff between risk
and return. In particular, a portfolio A is dominated by another B if B has a greater expected
gain and a lesser risk than A, if no portfolio dominates A, A is a Pareto-optimal portfolio. The
set of Pareto-optimal returns and risks is called the Pareto Efficient Frontier for the
Markowitz Portfolio selection problem.

Portfolio expected return is a weighted average of the expected return of the individual
securities but portfolio variance, in short contrast, can be something reduced portfolio risk is
because risk depends greatly on the co-variance among returns of individual securities.
Portfolios, which are combination of securities, may or may not take on the aggregate
characteristics of their individual parts.

Since portfolios expected return is a weighted average of the expected return of its securities,
the contribution of each security the portfolio’s expected returns depends on its expected
returns and its proportionate share of the initial portfolio’s market value. It follows that an
investor who simply wants the greatest possible expected return should hold one security; the
one which is considered to have a greatest expected return. Very few investors do this, and
very few investment advisors would counsel such and extreme policy instead. Investors
should diversify, meaning that their portfolio should include more than one security.

Portfolio Management is the art and science of making decisions about investment mix and
policy, matching investments to objectives, asset allocation for individuals and institutions,
and balancing risk against performance.

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A Portfolio Management refers to the science of analysing the strengths, weakness,
opportunities and threats for performing wide range of activities related to the one’s
portfolio for maximizing the return at a given risk. It helps in making selection of Debt vs
Equity, Growth Vs Safety, and various other trade-offs.

Major tasks involved with Portfolio Management are as follows:

 Taking decisions about investment mix and policy.

 Matching investments to objectives.
 Asset allocation for individuals and institution.
 Balancing risk against performance.

Portfolio Managers
Portfolio Managers means any person who enters into a contract or arrangement with a client.
Pursuant to such arrangement he advices the client or undertakes on behalf of such client
management or administration of portfolio of securities or invests or manages the client’s
funds.

A discretionary portfolio manager means a portfolio manager who exercises or may under a
contract relating to portfolio management, exercise any degree of discretion in respect of the
investment or management of portfolio of the portfolio securities or the funds of the client, as
the case may be. He shall independently or individually manage the funds of each client in
accordance with the needs of the client in a manner which does not resemble the mutual fund.

A non-discretionary portfolio manager shall manage the funds in accordance with the
directions of the client.

A portfolio manager by virtue of his knowledge, background and experience is expected to

study the various avenues available for profitable investment and advise his client to enable
the latter to maximize the return on his investment and at the same time safeguard the funds
invested.

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 SCOPE OF PORTFOLIO MANAGEMENT
Portfolio management is an art of putting money in fairly safe, quite profitable and
reasonably in liquid form. An investor’s attempt to find the best combination of risk and
return is the first and usually the foremost goal, In choosing among different investment
opportunities the following aspects risk management should be considered:

a) The selection of a level or risk and return that reflects the investor’s tolerance for risk
and desire for return, i.e. personal preferences.

b) The management of investment alternatives to expand the set of opportunities

available at the investors acceptable risk level.

The very risk-averse investor might choose to invest in mutual funds. The more risk-tolerance
investor might choose shares, if they offer higher returns. Portfolio management in India is
still in its infancy. An investor has to choose a portfolio according to his preferences. The
first preference normally goes to the necessities and comforts like purchasing a house or
domestic appliances. His second preference goes to some contractual obligations such as life
insurance or provident funds. The third preference goes to make a provision for savings
required for making day to day payments. The next preference goes to short term investments
such as UTI units and post office deposits which provide easy liquidity. The last choice goes
to investment in company shares and debentures. There are number of choices and decisions
to be taken on the basis of the attributes of risk, return and tax benefits from these shares and
debentures. The final decision is taken on the basis of alternatives, attributes and investor
preferences.

For most investors it is not possible to choose between managing one’s own portfolio. They
can hire a professional manager to do it. The professional managers provide a variety of
services including diversification, active portfolio management, liquid securities and
performance of duties associated with keeping track of investor’s money.

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 NEED FOR PORTFOLIO MANAGEMENT
Portfolio management is a process encompassing many activities of investment in assets and
securities. It is a dynamic and flexible concept and involves regular and systematic analysis,
judgement and action. The objective of this service is to help the unknown and investors with
the expertise of professionals in investment portfolio management. It involves construction of
a portfolio based upon the investor’s objectives, constraints, preferences for risk and returns
and tax liability. The portfolio is reviewed and adjusted from time to time in tune with the
market conditions. The evaluation of portfolio is to be done in terms of targets set for risk and
returns. The changes in the portfolio are to be effected to meet the changing condition.

Portfolio construction refers to the allocation of surplus funds in hand among a variety of
financial assets open for investment. Portfolio theory concerns itself with the principles
governing such allocation. The modern view of investment is investment is oriented more go
towards the assembly of proper combination of individual securities to form investment
portfolio.

A combination of securities held together will give a beneficial result if they grouped in a
manner to secure higher returns after taking into consideration the risk elements.

The modern theory is the view that by diversification risk can be reduced. Diversification can
be made by the investor either by having a large number of shares of companies in different
regions, in different industries or those types of product lines. Modern theory believes in the
perspective of combination of securities under constraints of risk and returns.

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 TYPES OF PORTFOLIO
Stock investors constantly hear the wisdom of diversification. The concept is to simply not
put all of your eggs in one basket, which in turn helps mitigate risk, and generally leads to
better performance or return on investment. Diversifying your hard-earned dollars does make
sense, but there are different ways of diversifying, and there are different portfolio types. We
look at the following portfolio types and suggest how to get started building them:
aggressive, defensive, income, speculative and hybrid.

1. The Aggressive Portfolio:

An aggressive portfolio or basket of stocks includes those stocks with high risk/high
reward proposition. Stocks in the category typically have a high beta, or sensitivity to
the overall market. Higher beta stocks experience larger fluctuations relative to the
overall market on a consistent basis. Most aggressive stocks (and therefore
companies) are in the early stages of growth, and have a unique value proposition.
Building an aggressive portfolio requires an investor who is willing to seek out such
companies, because most of these names, with a few exceptions, are not going to be
common household companies.

2. The Defensive Portfolio:

Defensive stocks do not usually carry a high beta, and usually are fairly isolated from
broad market movements. Cyclical stocks, on the other hand, are those that are most
sensitive to the underlying economic "business cycle." For example, during
recessionary times, companies that make the "basics" tend to do better than those that
are focused on fads or luxuries. Despite how bad the economy is, companies that
make products essential to everyday life will survive.

3. The Income Portfolio:

An income portfolio focuses on making money through dividends or other types of
distribution to stakeholders. These companies are somewhat like the safe defensive
stocks but should offer higher yields. An income portfolio should generate positive
cash flow. Real estate investment trusts (REITs) and master limited partnerships
(MLP) are excellent sources of income producing investments. These companies
return a great majority of their profits back to shareholders in exchange for favourable
tax status. REITs are an easy way to invest in real estate without the hassles of
owning real property. Keep in mind, however, that these stocks are also subject to the
economic climate.

4. The Speculative Portfolio:

A speculative portfolio is the closest to a pure gamble. A speculative portfolio present
more risk than any others discussed here. Finance gurus suggest that a maximum of
10% of one's investable assets be used to fund a speculative portfolio. Speculative
"plays" could be initial public offerings (IPOs) or stocks that are rumoured to be

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 takeover targets. Technology or health care firms that are in the process of researching
a breakthrough product, or a junior oil company which is about to release its initial
production results, would also fall into this category.
Speculative stocks are typically trades, and not your classic "buy and hold"
investment.

5. The Hybrid Portfolio:

Building a hybrid type of portfolio means venturing into other investments, such as
bonds, commodities, real estate and even art. Basically, there is a lot of flexibility in
the hybrid portfolio approach. Traditionally, this type of portfolio would contain blue
chip stocks and some high grade government or corporate bonds. REITs and MLPs
may also be an investable theme for the balanced portfolio. A common fixed income
investment strategy approach advocates buying bonds with various maturity dates,
and is essentially a diversification approach within the bond asset class itself.

6. The Bottom Line:

At the end of the day, investors should consider all of these portfolios and decide on
the right allocation across all five. Here, we have laid the foundation by defining five
of the more common types of portfolios. Building an investment portfolio does
require more effort than a passive, index investing approach. By going it alone, you
will be required to monitor your portfolio(s) and rebalance more frequently, thus
racking up commission fees.

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 TYPES OF PORTFOLIO MANAGEMENT
 Active Portfolio Management:
As the name suggests, in an active portfolio management service, the portfolio
managers are actively involved in buying and selling of securities to ensure maximum
profits to individuals.

 Passive Portfolio Management:

In a passive portfolio management, the portfolio manager deals with a fixed portfolio
designed to match the current market scenario.

 Discretionary Portfolio Management:

In discretionary portfolio management services, an individual authorizes a portfolio
manager to take care of his financial needs on his behalf. The individual issues money
to the portfolio manager who in turn takes care of all his investment needs, paper
work, documentation, filing and so on. In discretionary portfolio management, the
portfolio manager has full rights to take decisions on his client’s behalf.

 Non-Discretionary Portfolio Management:

In non-discretionary portfolio management, the portfolio manager can merely advice
the client what is good and bad for him but the client reserves full right to take his
own decisions.

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 OBJECTIVES OF PORTFOLIO MANAGEMENT
The objective of portfolio management is to invest in securities in such a way that one
maximizes one’s returns and minimizes risks in order to achieve one’s investment objective.

A good portfolio should have multiple objectives and achieve a sound balance among them.
Any one objective should not be given undue importance at the cost of others. Presented
below are some important objectives of portfolio management.

1. Stable Current Return:

Once investment safety is guaranteed, the portfolio should yield a steady current
income. The current returns should at least match the opportunity cost of the funds of
the investor. What we are referring here is current income by way of interest of
dividends, not capital gains.

2. Marketability:
A good portfolio consists of investment, which can be marketed without difficulty. If
there are too many unlisted or inactive shares in your portfolio, you will face
problems in encashing them, and switching from one investment to another. It is
desirable to invest in companies listed on major stock exchanges, which are actively
traded.

3. Tax Planning:
Since taxation is an important variable in total planning, a good portfolio should
enable its owner to enjoy a favourable tax shelter. The portfolio should be developed
considering not only income tax, but capital gains tax, and gift tax, as well. What a
good portfolio aims at is tax planning, not tax evasion or tax avoidance.

4. Appreciation in the value of capital:

A good portfolio should appreciate in value in order to protect the investor from any
erosion in purchasing power due to inflation. In other words, a balanced portfolio
must consist of certain investments, which tend to appreciate in real value after
adjusting for inflation.

5. Liquidity:
The portfolio should ensure that there are enough funds available at short notice to
take care of the investor’s liquidity requirements. It is desirable to keep a line of credit
from a bank for use in case it becomes necessary to participate in right issues, or for
any other personal needs.

6. Safety of the investment:

The first important objective of a portfolio, no matter who owns it, is to ensure that
the investment is absolutely safe. Other considerations like income, growth, etc., only
come into the picture after the safety of your investment is ensured.

