UNIVERSITY OF MUMBAI
PROJECT ON PORTFOLIO MANAGEMENT.
SUBMITTED BY SHUBHANGI S. ADENKAR.
PROJECT GUIDE MRS. MINAL GANDHI.
BACHELOR OF MANAGEMENT STUDIES
SEMESTER V (2009-10)
V.E.S. COLLEGE OF ARTS, SCIENCE & COMMERCE, SINDHI COLONY, CHEMBUR – 400071 1
UNIVERSITY OF MUMBAI PROJECT ON PORTFOLIO MANAGEMENT.
Submitted In Partial Fulfillment of the requirements For the Award of the Degree of Bachelor of Management By SHUBHANGI. S. ADENKAR. PROJECT GUIDE MRS. MINAL GANDHI.
BACHELOR OF MANAGEMENT STUDIES SEMESTER V (2009-10) V.E.S. COLLEGE OF ARTS, SCIENCE & COMMERCE, SINDHI COLONY, CHEMBUR – 400071 2
Declaration
I
student of BMS – Semester V
(2009-10) hereby declare that I have completed this project on
.
The information submitted is true & original to the best of my knowledge.
Student’s Signature (
)
3
C E R T I F I C A T E This is to certify that Ms.
_____ of
TYBMS has successfully completed the project on ___________________________ under the guidance of ___________________________.
Project Guide Mrs. MINAL GANDHI
Principal Dr. (Mrs.) J. K. PHADNIS
Course Co-ordinator Mrs. A. MARTINA
External Examiner
4
ACKNOWLEDGEMENT It gives me great pleasure to submit this project to the University of Mumbai as a part of curriculum of my BMS course. I take this opportunity with great pleasure
to
present
before
you
this
project
on
“PORTFOLIO
MANAGEMENT" which is a result of co-operation, hard work and good wishes of many people. The most pleasant part of any project is to express the gratitude towards all those who have contributed to the success of the project. I would like to thank Mrs. MINAL GANDHI who has been my mentor for this project. It was only through her excellence assistance and good suggestions that I have been able to complete this project. Library Staff: For giving valuable information about the various books related to this project. Family and Friends: For their constant support and encouragement. Last but not the least; I am thankful to the Almighty for giving me strength, courage and patience to complete this project.
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NEED FOR SELECTING THE PROJECT
To get the overall knowledge of securities and investment.
To know how the investment made in different securities minimizes the risk and
maximizes the returns.
To get the knowledge of different factors that affects the investment decision of investors.
To know how different companies are managing their portfolio i.e. when and in
which sectors they are investing.
To know what is the need of appointing a Portfolio Manager and how does he
meets the needs of the various investors.
To get the knowledge about the role (played) and functions of portfolio manager.
To get the knowledge of investment decision and asset allocation.
6
EXECUTIVE SUMMARY Investing in equities requires time, knowledge and constant monitoring of the market. For those who need an expert to help to manage their investments, portfolio management service (PMS) comes as an answer. The business of portfolio management has never been an easy one. Juggling the limited choices at hand with the twin requirements of adequate safety and sizeable returns is a task fraught with complexities. Given the unpredictable nature of the market it requires solid experience and strong research to make the right decision. In the end it boils down to make the right move in the right direction at the right time. That’s where the expert comes in. The term portfolio management in common practice refers to selection of securities and their continuous shifting in a way that the holder gets maximum returns at minimum possible risk. Portfolio management services are merchant banking activities recognized by SEBI and these activities can be rendered by SEBI authorized portfolio managers or discretionary portfolio managers. A portfolio manager by the virtue of his knowledge, background and experience helps his clients to make investment in profitable avenues. A portfolio manager has to comply with the provisions of the SEBI (portfolio managers) rules and regulations, 1993. This project also includes the different services rendered by the portfolio manager. It includes the functions to be performed by the portfolio manager. What is the difference between the value of time and money? In other words, learn to separate time from money.
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When it comes to the importance of time, how many of us believe that time is money. We all know that the work done by us is calculated by units of time. Have you ever considered the difference between an employee who is working on an hourly rate and the other who is working on salary basis? The only difference between them is of the unit of time. No matter whether you get your pay by the hour, bi-weekly, or annually; one thing common in all is that the amount is paid to you according to amount of time you spent on working. In other words, time is precious and holds much more importance than money. That is the reason the time is considered as an important factor in wealth creation. The project also shows the factors that one considers for making an investment decision and briefs about the information related to asset allocation.
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INDEX SRNO.
TOPICS
PAGE NO
1.
PORTFOLIO MANAGEMENT INTRODUCTION
1
2.
TYPES OF PORTFOLIO MANAGEMENT
11
3.
PORTFOLIO MANAGEMENT PROCESS
14
4.
RISK – RETURN ANALYSIS
28
5.
PORTFOLIO THEORIES
31
6.
PERSONS INVOLVED IN PORTFOLIO MANAGEMENT
41
7.
INVESTMENT ANALYSIS
47
8.
ASSEST ALLOCATION
59
CONCLUSION
63
BIBLOGRAPHY
65
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CHAPTER: 1 PORTFOLIO MANAGEMENT INTRODUCTION Stock exchange operations are peculiar in nature and most of the Investors feel insecure in managing their investment on the stock market because it is difficult for an individual to identify companies which have growth prospects for investment. Further due to volatile nature of the markets, it requires constant reshuffling of portfolios to capitalize on the growth opportunities. Even after identifying the growth oriented companies and their securities, the trading practices are also complicated, making it a difficult task for investors to trade in all the exchange and follow up on post trading formalities.
Investors choose to hold groups of securities rather than single security that offer the greater expected returns. They believe that a combination of securities held together will give a beneficial result if they are grouped in a manner to secure higher return after taking into consideration the risk element. That is why professional investment advice through portfolio management service can help the investors to make an intelligent and informed choice between alternative investments opportunities without the worry of post trading hassles.
10
MEANING OF PORTFOLIO MANAGEMENT Portfolio management in common parlance refers to the selection of securities and their continuous shifting in the portfolio to optimize returns to suit the objectives of an investor. This however requires financial expertise in selecting the right mix of securities in changing market conditions to get the best out of the stock market. In India, as well as in a number of western countries, portfolio management service has assumed the role of a specialized service now a days and a number of professional merchant bankers compete aggressively to provide the best to high net worth clients, who have little time to manage their investments. The idea is catching on with the boom in the capital market and an increasing number of people are inclined to make profits out of their hard-earned savings. Portfolio management service is one of the merchant banking activities recognized by Securities and Exchange Board of India (SEBI). The service can be rendered either by merchant bankers or portfolio managers or discretionary portfolio manager as define in clause (e) and (f) of Rule 2 of Securities and Exchange Board of India(Portfolio Managers)Rules, 1993 and their functioning are guided by the SEBI. According to the definitions as contained in the above clauses, a portfolio manager means any person who is pursuant to contract or arrangement with a client, advises or directs or undertakes on behalf of the client (whether as a discretionary portfolio manager or otherwise) the management or administration of a portfolio of securities or the funds of the client, as the case may be. A merchant banker acting as a Portfolio Manager shall also be bound by the rules and regulations as applicable to the portfolio manager. Realizing the importance of portfolio management services, the SEBI has laid down certain guidelines for the proper and professional conduct of portfolio management services. As per guidelines only recognized merchant bankers registered with SEBI are authorized to offer these services. Portfolio management or investment helps investors in effective and efficient management of their investment to achieve this goal. The rapid growth of capital markets in India has opened up new investment avenues for investors.
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The stock markets have become attractive investment options for the common man. But the need is to be able to effectively and efficiently manage investments in order to keep maximum returns with minimum risk. Hence this is the study on “PORTFOLIO MANAGEMENT & INVESTMENT DECISION” so as to examine the role, process and merits of effective investment management and decision.
DEFINITIONS OF PORTFOLIO Investor’sWords.com A collection of investments (all) owned by the same individual or organization. These investments often include stocks, which are investments in individual businesses; bonds, which are investments in debt that are designed to earn interest; and mutual funds, which are essentially pools of money from many investors that are invested by professionals or according to indices.
1) Financial Dictionary and WikiAnswers.com A collection of various company shares, fixed interest securities or money-market instruments. People may talk grandly of 'running a portfolio' when they own a couple of shares but the characteristic of a serious investment portfolio is diversity. It should show a spread of investments to minimize risk - brokers and investment advisers warn against 'putting all your eggs in one basket'.
2) YourDictionary.com a) All the securities held for investment as by an individual, bank, investment company, etc. b) A list of such securities.
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DEFINITIONS OF PORTFOLIO MANAGEMENT 1) Investor’swords.com The process of managing the assets of a mutual fund, including choosing and monitoring appropriate investments and allocating funds accordingly.
2) Investor Glossary Determining the mix of assets to hold in a portfolio is referred to as portfolio management. A fundamental aspect of portfolio management is choosing assets which are consistent with the portfolio holder's investment objectives and risk tolerance. The ultimate goal of portfolio management is to achieve the optimum return for a given level of risk. Investors must balance risk and performance in making portfolio management decisions. Portfolio management strategies may be either active or passive. An investor who prefers passive portfolio management will likely choose to invest in low cost index funds with the goal of mirroring the market's performance. An investor who prefers active portfolio management will choose managed funds which have the potential to outperform the market. Investors are generally charged higher initial fees and annual management fees for active portfolio management.
