 INTRODUCTION

Portfolio means a collection of investments all owned by the same individual or

organization. Portfolio may be defined as a bundle of securities. These
investments often include stocks, which are investments in individual
businesses; bonds, which are investments in debt that are designed to earn
interest; and mutual funds, which are essentially pools of money from many
investors that are invested by professionals or according to indices.

Definition of Portfolio Analysis :

Portfolio Analysis is the process of reviewing or assessing the elements of the

entire portfolio of securities or products in a business. The review is done for
careful analysis of risk and return. Portfolio analysis conducted at regular
intervals helps the investor to make changes in the portfolio allocation and
change them according to the changing market and different circumstances.
The analysis also helps in proper resource / asset allocation to different
elements in the portfolio. At some time in the future, the actual return will be
one of many possible outcomes. The various outcomes have some probability
of occurring. The expected return is just the average of these possible returns
weighted (multiplied) by the respective probabilities of occurring. Standard
deviation of annual returns is most useful for measuring risk over shorter time
periods. For measuring risk over longer time periods, the dispersion of possible
cumulative returns is a better measure of risk. This is because over many years,
a relatively small difference in annualized rate of return can result in a large
difference in cumulative returns. The cumulative return on your investments at
a specified future time is referred to as terminal wealth. The dispersion of
possible terminal wealth is referred to as terminal wealth dispersion.
 a) The collection of multiple investments is referred to as portfolio. Mostly
large size organizations and also some individuals maintain a portfolio of their
different investments and hence the risk and return is considered as the entire
portfolio risk and return. Portfolio may be composed of two or more bonds,
stocks, securities and investments or combination of all.
i) This is because trading individual securities creates costs - brokerage costs,
bid-ask spreads and price impact
ii) There is a critical mass value, below which it does not pay to actively manage
a portfolio - it is far better to invest in funds.
iii) The larger a portfolio, the more choices become available in terms of assets
- this is largely because some components of trading costs - the brokerage costs
and the spread - may get smaller for larger portfolios.
iv) If a portfolio becomes too large, it might start creating a price impact which
might cause trading costs to start increasing again.

 TRADITIONAL AND MODERN PORTFOLIO ANALYSIS:

Traditional portfolio analysis has been of a very subjective nature for each
individual. The investors made the analysis of individual securities through the
evaluation of risk and return conditions in each security. The normal method of
finding the return on an individual security was by finding out the amounts of
dividends that have been given by the company, the price earnings ratios, the
common holding period and by an estimation of the market value of the shares.
The traditional theory assumes that selection of securities should be based on
lower risk as measured by its standard deviation from the mean of expected
returns. The greater the variability of returns the greater is the risk. Thus, the
investor chooses assets with the lowest variability of returns. Moreover,
traditional theory believes that the market inefficient and the fundamental
analysis can take advantage of the situation. By analysing internal financial
statements of the company, he can make superior profits through higher
returns. The technical analyst believed in the market behaviour and past trends
to forecast the future of the securities. These analyses were mainly under the
risk and return criteria of single security analysis. As against the traditional
theory the modern portfolio theory emphasises the need of maximisation of
returns through a combination of securities whose total variability is lower. It is
not necessary that success can be achieved by trying to get all securities of
 minimum risk. The theory states that by combining a security of low risk with
another security of high risk, success can be achieved by an investor in making a
choice of investment. This theory, thus, takes into consideration the variability
of each security and covariance for their returns reflected through their
interrelationships. Thus, as per the modern theory expected returns, the
variance of these returns and covariance of the returns of the securities within
the portfolio are to be considered for the choice of a portfolio. A portfolio is
said to be efficient, if it is expected to yield the highest return possible for the
lower risk or a given level of risk. The modern portfolio theory emphasis the
need for maximisation of returns, through a combination of securities, whose
total variability is lower. The risk of each security is different from that of others
and by a proper combination of securities, called diversification, one can arrive
at a combination, where the risk of one is off set partly or fully by that of the
other. Combination of securities can be made in many ways. Markowitz
developed the theory of diversification through scientific reasoning and method
.

