Portfolio Management: An Overview

Portfolio management is a disciplined process carried out for very different clients, from a single saver to a sovereign wealth fund. This module explains why investors should think in terms of portfolios rather than individual securities, walks through the planning, execution and feedback steps, compares the needs of the main investor types and of defined benefit and defined contribution pension plans, and surveys the asset management industry and the pooled products through which most people invest.

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What you will learn

1. Describe the portfolio approach to investing, including how diversification reduces risk and where its protection ends.

Judge investments by their effect on the whole portfolio, not in isolation.
Diversification lowers risk while expected return remains the weighted average of the holdings.
Diversification ratio = risk of an equally weighted portfolio / risk of a single random security.
Diversification cannot remove systematic risk, and its benefit shrinks when correlations rise in crises.
Concentrated positions, such as large holdings of an employer's stock, carry unrewarded risk.

2. Describe the planning, execution and feedback steps of the portfolio management process.

Planning: understand the client and write the investment policy statement.
Execution: asset allocation, security analysis and portfolio construction.
Feedback: monitoring and rebalancing, plus performance measurement and reporting.
The IPS is the reference point for all later decisions and is reviewed regularly.
The process is continuous: feedback can trigger changes to the plan.

3. Describe the main types of investors and the distinctive characteristics and needs of each.

Individuals: needs vary widely with age, wealth, goals and circumstances.
DB pensions: long horizon; liquidity needs rise as members retire.
Endowments and foundations: perpetual horizon, high risk tolerance, low liquidity needs.
Banks: high liquidity needs, low risk tolerance, income focus.
Insurers: life = long liabilities; P&C = shorter, less predictable claims and more liquidity.
Sovereign wealth funds: usually long horizon and high risk tolerance, depending on purpose.

4. Describe and compare defined benefit and defined contribution pension plans, including who bears investment risk.

DB: benefit defined by a formula; the employer bears investment and longevity risk.
Funded ratio = plan assets / present value of the benefit obligation; below 100% is a deficit.
DC: contribution defined; the employee bears investment risk and owns a portable account.
DC participants usually choose their own investments from a menu.
Falling interest rates raise DB liabilities and can worsen funded status even when assets rise.

5. Describe key aspects of the asset management industry, including active versus passive management, traditional versus alternative managers, and major industry trends.

Asset managers are the buy side; brokers, dealers and investment banks are the sell side.
Active management seeks to beat a benchmark at higher cost; passive management tracks an index cheaply.
Traditional managers: long-only, asset-based fees; alternative managers: hedge funds, private markets, performance fees.
Key trends: growth of passive, fee compression, consolidation, big data and robo-advice, alternatives and ESG.

6. Describe mutual funds and compare them with other pooled investment products such as ETFs, separately managed accounts, hedge funds and private equity funds.

NAV = (total assets - liabilities) / shares outstanding.
Open-end funds trade at NAV with the fund; closed-end fund shares trade on an exchange at a premium or discount to NAV.
Loads are sales charges; no-load funds have none.
ETFs trade intraday; the creation/redemption mechanism keeps prices near NAV.
SMAs offer direct ownership and customization; hedge and private equity funds offer access to alternative strategies with less liquidity and performance fees.

Module at a glance

The portfolio approach judges each investment by its effect on the whole portfolio.
Diversification lowers risk without lowering expected return, but cannot remove systematic risk.
Process: planning (IPS), execution (allocation, analysis, construction), feedback (monitoring, rebalancing, reporting).
Liabilities shape investors: banks and P&C insurers need liquidity; endowments and sovereign funds can take long-term risk.
DB: the employer bears investment risk; DC: the employee does.
Industry trends: passive growth, fee compression, consolidation, technology, alternatives and ESG.
Open-end funds trade at NAV; closed-end funds at a premium or discount; ETFs intraday close to NAV.

This free module has 6 lessons, 18 practice questions with full explanations.

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