Active Equity Investing: Portfolio Construction

Correct Answer: Conduct thorough bottom-up analysis on the selected energy stocks to ensure they meet the portfolio's investment criteria and risk-return objectives, and then gradually build positions while closely monitoring sector exposure and portfolio diversification.

The most appropriate approach for John is to conduct thorough bottom-up analysis on the selected energy stocks to ensure they meet the portfolio's investment criteria and risk-return objectives, and then gradually build positions while closely monitoring sector exposure and portfolio diversification. While the client's investment policy statement allows for concentrated positions and sector bets, allocating a significant portion of the portfolio to a small number of energy stocks based solely on top-down analysis would be imprudent. John should first perform rigorous fundamental analysis on the individual stocks to assess their financial health, growth prospects, and alignment with the portfolio's objectives. Gradually building positions in the selected stocks allows John to manage risk and monitor the impact on portfolio diversification. This approach strikes a balance between capitalizing on the expected outperformance of the energy sector and maintaining a well-constructed portfolio that aligns with the client's long-term goals. Completely refraining from investing in the energy sector would be an overreaction, as the sector's absence from the current portfolio does not necessarily mean it is misaligned with the overall investment strategy. The top-down analysis suggests a compelling opportunity, and the client's investment policy statement allows for sector bets, so a measured approach to adding energy exposure is warranted.

Correct Answer: Maintain the current overweight position in the technology sector but refrain from adding additional technology stocks to the portfolio. Instead, focus on identifying attractive investment opportunities in other sectors to maintain diversification and align with the client's investment policy statement.

The most appropriate course of action for Jennifer is to maintain the current overweight position in the technology sector but refrain from adding additional technology stocks to the portfolio. Instead, she should focus on identifying attractive investment opportunities in other sectors to maintain diversification and align with the client's investment policy statement. While Jennifer has identified high-conviction technology stocks with strong potential for earnings growth and market share gains, further increasing the allocation to the technology sector would exacerbate the portfolio's existing overweight position relative to the benchmark. This could lead to excessive concentration risk and deviate from the client's emphasis on diversification across sectors. Significantly increasing the allocation to the technology sector would go against the client's investment policy statement, which emphasizes diversification. Although the client has a long-term investment horizon, taking on excessive risk in a single sector may not be prudent, especially given the client's moderate risk tolerance. Reducing the allocation to the technology sector to bring it in line with the benchmark would help achieve a more balanced portfolio. However, this approach would require selling some of the existing technology holdings, potentially missing out on the growth opportunities identified by Jennifer's bottom-up analysis. Therefore, maintaining the current overweight position while seeking attractive opportunities in other sectors strikes a balance between capturing the growth potential of the identified technology stocks and maintaining portfolio diversification in line with the client's objectives.

Correct Answer: David should thoroughly assess the risk-return characteristics of the high-conviction consumer discretionary stocks and their potential impact on the portfolio's overall risk profile. He should consider the client's risk tolerance and investment objectives, and ensure that the increased allocation to the consumer discretionary sector aligns with the client's goals and constraints. David should also evaluate the portfolio's diversification and factor exposures after incorporating the new consumer discretionary positions.

David should thoroughly assess the risk-return characteristics of the high-conviction consumer discretionary stocks and their potential impact on the portfolio's overall risk profile. This approach aligns with the client's risk tolerance, investment objectives, and the investment policy statement that allows for concentrated positions and sector deviations from the benchmark. David should carefully evaluate how the increased allocation to the consumer discretionary sector will affect the portfolio's diversification and factor exposures. This will ensure that the portfolio remains well-balanced and consistent with the client's goals and constraints. The other two options are less appropriate because: - Significantly increasing the allocation to the high-conviction stocks without proper risk assessment could lead to excessive concentration risk and potential misalignment with the client's objectives. - Maintaining the current underweight position in the consumer discretionary sector would mean foregoing potential alpha opportunities identified through David's top-down analysis and high-conviction stock picks, which goes against the principles of active management and the client's investment policy statement.