Module: 2 - Portfolio Investment & Management - The Profile and the Qualities
that Make an Accomplished Portfolio Manager
(Page: 1 of 3)

[Module Objective: Having understood what a portfolio manager is, it is now necessary to comprehend how to carry out the complex functions of the portfolio management efficiently. In the present module we will initially discuss the skill and knowledge resources needed for the task and later proceed further to describe the process or application of these in actual usage in the next module]

Portfolio Investment involves dedicated operations by a team of qualified persons at the corporate level. SEBI has prescribed the task of PMS to be attended by a corporate body. Domestic Portfolio Managers of FII, as also AMCs, who undertake portfolio management on behalf of Mutual Funds are required to adhere to this stipulation. Without registration with SEBI based on eligibility and possession of qualification etc., the service provider will not be able to effectively deal with stock exchanges. It is therefore important that a team of professionals develop amongst themselves the knowledge and skill in this task to act effectively in coordinated aggregation. In short this needs an organisational development well suited towards executing PMS service. What are the suitability criteria or what qualities, the possession of which will make a successful portfolio manager?

The SWOT model of Management Science recognises the two attributes of "strength" and "weakness" describing the internal dynamics of an organisation. It can be generally described that development of positive qualities suited for discharging efficiently PMS function amongst the team of executives attending to this responsibility designates the strength factor while its absence or inheritance of negative qualities signifies the attribute of weakness.

These positive qualities referred above should include following capabilities:

• Positive attitude;

• Acquisition of knowledge resources relevant to the tasks involved;

• Development of performance skill of the jobs involved.

Positive Attitude: Investors need to have a positive attitude drawing out clearly their objectives and goals. The goal should be that of making a pragmatic investment aimed at optimum rewards, along with managing risk enroute effectively. One does need a roof over his head. It may be also roof over roofs (multi-storied dwelling). The ambition is justified. This is similar to the genuine Investment function. It is OK. But in portfolio investment one should not aim at scaling Mount Everest (speculation.). And never should one aim straight at reaching the sky (gambling). PMS operators are however need to undertake hedging operations as part of containing risk involved in stock trading when the market turns volatile. The most suitable product for risk-containment by way of hedging is recourse to trading in derivatives. This is explained subsequently in this module.

By way of further elaboration positive attitude includes personal integrity and reputation for fairness in dealings. This is more so when PMS is a service provider and deals with funds mobilized from others. SEBI has prescribed general reputation and fairness in transactions as an essential qualification for persons of corporate undertaking PMS service. Similarly as per SEBI standards the directors and other officers of the Asset Management Company (who also discharge PMS functions) should be persons, who are not found guilty of moral turpitude or convicted of any economic offence or violation of any securities laws.

SEBI has stipulated necessary qualifications in respect of portfolio managers as under-

• The principal officer of the corporate body undertaking AMS service must have the professional qualifications in finance, law, accountancy or business management from an institution recognised by the Government;

• The corporate body must have in its employment minimum of two persons who, between them, have at least five years experience as portfolio manager or stock broker or investment manager or in the areas related to fund management;

These are the minimum and should not be considered as the benchmark. Other knowledge acquisitions should include:

• A thorough ongoing knowledge and understanding of stock market regulations; about SEBI and its functions. For this frequent referring to the contents of SEBI website is recommended.

• A complete understanding of the two segments of Stock Exchanges (Equity Trading & Derivatives Trading). It is recommended that the PMS service providers periodically update their knowledge of the contents of websites of NSE and BSE.

• Good knowledge of financial services and tools of financial analysis.

Skill development is the application of knowledge and expertise acquired in performance of live jobs. To acquire job skill the PMS service provider must-

• Study and learn to interpret the day-to-day behaviour of the stock market. This information can be gathered from the websites of the major stock exchanges and also from Financial Dailies like Economic Times, Financial Express and Business Line (of the Hindu). SEBI has advised not to be carried away by those claiming to be specialists and forecasting stock market behaviour. They could be more interested in promoting particular products for which they may be earning a commission or brokerage. The service provider must study and arrive at his own judgement.

