Introduction

Portfolio management may refer to: portfolio is a combination of securities

such as bonds stocks and other instruments. for example if i have purchase
100 shares of reliance, one lot of gold and one lot of silver along with few
bonds and debenture, all the above securities comprise my portfolio.
PO!"O#$O %O&'!(%!$O&: the process of blending together the broad
assets classes so as to obtain optimum return with minimum risk called
portfolio construction. !here are two approaches of portfolio construction:)
!raditional approach. *odern approach.
+e all dream of beating the market and being super investors and
spend an inordinate amount of time and resources in this endeavor.
%onse,uently, we are easy prey for the magic bullets and the secret formulae
offered by eager salespeople pushing their wares. $n spite of our best efforts,
most of us fail in our attempts to be more than average investors.
&onetheless, we keep trying, hoping that we can be more like the investing
legends - another +arren .uffett or Peter #ynch. +e read the words written
by and about successful investors, hoping to find in them the key to their
stock)picking abilities, so that we can replicate them and become wealthy
,uickly.
$n our search, though, we are whipsawed by contradictions and
anomalies. $n one corner of the investment towns,uare, stands one advisor,
yelling to us to buy businesses with solid cash flows and li,uid assets
because that/s what worked for .uffett. $n another corner, another
investment expert cautions us that this approach worked only in the old
world, and that in the new world of technology, we have to bet on companies
with solid growth prospects. $n yet another corner, stands a silver tongued
salesperson with vivid charts and presents you with evidence of his capacity
to get you in and out of markets at exactly the right times. $t is not surprising
that facing this cacophony of claims and counterclaims that we end up more
confused than ever.
!he art and science of making decisions about investment mix and policy,
matching investments to ob0ectives, asset allocation for individuals and
institutions, and balancing risk against performance.
Portfolio management is all about strengths, weaknesses, opportunities and
threats in the choice of debt vs. e,uity, domestic vs. international, growth vs.
safety, and many other tradeoffs encountered in the attempt to maximi1e
return at a given appetite for risk.
$n the case of mutual and exchange)traded funds 23!"s4, there are two forms
of portfolio management: passive and active. Passive management simply
tracks a market index, commonly referred to as indexing or index investing.
5ctive management involves a single manager, co)managers, or a team of
managers who attempt to beat the market return by actively managing a
fund6s portfolio through investment decisions based on research and
decisions on individual holdings. %losed)end funds are generally actively
managed
Portfolio Management - Technical vs. Fundamental Analysis
!here are two schools of thought about how a stock will behave relative to
the market, and like any investment strategy or philosophy, both have their
advocates and adversaries.
7 !echnical analysis, which involves detecting patterns in security
prices, goes on the assumption that the price of a stock ) like the price
of everything else ) is a matter of supply and demand. !echnical
analysts, or technicians, generate and interpret charts of the price and
volume histories of stocks to predict movement in stock prices
according to perceived trends.
7 "undamental analysis, which examines the earning potential of the
company issuing a stock, goes on the assumption that a share of
ownership of a company has an intrinsic value that is a function of the
underlying value of the company as a whole. "undamental analysts
report which shares are undervalued by the investor community and
which are overvalued, then trust the market to make corrections.
$n the world of stock analysis, fundamental and technical analysis are on
completely opposite sides of the spectrum. 3arnings, expenses, assets and
liabilities are all important characteristics to fundamental analysts, whereas
technical analysts could not care less about these numbers. +hich strategy
works best is always debated, and many volumes of textbooks have been
written on both of these methods. +e6ll discuss each in turn.
Portfolio Management - Technical Analysis
!echnical analysis is all about trends. 8ere is a simplified chart showing the
movement of a stock price over 19 months, as well as a trend line:
Figure 12.2
Trends
"igure 1:.: is not intended to be a particularly useful chart for analytical
purposes; however, it demonstrates what a trend line looks like against the
day)to)day changes in a stock price. 'pecifically, it shows a downtrend; if
the stock had started the period at <19 then risen to <::, it would show an
uptrend.
One reason the trend line above is not especially useful from an analytical
standpoint is that it is simply a linear, straight)arrow bullet path. $n technical
analysis, trend lines have to be far subtler than that. !echnical analysis
searches not only for trends, but also for reversals of trends.
(sing a polynomial trend curve, a technician may see a different pattern
emerge, as shown on "igure =:
Figure 12.3
Saucer
5s you can see above, the data line is exactly the same, but at this point a
technician might see a saucer shape, which suggests a trend reversal. 5
saucer bottom indicates the stock price has reached its support level, the
lowest price at which it is likely to trade, and it has nowhere to go but up. 5
saucer top signals exactly the opposite: the stock has reached its resistance
level, the highest price at which it is likely to trade. !he band between the
support and resistance levels is called the trading channel.
ead and Shoulders
5nother sign of a trend reversal is the head)and)shoulders pattern:
Figure 12.!
>ou do not need a trend line for this: the data line tells the story. !he stock
price glided up until it formed its first shoulder in *ay :001, then it dropped
off; then it surged to form a higher peak ) its head ) in ?ecember. $t then fell
off again and surged one more time ) weakly ) to form the second shoulder
in *arch :00:. !echnicians consider this a bearish chart. 5n inverted head)
and)shoulders would be bullish.
"rea#out
!echnicians have an old saying: @!he trend is your friend ) 6til it comes to an
end.@ !hat end is signaled by a breakout, which happens when a stock
penetrates through a support or resistance level. $f a stock price breaks out
through a resistance level and is accompanied by higher)than)usual trading
volumes, technicians consider this a bullish indicator. $t means, according to
technical analysis, that the stock is now looking for a new resistance level,
and it may be able to continue climbing on momentum for ,uite some time.
Moving Average
One other type of trend line that technicians consider is the moving average,
which shows changes in the average share price over a given period.
!echnicians believe that a stock price is likely to regress back to that average
) good news to anyone who bought the stock below that line:
Figure 12.$
$n this example, anyone who bought the stock in Auly :001, when it was
trading below its four)month moving average, would have been amply
rewarded later on.
Accumulation%&istri'ution (ine
'tock price is 0ust one component of technical analysis. Bolume is also
important because, according to technicians, changes in volume precede
changes in price. ight before a stock price gains, there may be a period of
increased volume. One key volume indicator is the
accumulationCdistribution line, which identifies divergences between stock
price and volume flow.
7 $f the price is declining but the volume is increasing, it is a bullish
sign.
7 +hen price gains while volumes decrease, it is bearish.
)ver'ought and )versold
!echnical analysis is as much an art as a science. 'ometimes a stock will be
trading higher than technicians can account for using their price and volume
charts. !hey will then call the stock @overbought@ rather than say @$6m
wrong.@
!he theory is that if all investors who want to buy the stock have already
bought it, then there are only sellers left in the market, and so the price must
drop. 'imilarly, a stock that is trading lower than can be accounted for by
technical analysis is said to be oversold and is expected to rise in price.
*an Technical Analysis "oost Portfolio +eturns,
5 recent white paper authored by ?avid 'mith, %hristophe "augDre, and
>ing +ang, entitled, 8ead and 'houlders above the estE !he Performance
of $nstitutional Portfolio *anagers who (se !echnical 5nalysis, may help to
change the way technical analysis is thought of in the world of asset
