Building a high performance portfolio step by step

Every finance student asks himself the question of building its own portfolio at some point. But how do you go about it? Replicate the portfolio of a large hedge fund? Follow the information you read two days ago? Faced with a continuous flow of different, based on contradictory information, how do you manage to make the best choice? This is what we will try to find out in this article. We present you with some concepts and ideas that may be useful if you want to start building a portfolio of financial assets. 

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1) Establish the portfolio construction method 

The construction of a portfolio is a technical and complex process that must follow several steps and meet objectives set in advance according to your investor profile. Depending on this point, everyone will build a different portfolio and must therefore establish a strategy that is specific to them. In any case, your portfolio must be flexible in order to be able to respond to the market dynamics, to the financial announcements of companies and, above all, to your own expectations, which will necessarily evolve over time. Even though your portfolio has been established with the greatest care, you can be sure that it will not remain static and that you will most likely want to evolve it on a daily basis. 

Building a portfolio is an ongoing process that must respond to some automatisms. Therefore, you must first establish a method of recurring tasks, which you repeat with each new adjustment. 

2) Formulate your investment goals according to your own expectations

According to your income, your confidence in the market, the expected return and your financial profile, you must determine the following criteria

• The risk/return ratio: this ratio is fundamental in finance. The more risk you are willing to take, the greater the potential for gains. However, and this is the problem, the greater the possibility of losses. So you have to decide if you are willing to lose a lot to gain a lot, or if you prefer to stay "safe" and limit your risks, knowing that you are limiting your possible return at the same time
• The amount of investment you are willing to bear
• The frequency of the investment: in most cases, it is advisable to carry out a recurring investment program. This means investing a certain amount every month/week/day depending on your expectations
• The duration of your investment: do you have a quick return objective or rather a long term one? This criterion will have a strong impact on the financial assets in which you will invest
• Portfolio management: a portfolio can be managed passively (investment at a given moment, which will not be modified according to the financial news. This is called a "hold strategy") or active (portfolio readjusted and modified daily, according to financial events)
  

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3) Analyze the market dynamics

When building your portfolio, you must analyze the market dynamics. Indeed, understanding these dynamics allows you to define which sectors are accelerating and which are declining. In this way, you can optimize your investments. This data can be found on specialized company platforms such as Bloomberg. 

Next, you need to determine the relationship between the market price and the company's valuation. This can be done by establishing existing valuation models or by creating your own. In any case, it can be useful to follow the recommendations of banks and specialized companies. 

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4) Define an optimal capital allocation strategy 

Next, you need to define how you want to allocate your money. For example, if you want to invest €1,000 initially, will you put €100 in each asset? €500 in a "safe" stock and €50 in 10 other more volatile assets? All this has to be determined before you start investing. Moreover, one asset may gain 10%, while another may lose 20%. All of these variations must be considered in order to mitigate the declines, while achieving an overall increase. 

In order to define this strategy, you must follow certain constraints related to the weighting of each asset: 

• The total return of the portfolio must be equal to the weighted average return of each asset
• The sum of the weights of all assets must be equal to 1
  

Finally, it is preferable to have a low correlation between the picked assets. In the opposite case, the decline of one of them will lead to a general decline of the portfolio. By diversifying the investment sectors, you avoid a general movement of your portfolio. 

5) Implement the defined strategy 

Now that your strategy is defined, you need to implement it. The first step is to buy all the assets you have chosen. Then you need to follow the market to buy the undervalued assets and sell the overvalued assets. One element that we haven't mentioned yet and that is crucial is the transaction cost. Indeed, each trading platform charges you a fee for every transaction. It is therefore necessary to deduct these fees from the capital gain you have made in order to have a correct view of your performance. 

6) Analyze the performance over a defined period of time

In order to permanently optimize your return, you must often analyze the portfolio's follow-up. This can (and should) be done regularly over defined periods (day, week, month, quarter) in order to take into account all the data and couple them with the market situation. 

This allows you to analyze the under- and over-performing factors of your portfolio. This way, you can readjust your portfolio regularly. 

7) Focus on sustainable and responsible investments

Finally, more and more companies and investment funds are focusing on sustainable investments. Sustainable investments are now part of the majority of professional portfolios. However, they must be evaluated in a different way, but facilitated by responsible rating agencies such as MSCI ESG Research or Sustainanalytics. 

The different possible investment strategies to apply according to your profile

You now have all the keys to successfully build your portfolio. During this step, you will realize that you have a certain investor profile that depends on your ability to bear risk. Here are the different strategies that can be applied: 

• The risk-avoiding strategy: this involves choosing assets that have a low enough volatility to have a "safe" portfolio. You will obtain a low risk/return ratio (low risk, therefore low return) which will allow you to have a low return (up to 3 to 5% per year) but almost guaranteed
• The risk-taking strategy: this strategy implies a desire for a high return, linked to an investment in risky assets. You have the possibility of obtaining very high returns (above 10%), but this also implies the possibility of seeing your initial investment reduced by 10% or more.
• The risk-neutral strategy: this strategy aims at an equitable distribution of risky assets and safe assets
• The climate-related investing strategy: the principle is to choose your assets according to the data related to the carbon emissions of these assets
  

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