TYPES OF PORTFOLIO MANAGEMENT

There are various types of portfolio management:

Investment Management
It Portfolio Management
Project Portfolio Management

1. INVESMENT MANAGEMENT:

Investment management is the professional management of various securities (shares, bonds

etc.) and assets (e.g., real estate), to meet specified investment goals for the benefit of the
investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or
private investors (both directly via investment contracts and more commonly via collective
investment schemes e.g. mutual funds or Exchange Traded Funds).

The term asset management is often used to refer to the investment management of collective
investments,(not necessarily) whilst the more generic fund management may refer to all forms of
institutional investment as well as investment management for private investors. Investment
managers who specialize in advisory or discretionary management on behalf of (normally
wealthy) private investors may often refer to their services as wealth management or portfolio
management often within the context of so-called "private banking". Fund manager (or
investment adviser in the U.S.) refers to both a firm that provides investment management
services and an individual who directs fund management decisions.

2. IT PORTFOLIO MANAGEMENT :

IT portfolio management is the application of systematic management to large classes of items

managed by enterprise Information Technology (IT) capabilities. Examples of IT portfolios would
be planned initiatives, projects, and ongoing IT services (such as application support). The

promise of IT portfolio management is the quantification of previously mysterious IT efforts,

enabling measurement and objective evaluation of investment scenarios.

The concept is analogous to financial portfolio management, but there are significant differences.
IT investments are not liquid, like stocks and bonds (although investment portfolios may also
include illiquid assets), and are measured using both financial and non-financial yardsticks (for
example, a balanced scorecard approach); a purely financial view is not sufficient.

At its most mature, IT Portfolio management is accomplished through the creation of two
portfolios:

Application Portfolio - Management of this portfolio focuses on comparing spending on

established systems based upon their relative value to the organization. The comparison can be
based upon the level of contribution in terms of IT investments profitability. Additionally, this
comparison can also be based upon the non-tangible factors such as organizations level of

experience with a certain technology, users familiarity with the applications and infrastructure,
and external forces such as emergence of new technologies and obsolesce of old ones.

Project Portfolio - This type of portfolio management specially address the issues with spending
on the development of innovative capabilities in terms of potential ROI and reducing investment
overlaps in situations where reorganization or acquisition occurs. The management issues with the
second type of portfolio management can be judged in terms of data cleanliness, maintenance
savings, suitability of resulting solution and the relative value of new investments to replace these
projects.

3. PROJECT PORTFOLIO MANAGEMENT:

Project portfolio management organizes a series of projects into a single portfolio consisting of
reports that capture project objectives, costs, timelines, accomplishments, resources, risks and
other critical factors. Executives can then regularly review entire portfolios, spread resources
appropriately and adjust projects to produce the highest departmental returns.

Project management is the discipline of planning, organizing and managing resources to bring
about the successful completion of specific project goals and objectives.

A project is a finite endeavor (having specific start and completion dates) undertaken to create a
unique product or service which brings about beneficial change or added value. This finite
characteristic of projects stands in contrast to processes, or operations, which are permanent or
semi-permanent functional work to repetitively produce the same product or service. In practice,
the management of these two systems is often found to be quite different, and as such requires the
development of distinct technical skills and the adoption of separate management.

PORTFOLIO MANAGEMENT PROCESS

(A) THERE ARE THREE MAJOR ACTIVITIES INVOLVED IN AN EFFICIENT

PORTFOLIO MANAGEMENT WHICH ARE AS FOLLOWS:-

Identification of assets or securities, allocation of investment and also identifying the classes of
assets for the purpose of investment.

They have to decide the major weights, proportion of different assets in the portfolio by taking in
to consideration the related risk factors.

Finally they select the security within the asset classes as identify.

The above activities are directed to achieve the sole purpose of maximizing return and minimizing
risk on investment.

It is well known fact that portfolio manager balances the risk and return in a portfolio investment.
With higher risk higher return may be expected and vice versa.

(B) INVESTMENT DECISION:

Given a certain sum of funds, the investment decisions basically depend upon the following
factors:-

I. Objectives of Investment Portfolio: This is a crucial point which a Finance Manager must
consider. There can be many objectives of making an investment. The manager of a provident
fund portfolio has to look for security and may be satisfied with none too high a return, where as
an aggressive investment company be willing to take high risk in order to have high capital
appreciation.

How the objectives can affect in investment decision can be seen from the fact that the Unit Trust
of India has two major schemes : Its capital units are meant for those who wish to have a good
capital appreciation and a moderate return, where as the ordinary unit are meant to provide a
steady return only. The investment manager under both the scheme will invest the money of the

Trust in different kinds of shares and securities. So it is obvious that the objectives must be clearly
defined before an investment decision is taken.

Selection of Investment: Having defined the objectives of the investment, the next decision is to
decide the kind of investment to be selected. The decision what to buy has to be seen in the
context of the following:-

There is a wide variety of investments available in market i.e. Equity shares, preference share,
debentures, convertible bond, Govt. securities and bond, capital units etc. Out of these what types
of securities to be purchased.

What should be the proportion of investment in fixed interest dividend securities and variable
dividend bearing securities? The fixed one ensures a definite return and thus a lower risk but the
return is usually not as higher as that from the variable dividend bearing shares.

C) If the investment is decided in shares or debentures, then the industries showing a potential in
growth should be taken in first line. Industry-wise-analysis is important since various industries
are not at the same level from the investment point of view. It is important to recognize that at a
particular point of time, a particular industry may have a better growth potential than other
industries. For example, there was a time when jute industry was in great favour because of its
growth potential and high profitability, the industry is no longer at this point of time as a growth
oriented industry.

Once industries with high growth potential have been identified, the next step is to select the
particular companies, in whose shares or securities investments are to be made.

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FUNDAMENTAL ANALYSIS:

(A)FUNDAMENTAL ANALYSIS OF GROWTH ORIENTED COMPANIES:

One of the first decisions that an investment manager faces is to identify the industries which
have a high growth potential. Two approaches are suggested in this regard. They are:

a) Statistical Analysis of Past Performance:

A statistical analysis of the immediate past performance of the share price indices of various
industries and changes there in related to the general price index of shares of all industries should
be made. The Reserve Bank of India index numbers of security prices published every month in
its bulletin may be taken to represent the behaviour of share prices of various industries in the
last few years. The related changes in the price index of each industry as compared with the
changes in the average price index of the shares of all industries would show those industries
which are having a higher growth potential in the past few years. It may be noted that an Industry
may not be remaining a growth Industry for all the time. So he shall now have to make an
assessment of the various Industries keeping in view the present potentiality also to finalize the
list of Industries in which he will try to spread his investment.

b) Assessing the Intrinsic Value of an Industry/Company:

After an investment manager has identified statistically the industries in the share of which the
investors show interest, he would assess the various factors which influence the value of a
particular share. These factors generally relate to the strengths and weaknesses of the company
under consideration, Characteristics of the industry within which the company fails and the
national and international economic scene. It is the job of the investment manager to examine
and weigh the various factors and judge the quality of the share or the security under
consideration. This approach is known as the intrinsic value approach.

The major objective of the analysis is to determine the relative quality and the quantity of the
security and to decide whether or not is security is good at current markets prices. In this, both
qualitative and quantitative factors are to be considered.

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INDUSTRY ANALYSIS

First of all, an assessment will have to be made regarding all the conditions and factors relating
to demand of the particular product, cost structure of the industry and other economic and
Government constraints on the same. As we have discussed earlier, an appraisal of the particular
industrys prospect is essential and the basic profitability of any company is dependent upon the
economic prospect of the industry to which it belongs. The following factors may particularly be
kept in mind while assessing to factors relating to an industry.

