Learning Module 3
Portfolio Management: An Overview
Key Outcomes Summary & Practice Problems
What you must be able to do
Curriculum Year: 2026
Describe the portfolio approach to investing.
Describe the steps in the portfolio management process.
Describe types of investors and distinctive characteristics and needs of each.
Describe defined contribution and defined benefit pension plans.
Describe aspects of the asset management industry.
Describe mutual funds and compare them with other pooled investment products.
1 · Portfolio Perspective: Diversification & Risk Reduction
Portfolio approach — Evaluating individual securities in relation to their contribution to the whole portfolio's investment characteristics.
Diversification benefit — Avoiding disastrous investment outcomes by not "putting all eggs in one basket" (e.g., Enron employees who held concentrated positions).
Risk reduction — Portfolios reduce risk more than they increase returns. Combining assets with low correlations lowers portfolio volatility.
Diversification ratio — Measures risk reduction benefits; ratio of portfolio standard deviation to average individual asset standard deviation.
2 · Steps in the Portfolio Management Process
Planning Step — Understand client's needs, develop an Investment Policy Statement (IPS) that describes objectives and constraints.
Execution Step — Asset allocation (top-down vs bottom-up), security analysis, portfolio construction, and trading.
Feedback Step — Portfolio monitoring and rebalancing, performance measurement and reporting.
Investment Policy Statement (IPS) — Written document capturing client's investment objectives and constraints.
Asset Allocation — Distribution among equities, fixed-income, cash, and alternative assets. The asset allocation decision is commonly viewed as having the greatest impact on portfolio performance.
3 · Types of Investors
Individual Investors — Variety of motives (retirement, education, major purchases). Invest through DC plans (401(k), superannuation) or directly with advisers.
Institutional Investors — Defined benefit pension plans, endowments & foundations, banks, insurance companies, sovereign wealth funds.
Defined Contribution (DC) Plans — Employee bears investment risk; contributions are defined; account balance at retirement depends on investment performance.
Defined Benefit (DB) Plans — Employer bears investment risk; benefit is defined; plan must ensure sufficient assets to pay promised benefits.
Investor Type | Time Horizon | Risk Tolerance | Liquidity Needs |
|---|---|---|---|
Individual | Varies | Varies | Varies |
DB Pension Plan | Long term | Quite high | Varies by maturity |
Endowment/Foundation | Very long term | High | Quite low |
Bank | Short term | Quite low | High |
Insurance Company | Short (P&C) / Long (Life) | Quite low | High (claims) |
4 · Asset Management Industry
Active vs Passive Management — Active managers seek to outperform benchmarks; passive managers replicate market indices (lower fees).
Traditional vs Alternative — Traditional: long-only equity, fixed-income, multi-asset. Alternative: hedge funds, private equity, venture capital.
Key Industry Trends — Growth of passive investing, use of "big data" in investment process, robo-advisers in wealth management.
5 · Pooled Investment Products
Mutual Funds — Comingled investment pool; investors have pro-rata claim. Open-end funds trade at NAV; closed-end funds trade at premiums/discounts.
Types of Mutual Funds — Money market, bond, stock (active/index), hybrid/balanced (lifecycle/target date).
Exchange-Traded Funds (ETFs) — Trade on exchanges like stocks; can be traded intraday; generally lower costs; may have capital gain distributions.
Hedge Funds — Private vehicles using leverage, derivatives, long/short strategies; high minimums, restricted liquidity, performance fees.
Private Equity/Venture Capital — Invest in private companies; 7-10 year lifespan; management fees + carried interest.