 Markowitz Portfolio Theory :

Markowitz portfolio theory is also known as Modern Portfolio Theory. The
author of the modern portfolio theory is Harry Markowitz who introduced the
analysis of the portfolios of investments in his article ‘Portfolio Selection’
published in the Journal of Finance in 1952. He got Nobel Prize in Economic
Sciences in the year 1990. He is best known for his pioneering work in modern
portfolio theory. He studied the effect of asset risk, return, correlation and
diversification on probable investment portfolio returns. Before this study, the
investors would examine investments individually, build up portfolios of
attractive stocks and not consider how they related to each other. Markowitz
showed how it might be possible to better of these simplistic portfolios by
taking into account the correlation between the returns on these stocks. The
diversification plays a very important role in the modern portfolio theory. The
theory also focuses on the benefits of diversifying the portfolio i.e. investing in
different asset classes like stocks, bonds, real estate, gold etc. It is based on the
underlying fact of ‘Do not put all your eggs in one basket’. Markowitz approach
is viewed as a single period approach. At the beginning of the period the
investor must make a decision in what particular securities to invest and hold
these securities until the end of the period. Because a portfolio is a collection of
securities, this decision is equivalent to selecting an optimal portfolio from a set
of possible portfolios. Essentiality of the Markowitz portfolio theory is the
problem of optimal portfolio selection. Markowitz Efficient Frontier : The
concept of Efficient Frontier was also introduced by Markowitz and is easier to
understand than it sounds. It is a graphical representation of all the possible
mixtures of risky assets for an optimal level of Return given any level of risk, as
measured by standard deviation.
a hyperbola showing all the outcomes for various portfolio combinations of
risky assets, where Standard Deviation is plotted on the X-axis and Return is
plotted on the Y-axis. The Straight Line (Capital Allocation Line) represents a
portfolio of all risky assets and the risk-free asset, which is usually a triple-A
rated government bond. Tangency Portfolio is the point where the portfolio of
only risky assets meets the combination of risky and risk-free assets. This
portfolio maximizes return for the given level of risk. Portfolio along the lower
part of the hyperbola will have lower return and eventually higher risk.
Portfolios to the right will have higher returns but also higher risk. Markowitz
Portfolio Theory (Modern Portfolio Theory or Passive Investment Approach) is
the base idea of the ways to wealth concept.

There are two main concepts in Modern Portfolio Theory –

a) Any investor’s goal is to maximize return for any level of risk.

b) Risk can be reduced by creating a diversified portfolio of unrelated assets.

