Limitation in portfolio

Small businesses occasionally start out offering only one product or service. But as
businesses grow, they typically expand their product offerings and tap into new
market by adapting the Portfolio Analysis. Portfolio analysis helps managers study the
profitability of the various products and services a business offers. It is designed to
help optimize the allocation of resources between those products and services. While
portfolio analysis can be a useful tool for thinking about how to optimize return on
investment, it does have a few limitations.i Portfolio Risk Management sets limits
operational limits and can be amended by a decision of the Board of Directors upon
the recommendation of the Manager. Operational limits may only be more severe than
the institutional limits.
The risk limits are conservative, unless specified otherwise; all limits described in this
document may be modified in accordance with the procedure. Unless specifically
stated, all limits apply simultaneously; for day-to-day operational purposes the most
restrictive/risk-averse ones apply with priority.
Total Portfolio Limit
Total Portfolio limits relate directly to an entitys statute and policy constraints,
investment objectives and cash flow projections. Although setting maximum maturity
constraints may help limit the market risk in a portfolio, it is not generally considered
to be the most effective way for managing market risk and understanding the potential
price volatility of either an individual security or an entire portfolio. Maximum
maturities allow the portfolio to take advantage of longer securities and the weighted
average maturity protects against over-extension of the portfolio in those longer
maturities.
Geographical Diversification Limit
Another way to diversify is by gaining exposure to different parts of the world. For
example, instead of investing only in U.S. stocks, we can add foreign stocks to the
mix. This makes the portfolio less sensitive to any large downturn that may occur in
the U.S. stock market. Geographical diversification is the practice of diversifying an

investment portfolio across different geographic regions in order to reduce the overall
risk and improve returns.
This technique can be used by both private investors and companies to limit and
manage risk. Firms are able to lower their risk exposure to political and economic
changes; and prevent any unexpected and disruptive event that may operate to excuse
a party from a contract. by locating particular departments and/or resources in
different parts of the world. If one of the companys assets is located in a region more
vulnerable to change (tsunami, earthquake, revolution, riots) the parts located in other
areas may compensate and provide balance.
Since the cycles that drive business and investment are experienced at different times
in different countries, foreign markets seldom move in perfect tandem with each
other. Losses in one market may be offset by gains in another. Geographical
diversification significantly reduces the overall level of instability and exposure to
external factors.ii
Portfolio Diversification Limit
The purpose of the stock portfolio diversification is to reduce the measures of risk.
Risk is taken to measure the uncertainty of the potential of future market value it is
done through applying the portfolio theory, which provides both theoretical
justifications for diversification analytical framework for assembling individual
securities to achieve proper diversification. A certain amount of diversification is
crucial; otherwise investment funds will be taking risk that it will not be compensated
for.
Here are some reasons on why managers need to limit portfolio diversification on a
specific investment:
1. Reduces Quality: There are only so many quality companies and even less
that are priced at levels that provide a margin of safety. The more stocks are
put into a portfolio the less concentrated the portfolio will be in the best
opportunities.

2. Indexing: when there are too many assets in a portfolio it essentially becomes
an index fund. The more stocks a company owns, the more correlated their
portfolio will be to market returns. While passive management or indexing
might work in bull markets it does not work well in flat or bear markets. Most
indices are skewed toward stocks that have already risen and underweight
stocks that have fallen, and may be at bargain prices.
3. Market Risk: Before a company buys an index fund, they should first
understand how the mathematics of portfolio volatility lowers their portfolio
performance. Few investors ever achieve even close to average returns
because of volatility caused by market risk.
4.

Bad Investment Vehicle: Most investors who over diversify use investment
vehicles such as index funds or actively traded mutual funds. Actively
managed mutual funds trade in and out of stocks and have a tendency to focus
on short term trading instead of value. Studies show these funds underperform
market indices in the long run.iii

i What Are the Limitations of Portfolio Analysis? | Chron.com. 2015. [ONLINE]

Available at: http://smallbusiness.chron.com/limitations-portfolio-analysis40254.html. [Accessed 01 September 2015].
ii Geographical diversification | Sunshine Profits. 2015.. [ONLINE] Available at:
http://www.sunshineprofits.com/gold-silver/dictionary/geographicaldiversification/. [Accessed 10 September 2015].
iii Disadvantages of Diversification in Investing - Arbor Asset Allocation Model
Portfolio (AAAMP) Value Blog. 2015. [ONLINE] Available at:
http://www.arborinvestmentplanner.com/disadvantages-of-diversification-ininvesting/. [Accessed 10 September 2015].