CFA® Portfolio Management
The CFA Portfolio Management topic is at the very core of the CFA Program. In fact, portfolio management is the most highly ranked career of interest among CFA candidates. The material starts off relatively light at Level 1 (5-8%) and increases in scope and weight at Level 2 (10-15%). Portfolio Management makes up a whopping 35-40% of the Level 3 exam. Candidates would be wise to build a strong foundation on this topic, as it will pay dividends as they progress through the material. The portfolio management process’s fundamentals are broken into three main steps: planning, execution, and feedback.
During the planning phase, a manager gains knowledge of the client’s (e.g., individual or institutional) needs. Subsequently, the manager captures critical information on managing the client’s portfolio in the Investment Policy Statement. Once a documented plan is in place, the manager executes the program by first setting an asset allocation. The client’s initial asset allocation is the amount placed in each broad asset class (e.g., equity, fixed income) that matches the client’s risk and return profile. The curriculum also covers risk management, behavioral biases, and technical analysis; recently, fintech topics were added to the curriculum, including machine learning, big data, and distributed ledger technology.
What to Expect in CFA Level 1 Portfolio Management?
The CFA Level 1 Portfolio Management is one of the most lightly weighted topics on the Level 1 exam, along with Derivatives and Alternative Investments. However, candidates should not take this to mean that Portfolio Management is less important than more heavily weighted topics like Financial Statement Analysis (FSA), but it is a more complex topic that draws on a lot of fundamental learning that is presented earlier in the CFA Program.
As you progress through the CFA Program, Portfolio Management increases in importance; by Level 3, it is nearly half of the exam. Candidates should view this lightly weighted L1 content as a primer for what is perhaps the most important topic of the CFA. Building a solid foundation in Portfolio Management is critical to obtaining a CFA charter.
Exam Weighting
The CFA Portfolio Management topic has a weighting of 5-8% of the total exam content so that approximately 9-14 of the 180 CFA Level 1 exam questions focus on this topic.
Topic Weight | No. of Learning Modules | No. of Formulas | No. of Questions |
---|---|---|---|
5-8% | 8 | ca. 50 | ca. 12 |
Level 1 Portfolio Management Syllabus, Readings, and Changes
The exam weight of the Portfolio Management section decreased from 2018 to 2019. Since 2021, weightage has fluctuated between 5-8%. The 2023 CFA Level 1 portfolio management syllabus spans 8 learning modules and contains 55 LOS. The CFA Level 1 exam includes 73 total Learning Modules for 2023. Eight of these center on Portfolio Management (11% of the total curriculum) .
While the weighting of the Portfolio Management section stayed constant in 2019 and 2020, it remained at 5-8% from 2021 to 2023.
2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
---|---|---|---|---|---|
7% | 6% | 6% | 5-8% | 5-8% | 5-8% |
Reading-related updates for 2023 include:
- Portfolio Risk and Return Part I: Updated the content to support risk management for international investments with currency risk
- Portfolio Risk and Return Part II: New EORQs added
- Introduction to Risk Management: Content added to support risk management for international investments with currency risk
- Fintech in Investment Management: Updated content to reflect recent evolution in decentralized finance (DeFi) and blockchain
Portfolio Management Overview
Due to the diversification of the investments held in the portfolio, portfolios can allow for a reduction in risk without compromising reward. One of the first steps in the portfolio management process is developing an investment policy statement (IPS) suited to the needs of the client. This assessment is followed by asset allocation, security analysis, portfolio construction/monitoring/rebalancing, performance measurement, and reporting.
- The reading introduces portfolio management and the asset management industry.
- Candidates will become familiar with the portfolio management process and the financial needs of various types of investors.
- The material also covers mutual funds and other pooled investment instruments.
Portfolio Risk and Return: Part I
The most important factors in portfolio development are the risk and return of individual assets, and the most efficient portfolios optimize that trade-off for the investor.
- The reading examines the characteristics of assets as they relate to risks and returns.
- Candidates will study risk aversion, the computation of portfolio risk, and how these tools narrow the choices of optimal risky portfolios.