3) Financial Dictionary Managing a large single portfolio or being employed by its owner to do so. Portfolio managers have the knowledge and skill which encourage people to put their investment decisions in the hands of a professional (for a fee).
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DEFINITION OF DISCRETIONARY PORTFOLIO MANAGEMENT BusinessDictionary.com Investment account arrangement in which an investment manager makes the buy-sell decisions without referring to the account owner (client) for every transaction. The manager, however, must operate within the agreed upon limits to achieve the client's stated investment objectives.
DEFINITIONS OF PROJECT PORTFOLIO MANAGEMENT 1) Internet.com – Webopedia PPM, short for project portfolio management, refers to a software package that enables corporate and business users to organize a series of projects into a single portfolio that will provide reports based on the various project objectives, costs, resources, risks and other pertinent associations. Project portfolio management software allows the user, usually management or executives within the company, to review the portfolio which will assist in making key financial and business decisions for the projects. 2)
Bitpipe.com Project portfolio management organizes a series of projects into a single portfolio
consisting of reports that capture project objectives, costs, timelines, accomplishments, resources, risks and other critical factors. Executives can then regularly review entire portfolios, spread resources appropriately and adjust projects to produce the highest departmental returns. Also called as Enterprise Project management and PPM
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MEANING OF PORTFOLIO MANAGERS
Portfolio manager means any person who enters into a contract or arrangement with a client. Pursuant to such arrangement he advises the client or undertakes on behalf of such client management or administration of portfolio of securities or invests or manages the client’s funds. A discretionary portfolio manager means a portfolio manager who exercises or may under a contract relating to portfolio management, exercise any degree of discretion in respect of the investment or management of portfolio of the portfolio securities or the funds of the client, as the case may be. He shall independently or individually manage the funds of each client in accordance with the needs of the client in a manner which does not resemble the mutual fund. A non discretionary portfolio manager shall manage the funds in accordance with the directions of the client. A portfolio manager by virtue of his knowledge, background and experience is expected to study the various avenues available for profitable investment and advise his client to enable the latter to maximize the return on his investment and at the same time safeguard the funds invested.
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SCOPE OF PORTFOLIO MANAGEMENT: Portfolio management is an art of putting money in fairly safe, quite profitable and reasonably in liquid form. An investor’s attempt to find the best combination of risk and return is the first and usually the foremost goal. In choosing among different investment opportunities the following aspects risk management should be considered: a)
The selection of a level or risk and return that reflects the investor’s tolerance for
risk and desire for return, i.e. personal preferences. b)
The management of investment alternatives to expand the set of opportunities
available at the investors acceptable risk level. The very risk-averse investor might choose to invest in mutual funds. The more risk-tolerant investor might choose shares, if they offer higher returns. Portfolio management in India is still in its infancy. An investor has to choose a portfolio according to his preferences. The first preference normally goes to the necessities and comforts like purchasing a house or domestic appliances. His second preference goes to some contractual obligations such as life insurance or provident funds. The third preference goes to make a provision for savings required for making day to day payments. The next preference goes to short term investments such as UTI units and post office deposits which provide easy liquidity. The last choice goes to investment in company shares and debentures. There are number of choices and decisions to be taken on the basis of the attributes of risk, return and tax benefits from these shares and debentures. The final decision is taken on the basis of alternatives, attributes and investor preferences. For most investors it is not possible to choose between managing one’s own portfolio. They can hire a professional manager to do it. The professional managers provide a variety of services including diversification, active portfolio management, liquid securities and performance of duties associated with keeping track of investor’s money.
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NEED FOR PORTFOLIO MANAGEMENT: Portfolio management is a process encompassing many activities of investment in assets and securities. It is a dynamic and flexible concept and involves regular and systematic analysis, judgment and action. The objective of this service is to help the unknown and investors with the expertise of professionals in investment portfolio management. It involves construction of a portfolio based upon the investor’s objectives, constraints, preferences for risk and returns and tax liability. The portfolio is reviewed and adjusted from time to time in tune with the market conditions. The evaluation of portfolio is to be done in terms of targets set for risk and returns. The changes in the portfolio are to be effected to meet the changing condition. Portfolio construction refers to the allocation of surplus funds in hand among a variety of financial assets open for investment. Portfolio theory concerns itself with the principles governing such allocation. The modern view of investment is oriented more go towards the assembly of proper combination of individual securities to form investment portfolio. A combination of securities held together will give a beneficial result if they grouped in a manner to secure higher returns after taking into consideration the risk elements. The modern theory is the view that by diversification risk can be reduced. Diversification can be made by the investor either by having a large number of shares of companies in different regions, in different industries or those producing different types of product lines. Modern theory believes in the perspective of combination of securities under constraints of risk and returns.
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OBJECTIVES OF PORTFOLIO MANAGEMENT: The major objectives of portfolio management are summarized as below:-
1)
Security/Safety of Prinicpal: Security not only involves keeping the principal
sum intact but also keeping intact its purchasing power intact.
2)
Stability of Income: So as to facilitate planning more accurately and
systematically the reinvestment consumption of income.
3)
Capital Growth: This can be attained by reinvesting in growth securities or
through purchase of growth securities.
4)
Marketability: i.e. is the case with which a security can be bought or sold. This is
essential for providing flexibility to investment portfolio.
5)
Liquidity i.e Nearness To Money: It is desirable to investor so as to take
advantage of attractive opportunities upcoming in the market.
6)
Diversification: The basic objective of building a portfolio is to reduce risk of loss
of capital and / or income by investing in various types of securities and over a wide range of industries.
7)
Favorable Tax Status: The effective yield an investor gets form his investment
depends on tax to which it is subject. By minimizing the tax burden, yield can be effectively improved.
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BASIC PRINCIPLES OF PORTFOLIO MANAGEMENT: There are two basic principles for effective portfolio management which are given below:I. Effective investment planning for the investment in securities by considering the
following factors-
a) Fiscal,
financial
and
monetary
policies
of
the
Govt.
of
India
and
the
Reserve Bank of India. b) Industrial
and
economic
environment
and
its
impact
on
industry.
Prospect in terms of prospective technological changes, competition in the market, capacity utilization with industry and demand prospects etc.
II. Constant Review of Investment: It requires to review the investment in securities and to
continue the selling and purchasing of investment in more profitable manner. For this purpose they have to carry the following analysis:
a) To assess the quality of the management of the companies in which investment has been
made or proposed to be made.
b) To assess the financial and trend analysis of companies Balance Sheet and Profit and Loss
Accounts to identify the optimum capital structure and better performance for the purpose of withholding the investment from poor companies.
c) To analyze the security market and its trend in continuous basis to arrive at a conclusion
as to whether the securities already in possession should be disinvested and new securities be purchased. If so the timing for investment or dis-investment is also revealed.
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CHAPTER – 2 TYPES OF PORTFOLIO MANAGEMENT There are various types of portfolio management: Investment Management
It Portfolio Management
Project Portfolio Management
1.
INVESMENT MANAGEMENT:
Investment management is the professional management of various securities (shares, bonds etc.) and assets (e.g., real estate), to meet specified investment goals for the benefit of the investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or private investors (both directly via investment contracts and more commonly via collective investment schemes e.g. mutual funds or Exchange Traded Funds). The term asset management is often used to refer to the investment management of collective investments,(not necessarily) whilst the more generic fund management may refer to all forms of institutional investment as well as investment management for private investors. Investment managers who specialize in advisory or discretionary management on behalf of (normally wealthy) private investors may often refer to their services as wealth management or portfolio management often within the context of so-called "private banking". 20
Fund manager (or investment adviser in the U.S.) refers to both a firm that provides investment management services and an individual who directs fund management decisions.
21
IT PORTFOLIO MANAGEMENT: IT portfolio management is the application of systematic management to large classes of items managed by enterprise Information Technology (IT) capabilities. Examples of IT portfolios would be planned initiatives, projects, and ongoing IT services (such as application support). The promise of IT portfolio management is the quantification of previously mysterious IT efforts, enabling measurement and objective evaluation of investment scenarios.
The concept is analogous to financial portfolio management, but there are significant differences. IT investments are not liquid, like stocks and bonds (although investment portfolios may also include illiquid assets), and are measured using both financial and non-financial yardsticks (for example, a balanced scorecard approach); a purely financial view is not sufficient. At its most mature, IT Portfolio management is accomplished through the creation of two portfolios: (i) Application Portfolio - Management of this portfolio focuses on comparing spending on
established systems based upon their relative value to the organization. The comparison can be based upon the level of contribution in terms of IT investment’s profitability. Additionally, this comparison can also be based upon the non-tangible factors such as organizations’ level of experience with a certain technology, users’ familiarity with the
22
applications and infrastructure, and external forces such as emergence of new technologies and obsolesce of old ones.
(ii) Project Portfolio - This type of portfolio management specially address the issues with
spending on the development of innovative capabilities in terms of potential ROI and reducing investment overlaps in situations where reorganization or acquisition occurs. The management issues with the second type of portfolio management can be judged in terms of data cleanliness, maintenance savings, suitability of resulting solution and the relative value of new investments to replace these projects.
2.
