Artificial Intelligence in Portfolio Management

Blog post description.

SCIENCE AND TECHNOLOGY

Samir Kumar Mandal

6/16/202411 min read

Introduction

Handling an investment portfolio might appear intimidating, particularly to those who are unfamiliar with the financial industry. Anybody, however, may manage their money successfully if they have the correct strategy and resources. With the use of clear explanations and useful examples adapted for an Indian setting, this essay seeks to demystify portfolio management using ChatGPT.

What is Portfolio Management?

Choosing and managing a group of investments that align with your risk tolerance and long-term financial objectives is known as portfolio management. Real estate, mutual funds, equities, bonds, and other assets are examples of these investments. To maximize financial results, risk and return must be balanced.

Essential Ideas for Portfolio Management

1. Diversification: Investing in a variety of asset classes to spread risk.

2. Asset Allocation: Selecting which asset classes to include in your portfolio and at what percentage.

3. Risk Tolerance: Knowing the maximum amount of risk you are willing to accept.

4. Rebalancing: Making regular changes to the portfolio to keep the intended asset allocation.

Utilizing ChatGPT for Portfolio Administration

By offering insights, coming up with investment suggestions, and supporting computations, ChatGPT can aid with portfolio management. This is how to make efficient use of ChatGPT:

1. Educational Resource: Get knowledge about various investment plans and approaches.

2. Financial Calculations: Compute expected returns, evaluate risk, and determine whether rebalancing is necessary.

3. Scenario Analysis: Examine several scenarios for investments and the possible results

Educational Resources: Learn About Different Investment Options and Strategies

Investing can be challenging due to the abundance of options and strategies available to one. A comprehensive grasp of these options is necessary to make selections that align with your financial goals and risk tolerance. ChatGPT provides straightforward and comprehensive information on a range of topics, making it an excellent teaching tool when it comes to investing.

Types of Investment Options

1. Equity is, by definition, a corporation's ownership. When you buy shares, you turn into a shareholder.

Types:

  • Large-cap stocks are companies with a big market capitalization, like HDFC Bank or Reliance Industries.

  • MRF and Bharat Forge are examples of companies with a medium market capitalization that are known as Mid-cap stocks.

  • Smaller businesses with greater growth potential but greater risk are known as Small-cap stocks.

Benefits: Dividend income and the possibility of large profits.

Risks: Include the possibility of loss if the business performs poorly and market volatility.

2. Fixed Income (Bonds)

Definition: Bonds are long-term, interest-paying loans from investors to borrowers, usually governments or corporations.

Types:

  • Government Bond: Government-issued low-risk bonds, like the 10-year Government of India Bonds.

  • Corporate bonds: These are higher-risk, maybe higher-return bonds that are issued by businesses.

Benefits: Less risk than stocks, consistent income from interest payments.

Risks: Include credit risk and interest rate risk (should the issuer default).

3. Mutual Funds

Definition: Investment vehicles that purchase a diverse portfolio of stocks, bonds, and other securities by pooling the money of multiple investors are defined

Types:

  • Equity mutual funds: Invest mostly in stocks.

  • Debt mutual funds: Invest in Bonds and other fixed-income instruments.

  • Balanced funds: Invest in a variety of equities and bonds.

Benefits: expert management and diversification.

Hazards: Market risk, management costs.

4. ETFs (Exchange-Traded Funds)

Definition; Mutual funds-like securities that are traded on stock markets.. ETFs can follow indices, industries, commodities, or other kinds of assets.

Nifty 50 ETF and Nippon India Gold ETF are two examples.

Benefits: Include freedom in trading, minimal expenses, and diversification.

Hazards: Tracking inaccuracy, market risk.

5. Investment Trusts for Real Estate (REITs):

Definition: Businesses that finance, manage, or own real estate that generates revenue. REIT shares are tradable by investors much like equities.

Reiterations of Embassy Office Parks and Mindspace Business Parks are two examples.

Benefits: Diversification and consistent dividend income.

Hazards: Interest rate risk, real estate market risk.

6. Gold

Definition: A precious metal that has historically served as a hedge against inflation and a store of value.

Forms: Available in ETFs that track gold prices and physical gold.

Benefits: Include liquidity and an inflation hedge.

Risks: Include fluctuating prices and lack of revenue creation

Investment Methods

1. Buy and Hold

  • Defination : This term refers to making investments in securities and holding them for an extended amount of time, irrespective of changes in the market.

  • Benefits: Lower transaction costs and long-term compound gains.

  • Risks: Needs perseverance; if the investment performs poorly, there could be a long-term capital loss.

2. Value Investing:

  • Defination; Buying cheap equities that are being offered at a discount to their true worth.

