Portfolio Management

portfolio management Apr 22, 2021

The fact that everyone must plan for a comfortable life, retirement and financial security of loved ones brings to the fore the most important need of financial planning. A carefully planned financial goal can then be achieved with an equally well-executed investment plan. This execution can be either self-directed or professionally managed. The latter is known as portfolio management. It is mostly discretionary with proper authorization given to the portfolio management entity to aim to achieve the client’s investment objectives with maximum overall realistic returns coupled with minimum volatility in the portfolio.    

What is Portfolio Management?

Portfolio management is a combination of art and science of selecting, constructing, and overseeing a basket of investments that aim to achieve the long-term financial objectives in line with the risk endurance of an individual, a company or an institution.

Need for Portfolio Management

A portfolio manager understands the investor’s financial requirements and suggests the most suitable and unique investment policy with prudent risk management structure. The investment policy is based upon the investor's age, structure (if a corporate entity), income, budget, existing investments, and risk tolerance parameters. It is the portfolio manager’s fiduciary responsibility to attempt to achieve the desired results within the framework of the client’s mandate. Without a proper portfolio management in place, an optimization of the investments with mitigation of undue risks is almost impossible.

Key Features of Portfolio Management

Asset Allocation

A major part of the portfolio returns are derived from right asset allocation. A suitable allocation to various asset classes balances the risk-reward favourably as different financial assets are correlated differently with each other.

Diversification

It is practically impossible to consistently single out winners. Unless mandated otherwise, the prudent approach is to create bouquets of different sectors, and further diversify within those sectors. A true diversification helps to capture the desired returns of all the sectors over long-term while reducing the overall volatility in the portfolio.

Rebalancing

Usually an annual exercise, rebalancing could very well be titled “Review”. A portfolio should have a “strategic” asset allocation e.g. 65% in equities and 35% in debt. Let us assume a period of strong bull run, equities register a solid gain and the original ratio becomes 75:25. The portfolio has unrealized gains, but has more risk.  Liquidation of 10% in equities, and adding it to the debt portion would be rebalancing to bring the portfolio’s strategic asset allocation to the original level. Rebalancing can be within asset classes, sectors, and even stocks.

Types of Portfolio Management

Active Portfolio Management

An actively managed portfolio aims to beat the relevant benchmark/s to create “alpha” (excess return over the benchmark). Portfolio managers engaged in active management tend to research economic conditions, market trends, political risks, stock-specific developments, and many cases, technical analysis. These data are used to make tactical moves to create superior returns than what an otherwise passively managed portfolio would generate. Needless to say, attempts to create alpha also inherently comes with greater volatility. 

Passive Portfolio Management

A passive portfolio management aims to mirror the performance of a particular market index or  benchmark. Hence they are also known as index fund management, and the portfolio mostly remains fixed. A passive strategy portfolio can be structured as an exchange-traded fund (ETF), a unit investment trust (UTI) or a mutual fund wherein the portfolio manager simply purchases the same listed stocks with the same weighing they represent in the index. Since the portfolio management simply replicates the index, with little turnover only when the index goes through any constituent or weighting changes, the expenses ratio on these strategies is generally far lower than a full-fledged actively managed portfolio.  

Discretionary Portfolio Management

In a discretionary portfolio, the portfolio manager has full authorization to make decisions to achieve client’s financial goals on his behalf. The client (investor) entrusts the money with the portfolio manager, who in turn takes care of client’s investment needs, documentation, filing, and overall review and supervision of the portfolio.

Non-Discretionary Portfolio Management

In a non-discretionary portfolio management, the portfolio manager has no authority to act on behalf of the client. He/she only provides advice to the client about the characteristics, features, pros and cons of investment products. The ultimate decision to act on these advice rests with the client. I personally believe there is no such thing as non-discretionary portfolio management because without a discretionary authority, it would merely be an advisory service. Many advisors, who call themselves portfolio managers, simply “service” the account, and not manage it. Management simply  means – act on discretionary basis, with proper and legal authorization.

There are, however, instances of certain parts of the assets entrusted with the portfolio manager that are just meant to be parked. This portion of the portfolio can be called non-discretionary.

Portfolio management Remuneration

Portfolio managers come in broadly two categories.

(i)                  Portfolio Manager Working For A Mutual Fund

 The mutual funds normally levy an annual expense ratio on the entire fund. This covers all expenses of the fund including operational costs, salaries, bonuses, marketing costs, client service, regulatory fees, advertisement and so on. Here, the portfolio manager is paid by the fund house in the form of salary and bonuses, based on his performance and the consistency thereof. Although clients end up paying indirectly to the manager in the form of expense ratio debited to the fund yet they do not pay anything directly.

 

(ii)                Portfolio Manager Handling Separately Managed Accounts

 

In this case, the portfolio manager may be associated with a financial services entity, other than any mutual fund arm. He manages portfolios on discretionary basis, and is compensated for his services by way of either the management fee client pays and/or a profit-sharing arrangement. The profit-sharing slab usually kicks in after a predetermined hurdle rate. This encourages the manager to work harder to achieve growth beyond the hurdle rate as his interest is now aligned with the client’s.  

Summary

A professional portfolio management service helps investors achieve their long-term investment objectives in a more structured manner. It relieves the client of the attention, effort and time needed to attend to his/her investments, which can instead be better-spent to enjoy the other important aspect in life close to heart such as family, travel, hobby, social work, passion or aspirations.  

- Ramesh Sadhwani

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