Since I wrote about financial services today, it inspired me to write about a work in progress that I have been thinking about. I can have several of these at any given time and I might as well share them and tag them as Work in Progress.
I believe that Portfolio Management can be an effective paradigm for looking at software for both vendors and buyers. The concept of portfolio management is to spread risk and outsource to others specialization that de-risks certain investments. Portfolio managers look to get the highest return on investment for their clients based upon the risk level their clients are willing to make. In the end, I’ll say how I think it is relevant to Open Source as well.
For buyers of IT, you can consider your portfolio as the overall architecture. Do you single source this or do you work with multiple vendors? How balanced and integrated are these holdings? How adaptable are these holdings to future requirements? What is your return on investment on these holdings? How exposed are you to failure in these holdings? What risk tools do you have in place?
For vendors of IT, you can consider your portfolio as the products that you offer, the same way that a fund manager would have several products that they offer composed of other products. How exposed are you to any particular sector, such as Web 2.0, enterprise software, ECM, CRM, etc.? How balanced is your investment strategy to fluctuations in these markets? Do you have a complete portfolio to achieve your objectives?
The questions you would ask about your strategy and operations are similar to the type of thinking that portfolio managers would go through in time horizons that can range from days to years. The explicit definition of how you manage the portfolio is guided by the Objective, the Investment Philosophy, and the Style which are essentially the mission statement of the portfolio. The Objective is what you are trying to achieve with the portfolio and over what period of time and risk are you taking. The Investment Philosophy is what guides your day to day investment and how you look at investments. The Style is how aggressive, what type of assets and what type of return you expect to get. If you veer off course from these principles, expect to get sued.
In understanding and formulating these principles, the portfolio manager can ask a number of questions that can be very relevant to an IT portfolio:
- What is my objective?
- If my objective fails, what is my downside risk?
- How much risk am I willing to take?
- What is my exposure to this risk?
- What is my time horizon?
- How fungible (inter-changeable) are my products?
- Based upon the rest of the industry or benchmark, how does my product perform?
- How close have I gotten to my objective in the past?
How portfolios are measured can be instructional to how we look at IT portfolios. These measures vary based upon what type of portfolio is being managed with higher performance products, such as stocks, measured one way and lower risk, such as bonds, measured another. The measures are:
- Alpha - Raw performance as measured against objective targets
- Beta - Measure of volatility and the risk being taken
- Return on Equity - For the assets allocated, how much return has their been
- Tracking Error - How far off the benchmark (+ and -) has the portfolio tracked. Even a positive error can be an indication of risk
- Ratings - Ratings from authoritative sources on how the portfolio has performed and can be a numeric measure of subjective factors such as style and philosophy
- Yield - What is the interest rate or on-going income that comes from the underlying portfolio
- Asset Allocation - As a percentage measure what sectors, asset classes and geographies has the portfolio been allocated. This is an indication of over-exposure in a particular area
- Asset Under Management - This is an indication of who is investing by sector and by geography in this portfolio and how large of investment they are making
- Domicile - Is this portfolio run from a tax and cost efficient location?
- Fees - How much does it cost to run this portfolio?
These measures can generally have IT analogies to measures. The objective is generally to get a balanced, lower risk return. Aside from just investing in stocks there are a number of ways in which the portfolio can be structured and packaged to meet investment objects in portfolio management:
- Stocks - Individual stocks of various risk and potential for performance. These are comparable to best of breed components in your IT portfolio.
- Bonds - Lower risk holdings that also generate income. This is comparable to commodity components of your IT components, the parts that are will not yield as much return.
- Cash - Cash is not always king and it is now considered an asset class itself. However, cash is cash and how much do you have to spend on other assets?
- Overlays - These are derivatives and hedge products that can compensate for different risk factors such as currency fluctuation or changes in interest rates. This is comparable to IT risk strategies, Service Level Agreements or insurance against failure.
- Wrappers and Vehicles - These are tax and legal structures designed to control regulation and minimize tax and increase overall return. Somewhat similar to where you locate your IT operations, who operates it and who owns it.
Take a look at these and consider how applicable they are to your IT product portfolio. How does it change your view of the risk that you are taking? Are you overexposed to one particular class of software? Are you overexposed to one particular vendor? What return are you missing out on by overexposure? How are you hedging your exposure?
Where is Open Source in your portfolio? Are you overexposed to Microsoft? Are you overexposed to IBM? What major trends have you missed out on? What happens if a single vendor ignores a class of IT infrastructure like the first wave of the Web or Web 2.0? What “fees” or “tax” are you paying in your IT portfolio?
It’s hard to imagine Open Source not being part of one’s portfolio, even if it is just a hedge.