Portfolio manager

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A portfolio manager (PM) is a professional responsible for making investment decisions and carrying out investment activities on behalf of vested individuals or institutions. Clients invest their money into the PM's investment policy for future growth, such as a retirement fund, endowment fund, or education fund. [1] PMs work with a team of analysts and researchers and are responsible for establishing an investment strategy, selecting appropriate investments, and allocating each investment properly towards an investment fund or asset management vehicle. [2]

Contents

Model

In the 1950s, Harry Markowitz, an American economist, developed the modern portfolio theory. [3] Jack Treynor (1961, [4] 1962 [5] ), William F. Sharpe (1964 [6] ), John Lintner (1965 [7] ) and Jan Mossin (1966 [8] ) later build the Capital Asset Pricing Model (CAPM) on the theory of Markowitz. Nowadays, the CAPM is one of the primary portfolio management tools. The formula calculates the potential return percentage of an investment vehicle based on its vested risk appetite. [9] The formula is:

where:

Investors

The goal of an investment manager is to earn a greater return than the return expected given the level of risk. This return can be monitored by investors through weekly, monthly, quarterly, or yearly performance reports that are shared by the PM. The manager may set up a performance benchmark or track their investment strategy alongside an index. The investment policy shared by the manager outlines investment details, such as minimum investment requirements, liquidity provisions, investment strategy, and the markets the manager will be actively investing in. [10]

Institutional investors include fund of hedge funds, insurance companies, endowment funds, and sovereign wealth funds. Individual investors include ultra-high net worth individuals (UHNW) or high net worth individuals (HNW).

Portfolio managers and investment analysts

Portfolio managers make decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance. Portfolio management is about strengths, weaknesses, opportunities, and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and other trade-offs encountered in the attempt to maximize return at a given appetite for risk. [11] [12]

Portfolio managers are presented with investment ideas by internal buy-side analysts and sell-side analysts from investment banks. It is their job to sift through the relevant information and use their judgment to buy and sell securities. Throughout the day they read reports, talk to company managers, and monitor industry and economic trends, looking for the right company and time to invest the portfolio's capital. [11] [12]

A team of analysts and researchers are ultimately responsible for establishing an investment strategy, selecting appropriate investments, and allocating each investment properly for a fund or asset management vehicle. [11] [12]

In the case of mutual and exchange-traded funds (ETFs), 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. Active management involves a single manager, co-managers, or a team of managers who attempt to beat the market return by actively managing a fund's portfolio through investment decisions based on research and decisions on individual holdings. Closed-end funds are generally actively managed. [13]

Insider trading


A portfolio manager risks losing his past compensation if he engages in insider trading; in fact, lawyers at the law firm Davis & Gilbert wrote in an article in a 2014 article in Financial Fraud Law Report that:

"Based upon courts current application of New York's faithless servant doctrine, it is virtually certain that if ... hedge fund ... managers engage in wrongdoing ... those .. managers will be forced to disgorge all compensation received during the period the wrongdoing occurred". [14]

In Morgan Stanley v. Skowron , 989 F. Supp. 2d 356 (S.D.N.Y. 2013), applying New York's faithless servant doctrine, the court held that a hedge fund's PM engaging in insider trading in violation of his company's code of conduct, which also required him to report his misconduct, must repay his employer the full $31 million his employer paid him as compensation during his period of faithlessness. [15] [16] [17] [18] The court called the insider trading the "ultimate abuse of a PM's position." [16] The judge also wrote: ""In addition to exposing Morgan Stanley to government investigations and direct financial losses, Skowron's behavior damaged the firm's reputation, a valuable corporate asset." [16]

Systems

The IT infrastructure for a PM facilitates the delivery of updated prices and market information to allow for trade orders, trade executions, and their overall portfolio value. The IT infrastructure, known as a portfolio management system (PMS), include components such as an order management system, execution management system, portfolio valuation, risk, and compliance. A front-back PMS will also include a middle office and back office components such as trade management, pre/post-trade tools, cash management, and net asset value calculations. [19]

See also

Related Research Articles

Passive management is an investing strategy that tracks a market-weighted index or portfolio. Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds.

An index fund is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that it can replicate the performance ("track") of a specified basket of underlying investments. While index providers often emphasize that they are for-profit organizations, index providers have the ability to act as "reluctant regulators" when determining which companies are suitable for an index. Those rules may include tracking prominent indexes like the S&P 500 or the Dow Jones Industrial Average or implementation rules, such as tax-management, tracking error minimization, large block trading or patient/flexible trading strategies that allow for greater tracking error but lower market impact costs. Index funds may also have rules that screen for social and sustainable criteria.

<span class="mw-page-title-main">Capital asset pricing model</span> Model used in finance

In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio.

