Portfolio Management Process

Portfolio management process is an on-going way of managing a client’s portfolio of assets. There are various components and sub-components of the process that ensure a portfolio is tailored to meet the client’s investment objectives well within his constraints. Portfolio managers need to chart out specific strategies for the portfolio management to maintain the risk-return trade-off.

Definition of Portfolio Management Process

The portfolio management process is an integrated compilation of steps implemented in a consistent way to create and manage a suitable portfolio of assets to achieve client’s specified goals.

Portfolio Perspective

The portfolio perspective is the key fundamental principle of portfolio management. According to this perspective, portfolio managers, analysts and investors need to analyze risk – return trade-off of the whole portfolio, and not of the individual assets in the portfolio. The individual investments carry an unsystematic risk, which is diversified away by bundling the investments into one single portfolio. The whole portfolio carries only the systematic risk, which is caused by the influence of economic fundamentals on the returns of a stock. GDP growth, consumer confidence, unexpected inflation, business cycles, etc. are the examples of such economic fundamentals. The portfolio managers, analysts and investors should only be concerned with the systematic risk of the whole portfolio. In fact, all the equity pricing models are based on the fact that only systematic risk is factored.

Steps of the Portfolio Management Process

The portfolio management process has the following steps and the sub-components:


This is the most crucial step as it lays down the foundation of the entire process. It comprises of these tasks:

  1. Identification of Objectives and Constraints: The identification of client’s investment objectives and any constraints is the foremost task in the planning stage. Any desired outcomes that the client has regarding return and risk are the investment objectives. Any limitations on the investment decisions or choices are the constraints. Both are specified at this stage.
  2. Investment Policy Statement: Once the objectives and constraints are identified, the next task is to draft an investment policy statement.
  3. Capital Market Expectations: The third step in the planning stage is to form expectations regarding capital markets. Risk and return of various asset classes are forecasted over a long term to choose portfolios that either maximizes the expected return for certain levels of risk or minimize the portfolio risk for certain levels of expected return.
  4. Asset Allocation Strategy: This is the last task in the planning stage.
    1. Strategic Asset Allocation: The investment policy statement and the capital market expectations are combined to determine the long term weights of the target asset classes, also known as strategic asset allocation.
    2. Tactical Asset Allocation: Any short-term change in the portfolio strategy as a result of the change in circumstances of the investor or the market expectations is a tactical asset allocation. If the changes become permanent and the policy statement is updated to reflect the changes, there is a chance that the temporary tactical allocation becomes the new strategic portfolio allocation.


Once the planning stage is completed, execution of the planned portfolio is the next step. This consists of these decisions:

  1. Portfolio Selection: The expectation of the capital markets is combined with decided investment allocation strategy to choose specific assets for the investor’s portfolio. Generally, the portfolio managers use the portfolio optimization technique while deciding the portfolio composition.
  2. Portfolio Implementation: Once the portfolio composition is finalised, the portfolio is executed. Portfolio executions are equally important as high transaction costs can reduce the performance of the portfolio. Transaction costs include both explicit costs like taxes, fees, commissions, etc. and implicit costs like bid-ask spread, opportunity costs, market price impacts, etc. Hence, the execution of the portfolio needs to be appropriately timed and well-managed.


Any changes required due to the feedback are analyzed carefully to make sure that they are as per the long-run considerations. The feedback stage has the following two sub-components:

  1. Monitoring and Rebalancing: The portfolio manager needs to monitor and evaluate risk exposures of the portfolio and compares it with the strategic asset allocation. This is required to ensure that investment objectives and constraints are being achieved. The manager monitors the investor’s circumstances, economic fundamentals and market conditions. Portfolio rebalancing should also consider taxes and transaction costs.
  2. Performance Evaluation: The investment performance of the portfolio must be evaluated regularly to measure the achievement of objectives and the skill of the portfolio manager. Both absolute returns and relative returns can be used as a measure of performance while analysing the performance of the portfolio.

Investment Policy Statement

A formal written document created to govern investment decision making after taking into account the client’s objectives and constraints. This statement is formulated in the planning stage of the process as mentioned above.

Role: Investment policy statement has the following roles to play:

  • Endorse long-term discipline in all the portfolio decisions.
  • Easily implemented by both current as well as future investment advisors.
  • Protect against short-term portfolio reallocation in case the changing markets or the performance of the portfolio causes overconfidence or panic.

Elements: An investment policy statement has several of these elements:

  • A complete client description providing enough background so that any investment advisor can understand the client’s situation.
  • A purpose with respect to investment objectives, policies, goals, portfolio limitations and restrictions.
  • Identification of responsibilities and duties of all the parties involved.
  • A formal statement depicting objectives and constraints.
  • A schedule for reviewing the performance of the portfolio and the policy statement.
  • Ranges of asset allocation and guidelines regarding rigidity and flexibility when devising or modifying the asset allocation.
  • Instructions for adjustments in the portfolio and rebalancing.

Types of Investment Strategies

Strategic asset allocation is a part of the asset allocation in the planning stage. The following are the approaches used to execute the strategic asset allocation:

  • Passive Investment: These strategies comprise of portfolios that do not respond to any changes in expectations. Buy and hold and indexing are examples of such passive strategies.
  • Active Investment: These strategies respond much more to changing expectations. They aim to benefit from the differences between the beliefs of a portfolio manager concerning the valuations and those of the marketplace. Making investments according to a particular style of investment and generating alpha are examples of such active investments.
  • Hybrids: These include enhanced index, risk-controlled active and semi-active strategies, which are hybrids of active and passive strategies. Index tilting is one example of a hybrid strategy, where the portfolio manager tries to match the risk attributes of a benchmark portfolio, but at the same time deviates from the same benchmark portfolio allocations to earn superior returns.


The portfolio management process is a set of comprehensive steps that needs to be followed with complete dedication and understanding to achieve the stated objectives. Investment policy statement is a crucial component of this process and is a key aspect in creating a portfolio or evaluating the performance of any portfolio. Both the client and the investment advisor need to share the same expectations and outlook of the portfolio.

Any discrepancy might defeat the purpose of portfolio management.


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Last updated on : March 19th, 2018
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