IFC Investment Strategies 5 — Questions and Answers
Question 1: A fund that benchmarks against the MSCI World Index but restricts holdings to companies meeting specific ESG criteria is best described as:
- A passive index fund
- An ESG-integrated or socially responsible investment (SRI) fund (Correct answer)
- A market-neutral hedge fund
- A liability-driven investment vehicle
Correct answer: An ESG-integrated or socially responsible investment (SRI) fund
An ESG-integrated fund uses non-financial environmental, social, and governance criteria to screen or tilt holdings while still tracking a conventional benchmark.
Question 2: Which scenario best illustrates 'style drift' in an actively managed Canadian equity fund?
- The fund outperforms its benchmark by 3% in a given year
- A large-cap growth fund begins purchasing significant positions in small-cap value stocks (Correct answer)
- The fund increases its cash allocation from 2% to 5% during a market downturn
- The portfolio manager replaces one technology stock with another technology stock
Correct answer: A large-cap growth fund begins purchasing significant positions in small-cap value stocks
Style drift occurs when a fund deviates from its stated investment mandate — such as a large-cap growth fund migrating into small-cap value territory.
Question 3: An investor in a Canadian mutual fund wants to reduce currency risk on U.S. dollar-denominated equity holdings. The most direct hedging tool would be:
- Purchasing Canadian REITs
- Entering a forward contract to sell U.S. dollars and buy Canadian dollars (Correct answer)
- Increasing the allocation to domestic fixed income
- Selling covered calls on the U.S. equity positions
Correct answer: Entering a forward contract to sell U.S. dollars and buy Canadian dollars
A CAD/USD forward contract locks in an exchange rate, directly offsetting the currency exposure from holding U.S. dollar assets.
Question 4: Which strategy involves constructing a portfolio that mirrors the liability structure of a pension fund to minimize funding risk?
- Absolute return strategy
- Liability-driven investing (LDI) (Correct answer)
- Momentum equity strategy
- Global macro strategy
Correct answer: Liability-driven investing (LDI)
Liability-driven investing aligns the portfolio's duration and cash flows with a fund's liability profile to reduce the risk that assets will fall short of obligations.
Question 5: A mutual fund that targets a consistent positive return regardless of market conditions and uses derivatives and alternative assets to achieve it is called:
- A balanced fund
- An absolute return fund (Correct answer)
- A segregated fund
- A money market fund
Correct answer: An absolute return fund
Absolute return funds aim to deliver positive returns in both rising and falling markets by using long/short positions, derivatives, and unconstrained mandates.
Question 6: In evaluating two Canadian equity mutual funds with identical returns, which fund is more efficient if Fund A has a standard deviation of 12% and Fund B has a standard deviation of 18%?
- Fund B, because higher volatility implies more opportunity
- Fund A, because it achieves the same return with lower total risk (Correct answer)
- Neither; only absolute returns matter for fund selection
- Fund B, because its higher beta indicates greater market sensitivity
Correct answer: Fund A, because it achieves the same return with lower total risk
Fund A is more efficient because it produces the same return as Fund B while exposing investors to less total risk, yielding a superior Sharpe ratio.
Question 7: Which of the following actions would MOST likely increase a fund's tracking error relative to its benchmark?
- Rebalancing the portfolio to benchmark weights monthly
- Increasing the number of securities held to match the index exactly
- Making large active bets in sectors not represented in the benchmark (Correct answer)
- Reducing cash holdings to near zero
Correct answer: Making large active bets in sectors not represented in the benchmark
Large overweights or underweights in sectors absent from the benchmark create significant active risk, which directly increases tracking error.
IFC Investment Strategies 5
A fund that benchmarks against the MSCI World Index but restricts holdings to companies meeting specific ESG criteria is best described as: