SUBMITTED TO SUBMITTED BY
Mr. Vikram Chaturvedi Ashok Kumar (RS1902--A03
The reforms, since 1991, have brought substantial deregulation to Indian
capital market; today the markets are moving towards computerized, scrip
less trading. In this process the market would become more efficient and the
lessons of portfolio theory would assume increased relevance.
About ten years ago, we often wondered whether many of the concepts that
we are dealing with had any relevance to India. Terms like Mutual Funds,
Portfolio Management, and Interest Rate Risk seemed alien to this land. The
last few years have, however, changed everything. Today, when we talk of
portfolio management in our classrooms or in seminars and conferences, we
sense a tremendous excitement and interest among the audience.
There is a little doubt that stock markets can be treacherous. But we have
learnt that investing in shares need not be such a nerve-racking experience,
provided the decisions are made on the basis of analysis and reasoning, and
are not guided by whims, fancies and rumors.
I have kept the use of mathematics to a minimum in the text as I believe that
the principles and techniques of portfolio management can be understood
and used without a rigorous knowledge of the mathematical foundations
upon which they are based.
Executive Summary 4-5
1. Introduction to Portfolio Management 6-8
2. Portfolio Construction 9-11
3. Steps to Stock Selection Process 12
4. Types of Assets 12-17
5. Phases of Portfolio Management 18
6. Security Analysis 19-26
7. Portfolio Analysis 27-28
8. Portfolio Selection 29-30
9. Portfolio Revision 31-32
10. Portfolio Evaluation 33-35
Investing is both Arts and Science. Every Individual has their own specific
financial need and expectation based on their risk taking capabilities,
whereas some needs and expectation are universal. Therefore, we find that
the scenario of the Stock Market is changing day by day hours by hours and
minute by minute. The evaluation of financial planning has been increased
through decades, which can be best seen in customers. Now a day¶s
investments have become very important part of income saving.
In order to keep the Investor safe from market fluctuation and make them
profitable, Portfolio Management Services (PMS) is fast gaining Investment
Option for the High Net worth Individual (HNI). There is growing
competition between brokerage firms in post reform India. For investor it is
always difficult to decide which brokerage firm to choose.
At the time of investing money everyone look for the Risk factor involve in
the Investment option.
The first of the two most consequential take-home messages that we want to
convey is that good portfolio management practice is not a matter of
establishing a discussion culture, but one of implementing sound, data
driven, and transparent decision processes. The second message is that, even
as seen in the light of the previous insight, portfolios and their constituent
projects are ultimately managed by people, not by functions. Objections to
portfolio management, or attempts to push it in a certain direction,
frequently arise from less rational elements in the personalities of the acting
people, even if they are driven by the best intentions. A good portfolio
manager will be aware of this and make use of these human features instead
of attempting their suppression.
Investing in securities such as shares, debenture and bonds is profitable as
well as exciting. Investing in financial securities is now considered to be one
of the best avenues for investing one¶s savings while it is acknowledged to
be one of the most risky avenues of investment.
It is rare to find investors investing their entire funds or savings in a single
security. Instead, they tend to invest in a group of securities. Such a group of
securities is called a portfolio. Creation of a portfolio helps to reduce risk
without sacrificing returns. Portfolio Management deals with the analysis of
individual securities as well as with the theory and practice of optimally
combining securities into portfolios. An investor who understands the
fundamental principles and analytical aspects of portfolio management has a
better chance of success.
WHAT IS PORTFOLIO MANAGEMENT
An investor considering investment in securities is faced with the problem
of choosing from among a large number of securities. His choice depends
upon the risk-return characteristics of individual securities. He would
attempt to choose the most desirable securities and like to allocate his funds
over this group of securities. Again he is faced with the problem of deciding
which securities to be held and how much to invest in each. The investor
faces an infinite number of possible portfolios or group of securities.
As the economic and financial environment keeps changing, the risk-return
characteristics of individual securities as well as portfolios also change. This
calls for periodic review and revision of investment portfolios of investors.
