Portfolio Management is defined as the art and science of making decisions about the investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance
The portfolio manager's ultimate goal is to maximize the investments' expected return within an appropriate level of risk exposure.Key Elements of Portfolio Management
Asset AllocationThe key to effective portfolio management is the long-term mix of assets. Generally, that means stocks, bonds, and "cash" such as certificates of deposit. There are others, often referred to as alternative investments, such as real estate, commodities, and derivatives.
Asset allocation is based on the understanding that different types of assets do not move in concert, and some are more volatile than others. A mix of assets provides balance and protects against risk.
Diversification is spreading risk and reward within an asset class. Because it is difficult to know which subset of an asset class or sector is likely to outperform another, diversification seeks to capture the returns of all of the sectors over time while reducing volatility at any given time.
Rebalancing is used to return a portfolio to its original target allocation at regular intervals, usually annually. For example, a portfolio that starts out with a 70% equity and 30% fixed-income allocation could, after an extended market rally, shift to an 80/20 allocation. The investor has made a good profit, but the portfolio now has more risk than the investor can tolerate.
Rebalancing generally involves selling high-priced securities and putting that money to work in lower-priced and out-of-favor securities.
The annual exercise of rebalancing allows the investor to capture gains and expand the opportunity for growth in high potential sectors while keeping the portfolio aligned with the original risk/return profile.
Types of Portfolio Management
Active Portfolio Management
An actively managed investment fund has an individual portfolio manager, co-managers, or a team of managers actively making investment decisions for the fund. The success of an actively managed fund depends on a combination of in-depth research, market forecasting, and the expertise of the portfolio manager or management team.
Portfolio managers engaged in active investing pay close attention to market trends, shifts in the economy, changes to the political landscape, and news that affects companies.
Passive Portfolio Management
Passive portfolio management, also referred to as index fund management, aims to duplicate the return of a particular market index or benchmark. Managers buy the same stocks that are listed on the index, using the same weighting that they represent in the index.
A passive strategy portfolio can be structured as an exchange-traded fund (ETF), a mutual fund, or a unit investment trust. Index funds are branded as passively managed because each has a portfolio manager whose job is to replicate the index rather than select the assets purchased or sold.
Discretionary Portfolio Management
A discretionary manager is given full leeway to make decisions for the investor. While the individual goals and time-frame are taken into account, the manager adopts whichever strategy he thinks best.
Once the cash has been handed to the professional, the investor sits back and trusts that the profits will roll in.
Non-Discretionary Portfolio Management
The non-discretionary manager is simply a financial counselor. He advises the investor in which routes are best to take. While the pros and cons are clearly outlined, it is up to the investor to choose his own path. Only once the manager has been given the go ahead, does he make a move on the investor's behalf.
Whether you decide to use a portfolio manager or you choose to take on the role yourself, it is important to opt for a viable strategy and ensure that it is put forward in a logical way. The merit of maintaining a sensible portfolio is that it cuts down the confusion while providing investments that fit the individual's goals.