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CFA Level III Updated
What are the fiduciary responsibilities of institutional investors regarding proxy voting, and when is it appropriate to abstain?
Proxy voting is a fiduciary duty requiring institutional investors to vote in clients' best economic interest. Managers can use proxy advisory firms but must exercise independent judgment. Abstention is appropriate when conflicts exist or costs clearly exceed benefits.
How do institutional investors use options to hedge tail risk, and what are the cost-effective alternatives to buying outright puts?
Tail risk hedging protects against extreme market drawdowns using options structures. Cost-effective alternatives to outright puts include put spreads, zero-cost collars with put spreads, ratio put spreads, and VIX calls, each balancing protection level against premium cost.
How do you decompose a bond portfolio's total return into its component sources using fixed income attribution analysis?
Fixed income return attribution decomposes total bond returns into income, Treasury curve, spread, and selection effects. Each component isolates a different manager decision: yield harvesting, duration positioning, credit allocation, and security-level alpha generation.
What is a liability glide path, and how do pension funds use it to de-risk their portfolios as funded status improves?
A liability glide path systematically shifts pension assets from equities to liability-hedging bonds as the funded ratio improves. Pre-defined triggers at funded ratio thresholds lock in funding gains by reducing surplus volatility, following either rule-based or discretionary implementation.
How do Qualified Opportunity Zone investments provide capital gains deferral and potential exclusion, and what are the holding period requirements?
Qualified Opportunity Zone investments offer three tax benefits: deferral of original capital gains, a 10% basis step-up after 5 years, and complete exclusion of appreciation after 10 years. The program requires reinvesting gains within 180 days into a qualified fund.
When should a retiree choose a life annuity over a systematic withdrawal plan, and what are the key trade-offs?
Life annuities provide higher income than systematic withdrawal through mortality credits (pooling longevity risk), but sacrifice capital and flexibility. The choice depends on longevity risk, bequest motive, other income sources, and risk tolerance. A hybrid approach often optimizes both security and flexibility.
How is Jensen's alpha calculated, and what does it actually tell you about manager skill?
Jensen's alpha is the intercept from a CAPM regression, measuring average risk-adjusted outperformance. A positive alpha does not necessarily indicate skill — you must check the t-statistic for significance and consider that single-factor models may attribute factor exposures to alpha.
What is the Treynor ratio, and when should you use it instead of the Sharpe ratio?
The Treynor ratio measures excess return per unit of systematic risk (beta), making it more appropriate than the Sharpe ratio when evaluating funds that will be held as part of a diversified portfolio where unsystematic risk is diversified away.
How do I construct an Individual Investment Policy Statement using the RRTTLLU framework?
The RRTTLLU framework covers Return, Risk, Time horizon, Taxes, Liquidity, Legal/regulatory, and Unique circumstances. Each factor must be addressed with specific client facts and quantified where possible, especially the return requirement and liquidity needs.
How should illiquid assets like private equity and real estate be incorporated into asset allocation?
Incorporating illiquid assets into asset allocation is theoretically challenging because standard mean-variance optimization assumes continuous trading. Key issues include stale pricing that understates volatility, commitment pacing lags, and the impossibility of rebalancing locked positions.
How do behavioral biases affect private wealth management decisions?
Behavioral biases are systematic deviations from rational decision-making that affect private wealth clients. CFA Level III tests your ability to identify cognitive biases (anchoring, confirmation) that can be corrected through education, and emotional biases (loss aversion, overconfidence) that often require adaptation.
What is the Permanent Portfolio and how does it differ from All-Weather?
Permanent Portfolio: equal 25% in stocks, long bonds, gold, cash. Unleveraged, simple, rebalance yearly. ~7.5% returns, smaller drawdowns than 60/40.
How does immunization work for fixed-income portfolios and what are the conditions for it to succeed?
Immunization structures a fixed-income portfolio so that price risk and reinvestment risk offset each other, ensuring the portfolio can meet a future liability regardless of rate changes. Success requires matching duration, maintaining sufficient present value, minimizing excess convexity, and regular rebalancing.
How do I calculate after-tax return on a taxable investment portfolio?
After-tax return accounts for the drag taxes impose on pre-tax returns, differentiating by income type because different tax rates apply to ordinary income, qualified dividends, and capital gains...
Why do bond indices have higher turnover than equity indices?
Bond indices turn over 15-25% annually due to maturities, continuous new issuance, and credit migration (fallen angels/rising stars). Drives higher transaction costs and wider tracking error for passive bond funds.
What exactly is the Capital Market Expectations (CME) framework and why does it matter for asset allocation?
Capital Market Expectations (CME) refer to the set of projected risk and return characteristics for various asset classes that an investor uses as inputs for portfolio construction. The framework has several key elements including setting the horizon, ensuring cross-sectional and intertemporal consistency, and conducting thorough macro analysis.
What's the difference between net-of-fees and gross returns in GIPS reporting?
Gross-of-fees return measures pure investment performance before management fees; net-of-fees reflects investor experience after fees. GIPS requires clear disclosure of which is reported...
What are GIPS rules for including portfolios in composites?
All actual fee-paying discretionary portfolios must be in composites. Non-discretionary excluded. Minimum asset thresholds allowed. Terminated portfolios remain in history. New portfolios added timely per policy...
How do I evaluate sector rotation strategies in fixed income?
Cobalt's IG→HY rotation (20pt shift) captures +40bps carry but risks -70bps per 100bps widening. Evaluate regime-shift risk, sub-sector selection within HY, exit triggers, and historical Sharpe 0.5-0.8 on similar rotation strategies.
What is the difference between absolute and relative return objectives?
Absolute return: stand-alone target (e.g. 6%). Relative return: benchmark plus alpha (e.g. S&P + 150 bps). Individuals use absolute; active managers use relative; many funds use both at different levels.
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