An investor invests his funds in a portfolio expecting to get a good return
consistent with the risk that he has to bear. The return realized from the
portfolio has to be measured and the performance of the portfolio has to be
Portfolio Management comprises all the processes in the creation and
maintenance of an investment portfolio. It deals specifically with security
analysis, portfolio analysis, portfolio selection, portfolio revision, and
portfolio evaluation. Portfolio Management is a complex process which tries
to make investment activity more rewarding and less risky.
A person making an investment expects to get some return from the
investment in the future. But, as the future is uncertain, so is the future
expected return. It is this uncertainty associated with the returns from an
investment that reduces risk into an investment.
The total variability in returns of a security represents the total risk of that
security. Systematic and Unsystematic Risk are the two components of total
Total Risk = Systematic Risk + Unsystematic Risk
The impact of economic, political and social changes on the performance of
companies and thereby on their stock prices caused by such system wide
factors is referred to as systematic risk. Systematic Risk is further
subdivided into interest rate risk, market risk, and purchasing power risk.
When variability of returns occurs because of company issuing factors such
as raw material scarcity, labour strike, management inefficiency, it is known
as Unsystematic Risk.
The systematic risk of a security is measured by a statistical measure called
Beta. The input data required for the calculation of beta are the historical
data of returns of the individual security as well as the returns of a
representive stock market index.
The Portfolio Construction of Rational investors wish to maximize the
returns on their funds for a given level of risk. All investments possess
varying degrees of risk. Returns come in the form of income, such as interest
or dividends, or through growth in capital values (i.e. capital gains).
The portfolio construction process can be broadly characterized as
comprising the following steps:
1. Setting objectives:
The first step in building a portfolio is to determine the main objectives of
the fund given the constraints (i.e. tax and liquidity requirements) that may
apply. Each investor has different objectives, time horizons and attitude
towards risk. Pension funds have long-term obligations and, as a result,
invest for the long term. Their objective may be to maximize total returns in
excess of the inflation rate. A charity might wish to generate the highest
level of income whilst maintaining the value of its capital received from
bequests. An individual may have certain liabilities and wish to match them
at a future date. Assessing a client¶s risk tolerance can be difficult. The
concepts of efficient portfolios and diversification must also be considered
when setting up the investment objectives.
2. Defining Policy:
Once the objectives have been set, a suitable investment policy must be
established. The standard procedure is for the money manager to ask clients
to select their preferred mix of assets, for example equities and bonds, to
provide an idea of the normal mix desired. Clients are then asked to specify
limits or maximum and minimum amounts they will allow to be invested in
the different assets available. The main asset classes are cash, equities,
gilts/bonds and other debt instruments, derivatives, property and overseas
assets. Alternative investments, such as private equity, are also growing in
popularity, and will be discussed in a later chapter. Attaining the optimal
asset mix over time is one of the key factors of successful investing.
3. Applying portfolio strategy:
At either end of the portfolio management spectrum of strategies are active
and passive strategies. An active strategy involves predicting trends and
changing expectations about the likely future performance of the various
asset classes and actively dealing in and out of investments to seek a better
performance. For example, if the manager expects interest rates to rise, bond
prices are likely to fall and so bonds should be sold, unless this expectation
is already factored into bond prices. At this stage, the active fund manager
should also determine the style of the portfolio. For example, will the fund
invest primarily in companies with large market capitalizations, in shares of
companies expected to generate high growth rates, or in companies whose
valuations are low? A passive strategy usually involves buying securities to
match a preselected market index. Alternatively, a portfolio can be set up to
match the investor¶s choice of tailor-made index. Passive strategies rely on
diversification to reduce risk. Outperformance versus the chosen index is not
expected. This strategy requires minimum input from the portfolio manager.
In practice, many active funds are managed somewhere between the active
and passive extremes, the core holdings of the fund being passively managed
and the balance being actively managed.
4. Asset selections:
Once the strategy is decided, the fund manager must select individual assets
in which to invest. Usually a systematic procedure known as an investment
process is established, which sets guidelines or criteria for asset selection.
Active strategies require that the fund managers apply analytical skills and
judgment for asset selection in order to identify undervalued assets and to try
to generate superior performance.
