Portfolio Management

Portfolio management in the context of investments refers to the process of making decisions about investment mix and policy, aligning investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance. This process involves a range of services, such as determining the suitable investments, asset allocation, risk management, and periodic rebalancing.

Here's a breakdown of some of the core components of portfolio management:

  1. Investment Policy: This is the first step in the portfolio management process. It involves understanding the client's needs and constraints. The client's financial goals, risk tolerance, time horizon, and income requirements are taken into consideration to create a suitable investment policy.

  2. Asset Allocation: Once the investment policy is established, the next step is asset allocation. This involves deciding the proportion of funds to be invested in various asset classes such as stocks, bonds, real estate, and other investment vehicles. The asset allocation decision is crucial as it determines the portfolio's risk and return characteristics.

  3. Security Selection: After determining the asset allocation, the next step is to choose specific securities within each asset class. This process can be driven by a variety of approaches, including fundamental analysis, technical analysis, or quantitative methods.

  4. Portfolio Implementation: This is the stage where the portfolio is actually created by purchasing the chosen securities. This requires careful consideration of transaction costs and market timing.

  5. Review and Rebalancing: Portfolio management also includes regular reviews of the portfolio to ensure that it is on track to achieve the client's objectives. This may involve rebalancing, which is the process of realigning the proportions of assets in the portfolio. Rebalancing is necessary to maintain the desired level of risk, as the relative values of assets in a portfolio can change over time due to varying returns from different assets.

  6. Risk Management: Throughout the process, the portfolio manager continually assesses and manages the risk levels of the portfolio, ensuring that it aligns with the client's risk tolerance and investment objectives.

Portfolio management can be either passive or active. Passive management, often referred to as "indexing", involves creating a portfolio that mirrors a market index, and it's generally a low-cost strategy. Active management, on the other hand, involves a portfolio manager making specific investments with the goal of outperforming an investment benchmark index. Active managers rely on analytical research, forecasts, and their own judgment and experience in making investment decisions on what securities to buy, hold, or sell.


Let's consider Ava, a software engineer who's just turned 30. She's started saving and investing with the goal of a comfortable retirement at the age of 60. She's also looking to save for a down payment for a house in 10 years.

Ava seeks the help of a portfolio manager at a financial services firm to help her with these goals. Here's how the process would unfold:

  1. Investment Policy: Ava's portfolio manager conducts an initial interview to understand her financial goals, risk tolerance, income requirements, and time horizon. Ava expresses that she wants to retire in 30 years, buy a house in 10 years, and that she's willing to take moderate risk to achieve her goals. They agree on an investment policy that reflects these considerations.

  2. Asset Allocation: Given Ava's age, time horizon, and risk tolerance, the portfolio manager decides on an aggressive asset allocation strategy. He suggests a portfolio split of 70% stocks, 20% bonds, and 10% in other asset classes like real estate and commodities. This allocation is geared towards capital growth, given her long time horizon and moderate risk tolerance.

  3. Security Selection: The portfolio manager then decides on which specific stocks, bonds, real estate investment trusts (REITs), and commodities to include in Ava's portfolio. This might involve investing in a diversified mix of blue-chip and growth stocks, government and corporate bonds, an index fund for the REITs, and a commodities ETF for the commodities portion.

  4. Portfolio Implementation: Once the decisions are made, the portfolio manager buys the chosen securities for Ava, creating her investment portfolio.

  5. Review and Rebalancing: Every year (or as agreed), Ava's portfolio manager reviews her portfolio's performance against the benchmark indices. Suppose the stock portion of her portfolio did very well and now represents 80% of her portfolio, instead of the planned 70%. To realign the portfolio with the initial plan, the portfolio manager might sell off some stocks and purchase more bonds and other assets. This process is called rebalancing.

  6. Risk Management: The portfolio manager is always monitoring risk. If he sees that one of the stocks in the portfolio has become riskier due to changes in the company's business or industry, he may decide to sell it and replace it with a less risky stock.

Through this systematic process, the portfolio manager is able to create, manage, and adjust a portfolio that suits Ava's unique needs, helping her work towards her financial goals while respecting her risk tolerance.