Portfolio Risk and Return: Part II
The reading dives deeper into the nuances of portfolio risk and return by examining the computation of risk, systematic and unsystematic risk, the capital asset pricing model (CAPM), and the role of correlation in diversifying risk. Candidates will study various risk-related models and how risk influences portfolio valuation.
Basics of Portfolio Planning and Construction
A common theme that is reiterated throughout the CFA Level 1 Portfolio Management topic is the importance of understanding a client’s situation and goals. While financial professionals categorize investors into broad groups, variations remain within these groups.
- The reading examines the portfolio construction process with special attention paid to client-centered planning.
- Candidates will learn more about the investment policy statement and the portfolio construction process in general.
Behavioral Biases of Individuals
Human irrationality is a variable that befuddles even the most thorough financial forecasting formulas. People often rely on their biases when making judgments and decisions. Behavioral finance challenges the assumptions of traditional economic and financial theories by accounting for this irrationality.
- The reading examines the possible consequences of cognitive errors and emotional biases and how to mitigate their potentially negative effects.
- Candidates will also study how the aggregate expression of individual biases manifests as market anomalies.
Introduction to Risk Management
Investment decisions are always made within an environment of uncertainty. Risk management is a skill that allows investors to more adeptly navigate this environment. To do this, investment advisers and managers must be able to identify appropriate measures of risk and keep risks aligned with investment goals.
- The reading offers a broad overview of the enterprise and portfolio risk management process.
- Candidates will learn about risk governance, risk tolerance, and how risk is measured and managed.
Technical Analysis
Technical analysis consists of various techniques among traders, analysts, and investors. While technical analysis is indeed technical, an analyst’s perspective on the results is open to interpretation. Therefore, savvy analysts will test and implement a combination of techniques to suit their goals.
- Candidates will examine the principles and assumptions of technical analysis.
- The reading explores potential connections between behavioral finance, technical analysis, and fundamental analysis.
- The material also introduces technical analysis charts, indicators, and patterns.
Fintech in Investment Management
Fintech employs big data, artificial intelligence, and machine learning to more effectively assess and identify investment opportunities, reduce risk, and develop successful portfolios. Automated robo-advisors fall under the umbrella of fintech and represent one way that finance is becoming more personalized and automated.
- The reading provides an outline of fintech’s key areas of influence in the investment industry.
- Candidates are introduced to the applications of big data, artificial intelligence, data science, and machine learning.
CFA Portfolio Management Level 1 Sample Questions and Answers
The sample questions are typical of the probing multiple-choice questions on the L1 exam. During the exam, you have about 90 seconds to read and answer each question, carefully designed to test knowledge from the CFA Curriculum. UWorld’s question bank is built to expose you to exam-like questions and illustrate and explain the concepts tested thoroughly.
In relation to other portfolios, unattainable portfolios are located:
- below the capital market line
- on the capital market line
- above the capital market line
The capital market line(CML) is the practical form of the capital allocation line (CAL). The CAL represents theoretical portfolios combining the optimal risky portfolio and a risk-free asset. The CML replaces the optimal risky portfolio with the real market portfolio (eg, global market index) and uses short-term domestic government bonds (US Treasury bills) in place of the risk-free asset. All portfolios above the CML are unattainable (gray shaded area).
At each level of risk along the CML, there is no combination of assets that can produce a return greater than the return on the CML. All portfolios below the CML (green shaded area) are attainable but are suboptimal since portfolios along the CML have the highest return at each level of risk (Choices A and B).
The CML represents portfolios that hold a combination of the global market index and the US Treasury bills. The market portfolio is the portfolio on the efficient frontier at the point where a straight line that originates from the risk-free rate is tangent to the efficient frontier. All portfolios on the CML dominate all other achievable portfolios.
Things to remember:
Portfolios on the capital market line (CML) have the highest return for a given level of risk. Portfolios above the CML are unattainable, and portfolios below the CML are suboptimal.
Which of the following performance measures most likely ignores nonsystematic risk?