Demand and Supply Pattern for the Industries Products and Its Growth Potential:

The main important aspect is to see the likely demand of the products of the industry and the gap
between demand and supply. This would reflect the future growth prospects of the industry. In
order to know the future volume and the value of the output in the next ten years or so, the
investment manager will have to rely on the various demand forecasts made by various agencies
like the planning commission, Chambers of Commerce and institutions like NCAER, etc.

The management expert identifies fives stages in the life of an industry. These are Introduction,
development, rapid growth, maturity and decline. If an industry has already reached the
maturity or decline stage, its future demand potential is not likely to be high.

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Profitability: It is a vital consideration for the investors as profit is the measure of performance
and a source of earning for him. So the cost structure of the industry as related to its sale price is
an important consideration. In India there are many industries which have a growth potential on
account of good demand position. The other point to be considered is the ratio analysis, especially
return on investment, gross profit and net profit ratio of the existing companies in the industry.
This would give him an idea about the profitability of the industry as a whole.

Particular Characteristics of the Industry: Each industry has its own characteristics, which
must be studied in depth in order to understand their impact on the working of the industry.
Because the industry having a fast changing technology become obsolete at a faster rate.
Similarly, many industries are characterized by high rate of profits and losses in alternate years.
Such fluctuations in earnings must be carefully examined.

Labour Management Relations in the Industry: The state of labour-management relationship

in the particular industry also has a great deal of influence on the future profitability of the
industry. The investment manager should, therefore, see whether the industry under analysis has
been maintaining a cordial relationship between labour and management.

Once the industrys characteristics have been analyzed and certain industries with growth
potential identified, the next stage would be to undertake and analyze all the factors which show
the desirability of various companies within an industry group from investment point of view.

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COMPANY ANALYSIS:

To select a company for investment purpose a number of qualitative factors have to be seen.
Before purchasing the shares of the company, relevant information must be collected and
properly analyzed. An illustrative list of factors which help the analyst in taking the
investment decision is given below. However, it must be emphasized that the past performance
and information is relevant only to the extent it indicates the future trends. Hence, the investment
manager has to visualize the performance of the company in future by analyzing its past
performance.

Size and Ranking: A rough idea regarding the size and ranking of the company within the
economy, in general, and the industry, in particular, would help the investment manager in
assessing the risk associated with the company. In this regard the net capital employed, the net
profits, the return on investment and the sales volume of the company under consideration may
be compared with similar data of other company in the same industry group. It may also be
useful to assess the position of the company in terms of technical knowhow, research and
development activity and price leadership.

Growth Record: The growth in sales, net income, net capital employed and earnings per share
of the company in the past few years must be examined. The following three growth indicators
may be particularly looked in to (a) Price earnings ratio, (b) Percentage growth rate of earnings
per annum and (c) Percentage growth rate of net block of the company. The price earnings ratio
is an important indicator for the investment manager since it shows the number the times the
earnings per share are covered by the market price of a share. Theoretically, this ratio should be
same for two companies with similar features. However, this is not so in practice due to many
factors. Hence, by a comparison of this ratio pertaining to different companies the investment
manager can have an idea about the image of the company and can determine whether the share
is under-priced or over-priced. An evaluation of future growth prospects of the company should
be carefully made. This requires the analysis of the existing capacities and their utilization,
proposed expansion and diversification plans and the nature of the companys technology.

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The existing capacity utilization levels can be known from the quantitative information given in
the published profit and loss accounts of the company. The plans of the company, in terms of
expansion or diversification, can be known from the directors reports the chairmans statements
and from the future capital commitments as shown by way of notes in the balance sheets. The
nature of technology of a company should be seen with reference to technological developments
in the concerned fields, the possibility of its product being superseded of the possibility of
emergence of more effective method of manufacturing.

Growth is the single most important factor in company analysis for the purpose of investment
management. A company may have a good record of profits and performance in the past; but if it
does not have growth potential, its shares cannot be rated high from the investment point of view.

FINANCIAL ANALYSIS:

An analysis of financial for the past few years would help the investment manager in
understanding the financial solvency and liquidity, the efficiency with which the funds are used,
the profitability, the operating efficiency and operating leverages of the company. For this
purpose certain fundamental ratios have to be calculated.

From the investment point of view, the most important figures are earnings per share, price
earnings ratios, yield, book value and the intrinsic value of the share. The five elements may be
calculated for the past ten years or so and compared with similar ratios computed from the
financial accounts of other companies in the industry and with the average ratios of the industry
as a whole. The yield and the asset backing of a share are important considerations in a decision
regarding whether the particular market price of the share is proper or not.

Various other ratios to measure profitability, operating efficiency and turnover efficiency of the
company may also be calculated. The return on owners investment, capital turnover ratio and
the cost structure ratios may also be worked out. To examine the financial solvency or liquidity
of the company, the investment manager may work out current ratio, liquidity ratio, debt equity

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ratio, etc. These ratios will provide an overall view of the company to the investment analyst. He
can analyze its strengths and weakness and see whether it is worth the risk or not.

Quality of Management: This is an intangible factor. Yet it has a very important bearing on the
value of the shares. Every investment manager knows that the shares of certain business houses
command a higher premium than those of similar companies managed by other business houses.
This is because of the quality of management, the confidence that the investors have in a
particular business house, its policy vis--vis its relationship with the investors, dividend and
financial performance record of other companies in the same group, etc.

This is perhaps the reason that an investment manager always gives a close look to the
management of the company whose shares he is to invest. Quality of management has to be seen
with reference to the experience, skill and integrity of the persons at the helm of the affairs of the
company. The policy of the management regarding relationship with the share holders is an
important factor since certain business houses believe in generous dividend and bonus
distributions while others are rather conservative.

Location and labour management relations: The locations of the companys manufacturing
facilities determine its economic viability which depends on the availability of crucial inputs like
power, skilled labour and raw materials etc. Nearness to market is also a factor to be considered.
In the past few years, the investment manager has begun looking into the state of labour
management relations in the company under consideration and the area where it is located.

Pattern of Existing Stock Holding: An analysis of the pattern of the existing stock holdings of
the company would also be relevant. This would show the stake of various parties associated with
the company. An interesting case in this regard is that of the Punjab National Bank in which the
L.I.C. and other financial institutions had substantial holdings. When the bank was nationalized,
the residual company proposed a scheme whereby those shareholders, who wish to opt out, could
receive a certain amount as compensation in cash.

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It was only at the instant and bargaining strength of institutional investors that the compensation
offered to the shareholders, who wish to opt out of the company, was raised considerably.

Marketability of the Shares: Another important consideration for an investment manager is the
marketability of the shares of the company. Mere listing of the share on the stock exchange does
not automatically mean that the share can be sold or purchased at will. There are many shares
which remain inactive for long periods with no transactions being affected.

To purchase or sell such scrips is a difficult task. In this regard, dispersal of share holding with
special reference to the extent of public holding should be seen. The other relevant factors are the
speculative interest in the particular scrip, the particular stock exchange where it is traded and the
volume of trading.

Fundamental analysis thus is basically an examination of the economics and financial aspects of a
company with the aim of estimating future earnings and dividend prospect. It included an analysis
of the macro economic and political factors which will have an impact on the performance of the
firm. After having analyzed all the relevant information about the company and its relative
strength vis--vis other firm in the industry, the investor is expected to decide whether he should
buy or sell the securities.