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 ADVANTAGES OF PORTFOLIO
MANAGEMENT
1. Maximize the value of investments:
It can maximize the value of departmental investments while minimizing risks.
Looking at various part of the business as a holistic entity tied allows for a strategic
balancing act. For instance, business goals may dictate a need for product diversity.
Looking from a portfolio perspective, executives may decide to limit ongoing support
resources, and focus PM activities toward new business initiatives.

2. Resources can be managed more efficiently:

With portfolio management, resources can be managed more efficiently. Planner,
whether executive or management, have a much better poit of reference when placing
resources when have the ability to “balance” the company portfolio depending on the
organization’s changing needs. Resources can be applied to areas needing attention,
not just for a particular department, but for the larger needs of the company.

3. Diversification:
Using mutual funds can help an investor diversify their portfolio with a minimum
investment. When investing in a single fund, an investor is actually investing in
numerous securities. Spreading your investment across a range of securities can help
to reduce risk. A stock mutual fund. If a few securities in the mutual fund lose value
or become worthless, the loss may be offset by other securities that appreciate in
value. Further diversification can be achieved by investing in multiple funds which
invest in different sectors or categories. This helps to reduce the risk associated with
a specific industry or category.

4. Professional Management:
Mutual funds are managed and supervised by investment professionals. As per the
stated objectives set forth in the prospectus, along with prevailing market conditions
and other factors, the mutual fund manager will decide when to buy or sell
securities. This eliminates the investor of the difficult task of trying to time the
market. Furthermore, mutual funds can eliminate the cost an investor would incur
when proper due diligence is given to researching securities.

5. Convenience:
With most mutual funds, buying and selling shares, changing distribution options, and
obtaining information can be accomplished conveniently by telephone, by mail, or
online. Although a fund's shareholder is relieved of the day-to-day tasks involved in
researching, buying, and selling securities, an investor will still need to evaluate a
mutual fund based on investment goals and risk tolerance before making a purchase

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 decision. Investors should always read the prospectus carefully before investing in
any mutual fund.

6. Liquidity:
Mutual fund shares are liquid and orders to buy or sell are placed during market
hours. However, orders are not executed until the close of business when the NAV
(Net Average Value) of the fund can be determined. Fees or commissions may or
may not be applicable. Fees and commissions are determined by the specific fund
and the institution that executes the order.

7. Minimum Initial Investment:

Most funds have a minimum initial purchase of $2,500 but some are as low as
$1,000. If you purchase a mutual fund in an IRA, the minimum initial purchase
requirement tends to be lower. You can buy some funds for as little as $50 per month
if you agree to dollar-cost average, or invest a certain dollar amount each month or
quarter.

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 DISADVANTAGES OF PORTFOLIO
MANAGEMENT

1. No Guarantees:
The value of your mutual fund investment, unlike a bank deposit, could fall and be
worth less than the principle initially invested. And, while a money market fund seeks
a stable share price, its yield fluctuates, unlike a certificate of deposit. In addition,
mutual funds are not insured or guaranteed by an agency of the U.S.
government. Bond funds, unlike purchasing a bond directly, will not re-pay the
principle at a set point in time.

2. The Diversification “Penalty”:

Diversification can help to reduce your risk of loss from holding a single security, but
it limits your potential for a "home run" if a single security increases dramatically in
value. Remember, too, that diversification does not protect you from an overall
decline in the market.

3. Costs:
In some cases, the efficiencies of fund ownership are offset by a combination of sales
commissions, 12b-1 fees, redemption fees, and operating expenses. If the fund is
purchased in a taxable account, taxes may have to be paid on capital gains. Keep
track of the cost basis of your initial purchase and new shares that are acquired by
reinvesting distributions. It's important to compare the costs of funds you are
considering.

4. Expenses:
Because mutual funds are professionally managed investments, there are management
fees and operating expenses associated with investing in a fund. These fees and
expenses charged by the fund are passed onto shareholders and deducted from the
fund's return. These expenses are typically expressed as the expense ratio - the percent
of fund assets spent (annually) on day-to-day operations. Expense ratios can vary
widely among funds. Expense ratios for mutual funds commonly range from 0.2% to
2.0%, depending on the fund. Make yourself aware of all fees and expenses that
impact the fund's return by reducing gains and increasing losses.

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 PRINCIPLES OF PORTFOLIO
MANAGEMENT
5 Flexible Principles which provide the foundation for successful
Portfolio Management (PFM) practice.
1. Senior Management Commitment:
Any change initiative struggles without it, so top-level support comes first in Mop’s
list. Change initiatives must have public champions to communicate the value and
benefits of Portfolio management. They need to use both the stick and carrot –
ensuring compliance with PFM standards and personally demonstrating the
behaviours essential to the success of the Portfolio. So, no ‘pet projects’ – not even
the Chief Executive's!

2. Governance Alignment:
Without proper governance – including clarity about what decisions are made – PFM
will fail. MoP provides examples and diagrams of a successful Portfolio governance
structure – from Programme and Project managers up through the Portfolio Progress
Group to the Director / Investment Committee level. Supporting these are the P3O
model and, working alongside them: Business As Usual areas which will be impacted
by the change. A full set of role descriptions are provided in the MoP manual as
ready-to-use templates.

3. Strategy Alignment:
Change initiatives which do not deliver benefit = waste and confusion. The ultimate
objective of PFM is to achieve the strategic objectives of the organization. MoP
suggests a driver based model starting with very high level strategy, down to strategic
objective then benefits and finally, change initiatives that will deliver them. It
provides useful, practical, examples for the private and public sectors.

4. Portfolio Office:
There has to be a business area which provides up to date and accurate information to
allow good decision making by Portfolio Managers. This is the role of the Portfolio
Office and this MoP principle is strongly linked to the OGC standard: P3O. MoP
shows different P3O models including linked (but temporary) Programme and Project
offices as well the permanent Portfolio office and aligned Centre of Excellence

5. Energized Change Culture:

The success of the Portfolio depends as much on people as process so this principle
recognizes the need for an engaged team working together to define and deliver the
Portfolio. Here, MoP gets into the ‘softer side’ by looking at areas such as
communication, the learning organization and listening and engagement with staff.

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 HOW IS PORTFOLIO MANAGEMENT
BEING APPLIED?

How a company applies portfolio management concepts can also be unique from company to
company. Datz (2003) points toward a practical, three-step roadmap: Inventory, evaluation,
and categorization and prioritization.

Portfolio begins with a detailed inventory of a company’s projects. However, this isn’t a
license to tackle only the local PMO. Instead, consider all the activities, such as in on-going
IT support or new business initiatives. Companies like Merrill Lynch maintain databases to
track high level project information, such as business objective, costs, duration, and return on
investment and business benefits. This is used in project planning and prioritization.

Next, projects must be evaluated. Using the inventory information, each project is judged on
how well it matches strategic objectives. Using a well-structured governance structure,
projects are scrutinized at how well the objectives are tracking to business needs currently,
and if proposed ones match. For example, the clinical diagnostics company Dade Behring
enlists an executive leadership team for project evaluation. The team comprises of business
and IT leaders, all which are in-tune with product and strategic development. Funding exists
based on passing the team’s criteria.

Next, the portfolios of projects are categorized. Often an organization has more potential
projects than funding allows. Portfolio management allows a company to triage and order
based on business objectives. Again utilizing an interdisciplinary leadership team, projects
with closest business alignment are given priority. Eli Lilly categorizes their portfolio into
four categories: strategic, informational, infrastructure, and transactional. This allows Lily to
balance risk and reward for more effective prioritization (Datz, 2003).

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 PORTFOLIO MANAGEMENT MATURITY
LEVELS
Linking portfolios to one another and operational system
Optimizing
to enable sense and respond. (4)

Refining the detailed underlying processes to ensure Managing (3)

quantitative metric accuracy.

People, processes, and policy to make

Governing (2)
portfolio management a Common

practice

Communicating (1)
Using portfolios to

Communicate.

Admitting Admitting (0)

Level O: Admitting
Although the CMM starts at level 1, the IT portfolio management maturity model starts at
level 0 because most organizations start from nothing.

 Projects: The focus is on determining what projects are active and in the pipeline. The
focus is on data collection.
 Applications: The focus is on determining which applications exist, their purpose, and
their owners. The focus, again, is on basic data collection.
 Infrastructure: The focus is on determining what infrastructure assets exist within the
organization. The focus remains on basic data collection.
 People: The focus is on determining what people exist and what their skills are.
 Process: The focus is on determining what processes are performed by the enterprise and
identifying their owners.

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Level 1: Communicating
At level 1, the benefits of the portfolio management approach become apparent visually;
however, accuracy is relative and precision is suspect.

 Projects: The focus of the project portfolio is aggregating and interrelating the projects
based on available information. A standard for obtaining project information exists, but
the project management processes are not standardized.
 Applications: For the application portfolio to be at level 1, a listing of all applications,
replete with attributes that enable high-level decision making, is required.
 Infrastructure: Infrastructure portfolio requires a list of all (major infrastructure assets
with sufficient attributes to enable decision making regarding their use. Ideally, at this
level infrastructure assets are compared relative to the technical standards outlined in the
enterprise technical architecture.
 People: People portfolios require a listing of all IT personnel, their skills, and skill
levels. To be of optimal value to the enterprise, an understanding of skill demand is
required.
 Process: Process portfolios require all major processes to be documented in sufficient
detail to enable similarities and differences to be identified. A process portfolio generally
augments other portfolios (e.g., information, application, people) to enable more refined
decision making.

Level 2: Governing
At level 2, the focus is on putting the people, processes, and policies in place to support more
refined portfolio decisions.

 Projects: Project and program managers provide consistent information to the

portfolio manager. Processes with defined frequency exist to provide consistency.
 Applications: Applications are assigned owners. Processes exist to manage
application life cycles, and policies exist to provide business rules over application
life cycles.
 Infrastructure: Basic asset management exists. Processes exist to periodically create
and balance the portfolio of infrastructure assets. Policies surrounding asset
management support the portfolio balancing.
 People: Basic human capital management practices exist to proactively update skills
in a skills (management) database and assist with updating information on people.
 Process: Process portfolios are generally enabled with a business improvement
methodology and team (e.g., Six Sigma). Processes are documented consistently and
stored in a common repository.

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Level 3: Managing
Level 3 focuses on having mechanisms and metrics in place to measure the effectiveness of
the technique and ensuring effectiveness of governance.

 Projects: Metrics for governing processes and key supporting processes are identified
and captured, preparing for level 4, where these metrics can be used to analyze and
optimize both the sub portfolio and the portfolio management process.
 Applications: Applications are treated as assets, with costs and benefits captured against
these assets, much the way plant machinery is managed through a maintenance, repair,
operations (MRO) system.
 Infrastructure: Metrics for governing processes and key supporting processes are
identified and captured, preparing for level 4, where these metrics can be used to analyze
and optimize both the sub portfolio and the portfolio management process.
 People: Metrics for governing processes and key supporting processes are identified and
captured, preparing for level 4, where these metrics can be used to analyze and optimize
both the sub portfolio and the portfolio management process.
 Processes: Metrics for governing processes and key supporting processes are identified
and captured, preparing for level 4, where these metrics can be used to analyze and
optimize both the sub portfolio and the portfolio management process.

