10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Meaning
It is a combination of securities such as

stocks, bonds and money market instruments.

The process of blending together the broad
asset classes so as to obtain optimum return
with minimum risk is called portfolio
construction.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Risk and return in

portfolio
Risk is the uncertainty of the income/capital
appreciation or loss of both.
Total return =income+price change

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Portfolio managers
Only those who are registered and pay the license

fee are eligible.

Should have necessary infrastructure with
professionally qualified persons and with
minimum of two persons with experience in the
business and a minimum networth of Rs.2 Crores.
For registration as a portfolio manager, an
applicant is required to pay a non-refundable
application fee of Rs.1,00,000/
Every portfolio manager is required to pay Rs. 10
lakhs as registration fees at the time of grant of
certificate of registration by SEBI.
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

The portfolio manager is required to pay Rs. 5

lakh as renewal fees to SEBI

Portfolio managers should not resort to price
rigging, insider trading etc.
Their books of account are subject to
inspection and audit by SEBI

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Portfolio management
service
It means the professional services rendered
for management of portfolio of others,
namely, clients or customers with the help of
experts in investment advisory services.
This involves advice regarding the worth of
investment instruments and advice of what to
buy and sell. It also involves continuing
relationship with the client to manage
investments with or without discretion for the
client as per his requirements.
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

SEBI norms
They cannot assure any fixed return to the

client.
The investment made is subject to market risk
No sharing of profits of discounts to client are
permitted
PMs are prohibited to do lending, bills
discounting etc.
Investment can be made in both capital and
money markets
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Clients money has to be kept in a separate

account with the public sector bank and

cannot be mixed up with his own funds. A
separate ledger account is to be maintained
for all purchases/sales
Notice of termination of contract as per the
contract.
No contract for less than a year is permitted.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Types of portfolios
Discretionary portfolio management services

(DPMS)
Non-discretionary portfolio management
services

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Discretionary portfolio
manager
and
NonThe discretionary portfolio manager
discretionary
portfolio
individually and independently
manages the
funds of each client in accordance with the
manager
needs of the client.
The non-discretionary portfolio manager

manages the funds in accordance with the

directions of the client.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Passive portfolio strategy

A strategy that involves minimal

expectational input, and instead relies on

diversification to match the performance of
some market index.
A passive strategy assumes that the market
will reflect all available information in the
price paid for securities, and therefore, does
not attempt to find mispriced securities.
The goal is to match a particular market
index's return
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Active portfolio strategy

An investment approach in which an investor

uses a variety of forecasting and assumption

techniques to determine which securities to
purchase in order to achieve a high return.
Unlike the buy and hold strategy, an active
portfolio strategy is more likely to buy and sell
securities with greater frequencies as the
investor seeks to move available capital into
more profitable stocks.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Patient Portfolio
Patient portfolio refers to holding of stocks of

eminent and established companies and

business corporations.
When investors invest in such companies they
are guaranteed of getting dividends and are
usually long-term investment avenues. It implies
that they have invested in companies that are
bound to grow and would provide the expected
returns irrespective of the market conditions.
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Aggressive Portfolio
Aggressive portfolios are exactly contrary to

patient portfolios. In this investors invest in

new or small companies that seem promising
and have an impressive start. Hence,
investors can expect greater returns but with
higher risks.
In this portfolio, the investor can earn huge
profits or equivalently suffer huge losses.
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Conservative Portfolio
The conservative portfolio is a combination of

the patient and the aggressive portfolios. In

this, investors can hold a combination of
stocks of established companies as well as
those of new and up-coming companies.
Investors can accomplish both the aims of
achieving greater returns along with steady
growth
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Steps involved in portfolio

construction

- Security valuation
-Asset allocation
-Portfolio optimization
-Performance measurement

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Traditional approach in
portfolio
construction

Investors needs in terms of income and

capital appreciation are evaluated and
appropriate securities are selected to meet
the needs.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Modern Portfolio Theory

A theory on how risk-averse investors can

construct portfolios to optimize or maximize

expected return based on a given level of
market risk, emphasizing that risk is an
inherent part of higher reward.
Stocks are not selected on the basis of need
for income or appreciation.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Capital market theory

Capital market theory is a generic term for

the analysis of securities. In terms of trade off

between the returns sought by investors and
the inherent risks involved, the capital market
theory is a model that seeks to price shares.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Assumptions of Capital
Market
Theory

All Investors are Efficient Investors

Investors Borrow/Lend Money at the Risk-Free
Rate
The Time Horizon is equal for All Investors
All Assets are Infinitely Divisible
There is No Mispricing within the Capital
Markets

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Markowitz model
Portfolio risk can be reduced by the simplest

kind of diversification.
Assumptions:
- Investor estimates risk on the basis of
variability of returns.
- investors decision solely based on the
expected return and variance of return only.
- For a given level of risk, investor prefers
higher return and a given level of return
investor prefers lower risk.
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Markowitz efficient
frontier
The risk and return of all portfolios plotted in
risk-return space would be dominated by
efficient portfolios.
Efficient frontier is the line along which all
attainable and efficient portfolios are
available.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Sharpe index model

William Sharpe developed a simplified model

to analyse the portfolio. He assumed that the

return on a security is linearly related to a
single index like the market index.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Capital Asset Pricing

Model(CAPM)
Assumptions:
- An individual seller/buyer cannot affect the price
-

of the stock.
Investors are assumed to have homogeneous
expectations during decision making period.
Investors can lend or borrow any amount of funds
at the riskless rate of interest.
Assets are infinitely divisible.
There is no transaction cost
There is no personal income tax
Unlimited quantum of short sales allowed.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

The expected return on the risky and riskfree

combination is
Rp = Rf Xf + Rm(1-Xf)
where Rp portfolio return
Xf proportion of funds invested in riskfree assets
1-Xf the proportion of funds invested in risky

assets
Rf riskfree rate of return
Rm return on risky assets
10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Capital Market Line - CML

Aline used in the capital asset pricing model

to illustrate the rates of return forefficient

portfolios depending on the risk-free rate of
return and the level of risk
(standarddeviation)for a particular portfolio

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Security Market Line - SML

Aline thatgraphs the systematic, or market

risk versus return of the whole market at a

certain time.
The SMLessentially graphs the results from
thecapital asset pricing model (CAPM)
formula. Thex-axis represents the risk (beta),
and the y-axis represents the expected return.
The market risk premium is determined
fromthe slope of the SML.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

The security market lineis a useful tool in

determiningwhether an asset being considered for a

portfolio offers a reasonableexpected return for risk.
Individual securitiesare plotted on the SML graph.
If the security's risk versus expected return is
plotted above the SML, it is undervaluedbecause
the investor can expect a greater return for the
inherent risk.A security plotted below the SMLis
overvaluedbecause the investor would be accepting
less return for the amount of risk assumed.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore

Beta
Beta is a measure of systematic risk which is

useful in portfolio management. It measures

the movement of one scrip in relation to the
market trend.
Beta can be positive or negative.
The scrips which are having a high beta of
more than 1 are called aggressive and that of
less than 1 are called defensive.

10/03/16

Prof. Nijumon K John, Christ University,

Bangalore