  • Benefits: Possibility of large profits should the market rectify the undervaluation.

  • Risks: The fundamental value of stocks could be exaggerated, or they could stay cheap for a long time

3. Growth Investing:

  • Definition: Investing in businesses that are predicted to grow faster than the average in Comparison to other businesses is known as growth investing.

  • Benefits: There may be significant capital gains possible.

  • Risks: Risk of overvaluation and high volatility.

4. Dividend Investing:

  • Definition: Investing in businesses that consistently distribute dividends is known as dividend investing

  • Benefits: Consistent income and possible capital growt

  • Risks: Lower dividend payments and, occasionally, slower capital growth

5. Index Investing:

  • Definition: Investing in index funds or exchange-traded funds (ETFs) that follow market indices such as the Nifty 50 is known as index investing.

  • Benefits: Include diversification, reduced costs, and index-matching performance.

  • Risks: Limited opportunity to outperform the index and market risk.

6. Asset Allocation:

  • Definition: Asset allocation is the process of allocating an investment portfolio across several asset classes, like cash, bonds, and stocks, in order to balance risk and return.

  • Benefits: Reduces risk through diversification, tailored to individual risk tolerance.

  • Risks: Requires regular rebalancing, potential underperformance of chosen assets

Acquiring Knowledge through ChatGPT

ChatGPT offers comprehensive explanations, precise responses to specific queries, and a wealth of information on various investment options and strategies. Utilizing ChatGPT can enhance your understanding of investments through the following methods:

1. Specific Inquiry:

  • Inquire about the advantages of investing in mutual funds.

  • Seek an explanation of how value investing operates. Request information on the risks associated with investing in corporate bonds.

2. Comparative Analysis:

  • Compare large-cap stocks to mid-cap stocks.

  • Explore the disparities between ETFs and mutual funds.

3. Seeking Strategy Guidance:

  • Request recommendations for a conservative investor's asset allocation strategy.

  • Inquire about initiating dividend investing in the Indian market.

4. Scenario Analysis:

  • Pose a question regarding the potential impact on your portfolio if interest rates were to rise.

Utilizing ChatGPT as a learning tool can enhance your comprehension of the investment environment, enabling you to make better-informed choices and efficiently oversee your portfolio.

Financial Calculations: How ChatGPT Can Assist

Managing a portfolio involves various financial calculations that are essential for understanding expected returns, evaluating risk, and determining rebalancing requirements. ChatGPT can serve as a valuable tool in performing these calculations by offering step-by-step guidance, explanations, and practical examples. Let's delve into how ChatGPT can provide assistance in each of these areas:

1. Calculation of Expected Returns

Definition: Expected return refers to the projected profit or loss from an investment within a specified timeframe. It serves as a crucial metric for comparing different investments and making well-informed decisions.

How ChatGPT Can Help:

  • Explanation of Concepts: ChatGPT can provide clear explanations regarding the concept of expected returns and the various factors that influence it.

  • Provision of Formulas: It can supply the necessary formulas for calculating expected returns across different asset classes

  • Execution of Calculations: ChatGPT can perform the calculations based on the data provided by the user.

Example Calculation:

Let's consider the case of Ravi, who wishes to determine the expected return for his portfolio comprising equities, bonds, gold, and REITs. Here's how ChatGPT can assist him in this calculation.

Portfolio Allocation

  • Equities: 50%

  • Bonds: 30%

  • Gold: 10%

  • REITs: 10%

Expected Annual Returns

  • Equities: 12%

  • Bonds: 6%

  • Gold: 8%

  • REITs: 7%

Expected Return Formula:

Expected Return=∑(Weight of each asset×Expected return of each asset)

Calculation:

Expected Return=(0.50×12%)+(0.30×6%)+(0.10×8%)+(0.10×7%)=9.5%

ChatGPT can walk Ravi through this process, ensuring he understands each step

2. Risk Assessment

Definition: Risk assessment evaluates the potential variability in investment returns, often measured by standard deviation or beta.

How ChatGPT Helps:

  • Explain Risk Metrics: ChatGPT can explain standard deviation, beta, and other risk metrics.

  • Provide Formulas and Examples: It can offer formulas and perform example calculations.

  • Simulate Scenarios: ChatGPT can simulate different risk scenarios based on input data.

Example Calculation:

Ravi wants to understand the risk of his portfolio. Suppose the standard deviations for his investments are:

  • Equities: 18%

  • Bonds: 4%

  • Gold: 10%

  • REITs: 12%

Simplified Portfolio Risk Calculation:

Assuming minimal correlations for simplicity, the combined standard deviation can be estimated using a weighted average (a simplified approach for illustration).