- M-squared
- Sharpe ratio
- Jensen’s alpha
Portfolio evaluation measures | ||||
---|---|---|---|---|
Sharpe ratio | Treynor ratio | M-squared | Jensen’s alpha | |
Rp – Rf
/
σp
|
Rp – Rf
/
βp
|
(Rp – Rf )
σm
/
σp
+ Rf
|
Rp – [Rf + βp (Rm – Rf )] | |
Standalone | ||||
Comparative |
Rp = portfolio return | βp = beta of portfolio returns | σp = standard deviation of portfolio returns |
Rf = risk-free rate | Rm = market return | σm = standard deviation of market returns |
Rp = portfolio return
Rf = risk-free rate
βp = beta of portfolio returns
Rm = market return
σp = standard deviation of portfolio returns
σm = standard deviation of market returns
Examining a manager’s return is only one part of a manager’s performance evaluation. Another part is determining how much risk the manager took to earn that return. In portfolio management, risk is quantified as either systematic risk (beta) or total risk (standard deviation).
Jensen’s alpha and the Treynor ratio are two performance measures that use beta as a measure of risk. Here, Jensen’s alpha is the only performance measure that uses beta (systematic risk) and ignores nonsystematic risk. Jensen’s alpha is the difference between an asset’s actual return and an asset’s return as predicted by the CAPM. If it is positive, then the manager has outperformed by having a greater return than its expected risk-adjusted return and vice versa.
(Choice A) M-squared is a performance measure based on total risk (standard deviation), not systematic risk (beta). It is a risk-adjusted performance measure, which determines how the portfolio performed relative to the market.
(Choice B) The Sharpe ratio measures excess return relative to the portfolio’s total risk (standard deviation), of returns, not beta.
Things to remember:
Jensen’s alpha and the Treynor ratio are two performance measures based on beta. M-squared and the Sharpe ratio are based on standard deviation (total risk). If Jensen’s alpha is positive, then the manager has exceeded expectations on a risk-adjusted basis.
Companies that raise capital through an initial coin offering (ICO) most likely benefit from:
- less dilution of ownership than through an initial public offering
- more regulation of cryptocurrencies than of traditional currencies
- central authority confirmation of future transactions involving tokens from the ICO
An initial coin offering (ICO) is similar to an initial public offering (IPO). As with an IPO, a company uses an ICO to raise funds, but investors receive cryptocurrency tokens instead of shares. The tokens usually do not convey voting rights, so one advantage of an ICO from the company’s perspective is that the owners retain the same ownership interest as before the ICO. The investors’ incentive is that the tokens may be worth more in the future.
Cryptocurrency is an application of a broader fintech category known as distributed ledger technology (DLT). DLT is a database that is shared among multiple users on a network (ie, shared ledger). Transactions between users are communicated to all other users, and the ledger is updated through a process that ensures its integrity. Since all users have an identical copy of the ledger, each user can see every other transaction.
(Choice B) Cryptocurrency transactions are not highly regulated.
(Choice C) The network’s users maintain and update the ledger, so transactions involving tokens issued through an ICO are not recorded with a central authority such as a clearinghouse. Also, the ICO process is mostly unregulated, so investors in an ICO do not enjoy regulatory protection.
Things to remember:
An initial coin offering (ICO) is the cryptocurrency equivalent of an initial public offering. The investors receive tokens from the company instead of shares, so in most cases they have no ownership or voting rights. An ICO is one application of fintech known as distributed ledger technology (DLT), which is an electronic ledger of transactions shared among multiple users on a network.
What to Expect in CFA Level 2 Portfolio Management?
The CFA Level 2 Portfolio Management topic is one of the more heavily weighted topics on the exam. The weight of Portfolio Management increases with every level of the CFA, making up nearly half of the weight of the Level 3 exam.
The Level 2 portfolio management syllabus discusses the creation, trading, costs, and risks of exchange-traded funds (ETFs) and how to use them strategically. Candidates explore the connections between financial markets and the real economy and are introduced to the Fundamental Law of Active Management. The material wraps up with case studies of portfolio management, which demonstrate how securities trading relates to the investment process.
