Portfolio management

Business Environment Portfolio
Management
Summary
The introduction and the implementation of portfolio management practices into the
organization is a significant undertaking. The potential value it offers is present in
multiple dimensions: achievement of goals and goals components of the business
strategy and direction, better overall oversight and control of initiatives, improved
application and targeting of all resources (human, financial, technical) to the real
needs of the organization and the delivery of value. As with any significant
undertaking, there is a need for well-understood risk management to improve the
chance of success.
I believe that understanding and addressing these four key points will assist in
prudent risk-taking, as well as improve the likelihood of success in the introduction
and implementation of portfolio management practices into the organization. To
recap, these points are:
• Understand what type of work effort the introduction and implementation of
portfolio management practices is, in order to identify an effective approach;
and, also to identify which capabilities and experience within your
organization (or outside it) you will require.
• Assess and understand the existing capabilities within the organization which
will be required to enable and sustain the exercise of portfolio management
practices; and, determine if a state of "readiness" exists to move ahead with
its introduction and implementation.
• Introduce the set of portfolio management practices in stages. However, you
must understand and agree on the most urgent needs and/or the most
potential value, and then implement the sub-set of practices which will most
directly address these.
Leena Rohela / MBA / Semester II 1.

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• Use the same practices and usages that the organization applies to any of its
significant initiatives, because the introduction and implementation of
portfolio management practices is a significant initiative.
PORTFOLIO
The art and science of making decisions about investment mix and policy, matching
investments to objectives, asset allocation for individuals and institutions, and
balancing risk vs. performance.
Notes:
Portfolio management is all about strengths, weaknesses, opportunities, and threats
in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and
numerous other trades-offs encountered in the attempt to maximize return at a given
appetite for risk.
In finance, a portfolio is an appropriate mix of or collection of investments held by
an institution or a private individual. In building up an investment portfolio a
financial institution will typically conduct its own investment analysis, whilst a
private individual may make use of the services of a financial advisor or a financial
institution which offers portfolio management services. Holding a portfolio is part
of an investment and risk-limiting strategy called diversification. By owning
several assets, certain types of risk (in particular specific risk) can be reduced. The
assets in the portfolio could include stocks, bonds, options, warrants, gold
certificates, real estate, futures contracts, production facilities, or any other item
that is expected to retain its value.

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Portfolio Management
Portfolio management involves deciding what assets to include in the portfolio,
given the goals of the portfolio owner and changing economic conditions. Selection
involves deciding what assets to purchase, how many to purchase, when to
purchase them, and what assets to divest. These decisions always involve some sort
of performance measurement, most typically expected return on the portfolio, and
the risk associated with this return (i.e. the standard deviation of the return).
Typically the expected returns from portfolios comprised of different asset bundles
are compared.
The unique goals and circumstances of the investor must also be considered. Some
investors are more risk averse than others.
Mutual fund has developed particular techniques to optimize their portfolio
holdings. See fund management for details.
Portfolio Formation
Many strategies have been developed to form a portfolio.
• Precision weighted portfolio
• Equally-weighted portfolio
• Capitalization-weighted portfolio
• Price-weighted portfolio
Optimal portfolio (for which the Sharpe ratio is highest)

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Models
Some of the financial models used in the process of Valuation, stock selection, and
management of portfolios include:
Modern Portfolio Theory
Capital Market Line Modern portfolio theory (MPT) proposes how rational
investors will use diversification to optimize their portfolios, and how a risky asset
should be priced. The basic concepts of the theory are Markowitz diversification,
the efficient frontier, capital asset pricing model, the alpha and beta coefficients, the
Capital Market Line and the Securities Market Line.
MPT models an asset's return as a random variable, and models a portfolio as a
weighted combination of assets; the return of a portfolio is thus the weighted
combination of the assets' returns. Moreover, a portfolio's return is a random
variable, and consequently has an expected value and a variance. Risk, in this
model, is the standard deviation of the portfolio's return.

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Post-Modern Portfolio Theory
This article discusses in detail the application of post-modern portfolio theory
(PMPT) to risk/return analysis and describes its theoretical and practical benefits
over modern portfolio theory (“MPT”), also referred to as Mean-Variance Analysis
(“MVA”). And like MPT, PMPT proposes how rational investors will use
diversification to optimize their portfolios, and how a risky asset should be priced

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Sortino ratio:-
The Sortino ratio measures returns adjusted for the target and downside risk. It is
defined as where,
r = the annualized rate of return,
t = the target return,
d = downside risk.
Index Sortino ratio Sharpe ratio
90-day T-bill -1.00 0.00
Lehman Aggregate -0.29 0.63
MSCI EAFE -0.05 0.30
Russell 2000 0.55 0.93
S&P 500 0.84 1.25

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This ratio replaces the traditional Sharpe ratio as a means for ranking investment
results. The following table shows risk-adjusted ratios for several major indexes
using both Sortino and Sharpe ratios. The data cover the five years 1992-1996 and
are based on monthly total returns. The Sortino ratio is calculated against a 9.0%
target
As an example of the different conclusions that can be drawn using these two
ratios, notice how the Lehman Aggregate and MSCI EAFE compare - the Lehman
ranks higher using the Sharpe ratio whereas EAFE ranks higher using the Sortino
ratio. In many cases, manager or index rankings will be different, depending on the
risk-adjusted measure used. These patterns will change again for different values of
t. For example, when t is close to the risk-free rate, the Sortino Ratio for T-Bill's
will be higher than that for the S&P 500, while the Sharpe ratio remains unchanged.
Overview
It has been a generation since Harry Markowitz laid the foundations and built much
of the structure of what we now know as MPT, the greatest contribution of which is
the establishment of a formal risk/return framework for investment decision-
making. By defining investment risk in quantitative terms, Markowitz gave
investors a mathematical approach to asset selection and portfolio management. But

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as Markowitz himself and William F. Sharpe, the other giant of MPT acknowledge,
there are important limitations to the original MPT formulation.
"Under certain conditions the MVA can be shown to lead to unsatisfactory
predictions of (investor) behavior. Markowitz suggests that a model based on the
semi-variance would be preferable; in light of the formidable computational
problems, however, he bases his (MVA) analysis on the mean and the standard
deviation."
The causes of these “unsatisfactory” aspects of MPT are the assumptions that 1)
variance of portfolio returns is the correct measure of investment risk, and 2) the
investment returns of all securities and portfolios can be adequately represented by
the normal distribution. Stated another way, MPT is limited by measures of risk and
return that do not always represent the realities of the investment markets.
Recent advances in portfolio and financial theory, coupled with today’s increased
electronic computing power, have overcome these limitations. The resulting
expanded risk/return paradigm is known as Post-Modern Portfolio Theory, or
PMPT. Thus, MPT becomes nothing more than a (symmetrical) special case of
PMPT.
Market portfolio
A Market Portfolio is a portfolio consisting of a weighted sum of every asset in
the market, with weights in the proportions that they exist in the market (with the
necessary assumption that these assets are infinitely divisible).

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Richard Roll's critique (1977) states that this is only a theoretical concept, as to
create a market portfolio for investment purposes in practice would necessarily
include every single possible available asset, including real estate, precious metals,
stamp collections, jewelry, and anything with any worth, as the theoretical market
being referred to would be the world market. As a result, proxies for the market
(such as the FTSE100 in the UK or the S&P500 in the US) are used in practice by
investors. Roll's critique states that these proxies cannot provide an accurate
representation of the entire market.
The concept of a market portfolio plays an important role in many financial theories
and models, including the Capital asset pricing model where it is the only fund in
which investors need to invest, to be supplemented only by a risk-free asset
(depending upon each investor's attitude towards risk).
Portfolio Diversification
An investor can reduce portfolio risk simply by holding instruments which are not
perfectly correlated. In other words, investors can reduce their exposure to
individual asset risk by holding a diversified portfolio of assets. Diversification will
allow for the same portfolio return with reduced risk.
If all the assets of a portfolio have a correlation of 1, i.e., perfect correlation, the
portfolio volatility (standard deviation) will be equal to the weighted sum of the
individual asset volatilities. Hence the portfolio variance will be equal to the square
of the total weighted sum of the individual asset volatilities.
If all the assets have a correlation of 0, i.e., perfectly uncorrelated, the portfolio
variance is the sum of the individual asset weights squared times the individual
asset variance (and volatility is the square root of this sum).

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If correlation is less than zero, i.e., the assets are inversely correlated, the portfolio
variance and hence volatility will be less than if the correlation is 0. The lowest
possible portfolio variance, and hence volatility, occurs when all the assets have a
correlation of −1, i.e., perfect inverse correlation
Portfolio diversification:-
Investing in different asset classes and in securities of many issuers in an attempt to
reduce overall investment risk and to avoid damaging a portfolio's performance by
the poor performance of a single security, industry, (or country).
1. Portfolio Dressing
The addition and deletion of securities by an institutional investor before a financial
reporting period in order to make the portfolio appear acceptable to investors.
Typically, portfolio dressing involves the sale of big losers and the addition of big
gainers to convey the impression that the portfolio manager is competent. Also
called dressing up a portfolio.
2. Portfolio Effect
A reduction in the variation of returns on a combination of assets compared with
the average of the variations of the individual assets. This effect measures the
extent to which variations in returns on a portion of assets held are partially
canceled by variations in returns on other assets held in the same portfolio.

