Portfolio Management And Investment Alternatives

Shruti Chavarkar

Portfolio :
It is a combination of various financial assets like shares, debentures, bonds etc. It refers to various assets of an investor, considered as a unit. It is a carefully assets combination within a unified framework. Objective: To minimize risk and maximize gains.

Portfolio Management :
It means Selection, Planning , Evaluation of securities. Effective portfolio management balances between the objectives of safety, liquidity and profitability.

Portfolio Manager :
A professional who manages other peoples or institutions investment portfolio with the object of profitability, growth and risk minimization is a portfolio manager.

Objectives of Portfolio Management :

Stability of Income Capital Growth Objectives of Portfolio Management Safety Liquidity

Tax Incentives

Objectives:
Stability : An investor wants stability in his income and also stability in his own purchasing power of income. Liquidity : Investments in shares, debentures etc. can be converted into cash by selling them. Investment should be liquid as well as marketable so that whenever he needs money can get it from his investment. Safety: It is nothing but protection against loss because fluctuations in the market. An investor wants that his basic amount should remain safe. For this he should have the knowledge of economic and industry needs. Whenever it is necessary he has to diversify his investment for safety. Tax : There should be less tax liability from the investments. A portfolio manager has to take decisions about investments by considering tax implications. Capital Growth: Investors seek growth stocks which provides a very large capital appreciation by way of rights, bonus, etc.

Investment Alternatives
Non- Marketable Financial Assets Money Market Instruments

Bonds

Equity Shares

Mutual Fund Schemes

Real Estates

Life Insurance Policies

Precious Objects Financial Derivatives

1. Non- Marketable Assets

A. These assets are represent personal transactions between the investor and the issuer. Eg. Opening a Saving bank account dealing with the bank personally, but buying equity share- Not know personally who is the seller. Bank Deposits :

Very safe- following regulations of RBI , guarantee provided by Depositor Insurance Corporation. Ceiling on the interest rate payable on deposits in the savings account. Interest varies as per the term , Fixed deposits with Short term less interest and long term High interest It enjoys high liquidity. Can be encashed prematurely by incurring small penalty. Loans can be raised against bank deposits.

B.

Post Office Time Deposits (POTD) :

Deposits can be made in multiples of Rs. 50 without any limit. Interest rates are slightly higher than those on bank deposits. Interest is calculated half yearly and paid annually. No withdrawal is allowed for 6 months. From 6months to 1 years if any withdrawal made , no interest is payable on it. And on withdrawal after one year , but before the term of deposit , interest is paid for the period the deposit held,subject to a penalty. Can get deduction under section 80 C for tax purpose. It can be Pledged for raising loans.

C.

Kisan Vikas Patra (KVP) :

Minimum amount Rs. 1000 and no maximum limit. . Investment doubles in 8 years. No tax deduction at source. It can be Pledged for raising loans. Withdrawal facility after 2 and half years.

D.

National Savings Certificates

Issued at post offices. It comes in denominations of Rs 100, Rs. 500, Rs. 1000, Rs. 5000 and Rs. 10000. The term is of 6 years. Rs. 100 becomes Rs. 160.1. ( compound rate of return is 8.16%) Can be deducted from taxable income under 80C. No TDS.

E.

It can be Pledged for raising loans. Monthly Income Scheme of the Post Office (MISPO)
It is meant to provide regular monthly income to the depositors Minimum amount of investment is Rs. 1000 and maximum Rs. 300,000 in single account and Rs. 6,00,000 in joint account. Interest rate is 8% monthly and 10% is payable on maturity. No TDS. Premature withdrawal after one year with 5% deduction before 3 years.

F.

