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Portfolio Management

Selection and management of investment mix to achieve investor's goals.

Portfolio management involves selecting and overseeing a group of investments that meet a client's long-term financial objectives and risk tolerance. It includes asset allocation, diversification, and rebalancing.

5 minutes 5 Questions

Concepts covered: Overview of Private Wealth Management, Topics in Private Wealth Management, Investment Manager Selection, Portfolio Management for Institutional Investors, Case Studies in Portfolio Management, Asset Allocation with Real-World Constraints, Portfolio Performance Evaluation, Principles of Asset Allocation, Trade Strategy and Execution, Risk Management for Individuals, Overview of Asset Allocation

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CFA Level 3 - Portfolio Management Example Questions

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Question 1

John, a 55-year-old investor, is reviewing his portfolio with his financial advisor. John's current portfolio consists of 60% stocks, 30% bonds, and 10% cash. He plans to retire in 10 years and wants to ensure that his portfolio is well-positioned to support his retirement lifestyle. John's risk tolerance is moderate, and he is comfortable with some short-term volatility in exchange for long-term growth potential. His advisor suggests three potential asset allocation strategies for John to consider. Strategy A consists of 50% stocks, 40% bonds, and 10% cash. Strategy B consists of 70% stocks, 25% bonds, and 5% alternative investments. Strategy C consists of 55% stocks, 35% bonds, and 10% real estate investment trusts (REITs). Given John's current situation, risk tolerance, and retirement goals, which asset allocation strategy would be most suitable for him?

Strategy B, which includes 70% stocks, 25% bonds, and 5% alternative investments, is the most suitable option for John's situation. The higher stock allocation will maximize the growth potential of his portfolio, allowing him to accumulate more wealth in the years leading up to retirement. The alternative investments component adds diversification and potential uncorrelated returns to the traditional stock and bond mix. Strategy A, with 50% stocks, 40% bonds, and 10% cash, would be the most appropriate choice for John. This conservative allocation prioritizes capital preservation over growth, ensuring that John's portfolio remains stable as he approaches retirement. The higher bond allocation will generate a steady income stream, while the cash position provides liquidity for any unforeseen expenses. Strategy C, which consists of 55% stocks, 35% bonds, and 10% REITs, would be the most suitable asset allocation for John. This strategy provides a balance between growth potential and stability, aligning with John's moderate risk tolerance and retirement goals. The inclusion of REITs offers diversification benefits and potential income generation.

Correct Answer: Strategy C, which consists of 55% stocks, 35% bonds, and 10% REITs, would be the most suitable asset allocation for John. This strategy provides a balance between growth potential and stability, aligning with John's moderate risk tolerance and retirement goals. The inclusion of REITs offers diversification benefits and potential income generation.

Strategy C is the most suitable asset allocation for John given his current situation, risk tolerance, and retirement goals. This strategy strikes a balance between growth potential and stability by allocating 55% to stocks, 35% to bonds, and 10% to REITs. The stock allocation allows for long-term growth, while the bond allocation provides a stable income stream and reduces overall portfolio volatility. The inclusion of REITs offers diversification benefits and potential income generation, which can be valuable for John as he approaches retirement. Strategy A, with its conservative allocation, prioritizes capital preservation but may not provide sufficient growth potential to support John's retirement lifestyle over the long term. Strategy B, with its higher stock allocation and alternative investments, may be too aggressive given John's moderate risk tolerance and the relatively short time horizon until his retirement.

Question 2

Lisa, a 42-year-old architect, is working with her financial advisor to create an investment strategy for her retirement savings. She currently has a portfolio consisting of 70% stocks, 25% bonds, and 5% cash. Lisa plans to retire in 20 years and has a moderate risk tolerance. Her advisor suggests three potential asset allocation strategies to consider. Strategy A involves maintaining the current 70/25/5 split but diversifying the stock portion to include 25% international stocks and 10% small-cap stocks. Strategy B consists of reducing stocks to 60%, increasing bonds to 35%, and allocating 5% to real estate investment trusts (REITs). Strategy C involves increasing stocks to 80%, reducing bonds to 15%, and adding a 5% allocation to commodities. Considering Lisa's age, risk tolerance, retirement timeline, and the need for growth and diversification, which strategy would be most suitable for her situation?

