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What Are The 7 Steps Of Portfolio Process

Every investor knows that an investment portfolio is essential to ensure long-term wealth creation and stability. In order to ensure that a portfolio remains in its optimal shape, investors should be guided by the principles of portfolio management process, which is essentially the practice of choosing the right asset classes, rebalancing the portfolio periodically and actively managing the portfolio against adversity and market cycles.

In this article, we will discuss the 7 steps of portfolio process in sufficient detail to help investors master the art of portfolio management.

Step 1—Development of Investment Policy Statement (IPS)

The first step of the portfolio management process is creating an Investment Policy Statement (IPS), which essentially outlines the investor’s attitude towards investment management. The IPS coverers a wide range of pertinent topics such as the investor’s financial goal and risk tolerance, the portfolio’s asset allocation, and portfolio diversification. With these inputs, portfolio managers can accurately determine the investor’s financial long-term needs and craft an IPS tailored to its needs.

By analyzing the IPS, investors can effectively determine the desired asset allocation and risk expectation of the investment.

Step 2—Asset Allocation

Once the financial needs are established via the IPS, the portfolio manager can accurately determine the desired asset allocation and risk expectation of the investment. Asset allocation is the proportion of funds allocated to each investment class such as stocks, bonds, cash and alternatives.

The goal of asset allocation is to generate higher returns while minimizing risks taken. Financial advisors and portfolio managers use modern mathematical tools such as Monte Carlo simulations and diversification analysis to identify the optimal asset allocation for their clients.

Step 3—Security Selection

The third step is security selection, which involves selecting the most suitable securities for the portfolio based on the the underlying asset classes, risk and expected returns. The goal of security selection is to maximize the return potential and minimize the potential for loss. Portfolio managers use quantitative, technical and fundamental analysis to identify and screen potential securities for their portfolios.

They also combine traditional and modern analysis tools to build a well-rounded portfolio that is optimally diversified and meets the IPS objectives.

Step 4—Implementation and Execution

Once the asset allocation and security selection are complete, the next step is to implement the portfolio. This is done typically through the purchase and sale of securities, but portfolio managers can also use different instruments such as futures, options and derivatives to implement the portfolio.

In addition, portfolio managers are also tasked with ensuring that the execution of the portfolio is done in conjunction with the IPS, that all transactions are completed in the most efficient manner, and that all legal and regulatory requirements are met.

Step 5—Risk Management

Risk management is an essential step in portfolio management. It involves the process of measuring and controlling the risk of the portfolio by assessing risk exposure and making strategic adjustments to mitigate risk.

Portfolio managers use various instruments and techniques to identify, measure and manage risk. These include technical indicators, sensitivity tests, scenario analysis and stress testing.

Step 6—Analysis and Performance Evaluation

The sixth step involves the process of analyzing and evaluating the performance of the portfolio over the given period. This helps to determine if the portfolio has been performing in line with the IPS objectives and provides the manager with key insights for further improvement.

Performance evaluation involves the analysis of financial metrics such as returns, volatility and alpha, as well as non-financial metrics such as liquidity, credit quality and tax efficiency. Based on the analysis, portfolio managers can make changes to the portfolio to make sure that it achieves the desired level of performance.

Step 7—Rebalancing

The final step of the portfolio process is rebalancing. Rebalancing involves adjusting the asset allocation of the portfolio to make sure that it is in line with the IPS objectives.

This helps to ensure that the portfolio remains aligned with the long-term goals of the investors and is not exposed to unnecessary risks due to changes in market dynamics. Rebalancing is typically done when the weight of an asset class exceeds the target level or when it falls below the acceptable level. ConclusionIn conclusion, portfolio management is essential for long-term wealth creation and stability.

It involves a systematic process of creating an IPS, determining the right asset allocation, selecting the most suitable securities, executing the portfolio, managing risk, evaluating performance and rebalancing. Understanding and mastering the portfolio management process will help investors to make well-informed decisions and maximize their investment returns.

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