5. Performance assessments:
In order to assess the success of the fund manager, the performance of the
fund is periodically measured against a pre-agreed benchmark ± perhaps a
suitable stock exchange index or against a group of similar portfolios (peer
group comparison). The portfolio construction process is continuously
iterative, reflecting changes internally and externally. For example, expected
movements in exchange rates may make overseas investment more
attractive, leading to changes in asset allocation. Or, if many large-scale
investors simultaneously decide to switch from passive to more active
strategies, pressure will be put on the fund managers to offer more active
funds. Poor performance of a fund may lead to modifications in individual
asset holdings or, as an extreme measure; the manager of the fund may be
Steps to Stock Selection Process
Types of assets
The structure of a portfolio will depend ultimately on the investor¶s
objectives and on the asset selection decision reached. The portfolio
structure takes into account a range of factors, including the investor¶s time
horizon, attitude to risk, liquidity requirements, tax position and availability
of investments. The main asset classes are cash, bonds and other fixed
income securities, equities, derivatives, property and overseas assets.
Cash and cash instruments
Cash can be invested over any desired period, to generate interest income, in
a range of highly liquid or easily redeemable instruments, from simple bank
deposits, negotiable certificates of deposits, commercial paper (short term
corporate debt) and Treasury bills (short term government debt) to money
market funds, which actively manage cash resources across a range of
domestic and foreign markets. Cash is normally held over the short term
pending use elsewhere (perhaps for paying claims by a non-life insurance
company or for paying pensions), but may be held over the longer term as
well. Returns on cash are driven by the general demand for funds in an
economy, interest rates, and the expected rate of inflation. A portfolio will
normally maintain at least a small proportion of its funds in cash in order to
take advantage of buying opportunities.
Bonds are debt instruments on which the issuer (the borrower) agrees to
make interest payments at periodic intervals over the life of the bond ± this
can be for two to thirty years or, sometimes, in perpetuity. Interest payments
can be fixed or variable, the latter being linked to prevailing levels of
interest rates. Bond markets are international and have grown rapidly over
recent years. The bond markets are highly liquid, with many issuers of
similar standing, including governments (sovereigns) and state-guaranteed
organizations. Corporate bonds are bonds that are issued by companies. To
assist investors and to help in the efficient pricing of bond issues, many bond
issues are given ratings by specialist agencies such as Standard & Poor¶s and
Moody¶s. The highest investment grade is AAA, going all the way down to
D, which is graded as in default. Depending on expected movements in
future interest rates, the capital values of bonds fluctuate daily, providing
investors with the potential for capital gains or losses.
Future interest rates are driven by the likely demand/ supply of money in an
economy, future inflation rates, political events and interest rates elsewhere
in world markets. Investors with short-term horizons and liquidity
requirements may choose to invest in bonds because of their relatively
higher return than cash and their prospects for possible capital appreciation.
Long Term investors, such as pension funds, may acquire bonds for the
higher income and may hold them until redemption ± for perhaps seven or
fifteen years. Because of the greater risk, long bonds (over ten years to
maturity) tend to be more volatile in price than medium- and short-term
bonds, and have a higher yield.
Equity consists of shares in a company representing the capital originally
provided by shareholders. An ordinary shareholder owns a proportional
share of the company and an ordinary share carries the residual risk and
rewards after all liabilities and costs have been paid.
Ordinary shares carry the right to receive income in the form of dividends
(once declared out of distributable profits) and any residual claim on the
company¶s assets once its liabilities have been paid in full. Preference shares
are another type of share capital. They differ from ordinary shares in that the
dividend on a preference share is usually fixed at some amount and does not
change. Also, preference shares usually do not carry voting rights and, in the
event of firm failure, preference shareholders are paid before ordinary
shareholders. Returns from investing in equities are generated in the form of
dividend income and capital gain arising from the ultimate sale of the shares.
The level of dividends may vary from year to year, reflecting the changing
profitability of a company. Similarly, the market price of a share will change
from day to day to reflect all relevant available information. Although not
guaranteed, equity prices generally rise over time, reflecting general
economic growth, and have been found over the long term to generate
growing levels of income in excess of the rate of inflation. Granted, there
may be periods of time, even years, when equity prices trend downwards ±
usually during recessionary times. The overall long-term prospect, however,
for capital appreciation makes equities an attractive investment proposition
for major institutional investors.
