Portfolio Management Software]

[PORTFOLIO MANAGEMENT SOFTWARE]

INTRODUCTION

Portfolio management is the discipline of planning, organizing, securing and managing resources to bring about the successful completion of specific project goals and objectives. It is sometimes conflated with program management, however technically a program is actually a higher level construct: a group of related and somehow interdependent projects. A project is a temporary endeavor, having a defined beginning and end (usually constrained by date, but can be by funding or deliverables), undertaken to meet unique goals and objectives, usually to bring about beneficial change or added value. The temporary nature of projects stands in contrast to business as usual (or operations), which are repetitive, permanent or semi- permanent functional work to produce products or services. In practice, the management of these two systems is often found to be quite different, and as such requires the development of distinct technical skills and the adoption of separate management.

OBJECTIVES OF THE PROJECT

• Learning and Understanding the concept of Portfolio.

• Understanding the Models of Portfolio Management.

• Learning about the Instruments in Portfolio.

• Advantages and Diadvantages of Portfolio management

• Application of Computer in Portfolio.

• Understanding the operation of the Software used in Portfolio.

• Advantages of Software used and it limitations.

INDIAN INSTITUTE OF FINANCE Page 1 [PORTFOLIO MANAGEMENT SOFTWARE]

RESEARCH METHODOLOGY

• PRIMARY DATA

Primary source is a term used in a number of disciplines to describe source material that is closest to the person, information, period, or idea being studied.

• SECONDARY DATA

Secondary source is a document or recording that relates or discusses information originally presented elsewhere. A secondary source contrasts with a primary source, which is an original source of the information being discussed. Secondary sources involve generalization, analysis, synthesis, interpretation, or evaluation of the original information. Primary and secondary are relative terms, and some sources may be classified as primary or secondary, depending on how it is used.

LIMITATIONS

• Project is based on Secondary data.

• Time constraint

Portfolio Management

Most investors leave the more technical aspects of portfolio management to their financial consultants. However, this need not be the case. The average educated person can certainly gain a grasp of the topic sufficient enough to make his or her own investment decisions. The

INDIAN INSTITUTE OF FINANCE Page 2 [PORTFOLIO MANAGEMENT SOFTWARE] key to learning is gaining the knowledge and then practice applying it to your own portfolio in small amounts until you feel confident enough to manage it completely on your own. This article will briefly describe some of the concepts behind portfolio theory as well as some general techniques applied by portfolio managers. There are many good books that can give more in depth information if you feel this is something you would like to know more about.

The first important facet of portfolio management is understanding the two main decisions, which are related but completely separate for purposes of practicality. These two decisions are

1) Broad-based asset allocation and

2) Specific security selection

The most important thing an investor can do is go through the in-depth process of determining a portfolio asset mix at the very onset of each year and again anytime there is a significant change to their portfolio. It is only after this mix is determined that the process of choosing individual investments should be made. Asset classes are by far a bigger factor in overall performance than individual security selection as time invested increases. Or to put this in a more pragmatic way, it doesn’t matter in a 10-year period of time which stock you chose as much as it matters that you chose stock. This doesn’t mean an individual security can’t make a difference. It just means that it becomes less important over a period of five years or so since all securities of a given class tend to move toward an average performance which balances out extreme movements in specific periods of time.

Another important facet of portfolio management is that one makes analytical decisions and not make decisions based on hunches or emotion. This kind of pragmatic and analytical approach will keep the average investor from making decisions to move money completely in or out of a security or an asset class based upon the latest market rumors or the five o’clock news. Regardless of what insight we feel inclined to follow, the numbers and the data of past performance gives us clear indications that moving in and out of asset classes or individual securities during adverse periods hurts more than it helps in the long run. And if a decision is made to divest out of a specific security, it is always advised to dollar-cost

INDIAN INSTITUTE OF FINANCE Page 3 [PORTFOLIO MANAGEMENT SOFTWARE] average out of the investment in the same manner that one should have dollar-cost averaged “in”.

Dollar cost averaging is a technique by which an investor divides the given investment over a period of time and invests that amount on a regular basis as opposed to buying in all at once. This technique is covered in more detail in a previous article.

The simple concepts above can help you to begin making decisions like a professional. Of course there are many other aspects of portfolio management that go in depth into both of the above investment decisions. Look for those more detailed articles elsewhere on this website.

The primary challenge of project management is to achieve all of the project goals[4] and objectives while honoring the preconceived project constraints.[5] Typical constraints are

INDIAN INSTITUTE OF FINANCE Page 4 [PORTFOLIO MANAGEMENT SOFTWARE] scope, time, and budget.[1] The secondary—and more ambitious—challenge is to optimize the allocation and integration of inputs necessary to meet pre-defined objectives.

•

History

Roman Soldiers Building a Fortress, Trajan's Column 113 ad.

Project management has been practiced since early civilization. Until 1900 civil engineering projects were generally managed by creative architects and engineers themselves, among those for example Vitruvius (1st century BC), Christopher Wren (1632–1723) , Thomas

INDIAN INSTITUTE OF FINANCE Page 5 [PORTFOLIO MANAGEMENT SOFTWARE]

Telford (1757-1834) and Isambard Kingdom Brunel (1806–1859). It was in the 1950s that organizations started to systematically apply project management tools and techniques to complex projects.

Henry Gantt (1861-1919), the father of planning and control techniques.

As a discipline, Project Management developed from several fields of application including construction, engineering, and defense activity. Two forefathers of project management are Henry Gantt, called the father of planning and control techniques[9], who is famous for his use of the Gantt chart as a project management tool; and Henri Fayol for his creation of the 5 management functions which form the foundation of the body of knowledge associated with project and program management.[10] Both Gantt and Fayol were students of Frederick Winslow Taylor's theories of scientific management. His work is the forerunner to modern project management tools including work breakdown structure (WBS) and resource allocation.

The 1950s marked the beginning of the modern Project Management era. Project management became recognized as a distinct discipline arising from the management discipline.[11] In the United States, prior to the 1950s, projects were managed on an ad hoc basis using mostly Gantt Charts, and informal techniques and tools. At that time, two mathematical project-scheduling models were developed. The "Critical Path Method" (CPM) was developed as a joint venture between DuPont Corporation and Remington Rand Corporation for managing plant maintenance projects. And the "Program Evaluation and Review Technique" or PERT, was developed by Booz-Allen & Hamilton as part of the United States Navy's (in conjunction with the Lockheed Corporation) Polaris missile

INDIAN INSTITUTE OF FINANCE Page 6 [PORTFOLIO MANAGEMENT SOFTWARE] submarine program;[12] These mathematical techniques quickly spread into many private enterprises.

PERT network chart for a seven-month project with five milestones

At the same time, as project-scheduling models were being developed, technology for project cost estimating, cost management, and engineering economics was evolving, with pioneering work by Hans Lang and others. In 1956, the American Association of Cost Engineers (now AACE International; the Association for the Advancement of Cost Engineering) was formed by early practitioners of project management and the associated specialties of planning and scheduling, cost estimating, and cost/schedule control (project control). AACE continued its pioneering work and in 2006 released the first integrated process for portfolio, program and project management (Total Cost Management Framework).

The International Project Management Association (IPMA) was founded in Europe in 1967, [13] as a federation of several national project management associations. IPMA maintains its federal structure today and now includes member associations on every continent except Antarctica. IPMA offers a Four Level Certification program based on the IPMA Competence Baseline (ICB).[14] The ICB covers technical competences, contextual competences, and behavioral competences.

In 1969, the Project Management Institute (PMI) was formed in the USA.[15] PMI publishes A Guide to the Project Management Body of Knowledge (PMBOK Guide), which describes project management practices that are common to "most projects, most of the time." PMI also offers multiple certifications.

The AAPM American Academy of Project Management International Board of Standards 1996 was the first to institute post-graduate certifications such as the MPM Master Project

INDIAN INSTITUTE OF FINANCE Page 7 [PORTFOLIO MANAGEMENT SOFTWARE]

Manager, PME Project Management E-Business, CEC Certified-Ecommerce Consultant, and CIPM Certified International project Manager. The AAPM also issues the post-graduate standards body of knowledge for executives.

Approaches

There are a number of approaches to managing project activities including agile, interactive, incremental, and phased approaches.

Regardless of the methodology employed, careful consideration must be given to the overall project objectives, timeline, and cost, as well as the roles and responsibilities of all participants and stakeholders.

The traditional approach

A traditional phased approach identifies a sequence of steps to be completed. In the "traditional approach", we can distinguish 5 components of a project (4 stages plus control) in the development of a project:

Typical development phases of a project

• Project initiation stage; • Project planning or design stage; • Project execution or production stage; • Project monitoring and controlling systems; • Project completion.

Not all the projects will visit every stage as projects can be terminated before they reach completion. Some projects do not follow a structured planning and/or monitoring stages. Some projects will go through steps 2, 3 and 4 multiple times.

Many industries use variations on these project stages. For example, when working on a brick and mortar design and construction, projects will typically progress through stages like Pre-

INDIAN INSTITUTE OF FINANCE Page 8 [PORTFOLIO MANAGEMENT SOFTWARE]

Planning, Conceptual Design, Schematic Design, Design Development, Construction Drawings (or Contract Documents), and Construction Administration. In software development, this approach is often known as the waterfall model[16], i.e., one series of tasks after another in linear sequence. In software development many organizations have adapted the Rational Unified Process (RUP) to fit this methodology, although RUP does not require or explicitly recommend this practice. Waterfall development works well for small, well defined projects, but often fails in larger projects of undefined and ambiguous nature. The Cone of Uncertainty explains some of this as the planning made on the initial phase of the project suffers from a high degree of uncertainty. This becomes especially true as software development is often the realization of a new or novel product. In projects where requirements have not been finalized and can change, requirements management is used to develop an accurate and complete definition of the behavior of software that can serve as the basis for software development[17]. While the terms may differ from industry to industry, the actual stages typically follow common steps to problem solving — "defining the problem, weighing options, choosing a path, implementation and evaluation."

Critical Chain Project Management

Critical Chain Project Management (CCPM) is a method of planning and managing projects that puts more emphasis on the resources (physical and human) needed in order to execute project tasks. It is an application of the Theory of Constraints (TOC) to projects. The goal is to increase the rate of throughput (or completion rates) of projects in an organization. Applying the first three of the five focusing steps of TOC, the system constraint for all projects is identified as are the resources. To exploit the constraint, tasks on the critical chain are given priority over all other activities. Finally, projects are planned and managed to ensure that the resources are ready when the critical chain tasks must start, subordinating all other resources to the critical chain.

Regardless of project type, the project plan should undergo Resource Leveling, and the longest sequence of resource-constrained tasks should be identified as the critical chain. In multi-project environments, resource leveling should be performed across projects. However, it is often enough to identify (or simply select) a single "drum" resource—a resource that acts

INDIAN INSTITUTE OF FINANCE Page 9 [PORTFOLIO MANAGEMENT SOFTWARE] as a constraint across projects—and stagger projects based on the availability of that single resource.

Planning and feedback loops in Extreme Programming (XP) with the time frames of the multiple loops.

Extreme Project Management

In critical studies of Project Management, it has been noted that several of these fundamentally PERT-based models are not well suited for the multi-project company environment of today.[citation needed] Most of them are aimed at very large-scale, one-time, non- routine projects, and nowadays all kinds of management are expressed in terms of projects.

Using complex models for "projects" (or rather "tasks") spanning a few weeks has been proven to cause unnecessary costs and low maneuverability in several cases[citation needed]. Instead, project management experts try to identify different "lightweight" models, such as Agile Project Management methods including Extreme Programming for software development and Scrum techniques.

The generalization of Extreme Programming to other kinds of projects is extreme project management, which may be used in combination with the process modeling and management principles of human interaction management.

Event chain methodology

Event chain methodology is another method that complements critical path method and critical chain project management methodologies.

Event chain methodology is an uncertainty modeling and schedule network analysis technique that is focused on identifying and managing events and event chains that affect project schedules. Event chain methodology helps to mitigate the negative impact of psychological heuristics and biases, as well as to allow for easy modeling of uncertainties in the project schedules. Event chain methodology is based on the following principles.

INDIAN INSTITUTE OF FINANCE Page 10 [PORTFOLIO MANAGEMENT SOFTWARE]

• Probabilistic moment of risk: An activity (task) in most real life processes is not a continuous uniform process. Tasks are affected by external events, which can occur at some point in the middle of the task. • Event chains: Events can cause other events, which will create event chains. These event chains can significantly affect the course of the project. Quantitative analysis is used to determine a cumulative effect of these event chains on the project schedule. • Critical events or event chains: The single events or the event chains that have the most potential to affect the projects are the “critical events” or “critical chains of events.” They can be determined by the analysis. • Project tracking with events: Even if a project is partially completed and data about the project duration, cost, and events occurred is available, it is still possible to refine information about future potential events and helps to forecast future project performance. • Event chain visualization: Events and event chains can be visualized using event chain diagrams on a Gantt chart.

PRINCE2

The PRINCE2 process model

PRINCE2 is a structured approach to project management, released in 1996 as a generic project management method.[18] It combined the original PROMPT methodology (which evolved into the PRINCE methodology) with IBM's MITP (managing the implementation of the total project) methodology. PRINCE2 provides a method for managing projects within a clearly defined framework. PRINCE2 describes procedures to coordinate people and activities in a project, how to design and supervise the project, and what to do if the project has to be adjusted if it does not develop as planned.

In the method, each process is specified with its key inputs and outputs and with specific goals and activities to be carried out. This allows for automatic control of any deviations from

INDIAN INSTITUTE OF FINANCE Page 11 [PORTFOLIO MANAGEMENT SOFTWARE] the plan. Divided into manageable stages, the method enables an efficient control of resources. On the basis of close monitoring, the project can be carried out in a controlled and organized way.

PRINCE2 provides a common language for all participants in the project. The various management roles and responsibilities involved in a project are fully described and are adaptable to suit the complexity of the project and skills of the organization.

Process-based management

Capability Maturity Model, predecessor of the CMMI Model

Also furthering the concept of project control is the incorporation of process-based management. This area has been driven by the use of Maturity models such as the CMMI (Capability Maturity Model Integration) and ISO/IEC15504 (SPICE - Software Process Improvement and Capability Estimation).

Agile Project Management approaches based on the principles of human interaction management are founded on a process view of human collaboration. This contrasts sharply with the traditional approach. In the agile software development or flexible product development approach, the project is seen as a series of relatively small tasks conceived and executed as the situation demands in an adaptive manner, rather than as a completely pre- planned process.

Processes

This section relies largely or entirely upon a single source. Please help improve this article by

INDIAN INSTITUTE OF FINANCE Page 12 [PORTFOLIO MANAGEMENT SOFTWARE]

introducing appropriate citations of additional sources. (August 2010)

Traditionally, project management includes a number of elements: four to five process groups, and a control system. Regardless of the methodology or terminology used, the same basic project management processes will be used.

The project development stages[19]

Major process groups generally include:

• Initiation

• Planning or development

• Production or execution

• Monitoring and controlling

• Closing

In project environments with a significant exploratory element these stages may be supplemented with decision points (go/no go decisions) at which the project's continuation is debated and decided. An example is the Stage-Gate model.

INDIAN INSTITUTE OF FINANCE Page 13 [PORTFOLIO MANAGEMENT SOFTWARE]

Initiation

Initiating Process Group Processes[19]

The initiation processes determine the nature and scope of the project. If this stage is not performed well, it is unlikely that the project will be successful in meeting the business’ needs. The key project controls needed here are an understanding of the business environment and making sure that all necessary controls are incorporated into the project. Any deficiencies should be reported and a recommendation should be made to fix them.

The initiation stage should include a plan that encompasses the following areas:

• Analyzing the business needs/requirements in measurable goals • Reviewing of the current operations • Financial analysis of the costs and benefits including a budget • Stakeholder analysis, including users, and support personnel for the project • Project charter including costs, tasks, deliverables, and schedule

Planning and design

Planning Process Group Activities[19]

INDIAN INSTITUTE OF FINANCE Page 14 [PORTFOLIO MANAGEMENT SOFTWARE]

After the initiation stage, the project is planned to an appropriate level of detail. The main purpose is to plan time, cost and resources adequately to estimate the work needed and to effectively manage risk during project execution. As with the Initiation process group, a failure to adequately plan greatly reduces the project's chances of successfully accomplishing its goals.

Project planning generally consists of

• determining how to plan (e.g. by level of detail or rolling wave); • developing the scope statement; • selecting the planning team; • identifying deliverables and creating the work breakdown structure; • identifying the activities needed to complete those deliverables and networking the activities in their logical sequence; • estimating the resource requirements for the activities; • estimating time and cost for activities; • developing the schedule; • developing the budget; • risk planning; • gaining formal approval to begin work.

Additional processes, such as planning for communications and for scope management, identifying roles and responsibilities, determining what to purchase for the project and holding a kick-off meeting are also generally advisable.

For new product development projects, conceptual design of the operation of the final product may be performed concurrent with the project planning activities, and may help to inform the planning team when identifying deliverables and planning activities.

INDIAN INSTITUTE OF FINANCE Page 15 [PORTFOLIO MANAGEMENT SOFTWARE]

Executing

Executing Process Group Processes[19]

Executing consists of the processes used to complete the work defined in the project management plan to accomplish the project's requirements. Execution process involves coordinating people and resources, as well as integrating and performing the activities of the project in accordance with the project management plan. The deliverables are produced as outputs from the processes performed as defined in the project management plan.

Monitoring and controlling

Monitoring and controlling consists of those processes performed to observe project execution so that potential problems can be identified in a timely manner and corrective action can be taken, when necessary, to control the execution of the project. The key benefit is that project performance is observed and measured regularly to identify variances from the project management plan.

Monitoring and Controlling Process Group Processes[19]

Monitoring and Controlling includes :

• Measuring the ongoing project activities ('where we are');

INDIAN INSTITUTE OF FINANCE Page 16 [PORTFOLIO MANAGEMENT SOFTWARE]

• Monitoring the project variables (cost, effort, scope, etc.) against the project management plan and the project performance baseline (where we should be); • Identify corrective actions to address issues and risks properly (How can we get on track again); • Influencing the factors that could circumvent integrated change control so only approved changes are implemented

In multi-phase projects, the monitoring and controlling process also provides feedback between project phases, in order to implement corrective or preventive actions to bring the project into compliance with the project management plan.

Project Maintenance is an ongoing process, and it includes:

• Continuing support of end users • Correction of errors • Updates of the software over time

Monitoring and Controlling cycle

In this stage, auditors should pay attention to how effectively and quickly user problems are resolved.

Over the course of any construction project, the work scope may change. Change is a normal and expected part of the construction process. Changes can be the result of necessary design modifications, differing site conditions, material availability, contractor-requested changes, value engineering and impacts from third parties, to name a few. Beyond executing the change in the field, the change normally needs to be documented to show what was actually constructed. This is referred to as Change Management. Hence, the owner usually requires a final record to show all changes or, more specifically, any change that modifies the tangible portions of the finished work. The record is made on the contract documents – usually, but not necessarily limited to, the design drawings. The end product of this effort is what the industry terms as-built drawings, or more simply, “as built.” The requirement for providing them is a norm in construction contracts.

INDIAN INSTITUTE OF FINANCE Page 17 [PORTFOLIO MANAGEMENT SOFTWARE]

When changes are introduced to the project, the viability of the project has to be re-assessed. It is important not to lose sight of the initial goals and targets of the projects. When the changes accumulate, the forecasted result may not justify the original proposed investment in the project.

Closing

Closing Process Group Processes.[19]

Closing includes the formal acceptance of the project and the ending thereof. Administrative activities include the archiving of the files and documenting lessons learned.

This phase consists of:

• Project close: Finalize all activities across all of the process groups to formally close the project or a project phase • Contract closure: Complete and settle each contract (including the resolution of any open items) and close each contract applicable to the project or project phase.

Project control systems

Project control is that element of a project that keeps it on-track, on-time and within budget. Project control begins early in the project with planning and ends late in the project with post- implementation review, having a thorough involvement of each step in the process. Each project should be assessed for the appropriate level of control needed: too much control is too time consuming, too little control is very risky. If project control is not implemented correctly, the cost to the business should be clarified in terms of errors, fixes, and additional audit fees.

Control systems are needed for cost, risk, quality, communication, time, change, procurement, and human resources. In addition, auditors should consider how important the projects are to the financial statements, how reliant the stakeholders are on controls, and how

INDIAN INSTITUTE OF FINANCE Page 18 [PORTFOLIO MANAGEMENT SOFTWARE] many controls exist. Auditors should review the development process and procedures for how they are implemented. The process of development and the quality of the final product may also be assessed if needed or requested. A business may want the auditing firm to be involved throughout the process to catch problems earlier on so that they can be fixed more easily. An auditor can serve as a controls consultant as part of the development team or as an independent auditor as part of an audit.

Businesses sometimes use formal systems development processes. These help assure that systems are developed successfully. A formal process is more effective in creating strong controls, and auditors should review this process to confirm that it is well designed and is followed in practice. A good formal systems development plan outlines:

• A strategy to align development with the organization’s broader objectives • Standards for new systems • Project management policies for timing and budgeting • Procedures describing the process • Evaluation of quality of change

Topics

Project managers

A project manager is a professional in the field of project management. Project managers can have the responsibility of the planning, execution, and closing of any project, typically relating to construction industry, engineering, architecture, computing, or telecommunications. Many other fields in the production, design and service industries also have project managers.

A project manager is the person accountable for accomplishing the stated project objectives. Key project management responsibilities include creating clear and attainable project objectives, building the project requirements, and managing the triple constraint for projects, which is cost, time, and scope.

INDIAN INSTITUTE OF FINANCE Page 19 [PORTFOLIO MANAGEMENT SOFTWARE]

A project manager is often a client representative and has to determine and implement the exact needs of the client, based on knowledge of the firm they are representing. The ability to adapt to the various internal procedures of the contracting party, and to form close links with the nominated representatives, is essential in ensuring that the key issues of cost, time, quality and above all, client satisfaction, can be realized.

Project Management Triangle

The Project Management Triangle.

Like any human undertaking, projects need to be performed and delivered under certain constraints. Traditionally, these constraints have been listed as "scope," "time," and "cost".[1] These are also referred to as the "Project Management Triangle", where each side represents a constraint. One side of the triangle cannot be changed without affecting the others. A further refinement of the constraints separates product "quality" or "performance" from scope, and turns quality into a fourth constraint.

The time constraint refers to the amount of time available to complete a project. The cost constraint refers to the budgeted amount available for the project. The scope constraint refers to what must be done to produce the project's end result. These three constraints are often competing constraints: increased scope typically means increased time and increased cost, a tight time constraint could mean increased costs and reduced scope, and a tight budget could mean increased time and reduced scope.

The discipline of Project Management is about providing the tools and techniques that enable the project team (not just the project manager) to organize their work to meet these constraints.

INDIAN INSTITUTE OF FINANCE Page 20 [PORTFOLIO MANAGEMENT SOFTWARE]

Work Breakdown Structure

Example of a Work breakdown structure applied in a NASA reporting structure.[20]

The Work Breakdown Structure (WBS) is a tree structure, which shows a subdivision of effort required to achieve an objective; for example a program, project, and contract. The WBS may be hardware, product, service, or process oriented.

A WBS can be developed by starting with the end objective and successively subdividing it into manageable components in terms of size, duration, and responsibility (e.g., systems, subsystems, components, tasks, subtasks, and work packages), which include all steps necessary to achieve the objective.[17]

The Work Breakdown Structure provides a common framework for the natural development of the overall planning and control of a contract and is the basis for dividing work into definable increments from which the statement of work can be developed and technical, schedule, cost, and labor hour reporting can be established.[20]

Project Management Framework

INDIAN INSTITUTE OF FINANCE Page 21 [PORTFOLIO MANAGEMENT SOFTWARE]

Example of an IT Project Management Framework.[19]

The Program (Investment) Life Cycle integrates the project management and system development life cycles with the activities directly associated with system deployment and operation. By design, system operation management and related activities occur after the project is complete and are not documented within this guide.[19]

For example, see figure, in the US United States Department of Veterans Affairs (VA) the program management life cycle is depicted and describe in the overall VA IT Project Management Framework to address the integration of OMB Exhibit 300 project (investment) management activities and the overall project budgeting process. The VA IT Project Management Framework diagram illustrates Milestone 4 which occurs following the deployment of a system and the closing of the project. The project closing phase activities at the VA continues through system deployment and into system operation for the purpose of illustrating and describing the system activities the VA considers part of the project. The figure illustrates the actions and associated artifacts of the VA IT Project and Program Management process.[19]

International standards

There have been several attempts to develop Project Management standards, such as:

• Capability Maturity Model from the Software Engineering Institute. • GAPPS, Global Alliance for Project Performance Standards- an open source standard describing COMPETENCIES for project and program managers. • A Guide to the Project Management Body of Knowledge • HERMES method , Swiss general project management method, selected for use in Luxembourg and international organizations. • The ISO standards ISO 9000, a family of standards for quality management systems, and the ISO 10006:2003, for Quality management systems and guidelines for quality management in projects. • PRINCE2 , PRojects IN Controlled Environments. • Team Software Process (TSP) from the Software Engineering Institute. • Total Cost Management Framework, AACE International's Methodology for Integrated Portfolio, Program and Project Management)

INDIAN INSTITUTE OF FINANCE Page 22 [PORTFOLIO MANAGEMENT SOFTWARE]

• V-Model , an original systems development method. • The Logical framework approach, which is popular in international development organizations. • IAPPM , The International Association of Project & Program Management, guide to Project Auditing and Rescuing Troubled Projects.

Project portfolio management

An increasing number of organizations are using, what is referred to as, project portfolio management (PPM) as a means of selecting the right projects and then using project management techniques[21] as the means for delivering the outcomes in the form of benefits to the performing private or not-for-profit organization.

Project management methods are used 'to do projects right' and the methods used in PPM are used 'to do the right projects'. In effect PPM is becoming the method of choice for selection and prioritising among resource inter-related projects in many industries and sectors.

Project Portfolio Management (PPM) is a term used by project managers and project management (PM) organizations to describe methods for analyzing and collectively managing a group of current or proposed projects based on numerous key characteristics. The fundamental objective of PPM is to determine the optimal mix and sequencing of proposed projects to best achieve the organization's overall goals - typically expressed in terms of hard economic measures, business strategy goals, or technical strategy goals - while honoring constraints imposed by management or external real-world factors. Typical attributes of projects being analyzed in a PPM process include each project's total expected cost, consumption of scarce resources (human or otherwise) expected timeline and schedule of INDIAN INSTITUTE OF FINANCE Page 23 [PORTFOLIO MANAGEMENT SOFTWARE]

investment, expected nature, magnitude and timing of benefits to be realized, and relationship or inter-dependencies with other projects in the portfolio.

The key challenge to implementing an effective PPM process is typically securing the mandate to do so. Many organizations are culturally inured to an informal method of making project investment decisions, which can be compared to political processes observable in the U.S. legislature.[citation needed] However this approach to making project investment decisions has led many organizations to unsatisfactory results, and created demand for a more methodical and transparent decision making process. That demand has in turn created a commercial marketplace for tools and systems which facilitate such a process.

Some commercial vendors of PPM software emphasize their products' ability to treat projects as part of an overall investment portfolio. PPM advocates see it as a shift away from one-off, ad hoc approaches to project investment decision making. Most PPM tools and methods attempt to establish a set of values, techniques and technologies that enable visibility, standardization, measurement and process improvement. PPM tools attempt to enable organizations to manage the continuous flow of projects from concept to completion.

Treating a set of projects as a portfolio would be, in most cases, an improvement on the ad hoc, one-off analysis of individual project proposals. The relationship between PPM techniques and existing investment analysis methods is a matter of debate. While many are represented as "rigorous" and "quantitative", few PPM tools attempt to incorporate established financial portfolio optimization methods like modern portfolio theory or Applied Information Economics, which have been applied to project portfolios, including even non- financial issues.[1][2][3][4]

Contents

• 1 Controversy over the "investment discipline" of PPM

• 2 Optimizing for payoff

• 3 Resource allocation

• 4 Pipeline management

INDIAN INSTITUTE OF FINANCE Page 24 [PORTFOLIO MANAGEMENT SOFTWARE]

• 5 Organizational applicability

• 6 References

• 7 Further reading

• 8 See also Controversy over the "investment discipline" of PPM

Developers of PPM tools see their solutions as borrowing from the financial investment world. However, other than using the word "portfolio", few can point to any specific portfolio optimization methods implemented in their tools.

A project can be viewed as a composite of resource investments such as skilled labour and associated salaries, IT hardware and software, and the opportunity cost of deferring other project work. As project resources are constrained, business management can derive greatest value by allocating these resources towards project work that is objectively and relatively determined to meet business objectives more so than other project opportunities. Thus, the decision to invest in a project can be made based upon criteria that measures the relative benefits (eg. supporting business objectives) and its relative costs and risks to the organization.

In principle, PPM attempts to address issues of resource allocation, e.g., money, time, people, capacity, etc. In order for it to truly borrow concepts from the financial investment world, the portfolio of projects and hence the PPM movement should be grounded in some financial objective such as increasing shareholder value, top line growth, etc. Equally important, risks must be computed in a statistically, actuarially meaningful sense. Optimizing resources and projects without these in mind fails to consider the most important resource any organization has and which is easily understood by people throughout the organization whether they be IT, finance, marketing, etc and that resource is money.

