PORTFOLIO
REVISION
PRESENTED BY
MBA (FS) Part 1: Group 3
Tahira de Sa
{03}
Tracy Fernandes
{06}
Omcar Harmalkar
{12}
Viplav Harmalkar
{13}
Sameer Shaikh
{23}
What is a Portfolio ?
1. A combination of various investment products.
2. individuals hire well trained and experienced
portfolio managers.
3. It is essential for every individual to save some
part of his/her income.
4. A combination of various financial products
where an individual invests his money is called a
portfolio.
Portfolio Selection
1. Portfolio analysis provides the input for the next
phase in portfolio management.
2. The aim of portfolio construction is to generate
a portfolio that provides the highest returns.
3. A portfolio having this characteristic is known as
an efficient portfolio.
4. From this set of efficient portfolios the optimum
portfolio has to be selected for investment.
Portfolio Revision
1. Portfolio revision means alteration of the
composition of debt/equity instruments.
2. Any portfolio requires monitoring and revision.
3. Portfolio revision involves changing the existing
mix of securities.
4. New securities may be added to the portfolio.
5. The objective of portfolio revision is the same as
the objective of portfolio selection.
6. As time passes, securities, which were once
attractive, may cease to be so.
7. Portfolio revision may also be necessitated due
to some investor related changes.
8. Portfolio revision has to be done scientifically
and objectively.
9. Portfolio revision is more important process.
10. Portfolio revision is not a casual process to be
carried out without much care.
Need for Portfolio Revision
Need to invest more
Change in investment goal
Fluctuations in the financial market
Portfolio Revision Strategies
Active revision strategy
frequent changes in an existing portfolio
sell and purchase securities on a regular basis
Passive revision strategy
rare changes in portfolio only under certain
predetermined rules(formula plans)
Constraints of portfolio revision
Statutory Stipulations
Transaction costs
commission and brokerage
Intrinsic difficulty
Methodology not established
Different approaches adopted
Taxes
Short term capital gains taxed at higher rates
Costs Involved in Portfolio Revision
Trading fees
commissions and transfer taxes
Market impact
cost of executing a transaction
Increased Portfolio Management costs
High charges time consuming process
Tax implications
taxes on the realized capital gains
Portfolio Upgrading
Portfolio upgrading calls for re-assessing the risk return
characteristics of various securities selling over priced
securities, and buying under priced securities
Portfolio Upgrading Strategies
A buy candidate
Attractive stock
A hold candidate
Unattractive/ mildly unattractive
Rebalance the Portfolio
Rebalancing a portfolio is the process of
periodically adjusting it to maintain the
original conditions
The rebalancing of investments is the action
of bringing a portfolio that has deviated away
from one's target asset allocation back into
line.
Under-weighted securities can be purchased
with newly saved money, alternatively, overweighted securities can be sold to purchase
under-weighted securities.
13
Strategies to Rebalance the Portfolio
1. Buy and Hold Strategy
2. Constant Mix Strategy
3. Constant Proportion Portfolio
Insurance
14
Buy and Hold strategy
A passive investment strategy in which an investor buys stocks and
holds them for a long period of time, regardless of fluctuations in
the market.
An investor who employs a buy-and-hold strategy actively selects
stocks, but once in a position, is not concerned with short-term
price movements and technical indicators.
A buy and hold strategy means that the portfolio manager hangs
on to its original investments
Academic research shows that portfolio managers often fail to
outperform a simple buy and hold strategy on a risk-adjusted basis
15
Constant Mix Strategy
The constant mix strategy:
Is one in which the manager makes adjustments to maintain
the relative weighting of the asset classes within the portfolio
as their prices change
Requires the purchase of securities that have performed poorly
and the sale of securities that have performed the best
A constant mix strategy sells stock as it rises
In the short run, the market will be volatile, which favors
constant mix and strategy outperforms
16
Constant Mix Strategy
Example
A portfolio has a market value of $2 million. The investment
policy statement requires a target asset allocation of 60 percent
stock and 40 percent bonds.
The initial portfolio value and the portfolio value after one
quarter are shown on the next slide.
Date
Portfolio Value Actual Allocation
Stock
Bonds
1 Jan
$2,000,000
60%/40%
$1,200,000 $800,000
1 Apr
$2,500,000
56%/44%
$1,400,000 $1,100,000
17
Constant Mix Strategy (contd)
Example (contd)
What dollar amount of stock should the portfolio manager buy
to rebalance this portfolio? What dollar amount of bonds
should he sell?
Solution: a 60 percent/40 percent asset allocation for a $2.5
million portfolio means the portfolio should contain $1.5
million in stock and $1 million in bonds. Thus, the manager
should buy $100,000 worth of stock and sell $100,000 worth of
bonds.
18
Constant Proportion Portfolio Insurance (CPPI)
A CPPI strategy buys stock as it rises
Does best in a rising market because the portfolio manager will be
buying stock in a rising market which is logically a moneymaker.
If the market falls, CPPI will gradually revert to 100 percent bonds
since stock is sold as the market falls.