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TIMING OF PURCHASES:-

The timing of dealings in the securities, specially shares is of crucial importance, because after
correctly identifying the companies one may lose money if the timing is bad due to wide
fluctuation in the price of shares of that companies.

The decision regarding timing of purchases is particularly difficult because of certain

psychological factors. It is obvious that if a person wishes to make any gains, he should buy
cheap and sell dear, i.e. buy when the share are selling at a low price and sell when they are at a
higher price. But in practical it is a difficult task.

When the prices are rising in the market i.e. there is bull phase, everybody joins in buying
without any delay because every day the prices touch a new high. Later when the bear face starts,
prices tumble down every day and everybody starts counting the losses. The ordinary investor
regretted such situation by thinking why he did not sell his shares in previous day and ultimately
sell at a lower price. This kind of investment decision is entirely devoid of any sense of timing.

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In short we can conclude by saying that Investment management is a complex activity which
may be broken down into the following steps:

Specification Of Investment Objectives And Constraints:

The typical objectives sought by investors are current income, capital appreciation, and safety of
principle. The relative importance of these objectives should be specified further the constraints
arising from liquidity, time horizon, tax and special circumstances must be identified.

2) Choice Of The Asset Mix :

The most important decision in portfolio management is the asset mix decision very broadly; this
is concerned with the proportions of stocks (equity shares and units/shares of equity-oriented
mutual funds) and bonds in the portfolio.

The appropriate stock-bond mix depends mainly on the risk tolerance and investment horizon of
the investor.

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ELEMENTS OF PORTFOLIO MANAGEMENT:

Portfolio management is on-going process involving the following basic tasks:

Identification of the investors objectives, constraints and preferences.

Strategies are to be developed and implemented in tune with investment policy formulated.

Review and monitoring of the performance of the portfolio.

Finally the evaluation of the portfolio

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Techniques Of Portfolio Management:

As of now the under noted technique of portfolio management: are in vogue in our country.

1) Equity Portfolio: It is influenced by internal and external factors the internal factors affect the
inner working of the companys growth plans are analyzed with referenced to Balance sheet,
profit & loss a/c (account) of the company.

Among the external factor are changes in the government policies, Trade cycles, Political
stability etc.

2) Equity Stock Analysis: Under this method the probable future value of a share of a company is
determined it can be done by ratios of earning per share of the company and price earnings ratio

EARNING PER SHARE = _ PROFIT AFTER TAX__

NO. OF EQUITY SHARES

PRICE EARNING RATIO = _MARKET PRICE (PER SHARE)_

EARNING PER SHARE

One can estimate trend of earning by EPS, which reflects trends of earning quality of company,
dividend policy, and quality of management.

Price Earnings ratio indicate a confidence of market about the company future, a high rating is
preferable.

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The following points must be considered by portfolio managers while analyzing the
securities.

Nature of the industry and its product: Long term trends of industries, competition within, and
outside the industry, Technical changes, labour relations, sensitivity, to Trade cycle.

Industrial analysis of prospective earnings, cash flows, working capital, dividends, etc.

Ratio analysis: Ratios such as debt equity ratio, current ratio, net worth, profit earnings ratio,
returns on investment, are worked out to decide the portfolio.

The wise principle of portfolio management suggests that Buy when the market is low or

BEARISH, and sell when the market is rising or BULLISH.

Stock market operation can be analyzed by:

Fundamental approach: - Based on intrinsic value of shares.

Technical approach: - Based on Dow Jones Theory, Random Walk Theory, etc.

Prices are based upon demand and supply of the market.

Objectives are maximization of wealth and minimization of risk. Diversification reduces risk and
volatility.

Variable returns, high illiquidity; etc.

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CHAPTER - 4

RISK RETURN ANALYSIS

RISK ON PORTFOLIO :

The expected returns from individual securities carry some degree of risk. Risk on the portfolio is
different from the risk on individual securities. The risk is reflected in the variability of the returns
from zero to infinity. Risk of the individual assets or a portfolio is measured by the variance of its
return. The expected return depends on the probability of the returns and their weighted
contribution to the risk of the portfolio. These are two measures of risk in this context one is the
absolute deviation and other standard deviation.

Most investors invest in a portfolio of assets, because as to spread risk by not putting all eggs in
one basket. Hence, what really matters to them is not the risk and return of stocks in isolation, but
the risk and return of the portfolio as a whole. Risk is mainly reduced by Diversification.

Following are the some of the types of Risk:

1) Interest Rate Risk: This arises due to the variability in the interest rates from time to time. A
change in the interest rate establishes an inverse relationship in the price of the security i.e. price
of the security tends to move inversely with change in rate of interest, long term securities show
greater variability in the price with respect to interest rate changes than short term securities.

Interest rate risk vulnerability for different securities is as under:

TYPES
RISK EXTENT

Cash Equivalent
Less vulnerable to interest rate risk.
Long Term Bonds
More vulnerable to interest rate risk.

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Purchasing Power Risk: It is also known as inflation risk also emanates from the very fact
that inflation affects the purchasing power adversely. Nominal return contains both the real
return component and an inflation premium in a transaction involving risk of the above type to
compensate for inflation over an investment holding period. Inflation rates vary over time and
investors are caught unaware when rate of inflation changes unexpectedly causing erosion in
the value of realized rate of return and expected return.

Purchasing power risk is more in inflationary conditions especially in respect of bonds and
fixed income securities. It is not desirable to invest in such securities during inflationary
periods. Purchasing power risk is however, less in flexible income securities like equity shares
or common stock where rise in dividend income off-sets increase in the rate of inflation and
provides advantage of capital gains.

Business Risk: Business risk emanates from sale and purchase of securities affected by
business cycles, technological changes etc. Business cycles affect all types of securities i.e.
there is cheerful movement in boom due to bullish trend in stock prices whereas bearish trend
in depression brings down fall in the prices of all types of securities during depression due to
decline in their market price.

Financial Risk: It arises due to changes in the capital structure of the company. It is also
known as leveraged risk and expressed in terms of debt-equity ratio. Excess of risk vis--vis
equity in the capital structure indicates that the company is highly geared. Although a
leveraged companys earnings per share are more but dependence on borrowings exposes it to
risk of winding up for its inability to honor its commitments towards lender or creditors. The
risk is known as leveraged or financial risk of which investors should be aware and portfolio
managers should be very careful.

Systematic Risk or Market Related Risk: Systematic risks affected from the entire market
are (the problems, raw material availability, tax policy or government

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policy, inflation risk, interest risk and financial risk). It is managed by the use of Beta of different
company shares.

Unsystematic Risks: The unsystematic risks are mismanagement, increasing inventory, wrong
financial policy, defective marketing etc. this is diversifiable or avoidable because it is possible to
eliminate or diversify away this component of risk to a considerable extent by investing in a large
portfolio of securities. The unsystematic risk stems from inefficiency magnitude of those factors
different form one company to another.

RISK RETURN ANALYSIS:

All investment has some risk. Investment in shares of companies has its own risk or uncertainty;
these risks arise out of variability of yields and uncertainty of appreciation or depreciation of
share prices, losses of liquidity etc

The risk over time can be represented by the variance of the returns while the return over time
is capital appreciation plus payout, divided by the purchase price of the share.

Normally, the higher the risk that the investor takes, the higher is the return. There is, however, a
risk less return on capital of about 12% which is the bank, rate charged by the R.B.I or long term,
yielded on government securities at around 13% to 14%. This risk less return refers to lack of
variability of return and no uncertainty in the repayment or capital. But other risks such
41

as loss of liquidity due to parting with money etc., may however remain, but are rewarded by the
total return on the capital.

