RiskManagement in PMS: Managing Volatility & Concentrated Portfolios
If you plan to invest in PMS, you needto consider several aspects. As an investor, it's essential to stay informed toget good returns on investments.
PMS is a professionally managed servicebacked by SEBI. The investments in PMS can be customized depending on your riskappetite & financial goals. Of course, the financial goals you set foryourself should align with the values of the PMS company. The best part aboutPMS is the kind of capital appreciation it offers.
Most importantly, you can choose threetypes of portfolios - discretionary, non-discretionary, and advisory. If youopt for discretionary PMS, the PMS company or fund manager will manage yourinvestment profile. Meaning, all the decisions will be taken by the PMScompany.
Well, in non-discretionary PMS, the fundmanager will suggest stocks and securities, but the final decision will beyours. The fund manager will not trade without the approval of the investor.
Advisory PMS is ideal for investors witha sound knowledge of PMS and the stock market. Here, the investor seeks advicefrom the fund manager on the investments that can yield good returns. It's morelike taking advice on portfolio management.
With good returns, there is always arisk in investments. It's important to mitigate the risk so that your PMSinvestments stay on track. Let's delve into the topic and learn more about riskmanagement in PMS.
What Is Risk Management in PMS?
Risk management strategy is a vital partof PMS. Due to the concentrated, high-conviction nature of portfoliomanagement, there can be a risk of market volatility.
PMS is unlike mutual funds, which arehighly regulated for diversification; PMS often holds 15 to 20 stocks inconcentrated form. Of course, this can lead to increased risk.
When you approach a PMS company, thefund manager suggests risk management strategies that focus more on controllingmarket drawdowns, ensuring complete liquidity, and also aligning portfolioswith investor goals.
Most PMS companies or fund managers canmanage risks associated with PMS with effective strategies. Let's further seehow you can manage market volatility.
How To Manage Market Volatility:
Fund managers & investors can managemarket volatility by considering these factors:
Active Portfolio Management
Unlike mutual funds, where investorshave to keep track of performance and markets, PMS is distinct. Of course, PMSmanagers or fund managers manage the portfolio by actively managing it.Depending on the market trends and updates, PMS managers adjust strategies whenthey sense market volatility.
Most fund managers arewell-versed in how the funds are expected to perform in the market. Because ofthis expertise, they can actively handle your portfolio.
In many instances, fund managers willincrease the cash position to adjust strategies so that the portfolio remainsaligned with financial goals. As an investor, you can also play a part inactively managing your portfolio.
Hedging Strategies
Hedging is another important strategythat fund managers consider to mitigate market risks. In this strategy, thefund managers mitigate market risks arising from sector concentration, marketvolatility, and price movements.
Hedging techniques involve usingfinancial instruments or distinct structural adjustments to offset anypotential loss. Hedging approaches can use derivatives like market trends,diversifying across non-correlated assets.
However, hedging can limit potentialgains if the market rises unexpectedly. This can happen with different collarstrategies. From the fund managers' side, hedging positions may requirecontinuous monitoring and market adjustments to remain on track. Indeed, it isan important strategy to mitigate risks in PMS.
Stop Losses & Target Prices
Another important tool that PMS managerscan use is stop losses and target prices. What's that? Well, it is an effectivestrategy that fund managers use to limit market losses & lock in gains. Thebest part is that they can help mitigate volatility risks by automating exits,which then prevents emotional decision-making.
The strategy helps to secure capitalduring sharp market downturns. The purpose of a stop loss is to limit lossesand provide capital protection. And the purpose of the target price is torealize profits and secure gains. Most importantly, stop losses act as a safetynet against market drawdowns.
Focus On Dollar Cost Average
Most PMS companies and fund managers usedollar-cost averaging to mitigate market risks. The strategy works by investinga fixed dollar amount at regular intervals, regardless of the market shareprices. Also, the strategy helps lower the average cost per share over timewhen the prices are low.