While being tied largely to IT and fairly synonymous with IT portfolio management, PPM is ultimately a subset of corporate portfolio management and should be exportable/utilized by any group selecting and managing discretionary projects.[citation needed] However, most PPM

INDIAN INSTITUTE OF FINANCE Page 25 [PORTFOLIO MANAGEMENT SOFTWARE] methods and tools opt for various subjective weighted scoring methods, not quantitatively rigorous methods based on options theory, modern portfolio theory, Applied Information Economics or operations research.

Beyond the project investment decision, PPM aims to support ongoing measurement of the project portfolio so each project can be monitored for its relative contribution to business goals. If a project is either performing below expectations (cost overruns, benefit erosion) or is no longer highly aligned to business objectives (which change with natural market and statutory evolution), management can choose to decommit from a project and redirect its resources elsewhere. This analysis, done periodically, will "refresh" the portfolio to better align with current states and needs.

Historically, many organizations were criticized for focusing on "doing the wrong things well." PPM attempts to focus on a fundamental question: "Should we be doing this project or this portfolio of projects at all?" One litmus test for PPM success is to ask "Have you ever canceled a project that was on time and on budget?" With a true PPM approach in place, it is much more likely that the answer is "yes." As goals change so should the portfolio mix of what projects are funded or not funded no matter where they are in their individual lifecycles. Making these portfolio level business investment decisions allows the organization to free up resources, even those on what were before considered "successful" projects, to then work on what is really important to the organization.

Optimizing for payoff

One method PPM tools or consultants might use is the use of decision trees with decision nodes that allow for multiple options and optimize against a constraint. The organization in the following example has options for 7 projects but the portfolio budget is limited to $10,000,000. The selection made are the projects 1, 3, 6 and 7 with a total investment of $7,740,000 - the optimum under these conditions. The portfolio's payoff is $2,710,000.

INDIAN INSTITUTE OF FINANCE Page 26 [PORTFOLIO MANAGEMENT SOFTWARE]

Presumably, all other combinations of projects would either exceed the budget or yield a lower payoff. However, this is an extremely simplified representation of risk and is unlikely to be realistic. Risk is usually a major differentiator among projects but it is difficult to quantify risk in a statistically and actuarially meaningful manner (with probability theory, Monte Carlo Method, statistical analysis, etc.). This places limits on the deterministic nature of the results of a tool such as a decision tree (as predicted by modern portfolio theory).

Resource allocation

Resource allocation is a critical component of PPM. Once it is determined that one or many projects meet defined objectives, the available resources of an organization must be evaluated for its ability to meet project demand (aka as a demand "pipeline" discussed below). Effective resource allocation typically requires an understanding of existing labor or funding resource commitments (in either business operations or other projects) as well as the skills available in the resource pool. Project investment should only be made in projects where the necessary resources are available during a specified period of time.

INDIAN INSTITUTE OF FINANCE Page 27 [PORTFOLIO MANAGEMENT SOFTWARE]

Resources may be subject to physical constraints. For example, IT hardware may not be readily available to support technology changes associated with ideal implementation timeframe for a project. Thus, a holistic understanding of all project resources and their availability must be conjoined with the decision to make initial investment or else projects may encounter substantial risk during their lifecycle when unplanned resource constraints arise to delay achieving project objectives.

Beyond the project investment decision, PPM involves ongoing analysis of the project portfolio so each investment can be monitored for its relative contribution to business goals versus other portfolio investments. If a project is either performing below expectations (cost overruns, benefit erosion) or is no longer aligned to business objectives (which change with natural market and statutory evolution), management can choose to decommit from a project to stem further investment and redirect resources towards other projects that better fit business objectives. This analysis can typically be performed on a periodic basis (eg. quarterly or semi-annually) to "refresh" the portfolio for optimal business performance. In this way both new and existing projects are continually monitored for their contributions to overall portfolio health. If PPM is applied in this manner, management can more clearly and transparently demonstrate its effectiveness to its shareholders or owners.

Implementing PPM at the enterprise level faces a challenge in gaining enterprise support because investment decision criteria and weights must be agreed to by the key stakeholders of the organization, each of whom may be incentivised to meet specific goals that may not necessarily align with those of the entire organization. But if enterprise business objectives can be manifested in and aligned with the objectives of its distinct business unit sub- organizations, portfolio criteria agreement can be achieved more easily. (Assadourian 2005)

From a requirements management perspective Project Portfolio Management can be viewed as the upper-most level of business requirements management in the company, seeking to understand the business requirements of the company and what portfolio of projects should be undertaken to achieve them. It is through portfolio management that each individual project should receive its allotted business requirements (Denney 2005).

Pipeline management

INDIAN INSTITUTE OF FINANCE Page 28 [PORTFOLIO MANAGEMENT SOFTWARE]

In addition to managing the mix of projects in a company, Project Portfolio Management must also determine whether (and how) a set of projects in the portfolio can be executed by a company in a specified time, given finite development resources in the company. This is called pipeline management. Fundamental to pipeline management is the ability to measure the planned allocation of development resources according to some strategic plan. To do this, a company must be able to estimate the effort planned for each project in the portfolio, and then roll the results up by one or more strategic project types e.g., effort planned for research projects. (Cooper et al. 1998); (Denney 2005) discusses project portfolio and pipeline management in the context of use case driven development.

Organizational applicability

The complexity of PPM and other approaches to IT projects (e.g., treating them as a capital investment) may render them not suitable for smaller or younger organizations. An obvious reason for this is that a few IT projects doesn't make for much of a portfolio selection. Other reasons include the cost of doing PPM—the data collection, the analysis, the documentation, the education, and the change to decision-making processes.

Portfolio Management Services

Gone are the days when an investor could directly participate in the capital markets, for they have not only become far more complex in terms of compliances, methodologies, effects and analysis but also need a constant tracking mechanism. As is the case globally, the Indian investor has also realized the advantages of seeking professional advice in order to not only manage but also augment his portfolio.

We at Unicon in our constant endeavor to bring to our esteemed clients global methodology have developed a proprietary model that has enabled us to outperform all major indices with a fair degree of consistency, over the longer term. We continue to be positive of both our approach and the Indian capital markets in general and especially so after UPA’s landslide mandate to guide the country over the next 5 years. However, we believe that the out- performance is more stock-specific and the major indices only provide a barometer for

INDIAN INSTITUTE OF FINANCE Page 29 [PORTFOLIO MANAGEMENT SOFTWARE]

evaluation. This view is expected to only be enhanced going forward, with larger players entering the markets with globally fine-tuned analytical tools.

The Portfolio Management Schemes of the Company offer Discretionary Schemes (Unicon Optimizer & Unicon Growth) for Individuals, Corporate Bodies, Partnership firms, Proprietors, Non Resident Indians etc. The Company is registered with SEBI enabling it to undertake Portfolio Management activities under a specific license.

The Schemes, duly approved by SEBI, are managed by a highly competent team comprising of portfolio managers and equity strategists, backed by a team of fundamental, technical and derivatives analysts. The principle objectives are to identify investment opportunities through globally recognized analytical methodologies, given pre-defined risk parameters construct portfolios to incorporate client objectives periodically review of portfolios in order to consistently deliver returns surpassing the benchmarked index and tailor-make portfolios to incorporate a judicious mix of equity, quazi-equity, money market instruments and derivate products.

PMS is a very personalized service wherein each portfolio has to be specifically constructed in order to reflect the objective and risk appetite of a particular client. Our qualified managers are constantly evolving methodologies and financial models that provide them with a composite mix of: 1. Medium term comprising of value investing and other fundament tools 2. Short term comprising primarily of technical analysis and tools 3. Hedging strategies comprising of derivative products Along with this water tight investment evaluation strategy we have up in place an equally foolproof client servicing and feedback methodology. All Investment advisors are hand picked and trained on a gamut of Wealth product, this ensures that he is in a very good position to deliver a wholesome wealth experience to the client. UNICON PMS provides following benefits: Strong Research Team Profile based investment solution Professional Fund Management Strict Risk Management Timely performance reporting Periodic reviews & rebalancing Dedicated relationship manager

INDIAN INSTITUTE OF FINANCE Page 30 [PORTFOLIO MANAGEMENT SOFTWARE]

ANALYSIS OF PORTFOLIO MANAGEMENT:-

Portfolio analysis involves quantifying the operational and financial impact of the portfolio. It is vital to evaluate the functioning of investments and timing the returns effectively.

The analysis of a portfolio extends to all classes of investments such as bonds, equities, indexes, commodities, funds, options and securities. Portfolio analysis gains importance because each asset class has peculiar risk factors and returns associated with it. Hence, the composition of a portfolio impacts the rate of return on the overall investment.

Portfolio analysis is broadly carried out for each asset at two levels:

 Risk aversion: This method analyzes the portfolio composition while considering the risk appetite of an investor. Some of the investors may prefer to play safe and accept low profits rather than invest in risky assets generating high returns.  Analyzing returns: While performing portfolio analysis, prospective returns are calculated through the average and compound return methods. An average return is simply the arithmetic average of returns from individual assets. However, compound return is the arithmetic mean that considers the cumulative effect on overall returns.

The next step in portfolio analysis involves determining dispersion of returns. It is the measure of volatility or standard deviation of returns for a particular asset. Simply put, dispersion refers is the difference between the real interest rate and the calculated average return. Measuring the recovery period after a negative market cycle is equally

INDIAN INSTITUTE OF FINANCE Page 31 [PORTFOLIO MANAGEMENT SOFTWARE]

Several specialized portfolio analysis software’s are available in the market to ease the task for an investor. These application tools can analyze and predict future trends for almost every investment asset. They provide essential data for decision making on the allocation of assets, calculation of risks and attainment of investment objectives.

It is still advisable to hire professional experts for highly sophisticated portfolio compositions as they can offer direct assistance to help their clients earn good returns.

MODERN PORTFOLIO THEORY:-

Modern portfolio theory (MPT) is a theory of investment which tries to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets. Although MPT is widely used in practice in the financial industry and several of its creators won a Nobel prize for the theory, in recent years the basic assumptions of MPT have been widely challenged by fields such as behavioral economics.

MPT is a mathematical formulation of the concept of diversification in investing, with the aim of selecting a collection of investment assets that has collectively lower risk than any individual asset. That this is possible can be seen intuitively because different types of assets often change in value in opposite ways. For example, when prices in the stock market fall, prices in the bond market often increase, and vice versa[citation needed]. A collection of both types of assets can therefore have lower overall risk than either individually. But diversification lowers risk even if assets' returns are not negatively correlated—indeed, even if they are positively correlated.

INDIAN INSTITUTE OF FINANCE Page 32 [PORTFOLIO MANAGEMENT SOFTWARE] are not perfectly positively correlated, MPT seeks to reduce the total variance of the portfolio return. MPT also assumes that investors are rational and markets are efficient.

Concept

The fundamental concept behind MPT is that the assets in an investment portfolio cannot be selected individually, each on their own merits. Rather, it is important to consider how each asset changes in price relative to how every other asset in the portfolio changes in price.

Investing is a tradeoff between risk and expected return. In general, assets with higher expected returns are riskier. For a given amount of risk, MPT describes how to select a portfolio with the highest possible expected return. Or, for a given expected return, MPT explains how to select a portfolio with the lowest possible risk (the targeted expected return cannot be more than the highest-returning available security, of course, unless negative holdings of assets are possible.)[3]

MPT is therefore a form of diversification. Under certain assumptions and for specific quantitative definitions of risk and return, MPT explains how to find the best possible diversification strategy.

Mathematical model INDIAN INSTITUTE OF FINANCE Page 33 [PORTFOLIO MANAGEMENT SOFTWARE]

In some sense the mathematical derivation below is MPT, although the basic concepts behind the model have also been very influential.[3]

This section develops the "classic" MPT model. There have been many extensions since.

Risk and expected return

MPT assumes that investors are risk averse, meaning that given two portfolios that offer the same expected return, investors will prefer the less risky one. Thus, an investor will take on increased risk only if compensated by higher expected returns. Conversely, an investor who wants higher expected returns must accept more risk. The exact trade-off will be the same for all investors, but different investors will evaluate the trade-off differently based on individual risk aversion characteristics. The implication is that a rational investor will not invest in a portfolio if a second portfolio exists with a more favorable risk-expected return profile – i.e., if for that level of risk an alternative portfolio exists which has better expected returns.

Note that the theory uses standard deviation of return as a proxy for risk. There are problems with this, however; see criticism.

Under the model:

• Portfolio return is the proportion-weighted combination of the constituent assets' returns.

• Portfolio volatility is a function of the correlations ρij of the component assets, for all asset pairs (i, j).

In general:

• Expected return:

where Rp is the return on the portfolio, Ri is the return on asset i and wi is the weighting of component asset i (that is, the share of asset i in the portfolio).

• Portfolio return variance:

INDIAN INSTITUTE OF FINANCE Page 34 [PORTFOLIO MANAGEMENT SOFTWARE]

where ρij is the correlation coefficient between the returns on assets i and j. Alternatively the expression can be written as:

where ρij = 1 for i=j.

• Portfolio return volatility (standard deviation):

For a two asset portfolio:

• Portfolio return:

• Portfolio variance:

For a three asset portfolio:

• Portfolio return: • Portfolio variance:

Diversification

An investor can reduce portfolio risk simply by holding combinations of instruments which are not perfectly positively correlated (correlation coefficient -1 <= ρij < 1)). In other words, investors can reduce their exposure to individual asset risk by holding a diversified portfolio of assets. Diversification may allow for the same portfolio expected return with reduced risk.

If all the asset pairs have correlations of 0—they are perfectly uncorrelated—the portfolio's return variance is the sum over all assets of the square of the fraction held in the asset times the asset's return variance (and the portfolio standard deviation is the square root of this sum).

INDIAN INSTITUTE OF FINANCE Page 35 [PORTFOLIO MANAGEMENT SOFTWARE]

The efficient frontier with no risk-free asset

Efficient Frontier. The hyperbola is sometimes referred to as the 'Markowitz Bullet', and is the efficient frontier if no risk-free asset is available.

As shown in this graph, every possible combination of the risky assets, without including any holdings of the risk-free asset, can be plotted in risk-expected return space, and the collection of all such possible portfolios defines a region in this space. The left boundary of this region is a hyperbola,[6] and the upper edge of this region is the efficient frontier in the absence of a risk-free asset (sometimes called "the Markowitz bullet"). Combinations along this upper edge represent portfolios (including no holdings of the risk-free asset) for which there is lowest risk for a given level of expected return. Equivalently, a portfolio lying on the efficient frontier represents the combination offering the best possible expected return for given risk level.

Matrices are preferred for calculations of the efficient frontier. In matrix form, for a given

"risk tolerance" , the efficient frontier is found by minimizing the following expression:

wTΣw − q * RTw where

• w is a vector of portfolio weights and ∑ wi = 1.

INDIAN INSTITUTE OF FINANCE Page 36 [PORTFOLIO MANAGEMENT SOFTWARE]

• (The weights can be negative, which means investors can short a security.); • Σ is the covariance matrix for the returns on the assets in the portfolio; • is a "risk tolerance" factor, where 0 results in the portfolio with minimal risk and results in the portfolio infinitely far out the frontier with both expected return and risk unbounded; and • R is a vector of expected returns. • wTΣw is the variance of portfolio return. • RTw is the expected return on the portfolio.

The above optimization finds the point on the frontier at which the inverse of the slope of the frontier would be q if portfolio return variance instead of standard deviation were plotted horizontally. The frontier in its entirely is parametric on q.

Many software packages, including Microsoft Excel, MATLAB, Mathematics and R, provide optimization routines suitable for the above problem.

An alternative approach to specifying the efficient frontier is to do so parametrically on expected portfolio return RTw. This version of the problem requires that we minimize

wTΣw subject to

RTw = μ for parameter μ. This problem is easily solved using a Lagrange multiplier.

The two mutual fund theorem

One key result of the above analysis is the two mutual fund theorem.[6] This theorem states that any portfolio on the efficient frontier can be generated by holding a combination of any two given portfolios on the frontier; the latter two given portfolios are the "mutual funds" in

INDIAN INSTITUTE OF FINANCE Page 37 [PORTFOLIO MANAGEMENT SOFTWARE] the theorem's name. So in the absence of a risk-free asset, an investor can achieve any desired efficient portfolio even if all that is accessible is a pair of efficient mutual funds. If the location of the desired portfolio on the frontier is between the locations of the two mutual funds, both mutual funds will be held in positive quantities. If the desired portfolio is outside the range spanned by the two mutual funds, then one of the mutual funds must be sold short (held in negative quantity) while the size of the investment in the other mutual fund must be greater than the amount available for investment (the excess being funded by the borrowing from the other fund).

The risk-free asset and the capital allocation line

Main article: Capital allocation line

The risk-free asset is the (hypothetical) asset which pays a risk-free rate. In practice, short- term government securities (such as US treasury bills) are used as a risk-free asset, because they pay a fixed rate of interest and have exceptionally low default risk. The risk-free asset has zero variance in returns (hence is risk-free); it is also uncorrelated with any other asset (by definition, since its variance is zero). As a result, when it is combined with any other asset, or portfolio of assets, the change in return is linearly related to the change in risk as the proportions in the combination vary.

When a risk-free asset is introduced, the half-line shown in the figure is the new efficient frontier. It is tangent to the hyperbola at the pure risky portfolio with the highest Sharpe ratio. Its horizontal intercept represents a portfolio with 100% of holdings in the risk-free asset; the tangency with the hyperbola represents a portfolio with no risk-free holdings and 100% of assets held in the portfolio occurring at the tangency point; points between those points are portfolios containing positive amounts of both the risky tangency portfolio and the risk-free asset; and points on the half-line beyond the tangency point are leveraged portfolios involving negative holdings of the risk-free asset (the latter has been sold short—in other words, the investor has borrowed at the risk-free rate) and an amount invested in the tangency portfolio equal to more the 100% of the investor's initial capital. This efficient half-line is called the capital allocation line (CAL), and its formula can be shown to be

INDIAN INSTITUTE OF FINANCE Page 38 [PORTFOLIO MANAGEMENT SOFTWARE]

In this formula P is the sub-portfolio of risky assets at the tangency with the Markowitz bullet, F is the risk-free asset, and C is a combination of portfolios P and F.

By the diagram, the introduction of the risk-free asset as a possible component of the portfolio has improved the range of risk-expected return combinations available, because everywhere except at the tangency portfolio the half-line gives a higher expected return than the hyperbola does at every possible risk level. The fact that all points on the linear efficient locus can be achieved by a combination of holdings of the risk-free asset and the tangency portfolio is known as the one mutual fund theorem,[6] where the mutual fund referred to is the tangency portfolio.

Asset pricing using MPT

The above analysis describes optimal behavior of an individual investor. Asset pricing theory builds on this analysis in the following way. Since everyone holds the risky assets in identical proportions to each other—namely in the proportions given by the tangency portfolio—in market equilibrium the risky assets' prices, and therefore their expected returns, will adjust so that the ratios in the tangecy portfolio are the same as the ratios in which the risky assets are supplied to the market. Thus relative supplies will equal relative demands. MPT derives the required expected return for a correctly priced asset in this context.

Systematic risk and specific risk

Specific risk is the risk associated with individual assets - within a portfolio these risks can be reduced through diversification (specific risks "cancel out"). Specific risk is also called diversifiable, unique, unsystematic, or idiosyncratic risk. Systematic risk (a.k.a. portfolio risk or market risk) refers to the risk common to all securities - except for selling short as noted below, systematic risk cannot be diversified away (within one market). Within the market portfolio, asset specific risk will be diversified away to the extent possible. Systematic risk is therefore equated with the risk (standard deviation) of the market portfolio.

INDIAN INSTITUTE OF FINANCE Page 39 [PORTFOLIO MANAGEMENT SOFTWARE]

Since a security will be purchased only if it improves the risk-expected return characteristics of the market portfolio, the relevant measure of the risk of a security is the risk it adds to the market portfolio, and not its risk in isolation. In this context, the volatility of the asset, and its correlation with the market portfolio, are historically observed and are therefore given. (There are several approaches to asset pricing that attempt to price assets by modelling the stochastic properties of the moments of assets' returns - these are broadly referred to as conditional asset pricing models.)

Systematic risks within one market can be managed through a strategy of using both long and short positions within one portfolio, creating a "market neutral" portfolio.

Capital asset pricing model

Main article: Capital Asset Pricing Model

The asset return depends on the amount paid for the asset today. The price paid must ensure that the market portfolio's risk / return characteristics improve when the asset is added to it. The CAPM is a model which derives the theoretical required expected return (i.e., discount rate) for an asset in a market, given the risk-free rate available to investors and the risk of the market as a whole. The CAPM is usually expressed:

• β, Beta, is the measure of asset sensitivity to a movement in the overall market; Beta is usually found via regression on historical data. Betas exceeding one signify more than average "riskiness" in the sense of the asset's contribution to overall portfolio risk; betas below one indicate a lower than average risk contribution.

• is the market premium, the expected excess return of the market portfolio's expected return over the risk-free rate.

This equation can be statistically estimated using the following regression equation:

INDIAN INSTITUTE OF FINANCE Page 40 [PORTFOLIO MANAGEMENT SOFTWARE]

where αi is called the asset's alpha , βi is the asset's beta coefficient and SCL is the Securities Characteristics Line.

Once an asset's expected return, E(Ri), is calculated using CAPM, the future cash flows of the asset can be discounted to their present value using this rate to establish the correct price for the asset. A riskier stock will have a higher beta and will be discounted at a higher rate; less sensitive stocks will have lower betas and be discounted at a lower rate. In theory, an asset is correctly priced when its observed price is the same as its value calculated using the CAPM derived discount rate. If the observed price is higher than the valuation, then the asset is overvalued; it is undervalued for a too low price.

(1) The incremental impact on risk and expected return when an additional risky asset, a, is added to the market portfolio, m, follows from the formulae for a two-asset portfolio. These results are used to derive the asset-appropriate discount rate.

Market portfolio's risk =

Hence, risk added to portfolio =

but since the weight of the asset will be relatively low,

i.e. additional risk =

Market portfolio's expected return =

Hence additional expected return =

(2) If an asset, a, is correctly priced, the improvement in its risk-to-expected return ratio achieved by adding it to the market portfolio, m, will at least match the gains of spending that money on an increased stake in the market portfolio. The assumption is that the investor will purchase the asset with funds borrowed at the risk-free rate, Rf; this is rational if

Thus:

INDIAN INSTITUTE OF FINANCE Page 41 [PORTFOLIO MANAGEMENT SOFTWARE]

i.e. :

is the “beta”, β -- the covariance between the asset's return and the market's return divided by the variance of the market return— i.e. the sensitivity of the asset price to movement in the market portfolio's value.

Criticism

Despite its theoretical importance, some people question whether MPT is an ideal investing strategy, because its model of financial markets does not match the real world in many ways.

Assumptions

The mathematical framework of MPT makes many assumptions about investors and markets. Some are explicit in the equations, such as the use of Normal distributions to model returns. Others are implicit, such as the neglect of taxes and transaction fees. None of these assumptions are entirely true, and each of them compromises MPT to some degree.

• Asset returns are (jointly) normally distributed random variables. In fact, it is frequently observed that returns in equity and other markets are not normally distributed. Large swings (3 to 6 standard deviations from the mean) occur in the market far more frequently than the normal distribution assumption would predict.[7] While the model can also be justified by assuming any return distribution which is jointly elliptical[8][9], all the joint elliptical distributions are symmetrical whereas asset returns empirically are not.

• Correlations between assets are fixed and constant forever. Correlations depend on systemic relationships between the underlying assets, and change when these relationships change. Examples include one country declaring war on another, or a general market crash. During times of financial crisis all assets tend to become positively correlated, because they all move (down) together. In other words, MPT breaks down precisely when investors are most in need of protection from risk.

INDIAN INSTITUTE OF FINANCE Page 42 [PORTFOLIO MANAGEMENT SOFTWARE]

• All investors aim to maximize economic utility (in other words, to make as much money as possible, regardless of any other considerations). This is a key assumption of the efficient market hypothesis, upon which MPT relies.

• All investors are rational and risk-averse. This is another assumption of the efficient market hypothesis, but we now know from behavioral economics that market participants are not rational. It does not allow for "herd behavior" or investors who will accept lower returns for higher risk. Casino gamblers clearly pay for risk, and it is possible that some stock traders will pay for risk as well.

• All investors have access to the same information at the same time. This also comes from the efficient market hypothesis. In fact, real markets contain information asymmetry, insider trading, and those who are simply better informed than others.

• Investors have an accurate conception of possible returns, i.e., the probability beliefs of investors match the true distribution of returns. A different possibility is that investors' expectations are biased, causing market prices to be information ally inefficient. This possibility is studied in the field of behavioral finance, which uses psychological assumptions to provide alternatives to the CAPM such as the overconfidence-based asset pricing model of Kent Daniel, David Hirshleifer, and Avanidhar Subrahmanyam (2001).[10]

• There are no taxes or transaction costs. Real financial products are subject both to taxes and transaction costs (such as broker fees), and taking these into account will alter the composition of the optimum portfolio. These assumptions can be relaxed with more complicated versions of the model.[citation needed]

• All investors are price takers, i.e., their actions do not influence prices. In reality, sufficiently large sales or purchases of individual assets can shift market prices for that asset and others (via cross-elasticity of demand.) An investor may not even be able to assemble the theoretically optimal portfolio if the market moves too much while they are buying the required securities.

INDIAN INSTITUTE OF FINANCE Page 43 [PORTFOLIO MANAGEMENT SOFTWARE]

• Any investor can lend and borrow an unlimited amount at the risk free rate of interest. In reality, every investor has a credit limit.

• All securities can be divided into parcels of any size. In reality, fractional shares usually cannot be bought or sold, and some assets have minimum orders sizes.

More complex versions of MPT can take into account a more sophisticated model of the world (such as one with non-normal distributions and taxes) but all mathematical models of finance still rely on many unrealistic premises.

MPT does not really model the market

The risk, return, and correlation measures used by MPT are based on expected values, which means that they are mathematical statements about the future (the expected value of returns is explicit in the above equations, and implicit in the definitions of variance and covariance.) In practice investors must substitute predictions based on historical measurements of asset return and volatility for these values in the equations. Very often such expected values fail to take account of new circumstances which did not exist when the historical data were generated.

More fundamentally, investors are stuck with estimating key parameters from past market data because MPT attempts to model risk in terms of the likelihood of losses, but says nothing about why those losses might occur. The risk measurements used are probabilistic in nature, not structural. This is a major difference as compared to many engineering approaches to risk management.

Options theory and MPT have at least one important conceptual difference from the probabilistic risk assessment done by nuclear power [plants]. A PRA is what economists would call a structural model. The components of a system and their relationships are modeled in Monte Carlo simulations. If valve X fails, it causes a loss of back pressure on pump Y, causing a drop in flow to vessel Z, and so on.

But in the Black-Scholes equation and MPT, there is no attempt to explain an underlying structure to price changes. Various outcomes are simply given probabilities. And, unlike the

INDIAN INSTITUTE OF FINANCE Page 44 [PORTFOLIO MANAGEMENT SOFTWARE]

PRA, if there is no history of a particular system-level event like a liquidity crisis, there is no way to compute the odds of it. If nuclear engineers ran risk management this way, they would never be able to compute the odds of a meltdown at a particular plant until several similar events occurred in the same reactor design.

—Douglas W. Hubbard, 'The Failure of Risk Management', p. 67, John Wiley & Sons, 2009. ISBN 978-0-470-38795-5

Essentially, the mathematics of MPT view the markets as a collection of dice. By examining past market data we can develop hypotheses about how the dice are weighted, but this isn't helpful if the markets are actually dependent upon a much bigger and more complicated chaotic system -- the world. For this reason, accurate structural models of real financial markets are unlikely to be forthcoming because they would essentially be structural models of the entire world. Nonetheless there is growing awareness of the concept of systemic risk in financial markets, which should lead to more sophisticated market models.

Variance is not a good measure of risk

Mathematical risk measurements are also useful only to the degree that they reflect investors' true concerns -- there is no point minimizing a variable that nobody cares about in practice. MPT uses the mathematical concept of variance to quantify risk, and this might be justified under the assumption of elliptically distributed returns such as normally distributed returns, but for general return distributions other risk measures (like coherent risk measures) might better reflect investors' true preferences.

In particular, variance is a symmetric measure that counts abnormally high returns as just as risky as abnormally low returns. Some would argue that, in reality, investors are only concerned about losses, and do not care about the dispersion or tightness of above-average returns. According to this view, our intuitive concept of risk is fundamentally asymmetric in nature.

INDIAN INSTITUTE OF FINANCE Page 45 [PORTFOLIO MANAGEMENT SOFTWARE]

"Optimal" doesn't necessarily mean "most profitable"

MPT does not account for the social, environmental, strategic, or personal dimensions of investment decisions. It only attempts to maximize risk-adjusted returns, without regard to other consequences. In a narrow sense, its complete reliance on asset prices makes it vulnerable to all the standard market failures such as those arising from information asymmetry, externalities, and public goods. It also rewards corporate fraud and dishonest accounting. More broadly, a firm may have strategic or social goals that shape its investment decisions, and an individual investor might have personal goals. In either case, information other than historical returns is relevant.

See also socially-responsible investing, fundamental analysis.

Extensions

Since MPT's introduction in 1952, many attempts have been made to improve the model, especially by using more realistic assumptions.