Risk-return is subject to variation and the objectives of the portfolio manager are to reduce that
variability and thus reduce the risk by choosing an appropriate portfolio.

Traditional approach advocates that one security holds the better, it is according to the modern
approach diversification should not be quantity that should be related to the quality of scripts
which leads to quality of portfolio.

Experience has shown that beyond the certain securities by adding more securities expensive.

RETURNS ON PORTFOLIO:

Each security in a portfolio contributes return in the proportion of its investments in security. Thus
the portfolio expected return is the weighted average of the expected return, from each of the
securities, with weights representing the proportions share of the security in the total investment.
Why does an investor have so many securities in his portfolio? If the security ABC gives the
maximum return why not he invests in that security all his funds and thus maximize return? The
answer to this questions lie in the investors perception of risk attached to investments, his
objectives of income, safety, appreciation, liquidity and hedge against loss of value of money etc.
this pattern of investment in different asset categories, types of investment, etc., would all be
described under the caption of diversification, which aims at the reduction or even elimination of
non-systematic risks and achieve the specific objectives of investors.

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CHAPTER: 5

PORTFOLIO THEORIES

I. DOW JONES THEORY:

The DOW JONES THEORY is probably the most popular theory regarding the behavior of stock
market prices. The theory derives its name from Charles H. Dow, who established the Dow Jones
& Co. and was the first editor of the Wall Street Journal a leading publication on financial and
economic matters in the U.S.A. Although Dow never gave a proper shape to the theory, ideas
have been expanded and articulated by many of his successors.

The Dow Jones theory classifies the movement of the prices on the share market into three major
categories:

Primary Movements,

Secondary Movements and

Daily Fluctuations.

Primary Movements: They reflect the trend of the stock market and last from one year to three
years, or sometimes even more. If the long range behavior of market prices is seen, it will be
observed that the share markets go through definite phases where the prices are consistently rising
or falling. These phases are known as bull and bear phases.

P3

P2

P1

T3

T2

T1

Graph 1

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During a bull phase, the basic trend is that of rise in prices. Graph 1 above shows the behavior
of stock market prices in bull phase.

You would notice from the graph that although the prices fall after each rise, the basic trend is
that of rising prices. As can be seen from the graph that each trough prices reach, is at a
higher level than the earlier one. Similarly, each peak that the prices reach is on a higher level
than the earlier one. Thus P2 is higher than P1 and T2 is higher than T1. This means that
prices do not rise consistently even in a bull phase. They rise for some time and after each rise,
they fall. However, the falls are of a lower magnitude then earlier. As a result, prices reach
higher levels with each rise.

Once the prices have risen very high, the bear phase in bound to start i.e., price will start
falling. Graph 2 shows the typical behavior of prices on the stock exchange in the case of a

P3

P2

T1

P1

T2

T3

Graph 2

Bear phase. It would be seen that prices are not falling consistently and, after each fall, there is
a rise in prices. However, the rise is not much as to take the prices higher than the previous
peak. It means that each peak and trough is now lower than the previous peak and trough.

The theory argues that primary movements indicate basic trends in the market. It states that if
cyclical swings of stock market prices indices are successively higher, the market trend is up
and there is a bull market. On the contrary, if successive highs and low are successively lower,
the market is on a downward trend and we are in bear market. This

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theory thus relies upon a behavior of the indices of share market prices in perceiving the trend in
the market.

Secondary Movements: We have seen that even when the primary trend is upward, there are
also downward movements of prices. Similarly, even where the primary trend is downward, there
is upward movement of prices also. These movements are known as secondary movements and
are shorter in duration and are opposite in direction to the primary movements. These movements
normally last from three weeks to three months and retrace 1/3 to 2/3 of the previous advance in
a bull market of previous fall in the bear market.

Daily Movements: There are irregular fluctuations which occur every day in the market. These
fluctuations are without any definite trend. Thus is the daily share market price index for a few
months are plotted on the graph it will show both upward and downward fluctuations. These
fluctuations are the result of speculative factor. An investment manger really is not interested in
the short run fluctuations in share prices since he is not a speculator. It may be reiterated that
anyone who tries to gain from short run fluctuations in the stock market, can make money only
be sheer chance. The investment manager should scrupulously keep away from the daily
fluctuations of the market. He is not a speculator and should always resist the temptation of
speculating. Such a temptation is always very attractive but must always be resisted. Speculation
is beyond the scope of the job of an investment manager.

Timing of investment decisions on the basis of Dow Jones Theory:

Ideally speaking the investment manage would like to purchase shares at a time when they have
reached the lowest trough and sell them at a time when they reach the highest peak. However, in
practice, this seldom happens. Even the most astute investment manager can never know when
the highest peak or the lowest through have been reached. Therefore, he has to time his decision
in such a manner that he buys the shares when they are on the rise and sells then when they are

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on the fall. It means that he should be able to identify exactly when the falling or the rising trend
has begun.

This is technically known as identification of the turn in the share market prices. Identification of
this turn is difficult in practice because of the fact that, even in a rising market, prices keep on
falling as a part of the secondary movement. Similarly even in a falling market prices keep on
rising temporarily. How to be certain that the rise in prices or fall in the same in due to a real turn
in prices from a bullish to a bearish phase or vice versa or that it is due only to short run
speculative trends?

Dow Jones Theory identifies the turn in the market prices by seeing whether the successive peaks
and troughs are higher or lower than earlier.

II. RANDOM WALK THEORY:

The first specification of efficient markets and their relationship to the randomness of prices for
things traded in the market goes to Samuelson and Mandelbrot. Samuelson has proved in

1965 that if a market has zero transaction costs, if all available information is free to all
interested parties, and if all market participants and potential participants have the same
horizons and expectations about prices, the market will be efficient and prices will fluctuate
randomly.

According to the Random Walk Theory, the changes in prices of stock show independent behavior
and are dependent on the new pieces of information that are received but within themselves are
independent of each other. Whenever a new price of information is received in the stock market,
the market independently receives this information and it is independent and separate from all the
other prices of information. For example, a stock is selling at Rs. 40 based on existing
information known to all investors. Afterwards, the news of a strike in that company will bring

down the stock price to Rs. 30 the next day. The stock price further goes down to Rs. 25. Thus,
the first fall in stock price from Rs. 40 to Rs. 30 is caused because of some information about the
strike. But the second fall in the price of a stock from Rs. 30 to Rs. 25 is due to additional
information on the type of strike. Therefore, each price change is independent of the

46

other because each information has been taken in, by the stock market and separately
disseminated. However, independent pieces of information, when they come together
immediately after each other show that the price is falling but each price fall is independent of the
other price fall.

The basic essential fact of the Random Walk Theory is that the information on stock prices is
immediately and fully spread over that other investors have full knowledge of the information.
The response makes the movement of prices independent of each other. Thus, it may be said that
the prices have an independent nature and therefore, the price of each day is different. The theory
further states that the financial markets are so competitive that there is immediate price
adjustment. It is due to the effective communication system through which information can be
disturbed almost anywhere in the country. This speed of information determines the efficiency of
the market.

III.
CAPITAL ASSETS PRICING MODEL (CAPM): CAPM provides a conceptual
framework for evaluating any investment decision. It is used to estimate the expected return of
any portfolio with the following formula:

E (Rp) = Rf +Bp (E( Rm) Rf )

Where,

E(Rp)
=
Expected return of the portfolio
Rf
= Risk free rate of return
Bp
=

Beta portfolio i.e. market sensitivity index

E(Rm)
=
Expected return on market portfolio
[E(Rm)-Rf]
=
Market risk premium

The above model of portfolio management can be used effectively to:-

47

Estimate the required rate of return to investors on companys common stock.

