Portfolio Management

What is portfolio management? What constitutes a good portfolio? A portfolio in my opinion constitutes any form of investment or savings that is geared towards generating returns and or income today or in the future. Portfolio management should then be the alignment of your investments with your financial goals over your chosen time horizon. One’s approach to share trading (if its part of their share-trading), should generally inform how you manage your portfolio. As with share trading, defining and getting basic essentials is a must. So for example, ask yourself;

• What do I want to buy?
• What is my risk/reward appetite i.e. what risk will I take to get my required income/capital growth?
• Why this investment-i.e. do I understand it sufficiently?
• At what price?
• I my after growth or and income?
• How do I maximise this growth/income?
• What proportion of my disposable income do I want to put in this investment?
• What are the opportunity costs if any, of this investment compared to others?
• For how long, when/why/how do I sell the investment?

One can then use this when considering various classes of investments, so for:

1. Savings: Ask yourself, what do you want to save for, how much do you need to save and for how long? You then need to look at rates on offer, accessibility (most banking industries will put a premium on a long-term saver who doesn’t require short-notice access to their funds). In some banking industries (notably UK), rates on savings are available tax free and thus taxation comes into the equation. Finally, choosing to save may mean that you miss out on higher returns in shares, thus there is an opportunity cost.
2. Bonds: Unless they are inflationary-linked, bonds (and especially gilts) are no different from savings. Again the key here will be length, amount of disposable income that you need to tie-in to this type of investment and rates offered (corporate bonds will generally offer higher but riskier returns). Because of the minimum amounts that one has to commit for bonds, the inflation risk, the opportunity cost in terms of alternative forms of investment is higher.
3. Unit trusts: These are funds that invest in a variety of shares (usually listed ones), economic sectors, countries or other tradable commodities and instruments. By their nature, they are allow you to diversify your risk, give you access to markets that you won’t otherwise be able to access and for the cash rich, time poor or otherwise financially illiterate, manage your cash. One buys into a unit trust thus getting units based on the price at the time of the investment. Before buying, look at the UT's costs and returns over say year to date or last calendar yr against similar UTs or other investments. UTs are off course risky even when investing in a cross-section of instruments (including fx, commodities, bonds and shares) and will often have a minimum amount that one has to invest. The opportunity cost is thus higher given losses can be incurred and that one might be better off investing in specific shares. Certain UTs will also entitle you to periodical dividends, tax free capital gains and these will need to be taken into account. Further, UTs also have entry and exit fees as well annual management fees that will in certain countries account for as high as 10% of original amount invested and this thus needs to be borne in mind because it will in most cases mean one has to stay longer to be able to make the returns. UTs are generally recommended for giving one access to forms of investment that one can’t ordinarily access.
4. Shares: Primarily will generate capital gains as well as dividends. These are covered elsewhere in this blog. However, there are opportunity costs, should one invest in a particular share as opposed to another, is this time better than 6 months from now, are money markets/bonds a better opportunity? Should one go for dividend yield, absolute dividends, capital gains or a mixture?
5. Land/Plots: This will apply more to Kenya than elsewhere. Prime issues to consider are liquidity (will depend on location), holding period, usage (farming, holding asset, future real estate development, own home), legal constraints e.g. on subdivision or certain developments. The opportunity cost of buying land will be driven by these issues e.g. if land is bought on an illiquid locale with intention to build future own home, price appreciation will be low and it maybe better to invest the cash elsewhere. Where the land/plot is used for farming again are there better more liquid alternatives?
6. House Ownership/Mortgage: Yes liquidity is important to note, but whether in a developing or developed economy, house ownership of any form remains a lucrative albeit capital consuming investment. Where there is sufficient capital to build one’s own home, or where paying a mortgage for the same, the opportunity cost is broadly the same. Taking into property appreciation (annualised) plus intangible benefits such as the comfort of owning your place, does this more than outweigh annual mortgage/rental costs? For those developing real estate (to generate rental income and capital appreciation) as a form of investment, are there better returns in more liquid and less involving forms of investment?
   Overall, portfolio management requires that every formof investment you undertake gives you the best returns in that class and that you consider liquidity, investment horizon and opportunity costs.