Portfolio Revision
Chapter 21

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.

 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 .

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.

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.

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.

Portfolio Revision Strategies
Two different strategies may be adopted for
portfolio revision which are as follows:
1}Active Revision Strategy
2}Passive Revision Strategy

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.

 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

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.

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.

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.

The Formula Plans
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 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.

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.

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.

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.

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.

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.

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.

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.