PROJECT PORTFOLIO MANAGEMENT:
Project portfolio management organizes a series of projects into a single portfolio consisting of reports that capture project objectives, costs, timelines, accomplishments, resources, risks and other critical factors. Executives can then regularly review entire portfolios, spread resources appropriately and adjust projects to produce the highest departmental returns. Project management is the discipline of planning, organizing and managing resources to bring about the successful completion of specific project goals and objectives. A project is a finite endeavor (having specific start and completion dates) undertaken to create a unique product or service which brings about beneficial change or added value. This finite characteristic of projects stands in contrast to processes, or operations, which are permanent or semi-permanent functional work to repetitively produce the same product or service. In practice, the management of these two systems is often found to be quite different, and as such requires the development of distinct technical skills and the adoption of separate management.
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CHAPTER: 3 PORTFOLIO MANAGEMENT PROCESS: (A)
THERE ARE THREE MAJOR ACTIVITIES INVOLVED IN
AN EFFICIENT PORTFOLIO MANAGEMENT WHICH ARE AS FOLLOWS:a) Identification of assets or securities, allocation of investment and also identifying the
classes of assets for the purpose of investment.
b) They have to decide the major weights, proportion of different assets in the portfolio by
taking in to consideration the related risk factors.
c) Finally they select the security within the asset classes as identify.
The above activities are directed to achieve the sole purpose of maximizing return and minimizing risk on investment. It is well known fact that portfolio manager balances the risk and return in a portfolio investment. With higher risk higher return may be expected and vice versa.
(B) INVESTMENT DECISION: Given a certain sum of funds, the investment decisions basically depend upon the following factors:I. Objectives of Investment Portfolio: This is a crucial point which a Finance Manager must
24
consider. There can be many objectives of making an investment. The manager of a provident fund portfolio has to look for security and may be satisfied with none too high a return, where as an aggressive investment company be willing to take high risk in order to have high capital appreciation.
How the objectives can affect in investment decision can be seen from the fact that the Unit Trust of India has two major schemes : Its “capital units” are meant for those who wish to have a good capital appreciation and a moderate return, where as the ordinary unit are meant to provide a steady return only. The investment manager under both the scheme will invest the money of the Trust in different kinds of shares and securities. So it is obvious that the objectives must be clearly defined before an investment decision is taken. II. Selection of Investment: Having defined the objectives of the investment, the next
decision is to decide the kind of investment to be selected. The decision what to buy has to be seen in the context of the following:-
a) There is a wide variety of investments available in market i.e. Equity shares, preference
share, debentures, convertible bond, Govt. securities and bond, capital units etc. Out of these what types of securities to be purchased.
b) What should be the proportion of investment in fixed interest dividend securities and
variable dividend bearing securities? The fixed one ensures a definite return and thus a lower risk but the return is usually not as higher as that from the variable dividend bearing shares.
c) If the investment is decided in shares or debentures, then the industries showing a
potential in growth should be taken in first line. Industry-wise-analysis is important since various industries are not at the same level from the investment point of view. It is important to recognize that at a particular point of time, a particular industry may have a 25
better growth potential than other industries. For example, there was a time when jute industry was in great favour because of its growth potential and high profitability, the industry is no longer at this point of time as a growth oriented industry. d) Once industries with high growth potential have been identified, the next step is to select
the particular companies, in whose shares or securities investments are to be made.
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FUNDAMENTAL ANALYSIS: (A) FUNDAMENTAL ANALYSIS OF GROWTH ORIENTED COMPANIES: One of the first decisions that an investment manager faces is to identify the industries which have a high growth potential. Two approaches are suggested in this regard. They are: a) Statistical Analysis of Past Performance:
A statistical analysis of the immediate past performance of the share price indices of various industries and changes there in related to the general price index of shares of all industries should be made. The Reserve Bank of India index numbers of security prices published every month in its bulletin may be taken to represent the behaviour of share prices of various industries in the last few years. The related changes in the price index of each industry as compared with the changes in the average price index of the shares of all industries would show those industries which are having a higher growth potential in the past few years. It may be noted that an Industry may not be remaining a growth Industry for all the time. So he shall now have to make an assessment of the various Industries keeping in view the present potentiality also to finalize the list of Industries in which he will try to spread his investment. b) Assessing the Intrinsic Value of an Industry/Company:
After an investment manager has identified statistically the industries in the share of which the investors show interest, he would assess the various factors which influence the value of a particular share. These factors generally relate to the strengths and weaknesses of the company under consideration, Characteristics of the industry within which the company fails and the national and international economic scene. It is the job of the investment manager to examine and weigh the various factors and judge the quality of the share or the security under consideration. This approach is known as the intrinsic value approach. The major objective of the analysis is to determine the relative quality and the quantity of the security and to decide whether or not is security is good at current markets prices. In this, both qualitative and quantitative factors are to be considered. 27
(B)
INDUSTRY ANALYSIS
First of all, an assessment will have to be made regarding all the conditions and factors relating to demand of the particular product, cost structure of the industry and other economic and Government constraints on the same. As we have discussed earlier, an appraisal of the particular industry’s prospect is essential and the basic profitability of any company is dependent upon the economic prospect of the industry to which it belongs. The following factors may particularly be kept in mind while assessing to factors relating to an industry.
(i) Demand and Supply Pattern for the Industries Products and Its Growth Potential:
The main important aspect is to see the likely demand of the products of the industry and the gap between demand and supply. This would reflect the future growth prospects of the industry. In order to know the future volume and the value of the output in the next ten years or so, the investment manager will have to rely on the various demand forecasts made by various agencies like the planning commission, Chambers of Commerce and institutions like NCAER, etc. The management expert identifies fives stages in the life of an industry. These are “Introduction, development, rapid growth, maturity and decline”. If an industry has already reached the maturity or decline stage, its future demand potential is not likely to be high.
28
(ii) Profitability: It is a vital consideration for the investors as profit is the measure of
performance and a source of earning for him. So the cost structure of the industry as related to its sale price is an important consideration. In India there are many industries which have a growth potential on account of good demand position. The other point to be considered is the ratio analysis, especially return on investment, gross profit and net profit ratio of the existing companies in the industry. This would give him an idea about the profitability of the industry as a whole. (iii) Particular Characteristics of the Industry: Each industry has its own characteristics,
which must be studied in depth in order to understand their impact on the working of the industry. Because the industry having a fast changing technology become obsolete at a faster rate. Similarly, many industries are characterized by high rate of profits and losses in alternate years. Such fluctuations in earnings must be carefully examined.
(iv) Labour Management Relations in the Industry: The state of labour-management
relationship in the particular industry also has a great deal of influence on the future profitability of the industry. The investment manager should, therefore, see whether the industry under analysis has been maintaining a cordial relationship between labour and management. Once the industry’s characteristics have been analyzed and certain industries with growth potential identified, the next stage would be to undertake and analyze all the factors which show the desirability of various companies within an industry group from investment point of view.
29
(C)
COMPANY ANALYSIS:
To select a company for investment purpose a number of qualitative factors have to be seen. Before purchasing the shares of the company, relevant information must be collected and properly analyzed. An illustrative list of factors which help the analyst in taking the investment decision is given below. However, it must be emphasized that the past performance and information is relevant only to the extent it indicates the future trends. Hence, the investment manager has to visualize the performance of the company in future by analyzing its past performance.
1) Size and Ranking: A rough idea regarding the size and ranking of the company within
the economy, in general, and the industry, in particular, would help the investment manager in assessing the risk associated with the company. In this regard the net capital employed, the net profits, the return on investment and the sales volume of the company under consideration may be compared with similar data of other company in the same industry group. It may also be useful to assess the position of the company in terms of technical knowhow, research and development activity and price leadership. 2) Growth Record: The growth in sales, net income, net capital employed and earnings per
share of the company in the past few years must be examined. The following three growth indicators may be particularly looked in to (a) Price earnings ratio, (b) Percentage growth rate of earnings per annum and (c) Percentage growth rate of net block of the company. The price earnings ratio is an important indicator for the investment manager since it shows the number the times the earnings per share are covered by the market price of a share. Theoretically, this ratio should be same for two companies with similar features. However, this is not so in practice due to many factors. Hence, by a comparison of this ratio pertaining to different companies the investment manager can have an idea about the image of the company and can determine whether the share is under-priced or over-priced. An evaluation of future growth prospects of the company should be carefully made. This requires the analysis of the existing capacities and their utilization, proposed expansion and diversification plans and the nature of the company’s technology. 30
The existing capacity utilization levels can be known from the quantitative information given in the published profit and loss accounts of the company. The plans of the company, in terms of expansion or diversification, can be known from the directors reports the chairman’s statements and from the future capital commitments as shown by way of notes in the balance sheets. The nature of technology of a company should be seen with reference to technological developments in the concerned fields, the possibility of its product being superseded of the possibility of emergence of more effective method of manufacturing. Growth is the single most important factor in company analysis for the purpose of investment management. A company may have a good record of profits and performance in the past; but if it does not have growth potential, its shares cannot be rated high from the investment point of view.
