Introduction Although proper care has been taken while constructing the portfolio but still there is a need to revise the portfolio keeping the present situation in mind. There may be a case where stock is not performing to expectations and then arises the need of portfolio revision. There are two ways of managing the portfolio:
Passive management Passive management is a process of holding a well diversified portfolio for a long term with the buy and hold approach. Passive management refers to the investor’s attempt to construct a portfolio that resembles the overall market returns. The simplest form of passive management is holding the index fund that is designed to replicate a good and well defined index of the common stock such as BSE-sensex or NSE-nifty. The fund manager buys every stock in the index in the exact proportion of the stock in that index. If reliance industry stock constitutes 5% of the index, the fund also invests 5% of its money in reliance industry stock.
` The problem in the index fund is transaction cost. It is NSE-nifty, the manager has to buy 50 stocks in the market proportion and cannot leave the stock to save the transaction cost. Further the reinvestment of the dividends also poses a problem. Here, the alternative is to keep the cash in hand or to invest the money in stocks incurring transaction cost. Keeping away the stock of smallest weights and the money in hand fail to replicate the index fund in proper manner. The commonly used approaches in constructing an index is as follows:
1. Keeping each stock in proportion to its representation in index.2. Holding a specified no. of stocks for example 20, which historically track the index in the best manner.3. Holding a smaller set of stocks to match the index in a pre-specified set of characteristic. This may be in terms of sector, industry and the market capitalisation.
Active management Active management is holding securities based on the forecast about the future. The portfolio managers who pursue active strategy with respect to market components are called market timers. The portfolio managers vary their cash position or beta of the equity portion of the portfolio based on the market forecast. Stocks that seem to be best or attractive are given more weights in the portfolio than their weights in the index.
Formula plans The formula plans provides the basic rules and regulations for the purchase and sale of securities. The amount to be spend on different securities is fixed. The amount may be fixed either in constant or variable ratio. This depends on the investor’s attitude towards risk and return.
Assumptions(I) The first assumption is that certain percentage of the investor’s fund is allocated to fixed income securities and common stocks. Like if market is at bottom more allocation is provided to equity and less to debt.(II) If market moves higher the proportion of stocks in the portfolio may either decline or remain constant(III) Stocks are bought and sold whenever there is a significant change in the price.(IV) Investor should strictly follow the formula plan once choosen.(V) Investor should select the goods that move along the market.
Advantages of formula plan(I) Basic rules and regulation for the purchase and sale of securities are provided.(II) The rules and regulations are rigid and help to overcome human emotion.(III) The investor can earn higher profits by adopting the plans.(IV) A course of action is formulated according to the investor’s objective.(V) It controls the buying and of securities by investor.(VI) It is useful for taking decisions on the timing of investment.
Disadvantages(I) The formula plan does not help the selection of security.(II) It is strict and not flexible with inherent problem of investment(III) The formula plan should be applied for long periods.(IV) Even if the investor adopts the formula plan, he needs forecasting. Market forecasting helps him to identify the best stocks.