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Larysa Dokiienko, PhD, associated professor
International University
of Finance, Kyiv, Ukraine
Ievgeniia Klochai
ASTARTA Holding NV
Effective management of a portfolio of financial instruments in modern practice
The global trends of countries striving towards the
establishment of efficient financial mechanism at macro- and micro levels of
economic system form the conditions for development of financial market and in
particular the financial instruments market. The impact of financial
instruments as the main elements of financial market on the economic system of
the country determines the interest to the problems of their effective
management.
All
financial instruments as well as operations with them are risky, whilst the
valuation of risk is subjective. The best way to discuss the risk is from the
point of securities portfolio. Securities portfolio is equated to the notion of
“investment portfolio”, which is a purposefully formed aggregate of financial
instruments, made for the financial investments in according with the
investment policy. Any suggestion on
improvement of the portfolio of financial instruments must be based on the estimation of current efficiency. For this
we can use common efficiency coefficients of investment portfolio management,
such as Sharpe and Treynor ratio.
Sharpe ratio, which
estimates the quality of the strategy over the reporting period, is calculated
as the ratio of overrun of the investment portfolio rate of return over the
rate of return of the risk free asset to the risk of this of this portfolio in
the form standard deviation. The higher is Sharpe ratio, the more successful is
the management and more efficient is the management strategy. The negative
meaning of the ratio proves that it would be more effective to invest into the
risk-free asset than to use the very management strategy.
Treynor Ratio, which
is also called, as reward to volatility ratio is the ratio of odd profitability
over the market risk. It is based on the CAPM model. The higher the Treynor
Ratio is the more efficient is the investments portfolio management. Generally
this ratio is used for structuring of portfolio ratings.
Other ratios are also
calculated, such as Jensen’s alpha, Jack Schwager index, Sortino ratio, M2
ratio (Modigliani ratio). All of them to some extend relate the rate of return
and risk.
There is also an
alternative approach. The newest research in the field of financial markets
functioning cast doubt upon the reasonableness of usage of the dispersion of
the rate of return as the measure of risk of the portfolio as far as at the
real market the distribution of rates of return does not correspond to the
normal distribution. Thus, the usage of dispersion as the measure of risk does
not give the adequate estimation.
According to the
authors, the advanced approach for the adequate estimation of the efficiency of
the actively managed portfolios is the detailed comparison of the dynamics of
the value of the managed portfolio with the dynamics of stock exchange market
as the whole. The author undertook the attempt to develop the method to
estimate the portfolio management efficiency with the usage of such approach.
This technique was named «Active Strategy Efficiency» (ASE) [2].
The method of asset portfolio management efficiency
estimation, developed the authors is based on two criteria, characterizing the
efficiency of portfolio management: precision in market forecasting and
instruments selection with the highest potential in the analyzed period, i.e.
the manager of the portfolio must seek to increase the portion of stocks in the
periods of stocks market growth (by decreasing the portion of funds and
instruments with the fixed income) and to decrease the portion of stocks in the
periods of quoting decline (by increasing the share of instruments with the low
risk); and stability (regularity) of precise forecasts and, therefore, of
portfolio decisions.
In the periods of
growth the portfolio manager must seek to obtain the maximum rate of return on
investments. Along with this he must reduce the losses in case of the market
fall to the minimum. The manager can stick to the aggressive strategy in cases
when the change of portfolio value in average exceeds the change of the market
portfolio value as well as to a conservative strategy in cases when the changes
in the portfolio are generally less than the value change of the market
portfolio. But anyway the efficient manager must press for the relative losses
in the decline periods would be less than the relative income in the periods of
growth.
If
the efficiency estimation gave the result, which is lower than the expected by
the investor, it is necessary to take actions on the efficiency increase of the
investment portfolio. The “set” of such action is individual and depends of the
results of efficiency estimation, goals a strategy of the investor, type of the
portfolio and behavior model and also a range of other factors, but it is
required to follow the main principles when compiling the action plan.
First
of all, it is necessary to follow a «golden rule», which states that you should
not put all your eggs into one basket, i.e. follow the principle of portfolio
diversification. But the one should remember that the maximum reduction of risk
is achievable in case of 10-15 different securities are selected for the
portfolio; further increase of the portfolio content is not reasonable because
of redundant diversification effect. This extra diversification can lead to
such negative results as: impossibility of qualitative portfolio management;
purchase of deficiently liable, profitable and liquid securities; cost increase
resulting from the search of securities (expenses for preliminarily analysis
etc); high expenses of small lots of securities etc [3].