Level 4: Optimizing
Level 4 focuses on being able to sense and respond appropriately to optimize allocation of
resources across the IT organization.

 Projects: Project/program operations are providing reliable information supported by

excellence in project management and execution.
 Applications: Application performance and life cycle information are affecting the
application and IT portfolio; information from other portfolios is used to balance the
application portfolio as well.
 Infrastructure: Asset management information is used to balance this sub portfolio and
associated to related portfolios, including the project, people, and process.
 People: The people portfolio is balanced against the process, project, and infrastructure
portfolio to ensure that the optimum mix of skills exists I sufficient quantities to support
current and future needs, and skill and resource shortages are identified proactively and
acted on through defined human capital management processes.
 Process: All processes exist in the portfolio with supporting metrics and ties to the
applications supported by these processes and the information touched by these processes.
Processes can be adjusted based on information from other sub portfolios.

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 PORTFOLIO MANAGEMENT STRATEGIES
Portfolio Management Strategies refer to the approaches that are applied for the efficient
portfolio management in order to generate the highest possible returns at lowest possible
risks. There are two basic approaches for portfolio management including Active Portfolio
Management Strategy and Passive Portfolio Management Strategy.

 Active Portfolio Management Strategy:

The Active portfolio management relies on the fact that particular style of analysis or
management can generate returns that can beat the market. It involves higher than
average costs and it stresses on taking advantage of market inefficiencies. It
implemented by the advices of analysts and managers who analyse and evaluate
market for the presence of inefficiencies. The active management approach of the
portfolio management involves the following styles of the stock selection.
 Top-down Approach: In this approach, managers observe the market as a
whole and decide about the industries and sectors that are expected to perform
well in the ongoing economic cycle. After the decision is made on the sectors,
the specific stocks are selected on the basis of companies that are expected to
perform well in that particular sector.
 Bottom-up Approach: In this approach, the market conditions and expected
trends are ignored and the evaluations of the companies are based on the
strength of their product pipeline, financial statements, or any other criteria. It
stresses the fact that strong companies perform well irrespective of the
prevailing market or economic conditions.

 Passive Portfolio Management Strategy:

A strategy that involves minimal expectation input, and instead relies
on diversification to match the performance of some market index. A passive strategy
assumes that the marketplace will reflect all available information in the price paid
for securities, and therefore, does not attempt to find mispriced securities. The Passive
asset management relies on the fact that markets are efficient and it is not possible to
beat the market returns regularly over time and best returns are obtained from the low
cost investments kept for the long term.

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 PORTFOLIO THEORY
Portfolio theory can be broadly classified into Traditional Portfolio Theory and Modern
Portfolio Theory.

Traditional Portfolio Theory

According to traditional portfolio theory, an investor concentrates just on risk and return. For
him the dividend and the capital appreciation constitute the rate of return. The uncertainty in
the future prices constitutes the risk. Hence, the investment will be spread over securities
having different levels of risk so that the risk is distributed among those securities. This holds
well with the theory, “don’t put all the eggs in a single basket.” Diversification of
investments across securities enhances the efficiency of the portfolio to produce higher
return. Traditionally diversification was done within the group. For example, an investor
could diversify his investments in different units in Ambuja Cement, ACC, L&T, etc., within
the cement industry. This did not save him from the risk exposure to the industry. If the
Reserve Bank of India (RBI) increased the reserve ratios, it could lead to the banks increasing
lending rate to housing sector, which could in turn adversely affect the construction industry.
Consequently, a demand pull down can cause price reduction leading to profit erosion and
slump in share prices of these companies. Since the investor’s concentration is in cement
industry, all the scrip in which he had invested could be affected adversely. Hence, his
portfolio selection and diversification may not meet the desired results.

If he had diversified into different sectors such as, Cement, Information Technology (IT),
Banks, Pharmaceuticals, Automobile industry, etc., the loss in one sector would have been
compensated by gains in the other sectors. Hence, he would have had a balanced approach
and could have enjoyed a steady or progressive return.

Modern Portfolio Theory

Modern portfolio theory was propounded by Harry Markowitz, for which he won the Nobel
Prize in 1990. According to this theory, the investors prefer more return and less risk. Hence,
the expected return and the risk in the case of each security are major factors deciding the
security’s inclusion in a portfolio.

Modern Portfolio Theory aims at maximising the expected return of a portfolio for a given
amount of portfolio risks or equivalently minimises the risk for a given level of expected
returns by carefully selecting the proportion of assets in a portfolio. MPT is a mathematical
formulation of the concept of diversification in investing. It involves selecting securities
having collectively lower risks than the risks with respect to an individual security. For

Portfolio Management & Investment Decisions Page 18

example, by spreading the investment in securities from different sectors, such as Banking,
IT, Pharmaceuticals, Oil etc., one can get better returns and lower risks than investing all the
money in a single sector. Markowitz built a model for optimization of risk-return trade-off for
investments in securities. This model was developed based on certain assumptions regarding
investors and markets. Some are explicit in the equations, such as the use of normal
distribution. Others are implicit, such as in the transactions that are free from taxes and fees.
However, practically these assumptions are not true. The following points are explained
further.

 Asset returns are jointly/normally distributed random variables:

This is not fully correct as returns in equity and other markets are normally
distributed. Large variations are often observed in the market more frequently than
predicted in normal distribution.

 Correlation between assets are fixed and constant forever:

This argument is also not correct as the correlation depends on the systematic
relationship between assets. Correlation changes when this relationship changes. For
example, in the recent financial crisis experienced across the world all the assets
turned to be positively correlated because all of them dropped together. In short, the
analysis fails when the investors need protection.

 All investors aim at maximising economic utility:

This is also not true. If all investors aim at maximising economic utility, they will
also be interested in making more money regardless of other considerations and will
be ready to take higher risks if they are compensated by higher expected returns. This
means that the investors aspiring for more expected returns need to take higher risks.
This may not hold true for investors who avoid taking higher risks.

 All investors have access to the same information at same time:

This is not true as there are investors who are better informed and take advantage by
way of insider trading and similar activities.

 Investors have accurate knowledge of possible returns:

This means the investors’ assumption based on probability matches the market’s
actual returns. Practically this is not true because of information asymmetry
prevailing in the market.

 There are no taxes or transaction costs:

This is also not true as the security market transactions are subject to payment of
transaction costs, such as brokerage, and the gains from security transactions are
taxable as per the law of the land.

 Investors can lend and borrow unlimited amounts at risk free interest rates:

Portfolio Management & Investment Decisions Page 19

 Contrary to this view, in practice, all the lending or borrowing transaction is subject
to credit limit and the borrower have to pay an interest at the prevailing market rate to
the lenders.

Markowitz had developed his model based on a portfolio of securities rather than on a single
security. His contention was that if a single security investment has to be accepted, the
investor should be completely sure of achieving his expected high return. But in the real
world no one can assure a specific amount of return due to the uncertainty in changes in asset
prices.

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 PORTFOLIO PERFORMANCE MEASURES

I. Sharpe’s Portfolio Performance Measure

The sharpe’s performance measure takes into account measurement of the risk premium for
performance of the portfolios. This model adjusts the performance for risk. Under this model
portfolio performance can be measured by the following formula:

Where,
S = Sharpe’s index of desirability.
Rp = Average return of portfolio.
Rf = Risk free rate of return.
p = Standard deviation of risk of the returns of portfolio.

II. Treynor’s Portfolio Performance Measure

Treynor’s model is another risk-adjusted model for measuring the performance of portfolio.
Treynor’s model is based on the concept of the characteristic straight line. It gives both the
linear and curvilinear relationship. The portfolio performance can be measured by Treynors
model with the help of the following formula

Where,
Tn = Treynor’s index of desirability.
Rp = Average return of portfolio.
Rf = Risk free rate of return.
= Beta coefficient of portfolio.

III. Jensen’s Portfolio Performance Measure

Jensen measure calculates the excess return that a portfolio generates over its expected return.
This measure is also known as Alpha. The Jensen ratio measures how much of the portfolio’s
rate of return is attributable to the manager’s ability to deliver above average returns, adjusted
for market risk. The higher the ratio, the better the risk adjusted returns. A portfolio with a
consistently positive excess return will have a positive alpha, while a portfolio with a
consistently negative excess return will have a negative alpha. The portfolio performance can
be measured by Jensen with the help of the following formula
[ ( )]
Where,
= Jensen’s alpha.

Portfolio Management & Investment Decisions Page 21

 Ri = Portfolio Return.
Rf = Risk free rate of return.
= Portfolio Beta.
Rm = Market return.

Portfolio performance measures should be a key aspect of the investment decision process.
These tools provide the necessary information for investors to assess how effectively their
money has been invested.

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 BENEFITS OF CHOOSING PORTFOLIO
MANAGEMENT SERVICE INSTEAD OF
MUTUAL FUNDS
Portfolio Management Services (PMS), service offered by the Portfolio Manager, is an
investment portfolio in stocks, fixed income, debt, cash, structured products and other
individual securities, managed by a professional money manager that can potentially be
tailored to meet specific investment objectives. When you invest in PMS, you own individual
securities unlike a mutual fund investor, who owns units of the fund. You have the freedom
and flexibility to tailor your portfolio to address personal preferences and financial goals.
Although portfolio managers may oversee hundreds of portfolios, your account may be
unique.

Discretionary: Under these services, the choice as well as the timings of the investment
decisions rest solely with the Portfolio Manager.

Non-discretionary: Under these services, the portfolio manager only suggests the investment
ideas. The choice as well as the timings of the investment decisions rest solely with the
Investor. However the execution of trade is done by the portfolio manager.

Advisory: Under these services, the portfolio manager only suggests the investment ideas.
The choice as well as the execution of the investment decisions rest solely with the Investor.
When you invest your hard earned money, it is imperative to know all about your
investments. We help you to take those steps forward towards Informed Investments - a
consultative and transparent method of investing. With our portfolio management services
you are always consulted and informed of all investment decisions, thus giving you total
control of your portfolio.

Note: In India majority of Portfolio Managers offer Discretionary Services.

Who is an ideal PMS Investors?

The Investment solutions provided by PMS cater to a niche segment of clients. The clients
can be Individuals or Institutions with high net worth. The offerings are usually ideal for
investors: who are looking to invest in asset classes like equity, fixed income, structured
products etc who desire personalized investment solutions who desire long-term wealth
creation who appreciate a high level of service

Portfolio Management & Investment Decisions Page 23

 How is PMS different from mutual funds?