(D)
FINANCIAL ANALYSIS:
An analysis of financial for the past few years would help the investment manager in understanding the financial solvency and liquidity, the efficiency with which the funds are used, the profitability, the operating efficiency and operating leverages of the company. For this purpose certain fundamental ratios have to be calculated. From the investment point of view, the most important figures are earnings per share, price earnings ratios, yield, book value and the intrinsic value of the share. The five elements may be calculated for the past ten years or so and compared with similar ratios computed from the financial accounts of other companies in the industry and with the average ratios of the industry as a whole. The yield and the asset backing of a share are important considerations in a decision regarding whether the particular market price of the share is proper or not. Various other ratios to measure profitability, operating efficiency and turnover efficiency of the company may also be calculated. The return on owner’s investment, capital turnover ratio and the cost structure ratios may also be worked out. To examine the financial solvency or liquidity of the company, the investment manager may work out current ratio, liquidity ratio, debt equity 31
ratio, etc. These ratios will provide an overall view of the company to the investment analyst. He can analyze its strengths and weakness and see whether it is worth the risk or not. (i) Quality of Management: This is an intangible factor. Yet it has a very important bearing
on the value of the shares. Every investment manager knows that the shares of certain business houses command a higher premium than those of similar companies managed by other business houses. This is because of the quality of management, the confidence that the investors have in a particular business house, its policy vis-à-vis its relationship with the investors, dividend and financial performance record of other companies in the same group, etc. This is perhaps the reason that an investment manager always gives a close look to the management of the company whose shares he is to invest. Quality of management has to be seen with reference to the experience, skill and integrity of the persons at the helm of the affairs of the company. The policy of the management regarding relationship with the share holders is an important factor since certain business houses believe in generous dividend and bonus distributions while others are rather conservative.
(ii) Location and labour management relations: The locations of the company’s
manufacturing facilities determine its economic viability which depends on the availability of crucial inputs like power, skilled labour and raw materials etc. Nearness to market is also a factor to be considered. In the past few years, the investment manager has begun looking into the state of labour management relations in the company under consideration and the area where it is located. (iii) Pattern of Existing Stock Holding: An analysis of the pattern of the existing stock
holdings of the company would also be relevant. This would show the stake of various parties associated with the company. An interesting case in this regard is that of the Punjab National Bank in which the L.I.C. and other financial institutions had substantial holdings. When the bank was nationalized, the residual company proposed a scheme whereby those shareholders, who wish to opt out, could receive a certain amount as compensation in cash. 32
It was only at the instant and bargaining strength of institutional investors that the compensation offered to the shareholders, who wish to opt out of the company, was raised considerably. (iv) Marketability of the Shares: Another important consideration for an investment manager
is the marketability of the shares of the company. Mere listing of the share on the stock exchange does not automatically mean that the share can be sold or purchased at will. There are many shares which remain inactive for long periods with no transactions being affected.
To purchase or sell such scrips is a difficult task. In this regard, dispersal of share holding with special reference to the extent of public holding should be seen. The other relevant factors are the speculative interest in the particular scrip, the particular stock exchange where it is traded and the volume of trading. Fundamental analysis thus is basically an examination of the economics and financial aspects of a company with the aim of estimating future earnings and dividend prospect. It included an analysis of the macro economic and political factors which will have an impact on the performance of the firm. After having analyzed all the relevant information about the company and its relative strength vis-à-vis other firm in the industry, the investor is expected to decide whether he should buy or sell the securities.
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(C)
TIMING OF PURCHASES:-
The timing of dealings in the securities, specially shares is of crucial importance, because after correctly identifying the companies one may lose money if the timing is bad due to wide fluctuation in the price of shares of that companies. The decision regarding timing of purchases is particularly difficult because of certain psychological factors. It is obvious that if a person wishes to make any gains, he should buy cheap and sell dear, i.e. buy when the share are selling at a low price and sell when they are at a higher price. But in practical it is a difficult task. When the prices are rising in the market i.e. there is bull phase, everybody joins in buying without any delay because every day the prices touch a new high. Later when the bear face starts, prices tumble down every day and everybody starts counting the losses. The ordinary investor regretted such situation by thinking why he did not sell his shares in previous day and ultimately sell at a lower price. This kind of investment decision is entirely devoid of any sense of timing.
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In short we can conclude by saying that Investment management is a complex activity which may be broken down into the following steps: 1)
Specification Of Investment Objectives And Constraints: The typical objectives sought by investors are current income, capital appreciation, and safety of principle. The relative importance of these objectives should be specified further the constraints arising from liquidity, time horizon, tax and special circumstances must be identified. 2) Choice Of The Asset Mix : The most important decision in portfolio management is the asset mix decision very broadly; this is concerned with the proportions of ‘stocks’ (equity shares and units/shares of equity-oriented mutual funds) and ‘bonds’ in the portfolio. The appropriate ‘stock-bond’ mix depends mainly on the risk tolerance and investment horizon of the investor.
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ELEMENTS OF PORTFOLIO MANAGEMENT: Portfolio management is on-going process involving the following basic tasks:
Identification of the investor’s objectives, constraints and preferences.
Strategies are to be developed and implemented in tune with investment policy
formulated.
Review and monitoring of the performance of the portfolio.
Finally the evaluation of the portfolio
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Technique’s Of Portfolio Management: As of now the under noted technique of portfolio management: are in vogue in our country. 1)
Equity Portfolio: It is influenced by internal and external factors the internal
factors affect the inner working of the company’s growth plans are analyzed with referenced to Balance sheet, profit & loss a/c (account) of the company. Among the external factor are changes in the government policies, Trade cycle’s, Political stability etc. 2)
Equity Stock Analysis: Under this method the probable future value of a share of
a company is determined it can be done by ratio’s of earning per share of the company and price earnings ratio
EARNING PER SHARE = _ PROFIT AFTER TAX__ NO. OF EQUITY SHARES PRICE EARNING RATIO = _MARKET PRICE (PER SHARE)_ EARNING PER SHARE
One can estimate trend of earning by EPS, which reflects trends of earning quality of company, dividend policy, and quality of management. Price Earnings ratio indicate a confidence of market about the company future, a high rating is preferable.
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The following points must be considered by portfolio managers while analyzing the securities. 1)
Nature of the industry and its product: Long term trends of industries,
competition within, and outside the industry, Technical changes, labour relations, sensitivity, to Trade cycle.
2)
Industrial analysis of prospective earnings, cash flows, working capital,
dividends, etc.
3)
Ratio analysis: Ratios such as debt equity ratio, current ratio, net worth, profit
earnings ratio, returns on investment, are worked out to decide the portfolio.
The wise principle of portfolio management suggests that “Buy when the market is low or BEARISH, and sell when the market is rising or BULLISH”. Stock market operation can be analyzed by: a)
Fundamental approach: - Based on intrinsic value of shares.
b)
Technical approach: - Based on Dow Jone’s Theory, Random Walk Theory, etc.
Prices are based upon demand and supply of the market.
Objectives are maximization of wealth and minimization of risk.
Diversification reduces risk and volatility.
Variable returns, high illiquidity; etc.
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CHAPTER - 4 RISK – RETURN ANALYSIS RISK ON PORTFOLIO : The expected returns from individual securities carry some degree of risk. Risk on the portfolio is different from the risk on individual securities. The risk is reflected in the variability of the returns from zero to infinity. Risk of the individual assets or a portfolio is measured by the variance of its return. The expected return depends on the probability of the returns and their weighted contribution to the risk of the portfolio. These are two measures of risk in this context one is the absolute deviation and other standard deviation. Most investors invest in a portfolio of assets, because as to spread risk by not putting all eggs in one basket. Hence, what really matters to them is not the risk and return of stocks in isolation, but the risk and return of the portfolio as a whole. Risk is mainly reduced by Diversification.
Following are the some of the types of Risk: 1)
Interest Rate Risk: This arises due to the variability in the interest rates from time
to time. A change in the interest rate establishes an inverse relationship in the price of the security i.e. price of the security tends to move inversely with change in rate of interest, long term securities show greater variability in the price with respect to interest rate changes than short term securities. Interest rate risk vulnerability for different securities is as under: TYPES
RISK EXTENT
Cash Equivalent
Less vulnerable to interest rate risk.
Long Term Bonds
More vulnerable to interest rate risk.
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2) Purchasing Power Risk: It is also known as inflation risk also emanates from the very fact that inflation affects the purchasing power adversely. Nominal return contains both the real return component and an inflation premium in a transaction involving risk of the above type to compensate for inflation over an investment holding period. Inflation rates vary over time and investors are caught unaware when rate of inflation changes unexpectedly causing erosion in the value of realized rate of return and expected return. Purchasing power risk is more in inflationary conditions especially in respect of bonds and fixed income securities. It is not desirable to invest in such securities during inflationary periods. Purchasing power risk is however, less in flexible income securities like equity shares or common stock where rise in dividend income off-sets increase in the rate of inflation and provides advantage of capital gains.
3) Business Risk: Business risk emanates from sale and purchase of securities affected by business cycles, technological changes etc. Business cycles affect all types of securities i.e. there is cheerful movement in boom due to bullish trend in stock prices whereas bearish trend in depression brings down fall in the prices of all types of securities during depression due to decline in their market price.
4)
Financial Risk: It arises due to changes in the capital structure of the company. It
is also known as leveraged risk and expressed in terms of debt-equity ratio. Excess of risk vis-à-vis equity in the capital structure indicates that the company is highly geared. Although a leveraged company’s earnings per share are more but dependence on borrowings exposes it to risk of winding up for its inability to honor its commitments towards lender or creditors. The risk is known as leveraged or financial risk of which investors should be aware and portfolio managers should be very careful. 5)
Systematic Risk or Market Related Risk: Systematic risks affected from the
entire market are (the problems, raw material availability, tax policy or government
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policy, inflation risk, interest risk and financial risk). It is managed by the use of Beta of different company shares. 6) Unsystematic Risks: The unsystematic risks are mismanagement, increasing inventory, wrong financial policy, defective marketing etc. this is diversifiable or avoidable because it is possible to eliminate or diversify away this component of risk to a considerable extent by investing in a large portfolio of securities. The unsystematic risk stems from inefficiency magnitude of those factors different form one company to another.
