A dynamic and effective portfolio management supported by the Strategy-Resources-Profitability tripod.

1. English Version Jun, 23 of 2015
INVESTMENT PORTFOLIO
MANAGEMENT
HOW TO ALIGN INVESTMENTS PORTFOLIO
AND BUSINESS STRATEGY
JULIO ARNAUD

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INVESTMENT PORTFOLIO
MANAGEMENT
HOW TO ALIGN INVESTMENTS PORTFOLIO AND BUSINESS STRATEGY
“And a closer look reveals that most plans don’t contain a strategy at all but
rather a smorgasbord of tactics that individually make sense but collectively
don’t add up to a unified, clear direction that sets a company apart – let alone
makes the competition irrelevant.”
Blue Ocean Strategy
W. Chan Kim / Renée Mauborgne
Introduction
Every company is a set of tangible and intangible assets. It produces or
distributes a utility (products or services) through coordinated processes and
activities. The main purpose of a company is to create and distribute wealth, so
the market must realize a higher value in its products than the costs involved in
its creation. However, this is not enough; you must do it better than the
competition. The customer should give a higher value to your products than to
the competitor products regarding on price, effectiveness, quality, or any other
product attribute.
In order to achieve market recognition to the value of its products and the fair
return on investment, a company shall face the competitive forces through the
implementation of the strategy. The business strategy assumes a fundamental
role in defining the company's position in its business environment determining
the attributes to be valued in its products, and therefore defines the way to run
and to integrate its processes and activities
Also, as important as defining a strategy is to ensure its execution and the
workforce commitment to it. In this sense, the model used for selecting, for
deciding investment projects and for the resources allocation plays a key role in
enabling the strategy implementation. Failure to observe the strategic objectives
will keep the investment portfolio in a huge distance from the company's
mission, its identity and therefore from the shareholders interest. Thus, the main
objective of the investment portfolio management is to ensure the fulfillment of
strategic objectives while keeping a healthy and profitable cash flow.
So, a definition of a consistent strategy, focused, unique, with a clear message
and simple understanding is a necessary condition for a good and effective

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portfolio management. A company must evaluate the value perceived by its
Customers in its products in order to develop an effective method for investment
portfolio management.
Although the company’s strategy defines the investments and actions for the
future profitability of the company, on the other hand the company also needs a
healthy cash flow that provides a sustainable economic and financial condition.
The company will often be compelled to invest in its current operation, in order
to create incremental value in their products and services, to ensure a
competitiveness and profitability. Thus, one great challenge of investment
portfolio management is to balance the investments of current operations with
future operations.
Although we can set some milestones for the portfolio management, this is a dynamic process.
Investment portfolio
Projects under an investment portfolio can be classified according to the stage
they are in.
1. Projects in operation: they are project already running and commercially
active, generating positive or negative results. These projects generate the
present cash-flow. However, they also receive resources, mainly for creating
incremental value needed to their competiveness and to maintain their
profitability.
A project in operation is not same of a company, in fact companies are formed from one or
more projects in operation.
2. Projects under implementation: They are in a foundation phase and they are
usually large resources consumer, and also they still don’t generate revenue.
They contribute to meeting the strategic objectives, to creating value and to the
future profitability. At the moment a project in implementation becomes
commercially active, it will be classified as a project in operation.
3. Projects in proposition: They are projects in the planning stages. They are
proposals of investment which haven’t had its approval to be implemented yet.
The basic premises for a project in proposal become a project in
implementation are its strategic alignment and the existence of resources for its
implementation.

