Portfolio Management & Asset Allocation Flashcards

In the context of behavioral finance, which bias causes investors to hold losing positions too long because they weigh losses more heavily than equivalent gains?

Answer: Loss aversion

Loss aversion, a core concept in prospect theory, explains why investors hold losers to avoid realizing losses, as losses feel approximately twice as painful as equivalent gains feel good.

A portfolio's active return is defined as:

Answer: Portfolio return minus benchmark return

Active return (also called alpha in performance attribution) is the difference between portfolio return and its benchmark return.

Which asset allocation approach explicitly accounts for a client's future financial obligations (e.g., pension payouts) when constructing the portfolio?

Answer: Liability-driven investing (LDI)

Liability-driven investing constructs the asset portfolio with the primary goal of funding known future liabilities, rather than maximizing return in isolation.

Factor investing (smart beta) seeks to capture returns from which of the following?

Answer: Specific systematic risk factors such as value, size, and momentum

Factor investing (smart beta) systematically tilts toward documented risk premia such as value, size, momentum, quality, and low volatility.

An investment counselor's client has a high marginal tax rate. Which portfolio management technique is MOST beneficial for this client?

Answer: Tax-loss harvesting to offset capital gains

Tax-loss harvesting realizes capital losses strategically to offset gains, reducing the tax drag on after-tax portfolio returns for high-bracket investors.

Which of the following BEST describes the concept of 'portable alpha'?

Answer: Using futures to separate alpha generation from beta exposure

Portable alpha uses derivatives (e.g., futures) to replicate desired market beta cheaply, while investing freed capital in an alpha-generating strategy uncorrelated with that beta.

What does a rising information ratio indicate about an active portfolio manager?

Answer: The manager is generating more active return per unit of tracking error

The information ratio equals active return divided by tracking error; a higher ratio means the manager consistently adds more alpha for each unit of active risk taken.