Step By Step Guide To Portfolio Management

“Portfolio management” means the conceptual development, implementation, monitoring, and, if necessary, modification of a securities portfolio by an asset manager or fund manager.

This article primarily discusses the portfolio management steps that independent financial portfolio managers use to structure and manage their clients’ assets. These are primarily portfolios that are permanently invested (buy and hold).

Portfolio Management – Step 1: How To Plan The Portfolio

Planning an individual securities portfolio requires that the client and asset manager discuss the client’s financial goals and opportunities in detail. Future cash inflows, such as a gift or the payment of a life insurance policy, are also included in the planning. Other assets, such as real estate, may be integrated into the planning. In this way, the client and asset manager gain an overview of the (net) assets of the investor and the resulting options.

What Risk Can The Customer Subjectively Bear?

Another important factor in portfolio development is the entire risk that the customer would like to invest. The question is: What temporary, i.e., short-term, the loss does the investor want to accept at most to achieve his longer-term goals? The aim is to find precisely the level of risk with which a particular investor can “live” well in the long run and thus also in rough stock market times.

This increases the likelihood that the customer will achieve their financial goals. The steps mentioned are not required in fund management, as fund portfolios, except special funds, are not individually tailored to individual investors.

Which Asset Allocation Suits This Client?

According to the possibilities and the investor’s desired risk, the investor’s assets are allocated to the various asset classes. This process is called asset allocation. According to current knowledge in public finance, the appropriate asset allocation determines more than anything else whether an investor will be successful in the long term. In this case, success means that the respective financial goals are achieved with the least possible risk.

The main asset classes, which differ in their return and risk profiles and their correlations, include stocks, bonds, precious metals, and cash. In the long term, stocks have proven to be the strongest return drivers, but they also show the most excellent fluctuation range and thus the most significant risk. The more willing an investor is to take risks, the higher the equity component can be. The lower his “risk tolerance,” the lower it has to be. An example of an asset allocation could look something like this:

  • European and international stocks: 40 to 60 percent
  • Government and corporate bonds: 25 to 35 percent
  • Gold: 5 to 15 percent
  • Cash: 5 to 15 percent.

Step 2: Building The Portfolio

Which Investment Instruments Are Suitable?

After developing the basic portfolio concept, the next step is implementing this strategy with suitable investment instruments. In the case of stocks, actively managed funds, passively managed index funds (ETFs), and individual stocks or a combination of these are ideal.

These instruments can also be used for government and corporate bonds. Precious metals are either bought physically and stored in the vault or acquired via secured certificates (ETCs). Cash can be kept in the account or an ultra-short-dated bond, although the latter is currently not recommended due to negative returns.

What Are The Advantages And Disadvantages Of Individual Values?

Portfolio management via individual stocks with independent asset managers often requires assets of at least 200,000 euros. The reason is that the portfolio cannot otherwise be sufficiently diversified. For assets below this limit, specially selected investment funds or ETFs are usually used.

As numerous studies have shown, that doesn’t have to be a disadvantage: As numerous studies have shown, most investors overestimate the influence the selection of individual stocks has on the long-term success of a well-diversified portfolio of securities. On the other hand, individual stocks offer the chance of an excess return on the market, which ETFs only offer under particular circumstances (see “Investment style”).

Which Accents Are Set By Regions, Industries, Running Times, etc.?

The choice of regions (industrialized or emerging countries), sectors (industry, technology, services, etc.), maturities and creditworthiness for bonds (1 to 30 years / triple-A or Junk Bond) as well as the currencies for all asset classes (euros, dollars, other currencies). The portfolio manager selects the financial products from these subcategories and is guided by the specifications of the asset allocation.

What Is The Importance Of The Investment Style?

The investment style affects several aspects of the portfolio. The first question is whether the portfolio manager is permanently invested ( buy and hold ) or whether certain asset classes, such as stocks, are wholly sold when specific signals (such as trend following) are present. The money is parked as cash.

Alternatively, the equity quota can be hedged throughput transactions. This approach offers the option of achieving a higher return compared to the market by avoiding market downturns or cushioning them with put profits. But there is also the risk of outperforming the market when it comes to false signals.

Second, it must be clarified whether the asset class quotas for buy-and-hold portfolios are static or whether they can move up to the upper or lower limit, depending on the portfolio manager’s market assessment. In the latter case, a balanced portfolio could have an equity quota of 60 percent in a good market situation and reduced to 40 percent in rough stock market weather or partially hedged throughput transactions. This approach also offers opportunities for excess return, albeit to a lesser extent than a complete sale.

Thirdly, it must be decided under which conditions funds, ETFs, or individual stocks are to be added to or removed from the portfolio. Many portfolio managers use a combination of fundamental analysis and technical analysis for this purpose. There are also finance professionals who exclusively use one approach or the other.

Actual value investors like to take advantage of shares when listed below their so-called intrinsic value, i.e., are particularly cheap because they see exceptionally high potential in this. A momentum investor, however, relies on stocks or ETFs that have risen significantly. His calculation: strong upward trends often continue more extended than most believe.

Accompanying The Portfolio

What Does The Monitoring Of A Portfolio Consist Of?

After the conception and construction, the observation, examination, and, if necessary, modification of the portfolio begins. This permanent monitoring includes all asset classes and investment instruments. The portfolio management also provides regular advice on investment products and makes tactical decisions, such as profit-taking or further buying or selling individual stocks or funds.

Independent asset managers inform their clients at least quarterly using a written report and, depending on the agreement with the client, in personal discussions about the development of the portfolio. If necessary, customers can also exchange ideas with their contact person in asset management.

How Can The Success Of A Portfolio Be Measured?

When planning the portfolio, a benchmark is established. In addition, a measure can be determined with which the risk-adjusted return can be measured. A benchmark for a balanced securities portfolio could be the index combination “50 percent global stock market/50 percent government bonds”.

However, this does not say anything about the risk with which the portfolio manager achieved the portfolio return. The so-called Sharpe ratio or another critical figure is better suited for this: it can be used to determine how much risk was taken to achieve a higher return compared to a comparable portfolio.

Back to top button