When we talk about portfolio investment, the first thing that appears is the image of Wall Street, the stock exchange, and flashy brokers. In the framework of this article, we will understand what this concept is at the professional level of the leader and investor. So what is an investment portfolio?
Concept
Under portfolio investment understand financial and monetary investments in the purchase of securities when it is planned to make a profit without the emergence of rights to control the issuer's activities.
In other words, an investment portfolio is a combination of financial (stocks and bonds) and real investor assets (real estate), which are a form of investment.
Like its individual components, it can be the subject of a statistical analysis of risk assessment, expected profitability and other things.
Portfolio investments are all transactions whose subject matter are debt or equity securities that are not direct investments. Portfolio investments include equity securities (if they do not guarantee effective control over the issuing company), shares of the investment fund. They do not include transactions such as repurchase (the so-called repo) or securities loan.
Simply put, portfolio investment is the operation of investors buying financial assets of one country (primarily securities) in another country. In this case, investors do not take active control over institutions issuing securities, but are satisfied with the sale of profits. Profit is generated by the difference in exchange rates or fluctuations in interest rates, therefore, investors interested in securities often base their decisions on the rating of a given country.
The set of securities packages includes:
- stocks;
- bills;
- bonds;
- bonded loans of the state and municipalities.
Types
There are several types of investment portfolios. The table shows the main ones.
Type of investment portfolio | Characteristic |
Stock portfolio | These are shares of companies with a highly structured fund. |
Balanced portfolio | Shares of companies with high growth potential, as well as treasury bonds and bonds |
Safe briefcase | Bank term deposits, bonds and treasury bills |
Active portfolio | These are treasury debt instruments, stocks of highly structured fund companies and derivative rights. |
Formation Methods
Among the many methods of portfolio formation, four main options stand out, which are presented in the table below.
Formation method | Method Description |
Tactical placement method | Its main goal is to ensure a constant level of risk in the investment portfolio in the long term |
Strategic allocation method | It is used in making long-term investment decisions. |
Safe Distribution Method | It includes adjusting the capital structure so that the risk and expected return on the investment remain unchanged |
Integration Distribution Method | Thanks to this method, it is possible to evaluate both the general conditions of individual investments and their goals |
Portfolio Composition
Most investment portfolios have the following composition, as reflected in the table below.
Element | Composition | Description |
1 | In the absence of risk | Income is fixed and stable. The yield bar is minimal |
2 | Risky | Ensuring increased returns, maximum capital gains. The value of profitability overtakes the average level in the market as a whole |
The balance between these two parts allows you to achieve the necessary parameters for combining riskiness and profitability.
Fundamentals of the functioning of the portfolio
The main goal of the portfolio is to achieve the optimal combination between risk and profit. To do this, investors use a whole arsenal of various tools (diversification, accurate selection). The table shows the options for investor portfolios.
Option | Characteristic |
Interest income | Income portfolio |
Exchange rate difference is growing | Growth portfolio |
The basic rule for optimization is the following: if the income from a security is high, then the risk is high. And vice versa: with low income, the risk is also lower. The option for investor behavior in the market depends on it: conservatively or aggressively, which is part of the investment policy.
Aggressive option | Conservative option |
Investment Portfolio Consists of Securities of Young Growing Firms | Stable income with reduced risk. Bet on highly liquid, but low-yield securities issued by mature and powerful companies in the market |
The essence of management. The basics
Managing a portfolio of financial investments is an ongoing process. It includes the stage of planning, execution and reporting on results. This process consists of analyzing the economic conditions, determining the limitations and goals of the client, as well as the distribution of assets.
Portfolio management is the art and science of making decisions about the structure of investments and politics, balancing between income and risk.
Portfolio management is all about identifying strengths and weaknesses in choosing between debt and capital, domestic and international, growth and security, and many other trade-offs that are encountered when trying to maximize profitability at a given level of risk.
Portfolio management can be both passive and active, as presented in the table below.