management. $n a broad)based study examining two decades worth of
returns, the authors found that fund managers who employed technical
analysis, which relies on the study of price and volume data to predict the
future direction of stocks and other financial instruments, delivered higher
returns than those who did not.
!echnical analysis has long been treated with a certain degree of scorn F or
at least skepticism F by the stock market cognoscenti. Perhaps it is the
suggestion implicit in technical analysis that something other than rigorous
fundamental analysis is behind all the buying and selling. G%hartists,H as
they are known, see asset prices as a function of supply and demand, and
while technical analysts generally agree with the efficient market
hypothesis 23*84 insofar as markets ,uickly reflect all available
information, it is at this point that the disciplines part ways. !echnicians
believe that price patterns tend to repeat over time and, as a result, are
somewhat predictable. !he repetitive behavior of markets is a result of the
irrationality of investors. !his irrationality mainfests itself in behavioral
biases that are, in the view of technicians, exploitable.
Past studies of the efficacy of technical analysis came to a range of
conclusions and no firm consensus. 3ugene "ama and *arshall .lume,
in "ilter ules and 'tock *arket !rading 21IJJ4, found that technical
analysis did not beat simple buy)and)hold strategies after transaction costs.
*ore recent studies, including a paper by +illiam .rock, Aosef
#akonishok, and .lake #e.aron entitled 'imple !echnical !rading ules
and the 'tochastic Properties of 'tock eturns 21II14, suggest some benefit
from trading on technical indicators, including moving averages and trading
range breaks.
'mith, "augDre, and +ang F all professors at the 'chool of .usiness at
the 'tate (niversity of &ew >ork at 5lbany F take a different, more holistic
approach than prior studies. ather than testing individual technical trading
rules, they simply relied on portfolio managers/ assertions about whether or
not, and to what extent, they employed technical analysis in their investment
process. !he authors/ sample includes 10,KL: actively managed (' e,uity,
global e,uity, (' balanced, and global balanced portfolios. !hey find that
technical analysis was utili1ed to some degree by about one)third of the
managers surveyed, with (' e,uity fund managers the most avid users and
(' balanced fund managers the least fre,uent users. !here were no notable
differences in the use of technical analysis by market capitali1ation of
holdings.
3xamining performance between 1II= and :01:, the authors considered
several different performance metrics and found mean and median alpha
values, as well as volatility, to be consistently higher for those funds using
technical analysis. !hey conclude:
GM!heN cross)section of portfolios managed using technical analysis shows
remarkably elevated skewness and kurtosis values relative to portfolios that
do not use technical analysis. $n the presence of the former, the latter can be
advantageous.H
+hile the paper suggests that technical analysis may indeed boost portfolio
returns, it is not clear whether it also extends careers. Over the course of
their study, the authors found that LLO of those disavowing the use of charts
were still in business, while only K9O of those managers who rated technical
analysis as Gvery importantH had survived. 5lthough the authors
convincingly demonstrate that fund managers might enhance their
portfolios/ performance through the use of technical analysis, they don/t tell
us which trading rules are most effective. 5nd for those who have
successfully employed technical analysis, the incentives to divulge their
Gsecret sauceH are few.
Portfolio Management - Fundamental Analysis
"undamental analysis is a very different approach. !he analysts in your
broker)dealer6s e,uity research department rely more on ,uarterly and annual
reports provided by companies.
-ey Financial Statements
5nnual and ,uarterly reports contain two key financial statements:
7 .alance sheet: $t shows assets, or what a company owns, and
liabilities, or what it owes. !he amount by which assets exceed
liabilities is called shareholders6 e,uity. 5 balance sheet is a snapshot
of the company6s solvency as of a given date, usually the last date in
the fiscal ,uarter.
7 $ncome statement: $t shows revenue, or the money coming in, and
expenses, or the money going out. !he amount by which income
exceeds expenses is called earnings. Penerally, expenses related to
costs of goods sold and to selling, general and administrative purposes
are subtracted from revenue first. !he result is earnings before interest
and taxes 23.$!4. !hen interest expense is taken out and the result is
earnings before taxes 23.!4. !hen tax expense is taken out and what
is left is net profit,which can be distributed to shareholders as
dividends or reinvested in the business. 5n income statement reflects
a company6s earnings for a period of time ) every three months for all
(.'.)head,uartered companies
8ere6s what the top half of a balance sheet ) the part that focuses on assets )
looks like:
.-( *)MPA/0 A/& S1"SI&IA+I2S
*)/S)(I&AT2& "A(A/*2 S22T
31S4 MI((I)/S5
02A+S 2/&2& &2*2M"2+ 316 277! A/& 277$
277$ 277!
5''3!'
%urrent assets
%ash and cash e,uivalents 10 1:
5ccounts receivable KK KI
$nventory
1
1I :9
!otal current assets Q= 9I
Property, plan and e,uipment, J00 J00
#ess accumulated depreciation
:
2:K04 2:004
&et property =J0 K00
$ntangible assets, less amorti1ation 190 :00
Total assets 813 89:
!he astute reader will be looking for footnotes to go with those superscript
numbers on the @$nventory@ and @#ess accumulated depreciation@ lines. $f
that6s you, then you might have a future as a fundamental analyst.
&evertheless, you can stop looking ) those superscript numbers are for
demonstration purposes only. 'till, you need to know what could be in those
footnotes and why they are crucial to fundamental analysis.
Fundamental analysis of a business involves analy1ing its financial
statements and health, its management and competitive advantages, and its
competitors and markets. +hen applied to futures and forex, it focuses on
the overall state of the economy, and considers factors including interest
rates, production, earnings, employment, P?P, housing, manufacturing and
management. +hen analy1ing a stock, futures contract, or currency using
fundamental analysis there are two basic approaches one can use; bottom up
analysis and top down analysis.
M1N
!he term is used to distinguish such
analysis from other types of investment analysis, such as ,uantitative
analysis and technical analysis.
"undamental analysis is performed on historical and present data, but with
the goal of making financial forecasts. !here are several possible ob0ectives:
7 to conduct a company stock valuation and predict its probable price
evolution,
7 to make a pro0ection on its business performance,
7 to evaluate its management and make internal business decisions,
7 to calculate its credit risk.
$nvestors may use fundamental analysis within different portfolio
management styles.
7 "uy and hold investors believe that latching onto good businesses
allows the investor6s asset to grow with the business. "undamental
analysis lets them find 6good6 companies, so they lower their risk and
probability of wipe)out.
7 *anagers may use fundamental analysis to correctly value 6good6 and
6bad6 companies. 3ventually 6bad6 companies6 stock goes up and down,
creating opportunities for profits.
7 *anagers may also consider the economic cycle in determining
whether conditions are 6right6 to buy fundamentally suitable
companies.
7 %ontrarian investors distinguish @in the short run, the market is a
voting machine, not a weighing machine@.
M:N
"undamental analysis
allows you to make your own decision on value, and ignore the
market.
7 ;alue investors restrict their attention to under)valued companies,
believing that 6it6s hard to fall out of a ditch6. !he value comes from
fundamental analysis.
7 *anagers may use fundamental analysis to determine future growth
rates for buying high priced growth stocks.
7 *anagers may also include fundamental factors along with technical
factors into computer models 2,uantitative analysis4.
$ Im<ortant 2lements in Fundamental Analysis
7 =hat is fundamental analysis,
7 =hy use fundamental analysis,
7 The true value of a stoc#,
7 $ #ey factors to loo# for
7 "uying at the right <rice
"undamental analysis is critical component in stock analysis. $t is ,uite
accessible, extremely valuable and you actually don6t need a finance degree
to get a basic understanding of it. !he problem of fundamental analysis is
however that it can very easily get ,uite complicated, but it doesn6t have to
be.

