S1 - Overview of IAPM-unlocked

Introduction to Investment Analysis
and Portfolio Management
Prof. Arnab Bhattacharya

PGP (Term V) IAPM
Portfolio Management
 Everyone owns a portfolio (group) of assets

 Real assets ~ Car, house, refrigerator
 Financial assets ~ Stocks, bonds, bank deposits, gold
 May be planned investments or unplanned decisions
 Investment Analysis and Portfolio Management

 Focus on financial assets
 Basic principles underlying rational portfolio choice
 Implementation and control of decision making process
 Implication for price discovery in financial market
Portfolio Management

 Investment decision problem statement
 Find most desirable group of securities to invest, given
properties of each securities
 Choice among enormous number of assets
 Structuring of objective to manage number of alternatives
 Rational choice among the shortlisted alternatives

 Implementation mechanism of decision making process
 Assumptions about capital market characteristics

 Models of equilibrium prices and returns in capital markets
Snapshot of Course Outline

 Determination of properties of portfolio of risky assets
 Determination of composition of preferred portfolios
 Implementation and simplification of portfolio theory
 Models of equilibrium capital market prices and returns

 Assumptions about market characteristics, investor behaviour
 Theoretical predications and empirical evidence
 Valuation models
 Methods of forecasting inputs to valuation models
 Theory of interest rates, pricing of bonds, options and futures
Snapshot of Course Outline

 Evaluation of investment process
 Methods of portfolio performance evaluation
 Evaluation of forecasts for security analysis
Investment Asset Classes
 Investment Asset Classes

 Cash, Corporate Deposits, Bank Deposits
 Short-term Treasury Bills, Notes, Bonds
 Corporate Bonds
 Commodities, Oil, Gold
 FX, Currencies, Derivatives
 Mutual Funds, Index Funds, ETFs
 Real Estate, Hedge Fund, Private Equity
 Lotteries, Paintings, Gambling
Investment Asset Classes
 Investment Asset Classes

Equity Fixed Income
Large Cap vs. Small Cap Treasury and Municipal Bonds
Growth vs. Value Stocks Corporate
Domestic vs. Foreign High Yield
Emerging Market Mortgage Backed, Asset Backed
Alternatives Domestic vs. Foreign
Commodities Emerging Market
Real Estate Cash
Currencies T-bills
Private Equity Money Market
Hedge Funds Savings
Life Time Earning and Spending Pattern
 Earning and Spending Pattern over Life Time
Spending
INR
Pattern
Earning
Pattern
Life time
(years)
Risk Return Characteristics of Assets
 Risk Return Characteristics of Asset Classes

 Risk-return trade-off for different asset classes
Return
VC
(%) PE
RE
MFs
ETFs
T-bills
Cash
Standard
Deviation (%)
Investment Philosophy
10
 Investment goal driven by investor philosophy

 Investment philosophy
 Coherent way of analysing financial markets
 Understanding market mechanisms and market failures
 Insights into common investor behavioural biases
 Example: Herding behaviour leading to price momentum
 Apparent in both financial and non-financial decision making
 “Key to success in investing may lie not in knowing what
makes others successful, but in finding out more about oneself”
Investment Philosophy Pivots
11
 Human behaviour ~ behavioural biases

 Traditional assumption of investor rationality
 Not a realistic view, especially in short term horizon
 Market efficiency ~ degree of efficiency

 Some investors more prone to make mistakes
 Individual vs. institutional; MF vs. PE / HFs
 Investor overreactions around earnings announcements
 Strategies and tactics

 How to exploit market inefficiencies / pricing errors?
 Technical indicators ~ to identify overbought / oversold market
The Big Picture of Investing
12
 Big picture of investing: Key knowledge & skills
Behavioural finance, Portfolio analysis, Corporate finance,

investor psychology investment management financial markets
Investment Investment
Investor
Process Instruments
Portfolio Invested
Client
Manager Portfolio
The Big Picture of Investing
13
 Big picture of investing
Investment Investment
Investor
Products Instruments
Portfolio Invested
Client
Manager Portfolio
Sales & Marketing role Technical role

Understanding the Investor
14
 Investor (Client)
 Understanding investor needs and beliefs
 Risk tolerance / aversion ~ utility function
 Investment size, time horizon, tax status
 Financial literacy, investment experience
Investor Risk Preferences
15
 How would you define risk?

 Potential for realizing low returns or even losing money
 Traditional risk models ~ standard deviation, volatility
 Risk one can afford vs. risk one can stand to take
 Affordability depends mainly on time horizon
 Risk one can stand to take depends on risk tolerance
 Investors may be conservative, moderate or aggressive
 Quizzes based on investing experience, financial security and
tendency to make risky or conservative choices
16
 Most investors tend to be risk averse

 Degree of risk aversion may vary depending on
investor characteristics (age, wealth, income and
spending profile)
 More risk averse investors should invest less of their
investment portfolio in riskier assets
 Lower (higher) weights for equity (debt) type securities
 Investment horizon
 Liquidity needs, investment styles
 Influences both choice of assets and their weights
17
 Risk aversion and investment horizon
Investor Type High Risk Aversion Low Risk Aversion
Short Term Horizon A B
Long Term Horizon C D
 Which investor’s portfolio should have highest (lowest)

proportion of equity type investments?
 (Highest to lowest): D > (B, C) > A
Management of Investment Portfolio
18
 Investment portfolio management

 Asset allocation ~ risk-return trade-offs, diversification
 Asset classes ~ stocks, bonds, real estates
 Geography ~ domestic, foreign, emerging markets
 Views on markets, growth rates, inflation, political risks
 Asset selection ~ active vs. passive selection

 Choice of financial instrument in each asset class
 Valuation (earnings estimates, trading comps)
 Private (non-public) information
Management of Investment Portfolio
19
 Investment portfolio management

 Execution ~ Trading mechanism, market microstructure
 Trading frequency, trade size, order type
 Trading commissions, liquidity, bid-ask spreads, price impact
 Hedging and risk management
Evaluation of Portfolio Performance
20
 Investment portfolio performance evaluation

 Risk-adjusted return ~ asset pricing models
 Capital Asset Pricing Model, Arbitrage Pricing Theory
 Under / outperformance relative to market / benchmark

 Stock selection and market timing ability are critical
Thank you 

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Introduction to Investment Analysis

and Portfolio Management

Prof. Arnab Bhattacharya

 Everyone owns a portfolio (group) of assets

 Investment Analysis and Portfolio Management

 Investment Analysis and Portfolio Management

 Rational choice among the shortlisted alternatives

 Assumptions about capital market characteristics

 Investment Analysis and Portfolio Management

 Models of equilibrium capital market prices and returns

 Investment Analysis and Portfolio Management

 Investment Asset Classes

 Investment Asset Classes

 Earning and Spending Pattern over Life Time

 Risk Return Characteristics of Asset Classes

 Investment goal driven by investor philosophy

 Human behaviour ~ behavioural biases

 Market efficiency ~ degree of efficiency

 Strategies and tactics

 Big picture of investing: Key knowledge & skills

Behavioural finance, Portfolio analysis, Corporate finance,

 Big picture of investing

Sales & Marketing role Technical role

 How would you define risk?

 Most investors tend to be risk averse

 Risk aversion and investment horizon

Investor Type High Risk Aversion Low Risk Aversion

Short Term Horizon A B

Long Term Horizon C D

 Which investor’s portfolio should have highest (lowest)

 Investment portfolio management

 Asset selection ~ active vs. passive selection

 Investment portfolio management

 Investment portfolio performance evaluation

 Under / outperformance relative to market / benchmark

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