Evaluate risky investment projects involving real Assets.

Explain why the use of borrowed fund increases the risk and increases the rate of return.

Reduce the risk of the firm by diversifying its project portfolio.

IV.
MOVING AVERAGE: It refers to the mean of the closing price which changes
constantly and moves ahead in time, there by encompasses the most recent days and deletes
the old one.

V.
MODERN PORTFOLIO THEORY: Modern Portfolio Theory quantifies the
relationship between risk and return and assumes that an investor must be compensated for
assuming risk. It believes in the maximization of return through a combination of securities.
The theory states that by combining securities of low risks with securities of high risks
success can be achieved in making a choice of investments. There can be various
combinations of securities. The modern theory points out that the risk of portfolio can be
reduced by diversification. Harry Markowitz and William Sharpe have developed this
theory.

VI.
MARKOWITZ THEORY: Markowitz has suggested a systematic search for
optimal portfolio. According to him, the portfolio manager has to make probabilistic
estimates of the future performances of the securities and analyse these estimates to
determine an efficient set of portfolios. Then the optimum set of portfolio can be selected in
order to suit the needs of the investors. The following are the assumptions of Markowitz
Theory:

48

Investors make decisions on the basis of expected utility maximization.

In an efficient market, all investors react with full facts about all securities in the market.

Investors utility is the function of risk and return on securities.

The security returns are co-related to each other by combining the different securities.

The combination of securities is made in such a way that the investor gets maximum return with
minimum of risk.

An efficient portfolio exists, when there is lowest level of risk for a specified level of expected
return and highest expected return for a specified amount of portfolio risk.

The risk of portfolio can be reduced by adding investments in the portfolio.

VII. SHARPES THEORY: William Sharpe has suggested a simplified method of

diversification of portfolios. He has made the estimates of the expected return and variance of
indexes which are related to economic activity. Sharpes Theory assumes that securities returns
are related to each other only through common relationships with basic underlying factor i.e.
market return index. Individual securities return is determined solely by random factors and on
its relationship to this underlying factor with the following formula:

Ri = ai + Bi I + ei

Where, Ri refers to expected return on security

ai = the intercept of a straight line or alpha coefficient

Bi = slope of straight-line or beta coefficient

I = level of market return index

ei = error, i.e. residual risk of the company.

49

RULES TO BE FOLLOWED BEFORE INVESTMENT IN PORTFOLIOS

Compile the financials of the companies in the immediate past 3 years such as turnover, gross
profit, net profit before tax, compare the profit earning of company with that of the industry
average nature of product manufacture service render and it future demand ,know about the
promoters and their back ground, dividend track record, bonus shares in the past 3 to 5 years
,reflects companys commitment to share holders the relevant information can be accessed from
the RDC (Registrant of Companies) published financial results financed quarters, journals and
ledgers.

Watch out the highs and lows of the scripts for the past 2 to 3 years and their timing cyclical
scripts have a tendency to repeat their performance, this hypothesis can be true of all other
financial,

The higher the trading volume higher is liquidity and still higher the chance of speculation, it is
futile to invest in such shares whos daily movements cannot be kept track, if you want to reap
rich returns keep investment over along horizon and it will offset the wild intraday trading
fluctuations, the minor movement of scripts may be ignored, we must remember that share
market moves in phases and the span of each phase is 6 months to 5 years.

50

CHAPTER 6

PERSONS INVOLVED IN PORTFOLIO MANAGEMENT

INVESTOR:

Are the people who are interested in investing their funds?

PORTFOLIO MANAGERS:

Is a person who is in the wake of a contract agreement with a client, advices or directs or
undertakes on behalf of the clients, the management or distribution or management of the funds of
the client as the case may be.

DISCRETIONARY PORTFOLIO MANAGER:

Means a manager who exercise under a contract relating to a portfolio management exercise any
degree of discretion as to the investment or management of portfolio or securities or funds of
clients as the case may be. The relationship between an investor and portfolio manager is of a
highly interactive nature.

The portfolio manager carries out all the transactions pertaining to the investor under the power of
attorney during the last two decades, and increasing complexity was witnessed in the capital
market and its trading procedures in this context a key (uninformed) investor formed ) investor
found himself in a tricky situation , to keep track of market movement ,update his knowledge, yet
stay in the capital market and make money , therefore in looked forward to resuming help from
portfolio manager to do the job for him . The portfolio management seeks to strike a balance
between risks and return.

The generally rule in that greater risk more of the profits but S.E.B.I. in its guidelines prohibits
portfolio managers to promise any return to investor.

Portfolio management is not a substitute to the inherent risks associated with equity investment.

51

WHO CAN BE A PORTFOLIO MANAGER?

Only those who are registered and pay the required license fee are eligible to operate as portfolio
managers. An applicant for this purpose should have necessary infrastructure with professionally
qualified persons and with a minimum of two persons with experience in this business and a
minimum net worth of Rs. 50lakhs. The certificate once granted is valid for three years. Fees
payable for registration are Rs 2.5lakhs every for two years and Rs.1lakhs for the third year.
From the fourth year onwards, renewal fees per annum are Rs 75000. These are subjected to
change by the S.E.B.I.

The S.E.B.I. has imposed a number of obligations and a code of conduct on them. The portfolio
manager should have a high standard of integrity, honesty and should not have been convicted of
any economic offence or moral turpitude. He should not resort to rigging up of prices, insider
trading or creating false markets, etc. their books of accounts are subject to inspection to
inspection and audit by S.E.B.I... The observance of the code of conduct and guidelines given by
the S.E.B.I. are subject to inspection and penalties for violation are imposed. The manager has to
submit periodical returns and documents as may be required by the SEBI from time-to- time.

52

FUNCTIONS OF PORTFOLIO MANAGERS:

Advisory role: Advice new investments, review the existing ones, identification of objectives,
recommending high yield securities etc.

Conducting market and economic service: This is essential for recommending good yielding
securities they have to study the current fiscal policy, budget proposal; individual policies etc
further portfolio manager should take in to account the credit policy, industrial growth, foreign
exchange possible change in corporate laws etc.

Financial analysis: He should evaluate the financial statement of company in order to

understand, their net worth future earnings, prospectus and strength.

Study of stock market : He should observe the trends at various stock exchange and analysis
scripts so that he is able to identify the right securities for investment

Study of industry: He should study the industry to know its future prospects, technical changes
etc, required for investment proposal he should also see the problems of the industry.

Decide the type of port folio: Keeping in mind the objectives of portfolio a portfolio manager
has to decide whether the portfolio should comprise equity preference shares, debentures,
convertibles, non-convertibles or partly convertibles, money market, securities etc or a mix of
more than one type of proper mix ensures higher safety, yield and liquidity coupled with balanced
risk techniques of portfolio management.

A portfolio manager in the Indian context has been Brokers (Big brokers) who on the basis of
their experience, market trends, Insider trader, helps the limited knowledge persons.

The ones who use to manage the funds of portfolio, now being managed by the portfolio of
Merchant Banks, professionals like MBAs CAs And many financial institutions have entered
the market in a big way to manage portfolio for their clients.

According to S.E.B.I. rules it is mandatory for portfolio managers to get them selfs registered.

Registered merchant bankers can acts as portfolio managers. Investors must look forward, for
qualification and performance and ability and research base of the portfolio managers.

