Portfolio Management (PM)
Summary, Syllabus, Topics, and Sample Questions (L1, L2, L3)
The Portfolio Management (PM) topic is at the core of the CFA® Program, thus making it the most highly ranked career of interest among the candidates. The material starts relatively light at Level 1 (8-12%) and increases in scope and weight at Level 2 (10-15%). PM makes up 35-40% of the Level 3 exam. Candidates should build a strong foundation on this topic, which will pay dividends as they progress through the material.
The Importance of Portfolio Management in the CFA Program
The fundamentals of the portfolio management process can be divided into three main steps: planning, execution, and feedback. In the planning phase, the manager acquires a deep understanding of the client's needs, whether an individual or an institutional investor. Subsequently, the manager compiles crucial information in the Investment Policy Statement, creating a documented plan.
Once the plan is established, the manager executes it by determining the appropriate asset allocation. This allocation involves determining how much of the client's portfolio should be allocated to each broad asset class, such as equity and fixed income, in alignment with the client's risk tolerance and desired return profile. The curriculum encompasses essential topics like risk management, behavioral biases, and technical analysis. More recently, the curriculum has expanded to include fintech subjects like machine learning, big data, and distributed ledger technology.
Portfolio Management: What to Expect in the CFA Level 1 Exam?
The Portfolio Management (PM) topic holds a relatively lower weightage on the Level 1 CFA exam, along with Derivatives and Alternative Investments. It’s crucial for candidates to recognize that PM is not any less significant than heavily weighted subjects such as Financial Statement Analysis (FSA). Instead, PM is a more intricate subject that builds upon fundamental concepts introduced earlier in the CFA Program.
As you progress through the CFA Program, the importance of PM grows, reaching nearly half of the Level 3 exam. Therefore, candidates should regard the lower-weighted content on Level 1 as a primer for this essential CFA exam topic. Establishing a strong foundation in PM is pivotal for achieving success and obtaining a CFA charter.
Exam Weighting
The topic weighs 8-12% of the total exam content, so approximately 15-21 of the 180 questions focus on this topic.
| Topic Weight | No. of Learning Modules | No. of Formulas | No. of Questions |
|---|---|---|---|
| 8-12% | 6 | ca. 50 | 15-21 |
Syllabus, Readings, and Changes
The 2024 PM syllabus spans 6 learning modules and contains 40 LOS. The CFA Level 1 exam includes 6 total Learning Modules for 2024, of which 4 modules center majorly on portfolio planning and management.
Reading-related updates for 2024 include:
- Addition of a new reading: Overview of Portfolio Management
- Removed two readings from 2023 and integrated into the rest of the curriculum: Technical Analysis and Fintech in Investment Management
Overview
The diversification of investments within a portfolio enables the potential for risk reduction while maintaining the potential for rewards. An essential initial step in the portfolio management process involves creating a tailored Investment Policy Statement (IPS) that aligns with the client’s specific requirements. This process is followed by asset allocation, security analysis, portfolio construction, ongoing monitoring, rebalancing, performance evaluation, 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 investors.
- The material also covers mutual funds and other pooled investment instruments.
Portfolio Risk and Return: Part I
The most critical 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 reiterated throughout the CFA Level 1 exam’s PM topic is 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 particular attention to client-centered planning.
- Candidates will learn more about the investment policy statement and the portfolio construction process.
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 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 navigate this environment. To do this, investment advisers and managers must be able to identify appropriate risk measures and keep risks aligned with investment goals.
- The reading offers a broad enterprise and portfolio risk management process overview.
- Candidates will learn about risk governance, tolerance, and measuring and managing risk.
Portfolio Management: Overview
This topic centers on comprehending the portfolio investment approach and detailing the steps involved in portfolio management. Furthermore, it examines diverse investor profiles, emphasizing their unique traits and requirements. The discourse extends to clarifying defined contribution and defined benefit pension plans, delving into facets of the asset management sector. Additionally, it encompasses an overview of mutual funds, accompanied by a comparative analysis of other pooled investment options.
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
Which of the following performance measures most likely ignores nonsystematic risk?
- M-squared
- Sharpe ratio
- Jensen’s alpha
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
Portfolio Management: What to Expect in the CFA Level 2 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 PM topic weighs 10-15% of the total exam content, so 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 Learning Modules | No. of Formulas | No. of Questions |
|---|---|---|---|
| 10-15% | 6 | ca. 70 | ca. 12 |
Syllabus, Readings, and Changes
The CFA Level 2 Portfolio Management (PM) syllabus encompasses 6 Learning Modules and 52 Learning Outcome Statements (LOS). The Level 2 exam focuses on Exchange-trades, Market Risks, Investments, and Portfolio Management. Notably, for the 2024 exam, specific LOS from 2023 have either been consolidated into other readings or omitted. For example, Trading Costs and Electronic Markets from the 2023 curriculum has been removed for the 2024 exam.
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 helpful in diversifying positions and portfolios.
- The reading introduces the primary and secondary markets for ETFs and how ETFs are used effectively for 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 precise and more 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, various 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. Risk management allows financial analysts to align risks with investment goals through the classification and measurement of such risks. This is done through 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 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 can defer consumption, providing governments and corporations 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. It 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 the MPT.
