Portfolio Management - Meaning and Important Concepts?

1 What is a Portfolio ?

2 Financial Investment - Meaning, its Need and Different Types of Investments?

3 What is a Financial Market ?

4 Shares and Stock Market - An Overview?

5 What are Market Indices ?

6 The Promise and Perils of High Frequency Trading or HFT?

What is a Portfolio ?

A portfolio refers to a collection of investment tools such as stocks, shares, mutual funds, bonds, cash and so on depending on the investor’s income, budget and convenient time frame.
Following are the two types of Portfolio:

1. Market Portfolio
2. Zero Investment Portfolio

What is Portfolio Management ?

The art of selecting the right investment policy for the individuals in terms of minimum risk and maximum return is called as portfolio management.
Portfolio management refers to managing an individual’s investments in the form of bonds, shares, cash, mutual funds etc so that he earns the maximum profits within the stipulated time frame.
Portfolio management refers to managing money of an individual under the expert guidance of portfolio managers.
In a layman’s language, the art of managing an individual’s investment is called as portfolio management.

Need for Portfolio Management

Portfolio management presents the best investment plan to the individuals as per their income, budget, age and ability to undertake risks.
Portfolio management minimizes the risks involved in investing and also increases the chance of making profits.
Portfolio managers understand the client’s financial needs and suggest the best and unique investment policy for them with minimum risks involved.
Portfolio management enables the portfolio managers to provide customized investment solutions to clients as per their needs and requirements.

Types of Portfolio Management

Portfolio Management is further of the following types:

• Active Portfolio Management: As the name suggests, in an active portfolio management service, the portfolio managers are actively involved in buying and selling of securities to ensure maximum profits to individuals.
• Passive Portfolio Management: In a passive portfolio management, the portfolio manager deals with a fixed portfolio designed to match the current market scenario.
• Discretionary Portfolio management services: In Discretionary portfolio management services, an individual authorizes a portfolio manager to take care of his financial needs on his behalf. The individual issues money to the portfolio manager who in turn takes care of all his investment needs, paper work, documentation, filing and so on. In discretionary portfolio management, the portfolio manager has full rights to take decisions on his client’s behalf.
• Non-Discretionary Portfolio management services: In non discretionary portfolio management services, the portfolio manager can merely advise the client what is good and bad for him but the client reserves full right to take his own decisions.

Who is a Portfolio Manager ?

An individual who understands the client’s financial needs and designs a suitable investment plan as per his income and risk taking abilities is called a portfolio manager. A portfolio manager is one who invests on behalf of the client.
A portfolio manager counsels the clients and advises him the best possible investment plan which would guarantee maximum returns to the individual.
A portfolio manager must understand the client’s financial goals and objectives and offer a tailor made investment solution to him. No two clients can have the same financial needs.

Portfolio Management Models

Portfolio management refers to the art of managing various financial products and assets to help an individual earn maximum revenues with minimum risks involved in the long run. Portfolio management helps an individual to decide where and how to invest his hard earned money for guaranteed returns in the future.

Portfolio Management Models

1. Capital Asset Pricing Model Capital Asset Pricing Model also abbreviated as CAPM was proposed by Jack Treynor, William Sharpe, John Lintner and Jan Mossin.
   When an asset needs to be added to an already well diversified portfolio, Capital Asset Pricing Model is used to calculate the asset’s rate of profit or rate of return (ROI).
   In Capital Asset Pricing Model, the asset responds only to:
   
   • Market risks or non diversifiable risks often represented by beta
   • Expected return of the market
   • Expected rate of return of an asset with no risks involved
   What are Non Diversifiable Risks ?
   Risks which are similar to the entire range of assets and liabilities are called non diversifiable risks.
   Where is Capital Asset Pricing Model Used ?
   Capital Asset Pricing Model is used to determine the price of an individual security through security market line (SML) and how it is related to systematic risks.
   What is Security Market Line ?
   Security Market Line is nothing but the graphical representation of capital asset pricing model to determine the rate of return of an asset sensitive to non diversifiable risk (Beta).
   