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3. Portfolio Expected Return
A weighted average of individual assets' expected returns.
4. Portfolio Income
Income from investments, including dividends, interest, royalties, and capital gains.
There are three main categories of income: active income, passive income, and
portfolio income. These categories of income are important because losses in
passive income generally cannot be offset against active or portfolio income.
5. Portfolio Insurance
 A method of hedging a portfolio of stocks against the market risk by
short selling stock index futures.
 Brokerage insurance such as the Securities Investor Protection
Corporation (SIPC).
Notes:
 This hedging technique is frequently used by institutional investors when the
market direction is uncertain or volatile. By short selling index futures they
offset any downturns, but they also hinder any gains.
 SIPC is an insurance that provides brokerage customers up to $500,000
coverage for cash and securities held by a firm.
6. Portfolio Internal Rate of Return
The rate of return computed by first determining the cash flows for all the bonds in
the portfolio and then finding the interest rate that will make the present value of
the cash flows equal to the market value of the portfolio

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7. Portfolio Management
The art and science of making decisions about investment mix and policy, matching
investments to objectives, asset allocation for individuals and institutions, and
balancing risk vs. performance.
Notes:
Portfolio management is all about strengths, weaknesses, opportunities, and threats
in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and
numerous other trade-offs encountered in the attempt to maximize return at a given
appetite for risk
8. Portfolio Manager
The person responsible for investing a mutual fund's assets, implementing its
investment strategy, and managing the day-to-day portfolio trading.
Notes:
The portfolio manager is one of the most important factors to consider when
looking at a mutual fund.
9. Portfolio Runoff
A decrease in the value and size of portfolios investing in mortgages and mortgage-
backed securities.
Notes:
This decrease occurs because of homeowners capitalizing on lowering interest rates
through refinancing. The resulting effects usually mean lower revenues for the
portfolio holders as the cash flow from mortgage interest decreases
10.Portfolio Theory

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The theory that holds that assets should be chosen on the basis of how they interact
with one another rather than how they perform in isolation. According to this
theory, an optimal combination would secure for the investor the highest possible
return for a given level of risk or the least possible risk for a given level of return.
Although individual investors can use some of the ideas of portfolio theory in
putting together a group of investments, the theory and the literature relating to it
are so complex and mathematically sophisticated that the theory is applied
primarily by market professionals. Also called modern portfolio theory.
11.Portfolio Transaction Costs
The expenses associated with buying and selling securities, including commissions,
purchase and redemption fees, exchange fees, and other miscellaneous costs. In a
mutual fund prospectus, these expenses are listed separately from the fund's
expense ratio.
Risks
The model assumes that investors are risk adverse, meaning that given two assets
that offer the same expected return, investors will prefer the less risky one. Thus, an
investor will take on increased risk only if compensated by higher expected returns.
Conversely, an investor who wants higher returns must accept more risk. The exact
trade-off will differ by investor based on individual risk aversion characteristics.
The implication is that a rational investor will not invest in a portfolio if a second
portfolio exists with a more favorable risk-return profile – i.e., if for that level of
risk an alternative portfolio exists which has better expected returns.

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Asset Pricing
A rational investor would not invest in an asset which does not improve the risk-
return characteristics of his existing portfolio. Since a rational investor would hold
the market portfolio, the asset in question will be added to the market portfolio.
MPT derives the required return for a correctly priced asset in this context.
Systematic Risk And Specific Risk
Specific risk is the risk associated with individual assets - within a portfolio these
risks can be reduced through diversification (specific risks "cancel out"). Specific
risk is also called diversifiable, unique, unsystematic, or idiosyncratic risk.
Systematic risk (a.k.a. portfolio risk or market risk) refers to the risk common to all
securities - except for selling short as noted below, systematic risk cannot be
diversified away (within one market). Within the market portfolio, asset specific
risk will be diversified away to the extent possible. Systematic risk is therefore
equated with the risk (standard deviation) of the market portfolio.
Since a security will be purchased only if it improves the risk / return characteristics
of the market portfolio, the risk of a security will be the risk it adds to the market
portfolio. In this context, the volatility of the asset, and its correlation with the
market portfolio, is historically observed and is therefore a given (there are several
approaches to asset pricing that attempt to price assets by modelling the stochastic
properties of the moments of assets' returns - these are broadly referred to as
conditional asset pricing models). The (maximum) price paid for any particular

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asset (and hence the return it will generate) should also be determined based on its
relationship with the market portfolio.
Systematic risks within one market can be managed through a strategy of using
both long and short positions within one portfolio, creating a "market neutral"
portfolio.
Security Characteristic Line
The Security Characteristic Line (SCL) represents the relationship between the
market return (rM) and the return ri of a given asset i at a given time t. In general,
it is reasonable to assume that the SCL is a straight line and can be illustrated as a
statistical equation:
Where αi is called the asset's alpha coefficient and βi the asset's beta coefficient.
Capital Asset Pricing Model
The asset return depends on the amount for the asset today. The price paid must
ensure that the market portfolio's risk / return characteristics improve when the
asset is added to it. The CAPM is a model which derives the theoretical required
return (i.e., discount rate) for an asset in a market, given the risk-free rate available
to investors and the risk of the market as a whole.

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Securities Market Line
The SML essentially graphs the results from the capital asset pricing model
(CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents
the expected return. The market risk premium is determined from the slope of the
SML.
The relationship between β and required return is plotted on the securities market
line (SML) which shows expected return as a function of β. The intercept is the
risk-free rate available for the market, while the slope is E(Rm − Rf). The securities
market line can be regarded as representing a single-factor model of the asset price,
where Beta is exposure to changes in value of the Market
It is a useful tool in determining if an asset being considered for a portfolio offers a
reasonable expected return for risk. Individual securities are plotted on the SML
graph. If the security's risk versus expected return is plotted above the SML, it is
undervalued since the investor can expect a greater return for the inherent risk. And

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a security plotted below the SML is overvalued since the investor would be
accepting less return for the amount of risk assumed.
Future
 Mean and Variance
It is further assumed that investor's risk / reward preference can be described via a
quadratic utility function. The effect of this assumption is that only the expected
return and the volatility (i.e. mean return and standard deviation) matter to the
investor. The investor is indifferent to other characteristics of the distribution of
returns, such as its skew (measures the level of asymmetry in the distribution) or
kurtosis (measure of the thickness or socalled "fat tail"). This seems not to be true
given the skeweness' risk seems to be priced by the market.
Note that the theory uses a historical parameter, volatility, as a proxy for risk, while
return is an expectation on the future. This is in line with the Efficiency Hypothesis
and most of the classical finding in Finance such as Black and Scholes European
Option Pricing (Martingale Measure: shortly speaking means that the best forecast
for tomorrow is the price of today)
Recent innovations in portfolio theory, particularly under the rubric of Post-Modern
Portfolio Theory (PMPT), have exposed many flaws in this total reliance on
standard deviation as the investor's risk proxy.
 Under The Model
Portfolio return is the proportion-weighted combination of the constituent assets'
returns.

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Portfolio volatility is a function of the correlation of the component assets. The
change in volatility is non-linear as the weighting of the component assets changes.
A PRACTICAL APPROACH TO PORTFOLIO MANAGEMENT
Portfolio Management is used to select a portfolio of new product development
projects to achieve the following goals:
• Maximize the profitability or value of the portfolio
• Provide balance
• Support the strategy of the enterprise
Portfolio Management is the responsibility of the senior management team of an
organization or business unit. This team, which might be called the Product
Committee, meets regularly to manage the product pipeline and make decisions
about the product portfolio. Often, this is the same group that conducts the stage-
gate reviews in the organization.
A logical starting point is to create a product strategy - markets, customers,
products, strategy approach, competitive emphasis, etc. The second step is to
understand the budget or resources available to balance the portfolio against. Third,
each project must be assessed for profitability (rewards), investment requirements
(resources), risks, and other appropriate factors.
The weighting of the goals in making decisions about products varies from
company. But organizations must balance these goals: risk vs. profitability, new
products vs. improvements, strategy fit vs. reward, market vs. product line, long-
term vs. short-term. Several types of techniques have been used to support the
portfolio management process:

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• Heuristic models
• Scoring techniques
• Visual or mapping techniques
The earliest Portfolio Management techniques optimized projects' profitability or
financial returns using heuristic or mathematical models. However, this approach
paid little attention to balance or aligning the portfolio to the organization's
strategy. Scoring techniques weight and score criteria to take into account
investment requirements, profitability, risk and strategic alignment. The
shortcoming with this approach can be an over emphasis on financial measures and
an inability to optimize the mix of projects. Mapping techniques use graphical
presentation to visualize a portfolio's balance. These are typically presented in the
form of a two-dimensional graph that shows the trade-off's or balance between two
factors such as risks vs. profitability, marketplace fit vs. product line coverage,
financial return vs. probability of success, etc.

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The chart shown above provides a graphical view of the project portfolio risk-
reward balance. It is used to assure balance in the portfolio of projects - either too
risky or conservative and appropriate levels of reward for the risk involved. The
horizontal axis is Net Present Value; the vertical axis is Probability of Success. The
size of the bubble is proportional to the total revenue generated over the lifetime
sales of the product.
While this visual presentation is useful, it can't prioritize projects. Therefore, some
mix of these techniques is appropriate to support the Portfolio Management
Process. This mix is often dependent upon the priority of the goals.
Our recommended approach is to start with the overall business plan that should
define the planned level of R&D investment, resources (e.g., headcount, etc.), and
related sales expected from new products. With multiple business units, product
lines or types of development, we recommend a strategic allocation process based
on the business plan. This strategic allocation should apportion the planned R&D
investment into business units, product lines, markets, geographic areas, etc. It may
also breakdown the R&D investment into types of development, e.g., technology
development, platform development, new products, and grades/enhancements/line
extensions, etc.
Once this is done, then a portfolio listing can be developed including the relevant
portfolio data. We favor use of the development productivity index (DPI) or scores
from the scoring method. The development productivity index is calculated as
follows: (Net Present Value x Probability of Success) / Development Cost
Remaining. It factors the NPV by the probability of both technical and commercial
success. By dividing this result by the development cost remaining, it places more
weight on projects nearer completion and with lower uncommitted costs. The
scoring method uses a set of criteria (potentially different for each stage of the

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project) as a basis for scoring or evaluating each project. An example of this
scoring method is shown with the worksheet below.
Weighting factors can be set for each criterion. The evaluators on a Product
Committee score projects (1 to 10, where 10 are best). The worksheet computes the
average scores and applies the weighting factors to compute the overall score. The
maximum weighted score for a project is 100.
This portfolio list can then be ranked by either the development priority index or
the score. An example of the portfolio list is shown below and the second
illustration shows the category summary for the scoring method.

