CES Portfolio Management & Strategy 3 — Questions and Answers
Question 1: What is the primary purpose of an Investment Policy Statement (IPS) in a trust portfolio?
- To guarantee a specific rate of return to beneficiaries
- To document investment objectives, constraints, and guidelines for managing trust assets (Correct answer)
- To limit trustee liability for investment losses
- To satisfy IRS reporting requirements for trust income
Correct answer: To document investment objectives, constraints, and guidelines for managing trust assets
An IPS codifies the trust's return objectives, risk tolerance, time horizon, liquidity needs, tax situation, and constraints, serving as the governing framework for investment decisions.
Question 2: Which alternative investment is most commonly used in trust portfolios to provide inflation protection and low correlation to stocks and bonds?
- Hedge funds
- Real estate investment trusts (REITs) (Correct answer)
- Cryptocurrency
- Structured notes
Correct answer: Real estate investment trusts (REITs)
REITs provide real estate exposure with inflation-linked income, liquidity advantages over direct property ownership, and low correlation to traditional asset classes.
Question 3: A trustee is evaluating whether to use separately managed accounts (SMAs) or mutual funds for a $2 million trust. What is the key advantage of SMAs?
- Lower minimum investment thresholds
- Direct ownership of securities enabling tax-loss harvesting and customization (Correct answer)
- Higher liquidity for emergency distributions
- Guaranteed outperformance of benchmark indices
Correct answer: Direct ownership of securities enabling tax-loss harvesting and customization
SMAs give the trust direct security ownership, allowing tax-loss harvesting, legacy holding management, and portfolio customization unavailable in pooled vehicles.
Question 4: In the context of trust investing, what is 'delegation' under the Uniform Prudent Investor Act?
- Transferring trustee responsibilities to a co-trustee permanently
- Engaging an agent to perform investment functions while retaining oversight duties (Correct answer)
- Assigning investment losses to beneficiaries
- Appointing a successor trustee for future administration
Correct answer: Engaging an agent to perform investment functions while retaining oversight duties
UPIA allows trustees to delegate investment functions to qualified agents but requires prudent selection, scope definition, and ongoing monitoring of the agent's performance.
Question 5: A trust portfolio holds a bond with a 5-year duration when interest rates are expected to rise significantly. What adjustment would reduce interest rate risk?
- Increase allocation to long-duration bonds
- Shorten portfolio duration by shifting to shorter-maturity bonds (Correct answer)
- Add equity exposure to offset bond losses
- Convert to zero-coupon bonds for greater convexity
Correct answer: Shorten portfolio duration by shifting to shorter-maturity bonds
Reducing portfolio duration by selling long-maturity bonds and buying short-maturity bonds decreases price sensitivity to rising interest rates.
Question 6: Which risk metric measures the potential loss in a portfolio under adverse market conditions, typically expressed as a dollar amount or percentage?
- Sharpe ratio
- Value at Risk (VaR) (Correct answer)
- Beta coefficient
- Standard deviation
Correct answer: Value at Risk (VaR)
Value at Risk quantifies the maximum expected loss over a given time period at a specified confidence level, helping trustees understand downside exposure.
Question 7: An estate planning client wants to minimize portfolio volatility while maintaining equity exposure. Which strategy is most appropriate?
- Concentrate holdings in a single sector ETF
- Use low-correlation asset classes to diversify systematic risk (Correct answer)
- Hold only domestic large-cap stocks
- Allocate entirely to money market funds
Correct answer: Use low-correlation asset classes to diversify systematic risk
Combining asset classes with low or negative correlations reduces overall portfolio volatility through diversification without eliminating equity participation.
CES Portfolio Management & Strategy 3
What is the primary purpose of an Investment Policy Statement (IPS) in a trust portfolio?