Portfolio (finance)

In finance, a portfolio is an appropriate mix of or collection of investments held by an institution or a private individual.

Holding a portfolio is part of an investment and risk-limiting strategy called diversification. By owning several assets, certain types of risk (in particular specific risk) can be reduced. The assets in the portfolio could include stocks, bonds, options, warrants, gold certificates, real estate, futures contracts, production facilities, or any other item that is expected to retain its value.

In building up an investment portfolio a financial institution will typically conduct its own investment analysis, whilst a private individual may make use of the services of a financial advisor or a financial institution which offers portfolio management services.


Portfolio management involves deciding what assets to include in the portfolio, given the goals of the portfolio owner and changing economic conditions. Selection involves deciding what assets to purchase, how many to purchase, when to purchase them, and what assets to divest. These decisions always involve some sort of performance measurement, most typically expected return on the portfolio, and the risk associated with this return (i.e. the standard deviation of the return). Typically the expected return from portfolios of different asset bundles are compared.

The unique goals and circumstances of the investor must also be considered. Some investors are more risk averse than others.

Mutual fund have developed particular techniques to optimize their portfolio holdings. See fund management for details.

Portfolio formation

Many strategies have been developed to form a portfolio.
* equally-weighted portfolio
* capitalization-weighted portfolio
* price-weighted portfolio
* optimal portfolio (for which the Sharpe ratio is highest)


Some of the financial models used in the process of Valuation, stock selection, and management of portfolios include:
* Maximizing return, given an acceptable level of risk.
* Modern portfolio theory—a model proposed by Harry Markowitz among others.
* The single-index model of portfolio variance.
* Capital asset pricing model.
* Arbitrage pricing theory.
* The Jensen Index.
* The Treynor Index.
* The Sharpe Diagonal (or Index) model.
* Value at risk model.


There are many different methods for calculating portfolio returns. A traditional method has been using quarterly or monthly money-weighted returns. A money-weighted return calculated over a period such as a month or a quarter assumes that the rate of return over that period is constant. As portfolio returns actually fluctuate daily, money-weighted returns may only provide an approximation to a portfolio’s actual return. These errors happen because of cashflows during the measurement period. The size of the errors depends on three variables: the size of the cashflows, the timing of the cashflows within the measurement period, and the volatility of the portfolio [ http://www.compoundinghappens.com/mw_tw.htm Investment Performance Measurement Errors] , accessed 2008-06-29.] .

A more accurate method for calculating portfolio returns is to use the true time-weighted method. This entails revaluing the portfolio on every date where a cashflow takes place (perhaps even every day), and then compounding together the daily returns.


Performance Attribution explains the active performance (i.e. the benchmark-relative performance) of a portfolio. For example, a particular portfolio might be benchmarked against the S&P 500 index. If the benchmark return over some period was 5%, and the portfolio return was 8%, this would leave an active return of 3% to be explained. This 3% active return represents the component of the portfolio's return that was generated by the investment manager (rather than by the benchmark).

There are different models for performance attribution, corresponding to different investment processes. For example, one simple model explains the active return in "bottom-up" terms, as the result of stock selection only. On the other hand, sector attribution explains the active return in terms of both sector bets (for example, an overweight position in Materials, and an underweight position in Financials), and also stock selection within each sector (for example, choosing to hold more of the portfolio in one bank than another).

An altogether different paradigm for performance attribution is based on using factor models, such as the Fama-French three-factor model.


ee also

* Modern portfolio theory
* Risk management
* Banking
* Styles of investment strategy
* Investment management
* Market portfolio
* Performance Attribution

External links

* [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=927331 Simultaneous Consumption Planning and Portfolio Management]

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