Company deposits
Fixed deposits mobilised by manufacturing companies are regulated by Company Law Board and fixed deposits mobilised by finance companies are regulated by RBI. A manufacturing company can mobilise upto 25% of its net worth from the public and an additional amount equal to 10% of its net worth from its shareholders. Anon- banking Finance companies can mobilise a higher amount. The interest rates on company deposits are higher than those on bank fixed deposits.. Company deposits represent unsecured loans They have to be necessarily credit- rated. No tax benefits on company deposits, no TDS upto interest income of Rs. 5000.

G. Employee Provident Fund Scheme

A major vehicle of savings for salaried employees. Each employee has a separate provident fund account in which both the employer and the employee are required to contribute a certain minimum amount on a monthly basis. The employee can choose to contribute additional amounts, subject to certain restrictions. Contribution made by the employer fully exempt, and contribution made by the employee can be deducted from taxable income under section 80 C. Compound interest is 9.5 % and totally exempted from taxes. Interest is accumulated in the account and not paid annually to the employee. Within a certain limit , the employee is eligible to take a loan against the provident fund balance

H.

Public Provident Fund

Individuals and HUFs can participate in this scheme. A PPF account may be opened at any branch of the State Bank of India or its subsidiaries or at specified branches of other nationalized banks. The number of contributions has to be 16. (The period of PPF is of 15 years. ) Minimum amount of Rs. 100 per year and maximum deposit per year is Rs. 70000. It can be deducted from taxable income u/s 80 C. Compound interest is 8.%. Interest is accumulated in the account and not paid annually to the employee and totally exempted from taxes. The Subscriber can make one withdrawal every year from the sixth year to fifteenth year.

2. Money Market Instruments

Debt instruments which have a maturity of less than one year at the time of issue are called as money market instruments. Highly liquid and have negligible risk. Individual participants scarcely participate in the money market directly. Treasury bills, Certificate of deposits, Commercial papers and repos.

A.

Treasury Bills:
They represent the obligations of the Government of India which have a primary tenor like 91 days and 364 days. They are sold on an auction basis every week in certain minimum denominations by the RBI. They are sold at discount and redeemed at par. Yield on TB is somewhat low. But still they have an appeal They can be transacted readily and there is a very active secondary market for them They have nil credit risk and negligible price risk.

B.

Certificates of Deposits. (CD)

They are short term deposits which are transferable from one party to another. Bank and Financial Institutes are major issuers of CDs. Principal investors in CDs are banks, financial institutions, corporates and mutual funds. Maturity period of 3 months to 1 year. CDs are risk free. CDs offer higher rate of interest than Treasury bills or term deposits.

C.

Commercial Paper
Short term Unsecured promisory note issued by firms that are considered to be financial strong. Maturity period is 90 to 180 days. It is sold at a discount and redeemed at par .

D.

Repos ( Repurchase Agreement)

It involves a simultaneous sale and purchase agreement. Example: A wants short term fund and B wants to make a short term- investment. A sells securities to B at a certain price and simultaneously agrees to repurchase the same after a specified time at a slightly higher price. The difference between the sale price and repurchase price represents the interest cost to A ( doing Repo) and the interest income to B ( doing Reverse Repo) .

3. Bonds ( Fixed Income Securities)

Bonds or debentures represents long- term debt instruments. The issuer of a bond promises to pay periodic interest over the life of the instruments and principal amount at the time of redemption.Government securities, PSU bonds, debentures, preference shares etc.

A.

Government Securities
Debt securities issued by Central govt., state govt.,and quazi- government agencies. It carries name of the holder and is registered with the PDO ( Public Debt Office) .For transfer , it has to be lodged with the PDO along with a duly completed transfer deed. The PDO pays interest to the holders registered with it on the specified date of payment. A promissory note, issued to the original holder, which contains a promise by the president of India ( Govt or State) to pay as per a given schedule. It can be transferred to a buyer by an endorsement by the seller. The current holder has to present the note to the Government Treasury to receive interest and other payments. A bearer security where the interest and other payments are made to the holder of the security. Even though these securities carry some tax advantages, they have traditionally not appeared to individual investors because of low rate of interest and long maturities and somewhat illiquid retail markets. They are held by banks, financial institutions, insurance companies and provident funds mainly because of some statutory compulsions.