Other names for this approach are Passive Investment Approach because you
build the right risk to return portfolio for broad asset with a substantial value
and then you behave passive and wait as it growth. Subject Matter of the
Markowitz Theory : Before the development of Markowitz theory, combination
of securities was made through ‘simple diversification’. The layman could make
superior returns on his investments by making a random diversification in his
investments. A portfolio consisting of securities of large number will always
bring a superior return than a portfolio consisting of ten securities because the
portfolio is more diversified. The simple diversification would be able to reduce
unsystematic or diversifiable risk. In securities, both diversifiable and un-
diversifiable risks are present and an investor can expect 75% risk to be
diversifiable and 25% to be un-diversifiable. Simple diversification at random
would be able to bring down the diversifiable risk if about 10 to 15 securities
are purchased. Unsystematic risk was supposed to be independent in each
security. Many research studies were made on diversification of securities. It
was found that 10 to 15 securities in a portfolio would bring adequate returns.
Too much diversification would also not yield the expected return. Some
experts have suggested that diversification at random does not bring the
expected return results. Diversification should be related to industries which
are not related to each other. Many industries are correlated with each other in
such a way that if the stock of ‘X’ increased in price the stock of ‘Y’ also
increased and vice versa. By looking at the trends, industries should be selected
in such a way that they are unrelated to each other. A person having on his
portfolio about 8 to 10 securities will reduce his risk but if he has too many
securities as described above it would not lead to any gain. If systematic risk is
reduced by simple diversification, research studies have shown that an investor
should spread his investments but he should not spread himself in so many
investments that it leads to ‘superfluous (extra) diversification’. When an
investor has too many assets on his portfolio he will have many problems.
These problems relate to inadequate return. It is very difficult for the investor
to measure the return on each of the investments that he has purchased.
Consequently, he will find that the return he expects on the investments will
not be up to his expectations by over diversifying. The investor will also find it
impossible to manage the assets on his portfolio because the management of a
larger number of assets requires knowledge of the liquidity of each investment,
return; the tax liability and this will become impossible without specialized
knowledge. An investor will also find it both difficult and expensive to look after
a large number of investments. This will also have the effect of cutting into the
profits or the return factor on the investments.
If the investor plans to switch over investments by selling those which are
unprofitable and purchasing those which will be offering him a high rate of
return, he will involve himself in high transaction costs and more money will be
spent in managing superfluous diversification. The research studies have shown
that random diversification will not lead to superior returns unless it is
scientifically predicted. Markowitz theory is also based on diversification. He
believes in asset correlation and in combining assets in a manner to lower risk.
Assumption of the Markowitz Theory : Markowitz theory is based on the
modern portfolio theory under several assumptions.
i) The market is efficient and all investors have in their knowledge all the
facts about the stock market and so an investor can continuously make
superior returns either by predicting past behavior of stocks through
technical analysis or by fundamental analysis of internal company
management or by finding out the intrinsic value of shares. Thus, all
investors are in equal category.
ii) All investors before making any investments have a common goal. This is
the avoidance of risk because they are risk averse.
iii) All investors would like to earn the maximum rate of return that they can
achieve from their investments.
iv) The investors base their decisions on the expected rate of return of an
investment. The expected rate of return can be found out by finding out
the purchase price of a security dividend by the income per year and by
adding annual capital gains. It is also necessary to know the standard
deviation of the rate of return expected by an investor and the rate of
return which is being offered on the investment. The rate of return and
standard deviation are important parameters for finding out whether the
investment is worthwhile for a person.
v) Markowitz brought out the theory that it was a useful insight to find out
how the security returns are correlated to each other. By combining the
assets in such a way that they give the lowest risk maximum return could
be brought out by the investor.
vi) From the above, it is clear that every investor assumes that while making
an investment he will combine his investments in such a way that he gets
a maximum return and is surrounded by minimum risk.
vii) The investor assumes that greater or larger the return that he achieves
on his investments, the higher the risk factor surround him. On the
contrary, when risks are low the return can also be expected to below.
viii) The investor can reduce his risk if he adds investment to his portfolio
ix) . An investor should be able to get higher return for each level of risk ‘by
determining the efficient set of securities’.

Markowitz Model :
Markowitz approach determines for the investor the efficient set of portfolio
through three important variables i.e. return, standard deviation and
coefficient of correlation. Markowitz model is called the ‘Full Covariance Model’
 Through this model the investor can, with the use of computer, find out the
efficient set of portfolio by finding out the tradeoff between risk and return,
between the limits of zero and infinity. According to this theory, the effects of
one security purchase over the effects of the other security purchase are taken
into consideration and then the results are evaluated.

Limitations of Markowitz Theory :

Based on the above assumptions, the limitations of Efficient Market Frontier
can be inferred as below

1) The portfolio returns are not normally distributed but are heavily skewed on
the tails.

2) The investors are irrational. They believe in risk taking, expecting that higher
the risk, higher the returns.

3) In reality, the investors in the market have limited access to borrowing or

lending of money at risk free rate.

 Tools Used in Portfolio Analysis

Some of the top ratios used are as follows –

1) Holding Period Return

It calculates the overall return during the investment holding period.

Holding Period Return ={(Ending Value–Beginning Value)+Dividends

Received}/Beginning Value

2) Arithmetic Mean

It calculates the average returns of the overall portfolio.

