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Dynamics of Managing a Good Portfolio

January 9, 2019


One of the key tenets of (investment) portfolio construction is that diversification reduces risk. However, just diversification does not reduce risk fully. The risks emanating from specific investments or loans must be closely monitored to reduce portfolio delinquency or losses.


The quality of the portfolio speaks about the strength of a financial services organization because it helps in containing the adverse effects of events that may erode the profitability and earnings. While managing and monitoring portfolio risk is the responsibility of all the employees in a financial services organisation, the Risk and Operations team takes the lead in ensuring that information on all forms of credit or operational risks are available in time and the risks are appropriately controlled through a series of preventive and sometimes curative measures. Likelihood – the probability of an event occurring, and consequence – the impact or outcome of an event, are the two components that characterize the magnitude of the risk. The objective of the risk and operations teams is to be on watch for both likelihood and consequence of any overdue, and devise methods to either contain them or reduce their impact on the portfolio. As a part of the team, I thought it will be useful to talk about how we think about portfolio risk management.


To effectively manage the loan or investment portfolio, we must look at its “health” status from dimensions other than just timely repayments.  Some of the dimensions/ mechanisms are as outlined below:


Legal Contract Administration: Each investment has a set of legally binding conditions that are specific to the loan.  These contracts become the backbone for setting the expectations and evaluating the performance of the particular investment.  All the legal clauses pertaining to loan collections, overdue calculations, signed covenants, trigger events of default must be duly noted and monitored.







Collections Management:

Like already mentioned, ensuring timely repayments or collections management is a primary risk management function.  It is imperative that the collections team doubly ensures correctness of all repayments as per the legal contracts. Any disputes arising due to error of calculations may have legal implications. Many organizations thus use technology-based solutions to do the maths. This helps in better control and avoid all possible collusions or human error.

Proactively sending advance reminders for upcoming repayments to clients and also agility in immediate follow-ups in cases of collection failures are simple but important steps that help to keep the collections in order. 


Overdues are part of most loan portfolios. As they say, only the “Crying baby gets the milk “, the same is also seen in the methods of overdue collections. The constant follow ups become necessary for ensuring that all overdues are closed. Overdues collection process are mapped with turnaround time matrix which has follow up tasks assigned to various employees based on their hierarchy and the amount in question.


Monitoring Client Performance: On time repayment is correlated with the actual operational performance of the company. Any negative movement in operating performance today may lead to overdues tomorrow, even if the loan is currently being paid on time. Thus, it becomes necessary to keep a tab on the overall performance of the company at a predefined frequency to identify future possibilities of slippage. While monitoring of the legally binding covenants is obvious, the risk team also needs to look out for current and past business trends, recent key events within the company and map or compare them with industry performance.

There is also a growing trend of where predictive models are being used to monitor the performance of the portfolio. They use current data (both structured and unstructured) and predict the possibility of a future default. With the aid of such tools, financial services organizations can take early decisions to pull back the investments within time or take corrective measures.


Setting and adhering to policies: Each organization’s risk appetite is different and hence the risk management strategies also vary. The risk appetite and appropriate risk management strategies come together to create organisation specific policies around risk management which set the boundaries of required performance from the portfolio. Once the policies are created, the financial services organisation has to adhere to the policies all the time to keep the portfolio health intact as per their risk appetite and agreed risk management strategies. Hence, what may be an issue for one financial services organisation, may not be an issue for another and hence the reaction to a similar incident will vary from lender/investor to investor to some extent.

Policies must be reviewed at least annually to keep them abreast with organizational goals and market situations. 


Reporting and Management Review:

Portfolio data must be represented in ways which is easily comprehensible and able to show trends and performance both at a point of time and also in a time series method. Data cuts can be based on products, sectors, earnings, business plan budgeted numbers vs. actual performance etc. Dashboards must be created for regular management review. This keeps the team abreast of the latest developments and also suggests the steps to be taken to manage the portfolio’s health.


Relationship management:

One action that aids in smooth loan life-cycle is an empathetic two-way relationship between client and lender. Many a times a casual discussion also helps in gathering information that is otherwise not obvious through the traditional methods of data collection. These inputs enable better risk management by figuring out areas where we can help our portfolio companies to overcome difficulties or manage (increase or decrease) exposure and in the process enable better portfolio quality. Each of the above aspects lead to efficient portfolio risk management. Interestingly, they not only monitor the portfolio from the lens of risk reduction, they also throw at us new business opportunities, the key is only to hear more closely and actively.

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