Pallavi S, Mcom, KSET Assistant Professor Department of Commerce & Management Surana College, Peenya Units Portfolio Management Ca hrs Portfolio Management: Meaning, Need, Objectives, process of Portfolio ‘management, Selection of securities and Portfolio analysis. Construction of| optimal portfolio using Sharpe's Single Index Model. Portfolio Performance evaluation (Theory only) Portfolio management refers to the systematic process of making investment decisions and managing assets on behalf of an individual, group, or organization. The goal of portfolio management is to achieve the highest possible return on investment while minimizing risk and volatility Portfolio management is the process of choosing and managing a mix of investments to meet specific financial goals. It involves deciding how to allocate assets like stocks, bonds, and cash The aim is to balance risk and reward according to an investor's risk tolerance, time horizon, and investment objectives. Essentially, it's about making smart decisions to grow and protect wealth over time. 1. Diversification: Spreading investments across different assets reduces risk. If one investment perfonns poorly, others may do well, balancing the overall performance Goal Alignment: Ensures your investments are in line with your finaneial goals, whether it's saving for retirement, buying a house, or funding education 3. Risk Management: Helps identify and manage tisks. By assessing the risk level of each investment, you can make informed decisions to protect your money 4, Performance Monitoring: Regularly tracks the performance of your investments. This helps in making necessary adjustments to stay on track with your financial goals 5. Optimized Returns: Aims to maximize retums based on your risk tolerance and investment horizon. By carefully selecting and managing investments, you can achieve better overall returns. Diversification: Spread investments across different assets to reduce risk. Risk Management: Balance risk and reward by adjusting the mix of investments, Return Maximization: Aim to achieve the highest possible returns based on risk tolerance. Liquidity: Ensure there's enough cash or easily sold assets to meet short-term needs. Financial Goals: Align investments with your financial goals and time horizon.Pallavi S, Mcom, KSET Assistant Professor Department of Commerce & Management Surana College, Peenya 1. Set Goals: Determine whatyou want to achieve with your investments. Goals can be short- term (like saving for a vacation) or long-term (like saving for retirement). 2. Assess Risk Tolerance: Understand how much risk you're willing to take. Risk tolerance depends on factors like your age, income, financial responsibilities, and how comfortable you are with the possibility of losing money. 3. Diversify: Spread your investments across different asset classes (like stocks, bonds, and real estate) to reduce risk. This way, if one investment performs poorly, others may perform, well and balance things out. 4, Allocate Assets: Decide what percentage of your portfolio to invest in each asset class. For example, you might choose to invest 60% in stocks, 30% in bonds, and 10% in real estate. 5. Select Investments: Choose specific investments within each asset class, For stocks, might pick individual companies or mutual funds. For bonds, you might select goverment or corporate bonds 6. Monitor and Rebalance: Regularly check your portfolios performance and adjust if necessary. Rebalancing means realigning your portfolio to maintain your desired asset allocation. For example, if your stocks perform very well and now maixe up 70% of your portfolio, you might sell some stocks aud buy more bonds to get back to your original 60/30/10 allocation. 7. Review and Adjust: Periodically review your goals, risk tolerance, and investment performance. Adjust your portfolio as needed to stay on track. > Selection of securities refers to the process of choosing specific financial assets, like stocks or bonds, to invest in > ‘The goal is to pick securities that align with an investor's objectives, such as risk tolerance, time horizon, and return expectations. This involves analysing various factors like company performance, market trends, and economic conditions. The ultimate aim is to build a portfolio that maximizes retums while managing risk. 1. Risk Tolerance: Choose securities that match your ability to handle losses. 2. Investment Goals: Align securities with your financial objectives, like growth or income. @Pallavi S, Mcom, KSET Assistant Professor Department of Commerce & Management Surana College, Peenya 3. Time Horizon: Select based on how long you plan to invest before needing the money. 4. Diversification: Pick a mix of securities to spread risk actoss different assets, 5. Performance History: Look at past performance to gauge potential future retums. 6. Market Conditions: Consider the current economic environment and market trends. 7. Company Health: Evaluate the financial stability and growth potential of companies. 8. Valuation: Ensure the security is fairly priced based on metrics like P/E ratio. 