2. Arbitrage Pricing Theory Stephen Ross proposed the Arbitrage Pricing Theory in 1976.
   Arbitrage Pricing Theory highlights the relationship between an asset and several similar market risk factors.
   According to Arbitrage Pricing Theory, the value of an asset is dependent on macro and company specific factors.
   
3. Modern Portfolio Theory
   Modern Portfolio Theory was introduced by Harry Markowitz.
   According to Modern Portfolio Theory, while designing a portfolio, the ratio of each asset must be chosen and combined carefully in a portfolio for maximum returns and minimum risks.
   In Modern Portfolio Theory emphasis is not laid on a single asset in a portfolio, but how each asset changes in relation to the other asset in the portfolio with reference to fluctuations in the price.
   Modern Portfolio theory proposes that a portfolio manager must carefully choose various assets while designing a portfolio for maximum guaranteed returns in the future.
4. Value at Risk Model Value at Risk Model was proposed to calculate the risk involved in financial market. Financial markets are characterized by risks and uncertainty over the returns earned in future on various investment products. Market conditions can fluctuate anytime giving rise to major crisis.
   The potential risk involved and the potential loss in value of a portfolio over a certain period of time is defined as value at risk model.
   Value at Risk model is used by financial experts to estimate the risk involved in any financial portfolio over a given period of time.
   
5. Jensen’s Performance Index Jensen’s Performance Index was proposed by Michael Jensen in 1968.
   Jensen’s Performance Index is used to calculate the abnormal return of any financial asset (bonds, shares, securities) as compared to its expected return in any portfolio.
   Also called Jensen’s alpha, investors prefer portfolio with abnormal returns or positive alpha.
   Jensen’s alpha = Portfolio Return – [Risk Free Rate + Portfolio Beta * (Market Return – Risk Free Rate)
   
6. Treynor Index
   Treynor Index model named after Jack.L Treynor is used to calculate the excess return earned which could otherwise have been earned in a portfolio with minimum or no risk factors involved.
   Where T-Treynor ratio
   

Financial Investment - Meaning, its Need and Different Types of Investments

It is human nature to plan for rainy days. An individual must plan and keep aside some amount of money for any unavoidable circumstance which might arise in days to come.
Future is uncertain and one must invest wisely to avoid financial crisis in any point of time.
Let us first understand what is investment ?
Investment is nothing but goods or commodities purchased today to be used in future or at the times of crisis. An individual must plan his future well to ensure happiness for himself as well as his immediate family members. Consuming everything today and saving nothing for the future is foolish. Not everyday is a bed of roses, you never know what your future has in store for you.

What is Financial Investment ?

Financial investment refers to putting aside a fixed amount of money and expecting some kind of gain out of it within a stipulated time frame.

What is Important in Financial Investment ?

Planning plays a pivotal role in Financial Investment. Don’t just invest just for the sake of investing. Understand why you really need to invest money? Investing just because your friend has said you to do so is foolish. Careful analysis and focused approach are mandatory before investing.
Explore all the investment plans available in the market. Go through the pros and cons of each plan in detail. Analyze the risk factors carefully before finalizing the plan. Invest in something which will give you the maximum return.
Appoint a good financial planning manager who takes care of all your investment needs. He must understand your requirement, family income, stability etc to decide the best plan for you.
One needs to be a little careful and sensible while investing. An individual must read the documents carefully before investing.

Types of Financial Investment

An individual can invest in any of the following:

• Mutual Funds
• Fixed Deposits
• Bonds
• Stock
• Equities
• Real Estate (Residential/Commercial Property)
• Gold /Silver
• Precious stones

Need for Financial Investment

Financial Investment ensures all your dreams turn real and you enjoy life to the fullest without actually worrying about the future.
Financial investment ensures you save for rainy days. Careful investment makes your future secure.
Financial investment controls an individual’s spending pattern. It decides how and what amount one should spend so that he has sufficient money for future.