Exam Weighting
The CFA Portfolio Management topic has a weight of 10-15% of the total exam content so that approximately 8-12 of the 88 CFA Level 2 exam questions or 2-3 of the 22 item sets focus on this topic.
Topic Weight | No. of Readings | No. of Formulas | No. of Questions |
---|---|---|---|
10-15% | 7 | ca. 70 | ca. 12 |
Level 2 Portfolio Management 2023 Syllabus, Readings, and Changes
The CFA Level 2 Portfolio Management syllabus spans 7 Learning Modules and 63 LOS. The CFA Level 2 exam includes 49 total Learning Modules for 2023. Seven center on Portfolio Management (14.3% of the total curriculum). There are no changes in the CFA Level 2 Portfolio Management curriculum.
While the weight of the Portfolio Management section has seen a slight change from 2018-2020, it has remained at a consistent 10-15% from 2021.
2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
---|---|---|---|---|---|
5-10% | 5-15% | 5-15% | 10-15% | 10-15% | 10-15% |
Exchange-Traded Funds: Mechanics and Applications
Exchange-traded funds (ETFs) were developed as an alternative to mutual funds based on the Modern Portfolio Theory discussed in the CFA curriculum. They have grown in popularity due to access, relatively low cost, transparency, and the diversity of available assets. ETFs are also typically more tax-efficient than mutual funds and can be shorted, making them more useful for diversifying positions and portfolios.
- The reading introduces the primary and secondary markets for ETFs and how ETFs are used effectively in relation to portfolio development.
- Candidates will also examine the risks and costs of ETFs and other important considerations for investors.
Using Multifactor Models
Multifactor models allow financial analysts to construct a more clear and nuanced view of risk than would be possible with a single-factor approach. This has made multifactor models a dominant investment practice for measuring and navigating risk.
- The reading provides a background on the modern portfolio theory of multifactor models.
- Candidates will be introduced to arbitrage pricing theory and various types of multifactor models and their applications.
Measuring and Managing Market Risk
Market risk may mean fluctuations in stock prices, interest rates, exchange rates, or commodity prices. The practice of risk management allows financial analysts to align risks with investment goals through the classification and measurement of such risks. This is done through a combination of financial models, experience, and good judgment.
- The reading provides a foundation for understanding and assessing Value at Risk.
- Candidates will learn about the constraints in risk management and sensitivity measures used for equities, fixed-income securities, and options.
Backtesting and Simulation
Backtesting is the practice of simulating the performance of an investment strategy without risking capital. This allows financial analysts to test hypotheses using historical data to simulate results that they can analyze for return. Backtesting and simulation have become increasingly popular in quantitative investing due to the rise in big data and other associated technological developments.
- The reading introduces backtesting techniques.
- Candidates will learn how these tools increase the usefulness of otherwise “random” data.
Economics and Investment Markets
Financial market activity is intimately interwoven with the overall state of the economy. Through financial markets, savers are able to defer consumption,which provides governments and corporations with greater access to capital.
- The reading explores the connection between the real economy and financial markets and demonstrates the usefulness of economic analysis in the valuation of securities and their aggregates.
- Candidates will review how the economy influences the prices of various forms of debt, equity, and credit.
Analysis of Active Portfolio Management
Modern portfolio theory (MPT) has its roots in the 1952 Markowitz framework and has since evolved into the dominant framework for discussing and applying the principles of risk and return in portfolio management. Since 1952, various models, concepts, terminology, and mathematics have been combined with the Markowitz framework to create MPT.
- Candidates are expected to have an understanding of basic portfolio theory (from Level 1) before reading this section.
- The reading introduces the mathematics of “value-added” through active portfolio management, compares various measurements of risk, and provides examples of active portfolio management strategies in equity and fixed-income markets.
Trading Costs and Electronic Markets
Trading is often considered the least understood and appreciated function of the investment process. However, understanding it is critical to understanding how explicit and implicit trading costs are measured and how trading strategies adapt to or can exploit market fragmentation.
- The reading discusses the direct and indirect costs of trading and how electronic trading has affected these costs.