Post-modern portfolio theory extends MPT by adopting non-normally distributed, asymmetric measures of risk. This helps with some of these problems, but not others.

Black-Litterman model optimization is an extension of unconstrained Markowitz optimization which incorporates relative and absolute `views' on inputs of risk and returns.

Other Applications

Applications to project portfolios and other "non-financial" assets

Some experts apply MPT to portfolios of projects and other assets besides financial instruments.[11] When MPT is applied outside of traditional financial portfolios, some differences between the different types of portfolios must be considered.

INDIAN INSTITUTE OF FINANCE Page 46 [PORTFOLIO MANAGEMENT SOFTWARE]

1. The assets in financial portfolios are, for practical purposes, continuously divisible while portfolios of projects like new software development are "lumpy". For example, while we can compute that the optimal portfolio position for 3 stocks is, say, 44%, 35%, 21%, the optimal position for an IT portfolio may not allow us to simply change the amount spent on a project. IT projects might be all or nothing or, at least, have logical units that cannot be separated. A portfolio optimization method would have to take the discrete nature of some IT projects into account. 2. The assets of financial portfolios are liquid can be assessed or re-assessed at any point in time while opportunities for new projects may be limited and may appear in limited windows of time and projects that have already been initiated cannot be abandoned without the loss of the sunk costs (i.e., there is little or no recovery/salvage value of a half-complete IT project).

Neither of these necessarily eliminate the possibility of using MPT and such portfolios. They simply indicate the need to run the optimization with an additional set of mathematically- expressed constraints that would not normally apply to financial portfolios.

Furthermore, some of the simplest elements of Modern Portfolio Theory are applicable to virtually any kind of portfolio. The concept of capturing the risk tolerance of an investor by documenting how much risk is acceptable for a given return could be and is applied to a variety of decision analysis problems. MPT, however, uses historical variance as a measure of risk and portfolios of assets like IT projects don't usually have an "historical variance" for a new piece of software. In this case, the MPT investment boundary can be expressed in more general terms like "chance of an ROI less than cost of capital" or "chance of losing more than half of the investment". When risk is put in terms of uncertainty about forecasts and possible losses then the concept is transferable to various types of investment.[11]

Application to other disciplines

In the 1970s, concepts from Modern Portfolio Theory found their way into the field of regional science. In a series of seminal works, Michael Conroy modeled the labor force in the economy using portfolio-theoretic methods to examine growth and variability in the labor force. This was followed by a long literature on the relationship between economic growth and volatility.[12]

INDIAN INSTITUTE OF FINANCE Page 47 [PORTFOLIO MANAGEMENT SOFTWARE]

More recently, modern portfolio theory has been used to model the self-concept in social psychology. When the self attributes comprising the self-concept constitute a well-diversified portfolio, then psychological outcomes at the level of the individual such as mood and self- esteem should be more stable than when the self-concept is undiversified. This prediction has been confirmed in studies involving human subjects.[13]

Recently, modern portfolio theory has been applied to modelling the uncertainty and correlation between documents in information retrieval. Given a query, the aim is to maximize the overall relevance of a ranked list of documents and at the same time minimize the overall uncertainty of the ranked list .

Comparison with arbitrage pricing theory

The SML and CAPM are often contrasted with the arbitrage pricing theory (APT), which holds that the expected return of a financial asset can be modeled as a linear function of various macro-economic factors, where sensitivity to changes in each factor is represented by a factor specific beta coefficient.

The APT is less restrictive in its assumptions: it allows for an explanatory (as opposed to statistical) model of asset returns, and assumes that each investor will hold a unique portfolio with its own particular array of betas, as opposed to the identical "market portfolio". Unlike the CAPM, the APT, however, does not itself reveal the identity of its priced factors - the number and nature of these factors is likely to change over time and between economies.

INDIAN INSTITUTE OF FINANCE Page 48 [PORTFOLIO MANAGEMENT SOFTWARE]

UNDERSTANDING PORTFOLIO MANAGEMENT

A good way to begin understanding what portfolio management is (and is not) may be to define the term portfolio. In a business context, we can look to the mutual fund industry to explain the term's origins. Morgan Stanley's Dictionary of Financial Terms offers the following explanation: If you own more than one security, you have an investment portfolio. You build the portfolio by buying additional stocks, bonds, mutual funds, or other investments. Your goal is to increase the portfolio's value by selecting investments that you believe will go up in price. According to modern portfolio theory, you can reduce your investment risk by creating a diversified portfolio that includes enough different types, or classes, of securities so that at least some of them may produce strong returns in any economic climate.

• A portfolio contains many investment vehicles. • Owning a portfolio involves making choices -- that is, deciding what additional stocks, bonds, or other financial instruments to buy; when to buy; what and when to sell; and so forth. Making such decisions is a form of management. • The management of a portfolio is goal-driven. For an investment portfolio, the specific goal is to increase the value. • Managing a portfolio involves inherent risks.

INDIAN INSTITUTE OF FINANCE Page 49 [PORTFOLIO MANAGEMENT SOFTWARE]

Over time, other industry sectors have adapted and applied these ideas to other types of "investments," including the following:

Application portfolio management. This refers to the practice of managing an entire group or major subset of software applications within a portfolio. Organizations regard these applications as investments because they require development (or acquisition) costs and incur continuing maintenance costs. Also, organizations must constantly make financial decisions about new and existing software applications, including whether to invest in modifying them, whether to buy additional applications, and when to "sell" -- that is, retire -- an obsolete software application.

Product portfolio management. Businesses group major products that they develop and sell into (logical) portfolios, organized by major line-of-business or business segment. Such portfolios require ongoing management decisions about what new products to develop (to diversify investments and investment risk) and what existing products to transform or retire (i.e., spin off or divest).

Project or initiative portfolio management. An initiative, in the simplest sense, is a body of work with: • A specific (and limited) collection of needed results or work products. • A group of people who are responsible for executing the initiative and use resources, such as funding. • A defined beginning and end. Managers can group a number of initiatives into a portfolio that supports a business segment, product, or product line. These efforts are goal-driven; that is, they support major goals and/or components of the enterprise's business strategy. Managers must continually choose among competing initiatives (i.e., manage the organization's investments), selecting those that best support and enable diverse business goals (i.e., they diversify investment risk). They must also manage their investments by providing continuing oversight and decision-making about which initiatives to undertake, which to continue, and which to reject or discontinue.

What Does Portfolio Management Mean? The art and science of making decisions about investment mix and policy, INDIAN INSTITUTE OF FINANCE Page 50 [PORTFOLIO MANAGEMENT SOFTWARE]

matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance.

Portfolio management is all about strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs encountered in the attempt to maximize return at a given appetite for risk.

Investopedia explains Portfolio Management In the case of mutual and exchange-traded funds (ETFs), there are two forms of portfolio management: passive and active. Passive management simply tracks a market index, commonly referred to as indexing or index investing. Active management involves a single manager, co-managers, or a team of managers who attempt to beat the market return by actively managing a fund's portfolio through investment decisions based on research and decisions on individual holdings. Closed-end funds are generally actively managed.

Portfolio Management is used to select a portfolio of new product development projects to achieve the following goals:

• Maximize the profitability or value of the portfolio • Provide balance • Support the strategy of the enterprise

Portfolio Management is the responsibility of the senior management team of an organization or business unit. This team, which might be called the Product Committee, meets regularly to manage the product pipeline and make decisions about the product portfolio. Often, this is the same group that conducts the stage-gate reviews in the organization.

A logical starting point is to create a product strategy - markets, customers, products, strategy approach, competitive emphasis, etc. The second step is to understand the budget or resources available to balance the portfolio against. Third, each project must be assessed for profitability (rewards), investment requirements (resources), risks, and other appropriate factors.

INDIAN INSTITUTE OF FINANCE Page 51 [PORTFOLIO MANAGEMENT SOFTWARE]

The weighting of the goals in making decisions about products varies from company. But organizations must balance these goals: risk vs. profitability, new products vs. improvements, strategy fit vs. reward, market vs. product line, long-term vs. short-term. Several types of techniques have been used to support the portfolio management process:

• Heuristic models • Scoring techniques • Visual or mapping techniques

The earliest Portfolio Management techniques optimized projects' profitability or financial returns using heuristic or mathematical models. However, this approach paid little attention to balance or aligning the portfolio to the organization's strategy. Scoring techniques weight and score criteria to take into account investment requirements, profitability, risk and strategic alignment. The shortcoming with this approach can be an over emphasis on financial measures and an inability to optimize the mix of projects. Mapping techniques use graphical presentation to visualize a portfolio's balance. These are typically presented in the form of a two-dimensional graph that shows the trade-off's or balance between two factors such as risks vs. profitability, marketplace fit vs. product line coverage, financial return vs. probability of success, etc.

INDIAN INSTITUTE OF FINANCE Page 52 [PORTFOLIO MANAGEMENT SOFTWARE]

The chart shown above provides a graphical view of the project portfolio risk-reward balance. It is used to assure balance in the portfolio of projects - neither too risky nor conservative and appropriate levels of reward for the risk involved. The horizontal axis is Net Present Value; the vertical axis is Probability of Success. The size of the bubble is proportional to the total revenue generated over the lifetime sales of the product.

While this visual presentation is useful, it can't prioritize projects. Therefore, some mix of these techniques is appropriate to support the Portfolio Management Process. This mix is often dependent upon the priority of the goals.

Our recommended approach is to start with the overall business plan that should define the planned level of R&D investment, resources (e.g., headcount, etc.), and related sales expected INDIAN INSTITUTE OF FINANCE Page 53 [PORTFOLIO MANAGEMENT SOFTWARE] from new products. With multiple business units, product lines or types of development, we recommend a strategic allocation process based on the business plan. This strategic allocation should apportion the planned R&D investment into business units, product lines, markets, geographic areas, etc. It may also breakdown the R&D investment into types of development, e.g., technology development, platform development, new products, and upgrades/enhancements/line extensions, etc.

Once this is done, then a portfolio listing can be developed including the relevant portfolio data. We favor use of the development productivity index (DPI) or scores from the scoring method. The development productivity index is calculated as follows: (Net Present Value x Probability of Success) / Development Cost Remaining. It factors the NPV by the probability of both technical and commercial success. By dividing this result by the development cost remaining, it places more weight on projects nearer completion and with lower uncommitted costs. The scoring method uses a set of criteria (potentially different for each stage of the project) as a basis for scoring or evaluating each project.

Basic concepts and components for portfolio management Now that we understand some of the basic dynamics and inherent challenges organizations face in executing a business strategy via supporting initiatives, let's look at some basic concepts and components of portfolio management practices.

The portfolio First, we can now introduce a definition of portfolio that relates more directly to the context of our preceding discussion. In the IBM view, a portfolio is: One of a number of mechanisms, constructed to actualize significant elements in the Enterprise Business Strategy. It contains a selected, approved, and continuously evolving, collection of Initiatives which are aligned with the organizing element of the Portfolio, and, which contribute to the achievement of goals or goal components identified in the Enterprise Business Strategy.

The basis for constructing a portfolio should reflect the enterprise's particular needs. For example, you might choose to build a portfolio around initiatives for a specific product, business segment, or separate business unit within a multinational organization.

INDIAN INSTITUTE OF FINANCE Page 54 [PORTFOLIO MANAGEMENT SOFTWARE]

The portfolio structure As we noted earlier, a portfolio structure identifies and contains a number of portfolios. This structure, like the portfolios within it, should align with significant planning and results boundaries, and with business components. If you have a product-oriented portfolio structure, for example, then you would have a separate portfolio for each major product or product group. Each portfolio would contain all the initiatives that help that particular product or product group contribute to the success of the enterprise business strategy.

The portfolio manager This is a new role for organizations that embrace a portfolio management approach. A portfolio manager is responsible for continuing oversight of the contents within a portfolio. If you have several portfolios within your portfolio structure, then you will likely need a portfolio manager for each one. The exact range of responsibilities (and authority) will vary from one organization to another, 1 but the basics are as follows: • One portfolio manager oversees one portfolio. • The portfolio manager provides day-to-day oversight. • The portfolio manager periodically reviews the performance of, and conformance to expectations for, initiatives within the portfolio. • The portfolio manager ensures that data is collected and analyzed about each of the initiatives in the portfolio. • The portfolio manager enables periodic decision making about the future direction of individual initiatives.

INDIAN INSTITUTE OF FINANCE Page 55 [PORTFOLIO MANAGEMENT SOFTWARE]

A significant aspect of oversight is setting multiple decision points for each initiative, so that managers can periodically evaluate data and decide whether to continue the work. These "continue/change/discontinue" decisions should be driven by an understanding (developed via the periodic reviews) of a given initiative's continuing value, expected benefits, and strategic contribution. Making these decisions at multiple points in the initiative's lifecycle helps to ensure that managers will continually examine and assess changing internal and external circumstances, needs, and performance.

Governance Implementing portfolio management practices in an organization is a transformation effort that typically involves developing new capabilities to address new work efforts, defining (and filling) new roles to identify portfolios (collections of work to be done), and delineating boundaries among work efforts and collections. Implementing portfolio management also requires creating a structure to provide planning, continuing direction, and oversight and control for all portfolios and the initiatives they encompass. That is where the notion of governance comes into play. The IBM view of governance is: An abstract, collective term that defines and contains a framework for organization, exercise of control and oversight, and decision-making authority, and within which actions and activities are legitimately and properly executed; together with the definition of the functions, the roles, and the responsibilities of those who exercise this oversight and decision-making.

INDIAN INSTITUTE OF FINANCE Page 56 [PORTFOLIO MANAGEMENT SOFTWARE]

Each of these dimensions requires an owner -- either an individual or a collective -- to develop and approve plans, continuously adjust direction, and exercise control through periodic assessment and review of conformance to expectations. A good governance structure decomposes both the types of work and the authority to plan and oversee work. It defines individual and collective roles, and links them to an authority scheme. Policies that are collectively developed and agreed upon provide a framework for the exercise of governance. The complexities of governance structures extend well beyond the scope of this article. Many organizations turn to experts for help in this area because it is so critical to the success of any business transformation effort that encompasses portfolio management. For now, suffice it to say that it is worth investing time and effort to create a sound and flexible governance structure before you attempt to implement portfolio management practices.

Portfolio management essentials Every practical discipline is based on a collection of fundamental concepts that people have identified and proven (and sometimes refined or discarded) through continuous application. These concepts are useful until they become obsolete, supplanted by newer and more effective ideas. For example, in Roman times, engineers discovered that if the upstream supports of a bridge were shaped to offer little resistance to the current of a stream or river, they would last longer. They applied this principle all across the Roman Empire. Then, in the Middle Ages, engineers discovered that such supports would last even longer if their downstream side was also shaped to offer little resistance to the current. So that became the new standard for bridge construction. Portfolio management, like bridge-building, is a discipline, and a number of authors and practitioners have documented fundamental ideas about its exercise. Recently, based on our experiences with clients who have implemented portfolio management practices and on our research into the discipline, we have started to shape an IBM view of fundamental ideas around portfolio management. We are beginning to express this view as a collection of "essentials" that are, in turn, grouped around a small collection of portfolio management themes. For example, one of these themes is initiative value contribution. It suggests that the value of an initiative (i.e., a program or project) should be estimated and approved in order to start INDIAN INSTITUTE OF FINANCE Page 57 [PORTFOLIO MANAGEMENT SOFTWARE] work, and then assessed periodically on the basis of the initiative's contribution to the goals and goal components in the enterprise business strategy. These assessments determine (in part) whether the initiative warrants continued support. This theme encompasses the notion that initiative value changes over time. When an initiative is in the proposal stage, it is possible to quantify an anticipated value contribution. On this basis (in part) the proposed initiative becomes an approved initiative. But what about an initiative that is a large program effort, with a two-year duration? It is highly unlikely that the program's expected value will remain static during the entire two-year period, so continuous value monitoring is necessary. From this, we can derive an essential statement: Initiative value changes and requires continuous monitoring over the life of the initiative.

Portfolio Management Process

The Processes on Demand portfolio management process is a best practice for management of the projects and programs of the portfolio. The portfolio management process steps include:

. Portfolio Management Process • Identification • Categorization • Evaluation • Selection • Prioritization • Balancing • Authorization • Review and Reporting • Strategic Change . Governance Process • Consultation • Preparation • Selection . Portfolio Management Dashboards • Status Summary View

INDIAN INSTITUTE OF FINANCE Page 58 [PORTFOLIO MANAGEMENT SOFTWARE]

• Gantt View • Cost View • Risk view

The process of portfolio management provides a better understanding about the benefits, loss and the risks regarding the business. The outcome of the process of the portfolio management is evaluated with the performance graph of the organization. The portfolio management is differentiated into two major types. They are the enterprise portfolio management process and the project portfolio management process.

The enterprise portfolio management gives information regarding the amount of finance to be spent over the business and the requirement of the enterprise architecture. The project portfolio management gives an analytical approach to the decisions over the sets of portfolio.

Portfolio management is the best process or making planned decisions and also for determining the expenditures of the business. An effective way of portfolio management ensures the growth of the organization and also the other business establishments of the organization.

1. Value Maximization Allocate resources to maximize the value of the portfolio via a number of key objectives such as profitability, ROI, and acceptable risk. A variety of methods are used to achieve this maximization goal, ranging from financial methods to scoring models.

2. Balance Achieve a desired balance of projects via a number of parameters: risk versus return; short-term versus long-term; and across various markets, business arenas and technologies. Typical methods used to reveal balance include bubble diagrams, histograms and pie charts.

3. Business Strategy Alignment Ensure that the portfolio of projects reflects the company’s product innovation strategy and that the breakdown of spending aligns with the company’s strategic priorities. The three main approaches are: top-down (strategic buckets); bottom-

INDIAN INSTITUTE OF FINANCE Page 59 [PORTFOLIO MANAGEMENT SOFTWARE]

up (effective gate keeping and decision criteria) and top-down and bottom-up (strategic check).

4. Pipeline Balance Obtain the right number of projects to achieve the best balance between the pipeline resource demands and the resources available. The goal is to avoid pipeline gridlock (too many projects with too few resources) at any given time. A typical approach is to use a rank ordered priority list or a resource supply and demand assessment.

5. Sufficiency Ensure the revenue (or profit) goals set out in the product innovation strategy are achievable given the projects currently underway. Typically this is conducted via a financial analysis of the pipeline’s potential future value.

What are the benefits of Portfolio Management?

When implemented properly and conducted on a regular basis, Portfolio Management is a high impact, high value activity:

• Maximizes the return on your product innovation investments • Maintains your competitive position • Achieves efficient and effective allocation of scarce resources • Forges a link between project selection and business strategy • Achieves focus • Communicates priorities • Achieves balance • Enables objective project selection

Top performers emphasize the link between project selection and business strategy.

Why is it so important?

INDIAN INSTITUTE OF FINANCE Page 60 [PORTFOLIO MANAGEMENT SOFTWARE]

ineffective portfolio management. According to benchmarking studies conducted by Dr. Cooper and Dr. Edgett, some of the problems that arise when portfolio management is lacking are:

• Projects are not high value to the business • Portfolio has a poor balance in project types • Resource breakdown does not reflect the product innovation strategy • A poor job is done in ranking and prioritizing projects • There is a poor balance between the number of projects underway and the resources available • Projects are not aligned with the business strategy

As a result too many companies have:

• Too many projects underway (often the wrong ones) • Resources are spread too thin and across too many projects • Projects are taking too long to get to market, and • The pipeline has too many low value projects

Portfolio Management is about doing the right projects. If you pick the right projects, the result is an enviable portfolio of high value projects: a portfolio that is properly balanced and most importantly, supports your business strategy.

Models

. Arbitrage pricing theory 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 . The Jensen Index INDIAN INSTITUTE OF FINANCE Page 61 [PORTFOLIO MANAGEMENT SOFTWARE]

. The Treynor Index . The Sharpe Diagonal (or Index) model . Value at risk model

MPT is a mathematical formulation of the concept of diversification in investing, with the aim of selecting a collection of investment assets that has collectively lower risk than any individual asset. That this is possible can be seen intuitively because different types of assets often change in value in opposite ways. For example, when prices in the stock market fall, prices in the bond market often increase, and vice versa. A collection of both types of assets can therefore have lower overall risk than either individually. But diversification lowers risk even if assets' returns are not negatively correlated—indeed, even if they are positively correlated.

More technically, MPT models an asset's return as a normally distributed (or more generally as an elliptically distributed random variable), defines risk as the standard deviation of return, and models a portfolio as a weighted combination of assets so that the return of a portfolio is the weighted combination of the assets' returns. By combining different assets whose returns are not perfectly positively correlated, MPT seeks to reduce the total variance of the portfolio return. MPT also assumes that investors are rational and markets are efficient.

MPT was developed in the 1950s through the early 1970s and was considered an important advance in the mathematical modeling of finance. Since then, many theoretical and practical criticisms have been leveled against it. These include the fact that financial returns do not follow a Gaussian distribution or indeed any symmetric distribution, and that correlations between asset classes are not fixed but can vary depending on external events (especially in crises). Further, there is growing evidence that investors are not rational and markets are not efficient. The fundamental concept behind MPT is that the assets in an

INDIAN INSTITUTE OF FINANCE Page 62 [PORTFOLIO MANAGEMENT SOFTWARE] investment portfolio cannot be selected individually, each on their own merits. Rather, it is important to consider how each asset changes in price relative to how every other asset in the portfolio changes in price.

In general:

. Expected return:

where Rp is the return on the portfolio, Ri is the return on asset i and wi is the weighting of component asset i (that is, the share of asset i in the portfolio).

. Portfolio return variance:

where ρij is the correlation coefficient between the returns on assets i and j. Alternatively the expression can be written as:

where ρij = 1 for i=j.

INDIAN INSTITUTE OF FINANCE Page 63 [PORTFOLIO MANAGEMENT SOFTWARE]

. Portfolio return volatility (standard deviation):

For a two asset portfolio:

. Portfolio return:

. Portfolio variance:

For a three asset portfolio:

. Portfolio return:

. Portfolio variance:

The single-index model (SIM) is a simple asset pricing model commonly used in the finance industry to measure risk and return of a stock. Mathematically the SIM is expressed as:

where:

rit is return to stock i in period t

rf is the risk free rate (i.e. the interest rate on treasury bills)

rmt is the return to the market portfolio in period t

αi is the stock's alpha, or abnormal return

βi is the stocks's beta, or responsiveness to the market return

INDIAN INSTITUTE OF FINANCE Page 64 [PORTFOLIO MANAGEMENT SOFTWARE]

Note that rit − rf is called the excess return on the stock, rmt − rf the excess return on the market

εit is the residual (random) return, which is assumed normally distributed with mean zero and standard deviation σi

These equations show that the stock return is influenced by the market (beta), has a firm specific expected value (alpha) and firm-specific unexpected component (residual). Each stock's performance is in relation to the performance of a market index (such as the All Ordinaries). Security analysts often use the SIM for such functions as computing stock betas, evaluating stock selection skills, and conducting event studies.

In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well- diversified portfolio, given that asset's non-diversifiable risk. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset. The model was introduced by Jack Treynor (1961, 1962), William Sharpe (1964), John Lintner(1965a,b) and Jan Mossin (1966) independently, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory. Sharpe, Markowitz and Merton Miller jointly received the Nobel Memorial Prize in Economics for this contribution to the field of financial economics.

The CAPM is a model for pricing an individual security or a portfolio. For individual securities, we make use of the security market line (SML) and its relation to expected return and systematic risk (beta) to show how the market must price individual securities in relation to their security risk class. The SML enables us to calculate the reward-to-risk ratio for any security in relation to that of the overall market. Therefore, when the expected rate of return for any security is deflated by its beta coefficient, the reward-to-risk ratio for any individual security in the market is equal to the market reward-to-risk ratio, thus:

INDIAN INSTITUTE OF FINANCE Page 65 [PORTFOLIO MANAGEMENT SOFTWARE]

The market reward-to-risk ratio is effectively the market risk premium and by rearranging the above equation and solving for E(Ri), we obtain the Capital Asset Pricing Model (CAPM).

where:

. is the expected return on the capital asset

. is the risk-free rate of interest such as interest arising from government bonds

. (the beta) is the sensitivity of the expected excess asset returns to the

expected excess market returns, or also ,

. is the expected return of the market

. is sometimes known as the market premium or risk premium (the difference between the expected market rate of return and the risk-free rate of return).

Restated, in terms of risk premium, we find that:

which states that the individual risk premium equals the market premium times β.

Note 1: the expected market rate of return is usually estimated by measuring the Geometric Average of the historical returns on a market portfolio (e.g. S&P 500).

Note 2: the risk free rate of return used for determining the risk premium is usually the arithmetic average of historical risk free rates of return and not the current risk free rate of return.

For the full derivation see Modern portfolio theory.

Arbitrage pricing theory (APT), in finance, is a general theory of asset pricing, that has become influential in the pricing of stocks.

INDIAN INSTITUTE OF FINANCE Page 66 [PORTFOLIO MANAGEMENT SOFTWARE]

APT holds that the expected return of a financial asset can be modeled as a linear function of various macro-economic factors or theoretical market indices, where sensitivity to changes in each factor is represented by a factor-specific beta coefficient. The model-derived rate of return will then be used to price the asset correctly - the asset price should equal the expected end of period price discounted at the rate implied by model. If the price diverges, arbitrage should bring it back into line. The theory was initiated by the economist Stephen Ross in 1976.

The APT model

Risky asset returns are said to follow a factor structure if they can be expressed as:

where

. E(rj) is the jth asset's expected return,

. Fk is a systematic factor (assumed to have mean zero),

. bjk is the sensitivity of the jth asset to factor k, also called factor loading,

. and εj is the risky asset's idiosyncratic random shock with mean zero.

Idiosyncratic shocks are assumed to be uncorrelated across assets and uncorrelated with the factors.

The APT states that if asset returns follow a factor structure then the following relation exists between expected returns and the factor sensitivities:

where

. RPk is the risk premium of the factor,

. rf is the risk-free rate,

INDIAN INSTITUTE OF FINANCE Page 67 [PORTFOLIO MANAGEMENT SOFTWARE]

That is, the expected return of an asset j is a linear function of the assets sensitivities to the n factors.

Note that there are some assumptions and requirements that have to be fulfilled for the latter to be correct: There must be competition in the market, and the total number of factors may never surpass the total number of assets (in order to avoid the problem of matrix singularity),

In finance, Jensen's alpha (or Jensen's Performance Index, ex-post alpha) is used to determine the abnormal return of a security or portfolio of securities over the theoretical expected return.

The security could be any asset, such as stocks, bonds, or derivatives. The theoretical return is predicted by a market model, most commonly the Capital Asset Pricing Model (CAPM) model. The market model uses statistical methods to predict the appropriate risk-adjusted return of an asset. The CAPM for instance uses beta as a multiplier.

Jensen's alpha was first used as a measure in the evaluation of mutual fund managers by Michael Jensen in 1968. The CAPM return is supposed to be 'risk adjusted', which means it takes account of the relative riskyness of the asset. After all, riskier assets will have higher expected returns than less risky assets. If an asset's return is even higher than the risk adjusted return, that asset is said to have "positive alpha" or "abnormal returns". Investors are constantly seeking investments that have higher alpha.

In the context of CAPM, calculating alpha requires the following inputs:

. the realized return (on the portfolio), . the market return, . the risk-free rate of return, and . the beta of the portfolio.

Jensen's alpha = Portfolio Return − [Risk Free Rate + Portfolio Beta * (Market Return − Risk Free Rate)]

Since Eugene Fama, many academics believe financial markets are too efficient to allow for repeatedly earning positive Alpha, unless by chance. To the contrary, empirical

INDIAN INSTITUTE OF FINANCE Page 68 [PORTFOLIO MANAGEMENT SOFTWARE]

studies of mutual funds spearheaded by Russ Wermers usually confirm managers' stock- picking talent, finding positive Alpha. However, they also show that after fees and expenses are deducted, the effective Alpha for investors is negative. (These results also explain why passive investing is increasingly popular.)

Nevertheless, Alpha is still widely used to evaluate mutual fund and portfolio manager performance, often in conjunction with the Sharpe ratioand the Treynor ratio.

The Treynor ratio (sometimes called the reward-to-volatility ratio or Treynor measure), named after Jack L. Treynor, is a measurement of the returns earned in excess of that which could have been earned on an investment that has no diversifiable risk (e.g., Treasury Bills or a completely diversified portfolio), per each unit of market risk assumed.

The Treynor ratio relates excess return over the risk-free rate to the additional risk taken; however, systematic risk is used instead of total risk. The higher the Treynor ratio, the better the performance of the portfolio under analysis.

where

Treynor ratio, portfolio i's return,

risk free rate

Portfolio i's beta

Like the Sharpe ratio, the Treynor ratio (T) does not quantify the value added, if any, of active portfolio management. It is a ranking criterion only. A ranking of portfolios based on the Treynor Ratio is only useful if the portfolios under consideration are sub-portfolios of a broader, fully diversified portfolio. If this is not the case, portfolios with identical systematic risk, but different total risk, will be rated the same. But the portfolio with a higher total risk is less diversified and therefore has a higher unsystematic risk which is not priced in the market.

An alternative method of ranking portfolio management is Jensen's alpha, which quantifies the added return as the excess return above the security in the capital asset pricing model. As

INDIAN INSTITUTE OF FINANCE Page 69 [PORTFOLIO MANAGEMENT SOFTWARE] they two both determine rankings based on systematic risk alone, they will rank portfolios identically.

