Portfolio Management: Meaning, Types, & Key Elements | 5paisa (2024)

Introduction

Maximising returns on investment is an ideal way of accumulating wealth. Portfolio management largely assists in balancing gains and protecting against risk. It is the compilation of investment tools like stocks, mutual funds, cash, bonds, insurance policies, etc. Portfolio management acts as a cushion against market risks. This article explains the portfolio management meaning.

What is Portfolio Management?

Portfolio management includes prioritising, choosing the right investments, and strategising to achieve good returns. It simply refers to overseeing a person's financial investments. The portfolio may consist of cash, bonds, mutual funds, or any other investment. This process needs a strong understanding of the stock market and the ability to direct investments.

Objectives of Portfolio Management

The key objectives of portfolio management are:

• Capital Growth: Achieve long-term wealth appreciation through a balanced mix of assets that grow over time.
• Risk Management: Minimize risks through diversification across various asset classes, sectors, and geographies.
• Income Generation: Ensure a steady income stream through dividends, interest, and returns from investments.
• Liquidity: Maintain a balance between liquid and illiquid assets to meet short-term financial needs.
• Tax Efficiency: Optimize the portfolio structure to minimize tax liabilities while maximizing returns.

Align with Investment Goals: Tailor the portfolio to meet specific financial goals, such as retirement or education funding, while considering the investor’s risk tolerance and time horizon.

Who is a Portfolio Manager?

A portfolio manager is a professional responsible for investments and efficiently handling a portfolio of assets. Solid portfolio management requires developing the best investment plan to match your income, age, and risk-taking capacity. Furthermore, to reduce the risk effectively, the portfolio manager needs to develop a customised solution for buying and selling assets.

Key Elements of Portfolio Management

To achieve the desired outcome, investors need to account for certain concepts when building a strong portfolio. These are some crucial components of portfolio management.

● Asset Allocation

Dividing the assets minimises the risk from a vulnerable market environment. It is predicated on the knowledge that a balanced portfolio with low risk requires a variety of assets. According to the investor's risk tolerance and financial objectives, experts advise using systematic asset allocation.

● Diversification

Diversification is the process of distributing risk in a portfolio. It aims to reduce volatility while capturing the long-term returns of all sectors since it is impossible to predict which sector of a market or asset class will perform better at any given time. Diversifying portfolios can significantly revamp the collection. It brings a perfect blend of risk and reward. Investing in multiple assets helps in dealing with market fluctuations in a better way.

● Rebalancing

Rebalancing is the method of returning a portfolio to its original target allocation at regular intervals. It is an important aspect of portfolio management as it helps investors to capture gains and expand the opportunity for growth. The process involves selling high-priced stocks and investing that amount in lower-priced stocks.

● Active Portfolio Management

In active portfolio management, the investor buys undervalued stocks and sells them when their value rises. Portfolio managers pay close attention to market trends and trade in securities. Investors have received higher returns through this strategy.

● Passive Portfolio Management

This is stated as index fund management. It aligns with the current and steady market trend. Investors invest with the objective of low and steady returns that seem profitable in the long run.

Who should opt for?

People who want to increase their wealth but have little experience with the stock market or the time to keep track of their investments should consider portfolio management. Furthermore, if someone wants to invest in bonds, stocks, or commodities but doesn't know enough about the process, they should go for portfolio management. Investors can reduce risk while achieving long-term financial goals with portfolio management.

Types of Portfolio Management

1. Active Portfolio Management

Active portfolio management entails constant selling and purchasing of securities. The primary objective of substantial buying and selling of assets or securities is to outperform the markets collectively. Active investment management aims to make the most of the market conditions, especially while the markets are rising.

2. Passive Portfolio Management

It follows the efficient market hypothesis. In most cases, the passive manager sticks with index funds with low turnover but promises good long-term value. Opting for the lower yield is to gain profitability through stability.

3. Discretionary Portfolio management services

Your investments are managed by a qualified portfolio manager through the discretionary portfolio management service. The portfolio manager has total discretion over the investments he makes on the client's behalf.

4. Non-Discretionary Portfolio management

In Non-Discretionary Portfolio management, the client receives periodic advice from the portfolio manager. However, the client is ultimately in charge of the investment and is responsible for it. The role of the portfolio manager is restricted to providing guidance and market information. The client makes decisions based on their risk appetite, market study, and manager's advice.

Ways of Portfolio Management

There are various approaches to portfolio management:

• Active management involves purchasing and selling assets on a regular basis in order to outperform the market. Fund managers and investors continually monitor market trends, economic circ*mstances, and corporate performance in order to make educated judgments.
• Passive management seeks to replicate market performance by investing in index funds or ETFs that track a certain index, resulting in minimum trading and reduced expenses.
• Discretionary Management: A portfolio manager takes investing choices on behalf of an investor that are consistent with the investor's objectives and risk profile.
• Non-discretionary Management: The management advises, but the investor takes the final choice on transactions.
• Tactical Asset Allocation combines active management with strategic modifications to asset allocations in response to market circ*mstances.
  

Risk, Return & Diversification

Risk, return, and diversification are critical components of portfolio management.

• Risk: Refers to the uncertainty of returns and the potential for financial loss. Different assets carry varying levels of risk. In portfolio management, understanding and managing risk is essential to align with the investor’s risk tolerance and financial goals.
• Return: This is the profit or loss generated from investments, typically expressed as a percentage of the initial investment. The goal of portfolio management is to maximise returns while keeping risk within acceptable levels. There is often a trade-off between risk and return—higher returns usually come with higher risk.
• Diversification: A strategy to reduce risk by spreading investments across various asset classes, sectors, or geographies. The idea is that not all assets move in the same direction simultaneously; gains in one area can offset losses in another. Diversification minimises the impact of a poor-performing investment on the overall portfolio, helping to achieve more stable returns.

In portfolio management, a balanced approach combining these elements ensures optimal growth, controlled risk, and alignment with the investor’s financial objectives.

Steps of Portfolio Management

This approach goes beyond managing your investments. Since it is an iterative process, comprehension of it is crucial. Formulating a portfolio strategy requires maintaining a manageable portfolio with a customized investment plan.

Step 1: Identifying the objective

An investor needs to identify the objective. The outcome achieved can be either capital appreciation or stable returns.

Step 2: Estimating capital markets

Research and analysis should be carried out to estimate expected returns with associated risks.

Step 3: Asset Allocation

A sound decision should be made on allocating assets. Asset allocation is identified depending on investors' risk tolerance and investment limit.

Step 4: Formulation of a Portfolio Strategy

An appropriate portfolio strategy must be developed considering investment capacity and risk susceptibility.

Step 5: Implementing portfolio

The profitability of assets is analysed thoroughly. The planned portfolio is then implemented by investing in various avenues. Portfolio execution is one of the important phases as it directly impacts investment performance.

Step 6: Evaluating portfolio

The portfolio is regularly evaluated and revised for efficient work. Evaluating a portfolio is a quantitative measurement of the portfolio's actual returns and risks. It gives a direction to continuously improve the quality of the portfolio.

Conclusion

Implementing an investment strategy and managing day-to-day portfolio trading is an important component of portfolio management. Following some guidelines for portfolio management not only provides cushioning against risk but also maximises returns successfully.