A closed-end fund, also known as a closed-end mutual fund, is an investment vehicle fund that raises capital by issuing a fixed number of shares at its inception, and then invests that capital in financial assets such as stocks and bonds. After inception it is closed to new capital, although fund managers sometimes employ leverage. Investors can buy and sell the existing shares in secondary markets.

<span class="mw-page-title-main">William F. Sharpe</span> American economist

William Forsyth Sharpe is an American economist. He is the STANCO 25 Professor of Finance, Emeritus at Stanford University's Graduate School of Business, and the winner of the 1990 Nobel Memorial Prize in Economic Sciences.

An exchange-traded fund (ETF) is a type of investment fund that is also an exchange-traded product, i.e., it is traded on stock exchanges. ETFs own financial assets such as stocks, bonds, currencies, debts, futures contracts, and/or commodities such as gold bars. The list of assets that each ETF owns, as well as their weightings, is posted on the website of the issuer daily, or quarterly in the case of active non-transparent ETFs. Many ETFs provide some level of diversification compared to owning an individual stock.

Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversification in investing, the idea that owning different kinds of financial assets is less risky than owning only one type. Its key insight is that an asset's risk and return should not be assessed by itself, but by how it contributes to a portfolio's overall risk and return. The variance of return is used as a measure of risk, because it is tractable when assets are combined into portfolios. Often, the historical variance and covariance of returns is used as a proxy for the forward-looking versions of these quantities, but other, more sophisticated methods are available.

In finance, arbitrage pricing theory (APT) is a multi-factor model for asset pricing which relates various macro-economic (systematic) risk variables to the pricing of financial assets. Proposed by economist Stephen Ross in 1976, it is widely believed to be an improved alternative to its predecessor, the capital asset pricing model (CAPM). APT is founded upon the law of one price, which suggests that within an equilibrium market, rational investors will implement arbitrage such that the equilibrium price is eventually realised. As such, APT argues that when opportunities for arbitrage are exhausted in a given period, then the expected return of an asset is a linear function of various factors or theoretical market indices, where sensitivities of each factor is represented by a factor-specific beta coefficient or factor loading. Consequently, it provides traders with an indication of ‘true’ asset value and enables exploitation of market discrepancies via arbitrage. The linear factor model structure of the APT is used as the basis for evaluating asset allocation, the performance of managed funds as well as the calculation of cost of capital. Furthermore, the newer APT model is more dynamic being utilised in more theoretical application than the preceding CAPM model. A 1986 article written by Gregory Connor and Robert Korajczyk, utilised the APT framework and applied it to portfolio performance measurement suggesting that the Jensen coefficient is an acceptable measurement of portfolio performance.

In finance, the beta is a statistic that measures the expected increase or decrease of an individual stock price in proportion to movements of the stock market as a whole. Beta can be used to indicate the contribution of an individual asset to the market risk of a portfolio when it is added in small quantity. It refers to an asset's non-diversifiable risk, systematic risk, or market risk. Beta is not a measure of idiosyncratic risk.

In finance, the Sharpe ratio measures the performance of an investment such as a security or portfolio compared to a risk-free asset, after adjusting for its risk. It is defined as the difference between the returns of the investment and the risk-free return, divided by the standard deviation of the investment returns. It represents the additional amount of return that an investor receives per unit of increase in risk.

In finance, Jensen's alpha is used to determine the abnormal return of a security or portfolio of securities over the theoretical expected return. It is a version of the standard alpha based on a theoretical performance instead of a market index.

In finance, a portfolio is a collection of investments.

Investment management is the professional asset management of various securities, including shareholdings, bonds, and other assets, such as real estate, to meet specified investment goals for the benefit of investors. Investors may be institutions, such as insurance companies, pension funds, corporations, charities, educational establishments, or private investors, either directly via investment contracts/mandates or via collective investment schemes like mutual funds, exchange-traded funds, or REITs.

Alpha is a measure of the active return on an investment, the performance of that investment compared with a suitable market index. An alpha of 1% means the investment's return on investment over a selected period of time was 1% better than the market during that same period; a negative alpha means the investment underperformed the market. Alpha, along with beta, is one of two key coefficients in the capital asset pricing model used in modern portfolio theory and is closely related to other important quantities such as standard deviation, R-squared and the Sharpe ratio.

A "fund of funds" (FOF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in stocks, bonds or other securities. This type of investing is often referred to as multi-manager investment. A fund of funds may be "fettered", meaning that it invests only in funds managed by the same investment company, or "unfettered", meaning that it can invest in external funds run by other managers.

<span class="mw-page-title-main">Constant proportion portfolio insurance</span>

Constant proportion portfolio investment (CPPI) is a trading strategy that allows an investor to maintain an exposure to the upside potential of a risky asset while providing a capital guarantee against downside risk. The outcome of the CPPI strategy is somewhat similar to that of buying a call option, but does not use option contracts. Thus CPPI is sometimes referred to as a convex strategy, as opposed to a "concave strategy" like constant mix.

