Portfolio Management:

What Is Portfolio Management?

Portfolio management is the art and science of selecting and overseeing a group of investments that meet the long-term financial objectives and risk tolerance of a client, a company, or an institution.

Some individuals do their own investment portfolio management. That requires a basic understanding of the key elements of portfolio building and maintenance that make for success, including asset allocation, diversification, and rebalancing.

KEY TAKEAWAYS

• Investment portfolio management involves building and overseeing a selection of assets such as stocks, bonds, and cash that meet the long-term financial goals and risk tolerance of an investor.

• Active portfolio management requires strategically buying and selling stocks and other assets in an effort to beat the performance of the broader market.

• Passive portfolio management seeks to match the returns of the market by mimicking the makeup of an index or indexes.

• Investors can implement strategies to aggressively pursue profits, conservatively attempt to preserve capital, or a blend of both.

• Portfolio management requires clear long-term goals, clarity from the IRS on tax legislation changes, understanding of investor risk tolerance, and a willingness to study investment options.

Understanding Portfolio Management

Professional licensed portfolio managers work on behalf of clients, while individuals may choose to build and manage their own portfolios. In either case, the portfolio manager's ultimate goal is to maximize the investments' expected return within an appropriate level of risk exposure.

Portfolio management requires the ability to weigh strengths and weaknesses, opportunities and threats across the full spectrum of investments. The choices involve trade-offs, from debt versus equity to domestic versus international, and growth versus safety.

Portfolio Management: Passive vs. Active

Portfolio management may be either passive or active.

Passive management is the set-it-and-forget-it long-term strategy. It may involve investing in one or more exchange-traded (ETF) index funds. This is commonly referred to as indexing or index investing. Those who build indexed portfolios may use modern portfolio theory (MPT) to help them optimize the mix.

Active management involves attempting to beat the performance of an index by actively buying and selling individual stocks and other assets. Closed-end funds are generally actively managed. Active managers may use any of a wide range of quantitative or qualitative models to aid in their evaluations of potential investments.

Active Portfolio Management

Investors who implement an active management approach use fund managers or brokers to buy and sell stocks in an attempt to outperform a specific index, such as the Standard & Poor's 500 Index or the Russell 1000 Index.

An actively managed investment fund has an individual portfolio manager, co-managers, or a team of managers actively making investment decisions for the fund. The success of an actively managed fund depends on a combination of in-depth research, market forecasting, and the expertise of the portfolio manager or management team.

Portfolio managers engaged in active investing pay close attention to market trends, shifts in the economy, changes to the political landscape, and news that affects companies. This data is used to time the purchase or sale of investments in an effort to take advantage of irregularities. Active managers claim that these processes will boost the potential for returns higher than those achieved by simply mimicking the holdings on a particular index.

Trying to beat the market inevitably involves additional market risk. Indexing eliminates this particular risk, as there is no possibility of human error in terms of stock selection. Index funds are also traded less frequently, which means that they incur lower expense ratios and are more tax-efficient than actively managed funds.

Passive Portfolio Management

Passive portfolio management, also referred to as index fund management, aims to duplicate the return of a particular market index or benchmark. Managers buy the same stocks that are listed on the index, using the same weighting that they represent in the index.

A passive strategy portfolio can be structured as an exchange-traded fund (ETF), a mutual fund, or a unit investment trust. Index funds are branded as passively managed because each has a portfolio manager whose job is to replicate the index rather than select the assets purchased or sold.

The management fees assessed on passive portfolios or funds are typically far lower than active management strategies.

Portfolio Management: Discretionary vs. Non-Discretionary

Another critical element of portfolio management is the concept of discretionary and non-discretionary management. This portfolio management approach dictates what a third-party may be allowed to do relating to your portfolio.

A discretionary or non-discretionary management style only pertains to if you have an independent broker managing your portfolio. If you only want the broker to execute trades that you have explicitly approved, you must opt for a non-discretionary investment account. The broker may advise on strategy and suggest investment moves. However, without your approval, the broker is simply an adviser that must follow your discretion.