• Development skill in balance sheet analysis and in the review of sectoral performance of major groups of industries, including the skill to forecast future trends.

• Development of hedging and risk containment skills based on forward security/market analysis through recourse to derivative trading.

Unlike the personal investor, the portfolio investor faces a multitude of risks, as frequently stock market may turn volatile. What is the effective tool to manage the ever-surging risk? The answer is "avail recourse to Derivatives". Today derivative trading has become beyond the scope of the ordinary investor. But it has to be an essential part of the strategy of the portfolio investor, who needs to hedge appropriate risks when the market is not stable and steadfast. To quote Fed Chairman Alan Greenspan:

"By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives... These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it -- a process that has undoubtedly improved national productivity growth and standards of living."

"Indian securities markets have indeed waited for too long for derivatives trading to emerge. Mutual Funds, FIIs and other investors who are deprived of hedging opportunities will now have a derivatives market to bank on. First to emerge are the globally popular variety - index futures.

"While derivatives markets flourished in the developed world Indian markets remain deprived of financial derivatives to the beginning of this millenium. Emerged in the global scenario in the 1970s, derivatives markets grew from strength to strength. The trading volumes nearly doubled in every three years making it a trillion-dollar business. They became so ubiquitous that, now, one cannot think of the existence of financial markets without derivatives.

"Two broad approaches of SEBI is to integrate the securities market at the national level, and also to diversify the trading products, so that more number of traders including banks, financial institutions, insurance companies, mutual funds, primary dealers etc. choose to transact through the Exchanges. In this context the introduction of derivatives trading through Indian Stock Exchanges permitted by SEBI in 2000 AD is a real landmark." (Personal website of R.Kannan)

The Securities Laws (Amendment) Bill 1999 was introduced to bring about the much-needed changes to enable trading in derivatives to be undertaken at the stock exchanges. In December 1999 the new framework has been approved. Derivatives have been accorded the status of `Securities'. The ban imposed on trading in derivatives way back in 1969 under a notification issued by the Central Government has been revoked recently. Thereafter SEBI formulated the necessary regulations/bye-laws and intimated the Stock Exchanges in the year 2000, while derivative trading started in India at NSE and BSE in the year 2001.

The Derivatives market in India is outside the reach of the ordinary investor. This is in view of the huge outlay needed in an individual transaction relating to buying or selling of derivatives in the market. The Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivatives traded in the Indian Markets should be pegged not below Rs. 2 Lakhs. Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 2 Lakh at the time of introducing the contract in the market. Stock exchanges prescribed the lot size of individual securities based on this minimum amount at that time. Lot size refers to number of underlying securities in one contract. Additionally, for stock specific derivative contracts SEBI has specified that the lot size of the underlying individual security should be in multiples of 100 and fractions, if any, should be rounded of to the next higher multiple of 100. This requirement of SEBI coupled with the requirement of minimum contract size forms the basis of arriving at the lot size of a contract. Subsequently over the course of years the market value of these premium securities listed for derivative trading consistently appreciated in value, with the result that the market value of particular lots of shares now stand at between Rs.6 to Rs.8 Lacs. This is a huge investment to distance small investors from this market. The market is thus typically the domain of institutional Investors.

The portfolio manager needs also to have a thorough knowledge and understanding of the functions and system of the derivatives market in India in addition to other knowledge resources referred earlier and a essential knowledge of investment functions as covered part: 1 of this project. More information about Indian Derivatives Market is provided in the Annexure-2.

As per SWOT analysis the environment provides both opportunities and threats to a business manager. To PMS service operator the environment represents the security market. The opportunities of the security market are indicated by the prospect and feasibility to earn sizeable returns or capital appreciation of the stocks in hand with the Investor. What are the skills needed to capture this opportunity? The threats inherent in the security market are the risk exposure on account of market fluctuations. What are the skills/tools needed to ward off or minimize the impact of this threat?