RISK RETURN ANALYSIS: All investment has some risk. Investment in shares of companies has its own risk or uncertainty; these risks arise out of variability of yields and uncertainty of appreciation or depreciation of share prices, losses of liquidity etc The risk over time can be represented by the variance of the returns while the return over time is capital appreciation plus payout, divided by the purchase price of the share.
Normally, the higher the risk that the investor takes, the higher is the return. There is, however, a risk less return on capital of about 12% which is the bank, rate charged by the R.B.I or long term, yielded on government securities at around 13% to 14%. This risk less return refers to lack of variability of return and no uncertainty in the repayment or capital. But other risks such 41
as loss of liquidity due to parting with money etc., may however remain, but are rewarded by the total return on the capital. Risk-return is subject to variation and the objectives of the portfolio manager are to reduce that variability and thus reduce the risk by choosing an appropriate portfolio. Traditional approach advocates that one security holds the better, it is according to the modern approach diversification should not be quantity that should be related to the quality of scripts which leads to quality of portfolio. Experience has shown that beyond the certain securities by adding more securities expensive.
RETURNS ON PORTFOLIO: Each security in a portfolio contributes return in the proportion of its investments in security. Thus the portfolio expected return is the weighted average of the expected return, from each of the securities, with weights representing the proportions share of the security in the total investment. Why does an investor have so many securities in his portfolio? If the security ABC gives the maximum return why not he invests in that security all his funds and thus maximize return? The answer to this questions lie in the investor’s perception of risk attached to investments, his objectives of income, safety, appreciation, liquidity and hedge against loss of value of money etc. this pattern of investment in different asset categories, types of investment, etc., would all be described under the caption of diversification, which aims at the reduction or even elimination of non-systematic risks and achieve the specific objectives of investors.
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CHAPTER: 5 PORTFOLIO THEORIES I. DOW JONES THEORY: The DOW JONES THEORY is probably the most popular theory regarding the behavior of stock market prices. The theory derives its name from Charles H. Dow, who established the Dow Jones & Co. and was the first editor of the Wall Street Journal – a leading publication on financial and economic matters in the U.S.A. Although Dow never gave a proper shape to the theory, ideas have been expanded and articulated by many of his successors. The Dow Jones theory classifies the movement of the prices on the share market into three major categories: 1. Primary Movements, 2. Secondary Movements and 3. Daily Fluctuations. 1) Primary Movements: They reflect the trend of the stock market and last from one year to three years, or sometimes even more. If the long range behavior of market prices is seen, it will be observed that the share markets go through definite phases where the prices are consistently rising or falling. These phases are known as bull and bear phases. P3 P2 P1
T3 T2
T1 Graph 1
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During a bull phase, the basic trend is that of rise in prices. Graph 1 above shows the behavior of stock market prices in bull phase. You would notice from the graph that although the prices fall after each rise, the basic trend is that of rising prices. As can be seen from the graph that each trough prices reach, is at a higher level than the earlier one. Similarly, each peak that the prices reach is on a higher level than the earlier one. Thus P2 is higher than P1 and T2 is higher than T1. This means that prices do not rise consistently even in a bull phase. They rise for some time and after each rise, they fall. However, the falls are of a lower magnitude then earlier. As a result, prices reach higher levels with each rise. Once the prices have risen very high, the bear phase in bound to start i.e., price will start falling. Graph 2 shows the typical behavior of prices on the stock exchange in the case of a P3
P2 T1
P1 T2 T3
Graph 2 Bear phase. It would be seen that prices are not falling consistently and, after each fall, there is a rise in prices. However, the rise is not much as to take the prices higher than the previous peak. It means that each peak and trough is now lower than the previous peak and trough. The theory argues that primary movements indicate basic trends in the market. It states that if cyclical swings of stock market prices indices are successively higher, the market trend is up and there is a bull market. On the contrary, if successive highs and low are successively lower, the market is on a downward trend and we are in bear market. This
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theory thus relies upon a behavior of the indices of share market prices in perceiving the trend in the market. 2) Secondary Movements: We have seen that even when the primary trend is upward, there are also downward movements of prices. Similarly, even where the primary trend is downward, there is upward movement of prices also. These movements are known as secondary movements and are shorter in duration and are opposite in direction to the primary movements. These movements normally last from three weeks to three months and retrace 1/3 to 2/3 of the previous advance in a bull market of previous fall in the bear market.
3) Daily Movements: There are irregular fluctuations which occur every day in the market. These fluctuations are without any definite trend. Thus is the daily share market price index for a few months are plotted on the graph it will show both upward and downward fluctuations. These fluctuations are the result of speculative factor. An investment manger really is not interested in the short run fluctuations in share prices since he is not a speculator. It may be reiterated that anyone who tries to gain from short run fluctuations in the stock market, can make money only be sheer chance. The investment manager should scrupulously keep away from the daily fluctuations of the market. He is not a speculator and should always resist the temptation of speculating. Such a temptation is always very attractive but must always be resisted. Speculation is beyond the scope of the job of an investment manager.
Timing of investment decisions on the basis of Dow Jones Theory: Ideally speaking the investment manage would like to purchase shares at a time when they have reached the lowest trough and sell them at a time when they reach the highest peak. However, in practice, this seldom happens. Even the most astute investment manager can never know when the highest peak or the lowest through have been reached. Therefore, he has to time his decision in such a manner that he buys the shares when they are on the rise and sells then when they are
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on the fall. It means that he should be able to identify exactly when the falling or the rising trend has begun. This is technically known as identification of the turn in the share market prices. Identification of this turn is difficult in practice because of the fact that, even in a rising market, prices keep on falling as a part of the secondary movement. Similarly even in a falling market prices keep on rising temporarily. How to be certain that the rise in prices or fall in the same in due to a real turn in prices from a bullish to a bearish phase or vice versa or that it is due only to short run speculative trends? Dow Jones Theory identifies the turn in the market prices by seeing whether the successive peaks and troughs are higher or lower than earlier.
II. RANDOM WALK THEORY:
The first specification of efficient markets and their relationship to the randomness of prices for things traded in the market goes to Samuelson and Mandelbrot. “Samuelson has proved in 1965 that if a market has zero transaction costs, if all available information is free to all interested parties, and if all market participants and potential participants have the same horizons and expectations about prices, the market will be efficient and prices will fluctuate randomly.” According to the Random Walk Theory, the changes in prices of stock show independent behavior and are dependent on the new pieces of information that are received but within themselves are independent of each other. Whenever a new price of information is received in the stock market, the market independently receives this information and it is independent and separate from all the other prices of information. For example, a stock is selling at Rs. 40 based on existing information known to all investors. Afterwards, the news of a strike in that company will bring down the stock price to Rs. 30 the next day. The stock price further goes down to Rs. 25. Thus, the first fall in stock price from Rs. 40 to Rs. 30 is caused because of some information about the strike. But the second fall in the price of a stock from Rs. 30 to Rs. 25 is due to additional information on the type of strike. Therefore, each price change is independent of the 46
other because each information has been taken in, by the stock market and separately disseminated. However, independent pieces of information, when they come together immediately after each other show that the price is falling but each price fall is independent of the other price fall. The basic essential fact of the Random Walk Theory is that the information on stock prices is immediately and fully spread over that other investors have full knowledge of the information. The response makes the movement of prices independent of each other. Thus, it may be said that the prices have an independent nature and therefore, the price of each day is different. The theory further states that the financial markets are so competitive that there is immediate price adjustment. It is due to the effective communication system through which information can be disturbed almost anywhere in the country. This speed of information determines the efficiency of the market. III.
CAPITAL ASSETS PRICING MODEL (CAPM): CAPM provides a conceptual framework for evaluating any investment decision. It is used to estimate the expected return of any portfolio with the following formula:
E (Rp) = Rf +Bp (E( Rm) – Rf ) Where, E(Rp)
=
Expected return of the portfolio
Rf
=
Risk free rate of return
Bp
=
Beta portfolio i.e. market sensitivity index
E(Rm)
=
Expected return on market portfolio
[E(Rm)-Rf]
= Market risk premium
The above model of portfolio management can be used effectively to:-
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Estimate the required rate of return to investors on company’s common stock.
Evaluate risky investment projects involving real Assets.
Explain why the use of borrowed fund increases the risk and increases the rate of return.
Reduce the risk of the firm by diversifying its project portfolio.
IV. MOVING AVERAGE: It refers to the mean of the closing price which changes constantly and moves ahead in time, there by encompasses the most recent days and deletes the old one.
V. MODERN PORTFOLIO THEORY: Modern Portfolio Theory quantifies the relationship between risk and return and assumes that an investor must be compensated for assuming risk. It believes in the maximization of return through a combination of securities. The theory states that by combining securities of low risks with securities of high risks success can be achieved in making a choice of investments. There can be various combinations of securities. The modern theory points out that the risk of portfolio can be reduced by diversification. Harry Markowitz and William Sharpe have developed this theory.
VI. MARKOWITZ THEORY: Markowitz has suggested a systematic search for optimal portfolio. According to him, the portfolio manager has to make probabilistic estimates of the future performances of the securities and analyse these estimates to determine an efficient set of portfolios. Then the optimum set of portfolio can be selected in order to suit the needs of the investors. The following are the assumptions of Markowitz Theory:
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Investors make decisions on the basis of expected utility maximization. In an efficient market, all investors react with full facts about all securities in the
market. Investors’ utility is the function of risk and return on securities. The security returns are co-related to each other by combining the different
securities. The combination of securities is made in such a way that the investor gets
maximum return with minimum of risk. An efficient portfolio exists, when there is lowest level of risk for a specified level
of expected return and highest expected return for a specified amount of portfolio risk. The risk of portfolio can be reduced by adding investments in the portfolio.
