Imperial Asset Management – Investors’ Notebook

A PORTFOLIO management strategy defines a way or style that is used by a portfolio manager in managing the assets of his portfolio.

In other words it defines the

aggressiveness of a fund manager with regards to issues pertaining to the management of a portfolio/fund. It is through the adoption of a specific portfolio management strategy that the portfolio manager will be in a position to accomplish whatever goals have been set, either internally or by the client. Portfolio management strategies also give an indication of the type of fund management as well as the control measures that the fund manager is operating within. Basically there are three types of portfolio management strategies – passive, active, and core and satellite investment strategies.

Passive technique

When a fund manager is given the mandate to manage an investor’s portfolio or funds, standards will be set that will act as benchmarks. These standards will be used to determine the performance of the fund manager by the investor/management. Under passive management technique the fund manager performs his mandate with a view of only achieving the set targets.

Basically, the two main examples of such a technique are indexing of the portfolio as well as buy and hold strategies. Under indexing, the fund manager attempts to track the performance of a particular index. This may be achieved through the construction of a portfolio that replicates the benchmark index or portfolio. For example, if the portfolio benchmark is the industrial index, then for the manager to perform in tandem to the index he will construct a portfolio that will include all or most of the constituent stocks that contribute to the movement of the industrial index in line with their market capitalisation. The manager will thus continuously rebalance the portfolio in line with the index.

In the case of “buy and hold”, the manager attempts to come up with a portfolio that meets the objectives and constraints of the client and hold on to that portfolio for the long-term.

There are, however, a number of pros that follow with a buy and hold strategy. These include simplicity of following a given guideline, competitive performance as the returns track those of the market as well as broad diversification of the portfolio. There will also be lower transaction and brokerage costs as stocks are bought and kept for some time. It can, however, be said with 95% confidence, that the fund will never out-perform the set benchmarks as there will be no market timing. The portfolio requirements are rigid as the fund manager needs to construct only a portfolio that tracks the market and nothing else.

Active technique

Unlike in the former case, the strategy of an active portfolio manager is to out-perform the set benchmarks. This is achieved through a process of selective stock picking arrived at through research and market timing.

The manager will adopt a rigorous selective stock buying through for example, buying stocks when the market is falling and selling when the market is rising.

As a result of the way investment decisions are arrived at, the method has the advantage of offering potentially higher returns by profiting from market trends and picking up stocks with value. The ultimate objective of such a manager would be to out-perform rather than track the benchmark.

However on the other hand, as the fund manager will be active and aggressive, the method is associated with potentially higher costs. These costs vary from brokerage fees, stamp duty, taxes etc and the more active the fund manager is the higher the costs. Worth noting also is the fact that under this method/strategy there is more of risk taking on some investments (for example being bullish on some stocks) and this on its own results in unpredictable returns.

Core satellite technique

This is the third strategy and is made up of a combination of the first two. The portfolio will be made up of a core group of conservatively managed assets that are supported by a set of smaller and riskier investments. The portfolio has the potential of producing returns that are higher than those from a passively managed portfolio but less than from the one being actively managed. The rationale behind the strategy being to take care of the volatilities associated with investments markets.

An example of such a strategy could be to have a core strategy consisting of passively managed bonds and equities and satellites consisting of actively managed equities and other investments.

To help fund managers come up with the best portfolios given the underlying investment constraints, in the next article we will consider the issue of optimal asset allocation.

Rueben Alberto is general manager (Investments) of Imperial Asset Management Company and can be contacted on email