- Candidates will become familiar with how electronic trading facilities are used, the risks associated with electronic trading, and how regulators attempt to mitigate these risks.
CFA Portfolio Management Level 2 Sample Questions and Answers
The sample questions here are typical of the L2 exam’s complexity and depth: formatted as item sets, with a vignette to deliver a scenario that tests the CFA L2 Curriculum. (On the actual exam, each vignette applies to four questions; we’ve thrown in a couple extra to get a bit more learning in). And be sure to review the illustrated explanations we’ve provided for each question: UWorld’s question bank is designed to expose you to exam-like questions and explain the concepts tested thoroughly.
Passage
New Age Management (“New Age”) is the fund sponsor of the Cutting-Edge Technology Fund (CETF), an exchange-traded fund (ETF). In its investment strategy, CETF invests in the 10 largest US technology stocks based on market capitalization. Broad Street Brokers (“Broad Street”) acts as an authorized participant (AP) for CETF. CETF trades on a US exchange and rebalances on the last trading day of every calendar quarter.
CETF’s current creation and redemption baskets are displayed below.
Exhibit 1 CETF baskets for March 31 | |
---|---|
Creation basket | Redemption basket |
Company A | Company A |
Company B | Company B |
Company C | Company C |
Company D | Company D |
Company E | Company E |
Company F | Company F |
Company G | Company G |
Company H | Company H |
Company I | Company I |
Company J | Company K |
Intraday on March 31, CETF last trades at $20.00, a premium to the current intraday NAV (ie, iNAV) of $19.98. The current bid-ask spread is $19.96–$20.02. Another broker/dealer, Zebra Trading (ZT)—which is not an AP—comes to Broad Street with a large order to buy 500,000 shares of CETF. Broad Street immediately fills the entire 500,000-share order at $20.00, although it has only 100,000 shares in inventory.
During the day, Broad Street also trades blocks of CETF with a third broker/dealer, Alpha Trading. The net trading activity at the end of the day is as follows:
Exhibit 2 Net Broker-to-Broker Trading Activity in CETF | |||
---|---|---|---|
Broad Street (BS) | Alpha Trading (AT) | Zebra Trading (ZT) | |
Sold (to): | 500,000 (ZT) | 700,000 (BS) | 200,000 (AT) |
Bought (from): | 700,000 (AT) | 200,000 (ZT) | 500,000 (BS) |
Which of the following best describes the role of Broad Street as authorized participant?
- Facilitates the creation/redemption of ETF shares with the fund sponsor
- Is authorized by the fund sponsor to trade its ETF in the secondary market
- Buys shares of stock directly from the fund sponsor to create new ETF shares
An authorized participant (AP) is a special type of market maker that has the right to create and redeem shares of an exchange-traded fund (ETF) in coordination with the fund sponsor (FS).
The AP initially works with the FS to bring the ETF to the primary market (ie, stock exchange). The AP initially buys a basket of securities (eg, $10,000,000 market value), which forms the ETF’s underlying basis, and delivers those shares to the FS in exchange for an equivalent value of ETF shares (eg, 500,000 shares at $20). The AP then sells the ETF shares to investors in the secondary market.
Once the ETF is created and is trading in the secondary market, the AP facilitates the in-kind creation and redemption of ETF shares with the FS, based on underlying investor demand.
(Choice B) Once listed on an exchange, the ETF can be traded by any broker/dealer like any other stock.
(Choice C) The AP buys the underlying securities directly from the market, not the fund sponsor, to create new ETF shares.
Things to remember:
An authorized participant is a special type of market maker that has the right to create and redeem shares of an exchange-traded fund in coordination with the fund sponsor.