VII.
SHARPE’S THEORY: William Sharpe has suggested a simplified method of diversification of portfolios. He has made the estimates of the expected return and variance of indexes which are related to economic activity. Sharpe’s Theory assumes that securities returns are related to each other only through common relationships with basic underlying factor i.e. market return index. Individual securities return is determined solely by random factors and on its relationship to this underlying factor with the following formula: Ri = ai + Bi I + ei
Where, Ri refers to expected return on security ai = the intercept of a straight line or alpha coefficient Bi = slope of straight-line or beta coefficient I = level of market return index ei = error, i.e. residual risk of the company. 49
RULES TO BE FOLLOWED BEFORE INVESTMENT IN PORTFOLIO’S 1)
Compile the financials of the companies in the immediate past 3 years such as
turnover, gross profit, net profit before tax, compare the profit earning of company with that of the industry average nature of product manufacture service render and it future demand ,know about the promoters and their back ground, dividend track record, bonus shares in the past 3 to 5 years ,reflects company’s commitment to share holders the relevant information can be accessed from the RDC (Registrant of Companies) published financial results financed quarters, journals and ledgers.
2)
Watch out the highs and lows of the scripts for the past 2 to 3 years and their
timing cyclical scripts have a tendency to repeat their performance, this hypothesis can be true of all other financial,
3)
The higher the trading volume higher is liquidity and still higher the chance of
speculation, it is futile to invest in such shares who’s daily movements cannot be kept track, if you want to reap rich returns keep investment over along horizon and it will offset the wild intraday trading fluctuation’s, the minor movement of scripts may be ignored, we must remember that share market moves in phases and the span of each phase is 6 months to 5 years.
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CHAPTER – 6 PERSONS INVOLVED IN PORTFOLIO MANAGEMENT 1)
INVESTOR:
Are the people who are interested in investing their funds? 2)
PORTFOLIO MANAGERS:
Is a person who is in the wake of a contract agreement with a client, advices or directs or undertakes on behalf of the clients, the management or distribution or management of the funds of the client as the case may be. 3)
DISCRETIONARY PORTFOLIO MANAGER:
Means a manager who exercise under a contract relating to a portfolio management exercise any degree of discretion as to the investment or management of portfolio or securities or funds of clients as the case may be. The relationship between an investor and portfolio manager is of a highly interactive nature. The portfolio manager carries out all the transactions pertaining to the investor under the power of attorney during the last two decades, and increasing complexity was witnessed in the capital market and its trading procedures in this context a key (uninformed) investor formed ) investor found himself in a tricky situation , to keep track of market movement ,update his knowledge, yet stay in the capital market and make money , therefore in looked forward to resuming help from portfolio manager to do the job for him . The portfolio management seeks to strike a balance between risk’s and return. The generally rule in that greater risk more of the profits but S.E.B.I. in its guidelines prohibits portfolio managers to promise any return to investor. Portfolio management is not a substitute to the inherent risks associated with equity investment.
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WHO CAN BE A PORTFOLIO MANAGER? Only those who are registered and pay the required license fee are eligible to operate as portfolio managers. An applicant for this purpose should have necessary infrastructure with professionally qualified persons and with a minimum of two persons with experience in this business and a minimum net worth of Rs. 50lakh’s. The certificate once granted is valid for three years. Fees payable for registration are Rs 2.5lakh’s every for two years and Rs.1lakh’s for the third year. From the fourth year onwards, renewal fees per annum are Rs 75000. These are subjected to change by the S.E.B.I.
The S.E.B.I. has imposed a number of obligations and a code of conduct on them. The portfolio manager should have a high standard of integrity, honesty and should not have been convicted of any economic offence or moral turpitude. He should not resort to rigging up of prices, insider trading or creating false markets, etc. their books of accounts are subject to inspection to inspection and audit by S.E.B.I... The observance of the code of conduct and guidelines given by the S.E.B.I. are subject to inspection and penalties for violation are imposed. The manager has to submit periodical returns and documents as may be required by the SEBI from time-to- time.
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FUNCTIONS OF PORTFOLIO MANAGERS:
Advisory role: Advice new investments, review the existing ones, identification of
objectives, recommending high yield securities etc.
Conducting market and economic service: This is essential for recommending good
yielding securities they have to study the current fiscal policy, budget proposal; individual policies etc further portfolio manager should take in to account the credit policy, industrial growth, foreign exchange possible change in corporate law’s etc.
Financial analysis: He should evaluate the financial statement of company in order to
understand, their net worth future earnings, prospectus and strength.
Study of stock market : He should observe the trends at various stock exchange and
analysis scripts so that he is able to identify the right securities for investment
Study of industry: He should study the industry to know its future prospects,
technical changes etc, required for investment proposal he should also see the problem’s of the industry.
Decide the type of port folio: Keeping in mind the objectives of portfolio a portfolio
manager has to decide whether the portfolio should comprise equity preference shares, debentures, convertibles, non-convertibles or partly convertibles, money market, securities etc or a mix of more than one type of proper mix ensures higher safety, yield and liquidity coupled with balanced risk techniques of portfolio management. A portfolio manager in the Indian context has been Brokers (Big brokers) who on the basis of their experience, market trends, Insider trader, helps the limited knowledge persons. The one’s who use to manage the funds of portfolio, now being managed by the portfolio of Merchant Bank’s, professional’s like MBA’s CA’s And many financial institution’s have entered the market in a big way to manage portfolio for their clients. According to S.E.B.I. rules it is mandatory for portfolio managers to get them self’s registered. Registered merchant bankers can act’s as portfolio managers. Investor’s must look forward, for qualification and performance and ability and research base of the portfolio managers. 53
NEED AND ROLE OF PORTFOLIO MANAGER: With the development of Indian Securities market and with appreciation in market price of equity share of profit making companies, investment in the securities of such companies has become quite attractive. At the same time, the stock market becoming volatile on account of various facts, a layman is puzzled as to how to make his investments without losing the same. He has felt the need of an expert guidance in this respect. Similarly non resident Indians are eager to make their investments in Indian companies. They have also to comply with the conditions specified by the RESERVE BANK OF INDIA under various schemes for investment by the non residents. The portfolio manager with his background and expertise meets the needs of such investors by rendering service in helping them to invest their fund/s profitably.
PORTFOLIO MANAGER’S OBLIGATION: The portfolio manager has number of obligations towards his clients, some of them are:
He shall transact in securities within the limit placed by the client himself with
regard to dealing in securities under the provisions of Reserve Bank of India Act, 1934. He shall not derive any direct or indirect benefit out of the client’s funds or securities. He shall not pledge or give on loan securities held on behalf of his client to a third person without obtaining a written permission from such clients. While dealing with his client’s funds, he shall not indulge in speculative transactions. He may hold the securities in the portfolio account in his own name on behalf of his client’s only if the contract so provides. In such a case, his records and his report to his clients should clearly indicate that such securities are held by him on behalf of his client. He shall deploy the money received from his client for an investment purpose as soon as possible for that purpose. He shall pay the money due and payable to a client forthwith. He shall not place his interest above those of his clients. He shall not disclose to any person or any confidential information about his client, which has come to his knowledge. 54
He shall endeavor to: o Ensure that the investors are provided with true and adequate information without making any misguiding or exaggerated claims. o Ensure that the investors are made aware of the attendant risks before any investment decision is made by them. o Render the best possible advice to his clients relating to his needs and the environment and his own professional skills. o Ensure that all professional dealings are affected in a prompt, efficient and cost effective manner.
COORDINATION WITH RELATING AUTHORITIES: The portfolio manager shall designate a senior officer as compliance offer. The senior officer: Shall coordinate with regulating authorities regarding various matters. Shall provide necessary guidance to and ensure compliance internally by the portfolio manager of all Rules, Regulations guidelines, Notifications etc. issued by SEBI, government of India and other regulating authorities. Shall ensure that observations made/ deficiencies pointed out by SEBI in the functioning of the portfolio manager do not recur.
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DEFAULTS AND PENALTIES: The following aspects must be kept in view:
Liabilities for action in case of default - A portfolio manager is liable to
penalties if he: 1.
Fails to comply with any conditions subject to which certificate of registration has been
granted. 2.
Contravenes any of the provisions of the SEBI act, its Rules and Regulations.
In such a case, he shall be liable to any of the following penalties, after
enquiry-
i. Suspension of registration for a specific period. ii. Cancellation of registration.
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CHAPTER - 7 INVESTMENT ANALYSIS
MEANING OF INVESTMENT Investment means employment of funds in a productive manner so as to create additional income. The word investment means many things to many persons. Investment in financial assets leads to further production and income. It is lending of funds for income and commitment of money for creation of assets, producing further income. Investment also means purchasing of securities, financial instruments or claims on future income. Investment is made out of income and savings credit or borrowings and out of wealth. It is a reward for waiting for money. There are two concepts of investment: 1) Economic Investment: The concept of economic investment means additions to the
capital stock of the society. The capital stock of society is the goods which are used in the production of other goods. The term investment implies the formation of new and productive capital in the form of new construction and producer’s durable instrument such as plant and machinery, inventories and human capital are also included in this concept. Thus, an investment, in economic terms, means an increase in building, equipment, and inventory.