B. Saving bonds
Individuals, HUF, and NRIs can invest in these bonds. Minimum Amount- Rs. 1000 and no upper limit. Maturity period- 5 years. Interest rate- 8% per annum . Payable half yearly. The interest is taxable. The bonds are exempt from Wealth tax ( No limit) . The bonds are transferable. Nomination facility is available. The bonds can be offered as security to banks for availing loans.

C.

Private Sector Debentures :

When a debenture issue is sold to the investing public, a trustee is appointed through a deed. The trustee is usually a bank or a financial Institution. Entrusted with the role of protecting the interest of debenture holders, the trustee is responsible for ensuring that the borrowing firm fulfills its contractual obligations. All debentures issued with a maturity period of more than 18 months must be necessarily creditrated. The company has the freedom to choose the redemption period. Debentures are convertible . They can covert into equity shares on certain terms and conditions that are pre- specified.

D.

Public Sector Undertaking Bonds ( PSU bonds) :

Two varieties: Taxable bonds and Tax free bonds A PSU can issue tax free bonds only with the prior approval of the Ministry of Finance. There is no TDS on interest. They are transferable. There is no stamp duty applicable on transfer. They are traded on the stock exchange.

E.

Preference Shares:
They carry a fixed rate of dividend. Dividend is payable only out of the distributable profit. Hence , when there is inadequacy of profit, No dividend is payable. Dividend is generally cumulative. Dividend skipped in one year has to be paid subsequently before equity dividend can be paid. These shares are redeemable. The period is usually 7 to 12 years. Dividend is exempted from tax.

4. Equity Shares :
Equity capital represents ownership capital. Shareholders collectively own the company. They bear the risk and enjoys the rewards of ownership. The amount of capital that a company can issue as per its memorandum represents the Authorized Capital. The amount offered by the company to the investors is called the Issued Capital. Part of the Issued Capital that has been subscribed by the investors is called Paid up Capital. The equity shareholders have a residual claim to the income of the firm. This means that the profit after tax less preference dividend belongs to equity shareholders. Shareholders elect the board of directors and have the right to vote on every resolution placed before the company. Equity Shareholders have a residual claim over the assets of the company in the event of liquidation.Claims of all others ( debenture holders, secured lenders, unsecured lenders, preferred shareholders and other creditors) are prior to the claim of the eq. Shareholders.

5. Mutual Fund
If you find difficulty in investing directly to shares or debentures , you can invest in these financial assets indirectly through a Mutual Fund. Mutual Fund represents a vehicle for collective investment. 1986 UTI was the only Mutual fund in India. Entities involved in Mutual Fund Sponsor, trustees, AMC( Asset Management Company) , Custodian, registrars and transfer agents. MF schemes invest in 3 categories :
Stocks- Equity and equity related instruments Bonds- debt instruments ( maturity period more than 1 year) Cash bank deposits and debt instruments ( maturity period less than 1 year)

Mutual funds in India are regulated by SEBI. Mutual Fund shall be constituted in the form of trust executed by the sponsor in favour of the trustees. The sponsor or the trustees( if authorized by the trust deed ) shall appoint the AMC. The Mutual Fund can appoint the custodian . No schemes shall be launched by the AMC unless it is approved by the trustees and a copy of the offer document has been filed with SEBI. The moneys collected under schemes shall be invested only in transferable securities. The net Assets Value ( NAV) and sale and repurchase price of MF schemes must regularly published in daily newspapers.

