Investment portfolio: concept, types, features of management

2024 Author: Howard Calhoun | [email protected]. Last modified: 2024-01-17 18:37

When we talk about portfolio investing, the first thing that comes to mind is the image of Wall Street, stock exchange, screaming brokers. In the framework of this article, we will understand what this concept is at the professional level of a manager and an investor. So what is an investment portfolio?

Concept

Portfolio investment is understood as the investment of financial and monetary resources in the purchase of securities, when it is planned to make a profit without the emergence of rights to control the activities of the issuer.

In other words, the investment portfolio is a combination of financial (stocks and bonds) and real assets of the investor (real estate), which are a form of investment.

Like its individual components, it can be subject to statistical analysis of risk assessment, expected return, and more.

Portfolio investments are all transactions involving debt or equity securities that are not direct investments. Portfolio investments include equity securities (if they do not guarantee effective control over the issuing company), investment fund shares. They are notinclude transactions such as selling back (called a repo) or lending securities.

Simplistically, portfolio investment is an operation by investors to buy financial assets of one country (primarily securities) in another country. In this case, investors do not take active control over the institutions issuing securities, but are satisfied with the realization of profits. Profit is generated by differences in exchange rates or fluctuations in interest rates, so investors interested in securities often base their decisions on a given country's rating.

The set of securities packages includes:

• shares;
• bills;
• bonds;
• bond loans of the state and municipalities.

Types

There are several types of investment portfolios. The table shows the main ones.

Type of investment portfolio	Characteristic
Stock Portfolio	These are highly structured stocks
Balanced portfolio	High-growth stocks, treasuries and bonds
Safe Portfolio	Bank time deposits, bonds and treasury bills
Active Placement Portfolio	These are treasury debt instruments, stockscompanies with highly structured fund and derivative rights

Formation methods

Among the many methods of portfolio formation, there are four main options, which are presented in the table below.

Formation method	Characteristics of the method
Tactical placement method	Its main goal is to ensure a constant level of risk in the investment portfolio over the long term
Strategic allocation method	It is used in making long-term investment decisions
Secure distribution method	Involves adjusting the capital structure so that the risk and expected return of the investment remain unchanged
Integration distribution method	Thanks to this method, both the general conditions of individual investments and their goals can be assessed

Portfolio composition

Most investment portfolios have the following composition as shown in the table below.

Element	Composition	Description
1	With no risk	Income is fixed and stable. Yield bar is minimal
2	Risk	Providing increased returns, maximum capital gains. Yield outperforms market average

The balance between these two parts allows you to achieve the necessary parameters for combining riskiness and profitability.

Fundamentals of portfolio operation

The main goal of a portfolio is to achieve the optimal balance between risk and reward. To do this, investors use a whole arsenal of various tools (diversification, precise selection). The table shows options for investor portfolios.

Option	Characteristic
Income is received as interest	Income Portfolio
Exchange rate difference grows	Growth Portfolio

The basic rule of optimization is this: if the return on a security is high, then the risk is high. Conversely, when income is low, the risk is also lower. This determines the investor's behavior in the market: conservatively or aggressively, which is part of the investment policy.

Aggressive variation	Conservative option
Investment portfolio consists of young growth firms	Stable income with reduced risk. Betting on highly liquid but low-yielding securities issued by mature and powerful companies in the market

The essence of management. Basics

Financial investment portfolio management is an ongoing process. It includes the stage of planning, execution and reporting on the results achieved. This process consists of analyzing economic conditions, defining client constraints and goals, and allocating assets.

Portfolio management is the art and science of making decisions about investment structure and policies, balancing return and risk.

Portfolio management is all about identifying strengths and weaknesses in the choice between debt and equity, domestic and international, growth and security, and the many other trade-offs that come with trying to maximize returns for a given level of risk.

Portfolio management can be either passive or active, as shown in the table below.

Passive	Active
Tracks the market index, commonly referred to as indexing	Investor trying to maximize returns

Main elements of the management process

The main element of management is the distribution of assets, which is based on their long-term structure. The distribution of assets is based on the fact that different types of assets do not move in a consistent manner, and some of them are more volatile than others. A focus is being formed on optimizing the risk profile /investor returns. This is done by investing in a collection of assets that have a low correlation with each other. Investors with a more aggressive profile can weight their investment portfolio towards more volatile holdings. And with a more conservative one, they can weigh it towards more stable investments.