In the long run, the market will probably rise, which favors CPPI
hence In a rising market, the CPPI strategy outperforms
A constant proportion portfolio insurance (CPPI) strategy requires
the manager to invest a percentage of the portfolio in stocks
Formula
$ in stocks = Multiplier (Portfolio value Floor value)
19
Constant Proportion
Portfolio Insurance (contd)
Example
A portfolio has a market value of $2 million. The investment
policy statement specifies a floor value of $1.7 million and a
multiplier of 2.
What is the dollar amount that should be invested in stocks
according to the CPPI strategy?
Solution: $600,000 should be invested in stock:
$ in stocks = 2.0 ($2,000,000 $1,700,000)
= $600,000
20
Constant Proportion Portfolio Insurance (contd)
Example (contd)
If the portfolio value is $2.2 million one quarter later, with
$650,000 in stock, what is the desired equity position under the
CPPI strategy? What is the ending asset mix after rebalancing?
Solution: The desired equity position after one quarter should be:
$ in stocks = 2.0 ($2,200,000 $1,700,000)
= $1,000,000
The portfolio manager should move $350,000 into stock. The
resulting percentage would be: $1,000,000/$2,200,000 = 45.5%
21
Rebalancing Within the
Equity Portfolio
There are 4 methods
1. Constant Proportion
2. Constant Beta Portfolio
3. Change the Portfolio Components
4. Indexing
22
1. Constant Proportion
A constant proportion strategy within an
equity portfolio requires maintaining the
same percentage investment in each stock
May be mitigated by avoidance of odd lot
transactions
Constant proportion rebalancing requires
selling winners and buying losers
23
Constant Proportion (contd)
Example
An investor attempts to invest approximately one third of funds in each of the
stocks. Consider the following information:
Stock
Price
Shares
Value
% of Total Portfolio
FC
22.00
400
8,800
31.15
HG
13.50
700
9,450
33.45
YH
50.00
200
10,000
35.40
$28,250
100.00
Total
After one quarter, the portfolio values are as shown below. Recommend
specific actions to rebalance the portfolio in order to maintain the constant
proportion in each stock.
Stock
Price
Shares
Value
% of Total Portfolio
FC
20.00
400
8,000
21.92
HG
15.00
700
10,500
28.77
YH
90.00
200
18,000
49.32
$36,500
100.00
Total
24
Constant Proportion (contd)
Example (contd)
Solution: The worksheet below shows a possible revision which
requires an additional investment of $1,000:
Stock
Price
Shares
Value
Before
FC
20.00
400
8,000
Buy 200
12,000
32.00
HG
15.00
700
10,500
Buy 100
12,000
32.00
YH
90.00
200
18,000
Sell 50
13,500
36.00
$37,500
100.00
Total
$36,500
Action
Value
After
% of
Portfolio
25
2. Constant Beta Portfolio
A constant beta portfolio requires maintaining the
same portfolio beta
It is more likely to have requirements that beta be
within some given range
To increase or reduce the portfolio beta, the portfolio
manager can:
Reduce or increase the amount of cash in the portfolio
Purchase stocks with higher or lower betas than the target
figure
Sell high-beta stocks or low-beta stocks
Buy high-beta stocks or low-beta stocks
26
3. Change the Portfolio Components
Changing the portfolio components is
another portfolio revision alternative
Events sometimes deviate from what the
manager expects:
The manager might sell an investment turned
sour
The manager might purchase a potentially
undervalued replacement security
27
4. Indexing
Indexing is a form of portfolio management that
attempts to mirror the performance of a market
index
e.g., the S&P 500, S&P CNX Nifty
Index funds eliminate concerns about
outperforming the market
Also the portfolio manager should properly track
the index.
The tracking error refers to the extent to which a
portfolio deviates from its intended behavior
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Summery
Rebalancing strategy based on reasonable monitoring
frequencies (such as annual or semiannual) and reasonable
allocation to provide sufficient risk control relative to the
target asset allocation for most portfolios with broadly
diversified stock and bond holdings.
Portfolio rebalancing is an important in bringing the different
asset classes back into proper relationship. Hence you
should look at your portfolio at least quarterly in terms of
rebalancing and more frequently if you have had a significant
gain or loss in any asset class.
Investment Timing
Timing is everything
Everything you do is an investment of time
Perfectly balances each areas and forms a productive and
pleasurable life.
In order to incur minimum loss, investors must know what the
safe timing of investment is.
Basic strategy
Buy when the economy looks bad, corporate profits look bad,
and consumers are dejected.
The reason for this is simple:
WHEN IT LOOKS REALLY BAD, THERES PLENTY OF
ROOM ON THE UPSIDE. AND WHEN IT FEELS REALLY
GOOD, THERES PLENTY OF ROOM ON THE
DOWNSIDE.
Principles
Look for Multiple Positives
Avoid Multiple Negatives
Utilize the Power of Compounding
Strategy
Neither bear nor bull market is bad for knowledgeable
investors because both can be used to their benefits - the most
important thing is stock market predictability.
Everything is subject to change.
It is always dark before sunrise", or "the good times come
back when you least expect them
Does investment timing success
depend on luck?
yes and no
You create your own luck if you put yourself out there, take
risks, put yourself in situations where you can take advantage
of investment timing opportunities.
