Last Updated on October 1, 2023 at 5:42 pm
This is a guest post by Bhavik Mehta. Bhavik is an avid Micro Cap Researcher and Personal Finance Writer. He has completed his CA and is a CFA (Certified financial analyst) and an FRM (certified Financial Risk Manager) . I requested him to write about how an investment portfolio is constructed. He was kind enough to offer to write a series of posts on the subject. Over to Bhavik.
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In the financial world, there is a rigorous race to separate the wheat from the chaff but most people in this quest consistently forget to separate the wheat from rice in the first place.
Financial Product research has been taken too casually with the advent of modern day web and media. Although individual product research or asset class views might be simpler for most people to gauge, the real trouble lies in creating a portfolio out of this.
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Most people inherently mistake good product or security selection to be a measure of portfolio creation too. This is the very reason that most portfolios are way away from their expected returns!
Through the initial years as an investor/trader, I too had the habit and zeal to chase individual stock ideas without understanding it’s impact on my portfolio. But over the years, I have understood the importance of portfolio evaluation as a whole through formal education and informal experiences.
The path of portfolio management although has a long way to go as short term stock successes overpowers the holistic portfolio vision more often than not. The focus would only be visible once an individual sits and understands the net returns of all investments within a portfolio as a one. So, once investing moves away from a hobby or entertainment mode, the portfolio making purpose would evolve into a bigger picture.
Portfolio Management could be informally bifurcated into parts, one is managing a multi-asset class portfolio and the other is managing a portfolio within a single asset class for example equity.
Let us try and fathom this second part for now. Equity in itself has embodied multiple models and segregation techniques. For most people in India, equity is a matter of casual investment through hearsays and self-research. The funnier part is that in spite of dismal portfolio returns, most people consider them as connoisseurs of equity investing. The root cause of the highly undermined returns is the lack of understanding a need for a dedicated portfolio strategy.
Portfolio Management need not be a complex task always, it could be as simple as buying 3 Mutual Fund Schemes but the complexity lies in managing the behaviour which guides the management.
Within equity too, there are multiple ways in which a portfolio could be created. One would be the Mutual Fund/PMS/Schemes way and the second is direct equity investing. Both measures have their own pros and cons though.
At first, let us try and decipher what drives the basics of portfolio management within the direct equity phase and how a portfolio manager would work towards creating a customised equity portfolio for you. The initial step would involve understanding the return expectations, the risk taking ability and the liquidity constraints of the investor.
Once that is figured out, creating a balance between all three to create a portfolio would be the beginning phase. It is important to know that investor’s expectations and willingness is not always the same, so a portfolio manager in a customised portfolio creation would have to put in a lot of effort to align the two! Investors who wish to know this process more, could read this piece: Investment Policy Statement
Once all the pre-requisites of building a portfolio are in place, the portfolio manager could move on to the next and the real task of building a portfolio. (Generally for mutual fund managers or PMS managers, an unified risk and return ritual is done within the scheme objective itself.) So, whether it is a portfolio of a fund or an individual, each one would have it’s own set of rules depending on the boundary created in the first step.
As an individual, you could have your own set of rules to build your portfolio, just that it is very difficult to follow the rules ;-). Remember that, concentrated or diversified, the need for a portfolio is always there. It is just that for some who have created immense amount of wealth, the importance would tilt towards multitude of other things other than a portfolio but for most of us a monitored portfolio would predominantly be the necessity. When Pattu is there to help us with the math, evaluating portfolios would be an easy task!
To be continued …
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