Investment Process | Investment Management
The investment process describes how an investor should go about making investment decisions. Investment decisions basically call for deciding the types of securities to invest in, the amount of funds to be invested, and the appropriate timing for investment. There are five distinct but interrelated steps in the investment decision-making process as shown in Figure 1.1. They are described in the ensuing paragraphs.
Also Read: Meaning of Investment
DETERMINING INVESTMENT POLICY:
The first step of the investment process is to set the investment policy. It involves determining the investor’s objectives and the amount of her/his investable funds. Investment objectives should be stated in terms of both risk and return. This step involves the identification of the potential categories of financial assets for consideration in the ultimate portfolio. This identification will be based on the investment objectives, amount of investable funds, and tax status of the investor.
Also Read: Real Assets Vs Financial Assets
PERFORMING SECURITY ANALYSIS:
The securities available to an investor for investment are numerous and of various types. The shares of about 2341 companies are listed on the Nepal Stock Exchange. Security analysis involves examining a number of individual securities (or groups of securities) within the broad categories of financial assets. The purpose of conducting such an examination is to identify those securities that currently appear to be mispriced. There are mainly two approaches to security analysis: technical analysis and fundamental analysis.
Technical analysis involves the study of stock market prices in an attempt to predict future price movements for the common stock of a particular firm. In this process, first, past prices are examined in order to identify recurring trends or patterns in price movements. Then, more recent stock prices are analyzed in order to identify emerging trends or patterns that are similar to the past ones. The matching of emerging trends with past ones is done in the belief that these trends repeat themselves. Therefore, it enables an analyst to predict future price movements for that particular stock.
Also Read: Financial Market and the Economy
Fundamental analysis begins with finding the intrinsic value of any financial asset. The intrinsic value is the present value of all future cash flows that the owner of the asset expects to receive. The intrinsic value of the financial asset is compared against its current market price to identify the mispriced securities. If the current market price of the security is below the intrinsic value, the asset is said to be undervalued and a purchase is recommended for such asset. Conversely, if the current market price is above the intrinsic value, it is said to be overvalued and a sale is recommended.
CONSTRUCTING INVESTMENT PORTFOLIO:
Constructing an investment portfolio involves identifying specific securities for investing. Then, it also calls for determining the proportion of wealth to be invested into each security. While constructing the portfolio, the investor needs to address the issues of selectivity. timing, and diversification. Selectivity is concerned with identifying the price movement of each individual security. Timing is concerned with the price movement of a broad category of securities with respect to market movement, And, diversification calls for adding a larger variety of securities with the objective of risk reduction.
REVISING THE PORTFOLIO:
Revising a portfolio involves both realizing that the currently held portfolio is not optimal and specifying another portfolio with superior risk-return characteristics. The investor must balance the costs Of moving into the new portfolio against the benefits of the revision.
EVALUATING THE PORTFOLIO PERFORMANCE:
Finally, evaluating the portfolio performance involves determining the actual performance of a portfolio in terms of risk and return, and comparing the performance with that of an appropriate “benchmark” portfolio.