Type C Investor: Only Market-timing Skills
The type C investor holds a well-diversified portfolio but switches actively between
defensive and offensive portfolios to take advantage of the market timing. If he expects
the market to rise, he should push his portfolio beta above his target level by any of the
techniques described in the section on market timing. The converse should be done if the
investor is bearish about the market. In either case, the portfolio would remain
diversified all through. The portfolio of this investor is diversified, but its beta is
managed and not constant.
Type D Investor: Both Stock-picking and Market-timing Skills
This type of investor would use the techniques used by both the type B and Type C
investor. These investors would have the most active and aggressive portfolio
management strategies. Using their superior ability to predict booms and busts in the
market as a whole and their skills in identifying undervalued scrips, they should hold
highly concentrated portfolios and let the beta fluctuate quite sharply around the long run
target value.
A pitfall to be very strenuously avoided is that of assuming that one has a skill which one
is reality does not have. For example, an investor who does not have very good abilities
in scrip selection may still think that he does have such skills. He would then end up
with an ill-diversified portfolio which earns mediocre returns; he would have been better
off with a passive portfolio.
Bond Portfolio Selection
The bond portfolio design problem consists of choosing a mix of bonds which has the
desired duration and provides the highest YTM. Of course, this must be done keeping in
mind the default risk of the bonds also.
There are two distinct ways in which default risk can be taken into account in designing
the bond portfolio:
- The legalistic approach establishes a minimum rating which a bond must
have to be included in the portfolio. Many bond portfolio managers
throughout the world operate under such explicit or implicit restrictions
which prohibit them from investing in low grade bonds. - The more sophisticated approach looks at the average quality of the bond
portfolio. The overall risk aversion of the investor determines the desired
average quality of the total portfolio. But it is not necessary that all bonds
be of this quality. Some lower grade bonds may be bought if the rest of
the portfolio is of sufficiently higher grade to maintain the average quality.