On the other hand, some investors would prefer placing all of the decision-making in the hands of their broker or financial manager. In these situations, the financial adviser can buy or sell securities without the approval of the investor. The adviser still has a fiduciary responsibility to act in their client's best interest when managing their portfolio.

Key Elements of Portfolio Management

Asset Allocation

The key to effective portfolio management is the long-term mix of assets. Generally, that means stocks, bonds, and cash equivalents such as certificates of deposit. There are others, often referred to as alternative investments, such as real estate, commodities, derivatives, and cryptocurrency.

Asset allocation is based on the understanding that different types of assets do not move in concert, and some are more volatile than others. A mix of assets provides balance and protects against risk.

Investors with a more aggressive profile weight their portfolios toward more volatile investments such as growth stocks. Investors with a conservative profile weight their portfolios toward stabler investments such as bonds and blue-chip stocks.

Rebalancing captures recent gains and opens new opportunities while keeping the portfolio in line with its original risk/return profile.

Diversification

The only certainty in investing is that it is impossible to consistently predict winners and losers. The prudent approach is to create a basket of investments that provides broad exposure within an asset class.

Diversification involves spreading the risk and reward of individual securities within an asset class, or between asset classes. Because it is difficult to know which subset of an asset class or sector is likely to outperform another, diversification seeks to capture the returns of all of the sectors over time while reducing volatility at any given time.

Real diversification is made across various classes of securities, sectors of the economy, and geographical regions.

Rebalancing

Rebalancing is used to return a portfolio to its original target allocation at regular intervals, usually annually. This is done to reinstate the original asset mix when the movements of the markets force it out of kilter.

For example, a portfolio that starts out with a 70% equity and 30% fixed-income allocation could, after an extended market rally, shift to an 80/20 allocation. The investor has made a good profit, but the portfolio now has more risk than the investor can tolerate.

Rebalancing generally involves selling high-priced securities and putting that money to work in lower-priced and out-of-favor securities. The annual exercise of rebalancing allows the investor to capture gains and expand the opportunity for growth in high-potential sectors while keeping the portfolio aligned with the original risk/return profile.

Tax-Efficiency

A potentially material aspect of portfolio management relates to how your portfolio is shaped to minimize taxes in the long-term. This pertains to how different retirement accounts are used, how long securities are held on for, and which securities are held.

For example, consider how certain bonds may be tax-exempt. This means that any dividends earned are not subject to taxes. On the other hand, consider how the IRS had different rules relating to short-term or long-term capital gains taxes. For individuals earning less than $41,675 in 2023, their capital gains rate may be $0. On the other hand, a short-term capital gains tax of 15% may apply if your income is above this IRS limit.1

Portfolio management encompasses investments across all vehicles such as cash accounts, 401(k)s, IRAs, and other retirement accounts.

Common Portfolio Management Strategies

Every investor's specific situation is unique. Therefore, while some investors may be risk-averse, others may be inclined to pursue the greatest returns (while also incurring the greatest risk). Very broadly speaking, there are several common portfolio management strategies an investor can consider:

• Aggressive: An aggressive portfolio prioritizes maximizing the potential earnings of the portfolio. Often invested in riskier industries or unproven alternative assets, an investor may not care about losses. Instead, the investor is looking for the "home run" investment by striking it big with a single investment.

• Conservative: On the other hand, a conservative portfolio relates to capital preservation. Extremely risk-adverse investors may adopt a portfolio management strategy that minimizes growth but also minimizes the risk of losses.

• Moderate: A moderate portfolio management strategy would simply blend an aggressive and conservative approach. In an attempt to get the best of both worlds, a moderate portfolio still invests heavily in equities but also diversifies and may be more selective in what those equities are.

• Income-Orientated: Often a consideration for older investors, some folks who do not have income may rely on their portfolio to generate income that can be used to live off of. Consider how a retiree no longer has a stable paycheck. However, that retiree may no longer be interested in generating wealth but instead of using their existing wealth to live. This strategy priorities fixed-income securities or equities that issue dividends.