The best part about the strategy is thatit reduces the market timing risk. With this strategy, fund managers canpredict market lows or highs, reducing the dangers of investing a large sumbefore there is a market drawdown. Basically, it manages psychological risk inPMS investing.
How To Manage Concentration Risk?
When a large portion of the portfolio isinvested in stocks, there is a concentrated risk. Fund managers can mitigatethese risks by:
Sector Diversification
Sector diversification mitigates PMSmarket risks by spreading investments across different industries, thusreducing overdependence on a single sector. By balancing underperformingsectors with stronger ones, the fund manager can reduce concentration risk.
In addition, this can smooth the marketvolatility and protect capital during market drawdowns. Most PMS managers alsoproactively adjust the sector weights based on economic cycles, making a shiftfrom defensive to aggressive when needed.
While some PMS strategies aresector-specific, diversified PMS strategies can cap individual sectors andstock exposure to ensure complete stability.
Position Sizing
Position sizing is another riskmanagement technique that most fund managers follow. It is an active tradingtechnique that is designed to protect capital and manage volatility. Further,it can also prevent a single losing trade from causing significant portfoliodamage.
The strategy involves determining aspecified number of units to buy or sell, which is based on account size andrisk tolerance. For example, most fund managers follow a widely recommendedrule where you never risk more than 1–2% of your total portfolio capital ona single trade. For a ₹10,00,000 portfolio, this means a maximum loss of₹10,000–₹20,000 per trade.
Source example:kotakwebsite
High Conviction Approach
If the fund manager follows ahigh-conviction approach, it can mitigate market risks through an intense &research-driven focus. This strategy involves a concentrated portfolio of 15 to20 stocks, which reduces risk as it ensures that companies with strongfundamentals & low debt are included.
Of course, mitigation begins with a deepanalysis of the company’s financial records. Also, concentration is mostlyplaced on businesses with high return on capital and pricing power. Most PMScompanies also follow a buy right and sit tight approach, which reduces risk byallowing high-conviction ideas to play out well.
Managing Operational Risk Management:
Constant Monitoring
A fund manager or PMS company alwaysensures regular monitoring to mitigate market risks. Most fund managersevaluate portfolio performance against benchmarks like the Nifty 50.
Of course, this gives a fair idea aboutrisk drift. What is it? Risk drift is when a particular portfolio is riskierthan it set out to be.
Constant monitoring can help a fundmanager stay on track with the portfolio performance. After all, the portfolioneeds to stay aligned with the financial objectives of the investor.
Regular Rebalancing
With monitoring, it's also important topay special attention to regular rebalancing. What makes PMS distinct frommutual funds is the rebalancing feature. Of course, risk mitigation is easierwhen the fund managers rebalance your portfolio if they sense market risks. PMScompanies research & analyse data, which gives them a hint at fundperformance.
Following this, they periodically adjustdifferent holdings to maintain the original asset allocation. Not onlyallocation, but regular rebalancing is also important to maintain the riskprofile.
No investor would want to deal withmarket losses. But if it happens, PMS managers are quick to deal with thechanges so that the portfolio stays aligned with the financial objectives.
Fund managers consider time-based &threshold-based rebalancing - for risk mitigation. Time-based rebalancing iswhen the portfolio is rebalanced quarterly or annually, depending on markettrends.
In threshold-based rebalancing, fundmanagers rebalance when the asset class deviates from the predefined amount.Rebalancing can mitigate concentration & market risks.
Liquidity Management
With liquidity management, fund managersensure that a considerable portion of the portfolio is invested in liquidassets, as this allows quick exits without significant price impacts. This iseven more important for small-cap focused strategies.
Conclusion
Evaluating the fund manager's trackrecord is vital before you invest in PMS. How a fund manager manages marketrisks will impact your overall PMS performance.
Of course, it's also important for fundmanagers to provide regular updates to investors regarding fund performance.This keeps the investor informed regarding the portfolio performance.
Risk management in PMS is important, soyou need to stay aware of how the strategies work. Lastly, your trust in fundmanagers is important for stable performance. Choose a PMS company that willhelp you with risk management!
