The Circle of Investment: Connecting the Dots of the Portfolio Management Cycle...

Abstract: We will look at the entire cycle of the investment process relating to all aspects of, formulating an investment hypothesis, constructing a portfolio based on that, executing the trades to implement it, on-going risk management, periodically measuring the performance of the portfolio, and rebalancing the portfolio either due to an increase in the risk parameters or due to a deviation from the intended asset allocation. We provide several illustrative analogies that are meant to intuitively explain the pleasures and the pitfalls that can arise while managing a portfolio. If we consider the entire investment management procedure as being akin to connecting the dots of a circle, then the Circle of Investment can be represented as a dotted circle with many dots falling approximately on the circumference and with no clue about the exact location of the centre or the length of the radius. We represent the investment process as a dotted circle since there is a lot of ambiguity in the various steps involved. The circle also indicates the repetitive nature of many steps that are continuously carried out while investing. This work introduces two new points pertaining to this dotted circle and improves the ability, to understand how far-off this dotted circle is, from a more well-defined circle and, to create a well-formed circle. The two innovations we introduce are: 1. The first, relating to the limitations that apply to any finding in the social sciences, would be the additional point we introduce that lies near the centre of the circle. We title this as, 'The Uncertainty Principle of the Social Sciences'. 2. The second, relating to establishing confidence levels in a systematic manner for each view we associate with a security or group of securities as required by the Black-Litterman framework, would be the new point we present near the circumference of the circle.