Arithmetic Mean = (R1 + R2 + R3 +……+ Rn) / n

R = Returns of Individual Assets

3) Sharpe Ratio

It calculates the excess return over and above the risk-free return per unit of
portfolio risk.
Sharpe Ratio Formula = (Expected Return – Risk-Free rate of
return) / Standard Deviation (Volatility)
4) Alpha

It calculates the difference between the actual portfolio returns and the
expected returns.

Alpha of portfolio = Actual rate of return of portfolio – Expected Rate of

Return on Portfolio
5) Tracking Error

It calculates the standard deviation of the excess return concerning the

benchmark rate of return.

Tracking Error Formula = Rp-Rb

Rp = Return of Portfolio, Rb = Return on Benchmark

6) Information Ratio

It calculates the success of the active investment manager strategy by

calculating excess returns and dividing it by tracking error.

Information ratio Formula = (Rp – Rb) / Tracking error

Rp = Return of Portfolio, Rb = Return on Benchmark

7) Sortino Ratio

It calculates the excess return over and above the risk-free return per unit of
negative asset returns.

Sortino Ratio Formula = (Rp – Rf) / σd

Rp = Return of Portfolio, Rf = Risk-Free Rate, σd = standard deviation of
negative asset returns
 Methods For Portfolio Analysis
Portfolio analysis has various methods which depend upon the purpose
and product. One of the things which influence the market analysis is the
strategy opted by the company: stability strategy, expansion Here are
different methods for portfolio analysis in strategic management:

 Technological Portfolio
 In portfolio analysis one of the methods is a technological portfolio which
is used to analyze the development opportunities of the company.
 This method became so popular due to the continuous development of
products, high competition, and rapid technology changes.
 However, a quick change in technology contributes to the fact that not
every product has the time and ability to generate an excess financial
surplus.
 Technological portfolio analysis in strategic management is based on the
position of the product on the product life cycle.
 In this method, measurement is done on the possibility of development
of technology, the dissemination of technology, level of standardization,
possible uses of technology in a different field and the versatility of the
time, technology and cost needed for the implementation and
development.

 BCG Matrix
Another method of portfolio analysis in strategic management is the BCG
matrix in which there are 4 segments which explain the following:
Dogs

 The segment with low market share and low market growth is called the
dogs because they have a minimal market share and growth rate.
 These products are called cash traps, as these products’ ROI is not
sufficient to generate profits.
 For these reasons, they come first in the list of divestiture.
 For example: Let’s take the beverage industry, here Minute Maid and Diet
Coke which are consumed rarely come in the category of “dogs”.

Cash Cow

 Products in this region have a large market share, but these products’
growth rate is very low.
 Because being in a strong position in the market product can generate
colossal cash;
 So, the company should generate cow milk for as long as possible, as the
growth perspective is very low.
 Cash flow patterns are highly predictable.
 For example, Limca and COCA-COLA are part of cash cows with a low
growth rate and high market share.

Question Marks

 In case of a question mark, the product has a low market share, but the
growth rate is high.
 These products consume huge amounts of resources, and its growth rate
is equally high, but the company cannot increase its market share.
 These products require regular analysis to check whether the product is
worth maintaining.
 For example, Fanta and Sprite come in the category of question marks
where growth rate is high and market share is low.

Stars

 Firstly, products in this segment have a high market share and the market
is growing strongly.
 Products that are called the star products require high cash resources.
  But, after some time, all growth gets slow, and the star products come
under the cash cows to keep their market share.
 If they are not able to keep their market share, these products will
become dogs.
 For example, Thumbs Up forms a part of “stars” with continuous growth
rate and high market share.

Strategy Recommendation

Based on the BCG matrix in portfolio analysis in strategic management and

above described product-market matrix, the company has to decide what
objective, strategy, and budget should be assigned to each SBU.

Several investment techniques may be recommended.

Growth Strategy

 Growth strategy is, however, appropriate for products in the question

mark segment, and the cash cow products can finance it.
 Extensive revenue from cash cows can be used in the question mark to
strengthen and make sustainable development in the question mark
segment.