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Once the organization has its prioritized list of projects, it then needs to determine
where the cutoff is based on the business plan and the planned level of investment
of the resources available. This subset of the high priority projects then needs to be
further analyzed and checked. The first step is to check that the prioritized list
reflects the planned breakdown of projects based on the strategic allocation of the
business plan. Pie charts such as the one below can be used for this purpose.

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Other factors can also be checked using bubble charts. For example, the risk-reward
balance is commonly checked using the bubble chart shown earlier. A final check is
to analyze product and technology roadmaps for project relationships. For example,
if a lower priority platform project was omitted from the portfolio priority list, the
subsequent higher priority projects that depend on that platform or platform
technology would be impossible to execute unless that platform project were
included in the portfolio priority list. An example of a roadmap is shown below.

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Finally, this balanced portfolio that has been developed is checked against the
business plan as shown below to see if the plan goals have been achieved - projects
within the planned R&D investment and resource levels and sales that have met the
goals.
With the significant investments required to develop new products and the risks
involved, Portfolio Management is becoming an increasingly important tool to
make strategic decisions about product development and the investment of
company resources. In many companies, current year revenues are increasingly
based on new products developed in the last one to three years. Therefore, these
portfolio decisions are the basis of a company's profitability and even its continued
existence over the next several years.
Work of the Portfolio Manager
Our Portfolio Managers are among a select group of Financial Advisors, whose
qualifications are based on experience and commitment to client service. Each
portfolio in the Portfolio Management Group is individually managed and designed
to meet your unique needs.
Benefits of the PM program:
• Customized investment management
• Personalized client service
• Diversification
• Resources of an industry leader addressing your individual needs
• Unified fee structure

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Investment Managers And Portfolio Structures
At the heart of the investment management industry are the managers who invest
and divest client investments.
A certified company investment advisor should conduct an assessment of each
client's individual needs and risk profile. The advisor then recommends appropriate
investments.
Asset Allocation
The different asset classes are stocks, bonds, real-estate and commodities. The
exercise of allocating funds among these assets (and among individual securities
within each asset class) is what investment management firms are paid for. Asset
classes exhibit different market dynamics, and different interaction effects; thus, the
allocation of monies among asset classes will have a significant effect on the
performance of the fund. Some research suggests that allocation among asset
classes has more predictive power than the choice of individual holdings in
determining portfolio return. Arguably, the skill of a successful investment manager
resides in constructing the asset allocation, and separately the individual holdings,
so as to outperform certain benchmarks (e.g., the peer group of competing funds,
bond and stock indices).
Long-Term Returns
It is important to look at the evidence on the long-term returns to different assets,
and to holding period returns (the returns that accrue on average over different
lengths of investment). For example, over very long holding periods (eg. 10+ years)
in most countries, equities have generated higher returns than bonds, and bonds
have generated higher returns than cash. According to financial theory, this is

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because equities are riskier (more volatile) than bonds which are themselves more
risky than cash.
Diversification
Against the background of the asset allocation, fund managers consider the degree
of diversification that makes sense for a given client (given its risk preferences) and
construct a list of planned holdings accordingly. The list will indicate what
percentage of the fund should be invested in each particular stock or bond. The
theory of portfolio diversification was originated by Markowitz and effective
diversification requires management of the correlation between the asset returns
and the liability returns, issues internal to the portfolio (individual holdings
volatility), and cross-correlations between the returns.
Investment Styles
There are a range of different styles of fund management that the institution can
implement. For example, growth, value, market neutral, small capitalisation,
indexed, etc. Each of these approaches has its distinctive features, adherents and, in
any particular financial environment, distinctive risk characteristics. For example,
there is evidence that growth styles (buying rapidly growing earnings) are
especially effective when the companies able to generate such growth are scarce;
conversely, when such growth is plentiful, then there is evidence that value styles
tend to outperform the indices particularly successfully.
Performance Measurement
Fund performance is the acid test of fund management, and in the institutional
context accurate measurement is a necessity. For that purpose, institutions measure

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the performance of each fund (and usually for internal purposes components of
each fund) under their management, and performance is also measured by external
firms that specialize in performance measurement. The leading performance
measurement firms (e.g. Frank Russell in the USA) compile aggregate industry
data, e.g., showing how funds in general performed against given indices and peer
groups over various time periods.
In a typical case (let us say an equity fund), then the calculation would be made (as
far as the client is concerned) every quarter and would show a percentage change
compared with the prior quarter (e.g., +4.6% total return in US dollars). This figure
would be compared with other similar funds managed within the institution (for
purposes of monitoring internal controls), with performance data for peer group
funds, and with relevant indices (where available) or tailor-made performance
benchmarks where appropriate. The specialist performance measurement firms
calculate quartile and decile data and close attention would be paid to the
(percentile) ranking of any fund.
Generally speaking, it is probably appropriate for an investment firm to persuade its
clients to assess performance over longer periods (e.g., 3 to 5 years) to smooth out
very short term fluctuations in performance and the influence of the business cycle.
This can be difficult however and, industry wide, there is a serious preoccupation
with short-term numbers and the effect on the relationship with clients (and
resultant business risks for the institutions).
An enduring problem is whether to measure before-tax or after-tax performance.
After-tax measurement represents the benefit to the investor, but investors' tax
positions may vary. Before-tax measurement can be misleading, especially in
regimens that tax realised capital gains (and not unrealised). It is thus possible that

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successful active managers (measured before tax) may produce miserable after-tax
results. One possible solution is to report the after-tax position of some standard
taxpayer.
Risk-Adjusted Performance Measurement
Performance measurement should not be reduced to the evaluation of fund returns
alone, but must also integrate other fund elements that would be of interest to
investors, such as the measure of risk taken. Several other aspects are also part of
performance measurement: evaluating if managers have succeeded in reaching their
objective, i.e. if their return was sufficiently high to reward the risks taken; how
they compare to their peers; and finally whether the portfolio management results
were due to luck or the manager’s skill. The need to answer all these questions has
led to the development of more sophisticated performance measures, many of
which originate in modern portfolio theory.
Modern portfolio theory established the quantitative link that exists between
portfolio risk and return. The Capital Asset Pricing Model (CAPM) developed by
Sharpe (1964) highlighted the notion of rewarding risk and produced the first
performance indicators, be they risk-adjusted ratios (Sharpe ratio, information ratio)
or differential returns compared to benchmarks (alphas). The Sharpe ratio is the
simplest and best known performance measure. It measures the return of a portfolio
in excess of the risk-free rate, compared to the total risk of the portfolio. This
measure is said to be absolute, as it does not refer to any benchmark, avoiding
drawbacks related to a poor choice of benchmark. Meanwhile, it does not allow the
separation of the performance of the market in which the portfolio is invested from
that of the manager. The information ratio is a more general form of the Sharpe
ratio in which the risk-free asset is replaced by a benchmark portfolio. This measure

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is relative, as it evaluates portfolio performance in reference to a benchmark,
making the result strongly dependent on this benchmark choice.
Portfolio alpha is obtained by measuring the difference between the return of the
portfolio and that of a benchmark portfolio. This measure appears to be the only
reliable performance measure to evaluate active management. In fact, we have to
distinguish between normal returns, provided by the fair reward for portfolio
exposure to different risks, and obtained through passive management, from
abnormal performance (or outperformance) due to the manager’s skill, whether
through market timing or stock picking. The first component is related to allocation
and style investment choices, which may not be under the sole control of the
manager, and depends on the economic context, while the second component is an
evaluation of the success of the manager’s decisions. Only the latter, measured by
alpha, allows the evaluation of the manager’s true performance.
Portfolio normal return may be evaluated using factor models. The first model,
proposed by Jensen (1968), relies on the CAPM and explains portfolio normal
returns with the market index as the only factor. It quickly becomes clear, however,
that one factor is not enough to explain the returns and that other factors have to be
considered. Multi-factor models were developed as an alternative to the CAPM,
allowing a better description of portfolio risks and an accurate evaluation of
managers’ performance. For example, Fama and French (1993) have highlighted
two important factors that characterise a company's risk in addition to market risk.
These factors are the book-to-market ratio and the company's size as measured by
its market capitalisation. Fama and French therefore proposed a three-factor model
to describe portfolio normal returns. Carhart (1997) proposed to add momentum as
a fourth factor to allow the persistence of the returns to be taken into account. Also
of interest for performance measurement is Sharpe’s (1992) style analysis model, in

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which factors are style indices. This model allows a custom benchmark for each
portfolio to be developed, using the linear combination of style indices that best
replicate portfolio style allocation, and leads to an accurate evaluation of portfolio
alpha.
Education or Certification
Increasingly, international business schools are incorporating the subject into their
course outlines and some have formulated the title of 'Investment Management'
conferred as specialist bachelors degrees (e.g. Cass Business School, London). Due
to global cross-recognition agreements with the 2 major accrediting agencies
AACSB and ACBSP which accredit over 560 of the best business school programs,
the Certification of MFP Master Financial Planner Professional from the American
Academy of Financial Management is available to AACSB and ACBSP business
school graduates with finance or financial services-related concentrations. For
people with aspirations to become an investment manager, further education may
be needed beyond a bachelor in business, finance, or economics. A graduate degree
or an investment qualification such as Chartered Financial Analyst (CFA) is needed
to move up in the ranks of investment management.
There is no evidence that any particular qualification enhances the most desirable
characteristic of an investment manager, that is the ability to select investments that
result in an above average (risk weighted) long-term performance. The industry has
a tradition of seeking out, employing and generously rewarding such people
without reference to any formal qualifications.