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Selecting and passing projects in proposition to an
implementation phase.
When we inspect the company’s project in proposition portfolio, we often come
to the conclusion there are not enough resources to develop all projects. We will
need to choose a set of projects that maximize value creation and the future
profitability of the company and at the same time it fits in the limitation of
resources available for new projects.
The first filter naturally required for an approval of a project in proposition is its
alignment to strategy. New project approvals must meet its strategic role it must
maximize the value attributes that make up the business strategy.
Although the dominant speech in companies is the alignment to strategy we can
often observe company’s staff appealing for projects that don’t contribute to
creation of the values set in the strategy. They usually argue the project has an
excellent profitability. But once the strategic objectives are met by the set of
projects in operation and under construction, the practice of approving projects
without adherence to strategy will keep the investment portfolio even more
distanced from the strategic planning and it will make uncertain the creation of
the expected strategic values, and therefore uncertain the company's
competitiveness and a more perennial profitability.
Strategic analysis (I) – Value Attributes
For those unfamiliar with the use of the Matrix of Value Assessment and Value Curve, please
refer to “Blue Ocean Strategy” by W. Chan Kim and Renée Mauborgne, teachers of strategy
and management at INSEAD – France.
The value attributes offered by the company's products or services, and also
how they are perceived by the chain of consumption are issues inherent to the
discussion and definition of the company’s strategy. The development of a
value consumes company resources, and off course, these resources are
limited. So it will be needed to choose those projects that best fit the values
pursued by the company within a framework of an appropriate use of the
company’s resources.
Therefore, an investment portfolio management is effective only when it
promotes the alignment of the portfolio with the strategy, provides the right
balance in the generation of these values and in the company's capacity to use
resources available. And also it must ensure a healthy and sustainable cash
flow. It is more than a traditional analysis of Capex, profitability and risk used by
many companies.
In order to check if strategic value attributes is being met by the investment
portfolio, it is necessary to compare the sum of each important values attributes
of all projects in operation and under construction to the level of the value
attributes designed in the strategy process. You can do that through the use of
Values Curves.

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When the sum of each value attributes of the portfolio has a perfect match to
the strategic Values Curve, we have an optimal portfolio and a maximization of
creating strategic value.
Chart 1 - Investment Portfolio perfect aligned to the strategy
However, gaps between attributes value of an investment portfolio with strategy
Value Curve frequently arise as can be seen in the areas  and  in the chart
below. When the investment in one value attribute of the portfolio is higher than
the level set by the strategy (graph area), there is a waste of resources and
therefore unnecessary cost. On the other hand when the investment in one
value attribute is lower the level set by the strategy (graph area), there is a
lack of investment and therefore the attribute will not reach the desired
investment level.
Chart 2 - Investment portfolio misaligned to the strategy
The analysis of an opportunity to approve the implementation of a project
should consider the project's contribution to the portfolio perfect match to the
strategy. Thus, the analysis must seek: (i) strengthen value attributes with high
importance in meeting the business strategy, especially those attributes with
poor investment effort, and (ii) avoid unnecessary investment in the
development of value attributes with lower importance. An approved project

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must contribute to the strategic value attributes and invests on high valuated
attributes. Furthermore, when as approved project invests on a low valuated
attributes, there is no significant contribution in creating strategic values and
there is a waste of resources. In fact, the more the project contributes to align
the investment portfolio to the strategy Values Curve, the greater its suitability to
strategy.
Consider the scenario where the portfolio investments have a perfect alignment
to the Value Curve of the company´s strategy, as area  on chart 3 bellow:
Chart 3 - Project analysis in when the investment portfolio is aligned to the strategy
 When a project in proposition invests more in a value attribute than it is
necessary to comply with the needs defined in the strategy I , there is a
waste of resources that will contribute to a misalignment to the strategy.
 When a project in proposition invests less in a value attribute than it is
necessary to comply with the needs defined in the strategy II , there is an
insufficient investment to develop the attribute and also there is a
contribution to a misalignment to the strategy.
Therefore, in the case of perfect alignment between the portfolio and the
strategy, we should give priority to a set of projects that shows direct alignment
to the strategy.
Now consider the scenario where the portfolio investments exceed the strategic
value as area  on chart 4 bellow. This scenario shows the portfolio misaligned
to the Value Curve of the company´s strategy, revealing waste of resources in
developing attributes not well valued by the consumer chain.