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2) Financial Investment: This is an allocation of monetary resources to assets that are
expected to yield some gain or return over a given period of time. It is a general or extended sense of the term. It means an exchange of financial claims such as shares and bonds, real estate, etc. in their view; investment is a commitment of funds to derive future income in the form of interest, dividends, rent premiums, pension benefits and the appreciation of the value of their principal capital. The economic and financial concepts of investment are related to each other because investment is a part of the savings of individuals which flow into the capital market either directly or through institutions. Thus, investment decisions and financial decisions interact with each other. Financial decisions are primarily concerned with the sources of money where as investment decisions are traditionally concerned with uses or budgeting of money.
MEANING OF SECURITY A security means a document that gives its owners a specific claim of ownership of a particular financial asset. Financial market provides facilities for buying and selling of financial claims and services. Thus, securities are the financial instruments which are bought and sold in the financial market for investment. The important financial instruments are shares, debentures, bonds, etc. other financial instruments are also known as Treasury bills, Mutual Fund Units, Fixed Deposits, Insurance Policies, Post Office Savings like National Savings certificates, Kisan Vikas Patras, public provident Funds etc. These securities are used by the investors for their investment. Some of these securities are transferable while some of them are not transferable.
INVESTMENT AVENUES The alternative investment avenues for the investor are to be considered first so as to satisfy the above objectives of investors. The following categories of investors are open to investors as avenues for savings to flow in financial form:
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(a) Investment in Bank Deposits – Savings And Fixed Deposits: This is the most common
form of investment for an average Indian and nearly 40% of funds in financial savings are used in this form these are least risky but the return is also low. (b)Investment in P.O. Deposits, National Savings Certificates and other Postal Savings
Schemes: Many people in villages and some urban areas are investors in these schemes due to lower risk of loss of money and greater security of funds. But returns are also lower than in Stocks & Shares. (c) Insurance Schemes of LIC/GIC etc. and Provident and Pension Funds: About 20-
25% of financial savings of the household sector are put in these forms and P.F., Pension and other forms of contractual savings. (d)Investment in Mutual Fund Schemes or UTI Schemes as and when announced:
These are less risky than direct investment in stocks and shares as these enjoy the expert management by the Portfolio Manager or Professional experts. They also have the advantage of diversified Portfolio involving the reduction of risk and economies of scale reducing the cost of investment. (e) Investment in New Issues Market: A new entrant in the Stock Market should preferably
invest in New Issues of existing and well reputed companies either in equity or debentures. Incidentally the instruments in which investment can be made in the new issues market are: 1.
Equity issues through prospectus or rights announced by existing
shareholders. 2.
Preference shares with a fixed dividend either convertible into
equity or not. 3.
Debentures of various categories – convertible, fully convertible,
partly convertible and non- convertible debentures. 4.
P.S.U. Bonds – taxable or free-taxed with interest rates.
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(f) Investment in gold, silver, precious metals and antiques.
(g) Investment in real estates. (h)Investment in gilt-edged securities and securities of Government and Semi-Government
organizations (e.g. Relief bonds, bonds of port trusts, treasury bills, etc.). The maturity period is varying generally upto10 to20 years. Gilt-edged securities market constitutes the largest segment of the Indian capital market. These are fully secured as they have government backing. Tax benefits are available to these securities.
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The following figure indicates alternative avenues for Investment:
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NEW ISSUES MARKET – INVESTMENT DECISION Investors would prefer debentures if they are interested in a fixed income. They may go for convertible debentures, if they want to have both fixed income and likely capital appreciation in future. If they are risk taking and aim only at capital gains, then they may invest in equity shares. Of the new issues those of well established existing companies are least risky while those of new companies floated by little known new entrepreneurs are most risky. In choosing the new issues for investment decision, the investor has to read a copy of the prospectus and note the following: 1. Who are the promoters and their past record? 2. Products manufactured and demand for those products at home or abroad – the competitors and the share of each in the market. 3. Availability of inputs, raw – materials and accessories and the dependence on imports. 4. Project location and its advantages. 5. Prospects through projected earnings, net profits and dividend paying capacity, waiting period involved, etc. If the new issues belong to a company promoted by well – known Business Groups like Tatas, Birlas etc. they are less risky. The company should belong to an industry which is expanding and has good potential like drugs, chemicals, Telecom etc. the terms of offer should be attractive like conversion or immediate prospects of dividend etc.
STOCK MARKET – INVESTMENT DECISION As far as the stock market is concerned, investment in shares is most risky as the likelihood of fall or rise in prices is uncertain. But the returns may also be high commensurate with risk. A host of imponderable factors operate in the stock market and a genuine investor has to do the following things:
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1. Study the Balance Sheet of the company and analyze the prospects of sales and profits. 2. Analyze the market price in terms of book value and profit earning capacity (or P/E Ratio) and use them to know whether the share is overvalued or undervalued. 3. Study the expansion plans or tax savings plans and analyze the company’s financial strength, bonus and dividend paying strength, through the mechanism of financial ratios. 4. Study whether the management is professional and good, whether other accounting practices are dependable and consistent. The company becomes attractive to buy if the financial ratios support the view that the fundamentals are strong and the shares are worth buying. 5. Lastly, if the price of the share is undervalued on the basis of the projected earnings for the coming half year or one year and its P/E Ratio is below the industry average, then it is worth buying. The same is worth selling if in his judgement it is overhauled. For assessing the under valuation and over valuation, the analyst and his analytical power count for this purpose.
GUIDELINES FOR INVESTORS IN THE STOCK MARKET 1. Never buy on rumours or market gossip. 2. Buy only on the basis of fundamental analysis of the companies based on balance sheet data analysis. 3. Buy a diversified list of companies and not put all the money in one or two companies. All investments in the stock market are risky. The risk can be reduced by proper diversification of the portfolio into 10 or 15 companies. 4. Study the sales, gross profit, net profit in relation to equity capital employed and attempt a forecast for the coming half year or one year. 5. A declaration of bonus or low P/E ratio, along with strong fundamentals shows that the company should be a good buy. 6. The investor should also watch for low priced shares which are about to turn around for more profitability in future.
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7. Investors should buy on declines and follow the principle of contrariness. This means that
if everyone is buying scrip, avoid that scrip but if a scrip is deserted and your study has shown that is has potential; for expanding earnings and profitability, then such scrip’s should be purchased by the investor. 8. Avoid both fear and greed on the stock market. If investor is not afraid of the market, he generally studies the market and buys at lows and sells at highs. 9. The investor should know how to analyze the security prices of companies and pick up the undervalued shares. The valuation may be based on the net profits discounted to the present by a proper discount rate or by the book value of share, estimated on the basis of net worth of the company. 10.
Timing of purchase and sale is also very important. If technical analysis and the
use of charts is not familiar to the investor he should follow the principle “buy low and sell high”. He should see whether there is a bull market or bear market in a share by a study of the share price over a period of 15 to 30 days. In a bull phase one can sell at one of the peaks and in a bear phase one can buy at one of troughs. If the investor is greedy to wait on to see the maximum peak, and then he may be disappointed if the price shows a down trend. Similarly, it is difficult to foresee the lowest price for a scrip for the buy. The investor has to use his discretion. The investors should not do the following things: 1) He should not put all his eggs in one basket which means that he should not put all his funds in one or two companies. 2) Do not go by heresy or rumours to buy or sell a scrip as that might be a dupe. 3) Do not speculate involving the buying and selling in the same day or during the same settlement period. A long – term investor gains more than speculator. 4) Avoid taking undue risks or beyond the capacity of your net worth. That means if capital
base is Rs. 2 lakhs, put a stop loss order at Rs. 20,000/- (or 1/8th or 1/10th of the capital base). 5) Do not get panicky if the scrips in which you have invested go down in price. Once the
investment is made after a study of fundamentals, a temporary fall in its price should not cause worry. What the investor needs is patience, which is possible if he is a long – term investor. 64
6) Do not be too greedy or ambitious. Put limits to your operations and buy and sell orders in a price range and your minimum profit limit is 20%.
INVESTMENT STRATEGY Portfolio management can be practiced by following either an active or passive strategy. Active strategy is based on the assumption that it is possible to beat the market. This is done by selecting assets that are viewed as under priced or by changing the asset mix or proportion of fixed income securities and shares. Active strategy is carried out as follows: 1) Aggressive Security Management: Aggressive purchasing and selling of securities to achieve high yields from dividend interest and capital gains.
2) Speculation And Short Term Trading: The objective is to gain capital profits. The risk is high and the composition of portfolio is flexible. Success of active strategy depends on correct decisions as regard the timing of movement in the market as a whole, weight age of various securities in the portfolio and individual share selection. The passive strategy does not aim at outperforming the market. Unlike the active strategy. On the other hand the stocks could be randomly selected on the assumption of a perfectly efficient market. The objective is to include in the portfolio a large number of securities so as to reduce risks specific to individual securities. The characteristics of positive strategy are: 1. Long Term Investment Horizon 2. Little Portfolio Revisions Thus it is basically a buy and hold strategy.
The strategy can be implemented by investing in securities so as to duplicate the portfolio of a market index which is called indexing.
