CIMA Asset Allocation 2 — Questions and Answers
Question 1: Which concept refers to the empirical finding that asset allocation decisions account for the majority of portfolio return variability over time?
- Security selection effect
- Policy portfolio dominance (Correct answer)
- Market timing premium
- Factor loading significance
Correct answer: Policy portfolio dominance
Research by Brinson, Hood, and Beebower found that investment policy (asset allocation) explains approximately 90% or more of the variability in portfolio returns over time.
Question 2: In a liability-driven investing (LDI) framework, the primary goal of asset allocation is to:
- Maximize total return regardless of liabilities
- Match or immunize the portfolio against future liability cash flows (Correct answer)
- Minimize tracking error against a broad market index
- Concentrate in high-yield assets to fund liabilities
Correct answer: Match or immunize the portfolio against future liability cash flows
LDI focuses on structuring assets so their value and cash flows are closely matched to the investor's liabilities, thereby reducing funding risk.
Question 3: Core-satellite portfolio construction combines which two elements?
- Active equities and passive bonds
- A passively managed core with actively managed satellite positions (Correct answer)
- Domestic and international allocations
- Long-only and long-short strategies
Correct answer: A passively managed core with actively managed satellite positions
Core-satellite combines a large, low-cost passively managed core for broad market exposure with smaller active or alternative satellite positions intended to generate alpha.
Question 4: Which of the following is a key advantage of including alternative assets in a traditional stock-bond portfolio?
- Guaranteed higher returns
- Elimination of all downside risk
- Potential diversification benefits due to low correlation with traditional assets (Correct answer)
- Increased liquidity across the entire portfolio
Correct answer: Potential diversification benefits due to low correlation with traditional assets
Alternative assets such as private equity, real estate, and hedge funds often have low or negative correlations with traditional stocks and bonds, potentially improving the risk-return profile of the overall portfolio.
Question 5: The 'glide path' concept in target-date funds refers to:
- The trajectory of management fees over time
- The gradual shift from growth-oriented to more conservative allocations as the target date approaches (Correct answer)
- The process of selecting international versus domestic allocations
- A fixed equity-to-bond ratio maintained throughout the fund's life
Correct answer: The gradual shift from growth-oriented to more conservative allocations as the target date approaches
A glide path describes the planned reduction in equity exposure and increase in fixed income exposure over time as an investor approaches their target date, reducing portfolio risk as the horizon shortens.
Question 6: When rebalancing a portfolio, a 'corridor' or 'threshold' rebalancing strategy triggers a rebalance when:
- A calendar date (e.g., quarter-end) is reached
- An asset class weight drifts outside a predefined band around its target (Correct answer)
- Transaction costs fall below a set level
- The portfolio's Sharpe ratio drops below 1.0
Correct answer: An asset class weight drifts outside a predefined band around its target
Threshold (corridor) rebalancing triggers action only when an asset class weight deviates beyond a specified tolerance band from its target, avoiding unnecessary transactions while controlling drift.
Question 7: Which of the following factors is LEAST likely to be considered when determining an individual investor's appropriate asset allocation?
- Time horizon
- Risk tolerance
- The portfolio manager's personal investment preferences (Correct answer)
- Liquidity needs
Correct answer: The portfolio manager's personal investment preferences
Asset allocation must be driven entirely by the client's objectives and constraints; the portfolio manager's personal preferences are irrelevant and would violate fiduciary duty.
CIMA Asset Allocation 2
Which concept refers to the empirical finding that asset allocation decisions account for the majority of portfolio return variability over time?