IFC Investment Strategies 3 — Questions and Answers
Question 1: Which strategy involves systematically selling appreciated securities to offset capital gains with capital losses, thereby reducing current tax liability?
- Tax-loss harvesting (Correct answer)
- Dividend stripping
- Return-of-capital distribution
- Income splitting
Correct answer: Tax-loss harvesting
Tax-loss harvesting deliberately realizes capital losses to offset capital gains, reducing the investor's net taxable income in the current year.
Question 2: In the context of Canadian mutual funds, 'distribution reinvestment' (DRIP) primarily benefits investors by:
- Eliminating all taxes on distributions
- Allowing compounding without incurring transaction fees (Correct answer)
- Guaranteeing a higher NAV growth rate
- Converting income distributions to capital gains
Correct answer: Allowing compounding without incurring transaction fees
DRIPs allow investors to automatically purchase additional units with distributions, enabling compounding while typically avoiding brokerage commissions.
Question 3: A portfolio constructed to minimize tracking error relative to a benchmark while allowing slight deviations for tax efficiency is known as:
- Enhanced indexing (Correct answer)
- Full replication indexing
- Absolute return strategy
- Long/short equity
Correct answer: Enhanced indexing
Enhanced indexing closely tracks a benchmark but permits small active tilts — often for tax efficiency or modest alpha — while keeping tracking error low.
Question 4: Which statement about dollar-cost averaging (DCA) is most accurate in volatile markets?
- DCA always produces higher returns than a lump-sum investment
- DCA reduces the average cost per unit when prices fluctuate (Correct answer)
- DCA eliminates market risk entirely
- DCA is only suitable for fixed-income funds
Correct answer: DCA reduces the average cost per unit when prices fluctuate
DCA reduces average cost per unit in volatile markets because the fixed periodic investment buys more units when prices are low and fewer when prices are high.
Question 5: A fund employing a 'long/short equity' strategy seeks to profit by:
- Holding only government bonds and shorting corporate bonds
- Buying undervalued stocks while simultaneously selling short overvalued stocks (Correct answer)
- Tracking an equity index while using options to cap downside
- Investing exclusively in dividend-paying large-cap equities
Correct answer: Buying undervalued stocks while simultaneously selling short overvalued stocks
Long/short equity funds buy stocks expected to rise and short stocks expected to fall, aiming to generate returns independent of the overall market direction.
Question 6: What is the primary purpose of using futures contracts in a 'portable alpha' strategy for a Canadian fund?
- To eliminate currency risk on foreign holdings
- To separate beta (market exposure) from alpha (manager skill) and transfer alpha to a different asset class (Correct answer)
- To hedge interest rate risk in a bond portfolio
- To replicate the dividend yield of an equity index
Correct answer: To separate beta (market exposure) from alpha (manager skill) and transfer alpha to a different asset class
Portable alpha uses derivatives to maintain desired market beta while 'porting' the active return (alpha) generated elsewhere into the target asset class.
Question 7: Under the IFC framework, which characteristic distinguishes a 'market-neutral' fund from a traditional long-only equity fund?
- It holds only cash and short-term government securities
- It maintains roughly equal dollar amounts of long and short equity positions to minimize market beta (Correct answer)
- It invests exclusively in companies with market capitalizations above $10 billion
- It limits holdings to five sectors to concentrate alpha
Correct answer: It maintains roughly equal dollar amounts of long and short equity positions to minimize market beta
A market-neutral fund balances long and short equity exposures so that net market beta approaches zero, isolating alpha from directional market moves.
IFC Investment Strategies 3
Which strategy involves systematically selling appreciated securities to offset capital gains with capital losses, thereby reducing current tax liability?