53

NEED AND ROLE OF PORTFOLIO MANAGER:

With the development of Indian Securities market and with appreciation in market price of equity
share of profit making companies, investment in the securities of such companies has become
quite attractive. At the same time, the stock market becoming volatile on account of various facts,
a layman is puzzled as to how to make his investments without losing the same. He has felt the
need of an expert guidance in this respect. Similarly non resident Indians are eager to make their
investments in Indian companies. They have also to comply with the conditions specified by the
RESERVE BANK OF INDIA under various schemes for investment by the non residents. The
portfolio manager with his background and expertise meets the needs of such investors by
rendering service in helping them to invest their fund/s profitably.

PORTFOLIO MANAGERS OBLIGATION:

The portfolio manager has number of obligations towards his clients, some of them are:

He shall transact in securities within the limit placed by the client himself with regard to dealing
in securities under the provisions of Reserve Bank of India Act, 1934.

He shall not derive any direct or indirect benefit out of the clients funds or securities.

He shall not pledge or give on loan securities held on behalf of his client to a third person without
obtaining a written permission from such clients.

While dealing with his clients funds, he shall not indulge in speculative transactions.

He may hold the securities in the portfolio account in his own name on behalf of his clients only
if the contract so provides. In such a case, his records and his report to his clients should clearly
indicate that such securities are held by him on behalf of his client.

He shall deploy the money received from his client for an investment purpose as soon as possible
for that purpose.

He shall pay the money due and payable to a client forthwith. He shall not place his interest above
those of his clients.

He shall not disclose to any person or any confidential information about his client, which has
come to his knowledge.

54

He shall endeavor to:

o Ensure that the investors are provided with true and adequate information without making any
misguiding or exaggerated claims.

o Ensure that the investors are made aware of the attendant risks before any investment decision is
made by them.

o Render the best possible advice to his clients relating to his needs and the environment and his
own professional skills.

o Ensure that all professional dealings are affected in a prompt, efficient and cost effective
manner.

COORDINATION WITH RELATING AUTHORITIES:

The portfolio manager shall designate a senior officer as compliance offer.

The senior officer:

Shall coordinate with regulating authorities regarding various matters.

Shall provide necessary guidance to and ensure compliance internally by the portfolio manager of
all Rules, Regulations guidelines, Notifications etc. issued by SEBI, government of India and
other regulating authorities.

Shall ensure that observations made/ deficiencies pointed out by SEBI in the functioning of the
portfolio manager do not recur.

55

DEFAULTS AND PENALTIES:

The following aspects must be kept in view:

Liabilities for action in case of default - A portfolio manager is liable to penalties if he:

Fails to comply with any conditions subject to which certificate of registration has been granted.

Contravenes any of the provisions of the SEBI act, its Rules and Regulations.

In such a case, he shall be liable to any of the following penalties, after enquiry-

Suspension of registration for a specific period.

Cancellation of registration.

56

CHAPTER - 7

INVESTMENT ANALYSIS

MEANING OF INVESTMENT

Investment means employment of funds in a productive manner so as to create additional

income. The word investment means many things to many persons. Investment in financial assets
leads to further production and income. It is lending of funds for income and commitment of
money for creation of assets, producing further income.

Investment also means purchasing of securities, financial instruments or claims on future

income. Investment is made out of income and savings credit or borrowings and out of wealth. It
is a reward for waiting for money.

There are two concepts of investment:

Economic Investment: The concept of economic investment means additions to the capital
stock of the society. The capital stock of society is the goods which are used in the production of
other goods. The term investment implies the formation of new and productive capital in the
form of new construction and producers durable instrument such as plant and machinery,
inventories and human capital are also included in this concept. Thus, an investment, in
economic terms, means an increase in building, equipment, and inventory.

57

Financial Investment: This is an allocation of monetary resources to assets that are expected to
yield some gain or return over a given period of time. It is a general or extended sense of the
term. It means an exchange of financial claims such as shares and bonds, real estate, etc. in their
view; investment is a commitment of funds to derive future income in the form of interest,
dividends, rent premiums, pension benefits and the appreciation of the value of their principal
capital.

The economic and financial concepts of investment are related to each other because investment
is a part of the savings of individuals which flow into the capital market either directly or
through institutions. Thus, investment decisions and financial decisions interact with each other.
Financial decisions are primarily concerned with the sources of money where as investment
decisions are traditionally concerned with uses or budgeting of money.

MEANING OF SECURITY

A security means a document that gives its owners a specific claim of ownership of a particular
financial asset. Financial market provides facilities for buying and selling of financial claims and
services. Thus, securities are the financial instruments which are bought and sold in the financial
market for investment.

The important financial instruments are shares, debentures, bonds, etc. other financial
instruments are also known as Treasury bills, Mutual Fund Units, Fixed Deposits, Insurance
Policies, Post Office Savings like National Savings certificates, Kisan Vikas Patras, public
provident Funds etc. These securities are used by the investors for their investment. Some of
these securities are transferable while some of them are not transferable.

INVESTMENT AVENUES

The alternative investment avenues for the investor are to be considered first so as to satisfy the
above objectives of investors. The following categories of investors are open to investors as
avenues for savings to flow in financial form:

58

(a)Investment in Bank Deposits Savings And Fixed Deposits: This is the most common
form of investment for an average Indian and nearly 40% of funds in financial savings are
used in this form these are least risky but the return is also low.

(b)Investment in P.O. Deposits, National Savings Certificates and other Postal Savings
Schemes: Many people in villages and some urban areas are investors in these schemes due
to lower risk of loss of money and greater security of funds. But returns are also lower than
in Stocks & Shares.

Insurance Schemes of LIC/GIC etc. and Provident and Pension Funds: About 20-25% of
financial savings of the household sector are put in these forms and P.F., Pension and other
forms of contractual savings.

(d)Investment in Mutual Fund Schemes or UTI Schemes as and when announced: These
are less risky than direct investment in stocks and shares as these enjoy the expert
management by the Portfolio Manager or Professional experts. They also have the advantage
of diversified Portfolio involving the reduction of risk and economies of scale reducing the
cost of investment.

(e)Investment in New Issues Market: A new entrant in the Stock Market should preferably
invest in New Issues of existing and well reputed companies either in equity or debentures.
Incidentally the instruments in which investment can be made in the new issues market are:

Equity issues through prospectus or rights announced by existing

shareholders.

Preference shares with a fixed dividend either convertible into

equity or not.

Debentures of various categories convertible, fully convertible, partly convertible and nonconvertible debentures.

P.S.U. Bonds taxable or free-taxed with interest rates.

59

Investment in gold, silver, precious metals and antiques.

Investment in real estates.

(h)Investment in gilt-edged securities and securities of Government and Semi-Government

organizations (e.g. Relief bonds, bonds of port trusts, treasury bills, etc.). The maturity period
is varying generally upto10 to20 years. Gilt-edged securities market constitutes the largest
segment of the Indian capital market. These are fully secured as they have government
backing. Tax benefits are available to these securities.

60

The following figure indicates alternative avenues for Investment:

61

NEW ISSUES MARKET INVESTMENT DECISION

Investors would prefer debentures if they are interested in a fixed income. They may go for
convertible debentures, if they want to have both fixed income and likely capital appreciation in
future. If they are risk taking and aim only at capital gains, then they may invest in equity shares.
Of the new issues those of well established existing companies are least risky while those of new
companies floated by little known new entrepreneurs are most risky. In choosing the new issues
for investment decision, the investor has to read a copy of the prospectus and note the following:

Who are the promoters and their past record?

Products manufactured and demand for those products at home or abroad the competitors and
the share of each in the market.

Availability of inputs, raw materials and accessories and the dependence on imports.