Features PMS Mutual funds

Management Provide ongoing, personalized Provide access to professional money
access to professional money management services.
management services .
Customization Portfolio can be tailored to address Portfolio structured to meet the fund's
each investor's specific needs. stated investment objectives.
Ownership Investors directly own the
individual securities in their The trustee own shares of the fund and
portfolio. cannot influence buy and sell decisions.
Minimums Significantly higher minimum Minimum investment – Rs.
investments than mutual funds. 25LMinimum Investment – Rs. 5,000.
Flexibility PMS products can be customized No customization possible.
to meet special customer
requirements.

While selecting Portfolio management service (PMS) over mutual funds services it is found
that portfolio managers offer some very services which are better than the standardized
product services offered by mutual funds managers. Such as:

Asset Allocation: Asset allocation plan offered by Portfolio management service PMS helps
in allocating savings of a client in terms of stocks, bonds or equity funds. The plan is tailor
made and is designed after the detailed analysis of client's investment goals, saving pattern,
and risk taking capacity.

Timing: portfolio managers preserve client's money on time. Portfolio management service
PMS help in allocating right amount of money in right type of saving plan at right time. This
means, portfolio manager provides their expert advice on when his client should invest his
money in equities or bonds and when he should take his money out of a particular saving
plan. Portfolio manager analyses the market and provides his expert advice to the client
regarding the amount of cash he should take out at the time of big risk in stock market.

Flexibility: portfolio managers’ plan saving of his client according to their need and
preferences. But sometimes, portfolio managers can invest client's money according to his
preference because they know the market very well than his client. It is his client's duty to
provide him a level of flexibility so that he can manage the investment with full efficiency
and effectiveness.

In comparison to mutual funds, portfolio managers do not need to follow any rigid rules of
investing a particular amount of money in a particular mode of investment.

Mutual fund managers need to work according to the regulations set up by financial
authorities of their country. Like in India, they have to follow rules set up by SEBI.

Portfolio Management & Investment Decisions Page 24

Services and Strategies Provided through Portfolio Management are:

 Portfolio managers’ works as a personal relationship manager through whom the

client can interact with the fund manager at any time depending on his own
preference.
 To discuss any concerns regarding money or saving, the client can interact with his
appointed portfolio manager on monthly basis.
 The client can discuss on any major changes he want in his asset allocation and
investment strategies.
 Portfolio management service (PMS) handles all type of administrative work like
opening a new bank account or dealing with any financial settlement or depository
transaction.
 While choosing online Portfolio management service (PMS), the client receives a
User-ID and Password, which helps him in getting online access to his portfolio
details and checking his portfolio as frequent as he want.
 Portfolio management service (PMS) also help in managing tax of his client based on
the detailed statement of the transactions found on his portfolio.

Portfolio Management & Investment Decisions Page 25

 PORTFOLIO MANAGER

Who can be a Portfolio Manager?

Only those who are registered and pay the required license fee are eligible to operate as
portfolio managers. An applicant for this purpose should have necessary infrastructure with
professionally qualified persons and with a minimum of two persons with experience in this
business and a minimum net worth of Rs. 50lakh's. The certificate once granted is valid for
three years. Fees payable for registration are Rs 2.5lakh's every for two years and Rs.1lakh's
for the third year. From the fourth year onwards, renewal fees per annum are Rs 75000.
These are subjected to change by the S.E.B.I.

The S.E.B.I. has imposed a number of obligations and a code of conduct on them. The
portfolio manager should have a high standard of integrity, honesty and should not have been
convicted of any economic offence or moral turpitude. He should not resort to rigging up of
prices, insider trading or creating false markets, etc. their books of accounts are subject to
inspection to inspection and audit by S.E.B.I... The observance of the code of conduct and
guidelines given by the S.E.B.I. are subject to inspection and penalties for violation are
imposed. The manager has to submit periodical returns and documents as may be required by
the SEBI from time-to- time.

Functions of Portfolio Managers:

 Advisory role:
Advice new investments, review the existing ones, identification of objectives,
recommending high yield securities etc.

 Conducting market and economic service:

This is essential for recommending good yielding securities they have to study the
current fiscal policy, budget proposal; individual policies etc. further portfolio manager
should take in to account the credit policy, industrial growth, foreign exchange possible
change in corporate law's etc.

 Financial analysis:
He should evaluate the financial statement of company in order to understand, their net
worth future earnings, prospectus and strength.

 Study of stock market:

He should observe the trends at various stock exchange and analysis scripts so that he

Portfolio Management & Investment Decisions Page 26

 is able to identify the right securities for investment.

 Study of industry: He should study the industry to know its future prospects,
technical changes etc. required for investment proposal he should also see the
problems of the industry.

 Decide the type of portfolio:

Keeping in mind the objectives of portfolio a portfolio manager has to decide whether
the portfolio should comprise equity preference shares, debentures, convertibles, non-
convertibles or partly convertibles, money market, securities etc. or a mix of more than
one type of proper mix ensures higher safety, yield and liquidity coupled with balanced
risk techniques of portfolio management.

A portfolio manager in the Indian context has been Brokers (Big brokers) who on the basis of
their experience, market trends, Insider trader, helps the limited knowledge persons.

The one who use to manage the funds of portfolio, now being managed by the portfolio of
Merchant Bank's, professional's like MBA's CA's And many financial institutions have entered the
market in a big way to manage portfolio for their clients.

According to S.E.B.I. rules it is mandatory for portfolio managers to get them self's
registered.

Registered merchant bankers can act's as portfolio managers. Investor's must look forward, for
qualification and performance and ability and research base of the portfolio managers.

Roles and Responsibilities of Portfolio Manager

A portfolio manager is one who helps an individual invest in the best available investment
plans for guaranteed returns in the future. Let us go through some roles and responsibilities of
a Portfolio manager:

 A portfolio manager plays a pivotal role in deciding the best investment plan for an
individual as per his income, age as well as ability to undertake risks. Investment is
essential for every earning individual. One must keep aside some amount of his/her
income for tough times. Unavoidable circumstances might arise anytime and one
needs to have sufficient funds to overcome the same.

 A portfolio manager is responsible for making an individual aware of the various

investment tools available in the market and benefits associated with each plan. Make

Portfolio Management & Investment Decisions Page 27

 an individual realize why he actually needs to invest and which plan would be the best
for him.

 A portfolio manager is responsible for designing customized investment solutions for

the clients. No two individuals can have the same financial needs. It is essential for
the portfolio manager to first analyze the background of his client. Know an
individual’s earnings and his capacity to invest. Sit with your client and understand
his financial needs and requirement.

 A portfolio manager must keep himself abreast with the latest changes in the financial
market. Suggest the best plan for your client with minimum risks involved and
maximum returns. Make him understand the investment plans and the risks involved
with each plan in a jargon free language. A portfolio manager must be transparent
with individuals. Read out the terms and conditions and never hide anything from any
of your clients. Be honest to your client for a long term relationship.

 A portfolio manager ought to be unbiased and a thorough professional. Don’t always

look for your commissions or money. It is your responsibility to guide your client and
help him choose the best investment plan. A portfolio manager must design tailor
made investment solutions for individuals which guarantee maximum returns and
benefits within a stipulated time frame. It is the portfolio manager’s duty to suggest
the individual where to invest and where not to invest? Keep a check on the market
fluctuations and guide the individual accordingly.

 A portfolio manager needs to be a good decision maker. He should be prompt enough

to finalize the best financial plan for an individual and invest on his behalf.

 Communicate with your client on a regular basis. A portfolio manager plays a major
role in setting financial goal of an individual. Be accessible to your clients. Never
ignore them. Remember you have the responsibility of putting their hard earned
money into something which would benefit them in the long run.

 Be patient with your clients. You might need to meet them twice or even thrice to
explain them all the investment plans, benefits, maturity period, terms and conditions,
risks involved and so on. Don’t ever get hyper with them.

 Never sign any important document on your client’s behalf. Never pressurize your
client for any plan. It is his money and he has all the rights to select the best plan for
himself.

With the development of Indian Securities market and with appreciation in market price of
equity share of profit making companies, investment in the securities of such companies has
become quite attractive. At the same time, the stock market becoming volatile on account of

Portfolio Management & Investment Decisions Page 28

various facts, a layman is puzzled as to how to make his investments without losing the same.
He has felt the need of an expert guidance in this respect. Similarly non-resident Indians are
eager to make their investments in Indian companies. They have also to comply with the
conditions specified by the RESERVE BANK OF INDIA under various schemes for
investment by the non-residents. The portfolio manager with his background and expertise
meets the needs of such investors by rendering service in helping them to invest their fund/s
profitably.

How to choose the right Portfolio Manager?

Portfolio managers charge a good amount of money form their clients for their services. One
must be careful while selecting the right portfolio manager.

 Make sure the portfolio manager you choose has complete market knowledge and
knows about the existing investment plans and the various risks involved. Taking the
assistance of someone who himself is not clear about the market policies does not
make sense.

 A portfolio manager should be trustworthy. You will find all types of portfolio
managers in the market - cheat, dishonest, unprofessional. An individual must hire the
best portfolio manager who understands the market well and can guide him correctly.
Don’t give money to someone who does not have a good background. You never
know he might run away with all your hard earned money. Ask for his business card.
Check his reputation in the market.

 An individual must not blindly trust his portfolio manager. Make it a point to read the
related documents carefully before investing. A/C payee cheques must be issued and
one should never sign any blank document.

 A good portfolio manager should be transparent with his client. One should not try to
confuse his client by using complicated terminologies and professional jargons. The
various plans must be explained to the client in the easiest possible way.

 Select a portfolio manager who does not have any personal interests in your investing
in any particular plan. He should be able to help you decide the best plan available in
the market.

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Defaults and Penalties

 Liabilities for action in case of default – A portfolio manager is liable to penalty if he:
 Fails to comply with any conditions subject to which certificate of registration
has been granted.
 Contravenes any of the provisions of the SEBI Act, its rules and regulations.

 In such a case, he shall be liable to any of the following penalties, after enquiry:
 Suspension of registration for a specific period.
 Cancellation of registration.

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 INVESTMENT ANALYSIS
Investment means employment of funds in a productive manner so as to create additional
income. The word investment means many things to many persons. Investment in financial
assets leads to further production and income. It is lending of funds for income and
commitment of money for creation of assets, producing further income.

Investment also means purchasing of securities, financial instruments or claims on future

income. Investment is made out of income and savings credit or borrowings and out of
wealth. It is a reward for waiting for money.

There are two concepts of investment:

1) Economic Investment:
The concept of economic investment means additions to the capital stock of the
society. The capital stock is the goods which are used in the production of other
goods. The term investment implies the formation of new and productive capital in
the form of new construction and producer’s durable instrument such as plant and
machinery, inventories and human capital are also included in this concept. Thus, an
investment, in economic terms, means an increase in building, equipment. And
inventory.
2) Financial Investment:
This is an allocation of monetary resources to assets that are expected to yield some
gain or return over a given period of time. It is a general or extended sense of the
term. It means an exchange of financial claims such as shares and bonds, real estate,
etc. in their view; investment is a commitment of funds to derive future income in the
form of interest, dividends, rent premiums, pension benefits and the appreciation of
the value of their principal capital.