=hat is a Fundamental Analysis,
5 fundamental analysis is all about getting an understanding of a company,
the health of its business and its future prospects. $t includes reading and
analy1ing annual reports and financial statements to get an understanding of
the company6s comparative advantages, competitors and its market
environment.
=hy use fundamental analysis,
"undamental analysis is built on the idea that the stock market may price a
company wrong from time to time. Profits can be made by finding
underpriced stocks and waiting for the market to ad0ust the valuation of the
company. .y analy1ing the financial reports from companies you will get an
understanding of the value of different companies and understand the pricing
in the stock market.
5fter analy1ing these factors you have a better understanding of whether the
price of the stock is undervalued or overvalued at the current market price.
"undamental analysis can also be performed on a sectors basis and in
the economy as a whole.
The true value of a stoc#,
"or a fundamental analyst, the market price of a stock tends to move towards
its 6intrinsic value6, which is the 6true value6 of a company as calculated by its
fundamentals. $f the market value does not match the true value of the
company, there is an investment opportunity.
3xample of this is that if the current market price of a stock is lower than the
intrinsic price, the investor should purchase the stock because he expects the
stock price to rise and move towards its true value. 5lternatively, if the
current market price is above the intrinsic price, the stock is considered
overbought and the investor sells the stock because he knows that the stock
price will fall and move closer to its intrinsic value. !o determine the true
price of the company6s stock, the following factors need to be considered.
$ #ey factors to loo# for
1. 2arnings
!he key element all investors look after is earnings. .efore investing in a
company you want to know how much the company is making in profits.
"uture earnings are a key factor as the future prospects of the company6s
business and potential growth opportunities are determinants of the stock
price.
"actors determining earnings of the company are such as sales, costs, assets
and liabilities. 5 simplified view of the earnings is earnings <er share
32PS5. !his is a figure of the earnings which denotes the amount of earnings
for each outstanding share.