Derivative instruments are financial assets that are derived from existing
primary assets as opposed to being issued by a company or government
The two most popular derivatives are futures and options. The extent to
which a fund may incorporate derivatives products in the fund will be
specified in the fund rules and, depending on the type of fund established for
the client and depending on the client, may not be allowable at all.
A futures contract is an agreement in the form of a standardized contract
between two counterparties to exchange an asset at a fixed price and date in
the future. The underlying asset of the futures contract can be a commodity
or a financial security. Each contract specifies the type and amount of the
asset to be exchanged, and where it is to be delivered (usually one of a few
approved locations for that particular asset). Futures contracts can be set up
for the delivery of cocoa, steel, oil or coffee. Likewise, financial futures
contracts can specify the delivery of foreign currency or a range of
government bonds. The buyer of a futures contract takes a µlong position¶,
and will make a profit if the value of the contract rises after the purchase.
The seller of the futures contract takes a µshort position¶ and will, in turn,
make a profit if the price of the futures contract falls. When the futures
contract expires, the seller of the contract is required to deliver the
underlying asset to the buyer of the contract. Regarding financial futures
contracts, however, in the vast majority of cases no physical delivery of the
underlying asset takes place as many contracts are cash settled or closed out
with the offsetting position before the expiry date.
An option contract is an agreement that gives the owner the right, but not
obligation, to buy or sell (depending on the type of option) a certain asset for
a specified period of time. A call option gives the holder the right to buy the
asset. A put option gives the holder the right to sell the asset. European
options can be exercised only on the options¶ expiry date. US options can be
exercised at any time before the contract¶s maturity date. Option contracts
on stocks or stock indices are particularly popular. Buying an option
involves paying a premium; selling an option involves receiving the
premium. Options have the potential for large gains or losses, and are
considered to be high-risk instruments. Sometimes, however, option
contracts are used to reduce risk. For example, fund managers can use a call
option to reduce risk when they own an asset. Only very specific funds are
allowed to hold options.
Property investment can be made either directly by buying properties, or
indirectly by buying shares in listed property companies. Only major
institutional investors with long-term time horizons and no liquidity
pressures tend to make direct property investments. These institutions
purchase freehold and leasehold properties as part of a property portfolio
held for the long term, perhaps twenty or more years. Property sectors of
interest would include prime, quality, well-located commercial office and
shop properties, modern industrial warehouses and estates, hotels, farmland
and woodland. Returns are generated from annual rents and any capital gains
on realization. These investments are often highly illiquid.
PHASES OF PORTFOLIO MANAGEMENT
Portfolio Management is a process encompassing many activities aimed at
optimizing the investment of one¶s funds. Five phases can be identified in
1. Security Analysis
2. Portfolio Analysis
3. Portfolio Selection
4. Portfolio Revision
5. Portfolio Evaluation
Security analysis is the initial phase of the portfolio management process.
This step consists of examining the risk-return characteristics of individual
securities. A basic strategy in securities investment is to buy underpriced
securities and sell overpriced securities.
There are two approaches to security analysis, namely fundamental
analysis and technical analysis.
Fundamental analysis is really a logical and systematic approach to
estimating the future dividends and share price. It is based on the basic
premise that the share price is determined by a number of fundamental
factors relating to the economy, industry, and company.
Each share is assumed to have an economic worth based on its present and
future earning capacity. This is called its intrinsic value or fundamental
value. The investor can then compare the intrinsic value of the share with the
prevailing market price to arrive at an investment decision. If the market
price of the share is lower than its intrinsic value, the investor would decide
to buy the share as it is underpriced. The price of such a share is expected to
move up in the future to match with its intrinsic value.
On the contrary, when the market price of a share is higher than its intrinsic
value, it is perceived to be overpriced. The market price of such a share is
expected to come down in future and hence, the investor would decide to
sell such a share.
The fundamental approach calls upon the investor to make his buy or sell
decision on the basis of a detailed analysis of the information about the
company, the industry to which the company belongs, and the economy in
which it is established. Thus, a fundamental makes use of EIC (Economy,
Industry, and Company) framework of analysis.
