Portfolio Management- Asset
2. Know Your Limitations
3. Have an Investment Philosophy
Some portfolio managers have inherit bias
toward small growth-comparisons; some
try to play the ‘cycle’; some buy based on
•Play relative Earnings Growth: Firms earnings
growing faster than the overall industry;
Play Relative P/E Ratio.
4. Develop an Investment Strategy- Essential to
implementation of investment philosophy
For an investment strategy, need to know the
‘character of the economy’, such as:
•Inflation forecasts – high or low
•Segment of economy that is strong
• Should the portfolio be weighed by capital
growth or be skewed from Cyclical Stocks?
5. Construction of Portfolio:
6. Revision and Portfolio Performance
2. Portfolio Management of Stocks
Return accruing to an individual stock is
1) Overall market effect
2) Affiliation to the industry
3) Unique characteristics of individual security
1) Market risk
2) Extra market covariance/group risk
3) Specific or residual risk
3. Portfolio Management Style
b) Disciplined Stock Selection
d) Asset Allocation Schemes
e) Modern Portfolio Theory
Active Strategy can be applied with respect to
I) Market Component – Market timer.
Organization will forecast rising market,
raise ß by moving from 1) cash to equity,
or 2) high ß assets.
Forecast declining market, opposite . . .
Passive for market timer, maintain ß in
line with portfolio objective, regardless
of market forecast.
II) Active strategy with respect to industry:
Group Rotation - under-weighting or
over-weighting depending on the
industry, favorable or unfavorable
Tech Sector, Drug Sector, etc., over time;
Passive Strategy: Organization that
believes that it has no capability to
forecast in this respect would set
portfolio weight with respect to broad
market sector and major industries in line
with their weighting in the market index.
III) Active strategy with respect to individual
stocks: Stocks identified as most attractive will
have more weight relative to market index, and
less attractive will weigh less relative to market
Organizations hold many stocks because their
forecasts about individual stock is imperfect,
known as diversification.
Passive strategy with respect to Individual
Stocks: Index Fund
A) Disciplined stock selection:
Several critical elements must be present
1) Must have predictive capability with respect to
2) Systematic Portfolio Construction Process
3) Routine Portfolio Rebalancing/ Transaction Cost
4. Asset Allocation
Asset Allocation: Purpose is to put assets together in
such a way as to maximize return at a level of risk
consistent with investor’s objectives.
Process involves 4 key elements:
1) Investors need to determine the assets that are
eligible for the portfolio.
2) Necessary to determine E(R) for these eligible
assets over a holding period.
3) Once returns have been estimated and risk
accessed, optimization technique is used.
4) Choose portfolio from efficient frontier,
provides maximum return, minimal risk.
Approaches to Asset Allocation
Three approaches to Asset allocation:
Fixed Weight: Fixed percentage of the portfolio to
each asset category – 3 to 5 in total. Fixed does
not mean equal weight.
Common Stock 30%
Foreign Securities 15
Short term Securities 5
Allocation does not change over time, may be
adjusted after a major market move to keep the
desired fixed allocation
Flexible Weight - also known as strategic asset
allocation: Weight changes on the basis of market
analysis. Favorable domestic inflation forecast
compared to foreign may result in revised
Common Stock 30% to 45%
Bonds 50 to 40
Foreign Securities 15 to 10
Short term Securities 5 to 5
Weights are changed to capture greater returns in
Tactical Asset Allocation: Form of market timing
that uses stock index futures and bond futures to
change a portfolio’s asset allocation.
Stocks are forecasted to be less attractive than bonds,
sell stock index futures and buy bond futures.
Bonds are forecasted to be less attractive than stocks,
buy stock index futures and sell bond futures.
Requires sophisticated technique, large portfolio,
Appropriate for large institutional investors.