Students in the AIM program manager three portfolios. While they learn the skills of how to become a solid fundamental analyst, they along have an opportunity to try their hands at being portfolio managers. The follow thoughts were taken from Larry Cao, CFA, who wrote in a recent CFA blog posting about the Seven Essential Steps in Portfolio Management.
These are seven steps that an aspiring portfolio manager must learn to master according to Cao:
1. Originating ideas.
Where does a portfolio manager start in his quest to beat the market? Fresh ideas. There are more than 7,000 listed companies in the world, and a portfolio manager needs to know where to look. You need to look beyond the index and the obvious, especially the ones shopped around by sell-side analysts. Adding value starts from idea generation, the first step in the investment process. This point is particularly important for value managers, who by default invest in companies that the market shies away from.
2. Conducting research.
Research is not the exclusive realm of research analysts — far from it. You need to be able to shorten the list from a few thousand companies to a few hundred. These companies are then ranked and analyzed. Focus on finding the right business run by the right people that can be bought at the right price. Consistent investment results depend on discipline and not on serendipity. How to rank the short-listed companies clearly reflects a manager’s investment philosophy.
3. Making decisions.
Decision making is tough. Investors are often better at investigating investment opportunities than making investment decisions because they are afraid of making mistakes that they’ll regret. It is critical, however, for a portfolio manager to be able to pull the trigger when presented with a killer opportunity. Decision-making authority is the single most important distinction between an analyst and a portfolio manager. The talented are particularly good at pulling the trigger although the instinct does not come easy, even to them.
4. Structuring transactions.
There are many ways of investing in a company. Buying shares in the open market is only one of them. Portfolio managers need to invest in ways that benefit investors the most. A manager needs to be familiar with the intricacies of these transactions, including accounting, legal, and tax implications. Portfolio managers need to have a total return perspective to investing. This is particularly important if they are managing an outsized portfolio or invest in alternatives.
5. Executing transactions.
A portfolio manager also needs to work with traders and ensure that ideas become investments. Traders are ultimately responsible for trading. Portfolio managers, however, need to have an appreciation for how their investment decision may affect the market. Trading remains an area that affects portfolio performance and cannot be ignored.
6. Maintaining investments.
Adding an investment to the portfolio is not the end of the story. Portfolio managers need to continue paying attention to portfolio companies once initial investments are made. This is a continuation of the research process. Maintain, not monitor, your investments.
7. Exiting investments.
Conventional wisdom seems to hold that exiting an investment is almost more important than entering one. And it could be right. If portfolio managers hesitate when they exit positions, they often run the risk of letting small losses balloon into major headaches. Similarly, if portfolio managers do not lock in profits when they should, it could be equally damaging to their performance. Don’t be afraid of selling too high or too low. Exit quickly once you’ve made the decision, especially when cutting losses.