Portfolio management Essay Example | Topics and Well Written Essays - 1750 words

Portfolio management - Essay Example The most vital decision regarding investing that an investor can make involves the amount of risk he or she is willing to bear. Most investors will want to obtain the highest return for the lowest amount of possible risk. However, there tends to be a trade-off between risk and return, whereby larger returns are generally associated with larger risk. Portfolio management helps to bring together various securities and other assets into portfolios that address investor needs, and then to manage those portfolios in order to achieve investment objectives. Effective asset management revolves around a portfolio manager's ability to assess and effectively manage risk. With the explosion of technology, access to information has increased dramatically at all levels of the investment cycle. It is the job of the portfolio manager to manage the vast array of available information and to transform it into successful investments for the portfolio for which he/she has the remit to manage. Portfolio management has faced lots of ups and downs due to the market turbulences caused by the global market credit crunch. In this following section, the functions and roles played by the portfolio managers are discussed upon.Portfolio management is principally about risk and return strategies. It is concerned with the construction and management of investment assets. There are two fundamental ways that a portfolio manager can add value which are follows ( Lumby, 1994): Strategic diversification- The portfolio manager generates value by effectively exploiting diversification opportunities between the assets in the portfolio. For instance, two stocks that are not well correlated can be combined so as to get more return relative to risk. Alpha return- The second way that fund managers add value is by generating returns that are in excess of what could be obtained by a reasonable combination of the asset classes in the fund. Alpha generation may be due to the relative weight given to each of a series of asset classes at any given time or it may be due to the specific stocks selected within an asset class-finding the best stocks in a sector. Passive portfolios have predictable styles. A passive investor knows exactly what types of securities he or she is invested in. Active managers, on the other hand, can vary the composition of their portfolios significantly over time - a problem known as "style drift". The styles of portfolio management are discussed in the following section. Active portfolio manager An active portfolio manager is one who constantly makes decisions and appraises the value of investments within the portfolio by collecting information, using forecasting techniques, and predicting the future performance of the various asset classes, market sectors, individual equities or assets. His goal is to obtain better performance for the portfolio. He uses personal ability and judgment to select undervalued assets to attempt to outperform the market. The active managers adopt strategies, all involving detailed analysis, as given below (Brentani, C. 2004, p.93): i. Top-down approach- This approach involves assessing the prospects for particular market sectors or countries (depending on the index), following a detailed review of general economic, financial and political factors. Sector weightings may be changed by fund managers depending on their view of the prevailing economic cycle (known as sector rotation). If a recession is likely, shares in consumer sectors such as retailing, homebuilders and motor distributors will be sold and the proceeds reinvested in, say, the food manufacturing sector. A portfolio is then selected of individual shares in the favored