Management
CASE STUDY
Portfolio Management Theory and Technical Analysis
The Bill of Rights of the Investor
 To earn a positive return (=yield) on their capital.
 To insure his investments against risks (=to hedge).
 To receive information identical to that of ALL other investors - complete,
accurate and timely and to form independent judgement based on this
information.
 To alternate between investments - or be compensated for diminished
liquidity.
 To study how to carefully and rationally manage his portfolio of investments.
 To compete on equal terms for the allocation of resources.
 To assume that the market is efficient and fair.
RISK
 The difference between asset-owners, investors and speculators.
 Income: general, free, current, projected (expectations), certain, uncertain.
 CASE A (=pages 3 and 4)
 The solutions to our FIRST DISCOVERY are called: "The Opportunities
Set"

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 The "INDIFFERENCE CURVE" or the "UTILITY CURVE"
 The OPTIMAL SOLUTION (=maximum consumption in both years).
 The limitations of the CURVES:
a. More than one investment alternative;
b. Future streams of income are not certain;
c. No investments is riskless;
d. Risk=uncertainty;
e. Frequency Functions.
 CASE B
CASE A
INVESTOR A has secured income of $20,000 p.a. for the next 2 years. One
investment alternative: a savings account yielding 3% p.a. (in real terms = above
inflation or inflation adjusted). One borrowing alternative: unlimited money at 3%
interest rate (in real terms = above inflation or inflation adjusted).
Mr. Spender
Will spend $20,000 in year 1 and $20,000 in year 2 and save $ 0
Mr. Spendthrift
Will save $20,000 in year 1 (=give up his liquidity) and spend this money plus 3%
interest $600 plus $20,000 in year 2 (=$40,600)
Mr. Big Problem

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Will spend $20,000 in year 1 plus lend money against his income in year 2.He will
be able to lend from the banks a maximum of: $19,417 (+3% = $20,000)
HIDDEN ASSUMPTIONS IN MR. BIG Problem’s CASE:
1. That he will live on long enough to pay back his debts.
2. That his income of $20,000 in the second year is secure.
3. That this is a stable, certain economy and, therefore, interest rates will remain
at the same level.
THE CONCEPT OF NET PRESENT VALUE
Rests on the above three assumptions (Keynes' theorem about the long run).
$19,417 is the NPV of $20,000 in one year with 3%.
OUR FIRST DISCOVERY:
THE CONSUMPTION IN THE SECOND YEAR = THE INCOME IN THE
SECOND YEAR + {Money Saved in the First Year X (1 + the interest rate)}
CASE B
 The concept of scenarios (Delphi) and probabilities
 The Mean Value Of An Asset's Yield = Sum {Yields In Different Scenarios
X Probabilities Of The Scenarios}
 The properties of the Mean Value:
 The mean of the multiplications of a Constant in the yields equals the
multiplication of the Constant in the Mean Value of the yields.

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 The Mean of the yields on two types of assets = The Sum of the Means of
each asset calculated separately
 Bi-faceted securities: the example of a convertible bond.
 VARIANCE and STANDARD DEVIATION as measures of the difference
between mathematics and reality. They are the measures of the frustration of
our expectations. THE RULE OF PREFERENCE: We will prefer a
security with the highest Mean Value plus the lowest Standard Deviation.
 The PRINCIPLE OF DIVERSIFICATION of the investment portfolio:
The Variance of combined assets may be less than the variance of each asset
separately.
 THE FOUR PILLARS OF DIVERSIFICATION:
a. The yield provided by an investment in a portfolio of assets will be closer to
the Mean Yield than an investment in a single asset.
b. When the yields are independent - most yields will be concentrated around
the Mean.
c. When all yields react similarly - the portfolio's variance will equal the
variance of its underlying assets.
d. If the yields are dependent - the portfolio's variance will be equal to or less
than the lowest variance of one of the underlying assets.
 Calculating the Average Yield of an Investment Portfolio.
 Short - cutting the way to the Variance:
PORTFOLIO COVARIANCE - the influence of events on the yields of
underlying assets.
 Simplifying the Covariance - the Correlation Coefficient.
 Calculating the Variance of multi-asset investment portfolios.

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Sr.no. State of investor Description Property Utility function
1. Diminishing avoidance of
absolute risk
Invests more in
risky assets as his
capital grows
Derivative of
avoidance of
absolute risk <
Æ
Natural
logarithm (Ln)
of capital
2. Constant Avoidance of
absolute risk
Doesn't change his
investment in risky
assets as capital
grows
Derivative = Æ (-1) (e) raised to
the power of a
constant
multiplied by
the capital
3. Increasing Avoidance of
absolute risk
Invests less in risky
assets as his capital
grows
Derivative > Æ (Capital) less
(Constant)
(Capital
squared)
4. Diminishing Avoidance of
relative risk
Percentage invested
in risky assets
grows with capital
growth
Derivative < Æ (-1) (e) squared
multiplied by
the square root
of the capital
5. Constant Avoidance of
relative risk
Percentage invested
in risky assets
unchanged as
capital grows
Derivative < Æ Natural
logarithm (Ln)
of capital
6. Increasing avoidance of
relative risk
Percentage invested
in risky assets
decreases with
capital growth
Derivative < Æ Capital -
(Number)
(Capital squared

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THE EFFICIENT MARKET
 Efficient Market: The price of the share reflects all available information.
 The Lenient Test: Are the previous prices of a share reflected in its present
price?
 The Quasi - Rigorous Test: Is all the publicly available information fully
reflected in the current price of a share?
 The Rigorous Test: Is all the (publicly and privately) available information
fully reflected in the current price of a share?
 A positive answer would prevent situations of excess yields.
 The main question: how can an investor increase his yield (beyond the
average market yield) in a market where all the information is reflected in the
price?
 The Lenient version: It takes time for information to be reflected in prices.
Excess yield could have been produced in this time - had it not been so short.
The time needed to extract new information from prices = the time needed
for the information to be reflected. The Lenient Test: will acting after the
price has changed - provide excess yield.
 The Quasi - Rigorous version: A new price (slightly deviates from
equilibrium) is established by buyers and sellers when they learn the new
information.
The QR Test: will acting immediately on news provide excess yield?

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Answer: No. On average, the investor will buy at equilibrium convergent
price.
 The Rigorous version: Investors cannot establish the "paper" value of a firm
following new information. Different investors will form different
evaluations and will act in unpredictable ways. This is "The Market
Mechanism". If a right evaluation was possible - everyone would try to sell
or buy at the same time. The Rigorous Test: Is it at all possible to derive
excess yield from information? Is there anyone who received excess yields?
 New technology for the dissemination of information, professional analysis
and portfolio management and strict reporting requirements and law
enforcement - support the Rigorous version.
 The Lenient Version: Analyzing past performance (=prices) is worthless. The
QR Version: Publicly available information is worthless. The Rigorous
version: No analysis or portfolio management is worth anything.
 The Fair Play Theorem: Since an investor cannot predict the equilibrium, he
cannot use information to evaluate the divergence of (estimated) future yields
from the equilibrium. His future yields will always be consistent with the risk
of the share.
 Insider - Trading and Arbitrageurs.
 Price predictive models assume: (a) The yield is positive and (b) High yield
is associated with high risk.
 Assumption (a) is not consistent with the Lenient Version.

