Portfolio - Alternative Investment Strategies - Essay Example

? Portfolio Management Contents Portfolio: alternative investment strategies 3 Diversification 3 Non-correlating assets 3 Leap Puts and other Option 4 Stop Losses 4 Dividends 5 Principal protected investments 5 Role of modern portfolio theory in investment strategies 5 References 7 Portfolio: alternative investment strategies The formation of a portfolio is done by combining assets of different categories in order to meet the investment goals of an investor. The portfolio formation is characterized by the attainment of optimal returns and diversification of risk. The main strategy in the formation of portfolio is the preservation of capital. However, the strategy of preservation of capital does not mean that one should exit his position of asset holdings in the event of incurring losses. The strategies on the other hand demands awareness of the market conditions and stock volatilities to decide on the investment strategies in order to maximize the returns. Since risk in investments is unavoidable, the management of portfolio helps to mitigate the risk with appropriate investment strategies. The various investment strategies for formation of a portfolio are given below. Diversification The investment in assets is characterized by risk and return. These are two types of risk, namely the systematic risk and the unsystematic risk. The systematic risks are the risks that appear due to uncertainties in the market condition. The unsystematic risks are due to the fluctuation of the performance of individual companies. The diversification strategy is used in portfolio investments in order to reduce the unsystematic risk. Through the formation of a portfolio containing investments on a wide range of assets reduce the risk of the overall portfolio due to positive and negative effects of the individual assets. The diversification strategy helps to obtain optimum return through diversification of risk. Non-correlating assets The use of non-correlating assets is another investment strategy for forming a portfolio. The non-correlating assets like the bonds, commodities, real estate stocks and currencies are not linked to each other’s performance. The performance of one asset may goes up with the decline in performance of the other asset. Although the systematic market risk could not be mitigated, the use of non-correlating assets helps to reduce the overall risk of the portfolio with the optimization of returns. Leap Puts and other Option The use of Put options and the Long Term Equity Anticipation securities are alternative investment strategies adopted by the investor. There may be cases where the returns of the portfolio have increased in short period of time and is likely to fall due to market volatility. However, there may be anticipations of future rise of returns. The objective behind adoption of this strategy is to secure the higher returns obtained and at the same time not withdraw from the position of investment. The use of Put options enables the investor to enter into a contract of selling the security at a particular price on a future date. Thus the investor could hold on to their investments without allowing the gains achieved to be depleted. The LEAP Puts are used as long term investment strategies with the same objective. Stop Losses This is another investment strategy in order to protect the portfolio from the risk of fall in the value of shares. The use of stop losses means that the stock would be automatically sold if the price of the share falls to the pre-fixed value of stop losses. The use of stop losses sells the low performing shares and provides an impulse to the investor to investment in shares that could replace the sold share in the portfolio. Dividends The use of information on dividend payments by the companies form part of the investment strategies. Especially in cases of market downturn, the information on dividend is used by risk-averse investors and an important to hedge their portfolio. The dividends paid by the companies are interpreted by the investors as indicators of strong financial performance and anticipation of good financial performance in future. This leads to the rise of share prices of companies that in turn lead to the capital gains. Thus the investment strategy of selecting stocks on the basis of dividend information is suitable for achieving a higher return and minimizing risk of the portfolio. Principal protected investments The use of principal protected investments is an alternative investment strategy in portfolio management. This strategy helps to ensure the principal amount invested in the portfolio. This is similar to the bond where a maturity amount is guaranteed in maturity. The other part of the investment in used in managing the stocks. This makes principal protected investments different from the bonds. The principal protected investment strategy helps to ensure a minimum return of a part of the investment with the other part producing return as per the performance of stocks in portfolio. Role of modern portfolio theory in investment strategies The modern portfolio theory explains the process of maximizing the returns of an investment for a specified level of investment risk. Conversely, the theory explains the reduction of risk of investment portfolio for a specified level of return. According to the modern portfolio theory, the performance of a diversified portfolio is higher than the performance of a concentrated portfolio. While the concentrated portfolio is described as a combination of assets of the same industry or a combination of correlated assets, the diversified portfolio is a combination of a wide range of assets which are uncorrelated (Elton, Gruber, Brown and Goetzmann, 2009, p.37). The assets in a diversified portfolio produce a return which is higher than the returns of individual assets also produce a portfolio risk which is lesser than the risk of individual assets. This is due to the fact that the performance of one class of assets moves up while the other class of assets decline. Due to the cancellation effect of each other the risk of the overall portfolio is reduced as compared to the risk of individual assets. The modern portfolio theory plays a significant role in formation of the portfolio. The selection of stocks, commodities, real estate stocks, currencies and a wide range of uncorrelated assets help to form a portfolio which would maximize the investment returns and also would diversify the risk of investments. Thus the modern portfolio theory acts as a guide to the investment strategies adopted for portfolio management. These strategies help the fund managers to insert the desired attributes of the portfolio management that attracts the client for investments. References Elton, E. J., Gruber, M. J., Brown, S. J. and Goetzmann, W. N. 2009. Modern Portfolio Theory and Investment Analysis. John Wiley & Sons; USA. Read More