IFC Constructing Investment Portfolios 3 — Questions and Answers
Question 1: Which of the following is an example of a liability-driven investment (LDI) approach?
- Maximizing total return regardless of obligations
- Matching asset cash flows to future pension liabilities (Correct answer)
- Concentrating in high-growth technology stocks
- Holding 100% equities to outpace inflation
Correct answer: Matching asset cash flows to future pension liabilities
LDI focuses on structuring the portfolio so that asset cash flows align with the timing and magnitude of specific future liabilities, such as pension payments.
Question 2: A core-satellite portfolio construction approach typically involves:
- Holding only passive index funds
- A passive core holding plus active satellite positions for alpha (Correct answer)
- Splitting assets equally between stocks and bonds
- Concentrating on a single high-conviction theme
Correct answer: A passive core holding plus active satellite positions for alpha
Core-satellite combines a low-cost passive core (tracking the market) with smaller active satellite positions that seek to generate excess returns.
Question 3: Which risk measure captures the potential loss in a portfolio under extreme but plausible market conditions?
- Standard deviation
- Sharpe ratio
- Conditional Value at Risk (CVaR) (Correct answer)
- Alpha
Correct answer: Conditional Value at Risk (CVaR)
CVaR (also called Expected Shortfall) measures the average loss beyond the Value at Risk threshold, capturing tail risk under extreme scenarios.
Question 4: When a client's time horizon shortens from 20 years to 5 years, how should their portfolio typically be adjusted?
- Increase equity allocation to capture more growth
- Shift toward more fixed-income and less volatile assets (Correct answer)
- Maintain the same allocation to avoid transaction costs
- Move entirely into cash and money market funds
Correct answer: Shift toward more fixed-income and less volatile assets
A shorter time horizon reduces the ability to recover from market downturns, so the portfolio should be shifted toward more stable, lower-risk assets.
Question 5: Which portfolio construction technique uses macroeconomic forecasts to adjust asset class weights?
- Strategic asset allocation
- Tactical asset allocation (Correct answer)
- Passive indexing
- Dollar-cost averaging
Correct answer: Tactical asset allocation
Tactical asset allocation involves making short-to-medium-term deviations from the strategic target weights based on current market views or economic forecasts.
Question 6: The Sharpe ratio measures portfolio performance by comparing excess return to:
- The portfolio's beta
- Total portfolio standard deviation (Correct answer)
- The risk-free rate alone
- The benchmark's return
Correct answer: Total portfolio standard deviation
The Sharpe ratio divides the portfolio's excess return (return minus risk-free rate) by its total standard deviation, measuring return per unit of total risk.
Question 7: In a mutual fund portfolio, what does 'style drift' mean?
- A fund manager deviates from the fund's stated investment style or mandate (Correct answer)
- The fund's NAV declines below its initial offering price
- The fund gradually reduces its MER over time
- Automatic rebalancing triggered by market movements
Correct answer: A fund manager deviates from the fund's stated investment style or mandate
Style drift occurs when a fund manager invests in securities outside the fund's declared style (e.g., a growth fund buying deep-value stocks), misaligning investor expectations.
IFC Constructing Investment Portfolios 3
Which of the following is an example of a liability-driven investment (LDI) approach?