Maintain Strategy

 Maintain strategy is used in the Stars and the Cash Cows to maintain a
strong position.

Harvest Strategy

 This Strategy is used to generate the cash flow in the short run despite
the long term consequences.
 This is most suitable for the products in cash cows and question marks.
 It is also used in the case of dogs but to remove them from the market.
Liquidation Strategy

 It should consider whether to harvest or divest its business units.

 In addition, it allows the decision of liquidation to reinvest its resources in
a more prosperous business.
 This strategy is mostly applicable for Dogs.

 Market Life Cycle-Competitive Strength Matrix

Market life cycle-competitive strength is a kind of portfolio analysis in

strategic management which holds a 16 cell structure with competitive
strength displayed on the vertical axis as :

 High
 Moderate
 Low
Whereas, the horizontal axis distributed in four stages of the product life
cycle as :

Introduction
 Growth
 Maturity
 decline
The market life competitive strength matrix is a subjective distribution of
competitive strength depending on various factors of favourable
maintaining and gaining of advantage.

The matrix design recognises potential losers along with developing

winners.

Apart from the above distributions, the matrix is segmented into 3 zones
namely;- push zone, caution zone and the danger zone.
Graph Explanation

For the SBUs coming in the sector of ‘Push zone’, there are potential
winners with adequate cash flow.

Also, the company adapts different growth marketing strategies and

invests rapidly. The Push zone resembles the cash cows and the stars.

For the SBUs coming in the sector of ‘Caution zone’, the company adopts
stability techniques and cautious decision-making investment.

This area showcases the question marks.

For the SBUs coming in the sector of ‘Danger zone’, should go for
strategies like divesting, liquidation and harvest along with the reduction
in further investment.

They further denote dogs with a falling structure.

 Conclusions
Positive aspect of portfolio matrix models is easy to use. The benefit of using such
models is to get an idea of the profile of strong or weak products or services in an
industrial or marketing mix. Furthermore, it can give insights into many strategic
situations. For instance, one purpose is to look at activities within organization's
business units relative to each other, so that strategic issues can be noticed within
company on time. The second purpose is to make the analysis more future oriented
by the next two effects. The one is to look at the likely positive and/or negative
movements across the portfolio. The second is the impact of the actions which
company or competitors can stimulate through planned strategy. To achieve these
goals, the portfolio analysis requires an approach that generates a deep
understanding of the factors which really influence business success, and which can
be related to other analytical approaches. The DPM has better recommendations
about strategy through matrix cells and better review of environment risk as opposite
to GE matrix. Great advantages of ADL matrix are that it includes PLC dimension and
is especially suitable for segmented market, for instance for one product. Due to
that, the ADL matrix instead of SBUs shows the combination of products/market
positions (strategic centers) on a matrix. Negative aspects of portfolio matrix models
may cause an organization to put too much stress on market growth and access into
high growth business activities. They may also cause companies to pay insufficient
attention to operation management with the current business activities.
Respectively, the attention is focused mostly toward the strategic management. DPM
matrices are responsive to the scores, weights and ratings (quantitative methods
with CSFs) and can be manipulated to assume desired results. Further, since an
averaging process is taking place, several SBUs may end up in the same cell location,
but could vary considerably in terms of their ratings against specific factors. It means
that many products or services will end up in the middle of the matrix and this makes
it difficult to suggest an appropriate strategy option. The matrix models do not
accommodate the synergy between two or more products/services (SBUs) and this
suggests that making strategic option for one in isolation from the others may be
short sighted. The ADL matrix PLC dimension is a questionable factor in a corporation
strategic decision, so it is advisable to use ADL matrix after implementation of GE
 matrix. However, the portfolio matrix models are useful strategic management tools.
Precautionary measures require more formal and detailed planning techniques and
schemes to complete the corresponding portfolio analysis. To achieve that, it is wise
to include other strategic matrices like Ansoff, Product/market evolution, B2B
customer/ supplier matrix etc.

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