Meaning of Portfolio Management
A portfolio refers to a collection of investments such as stocks, shares, mutual funds, bonds, cash, and so on. Portfolio Management refers to the selection of securities and their continuous shifting in the Portfolio for optimizing the return for a given level of risk and maximizing the wealth of an investor.
The Investment process consists of two tasks. The first is security analysis which focuses on assessing the risk and return characteristics of the available investment alternatives. The second task is portfolio selection which involves choosing the best possible portfolio from the set of feasible portfolios.
Portfolio theory was originally proposed by Harry Markowitz in the 1950s and was the first formal attempt to quantify the risk of a portfolio and develop a methodology for determining the optimal portfolio. Markowitz assumed that investor attitudes towards portfolio depend exclusively upon
(1) expected return and risk, and
(2) quantification of risk.
And the risk is, by proxy, the statistical notion of variance, or standard deviation of return.
Prior to the development of Portfolio theory, investors dealt with the concepts of return and risk somewhat loosely. Intuitively smart investors knew the benefit of diversification which is reflected in the traditional proverb “Do not put all your eggs in one basket”. Harry Markowitz was the first person to show quantitatively why and how diversification reduces risk. This chapter describes how investors can construct the best possible portfolios with the help of efficient diversification. It is based largely on the pioneering work of Harry Markowitz and further insights that evolved from his work.
Objectives of Portfolio Management
The objectives of Portfolio management are —
(i) Reduce Risk: To reduce the risk of loss of capital/income, by investing in various types of securities and over a wide range of industries, i.e. diversification.
(ii) Safety of Principal: To keep the capital/principal amount intact, in terms of value and in terms of purchasing power. The capital of the principal amount invested should not erode, either in value or in terms of purchasing power. By earning a return, the principal amount will not erode in nominal terms, and by earning returns at a rate not lesser than the inflation rate, the principal amount will be intact in present value terms too.
(iii) Stability of Income: To facilitate a more accurate and systematic re-investment of income, to ensure growth and stability in returns.
(iv) Capital Growth: to enable attainment of capital growth by reinvesting in growth securities or through the purchase of growth securities.
(v) Marketability / Liquidity: To have an easily marketable investment portfolio, so that the investor is able to liquidate investments and take advantage of attractive opportunities in the market.
(vi) Tax Savings: To effectively plan for and reduce the tax burden on income, so that the investor gains maximum from his investment.