2. Profit Margins
5mount of earnings do not tell the full story, increasing earnings are good
but if the cost increases more than revenues then the profit margin is not
improving. !he <rofit margin measures how much the company keeps in
earnings out of every dollar of their revenues. !his measure is therefore very
useful for comparing similar companies, within the same industry.
8igher profit margin indicates that the company has better control over its
costs than its competitors. Profit margin is displayed in percentages and a 10
percent profit margin denotes that the company has a net income of 10 cents
for each dollar of their revenues.
!o get better understanding of profit margins it is good to compare two
companies with alternative margins, see table below.



3. +eturn on 2>uity 3+)25
eturn of e,uity 2O34 is a financial ratio that does not account for the
stock price. 'ince it ignores the price entirely it is by many thought of as
T2 most important financial measure. $t can basically be thought of as the
parent ratio that always needs to be considered.
!his ratio is a measure of how efficient a company is in generating its
profits. $t is a ratio of revenue and profits to owners6 e,uity 2shareholders are
the owners4. 'pecifically it is:
5n easy example of this is that if company 5 and company . both generate
net profits of <1 *illion but company 5 has e,uity of <10 *illion but
company . has e,uity of <100 *illion. !heir O3 would be 10O and 1O
respectively meaning that company 5 is more efficient as it was able to
produce the same amount of earnings with 10 times less e,uity.