The economic and financial concepts of investment are related to each other because
investment is a part of the savings of individuals which flow into the capital market
either directly or through institutions. Thus, investment decisions and financial
decisions interact with each other. Financial decisions are primarily concerned with
uses or budgeting of money.

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Investment Avenues
The alternative investment avenues for the investor are to be considered first so as to satisfy
the above objectives of investors. The following categories of investors are open to investors
as avenues for savings to flow in financial form:

i. Investment in Bank Deposits – Savings and Fixed Deposits:

This is the most common form of investment for an average Indian and nearly 40% of
funds in financial savings are used in this form, these are least risky but the return is
also low.

ii. Investment in P.O.Deposits, National Savings Certificates and other Postal

Savings Schemes:
Many people in villages and some urban areas are investors in these schemes due to
lower risk of loss of money and greater security of funds. But returns are also lower
than in Stocks & Shares.

iii. Insurance Schemes of LIC/GIC etc. and Provident and Pension Funds:
About 20-25% of financial savings of the household sector are put in these forms and
P.F., Pension and other forms of contractual savings.

iv. Investment in Mutual Fund Schemes or UTI Schemes as and when announced:
These are less risky than direct investment in stocks and shares as these enjoy the
expert management by the Portfolio Manager or Professional experts. They also have
the advantage of diversified Portfolio involving the reduction of risk and economies
of scale reducing the cost of investment.

v. Investment in New Issues Market:

A new entrant in the Stock Market should preferably invest in New Issues of existing
and well reputed companies either in equity or debentures. Incidentally the
instruments in which investment can be made in the new issues market are:-
a) Equity issues through prospectus or rights announced by existing shareholders.
b) Preference shares with a fixed dividend either convertible into equity or not.
c) Debentures of various categories – convertible, fully convertible, partly
convertible and non-convertible debentures.
d) P.S.U. Bonds – taxable or free-taxed with interest rates.

vi. Investment in gold, silver, precious metals and antiques.

vii. Investment in real estates.

viii. Investment in gilt-edge securities:

Investment in gilt-edge securities of Government and Semi-Government organizations
(Example – Relief bonds, bonds of port trusts, treasury bills, etc.). The maturity

Portfolio Management & Investment Decisions Page 32

 period is varying generally upto 10 to 20 years. Gilt-edge securities market constitutes
the largest segment of the Indian capital market. These are fully secured as they have
government backing. Tax benefits are available to these securities.

The following figure indicates alternative avenues for

Investment

Portfolio Management & Investment Decisions Page 33

 FUNDAMENTAL ANALYSIS

Fundamental analysis is the study of economic, industry, and company conditions in an effort
to determine the value of a company's stock. Fundamental analysis typically focuses on key
statistics in a company's financial statements to determine if the stock price is correctly
valued.

 Economy Analysis
The economy of India is the tenth-largest in the world by nominal GDP and the third-
largest by purchasing power parity (PPP). The country is one of the G-20 major
economies and a member of BRICS. On a per-capita income basis, India ranked141st
by nominal GDP and 130th by GDP (PPP) in 2012, according to the IMF. India is
the 19th-largest exporter and the10th-largest importer in the world. The economy
slowed to around 5.0% for the 2012–13 fiscal year compared with 6.2% in the previous
fiscal. According to Moody's, the Economic Growth Rate of India would be 5.5% in
2014-15. On 28 August 2013 the Indian rupee hit an all-time low of 68.80 against
the US dollar. In order to control the fall in rupee, the government introduced capital
controls on outward investment by both corporate and individuals. India's GDP grew
by 9.3% in 2010–11; thus, the growth rate has nearly halved in just three years. GDP
growth rose marginally to 4.8% during the quarter through March 2013, from about
4.7% in the previous quarter. The government has forecast a growth rate of 6.1%–6.7%
for the year 2013–14, whilst the RBI expects the same to be at 5.7%. Besides this, India
suffered a very high fiscal deficit of US$ 88 billion (4.8% of GDP) in the year 2012–
13. The Indian Government aims to cut the fiscal deficit to US$ 70 billion or 3.7% of
GDP by 2013–14.

Portfolio Management & Investment Decisions Page 34

 During fiscal 2013, the economic environment remained challenging with growth
slowing down globally. India was impacted by both global and domestic events that led
to moderation in economic activity. India’s gross domestic product (GDP) grew by
5.0% during the first nine months of fiscal 2013 as compared to 6.6% during the
corresponding period of fiscal 2012. The Central Statistical Organization, in its advance
estimates, has projected GDP to grow by 5.0% during fiscal 2013 compared to growth
of 6.2% in fiscal 2012. Banking sector non-food credit growth moderated from 16.8%
at March 23, 2012 to 14.0% at March 22, 2013. Deposit growth remained subdued at
14.3% with demand deposits recording a growth of 5.9% at March 22, 2013. Amidst
these short term challenges, the Bank continued to stay focused on the long-term
prospects of the Indian economy and build capabilities for future growth. We believe
that the strong underlying fundamentals of the Indian economy with a young population
will support strong growth over the medium to long term, and our strategy revolves
around prudently managing short term challenges while being prepared to meet the
needs of a vibrant economy.

India’s real GDP growth continued to moderate for the second successive year in 2012-
13 and dropped to 5.0 per cent, the lowest in the past 10 years. A combination of
factors has contributed to growth moderation over past two years. These include
structural impediments, high inflation for three years and cyclical slowdown in both
global and domestic economies. Consequently, activity in all major sectors of the
economy decelerated during the year, with the industrial sector suffering the most while
the agriculture sector slowed for the second consecutive year in 2012-13 due to the
weak monsoon, industrial and services sector growth decelerated for the third
consecutive year after the recovery from the global crisis in 2009-10. Nevertheless
India’s growth continued to remain service-led with the highest contribution (90.0 per
cent) to GDP growth during the year Contraction in the mining sector, slack in
manufacturing activity due to slowing external and domestic demand and deceleration
in electricity generation on the back of coal shortages compounded to result in
stagnating industrial activity. Domestic policy uncertainties, governance concerns and
earlier monetary tightening adversely impacted growth in the industrial and services
Multi-faceted problems that have emerged in the infrastructure sectors have dampened
“animal spirits” and impacted the investment climate. Shortages in coal supply, slack in
capacity addition and the delayed and skewed distribution of the monsoon led to slower
growth in ‘electricity, gas and water supply’. Legal, regulatory and environment issues
also adversely impacted the output growth of the mining sector. On the other hand, a
slowdown in the services sector during 2012-13 was visible in all sub-sectors except
‘community, social and personal services.

The economy is studied to determine if overall conditions are good for the stock
market. Is inflation a concern? Are interest rates likely to rise or fall? Are consumers
spending? Is the trade balance favourable? Is the money supply expanding or
contracting? These are just some of the questions that the fundamental analyst would
ask to determine if economic conditions are right for the stock market.

Portfolio Management & Investment Decisions Page 35

 All investment decisions are made within the economic environment after taking into
account the economic prospect of the country. This environment varies as the economy
goes through stages of prosperity. Why economy fails to have prosperity forever? There
are several reasons. Often, when the company is booming companies over invest in
projects and create excess capacity and thus lead to slow down of the economy.
Further, government policies and external pressures also create complications to the
economy. For instance, increase in oil prices on account of gulf war to war with
neighbouring countries creates pressures to the domestic economy. Government also
can create problems to the economy by following wrong policies or failure to adopt
right policies like failure in meeting disinvestment target. Different stages of economic
prosperity are also referred to as the business cycle. The term cycle doesn’t mean that
there is some orderliness in the economic sequence such as the seasons of the year. The
economy doesn’t follow a regularly repeated sequence of events. It simply means how
economic output and growth moves from period one to next periods. If the initial period
is a period of rapid growth, it peaks out at some point of time and a recession sets in
subsequently. After some point of slow growth, the economy bottoms out by then, new
demand accrues and fresh activities emerge. The economy now sets into recovery mode
and then gets into expansion. The cycle moves on without any definite length of time
between the stages while trying to cut down the recession or speed up the recovery
phase.

The starting point of any investment decision is evaluation of future economic

performance. There is no point in investing in a security if future performance of the
economy is not good. Economic analysis also gives importance of asset allocation
between government securities and equity. Economic analysis is a part of fundamental
analysis. Various fundamentals or basic factors that affect risk return of a security are
examined. Price justified by the fundamentals is called as intrinsic value.

The level of economic activity has an impact on investment in many ways. If the
economy grows rapidly, the industry can also be expected to show rapid growth and
vice versa. When the level of economic activity is low, stock process are low, and when
the level of economic activity is high, stock prices are high reflecting the prosperous
outlook for sales and profits of the firms. The analysis of macro-economic environment
is essential to understand the behaviour of the stock prices. The commonly analysed
macro-economic factors are as follows
 Gross Domestic Product:
GDP indicates the rate of growth of economy. GDP represents the aggregate
value of goods and services produced in the economy. GDP consists of
personal consumption expenditure, gross private domestic investment and
government expenditure on goods and services and net export of goods and
services. The estimates of GDP are available on annual basis. The GDP
growth in 2013-14 is 4.9%. The higher growth rate is more favourable to the
stock market.

Portfolio Management & Investment Decisions Page 36

  Savings and Investment:
It is obvious that growth requires investment which in turn requires substantial
amount of domestic savings. Stock market is a channel through which the
savings of the investors are made available to the corporate bodies. Savings
are distributed over various assets like equity shares, deposits, mutual fund
units, real estate and bullion. The saving and investment patterns of the public
affect the stock to a great extent.

 Inflation:
Along with the growth of GDP, if the inflation rate also increases, then the real
rate of growth would be very little. The demand in the consumer product
industry is significantly affected. The industries which come under the
government price control policy may lose the market, for example Sugar. The
government control over this industry, affects the price of the sugar and
thereby the profitability of the industry itself. If there is a mild level of

Portfolio Management & Investment Decisions Page 37

 inflation, it is good to the stock market but high rate of inflation is harmful to
the stock market.

 Interest Rates:
The interest rate affects the cost of financing to the firms. A decrease in
interest rate implies lower cost of finance for firms and more profitability.
More money is available at a lower interest rate for the brokers who are doing
business with borrowed money. Availability of cheap fund encourages
speculation and rise in the price of shares.
Interest rate is one of the most important macro-economic factors. Suppose
you expect the interest rates to go down in near future, then you will shy away
from long term investments in fixed income securities.

 Budget:
The budget draft provides an elaborate account of the government revenues
and expenditures. A deficit budget may lead to high rate of inflation and

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 adversely affect the cost of production. Surplus budget may result in deflation.
Hence, balanced budget is highly favourable to the stock market.

 Tax Structure:
Every year in March, the business community eagerly awaits the
Government’s announcement regarding the tax policy. Concessions and
incentives given to a certain industry encourage investment in that particular
industry. Tax reliefs are given to encourage savings. The type of tax
exemption has impact on the profitability of the industries.