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 Random Walk Theory (RWT):
a. Current share prices are not dependent on yesterday's or tomorrow's prices.
b. Share prices are equally distributed over time.
 The Monte Carlo Fallacy and the Stock Exchange (no connection between
colour and number).
 The Fair Play Theorem does not require an equal distribution of share prices
over time and allows for the possibility of predicting future prices (e.g., a
company deposits money in a bank intended to cover an increase in its
annual dividends).
 If RWT is right (prices cannot be predicted) - the Lenient Version is right
(excess yields are impossible). But if the Lenient Version is right - it does not
mean that RWT is necessarily so.
 The Rorschach tendency to impose patterns (cycles, channels) on totally
random graphic images. The Elton - Gruber experiments with random
numbers and newly - added random numbers. No difference between graphs
of random numbers - and graphs of share prices.
 Internal contradiction between assumption of "efficient market" and the
ability to predict share prices, or price trends.
 The Linear Model P = Price of share; C = Counter; ED P = Expected
difference (change) in price DP = Previous change in price; R = Random
number

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Pa - Pa-1 = ( ED P + D P/ ED P ) · ( Pa-1-c - Pa-2-c + R ) Using a correlation
coefficient.
 The Logarithmic Model ( log CPn ) / ( log CPn-1 ) = Cumulative yield CP =
Closing Price Sometimes instead of CP, we use: D P / (div/P) D P = Price
change div = dividend
 These two models provide identical results - and they explain less than 2% of
the change in share prices.
 To eliminate the influence of very big or small numbers - some analyse only
the + and - signs of the price changes Fama and Macbeth proved the
statistical character of sign clusters.
 Others say that proximate share prices are not connected - but share prices
are sinusoidally connected over time. Research shows faint traces of
seasonality.
 Research shows that past and future prices of shares are connected with
transaction costs. The higher the costs - the higher the (artificial) correlation
(intended to, at least, cover the transaction costs).
 The Filter (Technical Analysis) Model Sophisticated investors will always
push prices to the point of equilibrium. Shares will oscillate within
boundaries. If they break them, they are on the way to a new equilibrium. It
is a question of timing.
 Is it better to use the Filter Model or to hold onto a share or onto cash?
Research shows: in market slumps, continuous holders were worse off than

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Filter users and were identical with random players. This was proved by
using a mirror filter.
 The filter Model provides an excess yield identical to transaction costs.
Fama - Blum: the best filter was 0, 5%. For the purchase side -1%, 1, 5%. Higher
filters were better than constant holding ("Buy and Hold Strategy") only in
countries with higher costs and taxes.
 Relative Strength Model ( CP ) / ( AP ) = RS CP = Current price AP =
Average in X previous weeks
a. Divide investment equally among highest RS shares.
b. Sell a share who’s RS fell below the RS' of X% of all shares Best
performance is obtained when: "highest RS" is 5% and X% = 70%.
 RS models instruct us to invest in upwardly volatile stocks - high risk.
 Research: RS selected shares (=sample) exhibit yields identical to the Group
of stocks it was selected from. When risk adjusted - the sample's performance
was inferior (higher risk).
 Short term movements are more predictable.
Example: the chances for a reverse move are 2-3 times bigger than the chances for
an identical one.
 Brunch: in countries with capital gains tax - people will sell losing shares to
materialize losses and those will become under priced. They will correct at

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the beginning of the year but the excess yield will only cover transaction
costs, (The January effect).
 The market reacts identically (=efficiently) to all forms of information.
 Why does a technical operation (split / reverse split) influence the price of
the share (supposed to reflect underlying value of company)? Split - a
symptom of changes in the company. Shares go up before a split was
conceived - so split is reserved for good shares (dividend is increased). There
is excess yield until the split - but it is averaged out after it.
 There is considerable gap (upto 2 months) between the announcement and
the split. Research shows that no excess yield can be obtained in this period.
 The same for M & A
 The QR Version: excess yields could be made on private information.
Research: the influence of Wall Street Journal against the influence of market
analyses distributed to a select public. WSJ influenced the price of the stocks - but
only that day.
 The Rigorous Version: excess yields cannot be made on insider information.
How to test this - if we do not know the information? Study the behaviour of those
who have (management, big players).
Research shows that they do achieve excess yields.
 Do's and Don'ts

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a. Select your investments on economic grounds. Public knowledge is no
advantage.
b. Buy stock with a disparity and discrepancy between the situation of the firm -
and the expectations and appraisal of the public (Contrarian approach vs.
Consensus approach).
c. Buy stocks in companies with potential for surprises.
d. Take advantage of volatility before reaching a new equilibrium.
e. Listen to rumours and tips, check for yourself.
Profitability and Share Prices
1. The concept of a business firm - ownership, capital and labour.
2. Profit - the change in an assets value (different forms of change).
3. Financial statements: Balance Sheet, PNL, Cash Flow, Consolidated - a
review.
4. The external influences on the financial statements - the cases of inflation,
exchange rates, amortization / depreciation and financing expenses.
5. The correlation between share price performance and profitability of the
firms.
6. Market indicators: P/E, P/BV (Book Value).
7. Predicting future profitability and growth.
Bonds
1. The various types of bonds: bearer and named;
2. The various types of bonds: straight and convertible;
3. The various types of bonds (according to the identity of the issuer);

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4. The structure of a bond: principal (face), coupon;
5. Stripping and discounting bonds;
6. (Net) Present Value;
7. Interest coupons, yields and the pricing of bonds;
8. The Point Interest Rate and methods for its calculation (discrete and
continuous);
9. Calculating yields: current and to maturity;
10.Summing up: interest, yield and time;
11.Corporate bonds;
12.Taxation and bond pricing;
13.Options included in the bonds.
The Financial Statements
1. The Income Statement revenues, expenses, net earning (profits)

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2. Expenses Costs of goods sold I Operating expenses General and administrative
(G & A) expenses I (including depreciation) Interest expenses Taxes
3. Operating revenues - Operating costs = Operating income
4. Operating income + Extraordinary, nonrecurring item = Earning before Interest
and Taxes (EBIT)
5. EBIT - Net interest costs = Taxable income
6. Taxable income - Taxes = Net income (Bottom line)
7. The Balance Sheet
Assets = Liabilities + Net worth (Stockholders' equity)
8. Current assets = Cash + Deposits + Accounts receivable + Inventory current
assets + Long term assets = Total Assets
Liabilities Current (short term) liabilities = Accounts payable + Accrued taxes +
Debts + Long term debt and other liabilities = Total liabilities
9. Total assets - Total liabilities = Book value
10. Stockholders' equity = Par value of stock + Capital surplus + Retained surplus
11. Statement of cash flows (operations, investing, financing)
12. Accounting Vs. Economics earnings (Influenced by inventories depreciation,
Seasonality and business cycles, Inflation, extraordinary items)

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13. Abnormal stock returns are obtained where actual earnings deviate from
projected earnings (SUE - Standardized unexpected earnings).
14. The job of the security analyst: To study past data, Eliminate ² "noise" and form
expectations about future dividends and earning that determine the intrinsic value
(and the future price) of a stock.
15. Return on equity (ROE) = Net Profits / Equity
16. Return on assets (ROA) = EBIT / Assets
17. ROE = (1-Tax rate) [ROA + (ROA - Interest rate) × Debt / Equity]
18. Increased debt will positively contribute to a firm's ROE if its ROA exceeds the
interest rate on the debt (Example)
19. Debt makes a company more sensitive to business cycles and the company
carries a higher financial risk.
20. The Du Pont system
ROE = Net Profit/Pretax Profit × Pretax Profit/EBIT × EBIT/Sales × Sales/Assets ×
Assets/Equity (1) (2) (3) (4) (5)
21. Factor 3 (Operating profit margin or return on sales) is ROS
22. Factor 4 (Asset turnover) is ATO
23. Factor 3 × Factor 4 = ROA
24. Factor 1 is the Tax burden ratio

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25. Factor 2 is the Interest burden ratio
26. Factor 5 is the Leverage ratio
27. Factor 6 = Factor 2 × Factor 5 is the Compound leverage factor
28. ROE = the burden × ROA × Compound leverage factor
29. Compare ROS and ATO only within the same industry!
30. Fixed asset turnover = Sales / Fixed assets
31. Inventory turnover ratio = Cost of goods sold / Inventory
32. Average collection period (Days receivables) = Accounts receivables / Sales
365
33. Current ratio = Current assets / Current liabilities
34. Quick ratio = (Cash + Receivables) / Current liabilities is the Acid test ratio
35. Interest coverage ratio (Times interest earned) = EBIT / Interest expense
36. P / B ratio = Market price / Book value
37. Book value is not necessarily Liquidation value
38. P / E ratio = Market price / Net earnings per share (EPS)
39. P / E is not P /E Multiple (Emerges from DDM - Discounted dividend models)
40. Current earnings may differ from Future earnings

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41. ROE = E / B = P/B / P/E
42. Earnings yield = E / P = ROE / P/B
43. The GAAP - Generally accepted accounting principles - allows different
representations of leases, inflation, pension costs, inventories and depreciation.
44. Inventory valuation: Last In First Out (LIFO) First In First Out (FIFO)
45. Economic depreciation - The amount of a firm's operating cash flow that must
be re-invested in the firm to sustain its real cash flow at the current level.
Accounting depreciation (accelerated, straight line) - Amount of the original
acquisition cost of an asset allocated to each accounting period over an arbitrarily
specified life of the asset.
46. Measured depreciation in periods of inflation is understated relative to
replacement cost.
47. Inflation affects real interest expenses (deflates the statement of real income),
inventories and depreciation (inflates).
B O N D S
1. BOND - IOU issued by Borrower (=Issuer) to Lender

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2. PAR VALUE (=Face Value) COUPON (=Interest payment)
3. The PRESENT VALUE (=the Opportunity Cost) 1 / (1+r) n
r = interest rate n =
years
4. ANNUITY CALCULATIONS and the INFLUENCE OF INTEREST RATES: n
Pb = å C / (1+r)t
+ PAR / (1+r)n
Pb = Price of the Bond t=1
C = Coupon PAR =
Principal payment n = number of payments
5. BOND CONVEXITY - an increase in interest rates results in a price decline that
is smaller than the price gain resulting from a decrease of equal magnitude in
interest rates.
YIELD CALCULATIONS
1. YIELD TO MATURITY (IRR) = YTM
2. ANNUALIZED PERCENTAGE RATE (APR) = YTM ´ Number of periods in 1
year
3. EFFECTIVE ANNUAL YIELD (EAY) TO MATURITY = [(1+r)n
- 1]
n = number of periods in 1 year
4. CURRENT YIELD (CY) = C / Pb
5. COUPON RATE (C)
6. BANK DISCOUNT YIELD (BDY) = PAR-Pb / PAR ´ 360 / n
n = number of days to maturity

