Portfolio Managemt Strategies | Types | And A Comparision

Whether it is a mutual fund or personal investment.  At last portfolio is a portfolio. No difference. Without strategic portfolio management, it’s very difficult to achieve the target. Investment into different asset classes like equity, debt, gold and cash will give the returns of different percentages and at different time periods. So, there is a need to manage, the balance between different asset classes. That’ where a strategic portfolio management plays a vital role.


STRATEGIES

Active Strategy

An active portfolio management strategy focuses on outperforming the related specific benchmark index that comprises of the assets in the portfolio. Either an individual investor /a broker /a mutual fund, the strategy remains same. Just outperforming the specific related Benchmark Index.

Suppose you might have come across the news that, BSE Midcap Index has fallen by 12% since the beginning of 2018. And’ all the Midcap Mutual Fund Schemes have fell lower than their respective benchmarks. But, Axis Midcap Scheme shown positive return of 0.74% from Jan’18 to June’18.

How it Works

Let’s better to explain with an example.

An investor  Mr. Gentleman aged 40 years has invested his savings of Rs. 10,00,000 in different asset classes as follows.

 

Initial

Asset Allocation

Amount Active

Asset Allocation

Amount
Equity

Debt

Gold

Cash

4,00,000

2,00,000

3,00,000

1,00,000

Equity

Debt

Gold

Cash

2,50,000

3,50,000

3,50,000

50,000

After allocating the total amount to gain under different classes, there was a signal of equity market down-trend. Then, to save his corpus, he planned to reduce the amount of equity exposure. So, he reduced the equity amount from 4  lakh rupees (40%) to 2.5 lakhs (25%). And, to safeguard his return, he transferred that amount to debt and Gold.

Here, the investor /portfolio manager has applied the active portfolio management strategy by timing the markets. And, trnsformed the existing portfolio to the new strategic portfolio comprised of same asset classes but with different asset allocation percentages. Sometimes, the strtegic portfolio management brings in new asset classes by the investors /portfolio managers, which they expected to be the best future performers.

After a year, his expectation got true and market had underperformed by 40%. That has similar effect on his equity investment. So he lost  Rs. Rs. 1,00,000 in equity and  instead of Rs. 1,60,000 if he might have invested Rs. 4,00,000. So, more exposer to the debt and gold has earned him more money in the form of interest and gold price appreciation. That’s how the strategic portfolio has saved him from big equity loss and earned extra money.

For each strategy there is always a second side of possibility. Let’s consider the scenario that markets moved forward and up by

 

Corporate Debt And Its Variations

There are four basic activities that companies usually show as the  sources of generation and use of cash. They are – the income from operations, cash generated by selling assets and /investments (if any), capital generated by issuing new shares and finally the cash flow due to debt. Most of the companies generate cash flows by using all these 4 mediums. But, few differ from, heavily relying on any particular one and less on the others.


As a part of expansion /fastening the growth, companies mostly rely either on debt or issue equity, either to the public or private players to accumulate the required capital. In the case of debt, interest cost adds-up to the borrowed capital. The result is that there is a negative cash-flow number on the balance-sheet. So, the borrowed funds need to be utilized efficiently, to make the overall cash flow a positive good number. Lets discuss about it in detail.

What is ‘Debt’

Whether it is an individual or a company, when the current finances don’t allow to make large purchases /harnessing the business activities, the most preferred alternative is making debt /borrowing the amount required, from the lender. This happens under an agreement that, the borrower will pay back the borrowed amount, later in the future, usually with along with an interest and that too at an agreed rate.

Hence, debt can be defined as the process of borrowing, a certain amount of capital, by one party (either by an individual or a company) for the purpose of financing the current needs, from an another party, usually called, the lender, under an agreement that, the borrowed party repays the borrowed amount called the debt, along with an agreed rate of interest, later in the future.

In the case of businesses, debt is a good alternative method of making the business a successful one, if utilized properly for its growth.

Types of Debt

Personal Debt

Credit Card Debt, Mortgages, Auto Loan and personal Loan fall in this category. Here the banks are the lenders /creditors, and the investors are the borrowers.

Corporate Debt

This type of debt is done by the companies rather than the individuals. Companies when they need funds, issue Bond and Commercial Papers. Through bonds and commercial papers they collect the required funds and utilize the same for the growth of their businesses. This type of debt facility is particularly in the corporate sector and not available to the individuals. Here, investors are the lenders /creditors and companies are the borrowers.