Fundamental analysis thus involves three steps:
1. Economy Analysis
2. Industry Analysis
3. Company Analysis
Economy analysis is the first stage of fundamental analysis and starts
with an analysis of historical performance of the economy. But as an
investment is a future oriented activity, the investor is more interested in the
expected future performance of the overall economy. Economic forecasting
thus becomes a key activity in economic analysis.
Economic forecasting may be carried out for short term periods (up to three
years), intermediate term periods (three to five years) and long-term periods
(more than five years). Some of the techniques of short term economic
forecasting are discussed below:
Much of the activities in government, business, trade and industry are
planned in advance and stated in the form of budgets. To the extent that
institutions and people plan and budget for expenditures in advance, surveys
of their intentions can provide valuable input to short term economic
Barometric or Indicator Approach
To find out how the economy is likely to perform in the future various kinds
of indicators such as time series data of certain economic variables are
studied to economic forecasting.
Econometric Model Building
This technique makes use of Econometrics, which is a discipline that
applies mathematical and statistical techniques to economic theory. The
precise relationship between the dependent and independent variables are
specified in a formal mathematical manner in the form of equations. The
system of the equation is then solved to yield a forecast that is quite precise.
Opportunistic Model Building
It is also known as GNP model building or sectoral analysis. Initially, an
analyst estimates the total demand in the economy, and based on this he
estimates the total income or GNP for the forecast period. This initial
estimate takes into consideration the prevailing economic environment such
as existing tax rates, interest rates, and rate of inflation and economic and
fiscal policies of the government.
Industry analysis is to determine the stage of growth through which
the industry is passing. Industry analysis refers to an evaluation of the
relative strengths and weaknesses of particular industries.
A number of key characteristics that should be considered by the analyst.
These features broadly relate to the operational and structural aspects of the
industry. They have a bearing on the prospects of the industry. Some of
these are discussed below:
Demand Supply Gap
An industry is likely to experience under supply and over-supply of capacity
at different times, usually the demand for the product tends to change at a
steady rate. Excess supply reduces the profitability of the industry through a
decline in the unit price realization. Therefore, the gap between demand and
supply in an industry is fairly good indicator of its short-term or medium-
Competitive Conditions in the Industry
The level of competition among various companies in an industry is
determined by certain competitive forces. These competitive forces are:
barriers to entry, the threat of substitution, bargaining power of the
buyers/suppliers, and the rivalry among competitors.
If the labour in a particular industry is rebellious and is inclined to resort to
strikes frequently, the prospects of that industry cannot become bright.
Attitude of Government
The government may encourage the growth of certain industries and can
assist such industries through favourable legislation or vice-versa. In India,
this has been the experience of alcoholic drinks and cigarette industries.
Company analysis is the final stage of fundamental analysis. In
company analysis, the analyst tries to forecast the future earnings of the
company because there is strong evidence that earnings have a direct and
powerful effect upon share prices. The level, trend and stability of earnings
of a company, however, depend upon a number of factors concerning the
operations of the company.
The prosperity of a company would depend upon its profitability and
financial health. The financial statements published by a company
periodically help us to assess the profitability and financial health of the
company. The Balance Sheet and the Profit and Loss Account are two
basic financial statements provided by accompany.
Financial ratios are most extensively used to evaluate the financial
performance of the company. Four groups of ratios may be used for
analyzing the performance of a company.
These measure the company¶s ability to fulfil its short term obligations and
reflect its short term financial strength or liquidity.
1. Current ratio = Current Assets
2. Quick Ratio = Current Assets ± Prepaid expenses
3. Leverage Ratios
(i) Debt-Equity Ratio = Long-term debt
(ii) Total debt ratio = Total Debt
(iii) Proprietary Ratio = Shareholders¶ equity
(iv) Interest Coverage Ratio = Earnings before interest and Taxes
4. Profitability Ratios
(i) Gross Profit Ratio = Gross Profit
(ii) Operating Profit Ratio = EBIT
(iii) Net Profit Ratio = Earnings after tax
(iv) Return on Capital Employed = EBIT
Total Capital Employed
(v) EPS = Net profit available to equity shareholders
Number of equity shares
(vi) Dividend Payout Ratio = DPS
(vii) Price- Earnings Ratio = Market Price per share
(viii) Return on Investment = Earnings after taxes
Technical analysis believes that share price are determined by the demand
and supply forces operating in the market. A technical analyst therefore
concentrates on the movement of share prices. He claims that by examining
past share price movement future share prices can be accurately predicted.