 Balance of Payment:
The balance of payment is the record of a country’s money receipts from and
payments abroad. The difference between receipts and payments may be
surplus or deficit. Balance of payment is a measure of the strength of rupee on
external account. If the deficit increases, the rupee may depreciate against
other currencies, thereby, affecting the cost of imports. The industries
involved in the export and import are considerably affected by the changes in
foreign exchange rate. The volatility of the foreign exchange rate affects the
investment of the foreign institutional investors in the Indian stock market. A
favourable balance of payment renders a positive effect on the stock market.

 Infrastructure Facilities:
Infrastructural facilities are essential for the growth of industrial and
agricultural sector. A wide network of communication system is a must for the
growth of the economy. Regular supply of power without any power cut
would boost the production. Banking and financial sectors also should be
sound enough to provide adequate support to the industry and agriculture.
Good infrastructure facilities affect the stock market favourably. In India even
though infrastructure facilities have been developed, still they are not
adequate. The government has liberalised its policy regarding the
communication, transport and power sector. For example, power sector has
been opened up to the foreign investors with assured rates of returns.

 Demographic Factors:
The demographic data provides details about the population by age,
occupation, literacy and geographic location. This is needed to forecast the
demand for the consumer goods. The population by age indicates the
availability of able work force. The cheap labour force in India has
encouraged many multinationals to start their ventures. Indian labour is
cheaper compared to the Western labour force. Population, by providing
labour and demand for products, affects the industry and stock market.

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 Economic Forecasting:
To estimate the stock price changes, an analyst has to analyse the macro-economic
environment and the factors peculiar to the industry he is concerned with. The
economic activities affect the corporate profits, investors, attitude and the share prices.
Fall in the GDP or slackness in the economic growth may lead to fall in corporate profit
and consequently the security prices. For the purpose of economic analysis, an analyst
should be familiar with the forecasting techniques. He should know the advantages and
disadvantages of various techniques. The common techniques used are analysis of key
economic indicators, diffusion index, surveys and econometric model building. These
techniques help him to decide the right time to invest and the typr of security he has to
purchase i.e. stocks or bonds or some combination of stocks and bonds.

 Industry Analysis
An industry is a group of firms that have similar technological structure of production
and produce similar products. The company's industry obviously influences the outlook
for the company. Even the best stocks can post mediocre returns if they are in an
industry that is struggling. It is often said that a weak stock in a strong industry is
preferable to a strong stock in a weak industry.
The purpose of the industry analysis is to identify the industries with a potential for
future growth and to invest in selected companies from such industries. An industry is a
homogenous group of companies. Industry broadly covers all the economic activities
happening in a country. A broad concept of industry would include factors of
production, transportation, trading activity and public utilities.
The industrial growth of the nation leads to the development of a nation. Industries are
to be considered as community interest. Industry consisting of products on process
oriented units. There are number of industries. The industries can be divided according
to the nature of their function. For example Automobile industry, steel industry etc.

Industry Life Cycle

According to the industry life cycle theory, the life of an industry can be segregated
into the development stage, the expansion stage and the stagnation stage. This kind of
segregation is extremely useful to an investor because the profitability of an industry
depends upon its stage of growth. While investing in a stock, it would be advisable to
study the industrial sector at which the company exists and its growth prospects.
Industries pass through different life cycle like development stage, expansion stage,
stagnation stage and decay stage. If an investor buys a stock which is facing stagnation
in business, he will end up with loses.
 Development Stage:
This stage is also known as the formative stage. This is the toughest period of
an industry, because it incurs huge expenditure and less income. During this
phase, the industry faces stiff competition, lower sales, and higher

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 advertisement expenditures, and so on. Companies with fewer resources will
be eliminated from this industrial cycle, and few will survive through proper
management. Investments in a company, when it is in the developing stage,
offer high risk to the investor.

 Expansion Stage:
Once the company successfully passes through the development stage, it will
enter into the expansion stage. This is the time when the company needs
additional working capital for machines, land and buildings, repayment debts,
and so on. Usually, companies raise money from the primary market, stake
sale to private equity funds, and so on. Investments in a company at this stage
are relatively less risky.

 Stagnation Stage:
The third stage of industry life cycle is also known as maturity stage. This
stage is the largest cycle of an industry. During the period, the growth of the
industry stagnates, as a result of competition and shrinking profit margins. As
the profit margin declines, companies will increase the production capacity,
may even acquire small firms which are facing liquidity crunch, thereby
increasing their market share. Sometimes companies diversify their business
by finding out various other opportunities.

 Decay Stage:
When a company’s products are no more in demand, it is said to be the decay
stage of that company. The floppy disc manufacturing industry is a classic
example. It can happen very frequently in the technological filed. When new
technology comes out with cutting edge technology over the previous
products, the latter will be completely wiped out from the universe. Shift from
radio to TV, again shift from Black and White TV to colour TV etc. are other
examples.

Apart from industry life cycle analysis, the investor has to analyse some other factors
too. They are listed below
 Growth of the Industry:
The historical performance of the industry in terms of growth and profitability
should be analysed. Industry wise growth is published periodically by the
Centre for Monitoring Indian Economy. The variability in return and growth
in reaction to macro-economic factors provide an insight into the future. Even
though history may not repeat in the exact manner, looking into the past
growth of the industry, the analyst can predict future.

 Cost Structure and Profitability:

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 The cost structure, that is the fixed and variable cost, affects the cost of
production and profitability of the firm. Higher the fixed cost component,
greater sales volume is required to reach the firm’s break-even point. Once the
break-even is reached and the production is on track, the profitability can be
increased by utilising the capacity to full.

 Government Policy:
The government policies affect the very nerve of the industry and the effects
differ from industry to industry. Tax subsidies and tax holidays are provided
for export oriented products. Government regulates the size of the production
and the pricing of certain products. The sugar, fertiliser and the
pharmaceutical industries are often affected by the inconsistent government
policies. When selecting an industry, the government policy regarding
particular industry should be carefully evaluated.

 Labour:
The analysis of labour scenario in a particular industry is of great importance.
The number of trade unions and their operating mode has impact on the labour
productivity and modernisation of the industry. Textile industry is known for
its militant trade unions. If the trade unions are strong and strikes occur
frequently, it would lead to fall in the production. In an industry of high fixed
cost, the stoppage of production may lead to loss. The unhealthy labour
relationship leads to loss of customers’ goodwill too.

 Research and Development:

For any industry to survive the competition in the national and international
markets, product and production process have to be technically competitive.
This depends on the R &D in the particular company or industry. Economies5
of scale and new market can be obtained only through R & D. The percentage
of expenditure made on R & D should be studied diligently before making an
investment.

 SWOT Analysis:
The above mention factors themselves would become strength, weakness,
opportunity and threat (SWOT) for the industry. Hence, the investor should
carry out a SWOT analysis for the chosen industry. Taken for instance,
increase in demand for the industry’s product becomes its strength; presence
of numerous players in the market, i.e. competition becomes the threat to a
particular company in the respective industry. The progress in the research and
development in that particular industry is an opportunity and entry of
multinationals in the industry and cheap imports of the particular products are
threat to that industry. In this way the factors have to be arranged and
analysed.

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  Company Analysis
In order to provide a proper perspective of this analysis, let us begin by discussing the
way investor takes the investment decision given his goal of return maximization. For
earning profits, investors apply a simple and common sense decision rule. That is,
 Buy the share at a low price, and
 Sell the share at a high price.
The above decision rule is very simple to understand but difficult to apply in actual
practice. Despite this, efforts are generally made to operationalize it by using proper
formal and analytical framework. To begin with, the problems faced by the investor
are:
The first question becomes easier if some benchmark is agreed upon with which the
prevailing market price can be compared. Fundamental analysis in fact helps the
investor in this respect by providing a benchmark in terms of intrinsic value. This
value is dependent upon economy, industry and company fundamentals. Out off these
three, company level analysis provides a direct link between investor’s action and his
investment goal in operational terms. This is because an investor buys the equity share
of company and not that of industry and economy. Industry and economy framework
indeed provide him with proper background against which he buys the shares of a
particular company. This setting is nevertheless very important, but for action to take
place it is the company with its quantitative and qualitative fundamentals is, therefore,
very essential. If the economic outlook suggests purchase at this time, the economic
analysis along with the industry analysis will aid the investor in selecting their proper
industry in which to invest. Nonetheless, knowing when to invest and in which
industry is not enough. It is also necessary to know which companies in which
industries should be selected.

To select a company for investment purpose a number of qualitative factors have to

be seen. Before purchasing the shares of the company, relevant information must be
collected and properly analyzed. An illustrative list of factors which help the analyst
in taking the investment decision is given below. However, it must be emphasized that
the past performance and information is relevant only to the extent it indicates the
future trends. Hence, the investment manager has to visualize the performance of the
company in future by analyzing its past performance.

 Size and Ranking:

A rough idea regarding the size and ranking of the company within the
economy, in general, and the industry, in particular, would help the
investment manager in assessing the risk associated with the company. In this
regard the net capital employed, the net profits, the return on investment and
the sales volume of the company under consideration may be compared with
similar data of other company in the same industry group. It may also be

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 useful to assess the position of the company in terms of technical knowhow,
research and development activity and price leadership.

 Growth Record:
The growth in sales, net income, net capital employed and earnings per share
of the company in the past few years must be examined. The following three
growth indicators may be particularly looked in to (a) Price earnings ratio, (b)
Percentage growth rate of earnings per annum and (c) Percentage growth rate
of net block of the company. The price earnings ratio is an important indicator
for the investment manager since it shows the number the times the earnings
per share are covered by the market price of a share. Theoretically, this ratio
should be same for two companies with similar features. However, this is not
so in practice due to many factors. Hence, by a comparison of this ratio
pertaining to different companies the investment manager can have an idea
about the image of the company and can determine whether the share is
under-priced or over-priced. An evaluation of future growth prospects of the
company should be carefully made. This requires the analysis of the existing
capacities and their utilization, proposed expansion and diversification plans
and the nature of the company's technology.

The existing capacity utilization levels can be known from the quantitative
information given in the published profit and loss accounts of the company.
The plans of the company, in terms of expansion or diversification, can be
known from the directors reports the chairman's statements and from the
future capital commitments as shown by way of notes in the balance sheets.
The nature of technology of a company should be seen with reference to
technological developments in the concerned fields, the possibility of its
product being superseded of the possibility of emergence of more effective
method of manufacturing.
Growth is the single most important factor in company analysis for the
purpose of investment management. A company may have a good record of
profits and performance in the past; but if it does not have growth potential, its
shares cannot be rated high from the investment point of view.

After determining the economic and industry conditions, the company itself is
analyzed to determine its financial health. This is usually done by studying the
company's financial statements. From these statements a number of useful ratios can
be calculated. The ratios fall under five main categories: profitability, price, liquidity,
leverage, and efficiency. When performing ratio analysis on a company, the ratios
should be compared to other companies within the same or similar industry to get a
feel for what is considered "normal." At least one popular ratio from each category is
shown below.
 Net Profit Margin:

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 A company's net profit margin is a profitability ratio calculated by dividing net
income by total sales. This ratio indicates how much profit the company is
able to squeeze out of each dollar of sales. For example, a net profit margin of
30%, indicates that $0.30 of every $1.00 in sales is realized in profits.