Best investment advice
To continually develop your investment timing skills and be
able to recognize opportunities as soon as they arise.
Formula Plans
Formula Plans
Basic rules and regulations for the purchase and sale of
securities
The amount to be spent on different type of securities is fixed
Depends on the investors attitude towards the risk and return
Certain predefined rules and regulations deciding when and
how much assets an individual can purchase or sell for
portfolio revision.
Why Formula Plans ?
To make the best possible use of fluctuations in the financial
market.
One can purchase shares when the prices are less and sell off
when market prices are higher.
An investor can divide his funds into aggressive and defensive
portfolio
Easily transfer funds from one portfolio to other.
Advantages
Basic rules and regulations for the purchase and sale of securities are
provided.
Rules and regulations are rigid and overcome human emotions
Higher profits
A course of action is formulated, according to investors objectives.
Controls the buying and selling of securities
Decision making on the timing of investments.
Disadvantages
Does not help the selection of the security.
It is strict and not flexible with the inherent problems of
adjustment.
Should be applied for long periods, otherwise the transaction
cost may be high.
Need for forecasting.
Types of Formula Plans:
The constant ratio plan
The variable ratio plan
Rupee cost averaging plan
Constant rupee value plan
Assumptions of the Formula Plans
1. Certain percentage of the investors fund is allocated to fixed
income securities and common stocks.
2. If the market moves higher, the proportion of stocks in the
portfolio may either decline or remain constant
3. The stocks are bought or sold whenever there is a significant
change in the price.
Assumptions
cont
4. The investor should strictly follow the formula plans once he
chooses it.
5. The investor should select good stocks that move along with
the market
Constant Ratio Plan
Attempts to maintain a constant ratio between the aggressive
and conservative portfolios.
The ratio is fixed by the investor. The investors attitude
towards the risk and return plays a major role in fixing the
ratio
It is maintained as the market moves up and down.
Example
Market
price
Number of
shares in
stock
portion
Value of
stock
(Rs)
Value of
defensive
Portfolio
(Rs)
Total
portfolio
value
(Rs)
50
100
5000
5000
10000
Ratio of
stock
portion to
Defensive
portion
1.00
48
100
4800
5000
9800
0.96
45
100
4500
5000
9500
0.90
Rs 248 transferred from bond portion and 5.5 shares purchased
45
105.5
4748
4752
9500
1.00
40.5
105.5
4273
4752
9025
0.90
Bought 5.9 shares by transferring Rs 239 from bond portion
40.5
111.4
4512
4511
9023
1.00
44.5
111.4
4357
4511
9468
1.10
5 shares are sold and invested in bonds to make the ratio equal 1:1
Constant Rupee plan
Period
Market
Price (Rs)
Number of
shares
Value of
stock
portfolio
(Rs)
Value of
Defensive
portfolio
Total
50
200
10,000
10,000
20,000
44
200
8,800
10,000
18,800
40
200
8,000
10,000
18,000
40
250
10,000
8,000
18,000
Bought 50 Shares
5
44
250
11,000
8,000
19,000
50
250
12,500
8,000
20,500
50
200
10,000
10,500
20,500
Sold 50 Shares
Advantages
The investor is not emotionally affected by the
price changes in the market.
Disadvantages
Security selection by analyzing merits of stock.
appropriate zones and trend for alteration of the
proportions
Small zones reduce portfolio performance.
Rupee Cost Averaging
Quarter
Market
Price
Shares
purchase
d
Cumulati Market
ve
Value
Investme (Rs)
nt
Unrealis
ed
Profit/
loss
Average
cost
per
share
Average
Market
price per
share
100
10
1000
1000
100
100
90
11
1990
1890
(100)
94.76
95
100
10
2990
3100
110
96.45
96.67
110
3980
4400
420
99.50
100
Advantages
Reduces the average cost per share
Pressure of timing stock purchase taken away
Makes the investors to plan the investment
programme based on the commitment of funds
that has to be done periodically.
Applicable to both falling and rising market,
although it works best if the stocks are acquired
in a declining market.
Disadvantages
Extra transaction costs are involved with small
purchase of shares.
The plan does not indicate when to sell.
It does not eliminate the necessity for selecting
the individual stocks that are purchased.
There is no indication of the appropriate interval
between purchases
The averaging advantage does not yield profit if
the stock price is on a downward trend.
The plan seems to work better when stock prices
have cyclical patterns
Variable Ratio plan
Share
Price (Rs)
Value of
Stock
portion
(Rs)
Value of
Defensive
(Rs)
Total
portfolio
value (Rs)
Stock as a
percentag
e of the
portfolio
Portfolio
adjustmen
t
Shares in
stock
portion
(Rs)
100
10,000
10,000
20,000
50.00
100
90
9,000
10,000
19,000
47.37
100
80
8,000
10,000
18,000
44.4
100
80
12,640
5,400
18,040
70.06
Bought 58
shares
158
90
14,220
5,400
19,620
72.48
158
100
15,800
5,400
21,200
74.53
Sold 50
shares
158
100
10,800
10,800
21,600
50.00
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