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11 S&PM PPT portfolio revision.ppt

  1. Portfolio Revision Chapter 21
  2. Meaning of Portfolio Revision  In portfolio management, the maximum emphasis is placed on portfolio analysis and selection which leads to the construction of the optimal portfolio .portfolio revision is an important as portfolio analysis and selection.  The financial markets are continually changing. In this dynamic environment ,a portfolio that was optimal when constructed may not continue to be optimal with the passage of time. It may have to be revised periodically so as to ensure that it continues to be optimal.  A portfolio is a mix of securities selected from a vast universe of securities. Two variables determine the composition of a portfolio: 1} the securities included in the portfolio,and 2} the proportion of total funds invested in each security.
  3.  Portfolio revision involves changing the existing mix of securities .this may be effected either by changing the securities currently included in the portfolio or by altering the proportion of funds invested in the securities.  New securities may be added to the portfolio or some of the existing securities may be removed from the portfolio.  Portfolio revision thus leads to purchases and sales of securities .
  4. Objective of portfolio revision  The objective of portfolio revision is the same as the objective of portfolio selection, i.e., maximization the return for a given level of risk or minimization the risk for a give for a give level of return. The ultimate aim of portfolio revision is: 1} to maximize the returns and 2} to minimize the risk.
  5. Need for Revision  The primary factor necessitating portfolio revision is changes in the financial markets since the creation of the portfolio . The need for portfolio revision may arise because of some investor related factors also. These factors may be listed as: 1} availability of additional funds for investment 2} change in risk tolerance 3} change in the investment goals. 4} need to liquidate a part of the portfolio to provide the required funds  The portfolio need to be revised to accommodate the changes in the investor’s position. Thus, the need for portfolio revision may arise from changes in the financial market or changes in the investor’s position, namely his financial status and preferences.
  6. Constraints in Portfolio Revision 1}Transaction cost: Buying n selling of securities involve transaction costs such as commission and brokerage. Frequent buying and selling of securities for portfolio revision may push up transaction costs there by reducing the gains from portfolio revision. hence, the transaction costs involved in portfolio revision may act as a constraint to timely revision of portfolio. 2}Taxes: Tax is payable on the capital gains arising from sale of securities .usually ,long-term capital gain are taxed at a lower rate that short-term capital gains. To qualify as long –term capital gain ,a security must be help by an investor for a period of not less that 12 months before sale. Frequent sales of securities in the course of periodic portfolio revision or adjustment will result in short-term capital gain which would be taxed at a higher rate compared to long-term capital gain . the higher tax on short-term capital gain may act as a constraint to frequent portfolio revisions. 3} Statutory stipulations: The largest portfolio in every country are managed by investment companies and mutual funds. These institutional investors are normally governed by certain statutory stipulations regarding their investment activity. These stipulations often act as constraints in timely portfolio revision. 4} Intrinsic difficulty: portfolio revision is a difficult and time consuming exercise. The methodology to be followed for portfolio revision is may be adopted for the purpose. The difficulty of carrying out portfolio revision itself may act as a constraint to portfolio revision.
  7. Portfolio Revision Strategies Two different strategies may be adopted for portfolio revision which are as follows: 1}Active Revision Strategy 2}Passive Revision Strategy
  8. 1}Active Revision Strategy :  Active revision strategy involves frequent and sometime substantial adjustment to the portfolio .  Active portfolio revision is essentially carrying out portfolio analysis and portfolio selection all over again .  It is based on an analysis of the fundamental factors affecting the economy , industry and company as also the technical factors like demand and supply. Implement active revision strategy will be must higher .  The frequency of trading is likely to be must higher. The frequency of trading is likely to be much higher under active revision strategy resulting in higher transaction costs.