9. Liquidity: Choose securities that can be easily bought or sold without affecting their price 10. Fees and Costs: Be aware of transaction fees, management fees, and other costs that could impact returns. BOMTORAWANS Portfolio analysis is the process of examining the various investments in your portfolio to understand their performance and risk. Ithelps identify which investments are doing well and which are not. This analysis can guide decisions to buy, hold, of sell certain assets, Ultimately, it aims to maximize returns while minimizing tisk. 1. Define Goals and Constraints: Determine your financial objectives (like growth, income, or preservation of capital) and any constraints (like risk tolerance or liquidity needs) 2. Gather Portfolio Information: Collect data onall investments in your portfolio, including types of assets (stocks, bonds, ete.), quantities, purchase prices, and current market values. 3. Performance Evaluation: Measure how well your portfolio has performed over a specified period, considering retums achieved relative to benchmarks and goals. 4. Risk Assessment: Evaluate the level of risk in your portfolio, assessing factors like volatility, diversification, and exposure to specific economic factors 5. Asset Allocation Analysis: Review how your assets are allocated across different types, (equities, fixed income, cash, etc.) and assess whether it aligns with your goals and risk tolerance. Diversification Review: Check the diversification level to see if you have spread your investments across different asset classes and sectors to reduce risk. 7. Rebalancing: Adjust your portfolio periodically to maintain desired asset allocation percentages and risk levels as market conditions and your financial goals change. 8. Monitoring and Reporting: Regularly monitor the performance of your portfolio against your goals and benchmarks. Report findings and adjustments to stakeholders or yourself.Pallavi S, Mcom, KSET Assistant Professor Department of Commerce & Management Surana College, Peenya 1. Diversification: By analysing a portfolio, you can see how different investments perform together. Diversification helps reduce the risk of losing money if one investment underperform because gains in others may offset losses. 2. Risk Assessment: Portfolio analysis helps you understand the level of risk you're taking with your investments. It allows you to see if your portfolio is too risky or not risky enough based on your goals and tolerance for risk 3. Performance Evaluation: You can assess how well your portfolio is performing compared tobenchmarks or goals you've set. This helps in making informed decisions about whether to hold, buy, or sell investments, 4. Asset Allocation: Analysing your portfolio helps in determining the right mix of asset classes (like stocks, bonds, cash) that align with your financial goals and risk tolerance. This balance can optimize retums while managing risk. 5. Decision Making: Itprovides a basis for making strategic decisions about buying or selling investments. By understanding the strengths and weaknesses of each investment in your portfolio, you can adjust your holdings to better achieve your financial objectives. Sharpe's Single Index Model, often used in portfolio construction, aims to create an optimal portfolio by considering the relationship between each asset's retums and its sensitivity to overall market movements (captured by a single index, typically the market index). Here's how you can construct an optimal portfolio using Sharpe's Single Index Model: 1. Calculate Expected Returns: Start by estimating the expected returns for each asset in your portfolio based on historical data, market trends, or analyst projections Determine Asset Betas: Calculate the beta (B) for each asset, which measures its sensitivity to movements in the market index. Beta indicates how much an asset's price typically ‘moves in relation to the market 3. Calculate Risk-Free Rate: Determine the risk-free rate, typically using government bond yields, as it represents the return on an investment with no risk.Pallavi S, Mcom, KSET Assistant Professor Department of Commerce & Management Surana College, Peenya 4. Construct the Capital Market Line (CML): ¢ The CML represents a line that plots the expected retum of a portfolio against its beta (tisk) Foumula for CML: E(rp)=rfBp»(E(m)-16) E(rp): Expected return of the portfolio. rf: Risk-free rate. Bp: Beta of the portfolio. E(rm): Expected return of the market. 5. Determine Optimal Portfolio: © The optimal portfolio is found where the Sharpe ratio is maximized. The Sharpe ratio calculates the excess return of a portfolio per unit ofrisk (measured as standard deviation or volatility) © Formula for Sharpe ratio: Sharpe Ratio= E(rp)-rf tf 6. Select Portfolio with Maximum Sharpe Ratio: Identify the portfolio that offers the highest Sharpe ratio, as it represents the optimal trade-off between risk and retum. By following these steps, investors can construct an optimal portfolio using Sharpe's Single Index Model, which balances expected returns with market risk to achieve the best possible risk-adjusted rerum, Portfolio performance evauation refers to the process of assessing how well a portfolio of investments has performed over a certain period. It involves comparing the portfolio's returns against benchmarks or goals set by the investor. This evaluation helps investors understand if their investments are meeting expectations, and it guides future investment decisions such as ‘whether fo continue with current strategies or adjust for better performance. 