Investment Policy & Portfolio Construction Flashcards

A defined benefit pension plan's investment policy is MOST influenced by which unique characteristic?

Answer: The timing and magnitude of future benefit payments to retirees

DB pension plans have contractually defined future liabilities, so the IPS must align asset strategy with the cash flow profile of promised benefit payments.

In the Black-Litterman model, what is the role of 'views'?

Answer: They are investor forecasts blended with market equilibrium returns to produce expected returns

Black-Litterman combines equilibrium (market-implied) returns with the manager's subjective views in a Bayesian framework to produce a revised set of expected returns.

Which of the following BEST describes the 'core-satellite' portfolio construction approach?

Answer: Combining a passive, low-cost core with actively managed satellite positions for alpha

Core-satellite pairs a passive, benchmark-tracking core (minimizing costs and tracking error) with smaller, active satellite positions seeking excess returns.

An investor's IPS specifies a maximum drawdown constraint of 15%. This is an example of a:

Answer: Risk constraint expressed as a downside limit

A maximum drawdown limit is a risk constraint that caps the allowable peak-to-trough portfolio loss, protecting against extreme downside scenarios.

When using mean-variance optimization, the 'efficient frontier' represents:

Answer: The set of portfolios offering the highest expected return for each level of risk

The efficient frontier is the upper boundary of the feasible set, containing portfolios that maximize expected return for a given level of variance (risk).

A portfolio manager adds a low-correlation asset class to an existing portfolio. The MOST likely effect on the portfolio's efficient frontier is:

Answer: The frontier shifts leftward (less risk for same return), improving the opportunity set

Adding a low-correlation asset expands the feasible set and shifts the efficient frontier to the left, offering better risk-adjusted return combinations.

Which investment policy constraint is PRIMARILY associated with endowments and foundations rather than individual investors?

Answer: Spending rate policy requiring regular distributions to fund operations

Endowments and foundations are governed by spending policies (often 4–5% annually) that dictate minimum distributions, directly shaping portfolio liquidity and return requirements.