The evolution of portfolio management


These days, the concept of the portfolio is so commonplace that it’s hard to imagine things were ever any different. In fact, though investing has a history dating back centuries, the modern concept of the portfolio and the management techniques applied to investing today are really quite current. Understanding how they came to be can help provide insights into the real nature of investing, the way most ordinary investors think, and how to approach making the best decisions for any given set of objectives.

Looking at long-established financial columns can be very helpful in understanding the multiple changes investing has gone through, from the risky betting of the 1980s to the Dot-com Crash, the equity issues behind the global recession of 2008 and investors’ role in the increasingly solid recovery that can be seen today. Ken Fisher’s Forbes column, Portfolio Strategy, –which he has written for 30 years—is a great place to start for an overview of the a great place to start.

 What is portfolio management?

At its most basic, portfolio management is simply the process of balancing investments across various stocks, shares and bonds to suit a particular investor’s needs. This involves considering a number of factors, the most prominent being profit potential and risk; issues like ethical investment and investment in local businesses are also a priority for some. A portfolio with effectively distributed assets provides some security in the event of a crisis developing in one business or sector.

A well-managed portfolio can be an excellent asset for individuals who might use it to fund their retirement or to generate revenue for a new business. For companies, it’s a useful means of putting capital to work while retaining liquidity so as to be able to deal with emergencies and take advantage of opportunities.

Portfolio Management
Portfolio Management

Different types of portfolio management

Portfolio management is generally divided into two main classes: active and passive. Passive management is very simple. It basically involves selecting assets and simply following the market index, which is generally low risk but also produces low returns. Active management means taking an active role over the long-term, selling assets and acquiring new ones in an attempt to maximize returns while retaining an acceptable level of risk (which varies from person to person). There are several different styles of active management, including the following:

  • Value investing – determining the “true” value of an asset and aiming to buy when it’s available for less than that and sell when people are willing to pay more.
  • Contrarian investing – basing decisions on the behavior of other investors and seeking to obtain assets at bargain prices by going against the herd.
  • Momentum investing – buying up stock in rapidly growing companies and selling it when they lose their momentum; this is generally seen as a high-risk strategy.

Patterns of risk

Over the years, approaches to risk have changed considerably. The mathematical formulation of risk, which became publicly accessible in the early 1960s, enabled investors to start developing much more complex systems of portfolio management than had been used in the past, because it was simpler for them to identify exactly what the risk was in any given situation. This led to a diversification of strategies and simultaneously democratized investment as people no longer relied on their bank managers to do everything on their behalf. These days, although it is often still advisable to utilize the services of a professional investment manager, ordinary people generally expect to assess their portfolios for themselves and have much more say over what is and is not included.

Despite all this, risk remains one of the most poorly understood aspects of investment as far as the general public is concerned. Humans have inbuilt biases around risk that can make the formulae for dealing with it seem counter-intuitive. One of the most important things for an investor to do before acting is to decide on just how much risk is acceptable – basing that decision, in part, on how much they can afford to lose.

A changing marketplace

Alongside this changing understanding of risk, the marketplace itself has changed over the years, altering the balance of factors to be considered when investing. Strategies that work well in a bull market may become problematic in a bear market, and those looking for long-term investments will want to find an acceptable compromise that can enable them to navigate both.

Anticipating future changes

The most important reason to try and gain an understanding of how portfolio management techniques have changed in the past is that this can make it easier to anticipate changes in the future. Smart investors follow long-term investment trends, as well as changes in individual sectors, because understanding the way other investors are likely to behave makes it much easier to predict the real value and direction of stocks and shares.