Tips for Financial investment

Don’t just blindly trust your financial advisor. Read the terms and conditions and go through all the related documents carefully before signing. Check out risk factors, tenure, clauses etc before selecting the plan.
Avoid cash transactions. It is always advisable to issue an account payee cheque in favour of the company rather than giving cash to your advisor. You never know when he disappears with all your hard earned money.
Carefully staple all the related documents and put it in a folder. Keep it at a proper and safe place. Loosing even a single paper might land you in trouble later on.
Make sure your investment plan is the best in the market and guarantees sufficient return in future.
If you plan to invest in property, ensure it is at a prime location and would have takers in the near future. Investing in non approved properties is worthless.

What is a Financial Market ?

A market is a place where two parties are involved in transaction of goods and services in exchange of money. The two parties involved are:

• Buyer
• Seller

In a market the buyer and seller comes on a common platform, where buyer purchases goods and services from the seller in exchange of money.

What is a Financial Market ?

A place where individuals are involved in any kind of financial transaction refers to financial market. Financial market is a platform where buyers and sellers are involved in sale and purchase of financial products like shares, mutual funds, bonds and so on.
Let us go through the various types of financial market:

Capital Market

A market where individuals invest for a longer duration i.e. more than a year is called as capital market. In a capital market various financial institutions raise money from individuals and invest it for a longer period.
Capital Market is further divided into:

1. Primary Market: Primary Market is a form of capital market where various companies issue new stock, shares and bonds to investors in the form of IPO’s (Initial Public Offering). Primary Market is a form of market where stocks and securities are issued for the first time by organizations.
2. Secondary Market: Secondary market is a form of capital market where stocks and securities which have been previously issued are bought and sold.

Types of Capital Market

1. Stock Markets: Stock Market is a type of Capital market which deals with the issuance and trading of shares and stocks at a certain price.
2. Bond Markets: Bond Market is a form of capital market where buyers and sellers are involved in the trading of bonds.
3. Commodity Market: A market which facilitates the sale and purchase of raw goods is called a commodity market. Commodity market like any other market includes a buyer and a seller. In such a market buyer purchases raw products like rice, wheat, grain, cattle and so on from the seller at a mutually agreed rate.
   
4. Money Market: As the name suggests, money market involves individuals who deal with the lending and borrowing of money for a short time frame.
5. Derivatives Market: The market which deals with the trading of contracts which are derived from any other asset is called as derivative market.
6. Future Market: Future market is a type of financial market which deals with the trading of financial instruments at a specific rate where in the delivery takes place in future.
7. Insurance Market: Insurance market deals with the trading of insurance products. Insurance companies pay a certain amount to the immediate family members of owner of the policy in case of his untimely death.
8. Foreign Exchange Market: Foreign exchange market is a globally operating market dealing in the sale and purchase of foreign currencies.
9. Private Market: Private market is a form of market where transaction of financial products takes place between two parties directly.
10. Mortgage Market: A type of market where various financial organizations are involved in providing loans to individuals on various residential and commercial properties for a specific duration is called a mortgage market. The payment is made to the individual concerned on submitting certain necessary documents and fulfilling certain basic criteria.

    Shares and Stock Market - An Overview

    An organization in order to raise money divides its entire capital into small units of equal value. Each unit is called a share.
    A share is nothing but an indivisible unit of a company’s capital to be sold among individuals to increase profit of the organization.
    

    Shareholder

    An individual owning one or more than one share of an organization is called a shareholder. In simpler words, an individual purchasing one or more than one share from any private or public organization is called a shareholder.
    
11. A shareholder can sell his shares anytime depending on the current value of the share.
12. He/she can purchase any new share issued by any other or same organization.
13. A shareholder has the right to declared dividend.

Dividend

Why do people invest in shares ?
An organization pays the shareholders for investing in their company’s shares. The income earned by an individual by investing in an organization’s share (private or public) is called as dividend.
What is Retained Earnings ?
The profit earned by an organization is put into use in the following two ways:

• It is paid to the shareholders as dividend.
• The profit earned by the organization is not distributed amongst the shareholders but is retained and reinvested in the organization. This portion of the income is called retained earnings.

