Portfolios are part of the bedrock of any financial services company. Yet, other industries are now starting to use a similar approach – not with stocks and bonds, but with business projects. Martin Lockett, Bert De Reyck and Andrew Sloper think it’s a great idea, but only if it’s done right.
In finance, the idea of managing a “portfolio” goes back to the 1950s. Simply put, assembling a portfolio of stocks, bonds and other financial instruments can be a way to balance the risk a manager is taking with any one of the investments: while the value of one holding may plunge, the value of another might soar. Risks and rewards offset one another. A properly constructed portfolio increases returns and promotes a better night’s sleep. Now portfolio management is making its way into the vocabulary of non-financial managers, and the concept is generating excitement. The term to add to your vocabulary is project portfolio management (PPM).
Harry Markowitz, in a seminal paper written in 1952, laid down the basis for financial portfolio theory. Markowitz’s model, which determines the mix of investments generating the highest return for a given level of risk, revolutionized the finance world. He justly received the 1990 Nobel Prize in Economics. Over time, a few people not directly involved in finance started to apply the model to a portfolio of business projects. Companies in the pharmaceutical and energy industries have long recognized the value of project portfolio management; and they are using sophisticated methods and software tools to support this process, sometimes with great success. Such project portfolio management processes are now also being adopted by other industries and functions, for example, for IT projects and organizational change programmes. The movement has gained impetus. For example, Gerald Kendall and Steven Rollins’ book on the subject, Advanced Project Portfolio Management and The PMO: Multiplying ROI at Warp Speed (J. Ross Publishing, 2003), outlined the generic approach one could use for a portfolio of projects instead of financial instruments:
We have often observed that project portfolios in organizations often contain projects that do not adequately support the strategic intent; suffer from overlap and duplication; compete for limited resources; do not share capabilities adequately; or exceed the organization’s capacity for change. Therefore, despite the success of portfolio management in finance, other fields and industries seem to have different concerns and portfolio management requirements, making it impossible to directly apply methods that have proven themselves in finance. So, despite the power of the insights from portfolio theory and their impact in finance, they cannot be applied in a naive way to other types of portfolio. This is because financial instruments such as stocks, bonds or options are very different in nature compared with projects.
What are the key difference in managing a portfolio of financial instruments versus a portfolio of business projects? Let’s profile the two kinds of portfolios under review. The main characteristics of investing in financial instruments include: