Investment portfolio

1. Chapter 7: Portfolio management
Investment analysts and portfolio managers
continuously monitor and evaluate the results of their
performance.
The revision of portfolio investments is conducted
on the basis of such monitoring and evaluation.

2. The features of good portfolio managers are their
ability to perceive the market trends correctly and
make correct expectations and estimates regarding
risk and return, ability to make proper
diversification, to reduce the company related risk.
This performance also depends on the timing of
investments and superior investment analysis and
security selection.
Evaluation of Portfolio Performance

3. • For evaluating the performance of a portfolio it is
necessary to consider both risk and return. This is
what the Sharpe measure, Treynor measure and the
two popularly employed portfolio performance
measures precisely do.
Performance Measures

4. • The performance measure developed by William Sharpe is
referred to as the Sharpe ratio or the reward to variability
ratio. It is the ratio of 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 = Risk free rate of return
p = Standard deviation of portfolio return
Sharpe Measure

5. Cont….
• Which portfolio perform better performance
from following two portfolio, by using Sharpe’s
model
Portfoli
o
Average return Standard d
eviation
Risk free ra
te
A 50% 10% 20
B 60% 18% 24%

6. • The performance measure developed by Jack
Treynor is refered to as Treynor ratio or reward to
variability ratio. It is the ratio of the reward or risk
premium to the volatility of return as measured by
the portfolio Beta.
• The formula for calculating Treynor ratio may be
stated as:
• Treynor ratio (TR) = (rp - rf ) / bp
Where,
rp = Realised return on the Portfolio
rf = Risk free rate of return
bp = Portfolio beta
Treynor Measure

7. cont……
• Which securities perform better performance from
following two portfolios, by using Treynor’s method
Portfolio return βm Risk free rate
x 44% 0.12 22%
z 52% 2.40 22%

8. Investment management process
• Investment management process is the process of managing
money or funds. The investment management process describes
how an investor should go about making decisions. Investment
management process can be disclosed by five-step procedure,
which includes following stages:
1. Setting of investment policy.
2. Analysis and evaluation of investment vehicles.
3. Formation of diversified investment portfolio.
4. Portfolio revision
5. Measurement and evaluation of portfolio performance.

9. Cont…
Setting of investment policy is the first and very
important step in investment management process.
Investment policy includes setting of investment
objectives. The investment policy should have the
specific objectives regarding the investment return
requirement and risk tolerance of the investor.
Analysis and evaluation of investment vehicles.
This step involves examining several relevant types of
investment vehicles and the individual vehicles
inside these groups.

10. Formation of diversified investment
portfolio
 In the stage of portfolio formation the issues of
selectivity, timing and diversification need to be
addressed by the investor.
Portfolio revision.
This step of the investment management process
concerns the periodic revision of the three previous
stages.

11. Measurement and evaluation of
portfolio performance
• is the last step in investment management process
involves determining periodically how the portfolio
performed, in terms of not only the return earned,
but also the risk of the portfolio.

12. Risk Mitigation, Monitoring, and
Management
• An effective strategy for dealing with risk must consider
three issues
(Note: these are not mutually exclusive)
– Risk mitigation (i.e., avoidance)
– Risk monitoring
– Risk management and contingency planning
• Risk mitigation (avoidance) is the primary strategy and is
achieved through a plan
– Example: Risk of high staff turnover (see next slide)

13. Cont,d
Strategy for Reducing Staff Turnover
Meet with current staff to determine causes for
turnover (e.g., poor working conditions, low pay,
competitive job market)
Mitigate those causes that are under our control
before the project starts
Once the project commences, assume turnover will
occur and develop techniques to ensure continuity
when people leave
Organize project teams so that information about
each development activity is widely dispersed

14. Cont,d
Strategy for Reducing Staff Turnover
Define documentation standards and establish
mechanisms to ensure that documents are
developed in a timely manner
Conduct peer reviews of all work (so that
more than one person is "up to speed")
Assign a backup staff member for every
critical technologist

15. Cont,d
• During risk monitoring, the project manager
monitors factors that may provide an indication of
whether a risk is becoming more or less likely
• Risk management and contingency planning assume
that mitigation efforts have failed and that the risk
has become a reality
• RMMM steps incur additional project cost

16. PORTFOLIO REVISION STRATEGIES
Two different strategies may be adopted for
portfolio revision, namely
 Active Revision Strategy
 Passive Revision Strategy
The choice of the strategy would depend
on the investors objectives, skill, resources
and time.

17. Continued….
• Active Revision Strategy:
 Active revision strategy involves frequent and
sometimes substantial adjustments to the portfolio.
The effectiveness of an actively-managed
investment portfolio obviously depends on the skill
of the manager and research staff. Investors who
undertake active revision strategy believe that
security markets are not continuously efficient.
They believe that securities can be mispriced at
times giving an opportunity for earning excess
returns through trading in them.

18. continued
Active portfolio revision is essentially carrying out
portfolio analysis and portfolio selection all over again.
It is based on an analysis of the fundamental factors
affecting the economy, industry and company as also
the technical factors like demand and supply.
Consequently, the time, skill and resources required
for implementing active revision strategy will be much
higher. The frequency of trading is likely to be much
higher under active revision strategy resulting in
higher transaction costs.

19. End of chapter Seven