PORTFOLIO EXECUTION

The next step is to implement the portfolio plan by buying and/or selling specified securities in
given amounts. This is the phase of portfolio execution which is often glossed over in portfolio
management literature. For effectively handling the portfolio execution phase, we have to
understand what the trading game is like, what is the nature of key players in this game, who are
the likely winners and losers in this game, & what guidelines should be borne in mind while
trading.

Trading Game

1- In a typical securities transaction, the motive & even the identity of the other party is not
known.

2- A security transaction tends to be a zero sum game. A security offers the same future
cash flow stream to the buyer as well as the seller. So, apart from considerations of taxes
& differential risk- bearing abilities, the value of security is the same to the buyer as well
as the seller. Hence, the constructive motives which guide the business transactions are
not present in most security transactions. This means if one wins the other wins.

Key Players

1- Value Based Transactors – A value based transactor (VBT) carries out extensive analysis
of publicly available information to establish values. They generally serve as the anchor
for the trading system & establish the framework for the operations of dealers.

2- Information Based Transactors – An information based transactors (IBT) transacts on the

basis of information which is not publicly domain & therefore not reflected in security
prices. Since he expects this information to have a significant impact on prices, he is keen
to transact soon. To him, time is a great value. They generally employs ‘incremental’
fundamental analysis and technical analysis.

3- Liquidity Based Transactors – A liquidity based transactor, trades primarily due to

liquidity considerations. He may be regarded as an informationless trader who is driven
mainly by liquidity considerations.

4- Pseudo- information Based Transactors – A pseudo- information based transactor (PIBT)

believes that he possesses information that can be a source of gain, even though that
information is already captured or impounded in the price of the security.

5- Dealers – A dealer intermediates between buyers & sellers eager to transact. The dealer is
ready to buy or sell with a spread which is fairly small for actively traded securities.

Who Wins, Who Loses

It appears that the IBT’s odds of winning are the highest, assuming that his information is
substantiated by the market. He is followed by the VBT, LBT, and PIBT in that order.

• The IBT seems to have a distinct edge over others.

• The VBT tends to lose against the IBT but gains against the LBT & PIBT

• The LBT may have some advantage over the PIBT

Guidelines

1- Maintain a dialogue with the broker – When a trade is seriously contemplated, check with
the broker about the sensitivity of the stock to buying or selling pressure, the volume that
can be traded without pushing the price out of the desirable range, the manipulative
games, if any, being played by operators, & the degree of market resilience.

2- Place an order which serves best interest – The more common types of orders are: the
market order, the best efforts order, the market-on-open order & the limit order.
The market order instructs the broker to execute the transaction promptly at the best
available price. The best efforts order gives the broker a certain measure of discretion to
execute the transaction when he considers the market condition more favourable. The
market-on-open order instructs the broker to execute the transaction during the opening
of the trading day. The limit order instructs the broker to execute the transaction only
within the price limits specified in the order.

3- Avoid serious trading errors – The worst trading errors appear to be following:
-a VBT sells time too cheaply,
-an IBT buys time too expensively, &
-an LBT, by appearing motivated by information, evokes very defensive responses from
dealers & other market participants.

PORTFOLIO REVISION
This usually entails two things, viz. portfolio rebalancing & portfolio upgrading.

• Portfolio Rebalancing

Portfolio rebalancing involves reviewing & revising the portfolio composition. There are
three basic policies with respect to portfolio rebalancing these are as under:-

a) Buy and hold policy – Under such policy, the initial portfolio is left undisturbed. For
example, if the initial portfolio has a stock-bond mix of 50:50 & after six months
The stock-bond mix happens to be say, 70:30 because the stock component has
appreciated & the bond component has stagnated, the portfolio mix is allowed to
drift.

b) Constant mix policy – It calls for maintaining the proportions of stocks & bonds in
line with their target value. For example, the desired mix of stocks & bonds is say
50:50, the constant mix policy calls for rebalancing the portfolio when relative
values of its components change, so that the target proportions are maintained.

c) Portfolio Insurance policy – It calls for increasing the exposure to stocks when the
portfolio appreciates in value & decreasing the exposure to stocks when the portfolio
depreciates in value. The basic idea is to ensure that the portfolio value does not fall
below a floor level.

• Portfolio Upgrading

Portfolio upgrading calls for re-assessing the risk-return characteristics of various securities,
selling over priced securities & buying under priced securities.