Thus, technical analysis is really a study of past or historical price and
volume movements so as to predict the future stock price behavior.
It is perhaps the most popular chart used by technical analysts. In this chart,
the highest price, the lowest price and the closing price of each day are
plotted on a day-to-day basis.
1 2 3 4 5 6 7 8
High Price (Rs.)
Low Price (Rs.)
Close Price (Rs.)
Date High Price (Rs.) Low Price (Rs.) Close Price (Rs.)
1 346.5 335 340.5
2 355 340 354.1
3 359.4 354 356.2
4 357.8 348 350.6
5 353.75 345.15 349.9
6 355.6 346 350.75
7 353.35 349.15 352.05
From a given set of securities, any number of portfolios can be constructed.
A rational investor attempts to find the most efficient of these portfolios. The
efficiency of each portfolio can be evaluated only in terms of the expected
return and risk of the portfolio as such. Thus, determining the expected
return and risk of different portfolios is a primary step in portfolio
management. This step is designated as portfolio analysis.
EXPECTED RETURN OF A PORTFOLIO
As a first step in portfolio analysis, an investor needs to specify the list of
securities eligible for selection in the portfolio. Next he has to generate the
risk-return expectations for these securities. These are typically expressed as
the expected rate of return (mean) and the variance or standard deviation of
Let¶s consider a portfolio of two equity shares P and Q with expected return
of 15% and 20% resp. if 40% of the available total funds is invested in share
P and the rest in Q, then the expected portfolio return will be:
(.4 x 15) + (.6 x 20) = 18 per cent
RISK OF A PORTFOLIO
The variance of return and standard deviation of return are alternative
statistical measures that are used for measuring risk in investment. The
variance or standard deviation of an individual security measures the
riskiness of a security in absolute sense. This depends on their interactive
risk, i.e. how the returns of a security move with the returns of other
securities in the portfolio and contribute to the overall risk of the
Covariance is the statistical measure that indicates the interactive risk of
Year Rx Deviation
Rx ± Rx
Ry ± Ry
(Rx ± Rx ) (Ry ± Ry )
1 10 -4 17 5 -20
2 12 -2 13 1 -2
3 16 2 10 -2 -4
4 18 4 8 -4 -16
Covariance = Product of deviation / 4 = -42/4 = -10.5
The covariance is a measure of how returns of two securities move
together. If the returns of the two securities move in the opposite
direction consistently the covariance would be negative.
The objective of every rational investor is to maximize his returns and
minimize the risk. Diversification is the method adopted for reducing
risk. It essentially results in the construction of portfolios. The proper
goal of portfolio construction would be to generate a portfolio that
provides the highest return and the lowest risk. Such a portfolio would be
known as the optimal portfolio. The process of finding the optimal
portfolio is described as portfolio selection.
The feasible set of portfolios in which the investor can possibly invest, is
known as the portfolio opportunity set. In the opportunity set some
portfolios will obviously be dominated by others. A portfolio will
dominate another if it has either a lower standard deviation and the same
expected return as other, or a higher expected return and the same
standard deviation as the other.
Efficient Set of Portfolios
Portfolio No. Expected Return
1 5.6 4.5
2 7.8 5.8
3 9.2 7.6
4 10.5 8.1
5 11.7 8.1
6 12.4 9.3
7 13.5 9.5
8 13.5 11.3
9 15.7 12.7
10 16.8 12.9
If we compare portfolio no. 4 and 5, for the same standard deviation of
8.1 portfolio no. 5 gives a higher expected return of 11.7, making it more
efficient than portfolio no. 4.
The financial markets are continually changing. In this dynamic
environment, a portfolio that was optimal when constructed may not
continue to be optimal with the passage of time. It may have to be revised
periodically so as to ensure that it continues to be optimal.