The second, when selecting the investment portfolio
the attention should be paid to the main principles of stocks portfolio
management: strategy of shares of growth (one should select the companies,
which profit will have the fastest growth, will gain large income for the
investor); strategy of underestimated shares (one should select stocks with the
excess of future (balance) value over the current market value); strategy of
companies with low capitalization (the stocks of underestimated companies often
bring high income as far as have a high growth potential); market-timing
strategy (means the selection of the best timing for the purchase and selling
of securities based in the technical analysis of the market environment).
The third, it is to the main principles of bonds
portfolio management: market-timing strategy is based on the forecast of
interest rates; strategy of sector selection (sector swap) – the portfolio is
formed from the bonds of a separate sector which profitability indexes
significantly differ from the average and in case of expected change of market
situation there is shift to bonds of another sector; and strategy of credit
risk acceptance – the portfolio is formed from the bonds with the probable
increase of credit rating [4].
In comparison with stocks profitability, the rates
of return of bonds (at least of bonds with relatively low level of default
risk) usually correlate a lot more with each other. This means that the
diversification here is not as important as at the stock market. When the
portfolio becomes more concentrated it becomes more difficult to eliminate the
risk, which you could avoid by diversification. As far as there is usually a
closer correlation between the profitability indexes of bonds, it is easier to
concentrate the “good value” assets in the portfolio and avoid risk, which must
have been diversified. Therefore for the bonds portfolio it is comparatively
more important to decide on the asset quality than the diversification.
Besides stocks and bonds the
portfolio might include also more complex structured products on the basis of
derivative financial instruments. There are three main categories of
investment-structured products, which are distinguished by the mechanism of
purchase of such derivative instruments on the required basic assets [5]:
─
Structures products, which use the flow of
instruments with the fixed rate of return for the purchase of the derivative
content, that allows to guarantee a certain level of return of capital. They
are meant mostly for investors that are not inclined to risk and oriented on
the conservative rate of return on investments.
─
Structured products, which use the selling of
one derivative to purchase the other profitable one. The derivative sale is
often called “volatility sale”, because the level of volatility is the main
factor impacting on the final profitability gained in this manner.
─
Structure products with the use of financial
leverage, which allows to gain higher profit in case of favorable market trend,
but without the guarantee of capital protection. Such product usually includes
the basic asset itself or a futures/forward contract on it. These are
anticipated for the most risky investors.
Traditional schemes of securities portfolio management
have three main forms: the scheme of the additional fixed sum (the most
effortless), the scheme of the fixed speculative sum and the scheme of the
fixed proportion.
If we add some modern elements to the traditional
approach of portfolio management, we get a scheme of floating proportions. It
requires a certain investor’s skills which would allows him to catch the trend
of the cyclical rates fluctuations of the speculative securities. It means that
the investor sets a range of interrelated correlations for the regulation of
the value of speculative and conservative parts of the portfolio.
When
making the portfolio the investor makes the decision not only upon the
financial instrument but also conducts the issuer appraisal. This important
thing at this stage is the technical and fundamental analysis. It terms of the
fundamental analysis the important place is given to the dynamics of company
market value (market capitalization of the company). Further to solve the
problem of the optimal portfolio structure we must use the Markowitz model. Out
of the framed efficient set of portfolios, investor can define the optimal one,
which will be optimal for him only in terms of his understanding of acceptable
proportion of risk and profitability.
Literature:
1.
Ivan Zhdan. Calculation of ratios of efficiency
of investment portfolio or trading strategy management. http://www.beintrend.ru
2.
O. Bakatanov. Alternative approach to the
estimation of the efficiency of investment funds asset management, 2008. http://www.globfin.ru
3.
Mischenko A.V., Popov A.A. Some approaches to
the optimization of investment portfolio, 2002. http://www.cfin.ru
4.
Steven Sheffer. Principles of bond portfolio
management, 2006. http://www.cfin.ru
5.
Shlyapochnik A.L., Sorokopud G.B. Investment
structured products, 2010. http://www.cfin.ru