Portfolio management

Definition

Portfolio management is the art and science of making decisions about investment mix and policy to match an investor's financial goals, risk tolerance, and investment horizon. It involves selecting a diverse array of assets, balancing risk and return, and regularly reviewing and adjusting the investment strategy to optimize performance. Effective portfolio management requires an understanding of various investment strategies, interest rate movements, and performance measurement techniques.

5 Must Know Facts For Your Next Test

1. Portfolio management can be active or passive; active management involves ongoing buying and selling to outperform a benchmark, while passive management aims to replicate the performance of a specific index.
2. A well-managed portfolio should consider both short-term and long-term investment goals, taking into account changing market conditions and economic forecasts.
3. Investors often use diversification as a key strategy in portfolio management to reduce risk by spreading investments across various asset classes.
4. The performance of a portfolio is regularly assessed using metrics such as return on investment (ROI), Sharpe ratio, and alpha to measure how well the investments are doing compared to a benchmark.
5. Behavioral finance plays a significant role in portfolio management, as investor psychology can influence decisions, leading to biases that may affect performance outcomes.

Review Questions

• How do different equity portfolio management strategies influence overall investment performance?
  • Different equity portfolio management strategies can greatly impact investment performance through their approach to asset selection and risk management. For instance, active management focuses on stock picking and timing the market for higher returns, while passive management seeks to mirror an index for steady growth. Understanding these strategies helps investors align their portfolios with their financial goals, risk tolerance, and market conditions.
• Discuss how duration and convexity are used in portfolio management to manage interest rate risk.
  • Duration measures the sensitivity of a bond's price to changes in interest rates, while convexity accounts for the curvature in the relationship between bond prices and interest rates. Portfolio managers use these concepts to assess and manage interest rate risk within fixed-income securities. By understanding the duration and convexity of the bonds in a portfolio, managers can better anticipate how changes in interest rates will impact overall portfolio value and make adjustments accordingly.
• Evaluate the importance of attribution analysis in assessing the effectiveness of portfolio management strategies.
  • Attribution analysis is critical for evaluating the effectiveness of portfolio management strategies by breaking down the sources of portfolio returns. This method allows managers to determine how much of the performance can be attributed to asset allocation decisions versus individual security selection. By analyzing these components, managers can refine their strategies based on empirical evidence, ensuring that they are effectively meeting investor objectives while managing risks.

Related terms

Asset Allocation: The process of dividing an investment portfolio among different asset categories, such as stocks, bonds, real estate, and cash.

Risk Tolerance: An investor's ability and willingness to endure market volatility and potential losses in pursuit of higher returns.

Rebalancing:

The act of realigning the proportions of assets in a portfolio to maintain the desired level of asset allocation or risk.