Project location and its advantages.

Prospects through projected earnings, net profits and dividend paying capacity, waiting period
involved, etc.

If the new issues belong to a company promoted by well known Business Groups like Tatas,
Birlas etc. they are less risky. The company should belong to an industry which is expanding and
has good potential like drugs, chemicals, Telecom etc. the terms of offer should be attractive like
conversion or immediate prospects of dividend etc.

STOCK MARKET INVESTMENT DECISION

As far as the stock market is concerned, investment in shares is most risky as the likelihood of
fall or rise in prices is uncertain. But the returns may also be high commensurate with risk. A
host of imponderable factors operate in the stock market and a genuine investor has to do the
following things:

62

Study the Balance Sheet of the company and analyze the prospects of sales and profits.

Analyze the market price in terms of book value and profit earning capacity (or P/E Ratio) and
use them to know whether the share is overvalued or undervalued.

Study the expansion plans or tax savings plans and analyze the companys financial strength,
bonus and dividend paying strength, through the mechanism of financial ratios.

Study whether the management is professional and good, whether other accounting practices are
dependable and consistent. The company becomes attractive to buy if the financial ratios support
the view that the fundamentals are strong and the shares are worth buying.

Lastly, if the price of the share is undervalued on the basis of the projected earnings for the
coming half year or one year and its P/E Ratio is below the industry average, then it is worth
buying. The same is worth selling if in his judgement it is overhauled. For assessing the under
valuation and over valuation, the analyst and his analytical power count for this purpose.

GUIDELINES FOR INVESTORS IN THE STOCK MARKET

Never buy on rumours or market gossip.

Buy only on the basis of fundamental analysis of the companies based on balance sheet data
analysis.

Buy a diversified list of companies and not put all the money in one or two companies. All
investments in the stock market are risky. The risk can be reduced by proper diversification of
the portfolio into 10 or 15 companies.

Study the sales, gross profit, net profit in relation to equity capital employed and attempt a
forecast for the coming half year or one year.

A declaration of bonus or low P/E ratio, along with strong fundamentals shows that the company
should be a good buy.

The investor should also watch for low priced shares which are about to turn around for more
profitability in future.

63

Investors should buy on declines and follow the principle of contrariness. This means that if
everyone is buying scrip, avoid that scrip but if a scrip is deserted and your study has shown that
is has potential; for expanding earnings and profitability, then such scrips should be purchased
by the investor.

Avoid both fear and greed on the stock market. If investor is not afraid of the market, he
generally studies the market and buys at lows and sells at highs.

The investor should know how to analyze the security prices of companies and pick up the
undervalued shares. The valuation may be based on the net profits discounted to the present by a
proper discount rate or by the book value of share, estimated on the basis of net worth of the
company.

Timing of purchase and sale is also very important. If technical analysis and the use of charts is
not familiar to the investor he should follow the principle buy low and sell high. He should see
whether there is a bull market or bear market in a share by a study of the share price over a
period of 15 to 30 days. In a bull phase one can sell at one of the peaks and in a bear phase one
can buy at one of troughs. If the investor is greedy to wait on to see the maximum peak, and then
he may be disappointed if the price shows a down trend. Similarly, it is difficult to foresee the
lowest price for a scrip for the buy. The investor has to use his discretion.

The investors should not do the following things:

He should not put all his eggs in one basket which means that he should not put all his funds in
one or two companies.

Do not go by heresy or rumours to buy or sell a scrip as that might be a dupe.

Do not speculate involving the buying and selling in the same day or during the same settlement
period. A long term investor gains more than speculator.

Avoid taking undue risks or beyond the capacity of your net worth. That means if capital base is
Rs. 2 lakhs, put a stop loss order at Rs. 20,000/- (or 1/8th or 1/10th of the capital base).

Do not get panicky if the scrips in which you have invested go down in price. Once the
investment is made after a study of fundamentals, a temporary fall in its price should not cause
worry. What the investor needs is patience, which is possible if he is a long term investor.

64

6) Do not be too greedy or ambitious. Put limits to your operations and buy and sell orders in a
price range and your minimum profit limit is 20%.

INVESTMENT STRATEGY

Portfolio management can be practiced by following either an active or passive strategy.

Active strategy is based on the assumption that it is possible to beat the market. This is done by
selecting assets that are viewed as under priced or by changing the asset mix or proportion of
fixed income securities and shares. Active strategy is carried out as follows:

Aggressive Security Management: Aggressive purchasing and selling of securities to achieve

high yields from dividend interest and capital gains.

Speculation And Short Term Trading: The objective is to gain capital profits. The risk is high
and the composition of portfolio is flexible. Success of active strategy depends on correct
decisions as regard the timing of movement in the market as a whole, weight age of various
securities in the portfolio and individual share selection.

The passive strategy does not aim at outperforming the market. Unlike the active strategy. On the
other hand the stocks could be randomly selected on the assumption of a perfectly efficient
market. The objective is to include in the portfolio a large number of securities so as to reduce
risks specific to individual securities. The characteristics of positive strategy are:

Long Term Investment Horizon

Little Portfolio Revisions

Thus it is basically a buy and hold strategy.

The strategy can be implemented by investing in securities so as to duplicate the portfolio of a

market index which is called indexing.

65

INVESTMENT AND SPECULATION

Speculation is an activity, quite contrary to its literal meaning, in which a person assumes high
risks, often without regard for the safety of his invested principal, to achieve large capital gains.
The time span in which the gain is sought to be made is usually very short.

The investor sacrifices some money today in anticipation of a financial return in future. He
indulges in a bit of speculation. There is an element of speculation involved in all investment
decisions. However it does not mean that all investments are speculative by nature. Genuine
investments are carefully thought out decisions. On the other hand, speculative investments are
not carefully thought out decisions. They are based on tips and rumours.

An investment can be distinguished from speculation in three ways Risk, capital gain and
time period. Investment involves limited risk while speculation is considered as an investment
of funds with high risk. The purchase of a security for earning a stable return over a period of
time is an investment whereas the primary motive is to earn high profits through price changes is
termed as speculation. Thus, speculation involves buying a security at low price and selling at a
high price to make a capital gain.

The truth is that any investment is a speculation if the investor uses his judgement and forecast
the probable course of events in order to reap the returns on his investment.

ELEMENTS OF INVESTMENTS

(a) Return: Investors buy or sell financial instruments in order to earn return on them. The
return on investment is the reward to the investors. The return includes both current income and
capital gains or losses, which arises by the increase or decrease of the security price.
(b) Risk: Risk is the chance of loss due to variability of returns on an investment. In case of
every investment, there is a chance of loss. It may be loss of interest, dividend or principal
amount of investment. However, risk and return are inseparable. Return is a precise statistical
term and it is measurable. But the risk is not precise statistical term. However, the risk can be
quantified: The investment process should be considered in terms of both risk and return.

66

Time: Time is an important factor in investment. It offers several different courses of action.
Time period depends on the attitude of the investor who follows a buy and hold policy. As time
moves on, analysts believe that conditions may change and investors may revaluate expected
return and risk for each investment.

FINANCIAL ANALYSIS:

An analysis of financial for the past few years would help the investment manager in
understanding the financial solvency and liquidity, the efficiency with which the funds are used,
the profitability, the operating efficiency and operating leverages of the company. For this
purpose certain fundamental ratios have to be calculated.

