Over time, many investment research analysts often become portfolio managers. After all, the goal of almost all investment analysis is to make an investment decision or suggest someone to make an investment decision. Analyzing stocks and managing stock portfolios are closely related: this is why most analysts have a good educational background in disciplines such as stock analysis and modern portfolio theory (MPT).
However, in finance—as in many professions—real-world applications of theoretical or academic concepts may involve thinking beyond personal professionalism and training. Running a set of stock portfolios involves attention to detail, software skills, and management efficiency.
In short, you need to understand the mechanics of stock portfolio management to create and process a set of different portfolios, ensuring that they not only perform well, but also behave like a homogeneous element.
- Before actually building and running a stock portfolio, you must learn certain mechanical elements of portfolio management.
- Portfolio managers may be limited by the style, values, and methods of the investment company they work for.
- Over time, understanding the tax consequences of portfolio management activities is essential for structuring and managing investment portfolios.
- Portfolio modeling is a good way to apply the analysis and evaluation of a set of key stocks to a set or style of a set of investment portfolios.
- Portfolio modeling can be an effective link between stock analysis and portfolio management.
Limitations of portfolio managers
Professional portfolio managers working for investment management companies usually cannot choose the general investment philosophy of managing the portfolios they manage. The investment company may have strictly defined the parameters of stock selection and asset management. For example, a company might define itself as a style of value investment choice and use certain trading guidelines to follow that style.
In addition, portfolio managers are often bound by market capitalization guidelines. Small-cap stock managers may be limited to selecting stocks with a market value of between $250 million and $1 billion.
There may also be “house style” in the choice relative to economic trends. Some portfolio managers use a bottom-up approach to make investment decisions by selecting stocks without considering industry or economic forecasts. Others are top-down, using the entire industry or macroeconomic trends as the starting point for analysis and stock selection. Many styles use a combination of these methods.
Of course, the preferences of individual managers also play a role. Nonetheless, the first step in portfolio management is to understand the investment field and mantra of your particular organization.
Portfolio managers and tax considerations
Understanding the tax consequences of portfolio management activities is
Over time, building and running a portfolio is critical.
Many institutional investment portfolios, such as those used in retirement funds or pension funds, do not require taxation every year. Compared with taxable portfolios, their tax avoidance status gives portfolio managers greater flexibility.
Compared with taxable investment portfolios, non-taxable investment portfolios can give you greater dividend income and short-term capital gains. Managers of taxable portfolios may need to pay special attention to stock holding periods, tax batches, short-term capital gains, capital losses, tax sales, and dividend income from their holdings. They may insist on a lower portfolio turnover rate (compared to non-taxable portfolios) to avoid taxable events.
Build a portfolio model
Whether a manager runs a portfolio or 1,000 of them in a single equity investment product or style, building and maintaining a portfolio model is a common aspect of equity portfolio management.
The portfolio model is the standard for matching a single investment portfolio. Usually, a portfolio manager assigns a percentage weight to each stock in the portfolio model. Then, modify the individual portfolio to match this weighted combination.
Portfolio models are usually created using specialized investment management software, although general programs such as Microsoft Excel can also be used.
For example, after a mix of company analysis, industry analysis, and macroeconomic analysis, the portfolio manager may decide that it needs a relatively large specific stock weight. In this style of portfolio manager, the relatively large weight is 4% of the total portfolio value. By reducing the weight of other stocks in the model, or reducing the overall cash weight, portfolio managers will be able to purchase enough stocks of specific companies in all portfolios to match the 4% model weight.
All portfolios look similar to each other and are similar to the portfolio model, at least in terms of the 4% weight for that particular stock.
In this way, given the specific style prescribed by the portfolio group, portfolio managers can run all portfolios in a similar or identical manner. All investment portfolios can be expected to produce returns relative to each other in a standardized manner. They will also be similar to each other in terms of risk/reward profile. In fact, all analysis and safety assessments done by portfolio managers are run on models, not on individual portfolios.
As the prospects of individual stocks improve or deteriorate over time, portfolio managers only need to change the weights of these stocks in the portfolio model to optimize the returns of all the actual portfolios they cover.
Efficiency of Portfolio Modeling
Modeling allows significant analysis efficiency. Portfolio managers only need to know 30 or 40 stocks held in similar proportions in all portfolios, not 100 or 200 stocks held in different proportions in many accounts.
By changing the model weights in the portfolio model over time, the changes in these 30 or 40 stocks can be easily applied to all portfolios. Since the prospects of individual stocks change over time, the portfolio manager only needs to change his or her model weights to trigger investment decisions for all portfolios at the same time.
The portfolio model can also be used to handle all daily transactions at the level of a single portfolio. Just make a purchase based on the model to quickly and effectively establish a new account. Cash deposits and withdrawals can be handled in a similar way.
If the investment portfolio is large enough, you only need to apply the model to changes in asset size to build a portfolio that reflects the portfolio model. Smaller portfolios may be limited by the number of stock boards, which affects the ability of portfolio managers to accurately buy or sell certain percentage weights.