Investment Strategies & Portfolio Management Flashcards

Which portfolio construction methodology explicitly equalizes the risk contribution of each asset class rather than equalizing capital allocation?

Answer: Risk parity

Risk parity allocates capital so each asset class contributes equally to total portfolio risk, typically resulting in larger bond allocations than traditional equity-heavy portfolios.

An RFC client holds concentrated stock from an employer. Which strategy allows diversification while deferring capital gains tax?

Answer: Exchange fund participation

An exchange fund allows investors to contribute appreciated stock to a partnership, diversifying without triggering an immediate taxable gain, though a 7-year holding period applies.

What is the primary purpose of using Monte Carlo simulation in retirement income planning?

Answer: To model the probability of portfolio success across thousands of random market scenarios

Monte Carlo simulation runs thousands of randomized return sequences to estimate the probability that a portfolio will sustain withdrawals throughout retirement.

A client's portfolio shows positive Jensen's alpha. What does this indicate?

Answer: The portfolio earned returns above what CAPM would predict for its beta level

Jensen's alpha is the excess return above the CAPM-predicted return for the portfolio's level of systematic risk, indicating skill or factor exposure beyond market beta.

Which asset class is most commonly added to a traditional stock-bond portfolio to improve diversification due to its low correlation with both equities and fixed income?

Answer: Commodities

Commodities historically exhibit low or negative correlation with stocks and bonds, particularly during inflationary periods, providing meaningful diversification benefits.

Under the prudent investor rule, an RFC managing a trust portfolio is most obligated to:

Answer: Diversify investments and consider the entire portfolio in context of beneficiary needs

The prudent investor rule requires fiduciaries to diversify, consider risk relative to return, and evaluate each investment in the context of the total portfolio and beneficiary needs.

What is 'sequence of returns risk' and when is it most consequential?

Answer: The danger that poor early returns devastate a portfolio during the withdrawal phase, reducing the base for recovery

Poor returns early in retirement permanently impair the portfolio because withdrawals lock in losses on a shrinking base, leaving less capital to recover when markets rebound.