Portfolio management is the process of selecting investments as per the long-term financial objectives and risk tolerance of a client, a company, or an institution. The objective of active portfolio management is to beat the broader market by strategically buying and selling stocks. Passive portfolio management mimics the performance of a particular index.
Who is a portfolio manager? What are their roles?
Portfolio managers are investment decision-makers who devise and implement investment strategies and processes to meet client goals and constraints, construct and manage portfolios and decide what and when to buy and sell investments. These professionals put in long hours during the weekdays and often work on weekends if necessary to make investments for their clients and investment firms. A portfolio manager must be capable of effective communication, problem-solving and conducting research. A portfolio manager must be able to assess strengths and weaknesses, opportunities and threats across the full spectrum of investments.
Key Elements of Portfolio Management:
Asset Allocation
Portfolio management relies on a long-term mix of assets, which includes stocks, bonds and cash such as certificates of deposit. Other investments, such as real estate, commodities and derivatives, are considered alternative investments. Asset allocation is based on the understanding that assets do not move in concert and some are more volatile than others. A mix of assets provides balance and reduces risks.
Diversification
It is impossible to predict winners and losers consistently when it comes to investments. So the prudent approach is to create a portfolio of investments that provides broad exposure within an asset class. Diversification is spreading risk and reward within an asset class. Diversification, which tries to capture the returns of all the sectors over time while reducing volatility at any given moment, is necessary as it is difficult to predict which subset of an asset class or sector will outperform another. Investing in a variety of securities, sectors of the economy and geographical regions are true diversification.
Rebalancing
The term rebalancing refers to a process of restoring a portfolio’s original asset allocation at regular intervals, usually annually, when the market shifts make it out of balance. Rebalancing involves selling high-priced securities and investing the proceeds in lower-priced, out-of-favor securities. Rebalancing allows an investor to capture gains and increase growth opportunities in high-potential sectors while keeping the portfolio aligned with the original risk/return profile.
There are some major types of portfolio management systems in practice. Let’s have a look at them:
Active portfolio management
An active portfolio strategy aims to generate maximum value by taking advantage of all available information and forecasting techniques in order to outperform a buy-and-hold portfolio in the long run. Its goal is to move capital consistently into profitable securities over the long term.
Passive portfolio management
Passive portfolio management is sometimes referred to as index fund management. The portfolio is designed to closely parallel the performance of a particular market index or benchmark. The goal of passive portfolio management is to generate returns that are similar to those generated by the benchmark or index.
