CIC Portfolio Management & Asset Allocation 5 — Questions and Answers
Question 1: 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?
- Overconfidence bias
- Anchoring bias
- Loss aversion (Correct answer)
- Herding bias
Correct 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.
Question 2: A portfolio's active return is defined as:
- Total portfolio return minus the risk-free rate
- Portfolio return minus benchmark return (Correct answer)
- Alpha plus beta times market return
- The Sharpe ratio minus 1
Correct answer: Portfolio return minus benchmark return
Active return (also called alpha in performance attribution) is the difference between portfolio return and its benchmark return.
Question 3: Which asset allocation approach explicitly accounts for a client's future financial obligations (e.g., pension payouts) when constructing the portfolio?
- Mean-variance optimization
- Liability-driven investing (LDI) (Correct answer)
- Equal-weight allocation
- Momentum-based allocation
Correct 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.
Question 4: Factor investing (smart beta) seeks to capture returns from which of the following?
- Pure market beta only, minimizing active bets
- Specific systematic risk factors such as value, size, and momentum (Correct answer)
- Individual manager stock-picking skill
- Random walk price movements
Correct 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.
Question 5: An investment counselor's client has a high marginal tax rate. Which portfolio management technique is MOST beneficial for this client?
- Frequent rebalancing to capture short-term gains
- Tax-loss harvesting to offset capital gains (Correct answer)
- Concentration in high-dividend stocks in taxable accounts
- Avoiding municipal bonds entirely
Correct 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.
Question 6: Which of the following BEST describes the concept of 'portable alpha'?
- Moving the portfolio's alpha-generating strategy to a different benchmark exposure
- Transferring realized gains to tax-deferred accounts
- Using futures to separate alpha generation from beta exposure (Correct answer)
- Porting a portfolio across different custodians
Correct 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.
Question 7: What does a rising information ratio indicate about an active portfolio manager?
- The manager is taking on more systematic market risk
- The manager is generating more active return per unit of tracking error (Correct answer)
- The manager's total return is increasing
- The manager is reducing the portfolio's standard deviation
Correct 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.
CIC Portfolio Management & Asset Allocation 5
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?