NEED FOR REVISION
The need for portfolio revision may arise because of some investor
related factors also. These factors may be listed as:
1. Availability of additional funds for investment
2. Changes in risk tolerance
3. Changes in the investment goals
4. Need to liquidate a part of the portfolio to provide funds for some
Constraints in Portfolio Revision
The practice of portfolio adjustment involving purchase and sale of
securities gives rise to certain problems which act as constraints in portfolio
1. Transaction Cost
Buying and selling of securities involve transaction costs such as
commission and brokerage. Frequent buying and selling may push up
transaction costs thereby reducing the gains from portfolio revision.
Frequent sales of securities of periodic portfolio revision will result in
short term capital gains which would be taxed at a higher rate
compared to long term capital gains.
3. Statutory Stipulations
The largest portfolios in every country are managed by investment
companies and mutual funds. These institutional investors are
governed by certain statutory stipulations regarding their investment
Portfolio Evaluation is the last step in the process of portfolio
management. It is the stage where we examine to what the extent the
objectives has been achieved. Through portfolio evaluation the
investor tries to find out how well the portfolio has performed.
Without portfolio evaluation, portfolio management would be
NEED FOR EVALUATION
Evaluation is an appraisal of performance. Whether the investment
activity is carried out by individual investors themselves or through
mutual funds and investment companies, different situations arise
where evaluation of performance becomes imperative.
An investor would like to evaluate the performance of his portfolio in
order to identify the mistakes committed by him. This self evaluation
will enable him to improve his skills and achieve better performance
Evaluation of Portfolio Managers
Evaluation of Mutual Funds
Two methods of measuring the reward per unit of risk have been proposed
by William Sharpe and Jack Treynor in their pioneering work on evaluation
of portfolio performance.
It is the ratio of the reward or risk premium to the variability of return or risk
as measured by the standard deviation of return. The formula for
calculating Sharpe Ratio may be stated as:
Sharpe Ratio (SR) = (rp ± rf) / p
Where rp = Realised return on the portfolio
rf = Rik free rate of Return
p = Standard deviation of portfolio return
It is the ratio of the reward or risk premium to the variability of return or risk
as measured by beta of portfolio.
Treynor Ratio (TR) = (rp ± rf) / p
Fund Return (%) Standard Deviation (%) Beta
A 12 18 .7
Z 19 25 1.3
M (Market Index) 15 20 1.0
the risk free rate of return is 7 per cent.
A = 12 ± 7 /18 = .277
Z = 19 ± 7 /25 = .48
M = 15 ± 7 /20 = .40
as per Sharpe¶s performance measure, fund Z has performed better than
the benchmark market index, while fund A has performed worse than the
A = 12 ± 7 /.7 = 7.14
Z = 19 ± 7 / 1.3 = 9.23
M = 15 ± 7 / 1.0 = 8.00
according to Treynor¶s performance measure also, fund Z has performed
better and fund A has performed worse than the benchmark.
The composition of a share portfolio says a lot about its owner. An
outsider should be able to look at the holdings in it and see
y whether the owner of the shares is aiming for growth or income
y whether the owner is risk-averse or willing to take risks
y whether the owner considers himself a beginner, an intermediate or
y whether the owner is a short term or long term investor
The point is that different types of investors, with different goals, resources
and aptitudes require very different types of investments. If you've put
together your portfolio rationally, it will reflect your circumstances.
The purpose of this workshop is to drive home the lesson that in creating and
managing a portfolio, do so rationally. Think about your objectives and how
different asset classes meet them, think about risk and how to reduce it,
think about diversification and the level you are comfortable with, and think
about your weaknesses and strengths and how to work within them.
Investing with a high degree of self-awareness will not only bring you the
best results but also preserve your peace of mind in what can be a fraught
theatre of nerves.
1. Avadhani, V.A., Securities Analysis and Portfolio Management,
Himalaya Publishing House, Mumbai, 1997
2. David Blake, Financial Market Analysis, McGraw-Hill, London,
3. Edwin J. Elton and Martin J. Gruber, Modern Portfolio Theory and
Investment Analysis, 4th
edition, John Wiley & Sons, New York,
4. James L. Farrell, Jr., Portfolio Management: Theory and
ed., McGraw-Hill, Inc., New York, 1997.
5. Preeti Singh, Investment Management, Himalaya Publishing House,
6. Samir K. Barua, J.R. Varma and V. Raghunathan, Portfolio
revised ed., Tata McGraw-Hill, New Delhi, 1996.