Weighted Standard Deviation:

Portflio Risk=√(∑(weight of each asset ×Variance of each asset))

Portfolio Risk ≈ √((0.50^2×18%^2)+(0.30^2×4%^2)+(0.10^2×10%^2)+(0.10^2×12%^2))

Portfolio Risk≈√((0.25×324)+(0.09×16)+(0.01×100)+(0.01×144))

Portfolio Risk ≈√(81+1.44+1+1.44)≈√84.88 ≈9.2%

ChatGPT can help Ravi understand and calculate this risk metric.

3. Rebalancing Need

Definition: Rebalancing is the process of adjusting the proportions of different assets in a portfolio in order to maintain the desired asset allocation. ChatGPT can assist in several ways:

  • Explanation: ChatGPT can provide a clear understanding of why rebalancing is necessary and how frequently it should be performed

  • Strategies: It can offer various rebalancing strategies, such as calendar-based or threshold-based approaches, to help investors make informed decisio

  • Calculations: ChatGPT is capable of calculating the necessary trades required to rebalance a portfolio.

Example Calculation

For instance, let's consider an example calculation: Ravi's portfolio has experienced changes in its composition after one year due to market performance. The current allocation is as follows:

  • Equities: ₹6,00,000 (60%)

  • Bonds: ₹2,50,000 (25%)

  • Gold: ₹80,000 (8%)

  • REITs: ₹70,000 (7%)

However, Ravi's desired allocation is as follows:

  • Equities: 50%

  • Bonds: 30%

  • Gold: 10%

  • REITs: 10%

    By utilizing ChatGPT, Ravi can determine the necessary adjustments to bring his portfolio back in line with his desired allocation.

Rebalancing Formula:

1. Determine the Target Values:

Total Portfolio Value: ₹10,00,000

  • Target Equities: 50% of ₹10,00,000 = ₹5,00,000

  • Target Bonds: 30% of ₹10,00,000 = ₹3,00,000

  • Target Gold: 10% of ₹10,00,000 = ₹1,00,000

  • Target REITs: 10% of ₹10,00,000 = ₹1,00,000

1. Establish Purchase/Sale Amounts:

  • Equities: Current ₹6,00,000 - Target ₹5,00,000 = Sell ₹1,00,000

  • Bonds: Current ₹2,50,000 - Target ₹3,00,000 = Buy ₹50,000

  • Gold: Current ₹80,000 - Target ₹1,00,000 = Buy ₹20,000

  • REITs: Current ₹70,000 - Target ₹1,00,000 = Buy ₹30,000

2. Carry out rebalancing:

  • Sell ₹1,00,000 of Equities

  • Buy ₹50,000 of Bonds, ₹20,000 of Gold, and ₹30,000 of REITs

ChatGPT can assist Ravi with completing these computations, making sure he comprehends the method and reasoning behind each action.

Conclusion:

Investors can do important financial computations with clarity and confidence by utilizing ChatGPT. Through thorough explanations, easy-to-follow directions, and useful examples, ChatGPT makes difficult financial topics more understandable for all users. ChatGPT may be a very useful tool in your portfolio management toolbox for estimating expected returns, evaluating risk, and figuring out when rebalancing is necessary.

Scenario Analysis: Exploring Different Investment Scenarios with ChatGPT

Exploring Different Investment Scenarios with ChatGPTA is vital technique for managing portfolios. Scenario analysis enables investors to comprehend the potential effects of various circumstances on their holdings. By emulating different market, investment, and economic conditions and estimating their possible repercussions on your portfolio, ChatGPT can help with scenario analysis. Here's how scenario analysis can benefit from ChatGPT:

1. Understanding Scenario Analysis

Definition: Scenario analysis is the process of assessing how many fictitious scenarios can affect your portfolio of investments. This can involve modifications to the state of the market, economic indices, or particular occurrences.

The main goal is to foresee prospective opportunities and risks so that you may make educated judgments and get ready for a variety of scenarios.

2. Scenarios Types

Market Scenarios: Variations in the conditions of the stock market, including corrections, bear markets, and bull markets.

  • Using the stock market as an example, what would happen to your portfolio if it fell by 20%?

Economic Scenarios: Shifts in the economy, such as GDP growth, inflation, and interest rates.

  • For instance, what effect would an increase in interest rates have on your bond holdings?

Event-Driven Scenarios: Particular occurrences such as shifts in politics, natural calamities, or breakthroughs in technology.

  • For instance, how might a new law impact your real estate holdings?

How ChatGPT Can Help

ChatGPT may assist in Creating Scenarios: Based on user inputs or broad market patterns, ChatGPT may create a range of fictitious scenarios.

  • Compute Outcomes: This can assist in determining the possible monetary effect of any situation on your holdings.