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INVESTMENT AND SPECULATION “Speculation is an activity, quite contrary to its literal meaning, in which a person assumes high risks, often without regard for the safety of his invested principal, to achieve large capital gains.” The time span in which the gain is sought to be made is usually very short. The investor sacrifices some money today in anticipation of a financial return in future. He indulges in a bit of speculation. There is an element of speculation involved in all investment decisions. However it does not mean that all investments are speculative by nature. Genuine investments are carefully thought out decisions. On the other hand, speculative investments are not carefully thought out decisions. They are based on tips and rumours. An investment can be distinguished from speculation in three ways – Risk, capital gain and time period. Investment involves limited risk while speculation is considered as an investment of funds with high risk. The purchase of a security for earning a stable return over a period of time is an investment whereas the primary motive is to earn high profits through price changes is termed as speculation. Thus, speculation involves buying a security at low price and selling at a high price to make a capital gain. The truth is that any investment is a speculation if the investor uses his judgement and forecast the probable course of events in order to reap the returns on his investment.
ELEMENTS OF INVESTMENTS (a) Return: Investors buy or sell financial instruments in order to earn return on them. The
return on investment is the reward to the investors. The return includes both current income and capital gains or losses, which arises by the increase or decrease of the security price. (b)Risk: Risk is the chance of loss due to variability of returns on an investment. In case of
every investment, there is a chance of loss. It may be loss of interest, dividend or principal amount of investment. However, risk and return are inseparable. Return is a precise statistical term and it is measurable. But the risk is not precise statistical term. However, the risk can be quantified: The investment process should be considered in terms of both risk and return.
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(c) Time: Time is an important factor in investment. It offers several different courses of
action. Time period depends on the attitude of the investor who follows a ‘buy and hold’ policy. As time moves on, analysts believe that conditions may change and investors may revaluate expected return and risk for each investment.
FINANCIAL ANALYSIS: An analysis of financial for the past few years would help the investment manager in understanding the financial solvency and liquidity, the efficiency with which the funds are used, the profitability, the operating efficiency and operating leverages of the company. For this purpose certain fundamental ratios have to be calculated. Quality of Management: This is an intangible factor. Yet it has a very important bearing
on the value of the shares. Every investment manager knows that the shares of certain business houses command a higher premium than those of similar companies managed by other business houses. This is because of the quality of management, the confidence that the investors have in a particular business house, its policy vis-à-vis its relationship with the investors, dividend and financial performance record of other companies in the same group, etc. This is perhaps the reason that an investment manager always gives a close look to the management of the company whose shares he is to invest. Quality of management has to be seen with reference to the experience, skill and integrity of the persons at the helm of the affairs of the company. The policy of the management regarding relationship with the share holders is an important factor since certain business houses believe in generous dividend and bonus distributions while others are rather conservative.
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Location and labour management relations: The locations of the company’s
manufacturing facilities determine its economic viability which depends on the availability of crucial inputs like power, skilled labour and raw materials etc. Nearness to market is also a factor to be considered. In the past few years, the investment manager has begun looking into the state of labor management relations in the company under consideration and the area where it is located.
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CHAPTER - 8 ASSEST ALLOCATION INTRODUCTION The portfolio manager has to invest in these securities that form the optimal portfolio. Once a portfolio is selected the next step is the selection of the specific assets to be included in the portfolio. Assets in this respect means group of security or type of investment. While selecting the assets the portfolio manager has to make asset allocation. It is the process of dividing the funds among different asset class portfolios.
ASSET ALLOCATION
The different asset class definitions are widely debated, but four common divisions are stocks, bonds, real-estate and commodities. The exercise of allocating funds among these assets (and among individual securities within each asset class) is what investment management firms are paid for.
Asset classes exhibit different market dynamics, and different interaction effects; thus, the allocation of monies among asset classes will have a significant effect on the performance of the fund. Some research suggests that allocation among asset classes has more predictive power than the choice of individual holdings in determining portfolio return. Arguably, the skill of a 69
successful investment manager resides in constructing the asset allocation, and separately the individual holdings, so as to outperform certain benchmarks (e.g., the peer group of competing funds, bond and stock indices). In order to achieve long term success, individual investors should concentrate on the allocation of their money among stocks, bonds and cash. It means how much to invest in stocks? How much to invest in bonds? And how much to keep in cash reserves? Thus, the asset allocation decision is the most important determinant of investment performance. The basic long term objective of any investor should be to maximize his real overall return on initial investment after investment. To achieve this objective, the investor should look where the best bargains lie. Asset allocation means different things to different people. The portfolio manager has to complete the following stages before making asset allocation. (a) SECURITY SELECTION: This means identifying groups of securities in each asset class
and decides the optimal portfolio. The following are the different asset classes: (1) Equity shares-new issues
(5) PSU bonds
(2) Equity shares-old issues
(6) Government Securities
(3) Preference Shares
(7) Company Fixed Deposits
(4) Debentures Portfolio management is handling the fund on behalf of the company or institution in order to determine the suitable combination of different assets so that the total risk can be reduced to the minimum while the return can be achieved to the maximum extent. This is a tricky job which needs efficiency of high caliber. Therefore, the portfolio manager has to keep in mind the following factors while making asset allocation and design an efficient portfolio. a) Liquidity or marketability
d) Maximization of return
b) Safety of investment
e) Minimization of return
c) Tax Saving
f) Capital appreciation or gain 70
g) Funds requirements
(b) BASIS OF SELECTION OF EQUITY PORTFOLIO: A portfolio is a collection of securities. It is essential that every security be viewed in a portfolio context. It is logical that the expected return of a portfolio should depend on the expected return of each of the security contained in it. Moreover, the amounts invested in each security should also be important. There are two approaches to the selection of equity portfolio. One is technical analysis and the other is fundamental analysis. Technical analysis assumes that the price of a stock depends on supply and demand in the capital market. All financial and market information of given security is already reflected in the market price. Charts are drawn to identify price movements of a given security over a period of time. These charts enable us to predict the future movement of the security. The fundamental analysis includes the study of ratio analysis, past and present track record of the company, quality of management, government policies etc… an efficient portfolio manager can obviously give more weight to fundamental analysis than technical analysis.
DIVERSIFICATION Investing funds in a single security is advisable only if the security’s performance is rewarding. To reduce risk of a portfolio investors resort to diversification. Diversification means shifting form one security to another security. The maximum benefits of risk reduction can be achieved by just having of 10 to 15 carefully selected securities. Portfolio risk can be divided into two groups- diversible risk and non-diversible risk. Diversible risk arises from company’s specific factors. Hence, such risk can be diversified by including stocks of other companies in the portfolio. Non-diversible risk arises from the influence of economy wide factors which affect returns of all companies; investors cannot avoid the risk arising from them. Often investors tend to buy or sell securities on casual tips, prevailing mood in the market, sudden impulse, or to follow others. An investor should investigate the following factors about the stock to be included in his portfolio: 71
(a) Earnings per share (b) Growth potential (c) Dividend and bonus records (d) Business, financial and market risks (e) Behavior of price-earnings ratio (f) High and low prices of the stock (g) Trend of share prices over the few months or weeks. Y
C --------------------------------------- B HIGH RISK (SHARES) A (DEBENT) MEDIUM
RISK
O
X Risk free (Bank Deposits)
We can observe from the above diagram that the strategy of an investor should be at A, B or C respectively, depending upon his preferences and income requirements. If he takes some risk at B or C, the risk can be reduced if it is concerned with a specific company risk, but the market risk is outside his control. The risk can be reduced by a proper diversification of scripts in the portfolio. There may be a combination of A, B and C positions in his portfolio so that he can have a diversified risk-return pattern. This diversification can help to minimize risk and maximum the returns.
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CONCLUSION From the above discussion it is clear that portfolio functioning is based on market risk, so one can get the help from the professional portfolio manager or the Merchant banker if required before investment because applicability of practical knowledge through technical analysis can help an investor to reduce risk. In other words Security prices are determined by money manager and home managers, students and strikers, doctors and dog catchers, lawyers and landscapers, the wealthy and the wanting. This breadth of market participants guarantees an element of unpredictability and excitement. If we were all totally logical and could separate our emotions from our investment decisions then, the determination of price based on future earnings would work magnificently. And since we would all have the same completely logical expectations, price would only change when quarterly reports or relevant news was released.
“I believe the future is only the past again, entered through another gate” –Sir Arthur wing Pinero. 1893.
If price are based on investors’ expectations, then knowing what a security should sell for become less important than knowing what other investors expect it to sell for. “There are two times of a man’s life when he should not speculate; when he can’t afford it and when he can” – Mark Twin, 1897.
A Casino make money on a roulette wheel, not by knowing what number will come up next, but by slightly improving their odds with the addition of a “0” and “00”. Yet many investors buy securities without attempting to control the odds. If we believe that this dealings is not a ‘Gambling” we have to start up it with intelligent way.
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I can conclude from this project that portfolio management has become an important service for the investors to identify the companies with growth potential. Portfolio managers can provide the professional advice to the investors to make an intelligent and informed investment.
Portfolio management role is still not identified in the recent time but due it expansion of investors market and growing complexities of the investors the services of the portfolio managers will be in great demand in the near future.
Today the individual investors do not show interest in taking professional help but surely with the growing importance and awareness regarding portfolio’s manager’s people will definitely prefer to take professional help.
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BIBLIOGRAPHY
REFERENCE BOOKS: Security Analysis and Portfolio Management - Dr. P.K.BANDGAR Investment Analysis and Portfolio Management
WEBLIOGRAPHY SOURCES: www.google.com www.yahoo.com www.wikipedia.com
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