• Tax-Efficient: As discussed above, investors may be inclined to focus primarily on minimizing taxes, even at the expense of higher returns. This may be especially important for high-earners who are in the highest capital gains tax bracket. This may also be a priority for young investors who have a very long way until retirement. By getting started with a Roth IRA, these investors may be able to grow their portfolio over their entire life and face no federal taxes on withdrawal when they retire.

Challenges of Portfolio Management

Regardless of the strategy chosen, portfolio management always faces several hurdles that often cannot be eliminated entirely. Even if an investor has a foolproof portfolio management strategy, investment portfolios are subject to market fluctuations and volatility which can be unpredictable. even the best management approach can lead to significant losses.

Though diversification is an important aspect of portfolio management, it can also be challenging to achieve. Finding the right mix of asset classes and investment products to balance risk and return requires a deep understanding of the market and the individual investor's risk tolerance. It may also be expensive to buy a wide range of securities to meet the desired diversification.

To devise the best portfolio management strategy, an investor must first know their risk tolerance, investment horizon, and return expectations. This requires a clear short-term and long-term goal. Because life circumstances can quickly and rapidly change, investors must be mindful of how some strategies limit investment liquidity or flexibility. In addition, the IRS may implement changes to tax legislation that may force changes to your ultimate strategy.

Last, should an investor turn to a portfolio manager to manage their investments, this will incur a management fee. The portfolio manager must often meet specific regulatory reporting requirements, and the manager may not have the same opinions or concerns about the market as you do.

What Are the Types of Portfolio Management?

Broadly speaking, there are only two types of portfolio management strategies: passive investing and active investing. Passive management is a set-it-and-forget-it long-term strategy. Often referred to as indexing or index investing, it aims to duplicate the return of a particular market index or benchmark and may involve investing in one or more exchange-traded (ETF) index funds. Active management involves attempting to beat the performance of an index by actively buying and selling individual stocks and other assets. Closed-end funds are generally actively managed.

What Is Asset Allocation?

Asset allocation involves spreading the investor's money among different asset classes so that risks are reduced and opportunities are maximized. Stocks, bonds, and cash are the three most common asset classes, but others include real estate, commodities, currencies, and crypto. Within each of these are sub-classes that play into a portfolios allocation. For instance, how much weight should be given to domestic vs. foreign stocks or bonds? How much to growth stocks vs. value stocks? And so on.

What Is Diversification?

Diversification involves owning assets and asset classes that have been shown over time to move in opposite directions. When one asset class performs poorly, other asset classes usually prosper. This provides a cushion to your portfolio, offsetting losses. Moreover, financial mathematics shows that proper diversification can increase a portfolio's overall expected return while reducing its riskiness.

What Is the Objective of Portfolio Management?

The objective of portfolio management is to create and maintain a personalized plan for investing over the long term in order to meet an individual's key financial goals. This means selecting a mix of investments that matches the person's responsibilities, objectives, and appetite for risk. Further, it means reevaluating the actual performance of the portfolio over time to make sure it is on track and to revise it as needed.

What Does an Investment Portfolio Manager Do?

An investment portfolio manager meets with a client one-on-one to get a detailed picture of the person's current financial situation, long-term goals, and tolerance for risk. From there, the portfolio manager can draw up a proposal for how the client can meet their goals. If the client accepts the plan, the portfolio can be created by buying the selected assets. The client may start out by contributing a lump sum, or add to the portfolio's balance periodically, or both. The portfolio manager takes responsibility for monitoring the assets and making changes to the portfolio as needed, with the approval of the client. Portfolio managers generally charge a fee for their service that is based on the client's assets under management.

The Bottom Line

Anyone who wants to grow their money has choices to make. You can be your own investment portfolio manager or you can hire a professional to do it for you. You can choose a passive management strategy by putting your money in index funds. Or, you can try to beat the markets by moving your money more frequently from one asset to another.

• Investment Philosophy: Capishare's approach emphasizes sustainable, long-term growth and risk management to maximize returns.

• Track Record: Capishare has consistently delivered strong returns, with a focus on capital preservation and growth.