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Different types of assets perform differently depending on market conditions. That’s why investors spread their money across various assets like mutual funds, gold, stocks, and bonds. This mix of investments is called an investment portfolio, and through this diversification, investors can better manage risk and aim for higher returns while staying aligned with their financial goals, situation, investment horizon, and risk tolerance. Balancing all these factors is a part of strategic portfolio management, and it’s nothing short of an art. Let’s find out what portfolio management is exactly, understand its different types, and processes, and look at some common strategies.
What is Portfolio Management?
Let’s start with the definition of portfolio management. It is the process through which investors buy and manage a variety of investments with the aim of achieving their financial goals while considering factors such as risk tolerance and time horizon. They aim to maximise returns while minimising risks by allocating assets strategically, diversifying their portfolio, and actively monitoring and rebalancing their portfolios as market conditions change. Another important part of portfolio management is conducting a SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis, which allows investors to assess the factors that can impact their investment decisions.
That answers what is portfolio management, but who is it for? Well, individual investors can certainly manage their investment portfolios if they are knowledgeable about key aspects such as asset allocation, diversification, and rebalancing. But generally, portfolio management is done by professional managers who oversee investments on behalf of individuals, institutions, or funds. Individuals who have limited time or expertise in the financial world can greatly benefit from entrusting the management of their investments to professionals.
Types of Portfolio Management
Some different portfolio management types are:
Passive Portfolio Management
Investors who passively manage their investment portfolios try to replicate the performance of specific market indices, such as the NIFTY 50. A key feature of passive portfolio management is that managers do not attempt to outperform these indices, as they believe that consistently outperforming market benchmarks is challenging. They hold their assets for the long term and maintain a very low level of buying and selling. Keeping transactions to a minimum allows passive managers to also reduce fees and taxes, which helps them save more over time. For this reason, this style of management is also sometimes known as the buy and hold strategy.
Active Portfolio Management
On the other hand, investors who actively manage their portfolios try to outperform a specific benchmark index and are said to use an active style of portfolio management. Unlike passive portfolio management, an active style demands in-depth research, accurate market forecasting, and frequent trading. Investors need a high level of expertise to actively manage their portfolios, and while this type of management has a better potential for high returns, it also comes with higher risks. Also, due to frequent buying and selling, active investors have to pay more fees and taxes than their passive counterparts, but they believe that the potential for more gains justifies the additional costs.
Hybrid Portfolio Management
As the name suggests, hybrid management mixes the elements of both strategies – active and passive. Investors who take this approach divide their portfolios into different portions, with one part being passively managed to track a benchmark index, while the other part is actively managed to capitalise on market opportunities and generate higher returns.
Discretionary and Non-Discretionary Portfolio Management
With discretionary portfolio management, investors give full control of their portfolios to their portfolio managers. The manager is free to act as they see fit and can make investment decisions on behalf of the client without needing approval for each transaction beforehand. The portfolio manager assesses the investor’s financial goals, investment horizon, financial situation, and risk appetite. This allows them to tailor the investment strategy to meet the specific needs and preferences of the investor.
Non-discretionary allows an investor to have the final say in investment decisions. While the manager will still give personalised guidance to the investor, he or she will also need full approval for each transaction. With this style, investors can maintain control over their portfolios and have the opportunity to review and authorise investment decisions before they are made.
Also Read: Goals of Financial Management
The Process of Portfolio Management
The main goal of portfolio management is to maximise returns while minimising risks, and making sure that the portfolio remains aligned with the investor’s financial goals, investment horizon and risk tolerance. With the help of portfolio advisory services you can efficiently manage all the investments in your portfolio with minimum risk and optimum return. The manager’s investing style and size of the portfolio can vary the specific steps of the portfolio management process, but generally, it has the following four steps:
- Goal Setting – Before any investment strategy can be laid down, clear and specific financial goals must be defined. From capital preservation to capital appreciation, these long-term goals will form the basis of your strategy. Along with goal setting, it’s important to assess risk tolerance based on age, income, current financial situation, and level of comfort.
- Asset Allocation – Now that you know your goals, investment horizon, and risk tolerance, asset allocation decisions can be made. You must decide on the combination and ratio of asset classes such as stocks, bonds, cash, and funds to make a diversified and balanced portfolio. This decision is very important as it directly impacts the risk and return potential of your investments. A well-diversified portfolio can help reduce risk by spreading investments across different asset classes that perform differently in different market conditions.
- Security Selection – You must conduct thorough research and analysis, and based on factors such as market size, sector, industry, and other metrics, pick individual securities within each asset class. You can excel in creating investment portfolios by actively selecting assets and choosing the right asset classes.
- Portfolio Monitoring and Rebalancing – Market conditions change frequently, as does one’s financial situation. This makes it necessary for you to regularly monitor your portfolio. If you find that your portfolio is no longer aligned with your financial goals, you can rebalance it by adjusting the mix of assets. Rebalancing can help you maintain the level of risk and returns you are comfortable with.
