Portfolio Management Techniques Flashcards

What is the primary goal of portfolio diversification?

Answer: Reduce unsystematic risk

Portfolio diversification involves investing in a variety of assets across different classes, industries, and geographies. Its primary goal is to reduce unsystematic risk (also known as specific or diversifiable risk), which is unique to a particular company or industry, by ensuring that poor performance in one investment is offset by better performance in others.

Which measure evaluates a portfolio’s risk-adjusted return?

Answer: Sharpe Ratio

The Sharpe Ratio is a widely used measure that calculates the risk-adjusted return of an investment or portfolio. It quantifies how much excess return an investor receives for the volatility or total risk taken, allowing for a standardized comparison of different investments' performance relative to their risk.

What does a negative alpha indicate in a portfolio?

Answer: Underperformance after risk adjustment

Alpha measures the excess return of an investment relative to the return of a benchmark index, after adjusting for risk. A negative alpha indicates that the investment or portfolio has underperformed its benchmark, even after accounting for the level of risk taken, suggesting that it did not generate sufficient return for the risk assumed.

Which asset class is typically considered the most volatile?

Answer: Equities

Equities, or stocks, represent ownership in a company and are generally considered the most volatile asset class compared to bonds, cash equivalents, or real estate. Their value can fluctuate significantly based on company performance, market sentiment, economic conditions, and industry trends, leading to higher potential returns but also higher risk.

What is rebalancing in portfolio management?

Answer: Adjusting allocations back to target levels

Rebalancing in portfolio management is the process of adjusting the asset allocation of a portfolio back to its original, target weights. Over time, market movements cause some asset classes to outperform others, leading the portfolio to drift from its desired risk and return profile. By selling assets that have grown beyond their target and buying those that have fallen below, rebalancing ensures the portfolio maintains its intended risk exposure and aligns with the investor's long-term strategy.

Which strategy focuses on minimizing downside risk?

Answer: Capital preservation

Capital preservation is an investment strategy primarily focused on minimizing the risk of losing the initial investment principal. Investors adopting this strategy prioritize protecting their capital over seeking high returns, making it suitable for those with low risk tolerance or short investment horizons. This approach typically involves investing in low-volatility assets to safeguard against significant market downturns.