3. Portfolio Management Theories
Transcript of 3. Portfolio Management Theories
Portfolio Management
The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against. performance.
Traditional Theory Parameters of investment avenues are risk
and return Correlation between securities is not
considered Risk is considered in total but as
systematic /unsystematic Selection of securities- risk & return Diversification is done on the basis of class
of securities.
Steps for Portfolio Creation (TPT)
Portfolio objectives and constraints Diversification Allocation of funds Execution of funds
Modern Portfolio Theory
Harry Markowitz Stresses – creation of a portfolio depends
upon the correlation of securities. Favour the concept of Efficient Frontier. EF-Contains all Efficient Portfolios EP- which gives max return or minimum
risk.
Principles of MPT
Principle of Risk
Principle of Diversification
Principle of portfolio effect (Never put all eggs in one basket)
Principle of Dominance (more return / less risk when compared with other Portfolio)
Principle of Market risk (systematic risk)
Principle of Beta
Principle of trade off between risk and return
Principle of Avoidance ( unsystematic risk)
Markowitz Portfolio Theory Selection of securities and construction of
portfolio is based on 2 factors1. Mean return2. variance return
Under this method expected mean return for each unit of risk is considered for the identification of efficient Portfolio.
Also called as “Mean –variance Criterion of Markowitz”.
Identifies the relationship between different securities in portfolio through the concept of Correlation
Introduces the concept of Diversification Correlation is + = securities move in
same direction Correlation is - = securities move in
opposite direction
Assumptions of MPT Only 2 attributes ;mean and variance Risk averse behaviour of investors( behaviour of either avoiding risk or covering
it). Higher the risk, higher the returns Investors are utility Maximizers (deriving
optimum satisfaction (return) by assuming a particular level of risk).
Correlation between the securities
Diversification can reduce risk.