Key Elements of Portfolio Management
Asset Allocation
Asset allocation refers to how you distribute your investments within your portfolio. When you invest, you buy across a range of asset classes such as stocks, bonds, funds, commodities, real estate, precious metals, and alternatives like cryptocurrency. Asset allocation is the process of deciding how much of your money to invest in each of these asset classes to achieve a balanced and diversified portfolio that aligns with your financial goals, risk tolerance, and investment horizon.
Each of these assets behaves differently in different market conditions, which is why spreading your investments across multiple asset classes can help manage risk and maximise returns.
Diversification
Diversification and asset allocation go hand in hand in building a strong investment portfolio. When you diversify your portfolio, you are spreading investments across various asset classes to reduce risk. If one asset class were to perform poorly, the others can help offset the losses, which makes sure that your overall portfolio remains stable. For more effective diversification, you should consider different economic sectors and industries, geographical regions, and classes of securities.
Rebalancing
Rebalancing is an essential part of portfolio management. Since the market is dynamic, the value of your investments can change quite a bit over time which can cause your portfolio to stray away from its original asset allocation. For example, if your portfolio was 50% stocks and 50% debt instruments, and a year later you make a lot of profit from your stocks, the asset allocation might change to something like 60% stocks and 40% debt. Now you are overexposed to stocks, which makes your portfolio riskier than the original asset allocation. You can sell some of your stocks and rebalance your portfolio so it remains aligned with your risk tolerance and financial goals. This process is done on a regular basis, generally semi-annually or annually.
Tax-Efficiency
When you are deciding on which assets to invest in, you should take taxes into consideration. Over the long term, taxes can eat into your profits and significantly reduce your overall returns. That’s why proper tax planning must be done to identify vehicles that can minimise your tax liabilities legally, while also helping you achieve your overall financial goals. For example, if you want to grow your wealth with an equity fund but also want tax benefits, you can consider investing in Equity Linked Savings Schemes (ELSS). ELSS offers high returns because it primarily invests in equity. It also allows you to claim a tax deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act.
Portfolio Management: Passive vs. Active
Previously, we touched upon active and passive portfolio management. Here’s a more detailed comparison between the two:
| Active Portfolio Management | Passive Portfolio Management |
| Aims to generate higher returns by outperforming the market. | Aims to follow a specific market index like Nifty 50. |
| Buying and selling are done frequently, so the cost is higher. | Investors have a buy and hold mindset, so not many transactions are done. |
| The manager tries to beat the market returns. | The goal is to replicate the performance of a market index. |
| Actively managed portfolios are very expensive due to frequent trading. | Due to low transactions, the fees and taxes are low. |
| High level of expertise is required to actively manage a portfolio. | This is a more hands-off approach that relies on the index, so it doesn’t require as much expertise. |
| Management risk is involved as the managers are only human and can make mistakes. | The investment strategy reduces the potential for human error or bias. |
| Managers have the flexibility to invest in a wide range of assets, so they are free to pursue new opportunities. | Extremely limited opportunities for managers as they are locked into specific holdings. |
| The potential for returns is higher. | Returns aren’t as high. |
Common Portfolio Management Strategies
Investors can choose from several different strategies for managing their portfolios as per their risk tolerance and financial goals. Here are some of them:
Conservative Strategy
This strategy is suited for investors with low-risk tolerance whose main goal is capital preservation. While the potential for growth is limited, the associated risk is also extremely low. Conservative investors generally prefer to invest in debt instruments and government options such as Government Securities (G-Secs), which eliminates credit risk.
Aggressive Strategy
Investors with high-risk tolerance adopt aggressive strategies to maximise returns over time. The primary goal of taking this approach is to create wealth, so this strategy is more suited to younger investors who have a longer investment horizon. These investors are willing to accept higher levels of volatility and risk in exchange for the potential of greater long-term gains, so they invest heavily in equities.
Moderate Strategy
Individuals with a moderate risk appetite build portfolios that strike a balance between growth potential and risk management. These investors take a balanced approach to asset allocation and generally diversify their investments across a mix of asset classes. This helps them achieve steady growth while also reducing risk.
Tax-Efficient Strategy
This strategy is generally favoured by investors in the highest tax bracket and young investors. The main aim of this strategy is to minimise tax liabilities by investing in vehicles such as the Public Provident Fund (PPF), ELSS, and Unit Linked Insurance Plans (ULIP). A key aspect of this approach is ensuring that investing doesn’t just help save tax but also contributes to overall financial growth and wealth accumulation.
Income Oriented Strategy
The aim of this strategy is to generate a steady income from investments. This is particularly used by retirees, as they may not get a reliable paycheck every month. Income can be generated through dividends from stocks, or by investing in government schemes such as Senior Citizen Saving Scheme (SCSS) and Pradhan Mantri Vaya Vandana Yojana (PMVVY). These schemes help investors secure a regular income stream while also preserving their capital.
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