What is a defined portfolio?
A defined portfolio is an investment trust that invests in a predefined set of bonds, stocks or both that have been selected by the fund company. Like some categories of mutual funds, trusts are closed-end and are not actively managed. Like a mutual fund, a closed-end fund is a mutual fund with a manager overseeing the portfolio. It raises fixed capital through an initial public offering (IPO). The fund is then structured, listed and traded like a stock exchange.
Key points to remember:
- A defined portfolio, or investment trust, is an already defined group of bonds, stocks, or a combination of both, which have been selected by the trust.
- The trust’s investments are closed and not actively managed, like some mutual funds.
- With a defined portfolio, the securities are fixed and the units can only be sold after the completion of the initial purchase phase.
- Since the units have a specified shelf life, once that term expires, the units are liquidated and the proceeds are paid out to investors.
- While different types of securities can be used to build a diversified portfolio, stocks, bonds and cash are the main components.
Understand a defined portfolio
Like other types of portfolio, a defined portfolio is a collection of financial assets such as stocks, bonds, commodities, currencies, cash equivalents and their fund counterparties, including mutual funds, traded and closed.
In a defined portfolio, the securities are fixed and the units can only be sold after the completion of the initial purchase phase. These units usually have a defined shelf life, after which they are liquidated and the proceeds are returned to investors. A defined portfolio can be traded at different prices during the trading day.
Supply and demand determine the price of units in a defined portfolio, which can lead to price deviations from the net worth of its underlying assets. Mutual funds may not be in sync with their net asset value, but their price is only set once per day at the net asset value at the close of trading. Shares in the portfolio are sold to investors in units.
Defined portfolio and risk tolerance
An investment portfolio is divided into segments of varying sizes, representing a variety of asset classes and investment types to achieve an appropriate risk-return portfolio allocation. There are many different types of securities that can be used to build a diversified portfolio, but stocks, bonds, and cash are generally considered to be the building blocks of a portfolio.
The most cautious investors build investment portfolios in line with their risk tolerance and their objectives. Risk tolerance can be defined as the degree of variability in investment returns that an investor is willing to accept, especially when the market turns down.
Risk tolerance is one of the most important considerations in determining how to invest. Investors need to have a realistic understanding of their ability and willingness to digest large movements in the value of their investments. If investors take too much risk, they might be more inclined to sell in a downturn in the market and miss a market rebound.