In financial mathematics and financial risk management, Value at Risk (VaR) is a widely used risk measure of the risk of loss on a specific portfolio of financial assets. For a given portfolio, probability and time horizon, VaR is defined as a threshold value such that the probability that the mark-to-market loss on the portfolio over the given time horizon exceeds this value (assuming normal markets and no trading in the portfolio) is the given probability level.

For example, if a portfolio of stocks has a one-day 5% VaR of $1 million, there is a 0.05 probability that the portfolio will fall in value by more than $1 million over a one day period, assuming markets are normal and there is no trading. Informally, a loss of $1 million or more on this portfolio is expected on 1 day in 20. A loss which exceeds the VaR threshold is termed a “VaR break.”

"Given some confidence level the VaR of the portfolio at the confidence level α is given by the smallest number l such that the probability that the loss L exceeds l is not larger than (1 − α)"

The left equality is a definition of VaR. The right equality assumes an underlying probability distribution, which makes it true only for parametric VaR. Risk managers typically assume that some fraction of the bad events will have undefined losses, either because markets are closed or illiquid, or because the entity bearing the loss breaks apart or loses the ability to compute accounts. Therefore, they do not accept results based on the assumption of a well- defined probability distribution. Nassim Taleb has labeled this assumption, "charlatanism." On the other hand, many academics prefer to assume a well-defined distribution, albeit usually one with fat tails. This point has probably caused more contention among VaR theorists than any other.

INDIAN INSTITUTE OF FINANCE Page 70 [PORTFOLIO MANAGEMENT SOFTWARE]

INSTRUMENTS IN PORTFOLIO

• BONDS BY COUPON

- Fixed Rate Bonds - Floating Rate Bonds - Zero Coupon Bond - Inflation Indexed Bond - Commercial Paper - Perpetual Paper

• BONDS BY ISSUER

INDIAN INSTITUTE OF FINANCE Page 71 [PORTFOLIO MANAGEMENT SOFTWARE]

- Corporate Bond - Government Bond - Muncipal Bond - Sovereign Bond

• EQUITIES • INVESTMENT FUNDS

- Mutual Fund - Indexed Fund - Exchange transfer Fund - Close End Fund - Segregated Fund - Hedge Fund

• STRUCTURED FINANCE

- Securitization - Asset Backed Security - Mortgage Backed Security - Commercial Mortgage Backed Security - Residential Mortgage Backed Security - Tranche - Collateralized Debt Obligation - Collateralized Fund Obligation - Collateralized Mortgage Obligation - Credit Linked Note - Unsecured Debt - Agency Security

• DERIVATIVES

- Option - Warrant

INDIAN INSTITUTE OF FINANCE Page 72 [PORTFOLIO MANAGEMENT SOFTWARE]

- Futures - Forward Contract - Swaps - Credit Derivative - Hybrid Security

BONDS

A bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals.

Thus a bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure. Certificates of deposit (CDs) or commercial paper are considered to be money market instruments and not bonds. Bonds must be repaid at fixed intervals over a period of time.

Bonds and stocks are both securities, but the major difference between the two is that stockholders have an equity stake in the company (i.e., they are owners), whereas

INDIAN INSTITUTE OF FINANCE Page 73 [PORTFOLIO MANAGEMENT SOFTWARE] bondholders have a creditor stake in the company (i.e., they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is a perpetuity (i.e., bond with no maturity).

The following descriptions are not mutually exclusive, and more than one of them may apply to a particular bond.

• Fixed rate bonds have a coupon that remains constant throughout the life of the bond.

• Floating rate note (FRNs) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor. For example the coupon may be defined as three month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months.

• Zero-coupon bonds pay no regular interest. They are issued at a substantial discount to par value, so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption date. An example of zero coupon bonds is Series E savings bonds issued by the U.S. government. Zero-coupon bonds may be created from fixed rate bonds by a financial institution separating "stripping off" the coupons from the principal. In other words, the separated coupons and the final principal payment of the bond may be traded separately. See IO (Interest Only) and PO (Principal Only).

• Inflation linked bonds , in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity (this position briefly reversed itself for short-term UK bonds in December 2008). However, as the principal amount grows, the payments increase with inflation. The United Kingdom was the first sovereign issuer to issue inflation linked Gilts in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government.

• Perpetual bonds are also often called perpetuities or 'Perps'. They have no maturity date. The most famous of these are the UK Consoles, which are also known as

INDIAN INSTITUTE OF FINANCE Page 74 [PORTFOLIO MANAGEMENT SOFTWARE]

Treasury Annuities or Undated Treasuries. Some of these were issued back in 1888 and still trade today. • In the global money market, commercial paper is a unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued (sold) by large banks and corporation to get money to meet short term debt obligations (for example, payroll), and is only backed by an issuing bank or corporation's promise to pay the face amount on the maturity date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings from a recognized rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face value, and carries higher interest repayment dates than bonds. Typically, the longer the maturity on a note, the higher the interest rate the issuing institution must pay. Interest rates fluctuate with market conditions, but are typically lower than banks' rates. • A corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. (The term "commercial paper" is sometimes used for instruments with a shorter maturity.)

Sometimes, the term "corporate bonds" is used to include all bonds except those issued by governments in their own currencies. Strictly speaking, however, it only applies to those issued by corporations. The bonds of local authorities and supranational organizations do not fit in either category.

• A bond is a debt investment in which an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company. A government bond is a bond issued by a national government denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. The first ever government bond was issued by the English government in 1693 to raise money to fund a war against France. It was in the form of a tontine.

INDIAN INSTITUTE OF FINANCE Page 75 [PORTFOLIO MANAGEMENT SOFTWARE]

Government bonds are usually referred to as risk-free bonds, because the government can raise taxes to redeem the bond at maturity. Some counter examples do exist where a government has defaulted on its domestic currency debt, such as Russia in 1998 (the "ruble crisis"), though this is very rare. As an example, in the US, Treasury securities are denominated in US dollars. In this instance, the term "risk-free" means free of credit risk. However, other risks still exist, such as currency risk for foreign investors (for example non-US investors of US Treasury securities would have received lower returns in 2004 because the value of the US dollar declined against most other currencies). Secondly, there is inflation risk, in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation outturn is higher than expected. Many governments issue inflation-indexed bonds, which should protect investors against inflation risk.

• A municipal bond is a bond issued by a city or other local government, or their agencies. Potential issuers of municipal bonds include cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and any other governmental entity (or group of governments) below the state level. Municipal bonds may be general obligations of the issuer or secured by specified revenues. Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt. • A sovereign bond is a bond issued by a national government. The term usually refers to bonds issued in foreign currencies, while bonds issued by national governments in the country's own currency are referred to as government bonds. The total amount owed to the holders of the sovereign bonds is called sovereign debt.

Nations with very high or unpredictable inflation or with unstable exchange rates often find it uneconomic to issue bonds in their own currencies and so are forced to issue bonds denominated in more stable foreign currencies. This raises the issue of sovereign default if the nation cannot afford to repurchase the necessary foreign currency at bond repayment time. Because of the risk of default, investors require the bonds to be issued with a higher yield. This makes the debt more expensive to service,

INDIAN INSTITUTE OF FINANCE Page 76 [PORTFOLIO MANAGEMENT SOFTWARE]

increasing risk of default. In the event of default, unlike a corporation or even a municipal subdivision, a nation cannot file for bankruptcy. But on the rare occasions that a default occurs, just as in defaults on corporate bonds, recent practice has been that the defaulting borrower presents an exchange offer to its bond holders in an effort to restructure the sovereign debt, as has been the case in US dollar denominated bonds issued by Peru (1996) and Argentina (2001). However, getting the bond holders to accept an exchange offer has become very difficult, something caused by the holdout problem.

•

EQUITY

COMMON SHARES:

It represents an ownership claim on the earnings and the assets of a company. After holders of debt claims are paid, the management of the company can either pay out the remaining earnings to stockholder in the form of Dividends or reinvest part or all the earnings. The holder of a common stock has limited liability up to the amount of share capital contributed.

The majority of stock issued is common stock, which represents a share of the ownership of a company and a claim on a portion of profits. This claim is paid in the form of Dividends. Stockholders receive one vote per share owned in the elections to the company board.

If a company goes into liquidation, common stock holders do not receive any money until the creditors, bondholders and preference shareholders are paid.

INDIAN INSTITUTE OF FINANCE Page 77 [PORTFOLIO MANAGEMENT SOFTWARE]

PREFERENCE SHARE:

It means shares can which fulfill the following 2 conditions. Therefore, a share which does not fulfill both these conditions is an equity shares.

• It carries preferential rights in respect of dividend at fixed amount or at fixed rate. The payment of dividend should be made before the payment of dividend to holders of equity shares. • It also carries preferential rights in regard to payment of capital or winding up or otherwise. It means the amount paid on preference shares must be paid back to preference shareholders before anything in paid to the equity shareholders.

INVESTMENT IN EQUITIES

There are primarily two routes to investing in equities.

a) Through the primary market b) Through the secondary market

PRIMARY MARKET

It provides opportunity to corporate and government to raise resources to meet their requirement of capital for funding their new business plan, or expanding the existing set up or meeting up the enhanced working capital requirement. The issuer thus issues fresh capital in the form of equity shares, preference shares or raises loan in form of debt via public issue or through private placements. These shares can be issued at face value, or at premium, or at discount.

SECONDARY MARKET

INDIAN INSTITUTE OF FINANCE Page 78 [PORTFOLIO MANAGEMENT SOFTWARE]

In finance, the private equity secondary market (also often called private equity secondaries or secondaries) refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds.

Sellers of private equity investments sell not only the investments in the fund but also their remaining unfunded commitments to the funds. By its nature, the private equity asset class is illiquid, intended to be a long-term investment for buy-and-hold investors. For the vast majority of private equity investments, there is no listed public market; however, there is a robust and maturing secondary market available for sellers of private equity assets.

Driven by strong demand for private equity exposure, a significant amount of capital has been committed to dedicated secondary market funds from investors looking to increase and diversify their private equity exposure.

INDIAN INSTITUTE OF FINANCE Page 79 [PORTFOLIO MANAGEMENT SOFTWARE]

SHORT SELLING

In finance, short selling (also known as shorting or going short) is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying identical assets back at a later date to return to the lender. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as the seller will pay less to buy the assets than the seller received on selling them. Conversely, the short seller will incur a loss if the price of the assets rises. Other costs of shorting may include a fee for borrowing the assets and payment of any dividends paid on the borrowed assets. "Shorting" and "going short" also refer to entering into any derivative or other contract under which the investor profits from a fall in the value of an asset.

Going short can be contrasted with the more conventional practice of "going long", whereby an investor profits from any increase in the price of the asset.

INDIAN INSTITUTE OF FINANCE Page 80 [PORTFOLIO MANAGEMENT SOFTWARE]

INVESTMENT FUNDS

MUTUAL FUNDS

A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests typically in investment securities (stocks, bonds, short-term money market instruments, other mutual funds, other securities, and/or commodities such as precious metals. The mutual fund will have a fund manager that trades (buys and sells) the fund's investments in accordance with the fund's investment objective. In the U.S., a fund registered with the Securities and Exchange Commission (SEC) under both SEC and Internal Revenue Service (IRS) rules must distribute nearly all of its net income and net realized gains from the sale of securities (if any) to its investors at least annually. Most funds are overseen by a board of directors or trustees (if the U.S. fund is organized as a trust as they commonly are) which is charged with ensuring the fund is managed appropriately by its investment adviser and other service organizations and vendors, all in the best interests of the fund's investors.

INDEX FUNDS

An index fund or index tracker is a collective investment scheme (usually a mutual fund or exchange-traded fund) that aims to replicate the movements of an index of a specific financial market, or a set of rules of ownership that are held constant, regardless of market conditions.

Tracking

INDIAN INSTITUTE OF FINANCE Page 81 [PORTFOLIO MANAGEMENT SOFTWARE]

Tracking can be achieved by trying to hold all of the securities in the index, in the same proportions as the index. Other methods include statistically sampling the market and holding "representative" securities. Many index funds rely on a computer model with little or no human input in the decision as to which securities are purchased or sold and is therefore a form of passive management.

Fees

The lack of active management generally gives the advantage of lower fees and lower taxes in taxable accounts. Of course, the fees reduce the return to the investor relative to the index. In addition it is usually impossible to precisely mirror the index as the models for sampling and mirroring, by their nature, cannot be 100% accurate. The difference between the index performance and the fund performance is known as the "tracking error" or informally "jitter".

Index funds are available from many investment managers. Some common indices include the S&P 500, the Nikkei 225, and the FTSE 100. Less common indexes come from academics like Eugene Fama and Kenneth French, who created "research indexes" in order to develop asset pricing models, such as their Three Factor Model. The Fama-French three- factor model is used by Dimensional Fund Advisors to design their index funds. Robert Arnott and Professor Jeremy Siegel have also created new competing fundamentally based indexes based on such criteria as dividends, earnings, book value, and sales.

EXCHANGE TRADED FUNDS

An exchange-traded fund (ETF), also known as an exchange-traded product (ETP), is an investment fund traded on stock exchanges, much like stock. An ETF holds assets such as stocks, commodities, or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features.

Only so-called authorized participants (typically, large institutional investors) actually buy or sell shares of an ETF directly from/to the fund manager, and then only in creation units, large blocks of tens of thousands of ETF shares, which are usually exchanged in-kind with baskets

INDIAN INSTITUTE OF FINANCE Page 82 [PORTFOLIO MANAGEMENT SOFTWARE] of the underlying securities. Authorized participants may wish to invest in the ETF shares long-term, but usually act as market makers on the open market, using their ability to exchange creation units with their underlying securities to provide liquidity of the ETF shares and help ensure that their intraday market price approximates to the net asset value of the underlying assets. Other investors, such as individuals using a retail broker, trade ETF shares on this secondary market.

An ETF combines the valuation feature of a mutual fund or unit investment trust, which can be bought or sold at the end of each trading day for its net asset value, with the tradability feature of a closed-end fund, which trades throughout the trading day at prices that may be more or less than its net asset value. Closed-end funds are not considered to be "ETFs", even though they are funds and are traded on an exchange. ETFs have been available in the US since 1993 and in Europe since 1999. In 1993, the first country specific ETFs were a collaboration between MSCI, BGI and a small independent third party Distribution firm called Funds Distributor, Inc. The product eventually evolved into the iShares brand widely known around the globe. ETFs traditionally have been index funds, but in 2008 the U.S. Securities and Exchange Commission began to authorize the creation of actively managed ETFs.

CLOSE END FUNDS

A closed-end fund, or closed-ended fund (CEF) is a collective investment scheme with a limited number of shares.

New shares are rarely issued after the fund is launched; shares are not normally redeemable for cash or securities until the fund liquidates. Typically an investor can acquire shares in a closed-end fund by buying shares on a secondary market from a broker, market maker, or other investor as opposed to an open-end fund where all transactions eventually involve the fund company creating new shares on the fly (in exchange for either cash or securities) or redeeming shares (for cash or securities).

The price of a share in a closed-end fund is determined partially by the value of the investments in the fund, and partially by the premium (or discount) placed on it by the market. The total value of all the securities in the fund divided by the number of shares in the

INDIAN INSTITUTE OF FINANCE Page 83 [PORTFOLIO MANAGEMENT SOFTWARE] fund is called the net asset value (NAV) per share. The market price of a fund share is often higher or lower than the per share NAV: when the fund's share price is higher than per share NAV it is said to be selling at a premium; when it is lower, at a discount to the per share NAV.

In the U.S. legally they are called closed-end companies and form one of three SEC recognized types of investment companies along with mutual funds and unit investment trusts. Other examples of closed-ended funds are investment trusts in the UK and listed investment companies in Australia.

SEGREGATED FUNDS

A Segregated Fund (Seg Fund) is a type of investment fund administered by Canadian insurance companies in the form of individual, variable life insurance contracts offering certain guarantees to the policyholder such as reimbursement of capital upon death. As required by law, these funds are fully segregated from the company's general investment funds, hence the eponym. A Seg Fund is synonymous with the U.S. insurance industry "separate account" and related insurance and annuity products.

Usage

A segregated fund is an investment fund that combines the growth potential of a mutual fund with the security of a life insurance policy. Segregated funds are often referred to as "mutual funds with an insurance policy wrapper".

Like mutual funds, segregated funds consist of a pool of investments in securities such as bonds, debentures, and stocks. The value of the segregated fund fluctuates according to the market value of the underlying securities.

Segregated funds do not issue units or shares, therefore a segregated fund investor is not referred to as a unitholder. Instead, the investor is the holder of a segregated fund contract.

INDIAN INSTITUTE OF FINANCE Page 84 [PORTFOLIO MANAGEMENT SOFTWARE]

Contracts can be registered (held inside an RRSP) or non-registered (not held inside an RRSP). Registered investments qualify for annual tax-sheltered RRSP contributions. Non- registered investments are subject to tax payments on the capital gains each year and capital losses can also be claimed.

Features

Insurance Contracts

Segregated funds are sold as deferred variable annuity contracts and can be sold only by licensed insurance representatives. Segregated funds are owned by the life insurance company, not the individual investors, and must be kept separate (or “segregated”) from the company’s other assets. Segregated funds are made up of underlying assets that are purchased via the Life assurance companies. Investors do not have ownership share. Segregated Funds have guarantees and run for a period. Should the investor leave before the end date, he/she may be penalized.

Maturity Dates

All segregated fund contracts have maturity dates, which are not to be confused with maturity guarantees (outlined below). The maturity date is the date at which the maturity guarantee is available to the contract holder. Holding periods to reach maturity are usually 10 or more years.

Maturity & Death Guarantees

Guarantee amounts are offered in all segregated funds whereby no less than a certain percentage of the initial investment in a contract (usually 75% or higher) will be paid out at death or contract maturity. In either case, the contract holder or their beneficiary will receive the greater of the guarantee or the investment’s current market value.

INDIAN INSTITUTE OF FINANCE Page 85 [PORTFOLIO MANAGEMENT SOFTWARE]

Potential Creditor Protection

Granted certain qualifications are met, segregated fund investments may be protected from seizure from creditors. This is an important feature for business owners or professionals whose assets may have a high exposure to creditors.

Probate Protection

If a beneficiary is named, the segregated fund investment may be exempt from probate and executor’s fees and pass directly to the beneficiary. If the named beneficiary is a family member (such as a spouse, child, or parent), the investment may also be secure from creditors in case of bankruptcy. These protections apply to both registered and non-registered investments.

Reset Option

A reset option allows the contract holder to lock in investment gains if the market value of a segregated fund contract increases. This resets the contract’s deposit value to equal the greater of the deposit value or current market value, restarts the contract term, and extends the maturity date. Contract holders are limited to a certain number of resets, usually one or two, in a given calendar year.

Cost of the Guarantees

The shorter the term of the maturity guarantees on investment funds - whether they are segregated funds or protected mutual funds - the higher the risk exposure of the insurer and the cost of the guarantees. This inverse relationship is based on the premise that there is a greater chance of market decline (and hence a greater chance of collecting on a guarantee) over shorter periods. A contract holder's use of reset provisions also contributes to costs, since resetting the guaranteed amount at a higher level means that the issuer will be liable for this higher amount.

HEDGE FUND

INDIAN INSTITUTE OF FINANCE Page 86 [PORTFOLIO MANAGEMENT SOFTWARE]

A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range of investment and trading activities than traditional long-only investment funds, and that, in general, pays a performance fee to its investment manager. Every hedge fund has its own investment strategy that determines the type of investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including shares, debt and commodities. ]

As the name implies, hedge funds often seek to hedge some of the risks inherent in their investments using a variety of methods, most notably short selling and derivatives. However, the term "hedge fund" has also come to be applied to certain funds that, as well as (or instead of) hedging certain risks, use short selling and other "hedging" methods as a trading strategy to generate a return on their capital.

In most jurisdictions hedge funds are open only to a limited range of professional or wealthy investors who meet certain criteria set by regulators, and are accordingly exempted from many regulations that govern ordinary investment funds. The exempted regulations typically cover short selling, the use of derivatives and leverage, fee structures, and the rules by which investors can remove their capital from the fund. Light regulation and the presence of performance fees are the distinguishing characteristics of hedge funds.

The net asset value of a hedge fund can run into many billions of dollars, and the gross assets of the fund will usually be higher still due to leverage. Hedge funds dominate certain specialty markets such as trading within derivatives with high-yield ratings and distressed debt.

DERIVATIVES

OPTIONS

An option is a derivative financial instrument that establishes a contract between two parties concerning the buying or selling of an asset at a reference price during a specified time frame. During this time frame, the buyer of the option gains the right, but not the obligation, to

INDIAN INSTITUTE OF FINANCE Page 87 [PORTFOLIO MANAGEMENT SOFTWARE] engage in some specific transaction on the asset, while the seller incurs the obligation to fulfill the transaction if so requested by the buyer. The price of an option derives from the value of an underlying asset (commonly a stock, a bond, a currency or a futures contract) plus a premium based on the time remaining until the expiration of the option. Other types of options exist, and options can in principle be created for any type of valuable asset.

An option which conveys the right to buy something is called a call; an option which conveys the right to sell is called a put. The price specified at which the underlying may be traded is called the strike price or exercise price. The process of activating an option and thereby trading the underlying at the agreed-upon price is referred to as exercising it. Most options have an expiration date. If the option is not exercised by the expiration date, it becomes void and worthless.

In return for granting the option, called writing the option, the originator of the option collects a payment, the premium, from the buyer. The writer of an option must make good on delivering (or receiving) the underlying asset or its cash equivalent, if the option is exercised.

An option can usually be sold by its original buyer to another party. Many options are created in standardized form and traded on an anonymous options exchange among the general public, while other over-the-counter options are customized to the desires of the buyer on an ad hoc basis, usually by an investment bank.

WARRANTS

A warrant is a security that entitles the holder to buy stock of the issuing company at a specified price, which can be higher or lower than the stock price at time of issue.

Warrants and options are similar in that the two contractual financial instruments allow the holder special rights to buy securities. Both are discretionary and have expiration dates. The word warrant simply means to "endow with the right", which is only slightly different to the meaning of an option.

INDIAN INSTITUTE OF FINANCE Page 88 [PORTFOLIO MANAGEMENT SOFTWARE]

Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. They can be used to enhance the yield of the bond, and make them more attractive to potential buyers. Warrants can also be used in private equity deals. Frequently, these warrants are detachable, and can be sold independently of the bond or stock.

In the case of warrants issued with preferred stocks, stockholders may need to detach and sell the warrant before they can receive dividend payments. Thus, it is sometimes beneficial to detach and sell a warrant as soon as possible so the investor can earn dividends.

Warrants are actively traded in some financial markets such as Deutsche Börse and Hong Kong. In Hong Kong Stock Exchange, warrants accounted for 11.7% of the turnover in the first quarter of 2009, just second to the callable bull/bear contract.

STRUCTURE AND FEATURES

Warrants have similar characteristics to that of other equity derivatives, such as options, for instance:

• Exercising: A warrant is exercised when the holder informs the issuer their intention to purchase the shares underlying the warrant.

The warrant parameters, such as exercise price, are fixed shortly after the issue of the bond. With warrants, it is important to consider the following main characteristics:

• Premium: A warrant's "premium" represents how much extra you have to pay for your shares when buying them through the warrant as compared to buying them in the regular way. • Gearing (leverage): A warrant's "gearing" is the way to ascertain how much more exposure you have to the underlying shares using the warrant as compared to the exposure you would have if you buy shares through the market. • Expiration Date: This is the date the warrant expires. If you plan on exercising the warrant you must do so before the expiration date. The more time remaining until

INDIAN INSTITUTE OF FINANCE Page 89 [PORTFOLIO MANAGEMENT SOFTWARE]

expiry, the more time for the underlying security to appreciate, which, in turn, will increase the price of the warrant (unless it depreciates). Therefore, the expiry date is the date on which the right to exercise no longer exists. • Restrictions on exercise: Like options, there are different exercise types associated with warrants such as American style (holder can exercise anytime before expiration) or European style (holder can only exercise on expiration date).

Warrants are longer-dated options and are generally traded over-the-counter.

FUTURES

A futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality at a specified future date at a price agreed today (the futures price). The contracts are traded on a futures exchange. Futures contracts are not "direct" securities like stocks, bonds, rights or warrants. They are still securities, however, though they are a type of derivative contract. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position.

The price is determined by the instantaneous equilibrium between the forces of supply and demand among competing buy and sell orders on the exchange at the time of the purchase or sale of the contract.

In many cases, the underlying asset to a futures contract may not be traditional "commodities" at all – that is, for financial futures, the underlying asset or item can be currencies, securities or financial instruments and intangible assets or referenced items such as stock indexes and interest rates.

The future date is called the delivery date or final settlement date. The official price of the futures contract at the end of a day's trading session on the exchange is called the settlement price for that day of business on the exchange.

A closely related contract is a forward contract; they differ in certain respects. Future contracts are very similar to forward contracts, except they are exchange-traded and defined on standardized assets. Unlike forwards, futures typically have interim partial settlements or

INDIAN INSTITUTE OF FINANCE Page 90 [PORTFOLIO MANAGEMENT SOFTWARE]

"true-ups" in margin requirements. For typical forwards, the net gain or loss accrued over the life of the contract is realized on the delivery date.

A futures contract gives the holder the obligation to make or take delivery under the terms of the contract, whereas an option grants the buyer the right, but not the obligation, to establish a position previously held by the seller of the option. In other words, the owner of an options contract may exercise the contract, but both parties of a "futures contract" must fulfill the contract on the settlement date. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position has to offset his/her position by either selling a long position or buying back (covering) a short position, effectively closing out the futures position and its contract obligations.

Futures contracts, or simply futures, (but not future or future contract) are exchange-traded derivatives. The exchange's clearing house acts as counterparty on all contracts, sets margin requirements, and crucially also provides a mechanism for settlement.

STANDARDIZATION

Futures contracts ensure their liquidity by being highly standardized, usually by specifying:

• The underlying asset or instrument. This could be anything from a barrel of crude oil to a short term interest rate. • The type of settlement, either cash settlement or physical settlement. • The amount and units of the underlying asset per contract. This can be the notional amount of bonds, a fixed number of barrels of oil, units of foreign currency,

INDIAN INSTITUTE OF FINANCE Page 91 [PORTFOLIO MANAGEMENT SOFTWARE]

the notional amount of the deposit over which the short term interest rate is traded, etc. • The currency in which the futures contract is quoted. • The grade of the deliverable. In the case of bonds, this specifies which bonds can be delivered. In the case of physical commodities, this specifies not only the quality of the underlying goods but also the manner and location of delivery. For example, the NYMEX Light Sweet Crude Oil contract specifies the acceptable sulphur content and API specific gravity, as well as the pricing point -- the location where delivery must be made. • The delivery month. • The last trading date. • Other details such as the commodity tick, the minimum permissible price fluctuation.

WHO TRADES FUTURES?

Futures traders are traditionally placed in one of two groups: hedgers, who have an interest in the underlying asset (which could include an intangible such as an index or interest rate) and are seeking to hedge out the risk of price changes; and speculators, who seek to make a profit by predicting market moves and opening a derivative contract related to the asset "on paper", while they have no practical use for or intent to actually take or make delivery of the underlying asset. In other words, the investor is seeking exposure to the asset in a long futures or the opposite effect via a short futures contract.

Hedgers typically include producers and consumers of a commodity or the owner of an asset or assets subject to certain influences such as an interest rate.

For example, in traditional commodity markets, farmers often sell futures contracts for the crops and livestock they produce to guarantee a certain price, making it easier for them to plan. Similarly, livestock producers often purchase futures to cover their feed costs, so that they can plan on a fixed cost for feed. In modern (financial) markets, "producers" of interest rate swaps or equity derivative products will use financial futures or equity index futures to reduce or remove the risk on the swap.

INDIAN INSTITUTE OF FINANCE Page 92 [PORTFOLIO MANAGEMENT SOFTWARE]

An example that has both hedge and speculative notions involves a mutual fund or separately managed account whose investment objective is to track the performance of a stock index such as the S&P 500 stock index. The Portfolio manager often "equitizes" cash inflows in an easy and cost effective manner by investing in (opening long) S&P 500 stock index futures. This gains the portfolio exposure to the index which is consistent with the fund or account investment objective without having to buy an appropriate proportion of each of the individual 500 stocks just yet. This also preserves balanced diversification, maintains a higher degree of the percent of assets invested in the market and helps reduce tracking error in the performance of the fund/account. When it is economically feasible (an efficient amount of shares of every individual position within the fund or account can be purchased), the portfolio manager can close the contract and make purchases of each individual stock.

The social utility of futures markets is considered to be mainly in the transfer of risk, and increased liquidity between traders with different risk and time preferences, from a hedger to a speculator, for example.

SWAPS

In finance, a swap is a derivative in which counterparties exchange certain benefits of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in question can be the periodic interest (or coupon) payments associated with the bonds. Specifically, the two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are calculated. Usually at the time when the contract is initiated at least one of these series of cash flows is determined by a random or uncertain variable such as an interest rate, foreign exchange rate, equity price or commodity price.

The cash flows are calculated over a notional principal amount, which is usually not exchanged between counterparties. Consequently, swaps can be in cash or collateral.

Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the expected direction of underlying prices.