An ETF creation unit is best described as stocks:
- included in the ETF that are publicly disclosed each day by the fund sponsor
- that the AP receives from the fund sponsor in exchange for shares of the ETF
- that the AP sends to the fund sponsor in exchange for large blocks of the ETF
Exchange-traded fund (ETF) creation/redemption terminology | |
---|---|
Creation unit | A large in-kind transaction occurring only between the fund sponsor and authorized participant. |
Creation basket | The basket of securities the authorized participant sends when creating an ETF. This list of securities is publicly disclosed each day. |
Redemption basket | The basket of securities the authorized participant receives when redeeming an ETF. |
Creation units refer to large in-kind transactions that occur only between a fund sponsor and an authorized participant (AP). A typical transaction size for a creation unit is 50,000 ETF shares (eg, CETF) in exchange for a basket of securities (eg, shares of 10 technology stocks) of equal value.
(Choice A) The list of an ETF’s underlying securities that is publicly disclosed each day by the fund sponsor is the fund’s creation basket, not its creation unit.
(Choice B) The underlying securities that an authorized participant receives from the fund sponsor in exchange for shares of the ETF are the redemption basket. If the basket is large (eg, 50,000 ETF shares), it is called a redemption unit (ie, the opposite of a creation unit).
Things to remember:
Creation units refer to large in-kind transactions that occur only between a fund sponsor and an authorized participant. A typical transaction size for a creation unit is 50,000 ETF shares in exchange for a basket of securities of equal value.
Based on Exhibit 1, the presence of Company K in the redemption basket is most likely related to:
- representative sampling
- the quarterly rebalancing
- adding Company K to the ETF
Although creation and redemption baskets usually share the same constituent securities, the securities sometimes differ. Since most ETFs are passively managed,additions and deletions to the underlying security baskets are often related to the periodic (eg, quarterly) rebalancing of the index.
Having different baskets allows the fund sponsor to add or remove positions in the fund organically (ie, through normal trading activity), just as a traditional mutual fund would buy or sell securities to adjust the composition of a portfolio.
If there is not enough intraday trading activity to completely add or remove a position in the fund, an AP will make a finalizing trade using that day’s closing prices to minimize any potential tracking error versus the index.
(Choice A) Representative sampling refers to holding only a portion of the index constituents in the index ETF. This is common when an index has very small exposure to many names or the underlying securities are illiquid. An ETF holding the 10 largest technology companies in the US market (ie, very large liquid positions) would not be a candidate for representative sampling since any tracking error would be substantial.
(Choice C) Company K is being removed (ie, redemption basket) from the ETF; it is Company J is being added (ie, creation basket).
Things to remember:
Since most ETFs are passively managed, additions and deletions to the underlying security baskets are often related to the periodic rebalancing of the index.
What to Expect in CFA Level 3 Portfolio Management?
The CFA Level 3 Portfolio Management is the most heavily weighted topic of the Level 3 CFA exam. At 35-40%, Portfolio Management comprises nearly half of the weight of the Level 3 exam. The material is covered over 7 study sessions, 15 readings, and 141 learning outcome statements (LOS).
The readings begin with a primer on behavioral finance, its influences on portfolio management, and its applications. Candidates will then dive more deeply into portfolio management topics covered in previous levels and be introduced to novel concepts, frameworks, models, tools, regulations, and perspectives.
The readings end with case studies that combine material covered over all the study sessions presented in the CFA Level 3 Portfolio Management topic. Here, candidates will assess the needs of clients given various scenarios and provide solutions.
Exam Weighting
The CFA Portfolio Management topic has a weight of 35-40% of the total exam content so that approximately 16-20 of the 44 CFA Level 3 item set exam questions or 4-5 item sets focus on this topic. In addition, about 4-5 of the 11 essay questions will address this topic.
Topic Weight | No. of Readings | No. of Formulas | No. of Questions |
---|---|---|---|
35-40% | 15 | – | ca. 4-5 item sets Ca. 4-5 essay questions |
Level 3 Portfolio Management Syllabus, Readings, and Changes
The weight of the Portfolio Management section decreased from 2018 to 2019. Since 2019, it has fluctuated between 35-40%. The CFA Level 3 exam includes 35 total readings for 2023. Fifteen of these readings center on Portfolio Management (43% of the total curriculum).
Study Session | No. of Readings | No. of LOS |
---|---|---|
7 | 15 | 141 |
Summary Provides a framework for ethical conduct via principles covered in the CFAI Standards of Practice Handbook. Demonstrates practical application of such concepts in everyday situations. |
The weighting of the Portfolio Management section has stayed constant since 2018.