1. Self-Evaluation: When individuals invest on their own, they make all the decisions. They need to check how their investments are doing to spot mistakes and improve their skills for better results in the future, Evaluation of Portfolio Managers: Professional Managers: Investment companies or mutual funds have different portfolios managed by professional managers. The company evaluates each manager's performance to compare and see who is doing better. Evaluation of Mutual Funds: Mutual Fund Comparison: With many mutual funds available, both public and private, they compete to attract investors. People andPallavi S, Mcom, KSET Assistant Professor Department of Commerce & Management Surana College, Peenya organizations want to know which mutual fund perfomns best in terms of retums, risk, safety, and liquidity to decide where to invest. 4, Evaluation Perspective: Different Views: A portfolio has many securities, bought and sold through several transactions. Evalvating the portfolio can be done from different angles like transactions, individual secunties, or the overall portfolio. 5. Transaction View: Each Transaction Matters: Investors can evaluate every buy or sell transaction to check if it was the right decision aud if it was profitable. 6. Security View: Each secusity in a portfolio was bought at a specific price. By the end of the holding period, its market price may have gone up or down. Additionally, dividends or interest may have been received. Evaluating each security separately lelps to understand its profitability. 1. Sharpe Measure > The Sharpe Measure, developed by William Sharpe, assesses the performance of an. investment by adjusting for its risk. > Ittells us how umch excess return we are getting for each unit of risk. A higher Sharpe ratio indicates better risk-adjusted performance > Formula Sharpe Ratio = Rp-Rf op Rp: Return of the portfolio Rf: Risk-free rate (such as the retum on government bonds) ‘op: Standard deviation of the portfolio's retum (a measure of risk) 2. Treynor's Model ¥ “Treynor’s Model, developed by Jack Treynor, evaluates the performance of a portfolio by considering systematic risk (market risk) rather than total risk. It measures how much excess return a portfolio generates for each unit of market risk, Its useful for comparing portfolios that are part of alarger diversified portfolio, where only systematic risk matters. % > Formula: ‘Treynor Ratio= Rp-RfPallavi S, Mcom, KSET Assistant Professor Department of Commerce & Management Surana College, Peenya Rp: Retum of the portfolio Rf: Risk-free rate Bp: Beta of the portfolio (a measure of the portfolio's sensitivity to market movements) Jensen's Model (Jensen's Alpha) > Jensen's Model, developed by Michael Jensen, calculates the excess retum a portfolio generates over ils expected retum, based on the Capital Asset Pricing Model (CAPM), > Jensen's Alpha indicates whether a portfolio has outperformed or underperformed the market after adjusting for risk. A positive alpha means the portfolio performed better than expected based on its risk, while a negative alpha indicates, underperformance > Formula: ap=Rp-[Rf+Bp(Rm-Rt)] ap: Jensen's Alpha (the performance measure) Rp: Return of the portfolio Rf Risk-free rate Bp: Beta of the portfolio Rm: Retum of the market 1. From the following datacomment on the performance of fundsas per Sharpe Index and ‘Treynor Index Fund ‘Return (in%) -Rp | Standard deviation | Beta- B (in%) - op ‘A Market Index | 12 18 07 B Market Index| 19 25 13 M Market Index| 15 20 10 The risk free rate of retum is 7% From the following data comment on the performance of fundsas per Sharpe Index and ‘Treynor Index Fund Retum (m%) | Standard Beta-P | Riskless Rate of Retum -Rp deviation (in%) -op ‘A Market Index [20 q 05 10 B Market Index | 20 8 ol 10Pallavi S, Mcom, KSET Assist Professor Department of Commerce & Management Surana College, Peenya 3. Suppose youare asked to analyse two portfolios having the following characterizations Funds Observed Return (%) | Beta _| Standard Deviation (%) PortfolioA | 18 20 | 3498 PortfolioB | 12 1s__|o The risk free rate is 0.07, the retum on the market portfolio is 0.15, the standard deviation of the market is 0.06 Compute the Jensen Index for Portfolio A &B Compute the Sharpe Index for the market portfolio Compute the Sharpe Index for Portfolio A &B Compute the Treynor Index for Portfolio A &B 4. With the given details, evaluate the performances of the different funds using Sharpe & Treynor performance evaluation techniques Funds | Retum [SD] Beta A 2 20 | 0.98 B 12 18 | 097 it 8 22 117 D 9 24 1.22 Risk Free rate of retum is 4% 5. Rank the three funds given below with the help of Treynor and Sharpe Index Growth. Retumn Beta SD. x 15 15 2 Y v7 1.6 4 Zi B 0.75 u Re 9% - - Is there any difference in the ranking according to theses measure? if so Why 6. Alpha & Beta Co-efficient for 5 Stocks are given below Stock Alpha | Beta Craft High crop 10 08 Crown crop 135 115 Courtesy crop is | 1.25 Cute crop 125 | 0.95 Cure crop 1S 14 Rank the 5 Stock using Jenson’s performance measure.