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CFA Level III Updated
What is Bridgewater's All-Weather portfolio philosophy?
All-Weather balances stocks, bonds, gold, commodities across 4 growth/inflation regimes. Levered version institutional. 2022 exposed stagflation vulnerability.
What is the core-satellite approach and how do I determine the allocation split?
The core-satellite approach combines a low-cost passive core providing market beta with concentrated active satellites targeting alpha in less efficient markets. The allocation split depends on efficiency beliefs, risk budget, fee sensitivity, and alpha conviction.
How does taxation affect investment portfolio construction?
Taxation affects nearly every portfolio decision for taxable investors — asset allocation, security selection, trading cadence, and location of holdings...
How are fixed income indices constructed?
Bond indices define universe, inclusion criteria, market-value weighting, monthly rebalancing, and evaluated pricing. Market-value weighting creates the 'bums problem' favoring largest debtors; sampling replaces full replication.
How do I quantify drag from taxes and fees on a portfolio?
Tax and fee drag compound dramatically over time. 3% total annual drag can reduce terminal wealth by 57% over 30 years. Mitigation includes low fees, tax loss harvesting, asset location...
What does GIPS require in a composite performance presentation?
GIPS requires composite presentations with 5-10 yr returns, benchmark, portfolio count, composite and firm assets, 3Y std dev, dispersion, plus disclosures (firm/composite defs, benchmark, fees, errors)...
How do I evaluate market timing risk in active bond management?
Silverpeak's +4.3yr duration bet creates asymmetric risk: -4.3% if rates rise 100bps vs +2.15% if rates fall 50bps. Frame for IC with probabilistic scenarios, position limits (+/-2yr typical), exit triggers, and recovery time analysis.
How do I calculate an after-tax return objective for an individual investor?
After-tax return: divide spending by assets for real return, add inflation for nominal, then gross up by (1 - tax rate) if portfolio is taxable. Show steps for partial credit on exam.
What are the main components of an investment policy statement (IPS)?
IPS has two sections: objectives (return, risk) and constraints (liquidity, time horizon, tax, legal/regulatory, unique circumstances). Foundational document for portfolio management.
How does a fund-of-funds structure work and what are its fee layers?
A fund of hedge funds (FoHF) invests in a portfolio of underlying hedge funds. Investors gain diversification across managers and strategies, access to closed funds...
How should portfolio managers evaluate cybersecurity risk as an investment factor, and what frameworks exist for assessing a company's cyber resilience?
Cybersecurity risk is a material investment factor. Portfolio managers can assess it through governance indicators, spending ratios, incident history, insurance coverage, and third-party security ratings. Major breaches cause average stock declines of 5-8% with sustained underperformance.
What is dynamic asset-liability management, and how does it differ from a static LDI approach?
Dynamic ALM adjusts the LHP/RSP allocation based on pre-defined triggers tied to the funded ratio, interest rate levels, credit spreads, and market drawdowns, rather than maintaining a fixed split with calendar-based rebalancing. This event-driven approach captures hedging opportunities in real time, prevents funded ratio overshoot, and follows a non-linear glide path that accelerates de-risking near full funding.
How does surplus optimization differ from traditional mean-variance optimization, and what does the surplus efficient frontier look like?
Surplus optimization maximizes the expected change in surplus (assets minus liabilities) for a given level of surplus volatility, rather than optimizing asset returns in isolation. The surplus efficient frontier is anchored at the minimum-surplus-variance portfolio of long-duration bonds with high liability correlation, and slopes upward as return-seeking assets are added.
How should the return-seeking portfolio be allocated within an LDI framework, and what determines its size relative to the liability-hedging portfolio?
The return-seeking portfolio's size is driven by the funded ratio — underfunded plans allocate more to RSP for growth, while overfunded plans shift toward the LHP to protect surplus. The RSP typically includes global equities, private equity, real estate, and high yield credit, and follows a glide path that systematically increases LHP allocation as funded status improves.
What is a liability-hedging portfolio, and how is it constructed to immunize a pension plan's funded status against interest rate movements?
A liability-hedging portfolio is constructed by matching the liability's key rate durations across the yield curve using long corporate bonds, STRIPS, swaps, and futures, while also matching credit spread exposure to the discount rate methodology. Duration matching alone is insufficient — KRD matching protects against non-parallel curve shifts, and AA corporate exposure matches the spread sensitivity of GAAP-discounted liabilities.
What are the three main categories of limits to arbitrage, and how do they explain persistent market anomalies?
The three limits to arbitrage are fundamental risk (no perfect hedge, possibility of being wrong), implementation costs (transaction costs, short-selling constraints, margin requirements), and model risk (valuation uncertainty). These interact to sustain anomalies, especially in illiquid or complex markets.
What are the key differences between listed and unlisted infrastructure investments for CFA candidates?
Listed infrastructure offers daily liquidity and transparent pricing but correlates highly with equity markets. Unlisted infrastructure reports lower volatility and correlation, but much of this advantage reflects appraisal-based smoothing rather than genuinely lower risk. After unsmoothing adjustments, the risk-return gap narrows considerably.
How do you decompose active return in fixed income to evaluate manager skill versus systematic exposures?
Active return in fixed income is decomposed into duration management, yield curve positioning, sector allocation, security selection, and trading contributions. Each component isolates a specific decision so that genuine manager skill can be distinguished from passive factor exposure.
What are stewardship codes, and how do they shape institutional investor behavior regarding corporate engagement?
Stewardship codes are principles-based frameworks that set expectations for institutional investor engagement with portfolio companies. Operating on a comply-or-explain basis, they require transparency, monitoring, constructive engagement, escalation strategies, and voting record disclosure.
How does CPPI work, and how does the multiplier affect the strategy's risk-return profile compared to a static allocation?
CPPI dynamically allocates between risky and safe assets using Risky = m x Cushion, where the cushion is the distance between portfolio value and a guaranteed floor. The multiplier determines aggressiveness and the maximum tolerable single-period drop (1/m) before the floor is breached.
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