Portfolio Management

Portfolio management is the art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance.

Types of Portfolio Management

1. Active Portfolio Management

Active portfolio management involves ongoing buying and selling actions by the portfolio manager. The goal is to outperform a specific benchmark index by taking advantage of market opportunities.

2. Passive Portfolio Management

Passive portfolio management aims to match the performance of a given benchmark or index. This strategy involves less frequent trading and is often achieved through index funds.

Key Components of Portfolio Management

• Asset Allocation: This involves splitting an investment portfolio among different asset categories, such as equities, fixed income, and cash, to optimize balance according to risk tolerance and investment timeline.
• Diversification: A strategy to reduce risk by investing in a variety of assets to minimize the impact of a single asset’s poor performance on the overall portfolio.
• Risk Management: Identifying, assessing, and prioritizing risks in the investment strategy to minimize potential losses.
• Rebalancing: The process of realigning the weightings of assets within the portfolio, which may involve selling high-performing assets and buying underperforming ones.

Example of Portfolio Management

Consider an investor who has a total investment of $100,000. The investor decides to allocate their portfolio as follows:

• Equities: 60% ($60,000)
• Bonds: 30% ($30,000)
• Cash: 10% ($10,000)

After some time, the market value of these assets changes, and the portfolio now is:

• Equities: $75,000
• Bonds: $25,000
• Cash: $10,000

This results in a new total portfolio value of $110,000.

Rebalancing Example

To rebalance the portfolio back to the original asset allocation, the proportions must be restored. The target allocations are 60% equities, 30% bonds, and 10% cash, based on the new total value of $110,000.

• Target Equities: 60% of $110,000 = $66,000
• Target Bonds: 30% of $110,000 = $33,000
• Target Cash: 10% of $110,000 = $11,000

After comparison to the current values:

• Current Equities: $75,000 (overweight)
• Current Bonds: $25,000 (underweight)
• Current Cash: $10,000 (underweight)

To rebalance:
– Sell $9,000 worth of equities (to achieve $66,000 target).
– Buy $8,000 worth of bonds (to achieve $33,000 target).
– Buy $1,000 worth of cash (to achieve $11,000 target).

Through this process, the investor manages risk and maintains their desired investment strategy. This is a core aspect of effective portfolio management.