!he reason for why this measure is so important is because it contains
information about several factors, such as:
7 #everage 2which is the debt of the company4
7 evenue, profits and margins
7 eturning values to shareholders
Pood approximation is that O3 should be 10)K0O greater than its peer.

!. Price-to-2arnings 3P%25
+hen taking the current market price into consideration, the most popular
ratio is the Price)to)3arnings 2PC34 ratio. 5s the name suggest it is the
current market price divided by its earnings per share 23P'4. $t is an easy
way to get a ,uick look of a stock6s value.
5 high PC3 indicates that the stock is priced relatively high to its earnings,
and companies with higher PC3 therefore seem more expensive. 8owever,
this measure, as well as other financial ratios, needs to be compared to
similar companies within the same sector or to its own historical PC3. !his is
due to different characteristics in different sectors and changing markets
conditions.
!his ratio does not tell the full story since it does not account for growth.
&ormally, companies with high earnings growth are traded at higher PC3
values than companies with more moderate growth rate. 5ccordingly, if the
company is growing rapidly and is expected to maintain its growth in the
future this current market price might not seem so expensive. !his is the
reasoning for the existence of different investment styles; Balue vs. Prowth
stocks.
2?am<le
+hile some sectors normally have low PC3 measures, other sectors
commonly have higher ratios. "or example, utilities commonly have PC3
ranging from L to 10 while technology companies commonly have a PC3
ratio ranging from 1L to :0 or above. !his is due to expectations in the
market about the sector and its earnings)growth possibilities. !he utility
sector has stable earnings and is not expected to grow rapidly while
technology companies are expected to grow faster and tend to need less
capital for its growth.
$n order to simplify, the following table illustrates four companies in two
sectors with alternative figures.
It is not very appropriate to compare Apple with GDF Suez as Apple has a
growth rate of 11 times more than GDF. It is more appropriate to compare
Apple with Google. In that relation, Apple seems cheaper than Google by
the loo of the !"#. $ow you shoul% as why that coul% be& 'is this bargain
or are some other reason why Apple is price% lower than Google. (ne
suggestion might be that the maret e)pects Google to have more earnings'
growth in the coming future an% Apple*s previous earnings growth is not
e)pecte% to grow much further.

$n order to account for growth, the PC3 ratio can be modified into the
Price%2arnings to @roAth 3P2@5 ratio. 5 P3P ratio is calculated by
dividing the stock6s PC3 ratio by its expected 1: month growth rate. 5
common rule of thumb is that the growth rate ought to be roughly e,ual to
the PC3 ratio and thus the P3P ratio should be around 1. 5 relatively low
P3P ratio indicates an undervalued stock and a P3P ratio much greater than
1 indicates an overvalued stock.
!he P3P ratio can be very informative figure, especially for fast growing
and cyclical companies. $n this one ratio you get an understanding of the
company6s earnings, growth expectations and whether it is trading at a
reasonable price relative to its fundamentals.

$. Price-to-"oo# 3P%"5
5 price)to)book 2PC.4 ratio is used to compare a stock6s market value to its
book value. $t can be calculated as the current share price divided to the
book value per share, according to previous financial statement. $n a broader
sense, it can also be calculated as the total market capitali1ation of the
company divided by all the shareholders e,uity.
!his ratio gives certain idea of whether you are paying too high price for the
stock as it denotes what would be the residual value if the company went
bankrupt today.
5 higher PC. ratio than 1 denotes that the share price is higher than what the
company6s assed would be sold for. !he difference indicates what investors
think about the future growth potential of the company.
"uying at the right <rice,
$n the long run the stock price should reflect its fundamental true value.
8owever in the short run a stock might have great fundamentals but still be
moving in wrong direction. !his can be due to other factors, such as news
releases and changes in future outlook, which also have effect on the price.
!rends in the market and investors emotions also effect the short)term
fluctuation in stock prices resulting in the current market price deviating
from its true value.
One ,uestion that is important to consider is: @+hat is the %ifference
between a great business an% a great investment&@ )the answer is @price@. $f
you pay too high price for even the best stock in the world, you will never
make a good return on your investment. !herefore, a great investment does
not likely have a high price. !he point of this ,uestion is that the price you
pay for a stock does matter enormously; it is the most important factor in
your return. 5ccordingly, doing your fundamental analysis 2thoroughly4 is of
a great importance when making your investments.
+hen determining whether a company6s stock is a good investment,
fundamental analysis is a great toolbox to reach a conclusion.