Types of Corporate Debt

Bonds

Bonds are a type of debt instruments, that allows companies to collect funds in a very amicable manner from the investors. Here investors may be either individual /institutional investors. Once the bonds are issued by the company, they are available to the public as well as institutional investment firms through banks and other financial investment channels.

A bond is a written agreement between the issuer company and the investor. Through bonds companies sell a ‘promise of repayment’ in the future. This repayment includes an interest rate called Coupon and the original amount received. The coupon rate is decided by the company at the time of issuance itself.

Each bond has its face value and the coupon rate. The purchaser of the bond receives the basic amount that’s invested at the end of the maturity period. And, the Coupon Rate, periodically at an intervals fixed at the time of issuance /at the end of the maturity period.

Commercial Papers

When companies are in scarcity of funds to pay off the accounts receivable, inventories and to meet all the short-term liabilities, they usually issue commercial papers.  During 1985 – 1990 there, the world economy witnessed a trend called the liberalization. This was the background push for the introduction short-term monetary instruments called the commercial papers in the Indian Money Market. An effective reform to avail the funds for short-term obligations by the corporate companies. This can be considered as an innovation in the financial system of India.  These are the most short-term instruments in Indian Money Market since 1990 onwards.

Prior to injection of commercial paper in Indian money market, that is before 1990, the corporate companies had to borrow the working capital from the commercial banks. Under this traditional process, companies were pledging the inventory as a collateral security. The introduction of commercial paper in the Indian money market avoided, all the hassles of borrowing the working capital, from the commercial banks. But, because of not backed by any form of collateral, here there are chances of default risk by the companies. This is usually called the corporate default problem. That’s the risk associated with these monetary instruments.

Role of Credit Rating Agencies

Credit Rating Agencies rate the companies depending on their secured credit. Hence it is always desirable to invest in commercial papers of companies with high credit ratings. That’s a company with high credit rating has, less chances of default risk. Others are riskier.

Companies with high credit rating has the advantage of finding buyers without discount to their cost. Whereas low credit companies need to offer a substantial discount (higher cost) for their debt.

In India, the maturity period of commercial papers ranges from 15 days to 1 year. Whereas in the United States, it’s no longer than 270 days.

Debentures

A debenture is just like a bond, but not not backed by any collateral. The credit and faithfulness of the issuer company are its underlying security. Debentures are issued to raise the short-term capital. Companies when they are expected to pay for future expenses or for expansion plans, they raise the capital through the issuance of debentures.

In corporate finance, a Debenture is a medium to long-term debt instrument, used by large companies to borrow money, at a fixed rate of interest.

In other words, a debenture is a movable property, issued by a company in the form of indebtedness, specifying the dates of redemption, repayment of principal and interest. Debentures may or may not create a charge on the assets of the company.

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Return On Debt (ROD) | Its Impact On The Company Performance

‘Return On Debt’. Spells short. But it’s as important as any other financial ratio, and also tells a  lot about the financial health of a company. Especially when there are big number of debts that peeps out of the balance sheet. So easy to analyze, but difficult to manage, ROD ratio has its own impact on any company’s performance.


Let’s try to have a few important points – What it may otherwise indicate the impact of ROD on any company’s performance as well as on our returns.

What Is ‘ROD’ Or The ‘Return On Debt’ Ratio

The ROD is a financial ratio, that compares the company’s net earnings to its long-term debt.

‘Return On Debt’ = Net Earnings / Net Long Term Debt

Here, debt means either taken /issued by the company. And sometimes the both the cases. And this ‘long-term-debt’ is in various forms and in distinctive interest rates depending on the creditor or the issuer. Anyhow, what we need to calculate is the ratio of the net earnings of the company to its net debt.

This ratio shows the amount of net earnings that is generated, for each coin that a company holds in debt. And, this ROD can either be positive /negative.

A positive ROD has been always beneficial to the company. And, it indicates that some income is being generated by the debt issued /taken by the company. Where as a negative ROD is a threat.

We can locate the long term debt data on the balance sheet as well as the notes to financial statements. The information explains the amount of debt taken out /issued and the number of years related to it.

How Important Is ‘Return On Debt’ In Any Company’s Financial  Analysis

Mostly, the ratio of ‘ROD’ is not used in the simplest financial analysis. But, it’s an important calculation that needs to be performed, while evaluating company’s solvency. It is generally used by the owners of the company while making a decision on, which financing sources would be better for the company.

It’s common to carry a certain amount of debt by any company. But, the amount should be limited. The more the debt to its earnings level, the more the credit risk’ is.

Moreover, companies carrying a significant amount of debt related to capital and/or assets are more prone to economic downturns during a decline in earnings.