RIA Investment Strategies 2 — Questions and Answers

Question 1: An alternative investment's primary benefit in a portfolio is typically:

Higher liquidity than stocks
Low or negative correlation with traditional assets, improving diversification (Correct answer)
Guaranteed positive returns
Simplified regulatory oversight

Correct answer: Low or negative correlation with traditional assets, improving diversification

Alternative investments (hedge funds, private equity, real assets) often have low correlation with stocks and bonds, enhancing portfolio diversification.

Alternative investments include hedge funds, private equity, real estate, commodities, infrastructure, and other non-traditional assets. Their main portfolio benefit is low correlation with stocks and bonds, which can reduce overall portfolio volatility and improve risk-adjusted returns. However, alternatives often come with illiquidity, higher fees, complexity, and accredited investor requirements. Advisers must weigh these tradeoffs when recommending alternatives.

Question 2: A momentum investing strategy:

Buys securities that have declined sharply
Buys securities showing recent strong performance expecting it to continue (Correct answer)
Focuses on dividend-paying stocks only
Invests in companies with strong balance sheets only

Correct answer: Buys securities showing recent strong performance expecting it to continue

Momentum investing buys recently outperforming securities, betting that the trend will continue for some period.

Momentum investing is based on the empirical observation that securities with strong recent performance tend to continue outperforming for some period (typically 3-12 months). It contradicts the efficient market hypothesis. Academic research (Jegadeesh and Titman, 1993) documented the momentum anomaly. Momentum strategies work well in trending markets but can suffer severe losses when trends reverse. Advisers using momentum must closely monitor for trend changes.

Question 3: A barbell bond strategy involves:

Investing equally across all maturities
Concentrating holdings in short and long maturities while avoiding intermediate (Correct answer)
Investing only in intermediate maturities
Focusing on high-yield bonds exclusively

Correct answer: Concentrating holdings in short and long maturities while avoiding intermediate

A barbell strategy concentrates bond investments at short and long maturities, avoiding the middle, to balance income (long bonds) and flexibility (short bonds).

The barbell bond strategy holds short-term bonds (for liquidity and rate adjustment) and long-term bonds (for higher yield and duration exposure) while avoiding intermediate maturities. This strategy offers: flexibility from short-term bonds when rates rise, income from long-term bonds, and a unique risk/return profile compared to bullet or ladder strategies. Advisers use barbells when they expect a flattening or humped yield curve.

Question 4: ESG investing incorporates which factors into investment decisions?

Earnings, Sales, Growth
Environmental, Social, and Governance criteria (Correct answer)
Equity, Stability, and Growth metrics
Economic, Sector, and Geographic factors

Correct answer: Environmental, Social, and Governance criteria

ESG investing considers Environmental (climate, pollution), Social (labor practices, diversity), and Governance (board structure, transparency) factors alongside financial metrics.

ESG investing integrates environmental (carbon emissions, water use, waste management), social (employee relations, supply chain standards, community impact), and governance (board independence, executive compensation, shareholder rights) factors into the investment process. Investors use ESG to align portfolios with values, manage long-term risks, and potentially enhance returns. Advisers must understand ESG methodologies and client expectations when implementing ESG strategies.

Question 5: Options trading that uses a 'protective put' strategy involves:

Selling puts to generate income
Buying puts on existing stock positions to limit downside risk (Correct answer)
Selling the underlying stock and buying futures
Using puts to increase leverage

Correct answer: Buying puts on existing stock positions to limit downside risk

A protective put buys put options on existing stock holdings, providing downside insurance while maintaining upside potential.

A protective put (or married put) involves buying a put option on stock you already own. If the stock falls below the put's strike price, the put limits losses. If the stock rises, you benefit from appreciation minus the put premium cost. The cost (premium) is the price of insurance. Protective puts are useful before known risk events (earnings, FDA decisions) or for clients who want to maintain equity exposure while protecting against large drawdowns.

Question 6: Core-satellite portfolio construction involves:

Equally weighting all securities
A passive core position supplemented by active satellite positions for potential alpha (Correct answer)
Using only index funds with no active management
Concentrating in one sector for the core

Correct answer: A passive core position supplemented by active satellite positions for potential alpha

Core-satellite combines a low-cost passive core (typically 60-80% of portfolio) with active satellite positions seeking additional returns.

Core-satellite portfolio construction uses a large passive index fund core (e.g., total market ETF) for broad market exposure at low cost, supplemented by smaller active satellite positions targeting specific opportunities—factor strategies (value, momentum), sector bets, individual stocks, or alternative investments. This approach balances cost efficiency with the opportunity to generate alpha through selective active management, meeting both risk-control and return-enhancement objectives.

RIA Investment Strategies 2

An alternative investment's primary benefit in a portfolio is typically: