What Is Portfolio Management?
Portfolio management is the art and science of selecting and overseeing a group of investments that meet the long-term financial objectives and risk tolerance of a client, a company, or an institution.
KEY TAKEAWAYS
- Portfolio management involves building and overseeing a selection of investments that will meet the long-term financial goals and risk tolerance of an investor.
- Active portfolio management requires strategically buying and selling stocks and other assets in an effort to beat the broader market.
- Passive portfolio management seeks to match the returns of the market by mimicking the makeup of a particular index or indexes.
Understanding Portfolio Management
Professional licensed portfolio managers work on behalf of clients, while individuals may choose to build and manage their own portfolios. In either case, the portfolio manager’s ultimate goal is to maximize the investments’ expected return within an appropriate level of risk exposure.
Portfolio management requires the ability to weigh strengths and weaknesses, opportunities and threats across the full spectrum of investments. The choices involve trade-offs, from debt versus equity to domestic versus international and growth versus safety.
Portfolio management may be either passive or active in nature.
- Passive management is a set-it-and-forget-it long-term strategy. It may involve investing in one or more exchange-traded (ETF) index funds. This is commonly referred to as indexing or index investing. Those who build Indexed portfolios may use modern portfolio theory (MPT) to help optimize the mix.
- Active management involves attempting to beat the performance of an index by actively buying and selling individual stocks and other assets. Closed-end funds are generally actively managed. Active managers may use any of a wide range of quantitative or qualitative models to aid in their evaluations of potential investments.
Key Elements of Portfolio Management
Asset Allocation
The key to effective portfolio management is the long-term mix of assets. Generally, that means stocks, bonds, and “cash” such as certificates of deposit. There are others, often referred to as alternative investments, such as real estate, commodities, and derivatives.
Investors with a more aggressive profile weight their portfolios toward more volatile investments such as growth stocks. Investors with a conservative profile weight their portfolios toward stabler investments such as bonds and blue-chip stocks.
 Rebalancing captures gains and opens new opportunities while keeping the portfolio in line with its original risk/return profile.
Diversification
The only certainty in investing is that it is impossible to consistently predict winners and losers. The prudent approach is to create a basket of investments that provides broad exposure within an asset class.
Diversification involves spreading the risk and reward of individual securities within an asset class, or between asset classes. Because it is difficult to know which subset of an asset class or sector is likely to outperform another, diversification seeks to capture the returns of all of the sectors over time while reducing volatility at any given time.
Real diversification is made across various classes of securities, sectors of the economy, and geographical regions.
Rebalancing
Rebalancing is used to return a portfolio to its original target allocation at regular intervals, usually annually. This is done to reinstate the original asset mix when the movements of the markets force it out of kilter.
For example, a portfolio that starts out with a 70% equity and 30% fixed-income allocation could, after an extended market rally, shift to an 80/20 allocation. The investor has made a good profit, but the portfolio now has more risk than the investor can tolerate.
Rebalancing generally involves selling high-priced securities and putting that money to work in lower-priced and out-of-favor securities.
The annual exercise of rebalancing allows the investor to capture gains and expand the opportunity for growth in high potential sectors while keeping the portfolio aligned with the original risk/return profile.
Active Portfolio Management
Investors who implement an active management approach use fund managers or brokers to buy and sell stocks in an attempt to outperform a specific index, such as the Standard & Poor’s 500 Index or the Russell 1000 Index.
An actively managed investment fund has an individual portfolio manager, co-managers, or a team of managers actively making investment decisions for the fund. The success of an actively managed fund depends on a combination of in-depth research, market forecasting, and the expertise of the portfolio manager or management team.
Portfolio managers engaged in active investing pay close attention to market trends, shifts in the economy, changes to the political landscape, and news that affects companies. This data is used to time the purchase or sale of investments in an effort to take advantage of irregularities. Active managers claim that these processes will boost the potential for returns higher than those achieved by simply mimicking the holdings on a particular index.
Trying to beat the market inevitably involves additional market risk. Indexing eliminates this particular risk, as there is no possibility of human error in terms of stock selection. Index funds are also traded less frequently, which means that they incur lower expense ratios and are more tax-efficient than actively managed funds.
Passive Portfolio Management
Passive portfolio management, also referred to as index fund management, aims to duplicate the return of a particular market index or benchmark. Managers buy the same stocks that are listed on the index, using the same weighting that they represent in the index.
A passive strategy portfolio can be structured as an exchange-traded fund (ETF), a mutual fund, or a unit investment trust. Index funds are branded as passively managed because each has a portfolio manager whose job is to replicate the index rather than select the assets purchased or sold.
The management fees assessed on passive portfolios or funds are typically far lower than active management strategies.
How Does Passive Portfolio Management Differ From Active?
Passive management is a set-it-and-forget-it long-term strategy. Often referred to as indexing or index investing, it aims to duplicate the return of a particular market index or benchmark and may involve investing in one or more exchange-traded (ETF) index funds. Active management involves attempting to beat the performance of an index by actively buying and selling individual stocks and other assets. Closed-end funds are generally actively managed.
How PMS is different from Mutual Fund?
| Specification | PMS | Mutual Fund |
| Objective | Portfolio Management Services provide tailor made professional service offer to meet the investment objective of various investor | Mutual Funds schemes are structured to meet the funds stated investment objective. |
| Ownership | In PMS Investors will directly own the portfolio stocks in their DP. | Mutual Funds Trustees will own the stocks of the fund and investors will be allocated Units. |
| MINIMUM INVESTMENT | As per SEBI regulation, minimum thresholds for investing in PMS is Rs 50 Lakhs by way of stock or cash/or combination of both. | Mutual Funds Investment thresholds as low as Rs.500. |
| CUSTOMIZATION | Customization is possible to meet special or specific requirements of investors. | No customization possible in mutual funds. |
| PORTFOLIO
CONSTRUCTION |
Majority of PMS portfolio are focused portfolios constructed within 15 to 25 stocks | Majority of MF portfolios are diversified portfolios with more than 50 stocks. |
| PORTFOLIO STOCK
WEIGHTAGE |
PMS fund managers have flexibility to allocate any weightage to single stocks. | Mutual Funds restrict maximum allocation cap to
single stock of not more than 10 %. |
| IDEAL INVESTOR | The Investment solutions provided by PMS cater to a niche segment
of clients |
Mutual Funds being structured for a wide mass of
retail investors |
Who is ideal investor for PMS?
The investment solutions provided by PMS cater to a niche segment of clients. Minimum investment for PMS is 50 lakhs as per SEBI regulation. These clients can be either Individuals or Institutional entities who require a dedicated investment management service. The PMS platform is ideal for investors who seek to invest in asset classes like equity with professional management require investment advice for long-term wealth creation.