  9.  Active Management is holding securities based on the forecast about the future.  The portfolio managers who pursue active strategy with respect to market components are called ‘market timers’.  The managers may indulge in ‘group rotations’. Active Management
  10. 2} Passive Revision Strategy:  Passive revision strategy ,in contrast , involves only minor and infrequent adjustment to the portfolio over time.  The practitioners of passive revision strategy believe in market efficiency and homogeneity of expectation among investors.  They find little incentive for actively trading and revision portfolios periodically.  Under passive revision strategy , adjustment to the portfolio is carried out according to certain predetermined rules and procedures designated as formula plans.  These formula plans. These formula plans help the investor to adjust his portfolio according to changes in the securities market.
  11. Passive Management  Passive management refers to the investor’s attempt to construct a portfolio that resembles the overall market returns.  The simplest form of passive management is holding the index fund that is designed to replicate a good and well defined index of the common stock such as BSE-Sensex or NSE-Nifty.
  12. Portfolio Revision  The investor should have competence and skill in the revision of the portfolio.  The portfolio management process needs frequent changes in the composition of stocks and bonds.  Mechanical methods are adopted to earn better profit through proper timing.  Such type of mechanical methods are Formula Plans and Swaps.
  13. The Formula Plans Stronglyefficientmarket Allinformationis reflectedonprices. Weaklyefficientmarket Allhistoricalinformation isreflectedonsecurity Semistrongefficientmarket Allpublicinformationis reflectedonsecurityprices Stronglyefficientmarket Allinformationis reflectedonprices. Weaklyefficientmarket Allhistoricalinformation isreflectedonsecurity Semistrongefficientmarket Allpublicinformationis reflectedonsecurityprices Stronglyefficientmarket Allinformationis reflectedonprices. Weaklyefficientmarket Allhistoricalinformation isreflectedonsecurity Semistrongefficientmarket Allpublicinformationis reflectedonsecurityprices  The formula plans provide the basic rules and regulations for the purchase and sale of securities.  The aggressive portfolio consists more of common stocks which yield high return with high risk.  The conservative portfolio consists of more bonds that have fixed rate of returns.
  14. Assumptions of the Formula Plan  Certain percentage of the investor’s fund is allocated to fixed income securities and common stocks.  The portfolio is more aggressive in the low market and defensive when the market is on the rise.  The stocks are bought and sold whenever there is a significant change in the price.  The investor should strictly follow the formula plan once he chooses it.  The investors should select good stocks that move along with the market.
  15. Advantages of the Formula Plan  Basic rules and regulations for the purchase and sale of securities are provided.  The rules and regulations are rigid and help to overcome human emotion.  The investor can earn higher profits by adopting the plans.  It controls the buying and selling of securities by the investor.  It is useful for taking decisions on the timing of investments.
  16. Disadvantages of the Formula Plan  The formula plan does not help the selection of the security.  It is strict and not flexible with the inherent problem of adjustment.  Should be applied for long periods, otherwise the transaction cost may be high.  Investor needs forecasting.
  17. Rupee Cost Averaging  Stocks with good fundamentals and long term growth prospects should be selected.  The investor should make a regular commitment of buying shares at regular intervals.  Reduces the average cost per share and improves the possibility of gain over a long period.
  18. Constant Rupee Plan  A fixed amount of money is invested in selected stocks and bonds.  When the price of the stocks increases, the investor sells sufficient amount of stocks to return to the original amount of the investment in stocks.  The investor must choose action points or revaluation points.  The action points are the times at which the investor has to readjust the values of the stocks in the portfolio.
  19. Constant Ratio Plan  Constant ratio between the aggressive and conservative portfolios is maintained.  The ratio is fixed by the investor.  The investor’s attitude towards risk and return plays a major role in fixing the ratio.
  20. Variable Ratio Plan  At varying levels of market price, the proportions of the stocks and bonds change.  Whenever the price of the stock increases, the stocks are sold and new ratio is adopted by increasing the proportion of defensive or conservative portfolio.  To adopt this plan, the investor is required to estimate a long term trend in the price of the stocks.