Diversification is a very common method used in portfolio management. It is impossible to consistently predict winners and losers. It is necessary to create an investment portfolio with a wide coverage of assets. Diversification is the distribution of risk and reward within an asset class. Since it is difficult to know which specific assets or sectors may be the leaders, diversification seeks to capture the returns of all sectors over time, but with less volatility at any given time.

Rebalancing is a technique that is used to bring a portfolio back to its original target allocation at yearly intervals. The method is important to maintain an asset structure that best reflects the investor's risk/return profile. Otherwise, market movements may expose the financial investment portfolio to greater risk or reduced opportunities for return. For example, an investment that starts with 70% equity and a 30% fixed income distribution may, as a result of extended market growth, move to an 80/20 distribution that exposes the investor to more risk than he or she can handle. Rebalancing involves the sale of securities withlow value and reallocation of proceeds to low value securities.

Types of portfolio management. What are?

Investment portfolio management involves making a decision on the optimal comparison of investments with goals with a balancing risk.

Let's consider the main types in more detail. The table below shows the characteristics of each of them.

Portfolio management type	Characteristic
Active	Management in which portfolio managers are actively involved in the trading of securities in order to maximize returns for the investor
Passive	With such management, managers are interested in a fixed portfolio, which is created in accordance with current market trends
Discretionary portfolio management	Portfolio management in which the investor places the fund with a manager and authorizes him to invest them as he sees fit on behalf of the investor. Portfolio Manager oversees all investment needs, documentation and more
Non-discretionary portfolio management	This is a management in which the managers give advice to the investor or client, who can accept or reject it. The result, i.e. profits made or losses incurred, belongs to the investor himself, while the service provider receives an adequate remuneration infee-for-service

Control process. Features

The investment portfolio management process itself can be represented as a sequence of steps, as shown in the table below.

Stage	Name	Characteristic
1 stage	Security Analysis	This is the first step in the portfolio building process, which involves assessing the risk and return factors of individual securities, as well as their interrelationships
2 stage	Portfolio analysis	After identifying the securities to invest and the associated risk, a number of portfolios can be created from them, called possible portfolios, which is very convenient
3 stage	Portfolio Selection	The optimal portfolio of financial investments is selected from all possible ones. It must match the risk-opportunities
4 stage	Portfolio review	After choosing the optimal investment portfolio, the manager closely monitors it to make sure it remains optimal in the future to make a good profit
5 stage	Portfolio Valuation	At this stage, portfolio performance is assessed over a set period, with respect toquantitative measurement of the profit and risk associated with the portfolio over the entire investment term

Portfolio management services are provided by finance companies, banks, hedge funds and money managers.

Fundamentals of portfolio investment. Differences from direct investments

Portfolio investment is different from foreign direct investment. With the latter, the investor assumes active control over the enterprises in a particular country. In the case of portfolio investment, it is satisfied by the realization of profits.

Everyone who has savings (financial assets) tries to make the best use of them in various financial areas: bank deposits, stocks, bonds, insurance policies, pension funds.

A set of financial instruments is called a portfolio, so the decision to allocate assets is called the investment(s) in the portfolio.

An investor may also decide to invest part of his savings abroad. The most typical transaction of this type is the purchase of treasury securities of another country.

The size of portfolio investments fluctuates, especially when they are mastered by speculative capital. They are focused on making quick profits and are ready for withdrawal at any time. These fluctuations, on the other hand, can destabilize the exchange rate, so financing the current account deficit with speculative capital can be dangerous. Currency crises, in which there is a sharp weakening of domestic money, are associated with an outflow ofportfolio capital.

Portfolio investments are primarily sensitive to changes in interest rates, their expectations and exchange rate forecasts, as well as to changes in the macroeconomic situation - the risk of destabilization and political upheavals. Depending on the risk assessment, investors demand a premium in the form of higher interest rates, otherwise they are not willing to buy domestic assets.

Calculation of yield

The basic formula for calculating the return on an investment portfolio is as follows:

Profit/ Investment100%.