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7. BOND EQUIVALENT YIELD (BEY) = PAR-Pb / Pb ´365 / n
8. BEY = 365 ´ BDY / 360 - (BDY ´ n)
9. BDY < BEY < EAY
10. FOR PREMIUM BOND: C > CY > YTM (Loss on Pb relative to par)
TYPES OF BONDS
1. Zero coupons, stripping
2. Appreciation of Original issue discount (OID)
3. Coupon bonds, callable
4. Invoice price = Asked price + Accrued interest
5. Appreciation / Depreciation and: Market interest rates, Taxes, Risk (Adjustment)
BOND SAFETY
a. Coverage ratios
b. Leverage ratios
c. Liquidity ratios
d. Profitability ratios
e. Cash flow to debt ratio
f. Altman's formula (Z-score) for predicting bankruptcies: Z = 3,3 times EBIT /
TOTAL ASSETS + 99,9 times SALES / ASSETS + 0,6 times MARKET
VALUE EQUITY / BOOK VALUE OF DEBT + 1,4 times RETAINED

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EARNINGS / TOTAL ASSETS + 1,2 times WORKING CAPITAL /
TOTAL ASSETS
MACRO ECONOMY
1. Macro economy - the economic environment in which all the firms operate
2. Macroeconomic Variables: GDP (Gross Domestic Product) or Industrial
Production - vs. GNP Employment (unemployment, underemployment) rate(s)
Factory Capacity Utilization Rate Inflation (vs. employment, growth) Interest rates
(=increase in PNV factor) Budget deficit (and its influence on interest rates &
private borrowing) Current account & Trade deficit (and exchange rates) "Safe
Haven" attributes (and exchange rates) Exchange rates (and foreign trade and
inflation) Tax rates (and investments / allocation, and consumption) Sentiment (and
consumption, and investment)
3. Demand and Supply shocks
4. Fiscal and Monetary policies
5. Leading, coincident and lagging indicators
6. Business cycles: Sensitivity (elasticity) of sales Operating leverage (fixed to
variable costs ratio) Financial leverage

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MANAGING BOND PORTFOLIOS
1. Return On Investment (ROI) = Interest + Capital Gains
2. Zero coupon bonds: Pb = PAR / (1+I) n
3. Bond prices change according to interest rates, time, and taxation and to
expectations about default risk, callability and inflation
4. Coupon bonds = a series of zero coupon bonds
5. Duration = average maturity of a bond's cash flows = the weight or the
proportion of the total value of the bond accounted for by each payment.
Wt = CFt/(1+y)t
/ Pb Swt = 1 = bond price
Macauley's formula D = S t ´ Wt (where yield curve is flat!)
6. Duration
a. Summary statistic of effective average maturity.
b. Tool in immunizing portfolios from interest rate risk.
c. Measure of sensitivity of portfolio to changes in interest rates.
7. DP/P = - D ´ [ D (1+y) / 1+y ] = [ - D / 1+y ] ´ D (1+y) = - Dm ´ D y
8. The EIGHT duration’s rules
a. Duration of zero coupon bond = its time to maturity.
b. When maturity is constant, a bond's duration is higher when the coupon rate
is lower.

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c. When the coupon rate is constant, a bond's duration increases with its time to
maturity. Duration always increases with maturity for bonds selling at par or
at a premium. With deeply discounted bonds duration decreases with
maturity.
d. Other factors being constant, the duration of a coupon bond is higher when
the bond's YTM is lower.
e. The duration of a level perpetuity = 1+y / y
f. The duration of a level annuity = 1+y/y - T/(1+y)T
-1
g. The duration of a coupon bond = 1+y/y - (1+y)+T(c-y) / c[(1+y)T
-1]+y
h. The duration of coupon bonds selling at par values = {1+y/y ´ [1 - 1/(1+y)T
]}
´ 100
9. Passive bond management - control of the risk, not of prices.
- indexing (market risk)
- immunization (zero risk)
10. Some are interested in protecting the current net worth - others with payments
(=the future worth).
11. BANKS: mismatch between maturities of liabilities and assets.
Gap Management: certificates of deposits (liability side) and adjustable rate
mortgages (assets side)
12. Pension funds: the value of income generated by assets fluctuates with interest
rates

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13. Fixed income investors face two types of risks: Price risk Reinvestment (of the
coupons) rate risks
14. If duration selected properly the two effects cancel out. For a horizon equal to
the portfolio's duration - price and re-investment risks cancel out.
15. BUT: Duration changes with yield rebalancing
16. BUT: Duration will change because of the passage of time (it decreases less
rapidly than maturity)
17. Cash flow matching -buying zeros or bonds yielding coupons equal to the future
payments (dedication strategy)
18. A pension fund is a level perpetuity and its duration is according to rule (E).
19. There is no immunization against inflation (except indexation).
20. Active bond management
- Increase / decrease duration if interest rate declines / increases are forecast
- Identifying relative mispricing
21. The Homer - Leibowitz taxonomy:
a. Substitution swap - replacing one bond with identical one.
b. Intermarket spread swap - when the yield spread between two sectors of the
bond market is too wide.
c. Rate anticipation swap - changing duration according to the forecasted
interest rates.

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d. Pure yield pickup swap - holding higher yield bond.
e. Tax swap - intended to exploit tax advantages.
22. Contingent immunization (Leibowitz - Weinberger):
Active management until portfolio drops to
minimum future value / (1+I)T
= Trigger value if portfolio drops to trigger value -
immunization.
23. Horizon Analysis Select a Holding Period
Predict the yield curve at the end of that period [We know the bond's time to
maturity at the end of the holding period] {We can read its yield from the yield
curve} determine price
24. Riding the yield curve
If the yield curve is upward sloping and it is projected not to shift during the
investment horizon as maturities fall (=as time passes) - the bonds will become
shorter - the yields will fall - capital gains
Danger: Expectations those interest rates will rise.

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INTEREST RATE SWAPS
1. Between two parties exposed to opposite types of interest rate risk.
Example: SNL CORPORATION Short term - Long term
Variable rate liabilities - Fixed rate liabilities Long term - Short term Fixed rate
assets - Variable rate assets Risk: Rising interest rates Risk: Falling interest rates
2. The Swap
SNL would make fixed rate payments to the corporation based on a notional
amount Corporation will pay SNL an adjustable interest rate on the same notional
amount
3. After the swap
SNL CORPORATION ASSETS LIABILITIES ASSETS LIABILITIES Long term
loans Short term deposits Short term assets Long term bonds (claim to) variable
(obligation to) make (claim to) fixed (obligation to) make - rate cash flows fixed
cash payments cash flows variable-rate payments net worth net worth William
Sharpe, John Lintner, Jan Mossin

Management
1. Capital Asset Pricing Model (CAPM) predicts the relationship between an asset's
risk and its expected return = benchmark rate of return (investment evaluation) =
expected returns of assets not yet traded
2. Assumptions
[Investors are different in wealth and risk aversion} but:
a. Investor's wealth is negligible compared to the total endowment;
b. Investors are price - takers (prices are unaffected by their own trade);
c. All investors plan for one, identical, holding period (myopic, suboptimal
behaviour);
d. Investments are limited to publicly traded financial assets and to risk free
borrowing / lending arrangements;
e. No taxes on returns, no transaction costs on trades;
f. Investors are rational optimizers (mean variance - Markowitz portfolio
selection model);
g. All investors analyse securities the same way and share the same economic
view of the world ® homogeneous expectations identical estimates of the
probability distribution of the future cash flows from investments.
3. Results
a. All the investors will hold the market portfolio.
b. The market portfolio is the best, optimal and efficient one. A passive
(holding) strategy is the best. Investors vary only in allocating the amount
between risky and risk - free assets.
c. The risk premium on the market portfolio will be proportional to: its risk and
the investor's risk aversion

Management
d. The risk premium on an individual asset will be proportional to the risk
premium on the market portfolio and the beta coefficient of the asset (relative
to the market portfolio). Beta measures the extent to which returns on the
stock and the market move together.
4. Calculating the Beta
a. The graphic method The line from which the sum of standard deviations of
returns is lowest. The slope of this line is the Beta.
b. The mathematical method ¥¥ bi = Cov (ri, rm) / sm
2
= S (yti-yai)(ytm-yam) / S (ytm-
tam)2 =1 t=1
5. Restating the assumptions
a. Investors are rational
b. Investors can eliminate risk by diversification
- sectoral
- international
c. Some risks cannot be eliminated - all investments are risky
d. Investors must earn excess returns for their risks (=reward)
e. The reward on a specific investment depends only on the extent to which it
affects the market portfolio risk (Beta)
f. Diversified investors should care only about risks related to the market
portfolio.