What is a Share Certificate ?
When an individual purchases shares from any organization, he/she is issued a certificate as a proof of his investment. Such a certificate issued by an organization to the shareholders is called a share certificate.

Types of Shares

1. Equity Shares Equity shares also called as ordinary shares are the shares where the payment of dividend is directly proportional to the profits earned by the organization. Higher the profits earned, higher the dividend, lower the profits, and lower the dividend. In an equity share, dividends are paid at a fluctuating/floating rate.
   
2. Preference Shares Shares which enjoy preference over payment of dividends are called preference shares. Shareholders enjoy fixed rate of dividends in case of preference shares.
   
3. Founder Shares Shares held by the management or founders of the organization are called as founder shares.
   
4. Bonus Shares Bonus shares are often issued to the shareholders when the organization earns surplus profits. The company officials may decide to pay the extra profits to the shareholders either as cash (dividend) or issue a bonus share to them.
   Bonus shares are often issued by organizations to the shareholders free of charge as a gift in proportion to their existing shares with the organization.
   

How to buy shares ?

• Find a good broker for yourself. Make sure he has good knowledge about the share market and can guide you properly.
• To invest in shares one needs to open a DEMAT Account for online trading. A DEMAT Account is mandatory for sale and purchase of shares anytime and anywhere.
• An individual needs to have his PAN Card, a bank account, other necessary Identity proofs, address proofs and so on.

What is a Stock Market ?

A stock market is a platform for trading of company’s shares at an agreed rate.

What are Market Indices ?

Stock market indices are ubiquitous. People come across these indices almost every day. However, many are not aware about their existence. For instance everyone knows about NYSE, NASDAQ, FTSE, NIFTY etc. However, few are aware that they are referring to stock market indices when they talk about the markets going up or down. The New Stock Exchange is just an exchange. It does not rise or fall in value. The indices calculated based on the data aggregated by New York Stock Exchange are what everyone seems to be referring to all the time.
In this article, we will provide a basic introduction of market indices. This will equip the reader to understand what these indices are and why they are important.

What are Market Indices ?

Market indices are merely statistical indicators. In financial markets, they are designed to let the people compare the performance of a portfolio of securities. This portfolio could represent an entire market or a particular segment of the market like banking, oil and gas etc.
The index can be easily created because the Pareto principle applies to financial markets. This means that only 20% of the companies that are listed account for more than 80% of the value on the stock exchange. Hence, these indices only track the movements of a handful of companies in the market. Since these companies broadly represent the market the performance of the entire market can be gauged from their performance.
Index values only make sense when compared to a base value. The base value could be a previous day’s value or it could be the value from many years ago. Usually the base value of an index is 100. The base value, along with the base year, need to be known in order to determine the compounded annual growth rate at which the securities have been growing.

What are Indices Used For

Indices can be used for many purposes. Some of them have been mentioned below.

• Monitoring: The most obvious use of an index is to monitor the movements in stock market. Since all the movements are anchored to the same base year and base value, drawing comparisons amongst them becomes relatively easy. Indices are the most common way to track the movement of stock prices worldwide. That being said the movement in one index cannot be compared to the movement in another index. These indices therefore do not allow from inter-index comparisons.
• Benchmarking: Indices tell investors how a stock behaved in comparison to the market in general. This makes it easier to benchmark stock. To know whether a stock outperformed the others, it is essential that the growth of the stock be known and the growth in the relative index be known. A stock cannot said to have outperformed even if it grew by 20%. If the index grew by 25% during the same period, a 20% growth would instead be considered a lackluster performance.
• Measure of Riskiness: The value derived from the indices is a critical component when the riskiness of a stock needs to be determined. Just like the returns are relative so is risk. A stock is said to be more or less risky in comparison to other stocks in the market. Data is collected which compares the risk of the stock vis-à-vis the indices. This data is then converted into a statistical measure called “beta” which is the universal measure of riskiness.
• Derivatives: Indices are also used as the basis on which derivative contracts are drawn. Since index movements cannot be manipulated, derivatives traders base their contracts on these indices. For instance, a contract may state that a 1% movement in the index will cause party A to pay 2% to party B. Another measure that is used for this purpose is called the LIBOR. However, there are speculations that the LIBOR may have been rigged. Therefore now-a-days traders prefer to use indices.