Passive | Active |
Keeps track of a market index, commonly referred to as indexing. | Investor is trying to achieve maximum profitability |
Key elements of the management process
The main element of management is the distribution of assets, which is based on their long-term structure. Asset allocation is based on the fact that their various types do not move in concert, and some of them are more volatile than others. A focus is being formed on optimizing the investor's risk / return profile. This is done by investing in a set of assets that have a low correlation with each other. Investors with a more aggressive profile can weigh their investment portfolio towards more volatile investments. And with a more conservative one, they can weigh it towards more stable investments.
Diversification is a very common method used in the portfolio management process. It is not possible to consistently predict winners and losers. It is necessary to create an investment portfolio with a wide coverage of assets. Diversification is the distribution of risk and profit within an asset class. Since it is difficult to understand which specific assets or sectors may be leaders, diversification seeks to gain profitability of all sectors over time, but with less volatility at any given time.
Restoring equilibrium is a method that is used to return a portfolio to its original target distribution at annual time intervals. The method is important for maintaining the asset structure that best reflects the investor's risk / return profile. Otherwise, market movements may expose the financial investment portfolio to greater risk or reduced return opportunities. For example, investments that start with 70% of equity and 30% of a fixed-income distribution can, as a result of expanded growth in the market, go over to an 80/20 distribution, which puts the investor at greater risk than he can bear. Rebalancing involves the sale of low-value securities and the redistribution of proceeds in low-price securities.
Types of portfolio management. Which are there?
Management of an investment portfolio involves making a decision on the optimal comparison of investments with goals with balancing risk.
Consider the main types in more detail. The table below shows the characteristics of each of them.
Portfolio Management Type | Characteristic |
Active | Such management, in which portfolio managers are actively involved in securities trading in order to maximize profits for the investor |
Passive | With this management, managers are interested in a fixed portfolio that is created in accordance with current market trends. |
Discretionary Portfolio Management | Portfolio management in which the investor places the fund with the manager and authorizes him to invest them at his discretion on behalf of the investor. Portfolio manager monitors all investment needs, documentation and other |
Non-discretionary portfolio management | This is a management in which managers give advice to an investor or client who can accept or reject it. The result, that is, the profit or loss incurred, belongs to the investor himself, while the service provider receives an adequate fee in the form of a fee for the provision of services |
Management process. Features
The investment portfolio management process itself can be represented as a sequence of steps, which is reflected in the table below.
Stage | Title | Characteristic |
Stage 1 | Safety analysis | This is the first stage of the portfolio creation process, which includes the assessment of risk factors and profitability of individual securities, as well as their relationship |
2 stage | Portfolio analysis | After determining the securities for investment and the corresponding risk, you can create a series of portfolios from them, which are called possible portfolios, which is very convenient |
3 stage | Portfolio Selection | From all possible, the optimal portfolio of financial investments is selected. It must be appropriate to risk. |
4th stage | Portfolio Review | After choosing the optimal investment portfolio, the manager carefully monitors him to make sure that he remains optimal in the future in order to get good profit. |
5 stage | Portfolio valuation | At this stage, the effectiveness of the portfolio is assessed over a specified period, in relation to the quantitative measurement of profit and risk associated with the portfolio for the entire investment period |
Portfolio management services are provided by financial companies, banks, hedge funds and money managers.
Fundamentals of portfolio investment. Differences from direct investments
Investment in a portfolio of securities differs from foreign direct. With the latter, the investor takes active control of enterprises in a particular country. In the case of portfolio investments, it is satisfied with the realization of profit.
Everyone who has savings (financial assets) is trying to make the best use of them in various financial fields: bank deposits, stocks, bonds, insurance policies, pension funds.
A set of financial instruments is called a portfolio, so the decision on the distribution of assets is called an investment (decisions) in the portfolio.
An investor may also decide to invest part of his savings abroad. The most typical transaction of this type is the purchase of treasury securities of another country.
The size of portfolio investments fluctuates, especially when they are assimilated by speculative capital. They are focused on making quick profits and are ready to withdraw at any time. These fluctuations, on the other hand, can destabilize the exchange rate, so financing a current account deficit through speculative capital can be dangerous. Currency crises, in which there is a sharp weakening of domestic money, are associated with the outflow of portfolio capital.
Portfolio investments are sensitive primarily to changes in interest rates, their expectations and exchange rate forecasts, as well as to changes in the macroeconomic situation - the risk of destabilization and political upheaval. Depending on the risk assessment, investors demand a premium in the form of higher interest rates, otherwise they do not want to buy domestic assets.