INDIAN INSTITUTE OF FINANCE Page 93 [PORTFOLIO MANAGEMENT SOFTWARE]

The first swaps were negotiated in the early 1980s. David Swensen, a Yale Ph.D. at Salomon Brothers, engineered the first swap transaction according to "When Genius Failed: The Rise and Fall of Long-Term Capital Management" by Roger Lowenstein. Today, swaps are among the most heavily traded financial contracts in the world: the total amount of interest rates and currency swaps outstanding is more thаn $426.7 trillion in 2009, according to International Swaps and Derivatives Association.

TYPES OF SWAPS

The five generic types of swaps, in order of their quantitative importance, are: interest rate swaps, currency swaps, credit swaps, commodity swaps and equity swaps. There are also many other types.

Interest rate swaps

A is currently paying floating, but wants to pay fixed. B is currently paying fixed but wants to pay floating. By entering into an interest rate swap, the net result is that each party can 'swap' their existing obligation for their desired obligation. Normally the parties do not swap payments directly, but rather, each sets up a separate swap with a financial intermediary such as a bank. In return for matching the two parties together, the bank takes a spread from the swap payments.

INDIAN INSTITUTE OF FINANCE Page 94 [PORTFOLIO MANAGEMENT SOFTWARE]

The most common type of swap is a “plain Vanilla” interest rate swap. It is the exchange of a fixed rate loan to a floating rate loan. The life of the swap can range from 2 years to over 15 years. The reason for this exchange is to take benefit from comparative advantage. Some companies may have comparative advantage in fixed rate markets while other companies have a comparative advantage in floating rate markets. When companies want to borrow they look for cheap borrowing i.e. from the market where they have comparative advantage. However this may lead to a company borrowing fixed when it wants floating or borrowing floating when it wants fixed. This is where a swap comes in. A swap has the effect of transforming a fixed rate loan into a floating rate loan or vice versa.

For example, party B makes periodic interest payments to party A based on a variable interest rate of LIBOR +70 basis points. Party A in return makes periodic interest payments based on a fixed rate of 8.65%. The payments are calculated over the notional amount. The first rate is called variable, because it is reset at the beginning of each interest calculation period to the then current reference rate, such as LIBOR. In reality, the actual rate received by A and B is slightly lower due to a bank taking a spread.

Currency swaps

A currency swap involves exchanging principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal loan in another currency. Just like interest rate swaps;the currency swaps also are motivated by comparative advantage.

Commodity swaps

A commodity swap is an agreement whereby a floating (or market or spot) price is exchanged for a fixed price over a specified period. The vast majority of commodity swaps involve crude oil.

INDIAN INSTITUTE OF FINANCE Page 95 [PORTFOLIO MANAGEMENT SOFTWARE]

Equity Swap

An equity swap is a special type of total return swap, where the underlying asset is a stock, a basket of stocks, or a stock index. Compared to actually owning the stock, in this case you do not have to pay anything up front, but you do not have any voting or other rights that stock holders do have.

Credit default swaps

A credit default swap (CDS) is a swap contract in which the buyer of the CDS makes a series of payments to the seller and, in exchange, receives a payoff if a credit instrument - typically a bond or loan - goes into default (fails to pay). Less commonly, the credit event that triggers the payoff can be a company undergoing restructuring, bankruptcy or even just having its credit rating downgraded. CDS contracts have been compared with insurance, because the buyer pays a premium and, in return, receives a sum of money if one of the events specified in the contract occur. Unlike an actual insurance contract the buyer is allowed to profit from the contract and may also cover an asset to which the buyer has no direct exposure.

Other variations

There are myriad different variations on the vanilla swap structure, which are limited only by the imagination of financial engineers and the desire of corporate treasurers and fund managers for exotic structures.

• A total return swap is a swap in which party A pays the total return of an asset, and party B makes periodic interest payments. The total return is the capital gain or loss, plus any interest or dividend payments. Note that if the total return is negative, then party A receives this amount from party B. The parties have exposure to the return of the underlying stock or index, without having to hold the underlying assets. The profit or loss of party B is the same for him as actually owning the underlying asset. • An option on a swap is called a swaption. These provide one party with the right but not the obligation at a future time to enter into a swap.

INDIAN INSTITUTE OF FINANCE Page 96 [PORTFOLIO MANAGEMENT SOFTWARE]

• A variance swap is an over-the-counter instrument that allows one to speculate on or hedge risks associated with the magnitude of movement, a CMS, is a swap that allows the purchaser to fix the duration of received flows on a swap. • An Amortising swap is usually an interest rate swap in which the notional principal for the interest payments declines during the life of the swap, perhaps at a rate tied to the prepayment of a mortgage or to an interest rate benchmark such as the LIBOR.

CREDIT DERIVATIVES

A credit derivative is a securitized derivative whose value is derived from the credit risk on an underlying bond, loan or any other financial asset. In this way, the credit risk is on an entity other than the counterparties to the transaction itself. This entity is known as the reference entity and may be a corporate, a sovereign or any other form of legal entity which has incurred debt. Credit derivatives are bilateral contracts between a buyer and seller under which the seller sells protection against the credit risk of the reference entity.

Stated in plain language, a credit derivative is a wager, and the reference entity is the thing being wagered on. Similar to placing a bet at the racetrack, where the person placing the bet does not own the horse or the track or have anything else to do with the race, the person buying the credit derivative doesn't necessarily own the bond (the reference entity) that is the object of the wager. He or she simply believes that there is a good chance that the bond or collateralized debt obligation (CDO) in question will default (go to zero value). Originally conceived as a kind of insurance policy for owners of bonds or CDO's, it evolved into a freestanding investment strategy. The cost might be as low as 1% per year. If the buyer of the derivative believes the underlying bond will go bust within a year (usually an extremely unlikely event) the buyer stands to reap a 100 fold profit. A small handful of investors anticipated the credit crunch of 2007/8 and made billions placing "bets" via this method.

The parties will select which credit events apply to a transaction and these usually consist of one or more of the following:

INDIAN INSTITUTE OF FINANCE Page 97 [PORTFOLIO MANAGEMENT SOFTWARE]

• bankruptcy (the risk that the reference entity will become bankrupt) • failure to pay (the risk that the reference entity will default on one of its obligations such as a bond or loan) • obligation default (the risk that the reference entity will default on any of its obligations) • obligation acceleration (the risk that an obligation of the reference entity will be accelerated e.g. a bond will be declared immediately due and payable following a default) • repudiation/moratorium (the risk that the reference entity or a government will declare a moratorium over the reference entity's obligations) • restructuring (the risk that obligations of the reference entity will be restructured)...

Where credit protection is bought and sold between bilateral counterparties, this is known as an unfunded credit derivative. If the credit derivative is entered into by a financial institution or a special purpose vehicle (SPV) and payments under the credit derivative are funded using securitization techniques, such that a debt obligation is issued by the financial institution or SPV to support these obligations, this is known as a funded credit derivative.

This synthetic securitization process has become increasingly popular over the last decade, with the simple versions of these structures being known as synthetic CDOs; credit linked notes; single tranche CDOs, to name a few. In funded credit derivatives, transactions are often rated by rating agencies, which allows investors to take different slices of credit risk according to their risk appetite.

Credit derivatives are fundamentally divided into two categories: funded credit derivatives and unfunded credit derivatives. An unfunded credit derivative is a bilateral contract between two counterparties, where each party is responsible for making its payments under the contract (i.e. payments of premiums and any cash or physical settlement amount) itself without recourse to other assets. A funded credit derivative involves the protection seller (the party that assumes the credit risk) making an initial payment that is used to settle any potential credit events. The advantage of this to the protection buyer is that it is not exposed to the credit risk of the protection seller.

Unfunded credit derivative products include the following products:

INDIAN INSTITUTE OF FINANCE Page 98 [PORTFOLIO MANAGEMENT SOFTWARE]

• Credit default swap (CDS) • Total return swap • Constant maturity credit default swap (CMCDS) • First to Default Credit Default Swap • Portfolio Credit Default Swap • Secured Loan Credit Default Swap • Credit Default Swap on Asset Backed Securities • Credit default swaption • Recovery lock transaction • Credit Spread Option • CDS index products

Funded credit derivative products include the following products:

• Credit linked note (CLN) • Synthetic Collateralised Debt Obligation (CDO) • Constant Proportion Debt Obligation (CPDO) • Synthetic Constant Proportion Portfolio Insurance (Synthetic CPPI)

HYBRID SECURITIES

Hybrid securities are a broad group of securities that combine the elements of the two broader groups of securities, debt and equity.

Hybrid securities pay a predictable (fixed or floating) rate of return or dividend until a certain date, at which point the holder has a number of options including converting the securities into the underlying share.

Therefore, unlike a share of stock (equity) the holder has a 'known' cash flow, and, unlike a fixed interest security (debt) there is an option to convert to the underlying equity. More common examples include convertible and converting preference shares.

INDIAN INSTITUTE OF FINANCE Page 99 [PORTFOLIO MANAGEMENT SOFTWARE]

A hybrid security is structured differently and while the price of some securities behave more like fixed interest securities, others behave more like the underlying shares into which they convert.

TRADITIONAL HYBRIDS

Traditional hybrids were usually structured in a way that leads the securities to react to the underlying share price. Although each has individual characteristics, typically:

• they have a set dividend until conversion • the conversion might occur at a number of dates • they are usually issued at a similar price to the underlying share • they convert at a set ratio. e.g. 1 hybrid converts into 1 underlying share

Note: This fixed conversion ratio means the price of these hybrids react to the movement in the underlying share price. (The extent of the co-relation is sometimes referred to as a delta, and these typically have a delta of between 0.5 and 1) In addition, some of these securities include minimum and maximum conversion terms, effectively giving the holder a put and call option if the share price reaches a certain prices.

LATEST HYBRIDS

Most of the hybrid securities issued recently are very bond-like. Although each has individual characteristics, typically:

• they have a set dividend rate for a 5 year period ('reset' period) • are issued at $100 • the holder has the ability to take the new 'reset' terms, redeem the face value or convert • the holder can convert into the shares at a discount to the current ordinary share price e.g. 5% • the conversion ratio is into a dollar amount of shares. e.g. $100 worth of the underlying equity Note: This 'variable' conversion ratio means the price of these hybrids does not react to the movement in the share price, and they therefore behave

INDIAN INSTITUTE OF FINANCE Page 100 [PORTFOLIO MANAGEMENT SOFTWARE]

in a similar way to fixed interest securities (this lack of co-relation with the underlying shares is sometime referred to as a zero delta).

STRUCTURED FINANCE

SECURITIZATION

Securitization is a structured finance process that distributes risk by aggregating assets in a pool (often by selling assets to a special purpose entity), then issuing new securities backed by the assets and their cash flows. The securities are sold to investors who share the risk and reward from those assets.

Securitization is similar to a sale of a profitable business ("spinning off") into a separate entity. The previous owner trades its ownership of that unit, and all the profit and loss that might come in the future, for present cash. The buyers invest in the success and/or failure of the unit, and receive a premium (usually in the form of interest) for doing so. In most securitized investment structures, the investors' rights to receive cash flows are divided into "tranches": senior tranche investors lower their risk of default in return for lower interest payments, while junior tranche investors assume a higher risk in return for higher interest.

Securitization is designed to reduce the risk of bankruptcy and thereby obtain lower interest rates from potential lenders. A credit derivative is also sometimes used to change the credit quality of the underlying portfolio so that it will be acceptable to the final investors. As a portfolio risk backed by amortizing cash flows - and unlike general corporate debt - the credit quality of securitized debt is non-stationary due to changes in volatility that are time- and structure-dependent. If the transaction is properly structured and the pool performs as expected, the credit risk of all tranches of structured debt improves; if improperly structured, the affected tranches will experience dramatic credit deterioration and loss.

Securitization has evolved from its tentative beginnings in the late 1970s to a vital funding source with an estimated outstanding of $10.24 trillion in the United States and $2.25 trillion

INDIAN INSTITUTE OF FINANCE Page 101 [PORTFOLIO MANAGEMENT SOFTWARE] in Europe as of the 2nd quarter of 2008. In 2007, ABS issuance amounted to $3,455 billion in the US and $652 billion in Europe.

SPECIAL TYPES OF SECURITIZATION

Master trust

A master trust is a type of SPV particularly suited to handle revolving credit card balances, and has the flexibility to handle different securities at different times. In a typical master trust transaction, an originator of credit card receivables transfers a pool of those receivables to the trust and then the trust issues securities backed by these receivables. Often there will be many tranched securities issued by the trust all based on one set of receivables. After this transaction, typically the originator would continue to service the receivables, in this case the credit cards.

There are various risks involved with master trusts specifically. One risk is that timing of cash flows promised to investors might be different from timing of payments on the receivables. For example, credit card-backed securities can have maturities of up to 10 years, but credit card-backed receivables usually pay off much more quickly. To solve this issue these securities typically have a revolving period, an accumulation period, and an amortization period. All three of these periods are based on historical experience of the receivables. During the revolving period, principal payments received on the credit card balances are used to purchase additional receivables. During the accumulation period, these payments are accumulated in a separate account. During the amortization period, new payments are passed through to the investors.

A second risk is that the total investor interests and the seller's interest are limited to receivables generated by the credit cards, but the seller (originator) owns the accounts. This can cause issues with how the seller controls the terms and conditions of the accounts. Typically to solve this, there is language written into the securitization to protect the investors.

INDIAN INSTITUTE OF FINANCE Page 102 [PORTFOLIO MANAGEMENT SOFTWARE]

A third risk is that payments on the receivables can shrink the pool balance and under- collateralize total investor interest. To prevent this, often there is a required minimum seller's interest, and if there was a decrease then an early amortization event would occur.

Issuance trust

In 2000, Citibank introduced a new structure for credit card-backed securities, called an issuance trust, which does not have limitations, that master trusts sometimes do, that requires each issued series of securities to have both a senior and subordinate tranche. There are other benefits to an issuance trust: they provide more flexibility in issuing senior/subordinate securities, can increase demand because pension funds are eligible to invest in investment- grade securities issued by them, and they can significantly reduce the cost of issuing securities. Because of these issues, issuance trusts are now the dominant structure used by major issuers of credit card-backed securities.

Grantor trust

Grantor trusts are typically used in automobile-backed securities and REMICs (Real Estate Mortgage Investment Conduits). Grantor trusts are very similar to pass-through trusts used in the earlier days of Securitization. An originator pools together loans and sells them to a grantor trust, which issues classes of securities backed by these loans. Principal and interest received on the loans, after expenses are taken into account, are passed through to the holders of the securities on a pro-rata basis.

Owner trust

In an owner trust, there is more flexibility in allocating principal and interest received to different classes of issued securities. In an owner trust, both interest and principal due to subordinate securities can be used to pay senior securities. Due to this, owner trusts can tailor maturity, risk and return profiles of issued securities to investor needs. Usually, any income remaining after expenses is kept in a reserve account up to a specified level and then after that, all income is returned to the seller. Owner trusts allow credit risk to be mitigated by over-collateralization by using excess reserves and excess finance income to prepay securities before principal, which leaves more collateral for the other classes.

INDIAN INSTITUTE OF FINANCE Page 103 [PORTFOLIO MANAGEMENT SOFTWARE]

ASSET BACKED SECURITY

An asset-backed security is a security whose value and income payments are derived from and collateralized (or "backed") by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually. Pooling the assets into financial instruments allows them to be sold to general investors, a process called securitization, and allows the risk of investing in the underlying assets to be diversified because each security will represent a fraction of the total value of the diverse pool of underlying assets. The pools of underlying assets can include common payments from credit cards, auto loans, and mortgage loans, to esoteric cash flows from aircraft leases, royalty payments and movie revenues.

Often a separate institution, called a special purpose vehicle, is created to handle the securitization of asset backed securities. The special purpose vehicle, which creates and sells the securities, uses the proceeds of the sale to pay back the bank that created, or originated, the underlying assets. The special purpose vehicle is responsible for "bundling" the underlying assets into a specified pool that will fit the risk preferences and other needs of investors who might want to buy the securities, for managing credit risk—often by transferring it to an insurance company after paying a premium—and for distributing payments from the securities. As long as the credit risk of the underlying assets is transferred to another institution, the originating bank removes the value of the underlying assets from its balance sheet and receives cash in return as the asset backed securities are sold, a transaction which can improve its credit rating and reduce the amount of capital that it needs. In this case, a credit rating of the asset backed securities would be based only on the assets and liabilities of the special purpose vehicle, and this rating could be higher than if the originating bank issued the securities because the risk of the asset backed securities would no longer be associated with other risks that the originating bank might bear. A higher credit rating could allow the special purpose vehicle and, by extension, the originating institution to pay a lower interest rate (that is, charge a higher price) on the asset-backed securities than if the originating institution borrowed funds or issued bonds.

Thus, one incentive for banks to create securitized assets is to remove risky assets from their balance sheet by having another institution assume the credit risk, so that they (the banks)

INDIAN INSTITUTE OF FINANCE Page 104 [PORTFOLIO MANAGEMENT SOFTWARE] receive cash in return. This allows banks to invest more of their capital in new loans or other assets and possibly have a lower capital requirement.

TYPES

Home equity loans

Securities collateralized by home equity loans (HELs) are currently the largest asset class within the ABS market. Investors typically refer to HELs as any nonagency loans that do not fit into either the jumbo or alt-A loan categories. While early HELs were mostly second lien subprime mortgages, first-lien loans now make up the majority of issuance. Subprime mortgage borrowers have a less than perfect credit history and are required to pay interest rates higher than what would be available to a typical agency borrower. In addition to first and second-lien loans, other HE loans can consist of high loan to value (LTV) loans, re- performing loans, scratch and dent loans, or open-ended home equity lines of credit (HELOC),which homeowners use as a method to consolidate debt.

Auto loans

The second largest subsector in the ABS market is auto loans. Auto finance companies issue securities backed by underlying pools of auto-related loans. Auto ABS are classified into three categories: prime, nonprime, and subprime:

• Prime auto ABS are collaterized by loans made to borrowers with strong credit histories. • Nonprime auto ABS consist of loans made to lesser credit quality consumers, which may have higher cumulative losses. • Subprime borrowers will typically have lower incomes, tainted credited histories, or both.

Owner trusts are the most common structure used when issuing auto loans and allow investors to receive interest and principal on sequential basis. Deals can also be structured to pay on a pro-rata or combination of the two.

Credit card receivables

Securities backed by credit card receivables have been benchmark for the ABS market since they were first introduced in 1987. Credit card holders may borrow funds on a revolving basis INDIAN INSTITUTE OF FINANCE Page 105 [PORTFOLIO MANAGEMENT SOFTWARE] up to an assigned credit limit. The borrowers then pay principal and interest as desired, along with the required minimum monthly payments. Because principal repayment is not scheduled, credit card debt does not have an actual maturity date and is considered a nonamortizing loan.

ABS backed by credit card receivables are issued out of trusts that have evolved over time from discrete trusts to various types of master trusts of which the most common is the delinked master trust. Discrete trusts consist of a fixed or static pool of receivables that are tranched into senior/subordinated bonds. A master trust has the advantage of offering multiple deals out of the same trust as the number of receivables grows, each of which is entitled to a pro-rata share of all of the receivables. The delinked structures allow the issuer to separate the senior and subordinate series within a trust and issue them at different points in time. The latter two structures allow investors to benefit from a larger pool of loans made over time rather than one static pool.

Student loans

ABS collateralized by student loans (“SLABS”) comprise one of the four (along with home equity loans, auto loans and credit card receivables) core asset classes financed through asset- backed securitizations and are a benchmark subsector for most floating rate indices. Federal Family Education Loan Program (FFELP) loans are the most common form of student loans and are guaranteed by the U.S. Department of Education ("DOE") at rates ranging from 95%- 98% (if the student loan is serviced by a servicer designated as an "exceptional performer" by the DOE the reimbursement rate was up to 100%). As a result, performance (other than high cohort default rates in the late 1980s) has historically been very good and investors rate of return has been excellent. The College Cost Reduction and Access Act became effective on October 1, 2007 and significantly changed the economics for FFELP loans; lender special allowance payments were reduced, the exceptional performer designation was revoked, lender insurance rates were reduced, and the lender paid origination fees were doubled.

A second, and faster growing, portion of the student loan market consists of non-FFELP or private student loans. Though borrowing limits on certain types of FFELP loans were slightly increased by the student loan bill referenced above, essentially static borrowing limits for FFELP loans and increasing tuition are driving students to search for alternative lenders.

INDIAN INSTITUTE OF FINANCE Page 106 [PORTFOLIO MANAGEMENT SOFTWARE]

Students utilize private loans to bridge the gap between amounts that can be borrowed through federal programs and the remaining costs of education[2].

The United States Congress created the Student Loan Marketing Association (Sallie Mae) as a government sponsored enterprise to purchase student loans in the secondary market and to securitize pools of student loans. Since its first issuance in 1995, Sallie Mae is now the major issuer of SLABS and its issues are viewed as the benchmark issues.

Stranded cost utilities

Rate reduction bonds (RRBs) came about as the result of the Energy Policy Act of 1992, which was designed to increase competition in the US electricity market. To avoid any disruptions while moving from a non-competitive to a competitive market, regulators have allowed utilities to recover certain "transition costs" over a period of time. These costs are considered nonbypassable and are added to all customer bills. Since consumers usually pay utility bills before any other, chargeoffs have historically been low. RRBs offerings are typically large enough to create reasonable liquidity in the aftermarket, and average life extension is limited by a "true up" mechanism.

Others

There are many other cash-flow-producing assets, including manufactured housing loans, equipment leases and loans, aircraft leases, trade receivables, dealer floor plan loans, and royalties. Intangibles are another emerging asset class.

MORTGAGE BACKED SECURITY

A mortgage-backed security (MBS) is an asset-backed security or debt obligation that represents a claim on the cash flows from mortgage loans through a process known as securitization.

Most bonds backed by mortgages are classified as an MBS. This can be confusing, because a security derived from an MBS is also called an MBS. To distinguish the basic MBS bond from other mortgage-backed instruments the qualifier pass-through is used, in the same way that "vanilla" designates an option with no special features.

INDIAN INSTITUTE OF FINANCE Page 107 [PORTFOLIO MANAGEMENT SOFTWARE]

Mortgage-backed security sub-types include:

• A pass-through mortgage-backed security is the simplest MBS, as described in the sections above. Essentially, it is a securitization of the mortgage payments to the mortgage originators. These can be subdivided into:

o A residential mortgage-backed security (RMBS) is a pass-through MBS backed by mortgages on residential property.

o A commercial mortgage-backed security (CMBS) is a pass-through MBS backed by mortgages on commercial property. • A collateralized mortgage obligation (CMO) is a more complex MBS in which the mortgages are ordered into tranches by some quality (such as repayment time), with each tranche sold as a separate security.[13] • A stripped mortgage-backed security (SMBS) where each mortgage payment is partly used to pay down the loan's principal and partly used to pay the interest on it. These two components can be separated to create SMBS's, of which there are two subtypes:

o An interest-only stripped mortgage-backed security (IO) is a bond with cash flows backed by the interest component of property owner's mortgage payments. . A net interest margin security (NIMS) is resecuritized residual interest of a mortgage-backed security.

o A principal-only stripped mortgage-backed security (PO) is a bond with cash flows backed by the principal repayment component of property owner's mortgage payments.

There are a variety of underlying mortgage classifications in the pool:

• Prime mortgages are conforming mortgages with prime borrowers, full documentation (such as verification of income and assets), strong credit scores, etc. • Alt-A mortgages are an ill-defined category, generally prime borrowers but non- conforming in some way, often lower documentation (or in some other way: vacation home, etc.) • Subprime mortgages have weaker credit scores, no verification of income or assets, etc.

INDIAN INSTITUTE OF FINANCE Page 108 [PORTFOLIO MANAGEMENT SOFTWARE]

• Jumbo mortgages when the size of the loan is bigger than the "conforming loan amount" as set by Fannie Mae.

These types are not limited to Mortgage Backed Securities. Bonds backed by mortgages, but are not MBS can also have these subtypes.

Covered bonds

In Europe there exists a type of asset-backed bond called a covered bond, commonly known by the German term Pfandbriefe. Covered bonds were first created in 19th century Germany when Frankfurter Hypo began issuing mortgage covered bonds. The market has been regulated since the creation of a law governing the securities in Germany in 1900. The key difference between covered bonds and mortgage-backed or asset-backed securities is that banks that make loans and package them into covered bonds keep those loans on their books. This means that when a company with mortgage assets on its books issue the covered bond its balance sheet grows, which it wouldn't do if it issued an MBS, although it may still guarantee the securities payments.

COMMERCIAL MORTGAGE BACKED SECURITY

Commercial mortgage-backed securities (CMBS) are a type of mortgage-backed security backed by mortgages on commercial rather than residential real estate.

CMBS issues are usually structured as multiple tranches, similar to CMOs, rather than typical residential "pass-through”. The typical structure for the securitization of commercial real estate loans is a Real Estate Mortgage Investment Conduit (REMIC), a creation of the tax law that allows the trust to be a pass-through entity which is not subject to tax at the trust level.

Many American CMBSs carry less prepayment risk than other MBS types, thanks to the structure of commercial mortgages. Commercial mortgages often contain lockout provisions after which they can be subject to defeasance, yield maintenance and prepayment penalties to protect bondholders. European CMBS issues typically have less prepayment protection. Interest on the bonds is usually floating, i.e. based on a benchmark (like LIBOR/EURIBOR) plus a spread.

INDIAN INSTITUTE OF FINANCE Page 109 [PORTFOLIO MANAGEMENT SOFTWARE]

RESIDENTIAL MORTGAGE BACKED SECURITY

Residential mortgage-backed securities (RMBS) are a type of bond commonly issued in American security markets. They are a type of mortgage-backed security which are backed by mortgages on residential rather than commercial real estate.

TRANCHING

A tranche (often misspelled as traunch or traunche) is one of a number of related securities offered as part of the same transaction. The word tranche is French for slice, section, series, or portion. In the financial sense of the word, each bond is a different slice of the deal's risk. Transaction documentation (see indenture) usually defines the tranches as different "classes" of notes, each identified by letter (e.g. the Class A, Class B, Class C securities) with different bond credit ratings (ratings).

The term "tranche" is used in fields of finance other than structured finance (such as in straight lending, where "multi-tranche loans" are commonplace), but the term's use in structured finance may be singled out as particularly important. Use of "tranche" as a verb is limited almost exclusively to this field.

HOW TRANCHING WORKS

All the tranches together make up what is referred to as the deal's capital structure or liability structure. They are generally paid sequentially from the most senior to most subordinate (and

INDIAN INSTITUTE OF FINANCE Page 110 [PORTFOLIO MANAGEMENT SOFTWARE] generally unsecured), although certain tranches with the same security may be paid pari passu. The more senior rated tranches generally have higher bond credit ratings (ratings) than the lower rated tranches. For example, senior tranches may be rated AAA, AA or A, while a junior, unsecured tranche may be rated BB. However, ratings can fluctuate after the debt is issued and even senior tranches could be rated below investment grade (less than BBB). The deal's indenture (its governing legal document) usually details the payment of the tranches in a section often referred to as the waterfall (because the moneys flow down).

Tranches with a first lien on the assets of the asset pool are referred to as "senior tranches" and are generally safer investments. Typical investors of these types of securities tend to be conduits, insurance companies, pension funds and other risk averse investors.

Tranches with either a second lien or no lien are often referred to as "junior notes". These are more risky investments because they are not secured by specific assets. The natural buyers of these securities tend to be hedge funds and other investors seeking higher risk/return profiles.

"Market information also suggests that the more junior tranches of structured products are often bought by specialist credit investors, while the senior tranches appear to be more attractive for a broader, less specialised investor community". Here is a simplified example to demonstrate the principle:

Example

• A bank transfers risk in its loan portfolio by entering into a default swap with a "ring-fenced" special purpose vehicle (SPV). • The SPV buys gilts (UK government bonds). • The SPV sells 4 tranches of credit linked notes with a waterfall structure whereby: o Tranche A absorbs the first 25% of losses on the portfolio, is the more risky. o Tranche B absorbs the next 25% of losses o Tranche C the next 25% o Tranche D the final 25%, is the least risky. • Tranches B, C and D are sold to outside investors. • Tranche A is bought by the bank itself.

INDIAN INSTITUTE OF FINANCE Page 111 [PORTFOLIO MANAGEMENT SOFTWARE]

COLLETRALIZED DEBT OBLIGATION

Collateralized debt obligations (CDOs) are a type of structured asset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets. CDOs securities are split into different risk classes, or tranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments (and interest rates) or lower prices to compensate for additional default risk.

A few academics, analysts and investors such as Warren Buffett and the IMF's former chief economist Raghuram Rajan warned that CDOs, other ABSs and other derivatives spread risk and uncertainty about the value of the underlying assets more widely, rather than reduce risk through diversification. Following the onset of the 2007-2008 credit crunch, this view has gained substantial credibility. Credit rating agencies failed to adequately account for large risks (like a nationwide collapse of housing values) when rating CDOs and other ABSs.

Many CDOs are valued on a mark to market basis and thus have experienced substantial write-downs on the balance sheet as their market value has collapsed.

CONCEPT

INDIAN INSTITUTE OF FINANCE Page 112 [PORTFOLIO MANAGEMENT SOFTWARE]

CDOs vary in structure and underlying assets, but the basic principle is the same. A CDO is a type of asset-backed security. To create a CDO, a corporate entity is constructed to hold assets as collateral and to sell packages of cash flows to investors. A CDO is constructed as follows:

• A special purpose entity (SPE) acquires a portfolio of underlying assets. Common underlying assets held include mortgage-backed securities, commercial real estate bonds and corporate loans.