The following outline is provided as an overview of and topical guide to finance:

<span class="mw-page-title-main">Security market line</span>

Security market line (SML) is the representation of the capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk. The risk of an individual risky security reflects the volatility of the return from security rather than the return of the market portfolio. The risk in these individual risky securities reflects the systematic risk.

Fundamentally based indexes or fundamental indexes, also called fundamentally weighted indexes, are indexes in which stocks are weighted according to factors related to their fundamentals such as earnings, dividends and assets, commonly used when performing corporate valuations. Indexes that use a composite of several fundamental factors attempt to average out sector biases that may arise from relying on a single fundamental factor. A key belief behind the fundamental index methodology is that underlying corporate accounting/valuation figures are more accurate estimators of a company's intrinsic value, rather than the listed market value of the company, i.e. that one should buy and sell companies in line with their accounting figures rather than according to their current market prices. In this sense fundamental indexing is linked to so-called fundamental analysis.

Jack Lawrence Treynor was an American economist who served as the President of Treynor Capital Management in Palos Verdes Estates, California. He was a Senior Editor and Advisory Board member of the Journal of Investment Management, and was a Senior Fellow of the Institute for Quantitative Research in Finance. He served for many years as the editor of the CFA Institute's Financial Analysts Journal.

References

  1. ↑ Conroy, Robert M. (2014). CFA Institute Level I: Corporate Finance & Portfolio Management. p. 237.
  2. ↑ Staff, Investopedia (2003-11-25). "Portfolio Management". Investopedia. Retrieved 2018-10-20.
  3. ↑ Markowitz, Harry (1952). "Portfolio Selection". The Journal of Finance. 7 (1): 77–91. doi:10.1111/j.1540-6261.1952.tb01525.x. ISSN   0022-1082.
  4. ↑ Treynor, Jack L. (1961). "Market Value, Time, and Risk". SSRN Electronic Journal. doi:10.2139/ssrn.2600356. ISSN   1556-5068. S2CID   153247715.
  5. ↑ "Toward a Theory of Market Value of Risky Assets", Treynor on Institutional Investing, Hoboken, NJ, USA: John Wiley & Sons, Inc., pp. 49–59, 2015-09-19, doi:10.1002/9781119196679.ch6, ISBN   978-1-119-19667-9 , retrieved 2020-12-21
  6. ↑ Sharpe, William F. (1964). "Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk". The Journal of Finance. 19 (3): 425–442. doi: 10.1111/j.1540-6261.1964.tb02865.x . ISSN   0022-1082.
  7. ↑ Lintner, John (1965). "The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets". The Review of Economics and Statistics. 47 (1): 13–37. doi:10.2307/1924119. ISSN   0034-6535. JSTOR   1924119.
  8. ↑ Mossin, Jan (1966). "Equilibrium in a Capital Asset Market". Econometrica. 34 (4): 768–783. doi:10.2307/1910098. ISSN   0012-9682. JSTOR   1910098.
  9. ↑ "Financial Concepts: Capital Asset Pricing Model (CAPM)". Investopedia. 2003-11-30. Retrieved 2018-10-20.
  10. ↑ Staff, Investopedia (2010-05-30). "Investment Manager". Investopedia. Retrieved 2018-10-20.
  11. 1 2 3 Investment Analysis and Portfolio Management
  12. 1 2 3 ProShares.com. "PORTFOLIO MANAGER, CASH". ProShares. Retrieved February 26, 2021.
  13. ↑ "Active Vs. Passive: The Case For And Against Index Funds | ETF.com". www.etf.com. Retrieved 2018-10-20.
  14. ↑ "Archived copy" (PDF). Archived from the original (PDF) on 2021-07-14. Retrieved 2019-08-07.{{cite web}}: CS1 maint: archived copy as title (link)
  15. ↑ Glynn, Timothy P.; Arnow-Richman, Rachel S.; Sullivan, Charles A. (2019). Employment Law: Private Ordering and Its Limitations. Wolters Kluwer Law & Business. ISBN   9781543801064 – via Google Books.
  16. 1 2 3 Jerin Matthew (December 20, 2013). "'Faithless' Ex-Morgan Stanley Fund Manager Ordered to Repay $31m to Former Employer". International Business Times UK.
  17. ↑ Henning, Peter J. (December 23, 2013). "The Huge Costs of Being a 'Faithless Servant'". DealBook. New York Times.
  18. ↑ "Morgan Stanley seeks $10.2 million from convicted former trader". GreenwichTime. January 15, 2013.
  19. ↑ "Portfolio Management Systems (PMS) - Vendormatch Directory". Celent. August 24, 2023. Retrieved August 24, 2023.
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