Characteristics of an Index

Market indices must have certain characteristics. The important ones have been listed below:

• Transparent: Market indices must be transparent. The methodology used for calculations must be revealed to the common public. This builds confidence in the market index and helps in its adaptation. The more people trust a market index, the more they will base their decisions on it.
• Unbiased: Market indices must be unbiased. This is to say that a party that has conflicting interests must not be part of the index calculation process. This is because if they get the information before the rest of the market, then they will be at an advantage. Also, they are likely to manipulate the information to their advantage. To avoid this conflict of interest situation, indices must be transparent.
• Current: Indices must be dynamic. The market situation is dynamic. This means it keeps changing from time to time. Therefore if an index that represents the situation is static, soon the index will no longer be relevant. Indices must therefore be updated from time to time.

Indices can be created based on multiple methodologies. In the next article, we will study some of the methodologies that are used to construct these indices and how they affect the outcomes of those indices.

The Promise and Perils of High Frequency Trading or HFT

What is HFT or High Frequency Trading ?

HFT or High Frequency Trading is a process where trading in equities, bonds, derivatives, and just about all financial instruments is done through computers driven by algorithms that determine the trading patterns rather than humans trading on the basis of information. In other words, HFT means that trading in financial instruments is done through computers talking to each other that are powered by complex algorithms that map how trading has to be done. HFT is a recent phenomenon that arose from the need to make sense of the increasingly complex nature of financial markets.
HFT resembles the 21st century trading paradigm where information is obtained real time and those market participants who can use the information instantaneously benefit more than those who are late to the react to the developments. Since computers driven by Artificial Intelligence or AI have the ability to react in real time to changing market trends, HFT has revolutionized the way in which financial markets operate in the West and especially on Wall Street. As we shall discuss subsequently, there are advantages and disadvantages of HFT.

The Promise of HFT

The promise of HFT lies in the fact that humans cannot make sense of the rapidly changing market trends and the accelerating changes in financial markets in real time. On the other hand, computers powered by AI have the ability to respond in real time to the changes and the flows of information. Since asymmetries of information are the real reason why financial markets are imperfect, it is believed that HFT would do away with this anomaly or shortcoming and lead to markets that are more efficient. Further, it is believed that handling the ever increasingly complexity and the explosion in the volumes of financial products that are traded can only be managed through computers that pack in a lot of punch with their computing power. Indeed, this is the best argument and the justification that is made for the use of HFT as it has the power to revolutionize the way in which financial markets operate. Indeed, in the west and on Wall Street, HFT has engineered a revolution in the way Wall Street brokers’ trade with each other and financial firms operate. The use of HFT is being adopted worldwide following the success of its venture in the West.

The Perils of HFT

However, there are many perils of using HFT as well. For starters, chances of the computer programs going haywire and large-scale swings in the markets is one big danger that HFT poses. As can be seen from the various flash crashes where the DOW and the NASDAQ crashed abysmally within a few minutes on several occasions within the last couple of years, the potential for dangerous situations to manifest themselves is very high. Further, as computers make the decisions on trading rather than humans and the AI can sometimes encounter a situation where human intervention is needed, HFT cannot be the solution all the time. The preferred method would be for a system where the actual human traders have the overall decision-making power rather than the computers alone wherein any potential for the software going haywire is immediately rectified through prompt human intervention. The other danger that HFT poses is that it elbows out the individual investor and the jobbers or the small traders and bestows all the benefits on large financial firms. Considering the fact that financial markets are supposed to work for the benefit of everybody, HFT moves away from democratization of the market.

Concluding Remarks

Finally, when one considers the promise and the perils of HFT, it is clear that the balance is even and hence, one has to watch how the future of trading in financial markets evolves to a situation that is more in tune with market participants and their desires.