Strategy A, which maintains Lisa's current 70/25/5 split but diversifies the stock portion to include 25% international stocks and 10% small-cap stocks, would be the most suitable option. This strategy aligns with her moderate risk tolerance and provides exposure to a broader range of equity markets, potentially enhancing returns and reducing portfolio volatility over her 20-year investment horizon. Strategy C, which involves increasing stocks to 80%, reducing bonds to 15%, and adding a 5% allocation to commodities, would be the most suitable option for Lisa. Given her 20-year investment horizon and the need for growth, a higher allocation to stocks can potentially maximize returns. The inclusion of commodities provides an additional layer of diversification and a hedge against inflation, which can be beneficial over the long term. Strategy B, which reduces stocks to 60%, increases bonds to 35%, and allocates 5% to real estate investment trusts (REITs), would be the most suitable option. This strategy aligns with Lisa's moderate risk tolerance and provides a balanced approach to growth and stability. The inclusion of REITs offers diversification benefits and potential income generation, which can be advantageous as she approaches retirement.

Correct Answer: Strategy A, which maintains Lisa's current 70/25/5 split but diversifies the stock portion to include 25% international stocks and 10% small-cap stocks, would be the most suitable option. This strategy aligns with her moderate risk tolerance and provides exposure to a broader range of equity markets, potentially enhancing returns and reducing portfolio volatility over her 20-year investment horizon.

Strategy A is the most suitable option for Lisa's situation. Here's why: 1. It maintains her current 70/25/5 asset allocation, which aligns with her moderate risk tolerance. 2. By diversifying the stock portion to include 25% international stocks and 10% small-cap stocks, Lisa can potentially enhance returns and reduce portfolio volatility over her 20-year investment horizon. 3. International stocks provide exposure to a broader range of equity markets, which can help mitigate country-specific risks. 4. Small-cap stocks have historically offered higher growth potential, albeit with higher volatility, which can be beneficial for long-term investors like Lisa. Strategy B, while more conservative, may not provide sufficient growth potential over Lisa's 20-year timeline. The increased bond allocation and reduced stock exposure could limit her portfolio's ability to keep pace with inflation and achieve her retirement goals. Strategy C, on the other hand, may be too aggressive for Lisa's moderate risk tolerance. The higher stock allocation and the inclusion of commodities could expose her portfolio to excessive volatility and short-term market fluctuations, which may not align with her investment preferences.

Question 3

Michael, a 60-year-old investor, has a $4 million portfolio allocated as follows: 50% U.S. large-cap stocks, 30% U.S. investment-grade bonds, 15% international stocks, and 5% cash. His primary objective is to generate a steady income stream while preserving capital for retirement. However, Michael is concerned about the potential impact of market volatility on his stock holdings and the low yields offered by bonds in the current low-interest-rate environment. Additionally, he wants to explore alternative investments to potentially enhance portfolio diversification and returns. Michael's financial advisor suggests considering a multi-strategy hedge fund allocation to address his concerns and objectives. Which of the following actions would be most appropriate for Michael, given his situation and goals?

Allocate a small portion (e.g., 5-10%) of the portfolio to a diversified multi-strategy hedge fund with a track record of delivering uncorrelated returns, while maintaining the core stock and bond allocations. Significantly reduce the allocation to U.S. large-cap stocks and invest the proceeds in a concentrated portfolio of high-yield bonds and leveraged hedge funds to maximize income potential. Liquidate the entire portfolio and invest solely in a multi-strategy hedge fund to maximize diversification and potential returns, accepting the higher fees and lower liquidity associated with hedge funds.

Correct Answer: Allocate a small portion (e.g., 5-10%) of the portfolio to a diversified multi-strategy hedge fund with a track record of delivering uncorrelated returns, while maintaining the core stock and bond allocations.

Given Michael's situation and goals, allocating a small portion (5-10%) of his portfolio to a diversified multi-strategy hedge fund with a track record of delivering uncorrelated returns is the most appropriate action. This allows him to maintain his core stock and bond allocations while potentially enhancing diversification and returns. Significantly reducing the allocation to U.S. large-cap stocks and investing in high-yield bonds and leveraged hedge funds would not be appropriate, as it would expose Michael's portfolio to excessive risk and volatility, which goes against his objectives of generating steady income and preserving capital. Liquidating the entire portfolio to invest solely in a multi-strategy hedge fund is also not advisable, as it would concentrate his investments in a single asset class and expose him to higher fees and lower liquidity. This approach would not provide the diversification and capital preservation Michael seeks.

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