• The SPE issues bonds (CDOs) in different tranches and the proceeds are used to purchase the portfolio of underlying assets. The senior CDOs are paid from the cash flows from the underlying assets before the junior securities and equity securities. Losses are first borne by the equity securities, next by the junior securities, and finally by the senior securities.

The risk and return for a CDO investor depends directly on how the CDOs and their tranches are defined, and only indirectly on the underlying assets. In particular, the investment depends on the assumptions and methods used to define the risk and return of the tranches. CDOs, like all asset-backed securities, enable the originators of the underlying assets to pass credit risk to another institution or to individual investors. Thus investors must understand how the risk for CDOs is calculated.

The issuer of the CDO, typically an investment bank, earns a commission at time of issue and earns management fees during the life of the CDO. The ability to earn substantial fees from originating and securitizing loans, coupled with the absence of any residual liability, skews the incentives of originators in favor of loan volume rather than loan quality.

INDIAN INSTITUTE OF FINANCE Page 113 [PORTFOLIO MANAGEMENT SOFTWARE]

COLLETRALIZED FUND OBLIGATION

A collateralized fund obligation (CFO) is a form of securitization involving private equity fund or hedge fund assets, similar to collateralized debt obligations. CFOs are a structured form of financing for diversified private equity portfolios, layering several tranches of debt ahead of the equity holders.

The data made available to the rating agencies for analyzing the underlying private equity assets of CFOs are typically less comprehensive than the data for analyzing the underlying assets of other types of structured finance securitizations, including corporate bonds and mortgage-backed securities. Leverage levels vary from one transaction to another, although leverage of 50% to 75% of a portfolio's net assets has historically been common.

The various CFO structures executed in recent years have had a variety of different objectives resulting in a variety of different structures. These differences tend to relate to the amount of equity sold through the structure as well as to the leverage levels.

INDIAN INSTITUTE OF FINANCE Page 114 [PORTFOLIO MANAGEMENT SOFTWARE]

COLLETRALIZED MORTGAGE OBLIGATION

A collateralized mortgage obligation (CMO) is a type of financial debt vehicle that was first created in 1983 by the investment banks Salomon Brothers and First Boston for U.S. mortgage lender Freddie Mac. (The Salomon Brothers team was lead by Gordon Taylor. The First Boston team was led by Dexter Senft).

Legally, a CMO is a special purpose entity that is wholly separate from the institution(s) that create it. The entity is the legal owner of a set of mortgages, called a pool. Investors in a CMO buy bonds issued by the CMO, and they receive payments according to a defined set of rules. With regard to terminology, the mortgages themselves are termed collateral, the bonds are tranches (also called classes), while the structure is the set of rules that dictates how money received from the collateral will be distributed. The legal entity, collateral, and structure are collectively referred to as the deal.

Investors in CMOs include banks, hedge funds, insurance companies, pension funds, mutual funds, government agencies, and most recently central banks. This article focuses primarily on CMO bonds as traded in the United States of America.

The term collateralized mortgage obligation refers to a specific type of legal entity, but investors also frequently refer to deals issued using other types of entities such as REMICs as CMOs.

INDIAN INSTITUTE OF FINANCE Page 115 [PORTFOLIO MANAGEMENT SOFTWARE]

CREDIT LINKED NOTES

A credit linked note (CLN) is a form of funded credit derivative. It is structured as a security with an embedded credit default swap allowing the issuer to transfer a specific credit risk to credit investors. The issuer is not obligated to repay the debt if a specified event occurs. This eliminates a third-party insurance provider.

It is issued by a special purpose company or trust, designed to offer investors par value at maturity unless the referenced entity defaults. In the case of default, the investors receive a recovery rate.

The trust will also have entered into a default swap with a dealer. In case of default, the trust will pay the dealer par minus the recovery rate, in exchange for an annual fee which is passed on to the investors in the form of a higher yield on their note.

The purpose of the arrangement is to pass the risk of specific default onto investors willing to bear that risk in return for the higher yield it makes available. The CLNs themselves are typically backed by very highly-rated collateral, such as U.S. Treasury securities.

The Italian dairy products giant, Parmalat, notoriously dressed up its books by creating a credit-linked note for itself, betting on its own credit worthiness.

In Hong Kong and Singapore, credit-linked notes have been marketed as "minibonds" and sold to individual investors. After Lehman Brothers, the major issuer of minibond in Hong Kong and Singapore, filed for bankruptcy in September 2008, many retail investors of

INDIAN INSTITUTE OF FINANCE Page 116 [PORTFOLIO MANAGEMENT SOFTWARE] minibonds claim that banks and brokers mis-sold minibonds as low-risk products. Many banks accepted minibonds as collateral for loans and credit facilities.

EXAMPLE

A bank lends money to a company, XYZ, and at the time of loan issues credit-linked notes bought by investors. The interest rate on the notes is determined by the credit risk of the company XYZ. The funds the bank raises by issuing notes to investors are invested in bonds with low probability of default. If company XYZ is solvent, the bank is obligated to pay the notes in full. If company XYZ goes bankrupt, the note-holders/investors become the creditor of the company XYZ and receive the company XYZ loan. The bank in turn gets compensated by the returns on less-risky bond investments funded by issuing credit linked notes.

UNSECURED DEBT

In finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation.

In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors, although the unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors.

In some legal systems, unsecured creditors who are also indebted to the insolvent debtor are able (and in some jurisdictions, required) to set-off the debts, which actually puts the unsecured creditor with a matured liability to the debtor in a pre-preferential position.

AGENCY SECURITY

Agency securities are specific securities that are issued by either Ginnie Mae, Fannie Mae, Freddie Mac or the Federal Home Loan Banks. These securities are backed by mortgage loans, and due to their creation from these particular corporations that are sponsored by the

INDIAN INSTITUTE OF FINANCE Page 117 [PORTFOLIO MANAGEMENT SOFTWARE]

U.S. government, they enjoy credit protection based on an explicit guarantee from the U.S. Government in the case of Ginnie Mae securities, or an implicit guarantee from the U.S. Government in the case of Fannie Mae and Freddie Mac.

Due to the expectation of federal backing, these securities historically hold the highest credit rating possible.

Importance of Portfolio Management Portfolio management is viewed as a very important task in the business.

provides the mean importance ratings of portfolio management, broken down by executive function. Not surprisingly, senior managers in technology (CTOs, VPs of R&D, etc.) are evaluated as giving portfolio management the highest importance ratings of all functions (see ‘technology management’ with a score of 4.1 out of 5, where 5 = critically important). They are followed by senior management overall and then by corporate executives Of the 20 percent top performing firms, senior managers are given the value of 4.2 on the 5-point scale, the technology managers in the top 20% are given a 4.6 out of 5.

INDIAN INSTITUTE OF FINANCE Page 118 [PORTFOLIO MANAGEMENT SOFTWARE]

Why So Critical?

Consider these eight key reasons cited by senior management who took part in the study:

1. Financial – to maximize return; to maximize R&D productivity; to achieve financial goals.

2. To maintain the competitive position of the business – to increase sales and market share.

3. To properly and efficiently allocate scarce resources.

4. To forge the link between project selection and business strategy: the portfolio is the expression of strategy; it must support the strategy.

5. To achieve focus – not doing too many projects for the limited resources available; and to resource the “great” projects.

6. To achieve balance – the right balance between long and short term projects, and high risk and low risk ones, consistent with the business’s goals.

7. To better communicate priorities within the organization, both vertically and horizontally.

8. To provide better objectivity in project selection – to weed out bad projects.

These eight reasons were uncovered in part by asking managers to rate possible reasons why portfolio management might be important in their businesses. Seven possible reasons were suggested, and ratings on each one were sought

INDIAN INSTITUTE OF FINANCE Page 119 [PORTFOLIO MANAGEMENT SOFTWARE]

1. Financial : Not surprisingly, the most frequently mentioned reasons by far for why portfolio management is so vital are financial – making the most money, bang for buck, and so on. Many of these financial reasons obviously are closely related to maintaining the competitive position of the business and to effective resource allocation, but it is indeed interesting to note how much the financial concerns dominate the discussion on why the business undertakes portfolio management. Comments such as “... because it [portfolio management] improves and maximizes R&D productivity” and “... to get the best return on investment” are typical here.

2. Maintaining (or improving) the competitive position of the business – the number one rated item in Figure 3 – is echoed in the “top of mind” comments as a reason why portfolio management is important. The types of comments offered include “... because we must continue to meet our growth targets” and “... because we must depend on new products to grow”.

INDIAN INSTITUTE OF FINANCE Page 120 [PORTFOLIO MANAGEMENT SOFTWARE]

3. Properly and efficiently allocating scarce resources is a key issue for managements, and is rated an important reason why portfolio management is critical (see Figure 3). Today’s business is called upon to develop and launch more new products, and faster than ever. But resources have not increased. Thus, allocating these scarce resources is more vital than ever, hence the increasing importance of portfolio management. A typical comment is that “portfolio management focuses resources on projects that matter most to the business”. In the same vein, “portfolio management is important to ensure that the limited number of new product projects we can do and our limited development resources are aimed at parts of the business that need them most and can maximize their value”.

4. Strategic issues is another major “top of mind” theme (see Figure 4), which coincidently, is the number three rated reason for the importance of portfolio management in Figure 3. Increasingly, the realization is that strategy begins when one starts spending money, and so resource allocation to projects is how strategy is implemented. Comments such as “portfolio management is the tangible expression of strategy” and “portfolio management is critical because it provides the basis for meeting defined business objectives” are common.

INDIAN INSTITUTE OF FINANCE Page 121 [PORTFOLIO MANAGEMENT SOFTWARE]

5. The desire to achieve better focus – not doing too many projects for the resources available – is also a highly rated reason, and emerges in the “top of mind” comments as well (see Figures 3 and 4). “We have too many projects ... we wish to resource the great ones!” and “we want to make sure that the resources are focused on the right ones” characterize the desire for focus.

6. The goal of the right balance of projects (e.g., between long term and short term, between high risk and low risk) is yet another highly rated reason (see Figure 3). “Portfolio management makes sure that where resources are spent is consistent with short term and long term business goals” and “portfolio management helps to balance short term and long term goals” are typical comments.

7. Improved communication within the organization is a frequently-mentioned “top of mind” reason for viewing portfolio management as important (see Figure 4). Some communication is vertical and for visibility reasons: “portfolio management is a very effective communication tool between executive management and divisional management” and “portfolio management provides visibility for all projects so that

INDIAN INSTITUTE OF FINANCE Page 122 [PORTFOLIO MANAGEMENT SOFTWARE] people understand why we are working on a certain project” are comments heard here.

Horizontal communication – across functions – is also a frequently cited “top of mind” reason for adopting portfolio management: Comments are that “portfolio management promotes communication between R&D and Commercial” and “... to maintain uniform priorities [of projects] across functions”.

8. Providing better objectivity in project selection is the final reason for the importance accorded portfolio management management “greatly reduces the tendency for ‘pet projects’ to enter the system – projects that cannot really be justified” and that effective portfolio management must be in place “... to ensure that projects do not take on a life of their own – that older projects which have outlived their usefulness can be killed and replaced by others.”

Popular Portfolio Management Methods Used

INDIAN INSTITUTE OF FINANCE Page 123 [PORTFOLIO MANAGEMENT SOFTWARE]

1. Financial methods dominate portfolio management and project selection approaches. Financial methods include various profitability and return metrics, such as NPV, RONA, ROI or payback period. See Figure 6 for an example of a typical financial method, the ECV approach. The popular Productivity Index method is yet another but similar approach here [13,20]. A total of 77.3 percent of businesses use a financial approach in portfolio management and project selection – see Figure 5 – while 40.4 percent of businesses rely on financial approaches as the dominant portfolio method. That is, project selection and the composition of the portfolio of projects boils down to a financial calculation, and the rating and ranking of projects is based on this financial number or index!

2. The business’s strategy as the basis for allocating money across different types of projects is the second most popular portfolio approach. For instance, having decided the business’s strategy, money is allocated across different types of projects and into different envelopes or buckets. Projects are then ranked or rated within buckets. See Figure 7 for a disguised example of one strategic method as used in a major

INDIAN INSTITUTE OF FINANCE Page 124 [PORTFOLIO MANAGEMENT SOFTWARE] materials company – we labelled it the Strategic Buckets approach A total of 64.8 percent of businesses use a strategic approach to select their portfolio of projects; for 26.6 percent of businesses, this is the dominant method.

INDIAN INSTITUTE OF FINANCE Page 125 [PORTFOLIO MANAGEMENT SOFTWARE]

3. Bubble diagrams or portfolio maps have received much hype and exposure in recent books, articles and software. Here, projects are plotted on an X-Y plot or map, much like bubbles or balloons. Projects are categorized according to the zone or quadrant they are in (e.g., pearls, oysters, white elephants, and bread-andbutter projects) – see Figure 8 for an example. These bubble diagrams resemble the original portfolio models – Stars, Cash Cows, Dogs, etc. – except that the axes are quite different, and projects rather than business units are plotted [12]. A total of 40.6 percent of businesses use portfolio maps; only 5.3 percent of businesses use this as their dominant method, however.

INDIAN INSTITUTE OF FINANCE Page 126 [PORTFOLIO MANAGEMENT SOFTWARE]

4. Scoring models: Here, projects are rated or scored on a number of questions or criteria (for example, low-medium-high; or 1-5 or 0-10 scales). The ratings on each scale are then added to yield a Total or Project Score, which becomes the criterion used to make project selection and/or ranking decisions. This addition is done in a simple or a weighted fashion (certain questions are weighted more heavily, reflecting greater importance). Figure 9 provides a sample of the scoring model used in a major chemical company [6]. A total of 37.9 percent of businesses use scoring models; in 13.3 percent, this is the dominant decision method.

INDIAN INSTITUTE OF FINANCE Page 127 [PORTFOLIO MANAGEMENT SOFTWARE]

INDIAN INSTITUTE OF FINANCE Page 128 [PORTFOLIO MANAGEMENT SOFTWARE]

5. Check lists: Projects are evaluated on a set of Yes/No questions. Each project must achieve either all Yes answers, or a certain number of Yes answers to proceed. The number of Yes’s is used to make Go/Kill and/or prioritization (ranking) decisions. Only 20.9 percent of businesses use check lists; and in only 2.7 percent is this the dominant method.

6. Others: Twenty-four percent of businesses indicate that they use some “other method”– other than the ones described above. A closer scrutiny of these “other” methods reveals that most are variants or hybrids of the above models and methods, for example:

Many businesses that responded “other method” describe a strategically driven process, much like the strategic method above. That is, they let their business’s strategy drive the spending splits (e.g., across buckets such as markets, product types, project types) and even let their strategy drive the choice of individual projects.

INDIAN INSTITUTE OF FINANCE Page 129 [PORTFOLIO MANAGEMENT SOFTWARE]

A number of businesses use multiple criteria – profitability, strategic, customer appeal – but not necessarily in a formal scoring model format (as in method 4 above).

Some businesses use probabilities of commercial and technical success, either multiplied together, or multiplied by various financial numbers (EBIT, NPV) – a variant of the financial methods (#1 above).

How Sound Are Their Portfolios?

Portfolio management appears to be working in a moderately satisfactory fashion on average in our sample of businesses. Mean scores across the six performance metrics are typically in the mid-range area – not stellar, but not disastrous either – although there are some major differences across performance metrics (see Figure 17; the black bars show mean values). But averages don’t tell the whole story here: there are broad distributions of responses on these six performance metrics, suggesting major differences between the best and worst performers.

INDIAN INSTITUTE OF FINANCE Page 130 [PORTFOLIO MANAGEMENT SOFTWARE]

The Best Versus the Rest

This large performance spread begs the question: Who are these better performers? And what is it that they are doing differently than the poor performers? To answer the questions, we developed a single performance gauge, based on the six individual metrics in Figure 175. To gain insights into best practices, we separated the top 20 percent of businesses – the Best – measured by their portfolio performance on this gauge, and compare their results and practices to the bottom 20 percent of businesses – the Worst.

As might be expected, the top performers – the Best – achieve dramatically better portfolio performance results across all six performance metrics (Figure 17, the pairs of shaded bars). For example, their portfolios are aligned with the business’s objectives and R&D spending mirrors the business’s strategy; and their portfolios contain very high value projects.

INDIAN INSTITUTE OF FINANCE Page 131 [PORTFOLIO MANAGEMENT SOFTWARE]

However, the two areas where the Best really excel are:

 portfolio balance – achieving the right balance of projects; and

 having the right number of projects for the resources available.

Both are areas where the average business performs fairly weakly.

Reasons for Portfolio Managements Failure

When portfolio management wrong, expect serious negative consequences in your total new product efforts. Indeed, many of the ailments that plague businesses’ new product efforts can be directly or indirectly traced to ineffective portfolio management, according to the mangers we interviewed in the exploratory phase of the investigation (see box):

 Strategic: One negative side of poor portfolio management is that strategic criteria are missing in project selection. This translates into no strategic direction to projects selected; projects not strategically aligned with the business strategy; many strategically unimportant projects in the portfolio; and R&D spending that does not reflect strategic priorities of the business. The end result is a scattergun R&D and new product effort that does not support the company’s strategy.

 Low value projects: Poor portfolio management means deficient Go/Kill and project selection decisions, which in turn leads to many mediocre projects in the pipeline – too many extensions, modifications, enhancements and short-term projects. Many of these are marginal value projects to the business. This translates into a lack of stellar, high reward projects, while the few really good projects are starved for resources – they take too long, and may fail to achieve their full potential.

INDIAN INSTITUTE OF FINANCE Page 132 [PORTFOLIO MANAGEMENT SOFTWARE]

 No focus: Another outcome of poor portfolio management is a strong reluctance to kill projects: there are no consistent criteria for Go/Kill decisions, and projects just get added to active list. The result is a lack of focus – too many projects, and resources thinly spread. This in turn leads to increased times to market, poor quality of execution, and decreased success rates.

 The wrong projects: Poor portfolio management means that often the wrong projects are selected. With no formal selection method, decisions are not based on facts and objective criteria, but rather on politics, opinion and emotion ... for example, “pet” projects of some senior executive. Many of these emotionally-selected projects fail. Portfolio management is typically very poorly handled, however. It was rated as the weakest area in new product management in a recent benchmarking study

Management confessed to no serious Go/Kill decision points in their new product process; no criteria for making the Go/Kill decision; poor project prioritization; and too many projects for the limited resources available.

How to identify the best portfolio

INDIAN INSTITUTE OF FINANCE Page 133 [PORTFOLIO MANAGEMENT SOFTWARE]

Importance of Portfolio Management

Senior managements in the Best companies consistently and significantly view portfolio management as much more important than do managements in the Worst (see Figure 18, the pairs of shaded bars). This is true regardless of functional area. Thus, there appears to be a direct link between whether senior management in a business recognizes portfolio management to be important, and the portfolio results it achieves. Once again, however, technology managers score by far the highest here, with senior technology management in the Best businesses rating portfolio management a very high 4.6 out of 5 in importance. Marketing/Sales and Operations/Production managements continue to be perceived as seeing portfolio management as less vital, even among the Best businesses.

Explicit Portfolio Method

Does having a consistently applied, explicit portfolio management process have any impact on performance? Definitely yes, according to the results of the survey. Consider

INDIAN INSTITUTE OF FINANCE Page 134 [PORTFOLIO MANAGEMENT SOFTWARE] the major and significant differences between the Best and the Worst in Figure 19: The Best, when compared to the Worst

 Have an explicit, established method for portfolio management,  Where management buys into the method, and supports it through their actions;  The method has clear rules and procedures,  It treats projects as a portfolio (considers all projects together and treats them as a portfolio), and  It is consistency applied across all appropriate projects.

These differences between Best and Worst are consistent and major. The clear message is this: Businesses that achieve positive portfolio results – a balanced, strategically aligned, high value portfolio, with the right numbers of projects and good times-to-market (no gridlock) – boast a clearly defined, explicit, all-project, consistently applied portfolio management process which management endorses. Poor performers lack this!

Portfolio Methods Used

The Best have decided preferences for which portfolio model or method dominates their decision process (see Figure 20):

 The Best tend to rely much less on financial models and methods as the dominant portfolio tool than does the average business. By contrast, the Worst place much more emphasis on financial tools. For example, only 35.9 percent of the Best rely on financial models as their dominant method, whereas 56.4 percent of the Worst use this as their dominant portfolio method.

 The Best let the business strategy allocate resources and decide the portfolio much more so than do the Worst. Only 10.3 percent of the Worst use the business’s strategy as the dominant method, compared to 38.5 percent of the Best. Indeed, business strategy methods are the number one method for the

INDIAN INSTITUTE OF FINANCE Page 135 [PORTFOLIO MANAGEMENT SOFTWARE]

Best, used even more so than the popular financial approaches as the dominant decision tool here – see Figure 20.

The use of other methods – scoring models, check lists, bubble diagrams – as the dominant approach is too infrequent to allow meaningful comparison of Best versus Worst (Figure 20).

Multiple Methods Used

The Best tend to reply on multiple methods for portfolio management – that is, they appear to acknowledge that no one method gives the correct results. For example, the Best on average use 2.43 different portfolio management techniques per business to select projects and manage their portfolio, while almost half of the Best (47.5%) use

INDIAN INSTITUTE OF FINANCE Page 136 [PORTFOLIO MANAGEMENT SOFTWARE] three or more methods! Even the average business uses multiple methods (2.34 per business). The Worst tend to rely on far fewer or even one portfolio method more so (1.83 methods per business, on average), with almost half of the Worst focusing on a single method only (46.3% of the Worst use only one portfolio approach).

Challenges Remaining

Although most businesses in the study recognize the need for and importance of portfolio management, there are still many issues that need to be addressed. Thus, we asked managers to identify what are the most significant challenges ahead The most common challenge identified is the need to create a positive climate, culture and buy-in for their portfolio method. As might be expected, a key issue in any new process is the need to obtain organizational buy-in. Without total senior executive support, the portfolio management process becomes a difficult sell.

INDIAN INSTITUTE OF FINANCE Page 137 [PORTFOLIO MANAGEMENT SOFTWARE]

Other challenges and issues pertain to achieving the primary goals of portfolio management – achieving business objectives, obtaining linkages to strategy and achieving balance – and to the tools needed to obtain the needed information to be able to make disciplined decisions.

The most common complaint cited by managers is the abundance of short term, low risk projects in the pipeline. People are too busy working on these types of projects to be able to devote the time and energy needed to develop the next generation of “big winners” for the company. Executives are concerned that the need for quick hits in the market is placing longer term projects at risk.

Is Portfolio Management worth an Investment ?

A number of benefits have been derived from implementing portfolio management aside from the obvious goals of obtaining better financial returns. Figure 22 lists the “top of the mind” near-term benefits that managers expect to reap from their efforts in portfolio management.

INDIAN INSTITUTE OF FINANCE Page 138 [PORTFOLIO MANAGEMENT SOFTWARE]

The most frequently cited benefit is the expectation of achieving a common basis for discussion. By putting discipline into the process and providing a consistent basis of comparison, people are able to compare projects and to assess them from the same base of information and using the same criteria. Consistency in evaluations across projects is the result.

Managers also expect to obtain better focus, balance and strategic alignment – to target projects that are better and are more closely aligned to strategy, and to obtain the right mix between short and long term projects. By being better able to focus their resources, they expect to be in a position to reduce time to market and have the resources to seek the projects that will make a significant difference to the organization. Implications for Management Action

Here then are our conclusions and suggestions – a call to action:

INDIAN INSTITUTE OF FINANCE Page 139 [PORTFOLIO MANAGEMENT SOFTWARE]

1. Portfolio management works! Those businesses that have gone to the trouble of installing a systematic, explicit portfolio management system – one with clear rules and procedures, that is consistently applied across all appropriate projects and treats all projects as a portfolio, and which management buys into – are the clear winners [8,10]. Their portfolios outperform the rest on all six performance metrics: higher value projects; better balance; the right number of projects; a strategically aligned portfolio; and so on. The message is clear:

Step #1 is to make a commitment to installing a systematic, formal and rigorous portfolio management system or process in your business.

2. Sell all senior management on the importance of portfolio management.

Management buy-in is one of the key challenges identified in the study. Further, while many senior managements are well aware of the importance of portfolio management, many others are not – perhaps out of ignorance, or perhaps because they think that project selection and portfolio management is “an R&D thing”, best handled by technology management people. Finally, those businesses where portfolio management is accorded great importance are also doing the best – their portfolios are in great shape! So there is a strong link here between perceived importance, management buyin, and doing well. Perhaps the toughest sell will be to the senior Marketing/Sales and Operations

Management people. They seem to be the least in tune with the importance of portfolio management. As ammunition, we offer you our list of eight key reasons why other businesses and their senior managements see portfolio management as so important

3. There is no one right portfolio management method – so try a hybrid approach.

Certainly financial models and methods are the most popular, with 77 percent of businesses using them, and 40 percent relying on them as the dominant portfolio decision tool. But there is great diversity of approaches as well: strategic approaches, scoring models and bubble diagrams are also popular, and can easily be used in INDIAN INSTITUTE OF FINANCE Page 140 [PORTFOLIO MANAGEMENT SOFTWARE] conjunction with financial models, and in concert with each other. Indeed, the Best businesses tend to use a combination or hybrid approach – an average of 2.43 portfolio methods per business. Finally, no one method has a monopoly on strengths and positive performance. Rather, strengths and weaknesses were offered in verbal comments for all methods, and while certain portfolio methods do yield superior portfolio results, when used in conjunction with other methods, the results are even better.

4. Beware an over-reliance on financial methods and models.

Those businesses that use financial methods as the dominant portfolio selection method end up with the worst and poorest performing portfolios! This is ironic: these businesses adopted what appeared to be a rigorous approach to project evaluation, namely a financial tool, in order to maximize returns and performance, yet achieved exactly the opposite outcomes. Why? One reason is that the sophistication of financial tools often far exceed the quality of the data inputs (These sophisticated tools can be quite elegant, andinclude ECV, Productivity Index and even probabilistic models such as At Risk and Crystal Ball6; but the data inputs are often based on flimsy market and costs analyses).A second reason is that the key Go/Kill and prioritization decisions must be made fairly early in the life of a project, precisely when the financial data are the least accurate! A final reason is that financial projections are fairly easy to “rig”, consciously or unconsciously, especially by an over-zealous project team

5. Look more to strategic approaches as the way to manage your portfolio.

Businesses that rely principally on strategic methods for portfolio management outperform the rest. Recall that 39 percent of the Best businesses use strategic approaches as the dominant portfolio method, while only 10 percent of the Worst do. Strategic approaches, such as Strategic Buckets, can be used to allocate resources or funds into different buckets. Look to Figure 11 for a list of the popular bucket categories: by market; by project type; by product line; by project size; and by technology type. So first consider electing one or more of these dimensions, and splitting resources into INDIAN INSTITUTE OF FINANCE Page 141 [PORTFOLIO MANAGEMENT SOFTWARE] buckets. Begin with your business’s new product goals, vision and strategy, and then move to resource splits

Remember: strategy begins when you start spending money!

INDIAN INSTITUTE OF FINANCE Page 142 [PORTFOLIO MANAGEMENT SOFTWARE]

Next, categorize your projects according to buckets, and then rank order your projects by bucket, as in Figure 7. You can consider financial methods or perhaps scoring models to do the ranking within buckets. This strategic method will ensure that your R&D spending reflects your business’s strategy

6. Consider a scoring model as an effective prioritization tool.

The users of scoring models have great praise for them, and see them as effective and efficient decision tools for portfolio management. Scoring models have the advantage that they combine the popular financial criteria with the desirable strategic criteria (Note that in the sample scoring model in Figure 9, the first two criteria are financial ones, and Factors 2 and 3 are both strategic factors). Use the sample in Figure 9, but also consider the often-used project evaluation criteria in Figure 14, and build these into a scoring model for your own use.

INDIAN INSTITUTE OF FINANCE Page 143 [PORTFOLIO MANAGEMENT SOFTWARE]

Employ scoring models at gate meetings to make Go/Kill and prioritization decisions; and utilize the project scores to help make prioritization decisions at periodic portfolio review meetings. A word of caution: don’t use the project score mechanistically. The real value is the process of decision-makers walking through the criteria, discussing each and gaining closure on each criterion, rather than dwelling on the score itself!

7. Bubble diagrams must also be part of your repertoire of portfolio models. They receive very high praise from management, who very strongly recommend their use to others. Moreover they are thought to be an effective decision tool, yielding correct portfolio decisions. Bubble diagrams have the advantage that they portray the entire portfolio in visual format, and are also able to display portfolio balance. Do look at the list of possible bubble diagrams: the majority of users plot the traditional risk-reward diagram (as in Figure 8), but Figure 15 shows some other axes that you should consider for your bubble diagrams.

INDIAN INSTITUTE OF FINANCE Page 144 [PORTFOLIO MANAGEMENT SOFTWARE]

UNDERSTANDING PORTFOLIO MANAGEMENT

Over time, other industry sectors have adapted and applied these ideas to other types of "investments," including the following:

INDIAN INSTITUTE OF FINANCE Page 145 [PORTFOLIO MANAGEMENT SOFTWARE] whether to buy additional applications, and when to "sell" -- that is, retire -- an obsolete software application.

What Does Portfolio Management Mean? The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance.