 P/E Ratio:
The P/E ratio (i.e., Price/Earnings ratio) is a price ratio calculated by dividing
the security's current stock price by the previous four quarter's earnings per
share (EPS). The P/E Ratio shows how much an investor must pay to "buy" $1
of the company's earnings. For example, if a stock's current price is $20 and
the EPS for the last four quarters was $2, the P/E ratio is 10 (i.e., $20 / $2 =
10). This means that you must pay $10 to "buy" $1 of the company's earnings.
Of course, investor expectations of company's future performance play a
heavy role in determining a company's current P/E ratio. A common approach
is to compare the P/E ratio of companies within the same industry. All else
being equal, the company with the lower P/E ratio is the better value.

 Book Value Per Share:

A company's book value is a price ratio calculated by dividing total net assets
(assets minus liabilities) by total shares outstanding. Depending on the
accounting methods used and the age of the assets, book value can be helpful
in determining if a security is overpriced or under-priced. If a security is
selling at a price far below book value, it may be an indication that the security
is under-priced.

 Current Ratio:
A company's current ratio is a liquidity ratio calculated by dividing current
assets by current liabilities. This measures the company's ability to meet
current debt obligations. The higher the ratio the more liquid the company. For
example, a current ratio of 3.0 means that the company's current assets, if
liquidated, would be sufficient to pay for three times the company's current
liabilities.

 Debt Ratio:
A company's debt ratio is a leverage ratio calculated by dividing total
liabilities by total assets. This ratio measures the extent to which total assets
have been financed with debt. For example, a debt ratio of 40% indicates that
40% of the company's assets have been financed with borrowed funds. Debt is
a two-edged sword. During times of economic stress or rising interest rates,
companies with a high debt ratio can experience financial problems. However,
during good times, debt can enhance profitability by financing growth at a
lower cost.

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  Inventory Turnover:
A company's inventory turnover is an efficiency ratio calculated by dividing
cost of goods sold by inventories. It reflects how effectively the company
manages its inventories by showing the number of times per year inventories
are turned over (replaced). Of course, this type of ratio is highly dependent on
the industry. A grocery store chain will have a much higher turnover than a
commercial airplane manufacturer. As stated previously, it is important to
compare ratios with other companies in the same industry.

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 INVESTMENT DECISIONS

Given a certain sum of funds, the investment decisions basically depend upon the following
factors:

1) Objectives of Investment Portfolio:

This is a crucial point which a Finance Manager must consider. There can be many
objectives of making an investment. The manager of a provident fund portfolio has to
look for security and may be satisfied with none too high a return, where as an
aggressive investment company is willing to take high risk in order to have high
capital appreciation.
How the objectives can affect in investment decision can be seen from the fact the
Unit Trust of India has two major schemes: Its “capital units” are meant for those who
wish to have a good capital appreciation and a moderate return, whereas the ordinary
unit are meant to provide a steady return only. The investment manager under both
the scheme will invest the money of the Trust in different kinds of shares and
securities. So it is obvious that the objectives must be clearly defined before an
investment decision is taken.

2) Selection of Investment:
Having defined the objectives of the investment, the next decision is to decide the
kind of investment to be selected. The decision what to buy has to be seen in the
context of the following:-
a) There is a wide variety of investments available in market i.e. Equity shares,
preferences share, debentures, convertible bond, Govt. securities and bond,
capital units etc. Out of these what types of securities to be purchased.
b) What should be the proportion of investment in fixed interest dividend
securities and variable dividend bearing securities? The fixed one ensures a
definite return and thus a lower risk but the return is usually not as higher as
that from the variable dividend bearing shares.
c) If the investment is decided in shares or debentures, then the industries
showing a potential in growth should be taken in first line. Industry-wise-
analysis is important since various industries are not at the same level from the
investment point of view. It is important to recognize that at a particular point
of time, a particular industry may have a better growth potential than other
industries. For example, there was a time when jute industry was in great
favour because of its growth potential and high profitability, the industry is no
longer at this point of time as a growth oriented industry.
d) Once industries with high growth potential have been identified, the next step
is to select the particular companies, in whose shares or securities investments
are to be made.

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 INVESTMENT STRATEGY

Portfolio management can be practiced by following either an active or passive strategy.

I. Active Strategy:
Active strategy is based on the assumption that it is possible to beat the market. This is
done by selecting assets that are viewed as under-priced or by changing the asset mix
or proportion of fixed income securities and shares. Active strategy is carried out as
follows:
a) Aggressive Security Management: Aggressive purchasing and selling of
securities to achieve high yields from dividend interest and capital gains.
b) Speculation and Short Term Trading: The objective is to gain capital
profits. The risk is high and the composition of portfolio is flexible. Success of
active strategy depends on correct decisions as regard the timing of movement
in the market as a whole, weight age of various securities in the portfolio and
individual share selection.

II. Passive Strategy:

The passive strategy does not aim at outperforming the market. Unlike the active
strategy. On the other hand the stocks could be randomly selected on the assumption of
a perfectly efficient market. The objective is to include in the portfolio a large number of
securities so as to reduce risks specific to individual securities. The characteristics of
positive strategy are:
a) Long Term Investment Horizon.
b) Little Portfolio Revisions.
Thus it is basically a buy and hold strategy.

Portfolio Management & Investment Decisions Page 48

 INVESTMENT AND SPECULATION

Speculation is an activity, quite contrary to its literal meaning, in which a person assumes
high risks, often without regard for the safety of his invested principal, to achieve large
capital gains." The time span in which the gain is sought to be made is usually very short.

The investor sacrifices some money today in anticipation of a financial return in future. He
indulges in a bit of speculation. There is an element of speculation involved in all investment
decisions. However it does not mean that all investments are speculative by nature. Genuine
investments are carefully thought out decisions. On the other hand, speculative investments
are not carefully thought out decisions. They are based on tips and rumours.

An investment can be distinguished from speculation in three ways - Risk, capital gain and
time period. Investment involves limited risk while speculation is considered as an
investment of funds with high risk. The purchase of a security for earning a stable return over
a period of time is an investment whereas the primary motive is to earn high profits through
price changes is termed as speculation. Thus, speculation involves buying a security at low
price and selling at a high price to make a capital gain.

The truth is that any investment is a speculation if the investor uses his judgement and
forecast the probable course of events in order to reap the returns on his investment.

Elements of Investments

a) Return: Investors buy or sell financial instruments in order to earn return on them.
The return on investment is the reward to the investors. The return includes both
current income and capital gains or losses, which arises by the increase or decrease
of the security price.

b) Risk: Risk is the chance of loss due to variability of returns on an investment. In case
of every investment, there is a chance of loss. It may be loss of interest, dividend or
principal amount of investment. However, risk and return are inseparable. Return is a
precise statistical term and it is measurable. But the risk is not precise statistical term.
However, the risk can be quantified: The investment process should be considered in
terms of both risk and return.

c) Time: Time is an important factor in investment. It offers several different courses of

action. Time period depends on the attitude of the investor who follows a 'buy and hold'
policy. As time moves on, analysts believe that conditions may change and investors
may revaluate expected return and risk for each investment.

Portfolio Management & Investment Decisions Page 49

 INVESTMENT PROCESS

Every investment proposition involves a certain process. The investment process is a stream
of activities which ultimately leads to the investment. It involves the steps followed in
creating a portfolio, and covers a sequence of activities such as undertaking the risk
preferences, acquiring knowledge of available investment avenues, allocation of resources
among chosen assets, evaluation of performance, and so on. The process enables an investor
to understand the various sources of investment strategies and philosophies. It also
emphasizes the different components that are essential for designing an appropriate
investment strategy. The various stages of investment process are as follows:

Construction of Evaluation of
Investment Valuation of Portfolio
Investment Policy Securities Portfolio
Analysis
Horizon Environment Technical Selection Performance
Funds Economy Cash Flow Allocation Risk
Taxes Industry Comparables Diversification Revision
Risk Company
Security

 Investment Policy:
Every investor has to develop an investment policy in order to be successful in his
investments. The investment policy generally covers the investment horizon, the
amount of funds which he desires to invest, setting objectives for investments, tax
position, risk perception, and so on. A well-developed investment policy helps an
investor to park his finds in appropriate securities with the desired maturity period
and with returns above his expectations. The investment policy should explore all
the available investment avenues and study the market potential. Understanding the
investment horizon properly enables one to choose the right form of investment.

 Investment Analysis:
The next stage is the investment analysis. In this step, the investor measures the
market timing by studying the market environment, economic condition of the

Portfolio Management & Investment Decisions Page 50

 country, performance and growth prospects of the industry, financial health, and
performance and growth prospects of the company in which the investor would like
to invest.

 Valuation of Securities:
The process involves understanding the intrinsic value and future value of the assets
in which investment is proposed to be made. The valuation is done from a technical
angle, based on cash flow and looking at the comparables. The valuation process
leads to taking the investment decision.

 Construction of Portfolios:
Once the decision is taken, the investor has to select the securities in which
investment is proposed to be made. The investor may invest in a single security or a
bunch of securities. The group of securities can pertain to a single industry or to
multiple industries. For example, an investor can buy shares of companies in IT
industry or the funds can be distributed in different sectors like IT, FMCG, Banking
and Finance, Realty, and so on. Hence, this step involves creation of the portfolio by
allocating resources under each portfolio. The whole process leads to the
management of portfolio.

 Evaluation of Portfolios:
The investment will not be successful unless the performance of the portfolio is
evaluated and the portfolio is churned by eliminating the portfolios with low return
or negative return and replacing them with the securities which pay high returns.
Similarly, the risk dimension of each portfolio also needs to be studied and the
portfolio needs to be reconstructed in tune with one’s risk perception. The post
investment analysis enables the investor to improve the efficiency of investments
and maximise the returns.

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 RISK-RETURN ANALYSIS

Risk on Portfolio

The expected returns from individual securities carry some degree of risk. Risk on the
portfolio is different from the risk on individual securities. The risk is reflected in the
variability of the returns from zero to infinity. Risk of the individual assets or a portfolio is
measured by the variance of its return. The expected return depends on the probability of the
returns and their weighted contribution to the risk of the portfolio.

Most investors invest in a portfolio of assets, because as to spread risk by not putting all eggs
in one basket. Hence, what really matters to them is not the risk and return of stocks in
isolation, but the risk and return of the portfolio as a whole. Risk is mainly reduced by
diversification.

Risk consists of two components, the systematic risk and the unsystematic risk. The
systematic risk is caused by factors external to the particular company and uncontrollable by
the company. The systematic risk affects the market as a whole. In the case of unsystematic
risk the factors are specific, unique, and related to the particular industry or company.

