A portfolio is a collection of investment instruments such as shares, bonds, mutual funds, structured products and other securities. Portfolio management is a specialized service offered to high net worth individuals who have large investable assets to be diversified across investment avenues to maximize wealth and minimize risks. The goal of PMS is generally higher risk-adjusted returns. Let us dive deep and understand what portfolio management is and its various components are.
This article covers:
- What is portfolio management?
- What are the different types of portfolio management?
- Objectives of portfolio management
- Key elements of portfolio management
What is portfolio management?
Portfolio management refers to the art of investing and managing a person’s capital by a professional portfolio manager with the aim of maximum capital appreciation. It involves careful selection of the most optimal investment plan per an individual’s risk-taking capacity and expectations of returns. Given the amount of effort and time it takes, portfolio management is generally provided to individuals who have liquid assets worth upward of Rs. 50 lakh (this is also the minimum investment amount to avail PMS).
Portfolio management involves the process of analysing the strengths, weaknesses, opportunities, and threats of various investment options available and allocating funds to each class of assets in line with the client’s risk profile and financial objectives. Catering to different investment strategies are different types of portfolios.
What are the different types of portfolio management?
Portfolio management strategies fall under four broad categories:
Active portfolio management
Active portfolio managers buy and sell stocks frequently in an attempt to beat the broader market (indices). These fund managers implement an aggressive investment strategy that requires constant monitoring of the market. The process involves pro-active quantitative analysis, diversification, and understanding of business cycles.
Active fund managers usually charge a higher fee for their expertise and services (usually around 1% of assets under management). Mature investors with higher risk tolerance may consider engaging with active portfolio managers.
Passive portfolio management
Passive management involves investing for the long term and does not concern with short-term market movements. Passive portfolio managers try to replicate market returns and believe in the effective market hypothesis, which means that fundamentals will always be accounted for in the prices of assets. Passive investing is suited for investors who want to earn consistent returns with lesser risk.
One characteristic feature of a passive portfolio is that they do not look to actively beat the markets and aim only at long-term wealth creation. That is why engaging with passive portfolio managers may be explored by those high net worth individuals looking to earn consistent returns over the long term at low expense rates.
Discretionary portfolio management
Under discretionary management, the portfolio manager is fully authorized to take decisions on their client’s behalf. The manager is responsible for all the buying and selling decisions.
This type of management is possibly suited for individuals who do not want to involve themselves directly as much and are more comfortable if their portfolio is handled by a capable professional. However, it must be noted that these managers charge fees accordingly in exchange for their premium services.
Non-discretionary portfolio management
The role of a non-discretionary portfolio manager is to merely advise the clients about investments that are good or bad for them. The clients have full authority over their investments besides expert guidance.
Objectives of portfolio management
Capital appreciation: The main aim of PMS is capital appreciation in such a way that the principal invested quickly grows into a corpus while minimizing risks such as market swings and erosion such as through taxes.
Regular income: A portfolio created through PMS generally yields regular income for the investor. Considering that the clients are mostly high net worth individuals, the strategy should ideally be smart enough to afford the clients their lifestyle.
Tax planning: An optimal portfolio management plan encompasses effective tax planning. Different assets attract different taxation. Some investors seek regular dividends and some investors prefer capital appreciation. These factors need to be considered when building the portfolio.
Liquidity: One of the objectives of portfolio management is to manage liquidity. The investor may spot an interesting venture or may want to reallocate a few assets, making liquidity an important portfolio component.
Safety of investments: Portfolios constructed need to match the investor’s risk potential. Funds should be allocated to ensure adequate protection against risks.
Key elements of portfolio management
Asset allocation: Asset allocation in PMS is performed in a way that the portfolio earns adequate returns as per the financial goals and risk capacity of the investor. It means investing a specific percentage of the portfolio value across asset classes such as stocks, bonds, real estate, commodities, and others. This percentage of allocation is arrived at through rigorous research and matching the client’s profile with the product features and risk-return profile.
Diversification: Diversification refers to investing across different asset classes and investment avenues that have a low correlation with each other. This especially helps cushion portfolios during bear markets. Diversifying your investments in different instruments also provides broader exposure and captures returns from various sectors and asset classes over time.
Rebalancing: Rebalancing involves selling securities that have become expensive and piping that money back into undervalued securities, or performing a risk-minimization move to cap the fall in portfolio value and divert funds to better performers. This allows the investor to earn capital gains and also helps in keeping the initial risk-return profile intact. It involves returning a portfolio to its original target allocation.
Effective portfolio management involves developing the best investment plans for high net worth individuals suitable to their goals, risk capacity, and personal profile. The main objective is diversifying risks and earning consistent returns. Portfolio managers can provide customized investment solutions and guidance.
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