INDIAN INSTITUTE OF FINANCE Page 146 [PORTFOLIO MANAGEMENT SOFTWARE]

Portfolio Management is used to select a portfolio of new product development projects to achieve the following goals:

• Maximize the profitability or value of the portfolio • Provide balance • Support the strategy of the enterprise

• Heuristic models • Scoring techniques • Visual or mapping techniques

INDIAN INSTITUTE OF FINANCE Page 147 [PORTFOLIO MANAGEMENT SOFTWARE]

INDIAN INSTITUTE OF FINANCE Page 148 [PORTFOLIO MANAGEMENT SOFTWARE] the vertical axis is Probability of Success. The size of the bubble is proportional to the total revenue generated over the lifetime sales of the product.

Our recommended approach is to start with the overall business plan that should define the planned level of R&D investment, resources (e.g., headcount, etc.), and related sales expected from new products. With multiple business units, product lines or types of development, we recommend a strategic allocation process based on the business plan. This strategic allocation should apportion the planned R&D investment into business units, product lines, markets, geographic areas, etc. It may also breakdown the R&D investment into types of development, e.g., technology development, platform development, new products, and upgrades/enhancements/line extensions, etc.

The portfolio First, we can now introduce a definition of portfolio that relates more directly to the context of our preceding discussion. In the IBM view, a portfolio is:

INDIAN INSTITUTE OF FINANCE Page 149 [PORTFOLIO MANAGEMENT SOFTWARE]

One of a number of mechanisms, constructed to actualize significant elements in the Enterprise Business Strategy. It contains a selected, approved, and continuously evolving, collection of Initiatives which are aligned with the organizing element of the Portfolio, and, which contribute to the achievement of goals or goal components identified in the Enterprise Business Strategy.

INDIAN INSTITUTE OF FINANCE Page 150 [PORTFOLIO MANAGEMENT SOFTWARE]

Portfolio reviews and decision making As initiatives are executed, the organization should conduct periodic reviews of actual (versus planned) performance and conformance to original expectations. Typically, organization managers specify the frequency and contents for these periodic reviews, and individual portfolio managers oversee their planning and execution. The reviews should be multi-dimensional, including both tactical elements (e.g., adherence to plan, budget, and resource allocation) and strategic elements (e.g., support for business strategy goals and delivery of expected organizational benefits). A significant aspect of oversight is setting multiple decision points for each initiative, so that managers can periodically evaluate data and decide whether to continue the work. These "continue/change/discontinue" decisions should be driven by an understanding (developed via the periodic reviews) of a given initiative's continuing value, expected benefits, and strategic contribution. Making these decisions at multiple points in the initiative's lifecycle helps to ensure that managers will continually examine and assess changing internal and external circumstances, needs, and performance.

INDIAN INSTITUTE OF FINANCE Page 151 [PORTFOLIO MANAGEMENT SOFTWARE]

Portfolio management governance involves multiple dimensions, including: • Defining and maintaining an enterprise business strategy. • Defining and maintaining a portfolio structure containing all of the organization's initiatives (programs, projects, etc.). • Reviewing and approving business cases that propose the creation of new initiatives. • Providing oversight, control, and decision-making for all ongoing initiatives. • Ownership of portfolios and their contents. Each of these dimensions requires an owner -- either an individual or a collective -- to develop and approve plans, continuously adjust direction, and exercise control through periodic assessment and review of conformance to expectations. A good governance structure decomposes both the types of work and the authority to plan and oversee work. It defines individual and collective roles, and links them to an authority scheme. Policies that are collectively developed and agreed upon provide a framework for the exercise of governance. The complexities of governance structures extend well beyond the scope of this article. Many organizations turn to experts for help in this area because it is so critical to the success of any business transformation effort that encompasses portfolio management. For now, suffice it to say that it is worth investing time and effort to create a sound and flexible governance structure before you attempt to implement portfolio management practices.

INDIAN INSTITUTE OF FINANCE Page 152 [PORTFOLIO MANAGEMENT SOFTWARE]

Portfolio management, like bridge-building, is a discipline, and a number of authors and practitioners have documented fundamental ideas about its exercise. Recently, based on our experiences with clients who have implemented portfolio management practices and on our research into the discipline, we have started to shape an IBM view of fundamental ideas around portfolio management. We are beginning to express this view as a collection of "essentials" that are, in turn, grouped around a small collection of portfolio management themes. For example, one of these themes is initiative value contribution. It suggests that the value of an initiative (i.e., a program or project) should be estimated and approved in order to start work, and then assessed periodically on the basis of the initiative's contribution to the goals and goal components in the enterprise business strategy. These assessments determine (in part) whether the initiative warrants continued support. This theme encompasses the notion that initiative value changes over time. When an initiative is in the proposal stage, it is possible to quantify an anticipated value contribution. On this basis (in part) the proposed initiative becomes an approved initiative. But what about an initiative that is a large program effort, with a two-year duration? It is highly unlikely that the program's expected value will remain static during the entire two-year period, so continuous value monitoring is necessary. From this, we can derive an essential statement: Initiative value changes and requires continuous monitoring over the life of the initiative.

Portfolio Management Process

The Processes on Demand portfolio management process is a best practice for management of the projects and programs of the portfolio. The portfolio management process steps include:

. Portfolio Management Process • Identification • Categorization • Evaluation • Selection • Prioritization

INDIAN INSTITUTE OF FINANCE Page 153 [PORTFOLIO MANAGEMENT SOFTWARE]

• Balancing • Authorization • Review and Reporting • Strategic Change . Governance Process • Consultation • Preparation • Selection . Portfolio Management Dashboards • Status Summary View • Gantt View • Cost View • Risk view

INDIAN INSTITUTE OF FINANCE Page 154 [PORTFOLIO MANAGEMENT SOFTWARE]

What are the benefits of Portfolio Management?

When implemented properly and conducted on a regular basis, Portfolio Management is a high impact, high value activity:

INDIAN INSTITUTE OF FINANCE Page 155 [PORTFOLIO MANAGEMENT SOFTWARE]

• Enables objective project selection

Top performers emphasize the link between project selection and business strategy.

Why is it so important?

Companies without effective new product portfolio management and project selection face a slippery road downhill. Many of the problems that plague new product development initiatives in businesses can be directly traced to ineffective portfolio management. According to benchmarking studies conducted by Dr. Cooper and Dr. Edgett, some of the problems that arise when portfolio management is lacking are:

As a result too many companies have:

Models INDIAN INSTITUTE OF FINANCE Page 156 [PORTFOLIO MANAGEMENT SOFTWARE]

. Arbitrage pricing theory 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 . The Jensen Index . The Treynor Index . The Sharpe Diagonal (or Index) model . Value at risk model

MPT is a mathematical formulation of the concept of diversification in investing, with the aim of selecting a collection of investment assets that has collectively lower risk than any individual asset. That this is possible can be seen intuitively because different types of assets often change in value in opposite ways. For example, when prices in the stock market fall, prices in the bond market often increase, and vice versa. A collection of both types of assets can therefore have lower overall risk than either individually. But diversification lowers risk even if assets' returns are not negatively correlated—indeed, even if they are positively correlated.

INDIAN INSTITUTE OF FINANCE Page 157 [PORTFOLIO MANAGEMENT SOFTWARE] are not perfectly positively correlated, MPT seeks to reduce the total variance of the portfolio return. MPT also assumes that investors are rational and markets are efficient.

In general:

. Expected return:

where Rp is the return on the portfolio, Ri is the return on asset i and wi is the weighting of component asset i (that is, the share of asset i in the portfolio).

INDIAN INSTITUTE OF FINANCE Page 158 [PORTFOLIO MANAGEMENT SOFTWARE]

. Portfolio return variance:

where ρij is the correlation coefficient between the returns on assets i and j. Alternatively the expression can be written as:

where ρij = 1 for i=j.

. Portfolio return volatility (standard deviation):

For a two asset portfolio:

. Portfolio return:

. Portfolio variance:

For a three asset portfolio:

. Portfolio return:

. Portfolio variance:

The single-index model (SIM) is a simple asset pricing model commonly used in the finance industry to measure risk and return of a stock. Mathematically the SIM is expressed as:

INDIAN INSTITUTE OF FINANCE Page 159 [PORTFOLIO MANAGEMENT SOFTWARE]

where:

rit is return to stock i in period t

rf is the risk free rate (i.e. the interest rate on treasury bills)

rmt is the return to the market portfolio in period t

αi is the stock's alpha, or abnormal return

βi is the stocks's beta, or responsiveness to the market return

Note that rit − rf is called the excess return on the stock, rmt − rf the excess return on the market

εit is the residual (random) return, which is assumed normally distributed with mean zero and standard deviation σi

The CAPM is a model for pricing an individual security or a portfolio. For individual securities, we make use of the security market line (SML) and its relation to expected return

INDIAN INSTITUTE OF FINANCE Page 160 [PORTFOLIO MANAGEMENT SOFTWARE] and systematic risk (beta) to show how the market must price individual securities in relation to their security risk class. The SML enables us to calculate the reward-to-risk ratio for any security in relation to that of the overall market. Therefore, when the expected rate of return for any security is deflated by its beta coefficient, the reward-to-risk ratio for any individual security in the market is equal to the market reward-to-risk ratio, thus:

The market reward-to-risk ratio is effectively the market risk premium and by rearranging the above equation and solving for E(Ri), we obtain the Capital Asset Pricing Model (CAPM).

where:

. is the expected return on the capital asset

. is the risk-free rate of interest such as interest arising from government bonds

. (the beta) is the sensitivity of the expected excess asset returns to the

expected excess market returns, or also ,

. is the expected return of the market

. is sometimes known as the market premium or risk premium (the difference between the expected market rate of return and the risk-free rate of return).

Restated, in terms of risk premium, we find that:

which states that the individual risk premium equals the market premium times β.

Note 1: the expected market rate of return is usually estimated by measuring the Geometric Average of the historical returns on a market portfolio (e.g. S&P 500).

INDIAN INSTITUTE OF FINANCE Page 161 [PORTFOLIO MANAGEMENT SOFTWARE]

Note 2: the risk free rate of return used for determining the risk premium is usually the arithmetic average of historical risk free rates of return and not the current risk free rate of return.

For the full derivation see Modern portfolio theory.

Arbitrage pricing theory (APT), in finance, is a general theory of asset pricing, that has become influential in the pricing of stocks.

The APT model

Risky asset returns are said to follow a factor structure if they can be expressed as:

where

. E(rj) is the jth asset's expected return,

. Fk is a systematic factor (assumed to have mean zero),

. bjk is the sensitivity of the jth asset to factor k, also called factor loading,

. and εj is the risky asset's idiosyncratic random shock with mean zero.

Idiosyncratic shocks are assumed to be uncorrelated across assets and uncorrelated with the factors.

INDIAN INSTITUTE OF FINANCE Page 162 [PORTFOLIO MANAGEMENT SOFTWARE]

The APT states that if asset returns follow a factor structure then the following relation exists between expected returns and the factor sensitivities:

where

. RPk is the risk premium of the factor,

. rf is the risk-free rate,

That is, the expected return of an asset j is a linear function of the assets sensitivities to the n factors.

In finance, Jensen's alpha (or Jensen's Performance Index, ex-post alpha) is used to determine the abnormal return of a security or portfolio of securities over the theoretical expected return.

In the context of CAPM, calculating alpha requires the following inputs:

. the realized return (on the portfolio), . the market return, . the risk-free rate of return, and INDIAN INSTITUTE OF FINANCE Page 163 [PORTFOLIO MANAGEMENT SOFTWARE]

. the beta of the portfolio.

Jensen's alpha = Portfolio Return − [Risk Free Rate + Portfolio Beta * (Market Return − Risk Free Rate)]

Since Eugene Fama, many academics believe financial markets are too efficient to allow for repeatedly earning positive Alpha, unless by chance. To the contrary, empirical studies of mutual funds spearheaded by Russ Wermers usually confirm managers' stock- picking talent, finding positive Alpha. However, they also show that after fees and expenses are deducted, the effective Alpha for investors is negative. (These results also explain why passive investing is increasingly popular.)

Nevertheless, Alpha is still widely used to evaluate mutual fund and portfolio manager performance, often in conjunction with the Sharpe ratioand the Treynor ratio.

where

Treynor ratio, portfolio i's return,

risk free rate

Portfolio i's beta

Like the Sharpe ratio, the Treynor ratio (T) does not quantify the value added, if any, of active portfolio management. It is a ranking criterion only. A ranking of portfolios based on

INDIAN INSTITUTE OF FINANCE Page 164 [PORTFOLIO MANAGEMENT SOFTWARE] the Treynor Ratio is only useful if the portfolios under consideration are sub-portfolios of a broader, fully diversified portfolio. If this is not the case, portfolios with identical systematic risk, but different total risk, will be rated the same. But the portfolio with a higher total risk is less diversified and therefore has a higher unsystematic risk which is not priced in the market.

An alternative method of ranking portfolio management is Jensen's alpha, which quantifies the added return as the excess return above the security in the capital asset pricing model. As they two both determine rankings based on systematic risk alone, they will rank portfolios identically.

"Given some confidence level the VaR of the portfolio at the confidence level α is given by the smallest number l such that the probability that the loss L exceeds l is not larger than (1 − α)"

INDIAN INSTITUTE OF FINANCE Page 165 [PORTFOLIO MANAGEMENT SOFTWARE]

"charlatanism." On the other hand, many academics prefer to assume a well-defined distribution, albeit usually one with fat tails. This point has probably caused more contention among VaR theorists than any other.

Software used in Portfolio management

Mprofit portfolio management software details describes the electronic portfolio development process further and covers seven different software and hardware tools for creating portfolios. Some very good commercial electronic portfolio programs are on the market, although they often reflect the developerís style or are constrained by the limits of the software structure. Many educators who want to develop electronic portfolios tend to design their own, using off-the-shelf software or generic strategies. Here, I discuss the structure of each type of program, the advantages and disadvantages of each strategy, the relative ease of learning the software, the level of technology required, and related issues. The seven generic types of software are:

INDIAN INSTITUTE OF FINANCE Page 166 [PORTFOLIO MANAGEMENT SOFTWARE]

1. Relational databases 2. Hypermedia "card" software 3. Multimedia authoring software 4. World Wide Web (HTML) pages 5. Adobe Acrobat (PDF files) 6. Multimedia slideshows 7. Video (digital and analog)

It helps us to maintain following attributes:-

 Manage an unlimited number of portfolios and groups.

 Manage assets like Stocks, MFs, ETFs,ULIPs, Insurance Policies, Private Equity, FDs, Bonds, PPF, Gold, Silver, Property, Art and many more...

 Import data from contract notes, CAMS/ KARVY, excel templates and online portals.

 Asset Allocation reports with graphs.

 Online update of BSE stock prices, Mutual Fund NAVs and ETFs.

 Quick Summary view with multiple sorting options by name or current value.

 Summary & detailed transaction wise Capital Gain Tax reports for Stocks & MFs.

 Annualised Returns (XIRR) report.

 Tax Calculator. INDIAN INSTITUTE OF FINANCE Page 167 [PORTFOLIO MANAGEMENT SOFTWARE]

 Online update for newly listed stocks, mutual funds and ETFs.

 Again very helpful in finding the following:-  Keep track of your purchase & sale transactions of stocks in a simple and familiar contract note format as well as subscription, redemptions & dividend reinvestment entries of mutual funds.

 Daily Gain, Overall Gain, Current Value for Stocks and MFs.

 Support for bonuses, splits, merger & demerger transactions (closing balances and capital gain calculations are adjusted based on these corporate actions as per the income tax rules).

 Support for adding multiple buy and sell transactions in one contract note form.

 Manage transactions related to short selling in stocks.

 Mutual Fund transactions can be entered to buy (subscribe), sell (redeem), dividend reinvestment and addition of bonus units (value for such bonus units is zero).

 Auto generate past SIP (Systematic Investment Plan) entries for mutual funds.

 Keep track of mutual funds schemes with folio numbers.

 Lock-In Period and reminder alert for MFs (very useful for ELSS tax saving schemes.

 Transactions related to Exchange Traded Funds (ETFs)..

It can also manage your investments such as ULIPs,insurance policies and your Private Equity holdings. The features for ULIPs and insurance policies are:-

INDIAN INSTITUTE OF FINANCE Page 168 [PORTFOLIO MANAGEMENT SOFTWARE]

Keep track of all the details associated with your ULIP and insurance plans. Information such as:

 Policy Number, Sum Assured, Name of the nominee, Premium Term, Lock-in Date and Maturity Date.

 Reminder alert for the premium, lock-in date and maturity date.

 Complete record of premium and withdrawals.

 Keep track of funds associated with ULIP plans.

 Manage units quantity and NAV values for ULIP funds.

 Option to set ULIP policy value based on funds values or manually as per the policy statement.

In the Private Equity category you can list transactions related to unlisted/delisted stocks as well as shares of Private Limited companies. It can manage other asset classes as well such as FDs,bonds, PPF/EPF, gold, silver, jewellry, property, art and many othersI

The features for FDs/Bonds/Deposits/Loans/PPF/EPF and Post Office Schemes are:

 Calculation of current value and maturity values

 Display of daily gain in terms of accrued (accumulated) interest

 Interest in PPF/EPF category is calculated based on PPF rules

INDIAN INSTITUTE OF FINANCE Page 169 [PORTFOLIO MANAGEMENT SOFTWARE]

 Interest calculation is based on reducing balance method in case of loans, deposits and Post Office schemes

 Current value can be set based on interest rate or market value for bonds  Track income received from rental income and other sources

It allows you to import your financial data from a wide variety of data sources. We have 4 categories of file types we support: Oynckjxcvsdnkfvnsdkjnfvsjdknvkjfdnvkjfdnvkjnrkjge4ut58598546845585ndng jdfngkjdfngkjdf  Brokerage digital contract notes - we support brokers such as Kotak, MF Global, Motilal Oswal, Reliance Securities, Way2Wealth and many others brokers, we are constantly adding new brokers to the list.

 CAMS/KARVY mutual fund files - we support Karvy 201/221, Karvy personal file, CAMS WBR2 and CAMS personal files.

 Predefined Excel formats - using the templates provided you can import your stock and mutual fund Transactions.

 Online portals - we currently support Value Research Online and NJ Fundz. This allows you to keep a backup of your financial data on your computer and also aggregate all your financial data.

INDIAN INSTITUTE OF FINANCE Page 170 [PORTFOLIO MANAGEMENT SOFTWARE]

The power of our software is via the reports that can be generated.These reports allow you to view your portfolio and understand where and how your investments are performing. Features include:

 Provides various reports that can be easily understood and customized per your needs.

 Choose from various report types, such as Capital Gains, Transaction, Analytical, Accounting and Miscellaneous Reports

 Investors can review the diversification and performance of their portfolios through Asset Allocation and Realised/Unrealised gains reports.

 Asset Allocation reports can display either a pie chart or bar chart. Portfolio Summary Reports can also be customised for printing of any single asset type, for e.g. Portfolio summary for only Stocks, MFs, ULIPs, etc.

 Detailed contract notes view for stock transactions.

 Annualised Returns (XIRR) report.

 Long Term, Short Term and Intra-day Profit/Loss reports in a variety of formats like Summary, Transaction Wise and Detailed Transaction Wise (where multiple purchased quantities of different dates are sold on  one date) are available.

 Categorised into stocks, equity mutual funds and debt mutual funds.  Reports are adjusted for bonuses, splits, merger & demerger transactions as per income tax rules.  It has many features that allow you to take control of your investments and analyze your portfolio. Some of the other features are:

INDIAN INSTITUTE OF FINANCE Page 171 [PORTFOLIO MANAGEMENT SOFTWARE]

 Online update of BSE stock prices, mutual fund NAVs and ETFs

 Automated weekly/monthly data backups to a local hard drive or USB pen drive.

 Database update for newly listed stocks, mutual funds, ETFs and company name change updates.

 Balloon notification of Annualised Returns (XIRR) for a single asset, an asset category or all assets for a particular portfolio or group

 Software updates as we keep improving the functionality and adding new features and reports

 Instant display of details like folio number, lock-in period, maturity date, agent name, reference name for various assets via balloon notification

 Instant display of details for ULIP and Insurance products like policy numbers, maturity date and lock-in date via balloon notification

 Password feature for owner (full access) and user (can only enter transactions and can’t see current prices and values)

 Support for internet proxy settings (helpful in corporate office networks)

 Various reminder alerts such as due dates for insurance premiums, maturity of FDs, deposits and insurance  policies, and for other investments can be set

INDIAN INSTITUTE OF FINANCE Page 172 [PORTFOLIO MANAGEMENT SOFTWARE]

Import Your Data

MProfit allows you to import your data from a wide variety of data sources including digital contract notes, CAMS/KARVY files, Excel templates and online portals.

Digital Contract Notes

• Anagram Securities • Atlas Integrated Finance • Eastern Financiers • ENAM Securities • Guiness Securities • IL&FS Invest smart • ISE Securities • Kotak Securities • Lalkar Securities • MF Global-Sify • Motilal Oswal • Networth Stock Broking • Reliance Securities • Way2Wealth

.CAMS/KARVY

• CAMS Online • CAMS WBR2 file • KARVY Online • KARVY 201 and 221 file

.Excel Templates

• MProfit stock template • MProfit mutual fund template .

INDIAN INSTITUTE OF FINANCE Page 173 [PORTFOLIO MANAGEMENT SOFTWARE]

Online Portals

• NJ Fundz

Software Features

The Family Office is a concept from the West where the management and investment decisions for a single wealthy family occur centrally. Although we don’t call them Family Office’s in India, most families are run like Family Office’s since the investment decisions affect the entire extended family. When we designed MProfit we took a look at the India Family Office concept and made it a central part of the software via our Groups feature. Our grouping feature allows you to aggregate all your individual personal portfolios into a single group view. This single group view is similar to how most Indian families view their portfolios as a single portfolio and not just individual portfolios.

The Grouping feature is very powerful when you create reports within MProfit. One example is the Group Asset Allocation report for Stocks, with this report you can easily see where you major stock holdings are for your entire family. Without the Grouping feature you would have to manually figure out each individual’s stock allocation and the add them together in Excel…not very efficient or easy. With MProfit, it takes just one click to generate the report.

Overall, MProfit is actually a Family Office software solution for Indian households and our easy to use interface is the perfect way to manage all your assets. Other family (group) features:

• Consolidated view of entire family (group) networth • Create and manage multiple family (group) portfolios in various combinations of your individual portfolios • Group Annualised Return (XIRR) for any asset, asset category or family portfolio • Group Holding report which gives you detailed holdings for group members • Asset Allocation report for the entire family (group) • Due Date report for the entire family (group) for insurance premium payment, maturity and lock-in

INDIAN INSTITUTE OF FINANCE Page 174 [PORTFOLIO MANAGEMENT SOFTWARE]

Overview of Reports

We have updated our Reporting Overview video to reflect the new reports and the changes to some existing reports. MProfit has 5 main categories for reports: Analytical, Transaction, Capital Gains, Accounts and Miscellaneous.

INDIAN INSTITUTE OF FINANCE Page 175 [PORTFOLIO MANAGEMENT SOFTWARE]

Capital Gains Calculations

The financial year 2009-10 is over and in the next several months most of us will be filing our income tax returns. If you invest in stocks and/or mutual funds, you will need to prepare the capital gains calculations for your short-term and long-term gains for stocks and mutual funds. Also, if you have any intra-day profits/losses for stocks you will have to calculate those gains as well.

MProfit provides various simplified reports for capital gains calculations. MProfit follows the First In First Out (FIFO) method for calculating capital gains. MProfit provides a summary as well as transaction wise capital gains reports. Capital gains reports are listed separately for equity mutual funds and debt mutual funds.

MProfit calculates and adjusts capital gains calculations based on corporate actions such as merger, de-merger and split and bonus.

Below are several articles which explain in detail how MProfit handles capital gains calculations.

Capital Gain Calculations for Shares (Stocks) http://www.mprofit.in/2009/07/capital-gain-calculations-for-shares-stocks/

Capital Gain Calculations for Mutual Funds (MF) http://www.mprofit.in/2009/07/capital-gain-calculations-for-mutual-funds-mf/

INDIAN INSTITUTE OF FINANCE Page 176 [PORTFOLIO MANAGEMENT SOFTWARE]

A video tutorial on Capital Gains Reports http://www.mprofit.in/2010/03/capital-gains-reports/

Lastly, MProfit not only calculates capital gains post sale, MProfit has a feature called Tax Calculator. The Tax Calculator can help you determine your short-term and long-term capital gains and the amount of tax payable before you decide to sell your stocks or mutual funds.

Reporting Capabilities

One the biggest benefits of using MProfit is our reporting capabilities. You may find other services available on the internet but most cannot compete with it comes to reporting. We provide over 45 types of reports and are adding new ones based on customer feedback.

We have 5 main categories for reports: Analytical, Transaction, Capital Gains, Accounts and Miscellaneous.

Managing your Mutual Funds

A continuing series that describes how MProfit handles specific asset classes and how you can benefit from it.

There are many product that manage Mutual Funds, but none are as powerful as MProfit. Whether you have equity or debt mutual funds…we can manage it. You can choose from the 1000s of mutual funds, Exchange Traded Funds (ETFs) and Fixed Maturity Plans (FMPs) to manage. With our unique Group view, you can aggregate and view your entire family’s portfolio. Some of the features are below:

• NAVs are automatically updated via the internet and reflected in your mutual funds holdings • Capital Gain tax reports are printed separately for Equity MF and Debt MF • Transactions in MF are categorised as subscription (buy), redemption (sale), dividend reinvestment and bonus units

INDIAN INSTITUTE OF FINANCE Page 177 [PORTFOLIO MANAGEMENT SOFTWARE]

• Provision for details like folio number, lock-in period, agent name and reminder alert for lock-in period • Record for dividend pay-out for MFs • Balloon notification displays folio number, lock-in period and Agent name (when your mouse is rolled over the MF name) • Tax Calculator to help identify short-term and long-term gain and calculate the tax liability before you redeem (sell) MF units • Generate past SIP entries through one form • MF holdings can be viewed alphabetically or by current values • Group (Family) portfolio will give you the consolidated view your entire family’s MF holdings. You can view the details of how many family members are holding one particular fund with details like quantity, purchase value and current value.

Reports

Wait, there is more. Where MProfit really shines is it’s reporting engine (it’s like a Ferrari!). The Group (Family) portfolio reports such as MF portfolio summary, asset allocation in mutual funds, group holding reports and annualised returns (XIRR) are very important reports to help you make the right investment decisions. Overall, the report feature list is quite impressive:

• MF portfolio pummary with overall gain percentage gain • Asset allocation with pie chart showing percent holding with respect to MF assets and overall assets • Annualised return (XIRR) reports for individual scheme as well as for all your MFs • Realised and unrealised gain for MF schemes • Various transaction reports such as Date wise, scheme wise as well as buy, sale and dividend re-investment transactions • Short term capital gain reports for equity and debt MFs in various formats • Closing balance report for MFs to reconcile with books of accounts

INDIAN INSTITUTE OF FINANCE Page 178 [PORTFOLIO MANAGEMENT SOFTWARE]

Asset Class: Bond’s

A continuing series that describes how MProfit handles specific asset classes and how you can benefit from it.

The current and maturity values for bonds are calculated based on the interest rate, frequency of interest payout and cumulative or payout option.

The current and maturity values of remaining bonds will be adjusted when you sell some bonds from your total holdings. The closing balance of bonds will be calculated based on the original purchase price and the remaining quantity. This balance cost will match with the balance in your books of accounts.

You can add transactions to your existing bond investments. The terms related to interest rate, frequency of interest pay-out, cumulative or pay-out options and maturity value will remain the same as original first investment. The current values and maturity values will be adjusted based on subsequent purchases.

There is also an option to add transactions related to interest payout, which will not have any affect on the current or maturity values. This transaction is helpful in computing the total gain from the investment and when calculating your annualised returns (XIRR).

You can decide to calculate the values of bonds based on two options:

1) Set the value based on the interest rate

2) Set the value by manually adding the bond price

The option to add cumulative interest is provided via the bonds transactions screen. Investors may want to pass this entry for tax calculation purposes. The accrued interest up to 31st March can be passed as a cumulative interest entry in MProfit. INDIAN INSTITUTE OF FINANCE Page 179 [PORTFOLIO MANAGEMENT SOFTWARE]

MProfit is designed in such a way that there will not be any difference in current and maturity values of bonds even if you pass the cumulative entry at the end of any period.

Asset Class: Fixed Deposit’s

A continuing series that describes how MProfit handles specific asset classes and how you can benefit from it.

The current value and maturity value of bank fixed deposit’s (FDs) are calculated based on the interest rate, frequency of interest payout and cumulative or payout option. MProfit has provided the option to enter transactions for partial withdrawals to take care of FDs which are linked to your bank accounts. If partial withdrawal has occured, you will need to enter the principal amount as well as the interest payout (optional) on this withdrawal.

The assumption is that the bank pays out interest on this partial withdrawal. Usually bank gives less interest for partial withdrawal as opposed to holding the FD till full maturity. After a partial withdrawal, MProfit will calculate daily gain, overall gain, current and maturity value based on your balance principal amount with the same terms of your original FD.

MProfit has provided the option to add cumulative interest in terms of FDs. Although, banks do not show this entry in their FD statement, investors may want to pass this entry for the tax calculation purposes. The accrued interest up to 31st March can be passed as cumulative interest entry in MProfit, so as to tally the balance with the books of accounts. MProfit is designed in such a way that there will not be any difference in current and maturity value of this FD even if you pass the cumulative entry at the end of any period.