2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
---|---|---|---|---|---|
40-55% | 35-40% | 35-40% | 35-40% | 35-40% | 35-40% |
Due to the latest transition in Level 3 exam windows —despite other major CFA syllabus changes in levels 1 and 2— CFA Institute has decided to freeze changes in CFA Level 3. This means that the 2023 CFA Level 3 curriculum will remain the same as the 2022 L3 curriculum.
The Behavioral Biases of Individuals
The reading examines the potential consequences of cognitive errors and emotional biases and how to mitigate their potentially negative effects. Candidates will also study how the aggregate expression of individual biases manifests as market anomalies.
Behavioral Finance and Investment Processes
The reading examines the potential consequences of cognitive errors and emotional biases and how to mitigate their potentially negative effects. Candidates will also study how the aggregate expression of individual biases manifests as market anomalies.
Behavioral Finance and Investment Processes
The reading explores an understanding of an individual investor’s decision process through the lens of behavioral finance: individual investors are not as rational as they may think. Candidates will examine how irrationality impacts portfolio construction, forecasting, client relationships, and the market in general.
- The material also introduces the classification of investors into types and the limitations of such classifications.
- Candidates will examine market anomalies that arise from market behavior and conclude with practice problems.
Overview of Asset Allocation
Asset allocation is one of the first decisions financial analysts must consider when developing a portfolio. The effective choice of portfolio asset classes and allocations has a huge influence on levels of return.
- The reading focuses on aligning asset allocation with the investment objective of the investor’s financial situation and goals.
- The material covered in this reading ties into portfolio management, risk management, and behavioral finance and is revisited in other readings.
- Candidates will be introduced to broad approaches to asset allocation and their associated risks and objectives.
Principles of Asset Allocation
Developing an effective, diversified, multi-asset portfolio involves the asset allocation decision process and its implementation via specific investments.
- This reading builds on the material covered in the previous reading “Overview of Asset Allocation” by diving deeper into the primary frameworks for developing an asset allocation.
- Candidates will study how to match the optimal asset allocation to the needs of various investors and how to develop an efficient mix of asset classes in the absence of liabilities.
Asset Allocation with Real-World Constraints
Asset allocation must be adapted to the financial situation and goals of particular asset owners.
- The reading covers how various adaptations can be made given a set of inputs and what circumstances warrant a re-evaluation of long-term asset allocation.
- Candidates will study how investors’ biases and behaviors can create obstacles to successful asset allocation long-term.
Overview of Private Wealth Management
An increase in global wealth has resulted in an increase in individual investors interested in taking on more responsibility for their finances. Private wealth managers help these investors generate wealth and achieve success in a complex financial environment.
- The reading covers the process of developing and implementing investment strategies for individual investors using various tools and techniques.
- Candidates will compare and contrast private clients with institutional clients and learn how private wealth managers can better understand their individual clients and plan accordingly.
Topics in Private Wealth Management
Private client asset management is broken down into three key areas of technical competency: the influence of taxes on wealth accumulation, the basic tools and strategies for retaining wealth from generation to generation, and the management of concentrated positions.
- The reading discusses the importance of taxes in determining an investor’s final returns and important points for managing assets with taxes in mind.
- Candidates will also learn about managing concentrated positions in public and private equity and real estate.
Risk Management for Individuals
An individual’s financial burdens, priorities, and goals change as they age. Life-cycle finance seeks to aid investors as they confront new financial realities. Proximity to retirement, prolonged illness, sudden or chronic disability, and the dwindling of resources are all variables that fall under the umbrella of life-cycle finance.
- The reading covers the potential risks that individuals and households face and strategies that can help mitigate such risks.
- Candidates will study the financial stages of life and associated financial products.
Portfolio Management for Institutional Investors
Institutional investors represent over $70 trillion (USD) in investable assets. These institutional investors include trusts, corporations, and legal entities tasked with investing on behalf of groups and individuals.
