Portfolio management refers to selecting and managing an investor’s assets in line with their strategic financial objectives and risk tolerance capacity. The objective of portfolio management is to optimise investment returns without exposing the invested capital to too much market risk. This article focuses on what portfolio management is, highlighting the objectives, functions, types, suitability, and processes of portfolio management in detail.
What is portfolio management?
According to the definition of portfolio management, it is the process of selecting and managing investments that align perfectly with the financial objectives and risk tolerance of the client or organisation. The portfolio management process is based on one’s ability to make sound decisions relating to creating a profitable investment mix, allocating assets per the risk tolerance and financial objectives of the investor, and diversifying investments to tackle investment risks. In simple words, portfolio management is the process of selecting and overseeing a group of assets like stocks, bonds, and mutual funds to maximise the investor’s returns within a given timeframe. Effective portfolio management requires comprehensive market knowledge and understanding of trends, asset allocation, and rebalancing strategies.
Key takeaways
- Portfolio management is the process of building, managing, and overseeing a group of investments spread across various asset classes like stocks, bonds, gold, commodities, and real estate according to the investor’s financial goals and risk tolerance capacity.
- Active portfolio management involves strategically trading securities to beat the broader market performance, while passive management involves replicating the makeup of top-performing market indexes to generate similar returns.
Portfolio management is a multi-step process that involves identifying investment goals, determining one’s risk tolerance capacity, ideating asset allocation plans, selecting assets, and periodically reviewing and rebalancing the portfolio.
Objectives of portfolio management
Now that you know what portfolio management is, let’s focus on exploring its objectives. Selecting the best investment option based on the investor’s risk tolerance, income, age, and investment horizon is the chief objective of portfolio management. The goal is to attain maximum returns on the investment against a minimum risk exposure. Effective portfolio management focuses on investing in assets with a good capital appreciation potential such that the investor’s portfolio grows over time. Additionally, portfolio management aims to improve the investment portfolio's overall proficiency through balanced asset allocation and risk optimisation.
In simple words, portfolio management aims to allocate funds across different asset classes like equities, fixed-income securities, and alternative investments to balance the risk-return potential of investments. By scattering risk across assets, portfolio management avoids risk concentration in a single asset class, sector, or industry. Diversified resource allocation protects the investor’s earnings from market risks and helps attain long-term objectives.
Types of portfolio management
Portfolio management can be classified into the following 4 broad categories:
Active portfolio management
In active portfolio management, the portfolio manager is continuously involved in the act of trading securities to outperform a particular market index. This hands-on approach aims to ensure maximum earnings for the investor, regardless of the prevailing market conditions. Those engaged in active management closely monitor market trends, changes in the political landscape, and company news to decide the right time to purchase or sell securities to exploit market irregularities.
Passive portfolio management
Passive portfolio management focuses on replicating the performance of a key market index like the Nifty 50 or Sensex. Managers buy the same stocks listed on the index, leveraging the same weighting they hold in the index. Passive management coincides with the buy-and-hold strategy, where the portfolio consists of a fixed investment profile that remains unchanged regardless of market fluctuations. The rationale is to achieve steady growth against minimum trading. Passive management generally invests in index mutual funds and ETFs to maximise long-term growth and minimise costs related to active management.
Discretionary portfolio management
Discretionary portfolio management is a type of management approach where the manager is entrusted to make buy and sell decisions on the investor’s behalf. The manager can use their discretion to shuffle, rebalance, and adjust the portfolio based on their knowledge of the investor’s financial goals and risk appetite.
Non-discretionary management
Under non-discretionary portfolio management, the manager can provide investment advice to the investor. The investor can take this advice or choose to reject it. However, the manager cannot execute trades without the investor’s approval.
Who should opt for portfolio management?
Portfolio management functions to streamline your investment approach. Portfolio management services can help investors identify their financial goals and risk tolerance capacity to curate a portfolio that aligns with these variables. Moreover, they can manage and track the performance of one’s investment portfolio to maximise returns.
As such, portfolio management can benefit all investors. However, the following category of people should seriously consider portfolio management:
Investors who seek to build a wealth corpus by investing in various market-linked investments like stocks, bonds, mutual funds, commodities, etc., but do not possess adequate market knowledge.
Beginner investors who are unsure of the entire investment process and require guidance.
Investors who do not have enough time to track their investments and rebalance their portfolios.
Investors who have limited knowledge about the various aspects of the investment market.