Lastly, you can set the alert for the lock-in period (if any) as well as the maturity date for FDs created in MProfit.

Unit Linked Insurance Plans (ULIPs) and Pension Plans INDIAN INSTITUTE OF FINANCE Page 180 [PORTFOLIO MANAGEMENT SOFTWARE]

Unit Linked Insurance Plans (ULIPs) are very complex products from the data management perspective. There are more than 25 insurance companies and each has many ULIP products and each ULIP product has 4 to 8 associated funds. ULIP holder can switch between the funds and the units are reduced to recover the mortality charges and other charges. We currently do not provide the NAV of each ULIP product. We will try to incorporate the same in future if we find it feasible.

In spite of the complexity, we have tried to provide the complete ULIP management module in MProfit. We believe that each investor would have one or two ULIP products to manage in his portfolio. How data should be entered and managed for ULIP products in MProfit is explained below in details.

Once you create the ULIP plan manually, fill out all the details about your policy (one time) and you can create the associated funds by going into Edit Fund Allocation. You can create the funds as per the plan you have chosen.

There are couple of ways you can set the current policy value to be reflected in your net worth summary.

Go to Transaction list of ULIP product and Click on the Set Current Value button and choose the appropriate option. a) Periodically, (suggested monthly), you can go to Transaction List and Click on Other Transactions and click on Edit Fund Allocation and change the Quantity of units and NAV of your funds. The policy value will be calculated based on these data. b) Second option is to calculate the policy value as per the total premium paid – withdrawal (Use Set Current Value feature) c) Third option is to set the policy value manually. You can directly enter the policy value periodically (say monthly) based on the statement of your ULIP policy and this will be reflected in your net worth of your portfolio (Use Set Current Value feature). You do not need to enter the fund details and this is the simplest method to capture your policy value to be included in your net worth.

INDIAN INSTITUTE OF FINANCE Page 181 [PORTFOLIO MANAGEMENT SOFTWARE]

ULIP products are very long term in nature and we recommend them to update the policy value every month as per the statement of your ULIP policy based on your choice of setting. By doing this, you can almost capture the true value of your ULIP investments in your net worth summary.

You can manage the Unit Linked Pension Plans in the same manner, which will be without insurance details.

Adding Exchange Traded Funds (ETFs) in MProfit

You can add all Exchange Traded Funds (ETFs) in MProfit. ETFs fall under the category of Mutual Funds.

A Mutual Fund/ETF scheme is classified as an equity-oriented scheme if it has holdings in the equity of domestic companies, amounting to 65 per cent or more, on an average, during the year. A scheme that does not fulfil this condition is considered as a debt-oriented scheme. All Gold ETFs fall under Debt MF category.

Some of the ETFs listed in MProfit are

• Gold Benchmark Exchange Traded Scheme (Gold BeES) • Reliance Gold Exchange Traded Fund-Dividend Payout Option • SBI GOLD EXCHANGE TRADED SCHEME • UTI GOLD Exchange Traded Fund • Liquid Benchmark Exchange Traded Scheme (Liquid BeES) • Nifty Benchmark Exchange Traded Scheme- Nifty BeES • Nifty Junior Benchmark Exchange Traded Scheme (Junior BeES) • Sensex ICICI Prudential Exchange Traded Fund • PSU Bank Benchmark Exchange Traded Scheme (PSU Bank BeES) • Banking Index Benchmark Exchange Traded Scheme (Bank BeES) • Reliance Banking Exchange Traded Fund-Dividend Option

Comparing Portfolio Values for Different Periods

INDIAN INSTITUTE OF FINANCE Page 182 [PORTFOLIO MANAGEMENT SOFTWARE]

Many of the users have asked us how they can compare their own individual portfolios as well as family (group) portfolios for different periods.

One of the easiest way to do this is to save asset allocation reports for individual portfolios and group portfolios in pdf or excel format, say monthly or quarterly. You can then always compare your portfolio values of past and current date.

You need to go to Analytical Reports and select Asset Allocation Reports. In stead of printing this report, you need to click the ‘Save’ button on the top panel of your report window. Select the format in which you want to save your reports and save it with the appropriate name ending with date, for e.g. Name1-NetWorth-31-Mar-2009, Name2-NetWorth-30-Jun-2009. Once you do that, it would be extremely easy to compare your net worth reports for different dates. Please let me know if you have any suggestions or better ideas.

Software Updates

As part of our continuous effort to improve MProfit we have added several new features based on customer feedback to MProfit v4.03:

• An income module • Reports relating to annualized returns (XIRR) • Group holding reports

With our new Income Module, you can track a variety of income related transactions:

• Dividends received from any stock or mutual fund • Rental income from property you own • Other income from your other assets • Bonus (accrued and pay-out) in case of insurance plans

A new feature that many of you have requested is finally here – reports relating to annualised returns (XIRR). With our new Annualized Returns report you can see how your specific investments are performing. Also, by highlighting a specific area of the summary screen we provide instant balloon notification of Annualised Returns (XIRR) for a single asset, an asset category or all assets for an individual portfolio or group portfolio. INDIAN INSTITUTE OF FINANCE Page 183 [PORTFOLIO MANAGEMENT SOFTWARE]

In addition, we have introduced new reports for group holdings. You can view the performance of your group holdings by stocks, equity MFs or debt MFs or a combined view of all your asset classes.

Also, this version fixes some minor bugs.

How Do I Get The Update?

When using MProfit you will be prompted about the availability of v4.03. You will need to accept and allow the installation to enjoy the latest features of MProfit.

When you accept, the update will be downloaded and installed on your desktop. Please make sure that you have internet connectivity during this process and your antivirus software and/or firewall is not blocking the download to allow the installation of the MProfit update.

Why Portfolios?

Portfolio assessment has become more commonplace in schools because it allows teachers to assess student development over periods of time, sometimes across several years.

People develop portfolios at all phases of the lifespan. Educators in the Pacific Northwest (Northwest Evaluation Association, 1990), developed the following definition of portfolio.

A portfolio is a purposeful collection of student work that exhibits the studentís efforts, progress, and achievements in one or more areas. The collection must include student participation in selecting contents, the criteria for selection; the criteria for judging merit, and evidence of student self- reflection. Electronic Portfolios. My definition of electronic portfolio includes the use of electronic technologies that allow the portfolio developer to collect and organize artifacts in many

INDIAN INSTITUTE OF FINANCE Page 184 [PORTFOLIO MANAGEMENT SOFTWARE] formats (audio, video, graphics, and text). A standards-based electronic portfolio uses hypertext links to organize the material to connect artifacts to appropriate goals or standards. Often, the terms electronic portfolio and digital portfolio are used interchangeably. However, I make a distinction: an electronic portfolio contains artifacts that may be in analog (e.g., videotape) or computer-readable form. In a digital portfolio, all artifacts have been transformed into computer-readable form. An electronic portfolio is not a haphazard collection of artifacts (i.e., a digital scrapbook or multimedia presentation) but rather a reflective tool that demonstrates growth over time.

Electronic Portfolio Development

Electronic portfolio development brings together two different processes: multimedia project development and portfolio development. When developing an electronic portfolio, equal attention should be paid to these complimentary processes, as both are essential for effective electronic portfolio development. (See the online supplement at www.iste.org/L&L for a complete discussion of these processes.

 It consists of Five Stages

I have created a process for developing an electronic portfolio based on the general portfolio and multimedia development processes (Table 1).

Table 1: Stages of Electronic Portfolio Development Portfolio Stages of Electronic Multimedia Development Portfolio Development Development Purpose & 1. Defining the Portfolio Decide, Assess Audience Context & Goals Collect, 2. The Working Portfolio Design, Plan Interject Select, Reflect, 3. The Reflective Portfolio Develop

INDIAN INSTITUTE OF FINANCE Page 185 [PORTFOLIO MANAGEMENT SOFTWARE]

Direct Inspect, 4. The Connected Portfolio Implement, Perfect, Evaluate Connect Respect 5. The Presentation Present, (Celebrate) Portfolio Publish

Differentiating the Levels of Electronic Portfolio Implementation. In addition to the stages of portfolio development, there appear to be at least five levels of electronic portfolio development. Just as there are developmental levels in student learning, there are developmental levels in digital portfolio development. Table 2 presents different levels for electronic portfolio development, which are closely aligned with the technology skills of the portfolio developer.

Table 2. Levels of electronic portfolio software strategies based on ease of use. 0 All documents are in paper format. Some portfolio data may be stored on videotape. 1 All documents are in digital file formats, using word processing or other commonly used software, and stored in electronic folders on a hard drive, floppy disk, or LAN server. 2 Portfolio data is entered into a structured format, such as a database or HyperStudio template or slide show (such as PowerPoint or AppleWorks) and stored on a hard drive, Zip, floppy disk, or LAN. 3 Documents are translated into Portable Document Format with hyperlinks between standards, artifacts, and reflections using Adobe Acrobat Exchange and stored on a hard drive, Zip, Jaz, CD-R/W, or LAN server. 4 Documents are translated into HTML, complete with hyperlinks between standards, artifacts, and reflections, using a Web authoring program and posted to a Web server. 5 Portfolio is organized with a multimedia authoring program, incorporating digital sound and video. Then it is converted to digital

INDIAN INSTITUTE OF FINANCE Page 186 [PORTFOLIO MANAGEMENT SOFTWARE]

format and pressed to CD-R/W or posted to the Web in streaming format.

Based on these levels and stages, I offer a few items to consider as you make this software selection.

Stage 1: Defining the Portfolio Context and Goals (Keywords: Purpose, Audience, Decide, Assess). What is the assessment context, including the purpose of the portfolio? Is it based on learner outcome goals (which should follow from national, state, or local standards and their associated evaluation rubrics or observable behaviors)? Setting the assessment context frames the rest of the portfolio development process.

What resources are available for electronic portfolio development? What hardware and software do you have and how often do students have access to it? What are the technology skills of the students and teachers? Some possible options are outlined in Tables 3 & 4.

Table 3. Technology skill levels. 1 Limited experience with desktop computers but able to use mouse and menus and run simple programs 2 Level 1 plus proficient with a word processor, basic e-mail, and Internet browsing; can enter data into a predesigned database 3 Level 2 plus able to build a simple hypertext (nonlinear) document

INDIAN INSTITUTE OF FINANCE Page 187 [PORTFOLIO MANAGEMENT SOFTWARE]

with links using a hypermedia program such as HyperStudio or Adobe Acrobat Exchange or an HTML WYSIWYG editor 4 Level 3 plus able to record sounds, scan images, output computer screens to a VCR, and design an original database 5 Level 4 plus multimedia programming or HTML authoring; can also create QuickTime movies live or from tape; able to program a relational database

Table 4. Technology Available 1 No computer 2 Single computer with 16 MB RAM, 500 MB HD, no AV input/output 3 One or two computers with 32 MB RAM, 1+ GB HD, simple AV input (such as QuickCam) 4 Three or four computers, one of which has 64+ MB RAM, 2+GB HD, AV input and output, scanner, VCR, video camera, high-density floppy (such as a Zip drive) 5 Level 4 and CD-ROM recorder, at least two computers with 128+ MB RAM; digital video editing hardware and software. Extra Gb+ storage (such as Jaz drive)

Who is the audience for the portfolioóstudent, parent, professor, or employer? The primary audience for the portfolio affects the decisions made about the format and storage of the presentation portfolio. Choose a format the audience will most likely have access to (e.g., a home computer, VCR, or the Web).

You will know you are ready for the next stage when you have:

INDIAN INSTITUTE OF FINANCE Page 188 [PORTFOLIO MANAGEMENT SOFTWARE]

• identified the purpose and primary audience for your portfolio, • identified the standards or goals you will use to organize your portfolio, and • selected your development software and completed the first stage using that software.

Stage 2: The Working Portfolio (Keywords: Collect, Interject, Design, Plan). What is the content of portfolio items (determined by the assessment context) and the type of evidence to be collected? This is where the standards become a very important part of the planning process. Knowing which standards or goals you are trying to demonstrate should help determine the types of portfolio artifacts to collect. For example, if the portfolio goal is to demonstrate the standard of clear communication, then examples should reflect studentís writing (scanned or imported from a word processing document) and speaking abilities (sound or video clips).

Which software tools are most appropriate for the portfolio context and the resources available? This question is the theme of the rest of this article. The software used to create the electronic portfolio will control, restrict, or enhance the portfolio development process. The electronic portfolio software should match the vision and style of the portfolio developer.

Which storage and presentation medium is most appropriate for the situation (computer hard disk, videotape, LAN, the Web, CD-ROM)? The type of audience for the portfolio will determine this answer. There are also multiple options, depending on the software chosen.

What multimedia materials will you gather to represent a learnerís achievement? Once you have answered the questions about portfolio context and content and addressed the limitations on the available equipment and usersí skills (both teachersí and studentsí), you will be able to determine the type of materials you will digitize.

This can include written work, images of 3-D projects, speech recordings, and video clips of performances. You will want to collect artifacts from different time periods to demonstrate growth and learning achieved over time.

You will know you are ready for the next stage when you have:

• collected digital portfolio artifacts that represent your efforts and achievement throughout the course of your learning experiences, and

INDIAN INSTITUTE OF FINANCE Page 189 [PORTFOLIO MANAGEMENT SOFTWARE]

• used the graphics and layout capability of your chosen software to interject your vision and style into the portfolio artifacts.

Stage 3: The Reflective Portfolio (Keywords: Select, Reflect, Direct, Develop). How will you select the specific artifacts from the abundance of the working portfolio to demonstrate achieving the portfolioís goals? What are your criteria for selecting artifacts and for judging merit? Having a clear set of rubrics at this stage will help guide portfolio development and evaluation.

How will you record self-reflection on work and achievement of goals? The quality of the learning that results from the portfolio development process may be in direct proportion to the quality of the studentsí self-reflection on their work. One challenge in this process is to keep these reflections confidential. The personal, private reflections of the learner need to be guarded and not published in a public medium.

How will you record teacher feedback on student work and achievement of goals, when appropriate? Even more critical is the confidential nature of the assessment process. Teachersí feedback should also be kept confidential so that only the student, parents, and other appropriate audiences have access. Security, in the form of password protection to control access, is an important factor when choosing electronic portfolio development software.

How will you record goals for future learning based on the personal reflections and feedback? The primary benefit of a portfolio is to see growth over time, which should inspire goal setting for future learning. It is this process of setting learning goals that turns the portfolio into a powerful tool for long-term growth and development.

You will know you are ready for the next stage when you have:

• selected the artifacts for your formal or presentation portfolio, and • written reflective statements and identified learning goals.

INDIAN INSTITUTE OF FINANCE Page 190 [PORTFOLIO MANAGEMENT SOFTWARE]

Stage 4: The Connected Portfolio (Keywords: Inspect, Perfect, Connect, Implement, Evaluate). How will you organize the digital artifacts? Have you selected software that allows you to create hyperlinks between goals, student work samples, rubrics, and assessment? The choice of software can either restrict or enhance the development process and the quality of the final product. Different software packages each have unique characteristics that can limit or expand the electronic portfolio options.

How will you evaluate the portfolioís effectiveness in light of its purpose and the assessment context? In an environment of continuous improvement, a portfolio should be viewed as an ongoing learning tool, and its effectiveness should be reviewed on a regular basis to be sure it is meeting the goals set.

Depending on portfolio context, how will you use portfolio evidence to make instruction/learning decisions? Whether the portfolio is developed with a young child or a practicing professional, the artifacts collected along with the self-reflection should help guide learning decisions. This process brings together instruction and assessment in the most effective way.

Will you develop a collection of exemplary portfolio artifacts for comparison purposes? Many portfolio development guidebooks recommend collecting model portfolio artifacts that demonstrate achievement of specific standards. This provides the audience with a frame of reference to judge a specific studentís work. It also provides concrete examples of good work for students to emulate.

You will know you are ready for the next stage when:

• your documents are converted into a format that allows hyperlinks and you can navigate using them, • you have inserted the appropriate multimedia artifacts into the document, and • you are ready to share your portfolio with others.

Stage 5: The Presentation Portfolio (Keywords: Respect, Celebrate, Present, Publish).

How will you record the portfolio to an appropriate presentation and storage medium? These will be different for a working portfolio and a presentation portfolio. I find that the best

INDIAN INSTITUTE OF FINANCE Page 191 [PORTFOLIO MANAGEMENT SOFTWARE] medium for a working portfolio is videotape, computer hard disk, Zip disk, or network server. The best medium for a formal portfolio is CD-Recordable disc, Web server, or videotape.

How will you or your students present the finished portfolio to an appropriate audience? This will be a very individual strategy, depending on the context. An emerging strategy is student- led conferences, which enable learners to share their portfolios with a targeted audience, whether parents, peers, or potential employers. This is also an opportunity for professionals to share their teaching portfolios with colleagues for meaningful feedback and collaboration in self-assessment.

Software Selection

One of the key criteria for software selection should be its capability to allow teachers and students to create hypertext links between goals, outcomes, and various student artifacts (products and projects) displayed in multimedia format. Another is Web accessibility. With seven options to choose from, you should be able to find software to fit your audience, goals, technology skills, and available equipment (See Table 5 for a comparison of software. Find detailed descriptions, software resources, comparison information, and selection guidelines throughout the process online at www.iste.org/L&L).

Relational Databases ( Microsoft Access). In recent years, new database management tools have become available that allow teachers to easily create whole-class records of student achievement. A relational database is actually a series of interlinked structured data files linked together by common fields. One data file could include the studentsí names, addresses, and various individual elements; another could include a list of the standards that each student should be achieving; still another could include portfolio artifacts that demonstrate each studentís achievement of those standards. The purpose of using a relational database is to link together the students with their individual portfolio artifacts and the standards these artifacts should clearly demonstrate.

Advantages include flexibility, network and Web capabilities, cross-platform capabilities, tracking and reporting, multimedia, and security. Disadvantages include the size of relational database files (they can become very large and unwieldy); they may not be accessible to users who do have the software; and they require a high level of skill to use effectively.

INDIAN INSTITUTE OF FINANCE Page 192 [PORTFOLIO MANAGEMENT SOFTWARE]

Databases are really teacher-centered portfolio tools. They allow teachers to keep track of student achievement at every level. They are less appropriate for students to use to maintain their own portfolios. You may save appropriate pages from the database as PDF files for students to include in their own portfolios.

Hypermedia "Card" Programs (e.g., HyperStudio, Digital Chisel, Toolbook, and SuperLink). A hypermedia program allows the integration of various media types in a single file, with construction tools for graphics, sound, and movies. The basic structure of a hypermedia file is described as electronic cards that are really individual screens that can be linked together by buttons the user creates.

Hypermedia programs are widely available in classrooms, usually all-inclusive, cross- platform, multimedia capable, and secure. Disadvantages include lack of integrated Web accessibility, size and resolution constraints, and increased effort linking artifacts to standards.

Hypermedia programs are most appropriate for elementary or middle school portfolios. Templates and strategies are widely available to help you begin using your chosen hypermedia tool as a portfolio development and assessment tool.

Multimedia Authoring Software (e.g., Macromedia Director or Authorware). In recent years, multimedia authoring software has emerged from such companies as Macromedia and mTropolis. Authorware is an icon-based authoring environment, in which a user builds a flow chart to create a presentation. Director is a time-based authoring environment, in which the user creates an interactive presentation with a cast and various multimedia elements. Both programs allow the user to create stand-alone applications that can run on Windows and Macintosh platforms.

These programs allow users to create presentations that are self-running, without separate player software. They were designed to incorporate multimedia elements. They are ideal for CD-ROM publishing, but they have a steep learning curve, require extra effort to link artifacts to standards, and may not offer the necessary security.

INDIAN INSTITUTE OF FINANCE Page 193 [PORTFOLIO MANAGEMENT SOFTWARE]

Multimedia authoring programs would be most appropriate for high school, college, or professional portfolio creation.

Web Pages (e.g., Adobe PageMill, Claris Home Page, Microsoft FrontPage, Netscape Composer). An emerging trend in the development of electronic portfolios is to publish them in HTML format. With wide accessibility to the Web, many schools are encouraging students to publish their portfolios in this format. Students convert word processing documents into Web pages with tools built into those programs and create hyperlinks between goals and the artifacts that demonstrate achievement.

The advantages of creating Web-based portfolios center on its multimedia, cross-platform, and Web capabilities. Any potential viewer simply needs Internet access and a Web browser. However, the learning curve is steep. Web pages require much more file-management skill than other types of portfolio development tools, and the security can be a problem.

Students in upper-elementary grades and beyond can create Web pages, but this type of portfolio is especially appropriate for those who wish to showcase their portfolio for a potential employer.

With all of these choices, which strategy should you choose? Are different tools more appropriate at different stages of the electronic portfolio development process? These questions can only be answered after addressing some of the questions posed at the beginning of the article, especially the purpose and audience for the portfolio, the resources available (equipment and technology skills required), and where the advantages of the strategy outweigh the disadvantages for your situation.

On such portfolio we can perform the following operations of buying,selling,dividend payout etc.

INDIAN INSTITUTE OF FINANCE Page 194 [PORTFOLIO MANAGEMENT SOFTWARE]

Quantit Date Portfolio Name Company Name Trans Type y Price Amount 01-11-2004 Master Aditya Mehta ICICI Bank BUY 400 500.00 200000.00 09-12-2006 Master Aditya Mehta ICICI Bank SELL 200 835.50 166264.50 20-02-2008 Mrs. Sapna Mehta 3M India BUY 200 1680.00 337680.00 28-10-2008 Mr. Madhu Mehta Kotak Mahindra Bank BONUS 400 200.00 80000.00 28-11-2008 Mr. Madhu Mehta Kotak Mahindra Bank BONUS 400 01-06-2009 Mr. Madhu Mehta ICICI Bank BUY 300 625.00 188437.50 15-02-2010 Mrs. Sapna Mehta 3i Infotech BUY 300 75.00 22612.50 DIV_PAYO 01-03-2010 Mr. Madhu Mehta ICICI Bank UT 1025.50 01-06-2010 Mr. Madhu Mehta Kotak Mahindra Bank SELL 400 960.00 385920.00 On such portfolio we can perform the following operations of buying ,selling, dividend payout etc on the behalf of folio numbers.

Folio Portfolio Number Name MF Scheme Name Trans Type Quantity Price Amount Mr. Madhu Reliance Growth - 12.589 10000.0 123456 Mehta Growth Option BUY 794.3127 5 0 Mr. Madhu Reliance Growth - 15.500 10000.0 123456 Mehta Growth Option SELL 645.1613 0 0 Mrs. Sapna HDFC Equity Fund 55.525 12000.0 575751 Mehta - Dividend Opion BUY 216.1189 0 0 Mr. Madhu Reliance Growth - 51.500 123456 Mehta Growth Option DIV_REINV 97.0874 0 5000.00 Mr. Madhu HDFC Equity Fund 123456 Mehta - Dividend Opion DIV_PAYOUT 158.50 Master Aditya HDFC Equity Fund 75.582 12000.0 985985 Mehta - Dividend Opion BUY 158.7669 5 0

A hypothetical portfolio

INDIAN INSTITUTE OF FINANCE Page 195 [PORTFOLIO MANAGEMENT SOFTWARE]

Value Research Online Portfolio Name : FUNDS Date : 06-Sep-2010 00:12 Fund/Stock/Fixed-Asset NAV NAV Date Change From Previous Units/Shares

(Rs) NAV/Price (Nos)

(Rs) (%)

DSPBR T.I.G.E.R. Reg-G 50.295 03-Sep-10 0.23 0.46 2,731.42 Franklin India Prima Plus-G 221.718 03-Sep-10 1.41 0.64 375.328 Franklin India Prima Plus-G 221.718 03-Sep-10 1.41 0.64 428.489 Franklin India Prima-G 290.7566 03-Sep-10 2.52 0.87 814.642 Franklin India Prima-G 290.7566 03-Sep-10 2.52 0.87 333.505 Franklin India Taxshield-G 202.7296 03-Sep-10 0.87 0.43 364.6207 Franklin India Taxshield-G 202.7296 03-Sep-10 0.87 0.43 92.3 Franklin Templeton FTF Ser IV 60 14.8682 03-Sep-10 0.01 0.1 10,000.00 M-G HDFC Equity-G 277.487 03-Sep-10 0.86 0.31 434.7895 HDFC Prudence-G 211.283 03-Sep-10 0.95 0.45 323.2511 HDFC Taxsaver-G 235.882 03-Sep-10 1.1 0.47 90.2876 HDFC Top 200-G 208.051 03-Sep-10 0.3 0.14 580.145 ICICI Pru Infrastructure-G 30.53 03-Sep-10 0.04 0.13 4,752.16 Magnum Contra-G 59.61 03-Sep-10 0.21 0.35 1,808.40 Magnum Contra-G 59.61 03-Sep-10 0.21 0.35 1,566.74 Magnum Taxgain-D 41.88 03-Sep-10 0.13 0.31 288.0411 Magnum Taxgain-D 41.88 03-Sep-10 0.13 0.31 1,019.00 Magnum Taxgain-D 41.88 03-Sep-10 0.13 0.31 889.02 Reliance Diversified Power Sector 84.5486 03-Sep-10 0.31 0.37 1,390.49 Retail-G Reliance Diversified Power Sector 84.5486 03-Sep-10 0.31 0.37 1,359.08 Retail-G Reliance Diversified Power Sector 84.5486 03-Sep-10 0.31 0.37 1,248.40 Retail-G Reliance Equity Opportunities-G 36.7404 03-Sep-10 0.5 1.39 1,818.18 Reliance Equity-G 15.2269 03-Sep-10 0.04 0.25 4,950.00 Reliance Growth-G 489.6783 03-Sep-10 3.04 0.63 245.4002

INDIAN INSTITUTE OF FINANCE Page 196 [PORTFOLIO MANAGEMENT SOFTWARE]

Reliance Vision-G 277.3521 03-Sep-10 0.95 0.34 206.694 Tata Infrastructure-G 35.7296 03-Sep-10 0.14 0.4 3,000.00 UTI Infrastructure-G 35.73 03-Sep-10 0.06 0.17 4,248.46 11,303.4 Fund Portfolio Total : 4 0.44 11,303.4 Portfolio Total : 4 0.44

Advantages

There are following advanteges of using portfolio management software:-

Powerful portfolio analysis and project reporting in Project Insight, online project management software, allows executives to view all the projects in the portfolio in real time. INDIAN INSTITUTE OF FINANCE Page 197 [PORTFOLIO MANAGEMENT SOFTWARE]

Access to real time information empowers project managers and executives to detect projects at risk in order to make timely decisions. Executives may then create, save and share customized reports, or even set a portfolio report as their default home page.

• Roll up your portfolio of projects by reporting on projects by organization, customer or project type. • Create your own scorecard to weigh projects in the portfolio • Use goals, critical success factors and key performance indicators to objectively assess project importance • Utilize score as an objective way to prioritize projects in the organization • View health indicators to know instantly the status of projects

Project portfolio management software enables the user, usually management or executives within the organisation, to review the portfolio, which will assist in making key financial and business decisions for the projects.

The objective of project portfolio management is to optimise the results of the project portfolio to obtain benefits the organisation wants.

Disadvantages

Following are the disadvantages:

1. Expensive

This entails software, hardware, implementation, consultants, training, etc. Or you can hire a programmer or two as an employee and only buy business consulting from an outside source, do all customization and end-user training inside. That can be cost-effective.

2. You could become complacent and not educate yourself thoroughly before selling investments or buying new ones. Remember that no computer program

INDIAN INSTITUTE OF FINANCE Page 198 [PORTFOLIO MANAGEMENT SOFTWARE]

or person is infallible, and you should stay on top of trends in your investment sector(s) without becoming obsessive about them.

3. You must be mindful to enter correct figures. A simple typo could render your investment software program useless depending upon your objective.

4. While software is usually independent of a brokerage, don't allow your use of it to coerce you into totally dismissing your stockbroker or investment counselor. Balancing the advice you get from investment professionals, what you read on your own initiative, and any software calculations is essential to smart investing.

Always remember that investing holds absolutely no guarantees; you could gain a small fortune or lose a small fortune in a matter of hours or days.

INDIAN INSTITUTE OF FINANCE Page 199 [PORTFOLIO MANAGEMENT SOFTWARE]

Working of Portfolio management software Mutual fund equity

INDIAN INSTITUTE OF FINANCE Page 200 [PORTFOLIO MANAGEMENT SOFTWARE]

Stocks

INDIAN INSTITUTE OF FINANCE Page 201 [PORTFOLIO MANAGEMENT SOFTWARE]

ULIP

INDIAN INSTITUTE OF FINANCE Page 202 [PORTFOLIO MANAGEMENT SOFTWARE]

INSURANCE PLAN

INDIAN INSTITUTE OF FINANCE Page 203 [PORTFOLIO MANAGEMENT SOFTWARE]

FIXED DEPOSITS

INDIAN INSTITUTE OF FINANCE Page 204 [PORTFOLIO MANAGEMENT SOFTWARE]

BONDS

INDIAN INSTITUTE OF FINANCE Page 205 [PORTFOLIO MANAGEMENT SOFTWARE]

BIBLIOGRAPHY

• www.google.co.in

• www.altavista.com

• www.wikipedia.org

• www.investopedia.com

INDIAN INSTITUTE OF FINANCE Page 206