- The reading contextualizes important variables that influence institutional investing and introduces the policies they work with.
- Candidates will examine a variety of factors that influence the asset allocation of various institutional investors.
Trade Strategy and Execution
Portfolio managers must work together with traders to develop optimal trading strategies. Trade execution quality is determined by the seamlessness of a strategy’s integration with its execution and the proper assessment of market conditions and a trader’s trading goals and risk aversion.
- The reading examines trading and execution from the perspective of a portfolio manager.
- Candidates will become familiar with a range of trade implementation options and trading algorithms. The material goes on to examine how trade costs and executions are measured and evaluated.
Portfolio Performance Evaluation
Evaluating the efficacy and quality of an investment approach leads to iterative progress and a greater probability of future success. This makes performance evaluation a particularly potent tool in the area of investment analysis. Financial analysts will further benefit from a thorough understanding of how and why such analyses work and how results are generated.
- The reading broadly covers the topics of performance measurement, attribution, and appraisal and how these topics tie together.
- Candidates will learn to use tools to evaluate the effectiveness of analyses and the strengths and weaknesses of various approaches.
Investment Manager Selection
The reading examines frameworks for selecting investment managers and conducting manager interviews. Candidates will learn how to apply risk and return measures to manager selection and unique considerations when selecting managers for traditional versus alternative investments.
Case Study in Portfolio Management: Institutional
This case study is divided into a section dealing with asset allocation and liquidity management, and a second section examines the use of derivatives in portfolio construction from the perspective of tactical asset allocation (TAA) overlay and rebalancing. Candidates will assess potential ethical violations in manager selection and the potential risks and rewards linked to increasing exploration of illiquidity through both private real estate and private equity.
Case Study in Risk Management: Private Wealth
In this case study, candidates will confront the challenges that arise when providing advice on risk management to individuals and families. Financial circumstances and their associated risks evolve over time, so the financial analyst must provide updated solutions addressed specifically to individual clients.
Integrated Cases in Risk Management: Institutional
This is a fictional case study that focuses on the portfolio of a sovereign wealth fund (SWF) examining the risk of long-term investments. This case study requires review of financial, social, and environmental risks associated with the portfolio strategy of institutional investors and readings that cover the risk management associated with long-term direct investments of institutional investors.
Study Tips for CFA Portfolio Management
While a candidate learns how to value individual securities, analyzing a portfolio is also crucial to becoming a competent asset or wealth manager. A great financial advisor must also be able to customize the combination of securities to fit clients’ risk profiles.
- Portfolio management questions may be heavy on calculations, typically involving risk, return, and/or diversification (i.e., correlation).
- Make sure to practice calculating risk measurements (such as variance, covariance, correlation, standard deviation, and beta), as well as returns (such as time-weighted or holding period return) and comparing them.
- Keep the terminology and definitions in mind. In portfolio management, they are numerous.
- Memorize and understand the objectives (risk and return) and constraints, of the Investment Policy Statement (IPS) and the risk categories and asset classes appropriate for institutional and individual investors.
- Understand how to describe the capital market line (CML), the capital allocation line (CAL), and how the SML is produced from the CML. And be familiar with the Efficient Frontier and the optimal portfolio.
- At Level 3, Portfolio Management questions usually have one or two item sets. It's important to keep in mind that the Portfolio Management content will be more in-depth on the Level 3 exam, so it's a good idea to have a general grasp of the concepts already.
- Though few, the principles that can be tested are significant. The Investment Policy Statement and its components, which is highly testable, is one such crucial notion.
- Portfolio Management is included in the exams for Levels 1 and 2, but it is the focus of the Level 3 exam. Asset allocation, risk management, managing institutional investor portfolios, and assessing portfolio performance are additional key ideas at Level 3.
Visit our CFA Level 1 Study Guide and Plan and CFA Level 2 preparation plan for more information.
Frequently Asked Questions
Do the CFAI’s End Of Chapter (EOC) questions along with any questions in their Ecosystem. Beyond that, we highly recommend going through UWorld’s CFA prep platform, which is known for intuitively explaining Portfolio Management.