Ways of portfolio management
Achieving the various objectives of portfolio management requires sound management strategies. Here’s a list of ways professionals manage investment portfolios:
Asset allocation
Optimised asset allocation is one of the chief objectives of portfolio management. Asset allocation is the process of allocating funds to different asset classes within an investor’s portfolio. Systematic asset allocation ensures investment in both volatile and non-volatile assets to maximise the portfolio’s return potential while minimising its risk exposure. Factors like the investor’s risk tolerance, age, income, and investment goals are thoroughly assessed to arrive at an appropriate asset allocation strategy. For instance, managers may suggest a higher exposure to equities for investors with an aggressive risk profile.
Diversification
Diversification is closely linked to the principle of asset allocation. It is the act of scattering investment risk across different investment avenues. Dispersing investments across asset classes, sectors, and industries helps minimise the impact of market volatility on the investor’s portfolio. In other words, it means investing in a varied basket of securities like stocks, bonds, mutual funds, gold, ETFs, and commodities to cushion investment risks. The rationale is sound: even if one asset class underperforms, others may perform better to ensure minimum losses. Diversification works best when assets with low or negative correlation are added to the investor’s portfolio.
Rebalancing
Rebalancing is as crucial as drafting a fresh investment portfolio. The process of portfolio rebalancing helps the investor’s portfolio return to its original target allocation. It is an important aspect of portfolio management that helps maximise returns. Market movements can cause asset allocations to shift over time. For instance, a market rally may shift your original 60/40 (equity/debt) allocation to an 80/20 allocation. While increasing equity exposure helps you earn higher returns, it also increases your portfolio's risk exposure. In other words, your portfolio no longer aligns with your original risk profile and requires correction. Experts suggest yearly reviewing and rebalancing your investment portfolio to align with market conditions and your own original mix.
Processes of portfolio management
Now that you understand what portfolio management is and the strategies used to manage portfolios, it’s time to focus on the processes of portfolio management. Portfolio management is a multi-step process that requires considerable deliberation. The following section outlines the steps involved in it:
- Identifying financial objectives: Portfolio management begins by identifying the investment objectives. In other words, investors need to pinpoint their investment's purpose—capital appreciation, income generation, or wealth creation.
- Reviewing capital markets: The next step in the process of portfolio management relates to the assessment of the capital markets. Researching and evaluating the capital market helps understand expected return and risk estimates for various asset classes.
- Deciding on asset allocation: To ensure good returns at minimal risk, a sound asset allocation strategy needs to be ideated. The investor’s risk tolerance capacity underpins the asset allocation ratio or how funds are distributed among various asset classes.
- Drafting a portfolio strategy: Next, a comprehensive portfolio strategy must be formulated. A portfolio strategy outlines how the investor’s funds will be invested in the market on the basis of the asset allocation ratio, investment goals, and time horizon.
- Selecting the right securities: Securities are selected on the basis of their return potential, liquidity, and fundamentals. Only securities that align with the investor’s risk tolerance, investment horizon, budget, and liquidity needs are shortlisted. For instance, mutual fund calculators can be used to estimate returns and understand if the fund should be added to your portfolio.
- Implementing the portfolio strategy: The planned portfolio is implemented by investing in the selected assets.
- Reviewing and revising the portfolio: Portfolio managers regularly review portfolios and revise them to ensure efficiency and an optimised risk-return balance.
- Rebalancing the portfolio: Managers may rebalance portfolios to ensure maximum returns while keeping up with changing market conditions. Portfolios may be rebalanced if the asset mix has diverted significantly from the original mix, resulting in a higher risk exposure.
Conclusion
Portfolio management is a crucial and inherent part of investing. Understanding the objectives and functions of portfolio management can help you master the art of investing. Effective portfolio management allows you to draft the best investment plan that’s well-aligned with your income, goals, and risk tolerance capacity. Prudent portfolio management can function to reduce the risk exposure of your investments and boost their return potential. Depending on your market knowledge and preferences, you can decide to self-manage or entrust portfolio management responsibilities to a skilled professional advisor.
When it comes to investing in mutual funds, thankfully, you already have skilled expert fund managers handling the portfolio management process. You can simply start investing through the smart and efficient Bajaj Finserv Mutual Fund Platform. This cutting-edge platform lets you compare 1000+ funds and choose mutual fund schemes that best match your goals and risk tolerance capabilities. Depending on your preferences, you can start your mutual fund investments with SIPs or opt for the lump-sum route.