6. Financial Derivatives
It is an instruments whose value depends on the value of some underlying assets. It may be viewed as a side bet on the assets. It is an agreement between two parties to exchange an asset for cash at a predetermined future date for a price that is specified today. The party which agrees to purchase the assets is said to have a Long Position and The party which agrees to sell the assets is said to have a Short Position. The party holding the long position benefits if the price increases , whereas the party holding the short position loses if the price increases and vice versa. Example :
A agrees to buy 1000 shares of XYZ limited at Rs.100 from B to be delivered 90 days hence. A Long position and B- Short Position On the 90th day , if the price of the XYZ limited happens to be 105 Then A gains Rs. 5000 ( 1000 no. ( 105-100) But B losses Rs. 5000. Now if the price of XYZ limied is Rs. 95. Then A loses Rs. 5000 ( 1000( 95-100) But B gains Rs. 5000.

Futures:

Options :
It gives owner the right to buy or sell an underlying assets on or before a given date at a predetermined price. Special kind of financial contract in which the holder enjoys the right , but has no obligations to do something. Two options- Call option to purchase and Put Option- to sell , a fixed number of shares of a certain stock at a given price on or before the expiration date.

7. Life Insurance

Basic need of customer-protection and savings. Protection from unwelcome events such as death or long term sickness/ disability. Policies that are designed as savings contracts allow the policyholder to build up funds to meet specific investment objectives such as income in retirement or repayment of a loan. In practice , many policies provide a mixture of savings and protection benefits. Premium payable can be deducted from taxable income under section 80 C of Income tax Act . Any sum received under a life Insurance policy, including the sum allocated by way of bonus on such policy is exempt from under Section 10(10 D) of the Income Tax Act. Profitable investment and there is no risk in this investment. It is a method of compulsory saving over a long period out of regular income. It provides loan facility from banks.
Residential house, Commercial property, agricultural land, etc. Interest on loan taken for buying and constructing is tax deductible within certain limits. Huge investment is required. It requires time and efforts for managing it. No liquidity. Tax saving investment. ( interest on loan, and principal amount) Supply of land is limited and demand for it is high, quick appreciation in the value of assets. Legal formalities , registration , etc. are complicated and there is a chance of cheating at the time of buying and selling

8. Real Estate:

9. Precious objects:

Small in size but highly valuable in monetary terms. Ex: gold, silver, precious stones , etc. Highly liquid with less trading commission. They can not provide regular current income. No tax advantage associated with them. There is a possibility of being cheated. The market prices are continuously increasing , therefore the return on investment is also increasing. Risky due to chances of theft.

Portfolio Management Process

1. Specification of investment objectives and constraints: The typical objectives sought by investors are current income, capital appreciation, and safety of principal. The relative importance of these objectives should be specified. short term high priority objectives long term high priority objectives low priority objectives money backing objectives 2.Choice of Asset Mix: The most important decision in portfolio management is the assets mix decisions. This is the proportion of Stocks and bonds in the portfolio. There are different classes of investments like money market instruments, fixed income securities, equity share, real estate, etc. 3. Formulation of Portfolio Strategy/ policy: Once a certain assets mix is chosen, an appropriate portfolio strategy has to be hammered out. Be careful about the current market conditions and about financial situation while deciding the investment policy. 4. Selection of securities: To maximize their expected return and at the same time to minimise the risk. 5. Portfolio Execution: Implementing portfolio plan by buying and or selling specified securities in given amounts.This is an important practical step that has a bearing on investment results. 6. Portfolio Revision and Evaluation : The value of the portfolio as well as its composition may change a stocks and bonds fluctuate. In response to such changes, periodic rebalancing of the portfolio is required. Revision means changing the asset allocation of a portfolio in such a

6. Portfolio Revision and Evaluation : The value of the portfolio as well as its composition may change a stocks and bonds fluctuate. In response to such changes, periodic rebalancing of the portfolio is required. Revision means changing the asset allocation of a portfolio in such a manner that it gives minimum risk and maximum return. The performance of a portfolio should be evaluated periodically. The key dimensions of portfolio performance evaluation are risk and return. Review may provide useful feedback to improve the quality of the portfolio management process on a continuing basis.