- Candidates are expected to have an understanding of basic portfolio theory (from Level 1) before reading in this section.
- The reading introduces the mathematics of “value-added” through active portfolio management, compares various risk measurements, and provides examples of active portfolio management strategies in equity and fixed-income markets.
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 exam Curriculum. (On the actual exam, each vignette applies to four questions; we’ve thrown in a couple extra to learn more). 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 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
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
Portfolio Management: What to Expect in the CFA Level 3 Exam?
Between 35-40% of the Level 3 exam weight is allocated to Portfolio Management (PM), making it a significant component. The readings kick off with an introduction to behavioral finance, exploring its impact on portfolio management and its practical applications. Subsequently, candidates will delve deeper into portfolio management topics that were covered in previous levels, while also encountering new concepts, frameworks, models, tools, regulations, and perspectives. The readings culminate with case studies that encompass material from all the study sessions within the CFA Level 3 PM topic. Candidates will analyze client needs under various scenarios and propose solutions in these cases.
Starting in 2025, as part of the 2024 evolution update, CFA Institute (CFAI) will introduce ‘Specialized Pathways.’ Within this framework, the PM pathway will remain available for Level 3 candidates alongside two new specialized pathways: Private Wealth and Private Markets. Those who opt for the PM pathway will receive a “common core” curriculum at Level III, supplemented with content tailored specifically to portfolio management. This pathway is an ideal choice for candidates with a keen interest in portfolio management or those aspiring to become portfolio managers.
Exam Weighting
The PM topic weighs 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 | – | 36-45 |
Syllabus, Readings, and Changes
The includes 35 total readings for 2023. Fifteen readings center on PM (43% of the total curriculum).
The Portfolio Management Syllabus for the CFA Level 3 exam 2024, marks significant changes from 2023. It includes a more detailed breakdown, such as
- Expanded content in “Overview of Asset Allocation” covering investment governance and diverse allocation approaches.
- “Principles of Asset Allocation” now explores mean–variance optimization and client needs incorporation.
- “Asset Allocation with Real-World Constraints” covers behavioral biases.
- “Overview of Private Wealth Management” expands to include retirement planning.
- “Topics in Private Wealth Management” includes wealth transfer strategies.
- “Risk Management for Individuals” introduces holistic balance sheets.
- “Portfolio Management for Institutional Investors” discusses legal and regulatory constraints.
- “Trade Strategy and Execution” includes motivations for trade.
- “Portfolio Performance Evaluation” details attribution processes.
- “Investment Manager Selection” covers style analysis and fees.
Case studies in 2024 are more specific, reflecting a nuanced approach to portfolio management.
| No. of Readings | No. of LOS | |
|---|---|---|
| 13 | 129 | |
|
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. |
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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 asset allocation development.
- 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 particular asset owners’ financial situations and goals.
- 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 long-term obstacles to successful asset allocation.
Overview of Private Wealth Management
An increase in global wealth has increased individual investors’ interest in taking on more financial responsibility. Private wealth managers help these investors generate wealth and succeed in a complex financial environment.
- The reading covers 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 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 public and private equity and real estate, which are positions.
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 individuals and households face and strategies to 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 for groups and individuals.
- The reading contextualizes important variables that influence institutional investing and introduces the policies they work with.
- Candidates will examine various 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, 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 various trade implementation options and trading algorithms. The material examines 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 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 risks and rewards linked to increasing illiquidity exploration through 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 associated risks evolve, so the financial analyst must provide updated solutions addressed specifically to individual clients.
Integrated Cases in Risk Management: Institutional
This fictional case study focuses on the portfolio of a sovereign wealth fund (SWF), examining the risk of long-term investments. This case study requires a 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.
Strategies for Excelling in Portfolio Management on the CFA Exam
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.
- Expect portfolio management questions to heavily involve calculations, particularly related to risk, return, and diversification, such as correlation.
- Prioritize practice in calculating crucial risk metrics like variance, covariance, correlation, standard deviation, and beta, as well as various return measures, such as time-weighted or holding period return, and comparing them.
- Keep a vigilant eye on terminology and definitions as they abound within the realm of portfolio management.
- Commit to memory and comprehension the objectives (risk and return) and constraints outlined in the Investment Policy Statement (IPS). Additionally, familiarize yourself with the risk categories and asset classes suitable for both institutional and individual investors.
- Gain a comprehensive understanding of key concepts like the Capital Market Line (CML), the Capital Allocation Line (CAL), and the derivation of the Security Market Line (SML) from the CML. Be well-acquainted with the Efficient Frontier and the concept of an optimal portfolio.
- Level 3 emphasizes portfolio management with typically one or two item sets in the exam. Therefore, it's essential to possess a foundational grasp of these concepts before attempting the Level 3 exam.
- Although few, the principles tested hold significant weight. The Investment Policy Statement (IPS) and its components are notably testable and should be thoroughly understood.
- While portfolio management is present in Levels 1 and 2, it becomes the primary focus in Level 3. In addition to portfolio management, Level 3 delves into critical concepts like asset allocation, risk management, managing institutional investor portfolios, and evaluating portfolio performance.
Visit our CFA exam level 1 Study Guide and Plan and CFA Level 2 preparation plan for more information.
