Portfolio Manager

The six-step portfolio management process

What does a portfolio manager do?

Portfolio managers are professionals who manage investment portfolios, with the goal of achieving their clients’ investment objectives. In recent years, the portfolio manager has become one of the most coveted careers in the financial services industry.  In this article we will answer the question, what does a portfolio manager do?

From the perspective of client objective, there are two types of portfolio managers: individual or institutional. Both types of manager serve to satisfy the earning goals for their respective clientele.


what does a portfolio manager do


Different investment styles of managers

Style investing generally refers to the investment philosophy that a manager employs in their attempts to add value (i.e. beat the market benchmark return). Some categories of major styles include small vs. big, value vs. growth, active vs. passive, momentum vs. contrarian, etc.

In order to answer the question, “what does a portfolio manager do?” we have to look at the various investing styles they could use.  The most common investment styles are:

  • Small vs. big styles refer to the preference of stocks between small market capitalization or big market capitalization.
  • Value vs. growth styles is based on preference between current valuation and future growth opportunities.
  • Active vs. passive investing refers to the varying amounts of interference desired by the manager.
  • Momentum vs. contrarian style reflects the manager’s attitude on whether or not to take advantage of market trends.

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The six-step portfolio management process

So how do portfolio managers meet their clients’ financial goals?  And what does a portfolio manager do? In most cases, portfolio managers conduct the following six steps to add value:


#1 Determine the clients’ objective

Individual clients typically have smaller investments with shorter, more specific time horizons. In comparison, institutional clients invest larger amounts and have longer investment horizons. For this step, managers communicate with each client to determine their respective desired return and risk appetite.


#2 Choose the optimal asset classes

Managers will determine the most suitable asset classes (e.g. equity, bond, real estate, private equity, etc.) based on the client’s investment goals.


#3 Conduct Strategic Asset Allocation (SAA)

Strategic Asset Allocation (SAA) is the process of setting weights for each asset class in the portfolio at the beginning of investment periods, so that the portfolio’s risk and return is compatible with that of the client’s desire. The portfolio will require periodic rebalancing, as asset weights may deviate significantly from the original allocations over the investment horizon due to unexpected returns from various assets.


#4 Conduct Tactical Asset Allocation (TAA) or Insured Asset Allocation (IAA)

Both Tactical Asset Allocation (TAA) and Insured Asset Allocation (IAA) refer to different ways of adjusting weights of assets within portfolios during an investment period. The TAA approach makes changes based on capital market opportunities, whereas IAA adjusts asset weights based on the client’s existing wealth at a given point of time.

A portfolio manager may choose to conduct either TAA or IAA, but not both at the same time, as the two approaches embed contrasting investment philosophies. TAA managers find predictor variables that are correlated with future stock returns, and covert the estimate of expected returns into a stock/bond allocation. IAA managers, on the other hand, strive to offer clients downside protection for their portfolios by insuring that portfolio values never drop below the clients’ investment floor (i.e. their minimum acceptable portfolio value).

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#5 Manage risk

By selecting weights for each asset classes, portfolio managers have control over the amount of 1) security selection risk, 2) style risk, and 3) TAA risk taken by the portfolio.

  • Security selection risk arises from the manager’s SAA actions. The only way the manager can avoid security selection risk is to hold the market index directly; this ensures that the manager’s asset class returns are exactly the same as that of the benchmark asset class.
  • Style risk arises from the manager’s investment style. For instance, “growth” managers usually beat the benchmark returns when the market index is doing well, but underperform when the index is doing poorly. Contrarily, “value” managers struggle to beat the benchmark returns when the market index is doing well, but beat the market when it’s doing poorly.
  • The manager can only avoid TAA risk by choosing the same systematic risk (β) as the benchmark index. By not choosing this path, and instead betting on TAA, the manager is exposed to higher levels of volatility.


#6 Measure performance

The performance of portfolios can be measured using the CAPM model. The CAPM performance measures can be derived from a regression of excess portfolio return on excess market return. This yields the systematic risk (β), the portfolio’s value-added (α), and the residual risk. Below are the calculations of the Treynor ratio and Sharpe ratio, as well as the information ratio.

The Treynor ratio, calculated as Tp = (Rp-Rf)/ β, measures the amount of excess return gained by taking on an additional unit of systematic risk.

The Sharpe ratio, calculated as Sp = (Rp-Rf)/ σ, where σ = Stdev(Rp-Rf), measures the excess return per unit of total risk.

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Comparing the Treynor and Sharpe ratios can tell us if a manager is undertaking a lot of unsystematic, or idiosyncratic, risk. Idiosyncratic risks can be managed by diversification within the portfolio. 

The information ratio is calculated as: Ip = [(Rp-Rf)- β(Rm-Rf)]/ω = α/ω, where ω represents unsystematic risk. As the numerator is value-added, and the denominator is the risk taken in order to achieve the added value, it is the most useful tool to assess the reward-to-risk of a manager’s value-added.


Learn more! 

Thanks for reading this overview of, “what does a portfolio manager do?”.  In order to continue planning and preparing for a career in portfolio management, please see these additional resources:

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