  • Giving Insights: ChatGPT is able to provide information on the probability of any situation as well as tactics to reduce risks or take advantage of possibilities.

Example: Scenario Analysis with ChatGPT

Let's look at an investor from India named Ravi who has a well-rounded portfolio. Ravi wishes to investigate the potential effects on his investments of various situations.

Composition of a Portfolio:

Portfolio Composition:

  • Equities: ₹5,00,000 (50%)

  • Bonds: ₹3,00,000 (30%)

  • Gold: ₹1,00,000 (10%)

  • REITs: ₹1,00,000 (10%)

Scenario 1: Decline in the Market

Description: A recession in the economy causes a 20% decline in the stock market.

Analysis of ChatGPT:

1. Equities

  • Current Value: ₹5,00,000

  • Drop by 20%: ₹5,00,000 × 0.20 = ₹1,00,000

  • New Value: ₹5,00,000 - ₹1,00,000 = ₹4,00,000

2. Bonds:

  • Have little effect because of their poor association with stocks.

  • New Value ₹3,00,000

3. Gold:

  • · Gold often acts as a safe haven.

  • Assume a 5% increase: ₹1,00,000 × 1.05 = ₹1,05,000

4. REITs:

  • Assume a 10% decline as a result of the economy: ₹1,00,000 × 0.90 = ₹90,000

Total Effect :

Overall Impact:

New Portfolio Value=₹4,00,000+₹3,00,000+₹1,05,000+₹90,000=₹8,95,000

Outcome: Ravi's portfolio value drops from ₹10,00,000 to ₹8,95,000, a loss of ₹1,05,000 or 10.5%.

Strategy: To protect against market downturns, ChatGPT can recommend tactics like expanding diversification, allocating a larger percentage of asset s to gold and bonds, or taking into account inverse ETFs.

2. Increasing Interest Rates

The central bank hikes interest rates by one percent.

Analysis of ChatGPT:

1. Equities

  • Increasing interest rates can have a negative effect on stocks, particularly those of fast-growing businesses.

  • Assume there is a 5% decline: ₹5,00,000 × 0.95 = ₹4,75,000

2. Bonds:

  • As interest rates rise, bond prices generally decrease.

  • Assume that there is a 2% decline: ₹3,00,000 × 0.98 = ₹2,94,000

3. Gold:

  • As interest rates rise and the opportunity cost of keeping non-yielding assets rises, gold may also decline.

  • Assuming a 3% decline, we get ₹1,00,000 × 0.97 = ₹97,000.

4. REITs:

  • Increasing borrowing costs could have a negative effect on REITs.

  • Assuming a 5% decline, we get ₹1,00,000 × 0.95 = ₹95,000.

Total Effect:

New Portfolio Value=₹4,75,000+₹2,94,000+₹97,000+₹95,000=₹9,61,000

Outcome: Ravi’s portfolio value drops from ₹10,00,000 to ₹9,61,000, a loss of ₹39,000 or 3.9%.

Strategy:

ChatGPT can offer recommendations such as allocating a larger portion of funds to floating-rate bonds, making investments in industries like finance that profit from rising interest rates, or taking inflation-protected assets into consideration.

Scenario 3: Boom in the economy

The economy goes through a phase of fast expansion, which boosts business profits.

. ChatGPT Analysis:

1. Equities:

  • ₹5,00,000 × 1.15 = ₹5,75,000 Let's assume a 15% rise.

2. Bonds:

  • There might not be much of a change or a modest drop in bonds.

  • Assume nothing notable has changed: ₹3,00,000

3. Gold:

  • As investors look elsewhere for greater profits, gold prices may decline.

  • Assuming a 5% decline, we get ₹1,00,000 × 0.95 = ₹95,000.

4. REITs:

  • Increasing demand for commercial space could be advantageous for REITs.

  • Let's say there is a 10% rise: ₹1,00,000 × 1.10 = ₹1,10,000

Total Effect:

New Portfolio Value=₹5,75,000+₹3,00,000+₹95,000+₹1,10,000=₹10,80,000

Result: Ravi's portfolio gains ₹80,000, or 8%, in value, going from ₹10,000,000 to ₹10,80,000.

Strategy:

ChatGPT can suggest maintaining the current strategy, increasing equity exposure to capitalize on growth, or diversifying into sectors poised to benefit the most from economic expansion.

Conclusion

Investors can do important financial computations with clarity and confidence by utilizing ChatGPT. Through thorough explanations, easy-to-follow directions, and useful examples, ChatGPT makes difficult financial topics more understandable for all users. ChatGPT may be a very useful tool in your portfolio management toolbox for estimating expected returns, evaluating risk, and figuring out when rebalancing is necessary.