Management
6. Return Beta 1/2 1 2 Investment with Beta 1/2 should earn 50% of the market's
return with Beta 2 - twice the market return.
7. Recent research discovered that Beta does not work.
A better measure: B / M (Book Value) / (Market Value)
8. If Beta is irrelevant - how should risks be measured?
9. NEER (New Estimator of Expected Returns):
The B to M ratio captures some extra risk factor and should be used with Beta
10. Other economists: There is no risk associated with high B to M ratios.
Investors mistakenly under price such stocks and so they yield excess returns.
11. FAR (Fundamental Asset Risk) - Jeremy Stein
There is a distinction between:
a) Boosting a firm's long term value and
b) Trying to raise the share's price
If investors are rational:
Beta cannot be the only measure of risk ® we should stop using it
Any decision boosting (A) will affect (B) ® (A) and (B) are the same?
If investors are irrational
Beta is right (it captures an asset's fundamental risk = its contribution to the market
portfolio risk) ® we should use it, even if investors irrational if investors are
making predictable mistakes - a manager must choose:
If he wants (B) ® NEER (accommodating investors expectations)
If he wants (A) BETA

Management
TECHNICAL ANALYSIS
Part A
 Efficient market hypothesis - share prices reflect all available information
 Weak form Are past prices reflected in present prices? No price adjustment
period - no chance for abnormal returns (prices reflect information in the
time that it takes to decipher it from them) If we buy after the price has
changed - will we have abnormal returns? Technical analysis is worthless
 Semistrong form Is publicly available information fully reflected in present
prices? Buying price immediately after news will converge, on average, to
equilibrium Public information is worthless Strong form
 Is all information - public and private - reflected in present prices? No
investor can properly evaluate a firm All information is worthless Fair play -
no way to use information to make abnormal returns An investor that has
information will estimate the yield and compare it to the equilibrium yield.
The deviation of his estimates from equilibrium cannot predict his actual
yields in the future. His estimate could be > equilibrium > actual yield or vice
versa. On average, his yield will be commensurate with the risk of the share.
Two basic assumptions
a) Yields is positive
b) High / low yields indicates high / low risk
If (A) is right, past prices contain no information about the future
 Random walk
a) Prices are independent (Monte Carlo fallacy)
b) Prices are equally distributed in time
 The example of the quarterly increase in dividends
 The Rorschach Blots fallacy (patterns on random graphical designs)

Management
® cycles (Kondratieff)
 Elton - Gruber experiments with series of random numbers
 Price series and random numbers yield similar graphs
 The Linear model
Pa - Pa-1 = (ED P +) ´ (Pa-1-c - Pa-z-c + R)
P = Price of share C = Counter ED P = Expected change in Price
R = Random number
 The Logarithmic model = cum. Y Sometimes, instead of Pc we use D P +
 Cluster analysis (Fama - Macbeth) + and - distributed randomly. No
statistical significance.
 Filter models - share prices will fluctuate around equilibrium because of
profit taking and bargain hunting
 New equilibrium is established by breaking through trading band
 Timing - percentage of break through determines buy / sell signals
 Filters effective in BEAR markets but equivalent to random portfolio
management
 Fama - Blum: best filter is the one that covers transaction costs
 Relative strength models - P / P Divide investment equally between top 5%
of shares with highest RS and no less than 0,7 Sell shares falling below this
benchmark and divide the proceeds among others
Reservations:
A) High RS shares are the riskiest
B) The group selected yields same as market - but with higher risk

Management
TECHNICAL ANALYSIS - Part B
 Versus fundamental: dynamic (trend) vs. static (value)
 Search for recurrent and predictable patterns
 Patterns are adjustment of prices to new information
 In an efficient market there is no such adjustment, all public information is
already in the prices
 The basic patterns:
a) momentum
b) breakaway
c) head and shoulders ® chartists
 Buy/sell signals Example: Piercing the neckline of Head and Shoulders
 The Dow theory uses the Dow Jones industrial average (DJIA) as key
indicator of underlying trends + DJTransportation as validator
 Primary trend - several months to several years Secondary (intermediate)
trend - deviations from primary trend: 1/3, 1/2, 2/3 of preceding primary
trend Correction - return from secondary trend to primary trend Tertiary
(minor) trend - daily fluctuations
 Channel - tops and bottoms moving in the direction of primary trend
 Technical analysis is a self fulfilling prophecy - but if everyone were to
believe in it and to exploit it, it would self destruct. People buy close to
resistance because they do not believe in it.
 The Elliott Wave theory - five basic steps, a fractal principle
 Moving averages - version I - true value of a stock is its average price prices
converge to the true value version II - crossing the price line with the moving

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average line predicts future prices Relative strength - compares performance
of a stock to its sector or to the performance of the whole market
 Resistance / support levels - psychological boundaries to price movements
assumes market price memory
 Volume analysis - comparing the volume of trading to price movements high
volume in upturns, low volume in down movements - trend reversal
 Trin (trading index) = Trin > 1 Bearish sign
 BEAR / Bull markets - down/up markets disturbed by up/down movements
 Trendline - price moves up to 5% of average
 Square - horizontal transition period separating price trends (reversal
patterns)
 Accumulation pattern - reversal pattern between BEAR and BULL markets
 Distribution pattern - reversal pattern between BULL and BEAR markets
 Consolidation pattern - if underlying trends continues
 Arithmetic versus logarithmic graphs
 Sea saw - non breakthrough penetration of resistance / support levels
 Head and shoulder formation (and reverse formation): Small rise (decline),
followed by big rise (decline), followed by small rise (decline). First
shoulder and head-peak (trough) of BULL (BEAR) market. Volume very
high in 1st shoulder and head and very low in 2nd shoulder.
 Neckline - connects the bottoms of two shoulders. Signals change in market
direction.
 Double (Multiple) tops and bottoms Two peaks separated by trough =
double tops Volume lower in second peak, high in penetration The reverse =
double bottoms

Management
 Expanding configurations Price fluctuations so that price peaks and troughs
can be connected using two divergent lines. Shoulders and head (last).
Sometimes, one of the lines is straight: UPPER (lower down) or -
accumulation, volume in penetration LOWER (upper up) 5% penetration
signals reversal
 Conservative upper expanding configuration Three tops, each peaking
Separated by two troughs, each lower than the other Signals peaking of
market 5% move below sloping trendline connecting two troughs or below
second through signals reversal
 Triangles - consolidation / reversal patterns
 Equilateral and isosceles triangle (COIL - the opposite of expansion
configuration) Two (or more) up moves + reactions Each top lower than
previous - each bottom higher than previous connecting lines converge Prices
and volume strongly react on breakthrough
 Triangles are accurate when penetration occurs Between 1/2 - 3/4 of the
distance between the most congested peak and the highest peak.
 Right angled triangle Private case of isosceles triangle. Often turn to squares.
 Trendlines Connect rising bottoms or declining tops (in Bull market)
Horizontal Trendlines
 Necklines of H&S configurations And the upper or lower boundaries of a
square are trendlines.
 Upward trendline is support Declining trendline is resistance
 Ratio of penetrations to number of times that the trendline was only touched
without being penetrated Also: the time length of a trendline the steepness
(gradient, slope)

Management
 The penetration of a steep trendline is less meaningful and the trend will
prevail.
 Corrective fan At the beginning of Bull market - first up move steep, price
advance unsustainable. This is a reaction to previous down moves and
trendline violated. New trendline constructed from bottom of violation
(decline) rises less quickly, violated. A decline leads to third trendline. This
is the end of the Bull market (The reverse is true for Bear market.)
 Line of return - parallel to up market trendline, connects rising tops (in
uptrends) or declining bottoms (in downtrends).
 Trend channel - the area between trendlines and lines of return.
 Breach of line of return signals (temporary) reversal in basic trend.
 Simple moving average of N days where last datum replaces first datum
changes direction after peak / trough.
 Price < MA ® Decline Price > MA ® Upturn
 MA at times support in Bear market resistance in Bull market
 Any break through MA signals change of trend. This is especially true if MA
was straight or changed direction before. If broken trough while continuing
the trend - a warning. We can be sure only when MA straightens or changes.
 MA of 10-13 weeks secondary trends MA of 40 weeks primary trends Best
combination: 10+30 weeks
 Interpretation 30w down, 10w < 30w downtrend 30w up, 10w > 30w uptrend
 10w up, 30w down (in Bear market) 10w down, 30w up (in Bull market) No
significance
 MAs very misleading when market stabilizes and very late.
 Weighted MA (1st version) Emphasis placed on 7w in 13w MA (wrong -
delays warnings) Emphasis placed on last weeks in 13w

Management
 Weighted MA (2nd version) Multiplication of each datum by its serial
number.
 Weighted MA (3rd version) Adding a few data more than once.
 Weighted MAs are autonomous indicators - without being crossed with other
MAs.
 Exponential MA - algorithm
1. Simple 20w MA
2. Difference between 21st datum and MA multiplied by exponent (2/N)
= result 1
3. Result 1 added to MA
4. If difference between datum and MA negative - subtract, not add
 Envelopes Symmetrical lines parallel to MA lines (which are the centre of
trend) give a sense of the trend and allow for fatigue of market movement.
 Momentum Division of current prices by prices a given time ago Momentum
is straight when prices are stable When momentum > reference and going up
market up (Bull) When momentum > reference and going down Bull market
stabilizing When momentum < reference and going down market down
(Bear) When momentum < reference and going up Bear market stabilizing
 Oscillators measure the market internal strengths:
 Market width momentum Measured with advance / decline line of market
(=the difference between rising / falling shares) When separates from index -
imminent reversal momentum = no. of rising shares / no. of declining shares
 Index to trend momentum Index divided by MA of index
 Fast lines of resistance (Edson Gould) The supports / resistances will be
found in 1/3 - 2/3 of previous price movement. Breakthrough means new
tops / bottoms.

