Portfolio Strategy Selection
The key stage in the formation of an investment portfolio is the choice of a portfolio strategy. Portfolio strategies are usually divided into passive and active. Let's consider the main substrategies of these major two ones.
It is generally accepted that the passive strategy is followed by investors who believe that the market is efficient. The passive portfolio is revised in cases where investment objectives have changed or, for example, new attitudes have been formed regarding the risk and return of the portfolio. Passive portfolio management consists of acquiring assets in order to hold them for a long period of time.
What are the most common passive strategies?
The indexing strategy is one of the most commonly used. Its essence lies in the fact that the portfolio is formed on the basis of a certain stock index. The disadvantage of this strategy is that exact copying of the index can entail high transaction costs, and when the index changes, the portfolio should be restructured. The fact is that when an asset is excluded from the index, its price falls, while the price of the stock included in the index increases. In order to avoid such a situation, - the index can be copied not in full, - but on the basis of a certain sample of stocks that most fully repeat its dynamics.
The yield curve sliding strategy is another type of passive strategy. Yield curve is the relationship between the amount of return on securities with a fixed interest rate and the time remaining to their maturity. If the yield curve has an upward movement, this means that long-term securities have a higher yield than short-term securities. If the investor's investment horizon is limited to a short period of time, then it is more profitable to invest in a longer-term asset and sell it in a month. As a result, you can get a higher return compared to investing in a monthly asset.
As for active strategies, it is considered that they are used by investors who believe that the market is not always efficient, at the least for individual securities, and investors have different expectations regarding risk and return. As a result, the asset price is either overstated or understated. Therefore, an active strategy comes down to frequent revision of the portfolio in search of financial instruments that are incorrectly priced by the market, and trading them in order to get a higher profitability.