Profitability calculation
The basic formula for calculating the return on investment portfolio is as follows:
Profit / Investments * 100%.
Where Profit is the difference between the amount of sale and the amount of purchase of a share.
However, in reality, this formula is insufficient. It must be clarified:
Profit = Profit and loss for each transaction + Dividends - Commissions.
It is most convenient to use Excell settlement tables. An example of such a table is presented below.
Money movement | date | Explanations |
100 t. Rub. | 01/01/2019 | The amount of 100 tons of rubles has been put into the account. |
50 t. Rub. | 03/01/2019 | At the beginning of March, the amount of another 50 tons was put. |
- 20 thousand rubles | 06/14/2019 | In April, the amount of 20 tons. |
-150 tons | 09/18/2019 | All funds in the account on day X |
Next, in the cell where we want to calculate the profitability, we need to insert the expression: PURE (B2: 5; 2: 5) * 100.
Where B2: B5 - the range of cells "Movement of money", C2: C5 - the range of cells "Date".
The program will automatically calculate the income.
The value will be 22.08%.
Portfolio Evaluation. Calculation principle
Profitability should be considered as a percentage when evaluating the investment portfolio, since only in this case the amount that the investor receives will become clear. It can be compared with profitability from other instruments.
To do this, use the formula for assessing the portfolio of financial investments:
Profitability in percent * Number of days in a year / number of days of investment. Example, above we got a yield of 22.08%. But these were investments only for half a year, and the annual return will be:
22.08% * 365/180 = 44.8%.
Main risks
Financial goals are considered in relation to the risk profile of the investment portfolio and profit. It is necessary to get answers to these questions in order to be able to determine the risk that the enterprise bears. Highlights that need permission:
- What are the short-term and long-term goals and financial needs of the client?
- What are the consequences if goals are not achieved?
The main risks of managing a portfolio of investments are reflected in the table below.
Risk | Characteristic | Ways to fight |
Security risk | Unsystematic risk. Defaulted on bonds, the value of shares drops to zero, and after they are completely withdrawn from circulation | 1. Search for quality assets 2. Diversification |
Market risk | Systematic risk | We must include those assets that are resistant to global market fluctuations. |
Main problems
An important problem is the ability to distinguish the expected rate of return from the required rate. The expected rate of return is related to the level of profit that is needed to finance the goals. However, the necessary rate of return is associated with the long-term achievement of financial goals.
Factors that may affect the choice of investments may be related to the following categories: legal conditions (trusts and funds), taxes, time frames, exceptional circumstances or liquidity.
Taxes are associated with the management of property of wealthy individuals, including tax: on income, on real estate, on transfer of property or on capital gains. Exceptional circumstances relate to organizations' preferences for assets. Liquidity refers to the demand (expected and unexpected) of an enterprise for cash. The time horizon is presented as long-term, medium-term, short-term and multi-stage profit.
Directions for reducing risks through diversification
Portfolio diversification is the diversification of the structure of an investment portfolio. What is meant by this? Only that it leads to a reduction in the specific (unsystematic) risk of the investment portfolio and individual assets. The essence of diversification is the purchase of diversified assets in the hope that a possible decrease in the value of some of them will be offset by an increase in the value of others.
Therefore, the effectiveness of portfolio diversification depends on the degree of coordination of changes in the prices of assets that form it (their ratio). The smaller it is, the better the results of diversification.
The strongest diversification is achieved when the correlation of changes in asset prices is negative, that is, when a rise in the price of one asset is accompanied by a fall in the price of another.
An accurate determination of the correlation of future changes in asset prices in a portfolio is difficult, mainly because historical changes should not be repeated in the future. For this reason, simplified diversification methods are often used, consisting in the purchase of assets from various sectors of the economy (for example, shares of banks, telecommunications, construction companies), assets from various market segments (e.g., shares and bonds), geographically differentiated assets (e.g. shares from different countries) or assets of small and large enterprises.
The issue of diversification of the investment portfolio was formally described in the so-called Markowitz portfolio theory. . , .
Conclusion
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