Management
 Relative strength Does not indicate direction - only strength of movement.
More Technical Analysis:
1. Williams %R = 100 x r = time frame
2. The Williams trading signals:
a. Divergence:
 Bearish - WM% R rises above upper reference line Falls Cannot rise above
line during next rally
 Bullish - WM% R falls below lower reference line Rallies Cannot decline
below line during next slide
b. Failure swing:
When WM%R fails to rise above upper reference line during rally
or
Fall below lower reference line during decline
3. Stochastic: A fast line (%K) + slow line (%D) Steps
a) Calculate raw stochastic (%K) = x 100
n = number of time units (normally 5)
b) %D = x 100 (smoothing)
4. Fast stochastic:
%K + %D on same chart (%K similar to WM%R)
5. Slow stochastic:

Management
%D smoothed using same method
6. Stochastic trading signals:
a. Divergence
 Bullish
Prices fall to new low Stochastic traces a higher bottom than during previous
decline
 Bearish
Prices rally to new high Stochastic traces a lower top than during previous rally
b. Overbought / Oversold
 When stochastic rallies above upper reference line - market O/B
 When stochastic falls below lower reference line - market O/S
 Line direction When both lines are in same direction - confirmation of trend
7. Four ways to measure volume
 No, of units of securities traded
 No, of trades
 Tick volume
 Money volume
8. OBV Indicator (on-balance volume) Running total of volume with +/- signs
according to price changes
9. Combined with:
a) The Net Field trend Indicator
(OBV calculated for each stock in the index and then rated +1, -1, 0)
b) Climax Indicator
The sum of the Net Field Trend Indicators
10. Accumulation / Distribution Indicator A/D = x V
11. Volume accumulator Uses P instead of 0.

Management
12. Open Interest Number of contract held by buyers or owed by short sellers in a
given market on a given day.
13. Herrich Payoff Index (HPI) HPI = Ky + (K' - Ky) K = [(P - Py) x C x V] x [1 ±
{(½ I - Iy½ x 2 / G} G= today's or yesterday's I (=open interest, whichever is less)
+/- determined: if P > Py (+), if P < Py (-)
Journals
Getting start with portfolio management
I'd like to take up a question that is frequently asked by clients and potential clients
regarding project portfolio management techniques: How do you begin introducing
this discipline into an organization? This question most frequently occurs during,
or immediately after, an overview briefing which describes the contents, context,
and basic ideas and concepts of portfolio management as a discipline. It's a fair
question, and there's a lot more to the answer than I can usually provide in a short
briefing session.
However, there are a few key points I would like to make.
As in the adoption of any new capability that addresses organizational structures,
policies, and processes, the climate and culture of the organization is a major
factor in determining how difficult or easy the change will be. The introduction of
portfolio management practices must not only take into consideration process at
the practitioner and project manager levels of the organization; it must be driven
by the strategic direction which is set by the senior management.
If they're committed to the use of portfolio management, senior management will
see the initiatives undertaken by the organization as investments with various rates

Management
of return, benefits and needed outcomes, and associated risks. And, this is why the
whole concept of the "portfolio"(as in "investment portfolio") is applied to this area
of business and IT governance.
As I noted in my October 2005 article in The Rational Edge, Morgan Stanley's
Dictionary of Financial Terms offers the following explanation of the term
"portfolio":
If you own more than one security, you have an investment portfolio. You build the
portfolio by buying additional stocks, bonds, mutual funds, or other investments.
Your goal is to increase the portfolio's value by selecting investments that you
believe will go up in price.
According to modern portfolio theory, you can reduce your investment risk by
creating a diversified portfolio that includes enough different types, or classes, of
securities so that at least some of them may produce strong returns in any economic
climate.1
In a non-financial business context, projects and initiatives are the instruments of
investment. An Initiative, in the simplest sense, is a body of work with:
• A specific (and limited) collection of needed results or work products.
• A group of people who are responsible for executing the initiative and use
resources, such as funding.
• A defined beginning and end.
Managers can group together a number of initiatives into a portfolio that supports a
business segment, product, or product line (or some other segmentation scheme).
These efforts are goal-driven; that is, they support major goals and/or components
of the enterprise's business strategy.
Managers must continually choose among competing initiatives (i.e., manage the
organization's investments), selecting those that best support and enable diverse

Management
business goals (i.e., they diversify investment risk). They must also manage their
investments by providing continuing oversight and decision-making about which
initiatives to undertake, which to continue, and which to reject or discontinue.
Understanding the type of effort involved
So, here is my first key point: You must understand what type of work effort the
introduction and implementation of portfolio management practices represents in
order to identify an effective approach to its execution. You must also identify
which capabilities and experience within your organization (or outside it) you will
require enabling that execution.
The type and context of the effort must be understood in order to approach, plan,
and execute the implementation of portfolio management practices. For example,
we would approach a piece of work identified as "research and development"
differently from a piece of work identified as "building construction." Even better,
if we understand the type of work, and its context; we may be able to identify
organizational and individual capabilities and experience, and we may identify
which existing methods, practices, and approaches exist now, and be able to adapt
and reuse them.
Here is an example:-
In a conversation with an IT executive, a financial executive said that he wanted to
implement and automate certain types of financial management practices. The IT
executive thinks: "Ah ha, sounds like he is looking for a software package!" So he
asks his staff to use existing organizational practices to research and identify the
leading software packages in the area of financial management. As candidates, they
identify such software packages as Oracle Financials and SAP Analytics.2
If the need of the financial executive is pursued as an organizational initiative, a
project or program manager in the IT area will, as a beginning point for planning,

Management
reference a portion of the organizational IT practices that deals with "Commercial-
Of-The-Shelf (COTS) Selection, Planning and Implementation."
Determining the type of work, or the context for the work, has a direct correlation
to the selection of an approach to the completion of the work, and the identification
and the use of capabilities, experience, and well- understood and documented
methods and practices.
In this example, the "type of work" identified is that which deals with the selection
and implementation of COTS (packaged) software.
The type or context for the work for getting started with portfolio management and
its practices has multiple elements. We will examine three elements.
Capability Assessment
Portfolio Management, as a discipline, does not exist in isolation. Rather, it is
effectively exercised based upon a solid foundation of existing organizational (and
individual) capabilities. These capabilities support, enable, and sustain certain
aspects of the work of portfolio management.
For example, much in the same way that excellent hand-eye coordination is a
sustaining capability for a baseball or cricket player, the existence of a solid project
management capability is a sustaining capability for portfolio management.
Let us define capability assessment as follows:
Capability assessment is the activity of surveying, analyzing, and measuring the
ability of organizations and individuals to perform and be successful at some
discipline. In order to be successful with portfolio management, there are a number
of enabling capabilities which an organization and its staff must possess. One of the
early tasks on the road to the successful use of portfolio management and its

Management
practices is to survey the current state of these enabling capabilities and to measure
their maturity across the organization.
The survey results, when analyzed, will indicate which enabling items provide a
solid foundation and where some improvement work is required. For the areas in
which improvement is needed, it is possible to define, plan, and execute multiple
efforts over time to improve various capabilities, and to achieve a maturity and
practice level which will contribute to enabling and sustaining one or more aspects
of portfolio management and its practices.
It is important to understand that there are a variety of models and practices
which exist and which can be used to define and to plan a form of capability
assessment appropriate to portfolio management and its practices.
Process Definition And Implementation
Portfolio management is a discipline. Its exercise requires the definition,
communication, and use of agreed policies, principles, and practices shared by all
in the organization. Taken all together, the combination of these policies,
principles, and practices form the basis of an organizational process.
Here is an illustration:
Consider a group of investors that decides to go into the automobile manufacturing
business. The approach they use is to hire individuals with previous experience in
various aspects of automobile manufacturing. They lease manufacturing buildings,
and they order a variety of machine tools. They appoint a chief executive officer
(CEO).
On a specific day, all of the staff is directed to report to work. The leader of the
investment group, and the CEO, deliver short remarks to inspire the workers for the
future. Finally, they are all directed to "get to work," and they are wished "good
luck."

Management
In this rather simple (and not very realistic example) one element (among many!) is
missing. There is no agreed and ordered set of work steps, allocation of skills,
definition of interim results, or metrics for production to guide the work of the staff.
That is, there is no organizational process.
Portfolio management, as a discipline, must be exercised by means of a number of
integrated and interacting work processes. These processes must be defined,
reviewed, validated (by means of use) and continuously refined and adjusted.
Their development and introduction (process definition and implementation) and
use must be accompanied by the work of communication, consensus building, risk
management, assignment of responsibilities, and other effort to ensure that they are
effectively instantiated, and also "fit" into the overall ways-of-working of the
organization.
Again, there are a variety of models, and methods and practices which deal with the
definition (or "tailoring" of existing) of processes, and the implementation of
processes within an organization.
Organizational Change Management
Organizations are complex organisms which evolve continuously. They
contain individuals and organizational entities with multiple (and often competing)
goals, a variety of functions and initiatives which are carried on, and a need for
successes in the form of results and deliveries which create the revenue to ensure
the continuance of the organization.
Portfolio management is a discipline which requires the definition and
implementation of specific organizational entities and individual roles in order to
establish who carries on what work effort. Clearly the existing organization -- as a
complex organism -- will be impacted by the need to "fit" a new discipline and its

Management
organizational entities, individual roles, and also its goals, and functions, into the
existing order.
The type of work effort which is concerned with the capabilities, policies, and
practices that, ideally, are successful in the introduction of change into an existing
organization is typically identified as organizational change management. The
disciplines associated with organizational change management provide an
approach, a lifecycle, and well-understood work products and outcomes to
minimize the impact and the risk of the insertion of change into an existing order.
Understanding The Current State: Capabilities And
Readiness
My second key point is that management must assess and understand existing
capabilities within the organization that will be required to enable and sustain the
exercise of portfolio management practices. Management must also determine if the
organization is ready to move ahead with portfolio management practices
introduction and implementation.
Management needs to identify an organizational starting point that will
provide needed input to the development of an implementation strategy for
portfolio management practices.
As anyone who has done any cross-country hiking will tell you, there are two data
points which must be in-hand before a course can be plotted: the starting point and
the ending point. A compass and a good map will do you no good unless you know
where you're starting and ending.
This is not an over-simplification. Many times in various kinds of projects and
programs, there is a great deal of time and work devoted to identifying the ending

Portfolio management

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