Portfolio Management & Asset Allocation Flashcards

What is the main goal of portfolio management?

Answer: Balance risk and return

The main goal of portfolio management is to optimize the trade-off between risk and return according to an investor's specific objectives and constraints. It involves constructing a diversified portfolio that aims to achieve the highest possible return for a given level of risk, or the lowest possible risk for a desired level of return. This balance ensures the portfolio is suitable for the investor's risk tolerance and financial goals.

What does asset allocation determine?

Answer: Distribution across asset classes

Asset allocation is the strategic decision of how an investment portfolio's assets are divided among different categories, such as stocks, bonds, and cash. This distribution is based on an investor's risk tolerance, investment horizon, and financial goals. It is considered one of the most critical determinants of a portfolio's long-term return and risk characteristics.

Why is diversification important?

Answer: To reduce risk

Diversification is the strategy of spreading investments across various asset classes, industries, and geographies to minimize exposure to any single risk. By not putting all "eggs in one basket," the negative performance of one investment can be offset by the positive performance of another. This helps to reduce overall portfolio volatility and mitigate specific (unsystematic) risks without necessarily sacrificing returns.

What is rebalancing in portfolio management?

Answer: Adjusting to target allocation

Rebalancing in portfolio management involves periodically adjusting the portfolio's asset weights back to their original or desired strategic allocation. Market movements can cause certain asset classes to outperform or underperform, leading the portfolio to drift from its target risk and return profile. This process helps maintain the intended risk level and ensures the portfolio remains aligned with the investor's long-term goals.

What is systematic risk?

Answer: Market-wide risk

Systematic risk, also known as market risk or non-diversifiable risk, refers to the inherent risks that affect the entire market or a large segment of it. These risks are caused by macroeconomic factors such as interest rate changes, inflation, recessions, or political events, and cannot be eliminated through diversification. Investors are typically compensated for bearing systematic risk through higher expected returns.

Which strategy aims to outperform market benchmarks?

Answer: Active management

Active management is an investment strategy where portfolio managers make specific investment decisions, such as stock picking and market timing, with the goal of outperforming a specific market benchmark or index. This approach involves extensive research and analysis to identify undervalued assets or anticipate market trends. In contrast, passive management aims to replicate the performance of a benchmark.

What does a benchmark provide?

Answer: Performance comparison

A benchmark is a standard against which the performance of an investment portfolio or fund can be measured. It provides a relevant point of comparison to assess whether the portfolio manager is achieving their objectives relative to a specific market segment or investment strategy. For example, the S&P 500 is a common benchmark for large-cap U.S. equities.

What is the primary role of a portfolio manager?

Answer: Manage assets per objectives

The primary role of a portfolio manager is to construct, monitor, and adjust an investment portfolio to meet the specific financial objectives and risk tolerance of their clients or fund. This involves making strategic asset allocation decisions, selecting individual securities, and rebalancing the portfolio as needed. Their goal is to achieve the best possible risk-adjusted returns aligned with the client's goals.

What is meant by risk-adjusted return?

Answer: Return relative to risk

Risk-adjusted return is a measure that evaluates an investment's return in relation to the amount of risk taken to achieve that return. It provides a more comprehensive view of performance than simply looking at raw returns, as it accounts for the volatility or uncertainty associated with the investment. Common metrics include the Sharpe ratio or Treynor ratio, which help investors compare investments with different risk profiles.