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Chart 4 - Project analysis in when the investment portfolio exceeds the strategy
 When a project in proposition invest less than it is necessary to comply with
the needs defined in the strategy I , it should seem as an insufficient
investment to the attribute. However, once there is an over investment in the
portfolio and therefore a waste of resources II , this occurrence helps to
align the portfolio with the strategy.
 On the other hand, when a project in proposition invest more than it is
necessary to comply with the needs defined in the strategy III , it will
strengthen the waste of resources in the portfolio IV .
Consider the scenario of the area  on chart 4 bellow, where the portfolio
investments are insufficient to develop the strategic value.
Chart 5 - Project analysis in when the strategy exceeds the investment portfolio

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 When a project in proposition invests more than it is necessary to comply
with the needs defined in the strategy I , it should seem as a waste of
resources. Nevertheless, considering the portfolio doesn’t invest enough
resources to develop the strategic value, this occurrence helps to fix such
portfolio failure and therefore it helps to align the portfolio with the strategy
II .
 Also, When a project in proposition invest less than it is necessary to comply
with the needs defined in the strategy III , it will strengthen the lack of
investment to develop the strategic value IV .
Based on the above considerations we can assume the misalignment between
portfolio and strategy can be mitigated through the approval and implementation
of new projects with prominent qualities to compensate portfolio deviations from
strategy. Also, projects that contribute to appropriately strength the company’s
strategy can be easily identified by a comparative analysis of investments on
value attributes of the project, of the project portfolio and of the strategy.
Moreover, we can easily identify projects that they need to be reviewed and
those that should be eliminated from the portfolio.
Strategic analysis II – Strategic objectives
So far we have analyzed the projects regarding their contribution to align the
investment portfolio to the strategic Value Curve. However, it is also necessary
to investigate the contribution of each project in analysis to meet the strategic
goals. As expected, all selected projects in proposition should reach or exceed
the strategic goals along all projects already in implementation and operation.
When the decision makers analyze a project in proposition, they should be
aware of how much such project will contribute to the achievement of strategic
goals and how much resources it will consume. The higher contribution and the
lower resources consumption better will be the project.
Important: resource is not just money, includes other sources such equipment, human
resources, natural resources, knowledge, etc.
Decision makers should also compare the project in analysis to all other
projects in portfolio (either in proposition, implementation or operation) in order
to identify the best projects and then set their priorities for implementation.
Graphical representation can be built to help the managers to compare projects
in portfolio. For instance, a chart (chart 6) can be built where the vertical axis
represents the contribution to the strategic goals and the horizontal axis
represents the amount of resources consumed by the projects. Also, the
minimum degree of project’s contribution and the maximum use of resources
should be defined too splitting the chart into four parts. Then, the projects are
plotted on the chart revealing projects with a high interest for its implementation
(a high contribution to the strategic goals and low resources consumption),
projects with some attractiveness (high contribution and high consumption of
resources) and also disposable projects (poor contribution to the strategic
goals).

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Chart 6 - Strategic and Resources Analysis of projects
If you have a more complex portfolio, it should be difficult to build a chart and
plot all projects. Another approach is to create a matrix with all projects in
portfolio that states how much each project contributes to the strategic goals
and how much each projects consumes strategic resources. The matrix could
be processed in spreadsheets, or simulation software or other automated
process in order to evaluate priorities in investment and to maximize the
strategic outcomes for the available resources.
Financial and economic analysis
Beside to addressing the projects’ contribution to the company's strategy, we
must also address economic and financial evaluation and viability for all
projects, including a detailed analysis of technical aspects of production, their
potential financial return on investment and also their risks.
The analysis of the project's cash flow and their key factors brings highly
relevant information that will support their approval decision – for example their
wealth creation (NPV), Internal rate of return (IRR or MIRR), payback,
breakeven, opportunity cost, etc. The information elected to be used in decision
making process and their eventual weights vary according to culture and needs
of each company and moreover its business environment.
Similar to the strategic analysis, the decision makers should be concerned
about the comparison of the project in evaluation with all other projects in