 Systematic Risk
The systematic risk affects the entire market. Often we read in the newspaper that the
stock market is in the bear hug or in the bull grip, this indicates that the entire market
is moving in a particular direction either downward or upward. The economic
conditions, political situations and the sociological changes affect the security market.
The recession in the economy affects the profit prospect of the industry and the stock

Portfolio Management & Investment Decisions Page 52

 market. These factors are beyond the control of the corporate and the investor. They
cannot be entirely avoided by the investor. It drives home the point that the systematic
risk is unavoidable. The systematic risk is further sub-divided into market risk,
interest rate risk and purchasing power risk.
i. Market Risk: Market risk is the fluctuation of returns caused by the
macroeconomic factors that affect all risky assets. Market risk is associated
with consistent fluctuations seen in the trading price of any particular shares or
securities. That is, it arises due to rise or fall in the trading price of listed
shares or securities in the stock market. Every investor faces market risk as a
securities market follows economic indicators, recessions and the normal
business cycle.

ii. Interest Rate Risk: Interest rate risk is the variation in the single period rates
of return caused by the fluctuations in the market interest rate. Most
commonly interest rate risk affects the price of bonds, debentures and stocks.
The fluctuations in the interest rates are caused by the changes in the
government monetary policy and the changes that occur in the interest rates of
treasury bills and the government bonds. The bonds issued by the government
and quasi-government are considered to be risk free. Many companies use
borrowed funds to finance their operation. When interest rates move up,
companies using borrowed funds have to make higher interest payments. This
leads to lower earnings, dividends and share prices. On the contrary, lower
interest rates may push up earnings and prices. Thus, we see that variations in
interest rates may indirectly influence stock prices. Interest rate risk is a
systematic risk which affects bonds directly and shares indirectly.

iii. Purchasing Power Risk: Purchasing power risk is the uncertainty of the
purchasing power of the amounts to be received. In more everyday terms,
purchasing power risk refers to the impact of inflation or deflation on an
investment. Inflation rates vary over time and investors are caught unaware
when rate of inflation changes unexpectedly causing erosion in the value of
realized rate of return and expected return. Fixed income securities, such as
bonds and preferred stock, subject investors to the greatest amount of
purchasing power risk since their payments are set at the time of issue and
remain unchanged regardless of the inflation rate.

 Unsystematic Risk
The returns from a security may sometimes vary because of certain factors affecting
only the company issuing such security. Examples are raw material scarcity, labour
strike, and management inefficiency. When variability of returns occurs because of
such firm specific factors, it is known as unsystematic risk. This risk is unique or
peculiar to a company or industry and affects it in addition to the systematic risk

Portfolio Management & Investment Decisions Page 53

 affecting all securities. The unsystematic or unique risk affecting specific securities
arises from two sources: the operating environment of the company and the financing
pattern adopted by the company. These two types of unsystematic risk are referred to
as business risk and financial risk respectively.
i. Business Risk: Business risk is a function of the operating conditions faced
by a firm and the variability these conditions inject into operating income and
expected dividends. In other words, if operating earnings are expected to
increase 10 percent per year over the foreseeable future, business risk would
be higher if operating earnings could grow as much as 14 percent or as little as
6 percent than if the range were from a high of 11 percent to a low of 9
percent. The degree of variation from the expected trend would measure
business risk.

ii. Financial Risk: Financial risk is associated with the way in which a company
finances its activities. We usually gauge financial risk by looking at the capital
structure of a firm. The presence of borrowed money or debt in the capital
structure creates fixed payments in the form of interest that must be sustained
by the firm. The presence of these interest commitments-fixed interest
payments due to debt or fixed –dividend payments on preferred stock-causes
the amount of residual earnings available for common stock dividends to be
more variable than if no interest payments were required. Financial risk is
avoidable risk to the extent that managements have the freedom to decide to
borrow or not to borrow funds. A firm with no debt financing has no financial
risk.

Risk Return Analysis

All investment has some risk. Investment in shares of companies has its own risk or
uncertainty; these risks arise out of variability of yields and uncertainty of appreciation or
depreciation of share prices, losses of liquidity etc.

The risk over time can be represented by the variance of the returns while the return over
time is capital appreciation plus pay-out, dividend by the purchase price of the share.

Normally, the higher the risk that the investor takes, the higher is the return. There is,
however, a risk less return on capital of about 12% which is the bank rate charged by the RBI
or long term, yielded on government securities at around 13% to 14%. This risk less return
refers to lack of variability of return and no uncertainty in the repayment or capital. But other
risks such as loss of liquidity due to parting with money etc., may however remain, but are
rewarded by the total return on the capital.

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Risk-return is subject to variation and the objectives of the portfolio manager are to reduce
that variability and thus reduce the risk by choosing an appropriate portfolio.

Traditional approach advocates that one security holds the better, it is according to the
modern approach diversification should not be quantity that should be related to the quality of
scripts which leads to quality of portfolio.

Returns on Portfolio

Each security in a portfolio contributes return in the proportion of its investments in security.
Thus the portfolio expected return is the weighted average of the expected return, from each
of the securities, with weights representing the proportions share of the security in the total
investment. Why does an investor have so many securities in portfolio? If the security ABC
gives the maximum return why not he invests in that security all his funds and thus maximize
return? The answer to this questions lie in the investor’s perception of risk attached to
investments, his objectives of income, safety, appreciation, liquidity and hedge against loss of
value of money etc. this pattern of investment in different asset categories, types of
investment, etc., would all be described under the caption of diversification, which aims at
the reduction or even elimination of non-systematic risks and achieve the specific objectives
of investors.

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 FUTURE OF PORTFOLIO MANAGEMENT IN
INDIA

Proper portfolio management can help you gain control of your own investments and deliver
good returns to your investments. As the middle-class income group is slowly and steadily
increasing in India, scope for portfolio management is also increasing simultaneously. High
GDP growth and high job opportunities are the key characteristics of the Indian economy. Its
growth can exceed double digits; can offer higher opportunity for portfolio management.
Higher inflation is always a threat to economy and its citizens. Citizens usually find out
alternative ways to increase wealth, because higher inflation can cause higher prices for food
stuffs and other essentials. In India, like other western countries, portfolio management has
assumed the role of a specialised service. Each of the portfolio managers compete
aggressively to provide the best to high investors, who lack knowledge and time. The major
concern of investors is safety to their and returns on investments. During 2007-2008, most of
the fund managers in India and abroad suffered heavy losses due to global economic
slowdown. After this incident, the money flow, which usually flows to the portfolio
management, has come down. Later, in 2011, once again market have gained their lost
momentum and managed to attract a lot of investors. In India, dividend yield on portfolios are
tax exempted and there is no long-term capital gain tax on equities, which will attract a lot of
investors to depend on portfolio managers to manage their funds. Demand for aggressive
portfolio managers in India is likely to get the maximum attention in the coming years. A
successful portfolio manager should have to identify the investor’s objectives, constrains, and
preferences; he should evaluate the portfolio on a regular basis; revise his portfolios; and
implement the available strategies for fine tuning the portfolios.

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 QUESTIONNAIRE
Survey on Investor’s views about Portfolio Management

Name :

Age :

Q. Are you aware of services offered by portfolio manager?

 Yes
 No

Q. If yes, what types of services you are aware of?

 Management of Mutual Fund Investment.

 Management of Equities.
 Management of Money Market Investment.
 Advisory or consultancy services.
 Others

Q. Would you want to hire a portfolio manager at present or in future?

 Yes
 No

Q. If yes, for what type of services?

 Investments in Mutual Funds.

 Investments in Equities.
 Investments in Money Market.
 Advisory or consultancy service.
 Investment in Others.

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Q. If no, why?

_____________________________________________________________________
_____________________________________________________________________

Q. Do you think there will be growth in portfolio management in future?

 Yes
 No

Q. What type of services would you want from portfolio manager in future?

_____________________________________________________________________
_____________________________________________________________________

Q. Suggestions, if any?

_____________________________________________________________________
_____________________________________________________________________

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 FINDINGS

This survey has been conducted on various age groups of individual investors on portfolio
management. These consist of age group ranging from 18-30, 30-45, 45-60 and 60 & above.
Following interpretation has been made on the basis of the information collected from
individual investors of various age groups through questionnaire:

 Age group of 18-30 is lore aware about services offered by portfolio manager whereas
age group of 60 & above is less aware of such services.

 Management of mutual fund investment, management of equities, management of

money market investment, advisory and consultancy services are the services
provided by the portfolio management institution. Among these, advisory and
consultancy services are the services that the individual investors are more aware of.

 Due to lack of experience and market knowledge, the age group of 45-60 is more
interested to hire portfolio manager at present in order to manage their portfolio. The
age group ranging from 18-30 is more interested in making investment in equities
whereas group ranging from 60 & above are more interested in making investment in
mutual fund. On the other hand, age group of 30-45 and 45-60 are least interested in
any of the services provided by portfolio management institutions. Reasons specified
for the presence of disinterest in any of these services were that the investors are
having good hold on their investments. Also they possess good knowledge with
regards to market fluctuations, investment portfolios and other factors relating to
portfolio management.

 All the age groups of individual investors in portfolio management believe that there
is a better scope for portfolio management in future.

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 CONCLUSION

From the above discussion it is clear that portfolio functioning is based on market risk, so one
can get the help from the professional portfolio manager or the merchant banker if required
before investment because applicability of practical knowledge through technical analysis can
help an investor to reduce risk. The breadth of market participants guarantees an element of
unpredictability and excitement. If we were all totally logical and could separate our
emotions from our investment decisions then, the determination of price based on future
earnings would work magnificently. And since we would all have the same completely
logical expectations, price would only change when quarterly reports or relevant news was
released.

A casino make money on a roulette wheel, not by knowing what number will come up next,
but by slightly improving their odds with the addition of a “0” and “00”. Yet many investors
buy securities without attempting to control the odds, If we believe that this dealings is not a
‘Gambling’ we have to start up it with intelligent way.

I can conclude from this project that portfolio management has become an important service
for the investors to identify the companies with growth potential. Portfolio managers can
provide the professional advice to the investors to make an intelligent and informed
investment.

Portfolio management role is still not identified in the recent time but due it expansion of
investors market and growing complexities of the investors the services of the portfolio
managers will be in great demand in the near future.

Due to the benefits available to the individual’s such as reduction in risk, expert professional
management, diversified portfolios, tax benefits, etc. young generation (i.e. age group of 18-
30) is willing to invest in different investment avenues through portfolio manager or through
mutual funds which are again managed by portfolio managers. On the other hand, age group
of 60 & above are least interested in making investment in different avenues through
portfolio managers.

Today the individual investors do not show much interest in taking professional help but
surely with the growing importance and awareness regarding portfolio manager’s people will
definitely prefer to take professional help.

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 REFERENCES

Books
 Security Analysis and Portfolio Management – By Donald E. Fischer & Ronald J.
Jordan.
 Security Analysis and Portfolio Management – By K Sasidharan & Alex K Mathews.
 Security Analysis and Portfolio Management – By Punithavathy Pandian.
 Security Analysis and Portfolio Management – By S. Kevin.

Websites
 http://www.portfoliomanagement.in
 http://www.investopedia.com
 http://managementstudyguide.com
 https://www.google.co.in

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