Portfolio analysis in strategic management is a branch of management theory that has emerged from the discipline of financial accounting. Analyzing a company's assets and liabilities as per their individual risk factors enables managers to allocate capital funds in accordance with their objectives and to minimize the potential losses in specific asset classes. For managers, it is essential to analyze not only the individual risk factors but also the combination of individual risk factors. Such analysis is crucial for the purpose of achieving a balanced portfolio that is economically and adequately balanced to meet the goals and objectives of the company.
The term "Portfolio analysis in strategic management" actually comes from the technical description of the process of evaluating a portfolio's assets and liabilities as per their individual potential risks. This is done by calculating and comparing the expected losses on different categories of assets and liabilities. While every portfolio is inherently risky, some portfolios are made more risk-resistant than others. In fact, a very good portfolio analysis will attempt to minimise portfolio risk within acceptable limits. Usually, the aim of a portfolio manager is to create a portfolio that is both risk-resistant and cost-efficient.
A manager must have in place a robust methodology for assessing the health of the portfolio. This requires the formulation of a portfolio optimization strategy and the application of a set of techniques for identifying, measuring and prioritizing risk factors. The core elements of the Portfolio analysis in strategic management include identification of the key risk indicators, estimation of the strength of these indicators, and estimation of the key risk outcomes. Separate concepts such as cost of capital and expected return are also incorporated in this process.
As mentioned earlier, the key risk indicator is the total expected loss per category of asset category. The other underlying concepts associated with portfolio analysis make it a powerful tool for managers to choose the appropriate mix of investments that go into a portfolio. The concepts such as replacement value, cost of ownership, and life expectancy all come from the analysis of the portfolio. These concepts can be understood easily and applied in the portfolio analysis itself.
One can also identify the allocation of resources in the portfolio. In this context, it is important for managers to understand their own allocation strategy and the results that come from it. well-planned portfolio allocation strategy addresses the complete investment plan. Therefore, it is necessary for a manager to understand the investment objectives of the company in the long run. The portfolio should also take into account the allocation of risk into a portfolio so that a certain proportion of the portfolio's value is going to portfolio effects, such as the effects of inflation and economic conditions.
When there are significant changes in investment portfolio allocations, a manager has to apply the same risk analysis principles across all the portfolio. Applying the same analysis across all portfolio means that the effects of a change in risk factor will be similar across all investments. In other words, portfolio analysis in Strategic Management is nothing but the identification of all the risk factors associated with the portfolio and applying a particular risk density function on them to identify the equilibrium point at which all the risk-weights are equally spread out. In order to find this point, the manager has to apply a mathematical expression to the portfolio.
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