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portfolio. Such comparison helps to identify the most profitable projects, its risk
exposure and the resources that will consume.
Note: For each risk identified during the project planning and in its financial and economic
analysis, a respective mitigation and contingency plan shall be submitted.
Putting all together
The projects’ economic and financial analysis itself does not guarantee the
effective implementation of business strategy, regardless the criteria used. So it
isn’t enough to ensure a proper selection of projects to constitute the company
portfolio.
On the other hand, the strategic analysis of the projects does not guarantee the
profitability and it could create a future situation of low profitability, or even the
loss of sustainability.
Therefore, to identify and select the best investment projects – those with better
contribution to strategic and profitability goals, it is necessary to consider both
analyzes together.
In order to ease the comparative assessment between projects, you can use
charts or graphs like the strategic analysis chart - goals x resources presented
earlier modified with the inclusion of profitability information – represented by
the size of the circle for each plotted project.
Chart 7 - Strategic and financial analysis.

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Alternatively, for an evaluation that demands more complexity, you can build a
project matrix stating the project’s contribution for each strategic goals, the
resources needed and the most important economic and financial information.
The matrix analysis is usually made with the aid of mathematical tools that can
generate an optimal set of investment projects that maximize the strategic and
financial results (regarding the criteria used)
The use an evaluation that considers at the same time the economic and
financial analysis and the strategic goals and resource constraints, as well,
creates valuable conditions to mitigate the risk of a loss-making portfolio or a
failure in the strategy execution. It’s creates a breeding ground for value
creation in behalf of the company and its shareholders.
Projects under implementation
The projects being implemented should be reviewed periodically to endorse its
strategic adherence, profitability and risks, despite the investments already
made. So, it is necessary to periodically update of the analysis performed at the
time of their approval or their last update – using the same criteria developed for
project in proposition.
The update of an analysis may indicate that a specific project does not
contribute adequately to create value, or even destroys the value of the
investment portfolio, either profitability and / or strategic value. Such projects
are not intended to remain in the portfolio, but that decision cannot be taken
solely considering this analysis. You will need a further investigation to identify
and compare all viable alternatives like suspend, sell, shut, transform, etc. In
order to select the best alternative, you will need to compare all alternatives
through strategic analysis, and financial and economic analysis of each
alternative, including the identification and mitigation of the risks involved.
Projects in operation
Projects in operation should suffer periodic reviews as the projects under
implementation.
They can be divided into four groups:
 Projects that deliver profitability equal to or above the minimum
acceptable rate of return (MARR), and effectively contribute to the
achievement of the strategic goals and value attributes. Those are
projects that deliver value to the company and must remain in the
company's portfolio.
 Projects without profitability or projects less profitable than the MARR
and at the same time do not contribute to the achievement of the

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strategic goals and value attributes. Those are projects that destroy
value and, if possible, should be removed from the company's portfolio.
 Projects without profitability or projects with lower profitability than the
MARR, but effectively contribute to the achievement of the strategic
goals and value attributes. These projects should be reviewed. The first
question to be answered is if there is an incremental investment that can
raise profitability to the desired level. If so, the project should remain in
the portfolio and the incremental investment is expected to compete for
company resources. If not, you should identify the alternatives and
perform a comparative analysis of alternatives (like in projects under
implementation).
 Projects that deliver profitability equal to or above the MARR, but do not
contribute to the achievement of the strategic goals and value attributes.
Those projects should also be investigated. Is there any incremental
investment that can create value and contribute to the achievement of
strategic goals? We should also investigate whether the resources
generated by the project contribute to the support projects under
construction or projects proposition. If the project does not meet any of
these requirements, it would be removed from the portfolio.
Important: If the portfolio contains a substantial number of projects in operation with suitable
profitability that do not contribute to the construction of the desired strategic value, the portfolio
is misaligned with the business strategy. Therefore is strongly recommended to consider selling
some these projects in order to bring focus on the strategy execution.
Project in Operation Analysis
STRATEGIC ADHERENCE
Yes No
PROFITABILITY
Yes KEEP REVIEW
No REVIEW ELIMINATE
Present profitability Vs. Future profitability
Although an adequate management of a projects investment portfolio seek
incessantly to achieve the targets set in the business strategy, it is essential that
the portfolio guarantees the economic and financial conditions necessary for the
survival of the company. Investing in projects in operation generates the
incremental value necessary to compete and maintain or enhance the
company's profitability. Those projects in operation are an extremely important
generation source of the resources to support projects under implementation
and future projects.

