What Is Portfolio Management? (With Benefits And Types)

Updated 30 September 2022

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Many individuals rely on portfolio management services to manage and oversee their investment portfolios. Portfolio management ensures minimum risk, maximises return for clients' investment and increases their capital. Understanding how to manage portfolios can help you successfully handle investments and ensure every client meets their financial goals. In this article, we answer the question, ‘What is portfolio management?', explore its benefits, types and elements and outline the steps for managing a portfolio.

What Is Portfolio Management?

Knowing the answer to the question, ‘What is portfolio management?' can help you manage and oversee a client's investment portfolio. Portfolio management is managing a client's investment by selecting the right investment tools in the right proportion. It focuses on maintaining a balance of risk and helping clients maximise their earnings over a period. Such practices ensure that the money or capital invested by clients does not get exposed to too much risk. The entire portfolio management process relies on the ability to make wise investment decisions.

A portfolio manager can manage stocks, bonds, real estate, mutual funds and other financial assets. These managers focus on matching goals to outcomes. They analyse the potentials and risks associated with each investment based on the financial goal. Apart from selecting the best investment option, some objectives of portfolio management are:

Ensuring capital appreciation
Optimising risk
Allocating resources optimally
Ensuring flexibility of portfolio
Protecting capital against potential market risk
Improving the proficiency of the portfolio

What Are The Benefits Of Portfolio Management?

Here are the benefits of portfolio management:

Helps make the right investment choice

Portfolio management is a strategic investment strategy that helps an investor choose the right portfolio of assets. It helps in making more informed investment decisions regarding the investment plan. These strategies guide investors to invest in stocks, bonds and other financial securities according to their investment goals and objectives.

Ensures higher returns

Without investing, it is impossible to grow an investor's capital. Maximising the return is one of the most critical works of portfolio management. It provides a structured framework for analysis and helps the investor select the best assets that offer higher returns. Portfolio managers can help clients earn higher returns, even with limited funds.

Helps manage liquidity

Portfolio management encourages investors to structure their investments. A portfolio manager makes investment decisions so the investors can sell some of their funds in an emergency. These professionals ensure investors can convert assets, including stocks and bonds, into cash without affecting the market price.

Reduces risk

Investment in securities and stocks is risky because of market volatility. This can increase the chances of incurring a loss. Portfolio management can help in reducing risks through portfolio diversification. This primarily means investing in over one financial asset, like stocks or bonds.

Improves financial understanding

Portfolio management improves the financial knowledge of investors. While managing their portfolio, investors can come across many financial concepts and learn how a financial market works. This can be useful in making intelligent investment decisions and enhancing overall financial understanding.

Types Of Portfolio Management

Here are some common types of portfolio management:

Active portfolio management

In active portfolio management, a portfolio manager generates maximum results and uses the hands-on approach when making investment decisions. This type of portfolio management focuses on a quantitative analysis of companies to understand the stock's actual cost. Portfolio managers buy undervalued stocks and start selling them when they increase. Often, these managers ignore the market hypothesis and rely on ratios to support their investment decision. These professionals diversify investments amongst various sectors and industries to reduce investment risk.

Having a good understanding of the business cycle is essential for making intelligent investment decisions. Usually, managers prefer this portfolio manager for investors with high risk-taking ability. These investors are ready to assume greater returns for greater investment risk.

Passive portfolio management

Passive portfolio management is the opposite of active portfolio management. The primary aim of passive portfolio management is to reduce risk and provide substantial profits to investors. Portfolio managers using this type of strategy believes in efficient market hypothesis. The strategy focuses on a company's fundamentals to understand its stock price. Typically, investors who want to minimise risk prefer the passive strategy. Plus, this strategy generates consistently long-term gains.

Discretionary portfolio management

In discretionary portfolio management, the portfolio manager has the authority to make financial decisions based on the client or investor. These managers make buy and sell decisions on clients' behalf and utilise investment strategies to maximise their returns. Based on these investor goals and their risk-taking abilities, the manager might choose whichever investment strategy they think is suitable. As investors transfer decision-making power to portfolio managers, they feel relaxed about their investments.

Non-discretionary portfolio management

Portfolio managers who focus on non-discretionary management can work as financial counsellors. Their role primarily entails advising investors on the routes to take to enhance profits. Interestingly, after managers receive approval from their investors, they decide on the investor's behalf. It is up to the investor to decide whether to accept or reject the manager's advice.

What Are The Elements Of Portfolio Management?

The following are some essential elements of portfolio management:

Asset allocation

Asset allocation is an investment strategy that a portfolio manager uses to balance risk and reward. It helps decide which financial security and asset to work in the market. In asset allocation, the portfolio manager makes investments in volatile and non-volatile assets, generating substantial interest without facing any risk. Asset allocation aligns with an investor's financial goals and risk-taking ability.

Diversification

When investing, predicting which stock is likely to provide profit or loss is impossible. The best approach is to create a diversified portfolio with broad exposure within an asset class. It involves spreading the risk and reward of individual securities. As it is difficult to predict which subset of an asset class is likely to outperform, diversification captures the return of all sectors with time while reducing volatility. It helps in generating risk-adjusted returns.

Rebalancing

Rebalancing improves the profit-generation aspect of an investment portfolio. It helps portfolio managers and investors to minimise risk while ensuring higher profits. Portfolio managers focus on rebalancing because it involves changing the weightings of assets in an investment portfolio. This brings a portfolio back to the desired asset mix. Usually, portfolio managers do it by divesting underperforming assets and investing in assets that have the potential to grow. The primary objective of rebalancing is ensuring better risk control and ensuring that an investor's portfolio is not dependent on the failure or success of a particular investment asset.

What Is The Process Of Portfolio Management?

Here is a step-by-step process for managing a portfolio:

Setting goals and objectives

The first step of the portfolio management process is identifying the investor's risk-return profile. Identifying how much risk an investor can take and how much volatility an investor can withstand is the key to planning a portfolio strategy. It helps in delivering the required returns at an acceptable level of risk.

Identifying backup assets

The next important step in portfolio management is identifying alternative or backup assets to help the clients distribute risk and limit financial loss. Focus on including equity shares, preference shares, bonds and other securities. Managers determine the percentage of financial asset mix by understanding the investor's risk-taking ability.

Creating a portfolio strategy

After selecting the right asset mix, focus on creating a portfolio strategy. Portfolio managers can choose from active or passive portfolio strategies. An active portfolio strategy focuses on the market timings based on the market condition, while a passive strategy focuses on ensuring a low-risk exposure. It helps in maintaining a well-managed and well-balanced portfolio.

Selecting profitable securities and investment

The investor and portfolio manager select stocks and financial securities in this stage. Before choosing security, the manager considers the portfolio's price, associated risks and potential returns. It helps understand the amount of risk connected to a specific security or bond. In this step, the manager focuses on micro and macro analysis. The macro-analysis involves studying the securities market, while micro-analysis involves studying particular security.

Implementing portfolio

After choosing the desired portfolio, managers focus on implementing the portfolio. Portfolio execution or implementation has a positive impact on investment performance. It primarily involves purchasing and selling certain assets at a pre-determined amount.

Evaluating and revising the portfolio

In this phase, portfolio managers evaluate and assess the returns obtained from the portfolio. They conduct quantitative measurements of the returns obtained and focus on the risks involved in the portfolio. Based on their assessment, these professionals can revise the portfolio.