Quality of Management: This is an intangible factor. Yet it has a very important bearing on the
value of the shares. Every investment manager knows that the shares of certain business houses
command a higher premium than those of similar companies managed by other business houses.
This is because of the quality of management, the confidence that the investors have in a
particular business house, its policy vis--vis its relationship with the investors, dividend and
financial performance record of other companies in the same group, etc. This is perhaps the
reason that an investment manager always gives a close look to the management of the company
whose shares he is to invest. Quality of management has to be seen with reference to the
experience, skill and integrity of the persons at the helm of the affairs of the company. The policy
of the management regarding relationship with the share holders is an important factor since
certain business houses believe in generous dividend and bonus distributions while others are
rather conservative.

67

Location and labour management relations: The locations of the companys

manufacturing facilities determine its economic viability which depends on the
availability of crucial inputs like power, skilled labour and raw materials etc. Nearness to
market is also a factor to be considered.

In the past few years, the investment manager has begun looking into the state of labor
management relations in the company under consideration and the area where it is
located.

68

CHAPTER - 8

ASSEST ALLOCATION

INTRODUCTION

The portfolio manager has to invest in these securities that form the optimal portfolio. Once a
portfolio is selected the next step is the selection of the specific assets to be included in the
portfolio. Assets in this respect means group of security or type of investment. While selecting
the assets the portfolio manager has to make asset allocation. It is the process of dividing the
funds among different asset class portfolios.

ASSET ALLOCATION

The different asset class definitions are widely debated, but four common divisions are stocks,
bonds, real-estate and commodities. The exercise of allocating funds among these assets (and
among individual securities within each asset class) is what investment management firms are
paid for.

Asset classes exhibit different market dynamics, and different interaction effects; thus, the
allocation of monies among asset classes will have a significant effect on the performance of the
fund. Some research suggests that allocation among asset classes has more predictive power than
the choice of individual holdings in determining portfolio return. Arguably, the skill of a

69

successful investment manager resides in constructing the asset allocation, and separately the
individual holdings, so as to outperform certain benchmarks (e.g., the peer group of competing
funds, bond and stock indices).

In order to achieve long term success, individual investors should concentrate on the allocation of
their money among stocks, bonds and cash. It means how much to invest in stocks? How much to
invest in bonds? And how much to keep in cash reserves? Thus, the asset allocation decision is
the most important determinant of investment performance.

The basic long term objective of any investor should be to maximize his real overall return on
initial investment after investment. To achieve this objective, the investor should look where the
best bargains lie.

Asset allocation means different things to different people. The portfolio manager has to complete
the following stages before making asset allocation.

(a) SECURITY SELECTION: This means identifying groups of securities in each asset class
and decides the optimal portfolio. The following are the different asset classes:

(1)
Equity shares-new issues
(5)
PSU bonds
(2)
Equity shares-old issues
(6)
Government Securities
(3)
Preference Shares
(7)

Company Fixed Deposits

(4)
Debentures

Portfolio management is handling the fund on behalf of the company or institution in order to
determine the suitable combination of different assets so that the total risk can be reduced to the
minimum while the return can be achieved to the maximum extent. This is a tricky job which
needs efficiency of high caliber. Therefore, the portfolio manager has to keep in mind the
following factors while making asset allocation and design an efficient portfolio.

a)
Liquidity or marketability
d)
Maximization of return
b)
Safety of investment
e)
Minimization of return
c)
Tax Saving
f)
Capital appreciation or gain

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Funds requirements

BASIS OF SELECTION OF EQUITY PORTFOLIO:

A portfolio is a collection of securities. It is essential that every security be viewed in a portfolio

context. It is logical that the expected return of a portfolio should depend on the expected return
of each of the security contained in it. Moreover, the amounts invested in each security should
also be important.

There are two approaches to the selection of equity portfolio. One is technical analysis and the
other is fundamental analysis. Technical analysis assumes that the price of a stock depends on
supply and demand in the capital market. All financial and market information of given security is
already reflected in the market price. Charts are drawn to identify price movements of a given
security over a period of time. These charts enable us to predict the future movement of the
security.

The fundamental analysis includes the study of ratio analysis, past and present track record of the
company, quality of management, government policies etc an efficient portfolio manager can
obviously give more weight to fundamental analysis than technical analysis.

DIVERSIFICATION

Investing funds in a single security is advisable only if the securitys performance is rewarding.
To reduce risk of a portfolio investors resort to diversification. Diversification means shifting
form one security to another security. The maximum benefits of risk reduction can be achieved by
just having of 10 to 15 carefully selected securities.

Portfolio risk can be divided into two groups- diversible risk and non-diversible risk. Diversible
risk arises from companys specific factors. Hence, such risk can be diversified by including
stocks of other companies in the portfolio. Non-diversible risk arises from the influence of
economy wide factors which affect returns of all companies; investors cannot avoid the risk

arising from them. Often investors tend to buy or sell securities on casual tips, prevailing mood in
the market, sudden impulse, or to follow others. An investor should investigate the following
factors about the stock to be included in his portfolio:

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(a) Earnings per share (b) Growth potential (c) Dividend and bonus records (d) Business,
financial and market risks (e) Behavior of price-earnings ratio (f) High and low prices of the
stock (g) Trend of share prices over the few months or weeks.

--------------------------------------- B HIGH RISK (SHARES) A (DEBENT) MEDIUM

RISK

Risk free (Bank Deposits)

We can observe from the above diagram that the strategy of an investor should be at A, B or C
respectively, depending upon his preferences and income requirements. If he takes some risk at B
or C, the risk can be reduced if it is concerned with a specific company risk, but the market risk
is outside his control. The risk can be reduced by a proper diversification of scripts in the

portfolio. There may be a combination of A, B and C positions in his portfolio so that he can
have a diversified risk-return pattern. This diversification can help to minimize risk and
maximum the returns.

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CONCLUSION

From the above discussion it is clear that portfolio functioning is based on market risk, so one
can get the help from the professional portfolio manager or the Merchant banker if required
before investment because applicability of practical knowledge through technical analysis can
help an investor to reduce risk. In other words Security prices are determined by money manager
and home managers, students and strikers, doctors and dog catchers, lawyers and landscapers,
the wealthy and the wanting. This breadth of market participants guarantees an element of
unpredictability and excitement. If we were all totally logical and could separate our emotions
from our investment decisions then, the determination of price based on future earnings would
work magnificently. And since we would all have the same completely logical expectations,
price would only change when quarterly reports or relevant news was released.

I believe the future is only the past again, entered through another gate Sir Arthur wing
Pinero. 1893.

If price are based on investors expectations, then knowing what a security should sell for
become less important than knowing what other investors expect it to sell for. There are two
times of a mans life when he should not speculate; when he cant afford it and when he can
Mark Twin, 1897.

A Casino make money on a roulette wheel, not by knowing what number will come up next, but
by slightly improving their odds with the addition of a 0 and 00. Yet many investors buy
securities without attempting to control the odds. If we believe that this dealings is not a
Gambling we have to start up it with intelligent way.

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I can conclude from this project that portfolio management has become an important service for
the investors to identify the companies with growth potential. Portfolio managers can provide the
professional advice to the investors to make an intelligent and informed investment.

Portfolio management role is still not identified in the recent time but due it expansion of
investors market and growing complexities of the investors the services of the portfolio
managers will be in great demand in the near future.

Today the individual investors do not show interest in taking professional help but surely with
the growing importance and awareness regarding portfolios managers people will definitely
prefer to take professional help.

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BIBLIOGRAPHY

REFERENCE BOOKS:

Security Analysis and Portfolio Management - Dr. P.K.BANDGAR

Investment Analysis and Portfolio Management

WEBLIOGRAPHY

SOURCES:

www.google.com www.yahoo.com
www.wikipedia.com

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