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Chart 8 - Projects' resource allocation
So, one of the big questions to be answered in the investment portfolio
management is: how much resources I allocate for projects in operation at the
expense of projects under implementation or proposition.
Quantification
In order to balance the allocation of resources in projects in operation, under
implementation and proposal stages in the portfolio, it is necessary to know and
quantify the resources available in the company and the resources needed to
implement such projects as well. Resources is all necessary and relevant inputs
to the correct execution of projects, it isn’t limited to financial resources, it can
be equipment availability, skilled labor, management capacity, among others.
Notice that that both the availability and the need for resources changes in time.
Thus, quantifying these features means determining the distribution of
availability and need over a period of time.
The identification and quantification of available resources should consider the
own resources as well the resources offered by third parties, such as financing,
partnerships, service contracts, leases, among others. On the other hand, the
identification and quantification of the resources required to implement projects
requires a careful analysis of the requirements and needs of each of these
projects.
An especial attention is necessary regarding projects in proposition. Since some
projects in proposal stage will be approved and others won’t, and also new
project proposals will appear and will be added in portfolio, the portfolio
behaves in a very dynamic way. There is lot of uncertainty about the
implementation of projects under this category. Thus, it´s too difficult to predict
exactly the total amount of resources needed to implement all good projects in
the proposal stage. One good approach to estimate the resources to be

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reserved to such projects is to identify and quantify the resources needed to
remove the gaps between: i) the projects in operation and under
implementation; ii) and the strategic goals and values, taking into account the
present projects in proposition portfolio, the projects execution and business
opportunities history.
Finally, the total amount of resources required for the portfolio is obviously the
sum of: i) resources required for the execution of projects in operation and
under construction; ii) the projection of resources earmarked for new projects in
proposition stage.
Resources analysis
Once we have identified and quantified the resources available and needed, the
next step is to match the availability with the need over time. Very often this
analysis will point to a situation that the need for resources will exceed
availability, revealing a momentary incapacity to run the projects portfolio. Other
times this analysis will identify an excess of unused available resources,
revealing waste of resources. Both situations indicate the need for adjustments
in the portfolio. Such adjustment can be done anticipating or postponing
projects, or through a scope or technology review, identifying new sources of
resources, and so on. However, you must analyze the impacts of such
adjustment in the portfolio regarding economic and financial perspective, and
strategic goals achievement, as well.
Important: Normally companies tend to review only projects in proposition. Those projects are
easier to be changed since they have not started yet. However, these projects are essential to
long-term strategy. To sacrifice only them can mean sacrifice the whole strategy. Consider ever
reviewing the entire portfolio.
In the extreme case, we can have a situation that the portfolio is infeasible
because the resources needed to meet the strategic goals exceed the available
resources most of the time. In this case, you must rethink the projects portfolio
to ensure its feasibility and adherent to the strategy. Sometimes, you will need
to review the strategic goals for more consistent values compatible the
company reality and its market position.
Final considerations
An effective projects portfolio management should not be focused solely on
profitability and on the use of financial resources. It is critical that the selection,
maintenance and implementation of projects are taken to achieve the
company´s strategy, since the execution of the portfolio will lead to the future
positioning for the company. In other words, the portfolio must objectively
contribute to the strategic goals achievement and to strengthen the value
attributes defined for the company’s products and services.

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Also the strategic resources essential to run the portfolio are more than solely
the financial resources available. All essential resource needed to run the
portfolio must be considered.
Moreover, bearing in mind the frenetic changes in business environments, the
market volatility, the frequent launch of innovations, the deviations in projects
execution, among other factors, it is essential manage your projects portfolio in
a very dynamic way otherwise you will increase the risk of profitability loss and
failure in the strategic objectives achievement.
Thus, we finally conclude that an effective portfolio management must
necessarily be a dynamic activity and supported by the Strategy-Resources-
Profitability tripod.