Where Profit is the difference between the amount sold and the amount bought of the stock.

However, in reality, this formula is insufficient. It needs to be clarified:

Profit=Profit and Loss on each trade + Dividends - Commissions.

It is most convenient to use Excell calculation tables. An example of such a table is shown below.

Money movement	Date	Explanations
100 t. rub.	01.01.2019	The account is credited with the amount of 100 thousand rubles.
50 t. rub.	01.03.2019	At the beginning of March, another 50 thousand rubles were due.
- 20 t. rub.	14.06.2019	In April, the amount of 20 thousand rubles was withdrawn.
-150 t. rub.	18.09.2019	All meanson the account for the day Х

Next, in the cell where we want to calculate the profitability, we need to insert the expression: NETVNDOH(B2:B5; C2:C5)100.

Where B2:B5 is the range of "Money Flow" cells, C2:C5 is the range of "Date" cells.

The program will automatically calculate the income.

The value will be 22.08%.

Portfolio valuation. Calculation principle

Yield must be calculated as a percentage when evaluating the investment portfolio, since only in this case the amount that the investor receives will become clear. It can be compared with the yield from other instruments.

To do this, use the formula for evaluating a portfolio of financial investments:

Profitability in percentNumber of days in a year / number of days of investment. Example, above we got a yield of 22.08%. But these were investments only for six months, and the annual return will be:

22.08%365 / 180=44.8%.

Main Risks

Financial targets are considered in relation to investment portfolio risk and return parameters. It is necessary to get answers to these questions in order to be able to determine the risk that the enterprise bears. Highlights that require permission:

1. What are the client's short and long term goals and financial needs?
2. What are the consequences if goals are not achieved?

The main risks of investment portfolio management are shown in the table below.

Risk	Characteristic	Ways to fight
Security risk	Unsystematic risk. Bonds default, stock price drops to zero, and then they are completely withdrawn from circulation	1. Finding Quality Assets 2. Diversification
Market risk	Systematic risk	It is necessary to include those assets that are resistant to global market fluctuations

Main issues

An important issue is the ability to distinguish the expected rate of return from the required rate. The expected rate of return is related to the level of profit required to finance the goals. However, the required rate of return is linked to the long-term achievement of financial goals.

Factors that may influence the choice of investments may be related to the following categories: legal conditions (trusts and funds), taxes, time frame, exceptional circumstances or liquidity.

Taxes are related to the management of we althy individuals, including tax: on income, on real estate, on the transfer of property or on capital gains. Exceptional circumstances relate to an entity's preference for assets. Liquidity refers to the demand (expected and unexpected) of a business for cash. The time horizon is presented as long-term, medium-term, short-term and multi-stage profit.

Directions to reduce risks through diversification

Portfolio diversification isdiversification of the structure of the investment portfolio. What should be understood by this? Only that it leads to a decrease in the specific (non-systematic) risk of the investment portfolio and individual assets. The essence of diversification is to buy diversified assets in the hope that a possible decrease in the value of some of them will be offset by an increase in the value of others.

Therefore, the effectiveness of portfolio diversification depends on the degree of linkage of changes in prices for the assets that form it (their ratio). The smaller it is, the better the results of diversification.

The strongest diversification is achieved when asset price changes are negatively correlated, i.e. when the price of one asset rises with a fall in the price of another.

Precise determination of the correlation of future asset price changes in a portfolio is difficult, mainly because historical changes should not be repeated in the future. For this reason, simplified diversification methods are often used, consisting in the purchase of assets from various sectors of the economy (for example, shares of banks, telecommunications, construction companies), assets from different market segments (for example, stocks and bonds), geographically differentiated assets (for example, shares from different countries) or assets of small and large enterprises.

The issue of investment portfolio diversification was formally described in the so-called Markowitz Portfolio Theory. Higher returns on an investment portfolio are usually associated with higher risk. Markowitz theory shows howdefine efficient portfolios in terms of the ratio of the expected rate of return to risk.

Conclusion

As part of this article, the methods and techniques used in the process of forming a portfolio of financial investments were considered. With it, you can manage the risks and profits of the investor. The issues of investment portfolio optimization relate to a balanced combination of minimal risk while obtaining the maximum possible income from the composition of assets.