How to Manage a Portfolio

Given the title above, I feel embarrassed to write, because the topic is too basic. I write because too few managers think clearly on the topic. The following analysis applies to long only funds and hedge funds; it also applies to equity and bond funds. The impetus to write this note arrived because the Fidelity Magellan Fund is reopening because cash inflows will make the life of the portfolio manager easier… not that he will get many inflows for now.

My view is that it should not be hard to manage a shrinking portfolio. It is much harder to manage a rapidly growing portfolio. (I have experienced that, and that is a topic for another day.) Here is the key concept: the portfolio manager must rank his portfolio by expected returns, adjusted for risk. This applies to both the longs and shorts. If there are cash inflows to a portfolio, assets should be allocated to the highest returning assets. If cash outflows, assets should be liquidated from the situations with the lowest expected returns. It is that simple, and I did that when I was a corporate bond manager. It worked well.

The reason why it will not be implemented at many asset management shops is that it takes work to do it, and we all avoid work if we can. But maintaining lists of long and short ideas ranked by likely risk-adjusted returns will yield better decision making, if one will do it.

One thought on “How to Manage a Portfolio

  1. Hi David

    Don’t be embarassed about the topic. David Swendson wrote very cogently about portfolios and his Yale experience but there is very little material for the average investor. Most of the investment advice is about the buyside. I hope you get some thought provoking comments.

    You are right about is being work that most don’t want to do.

    I use you basic strategy but with different tactics. I break the assets down into purchase lots and calculate the yield-to-market and yield-to-cost on each lot. Because not every purchase lot is purchased at the optimal point every so often I prune the weaker lots. I do not consider risk (beta). I do look at debt as an element of risk.

    I look at projected returns also as modeled by extending P/E ratios and am careful about assessing changes in the corporate business model as these can render the P/E ratio extension invalid.

    The question I try and amateurishly ask is “how hard is my money working for me.”

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