Portfolio management

PORTFOLIO MANAGEMENT

NISHANT MALHOTRA THE QUINTESSENTIAL DUDE

What is portfolio management?

Diversification of portfolio across asset classes Why?

To reduce risk To generate better return due to little correlation among different asset classes Increase risk adjusted returns through active portfolio management

To generate alpha in the portfolio

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What are different asset classes Equities Fixed Income Alternative Investments Real Estate Commodities Derivative and Derivative Strategies Structured Products Managed Futures Alternative Strategies

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How to we do asset allocation?

Understand your client needs through risk profiling by measuring risk and return appetite, cash flow requirements, retirement needs etc.

The client requirements can be arrived through questionnaire now being used by all financial institutions. Usually there are 4 to 5 risk profiles defining investor profile Risk Averse Conservative Moderate Growth Aggressive

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An example of how asset classes are divided among risk profiles Risk Averse

Investment in fixed income

Conservative

Investment in fixed income and large cap diversified equities

Moderate

Reduced investment in fixed income, equities exposure in large cap and mid cap and small alternative investments

Growth

Aggressive

Increased exposure to equities including direct equities, sector funds and alternative investments Highest exposure to equities and alternative investments Nishant Malhotra Copyright

Portfolio Management Fixed portfolio management Flexible or Dynamic portfolio management Constant Mix Constant Proportion (CPPI) Strategic portfolio management

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Portfolio Management: Payoff diagram for ,Maximum return and Minimum Risk Strategies

Source: Perold and Sharpe

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Portfolio Management:- Payoff diagram for 60/40 Stock/Bill Buy and Hold Strategy

Source: Perold and Sharpe

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Constant Mix : Rebalancing when stock market falls

Source: Perold and Sharpe dynamic asset allocation

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Constant Mix : Rebalancing when stock market rises

Source: Perold and Sharpe dynamic asset allocation

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Payoff of constant fix vs buy and hold strategies

Source: Perold and Sharpe dynamic asset allocation

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Constant mix results with market volatility

Source: Perold and Sharpe dynamic asset allocation

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Portfolio Management: Type of Dynamic Portfolio Management -CPPI CPPI ( Constant Proportion Portfolio Insurance) In this structure the portfolio is dynamically balanced between risky and risk free assets depending on the market performance. When the markets go up more capital is allocated to risky assets and vice versa Insurance here is the usual guarantee in Principal at maturity The product is designed as a call option where the principal is secured with participation in upside CPPI strategy sells stocks as they fall and buys stock as they rise

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Portfolio Management: Type of Dynamic Portfolio Management -CPPI Lets assume you have invested $10000 in CPPI based product.

Let this amount be A. The investors will place all their assets in risk free assets when the capital reduces to $9000 The amount A-F along with multiplier is sued to calculate the ratio of assets in risky and risk free assets

A multiplier M is calculated M It depends on the maximum one day. Assume that the maximum one day loss is 25% Multiplier is calculated by dividing 1/0.25=4 Risk Free Assets here are Zero Coupon Bonds which have no coupon payments i.e. no interest payments but trade at a discount to the face value. Example consider a bond of Face Value ( FV) 100 selling at 90 which matures at 100 after 3 years

Dynamic Portfolio Management: CPPI The investment is divided into risky and risk free assets as follows

M*(A-F)=4(10000-9000)=4*1000=4000 The investor should allocate 4000 to risky assets based on the calculation when the investment reduces to 9000. The rest is invested in risk free assets

The portfolio will be rebalanced periodically depending on the market value of the portfolio. If the value of the portfolio increases to 11000 then the amount allocated to risky assets in 8000 while if the portfolio reduces to 9500 then the amount allocated to risky asset reduces to 2000

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To Be Continued This is the beginning of series of tutorials on portfolio management.

This presentation is part of the study material which I had made use whilst as a visiting professor at SIBM, Pune. The series here would be part of the tutorial Portfolio Management and Investment Analysis.

Going forward shall be sharing series of tutorials on Investment and Portfolio Management

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