Section 5: Portfolio Management - Quiz questions

Your client owns all of the assets below and each plays an important role in the asset selection you have chosen. Two assets must be owned through a taxable account while the other two may be held in a tax-deferred IRA account. Assuming no other information, which two assets would be most tax-efficient if held in the IRA account? 1. Limited partnership with significant UBTI 2. Real Estate Investment Trust (REIT) 3. Zero-coupon bond 4. Small-cap equity index ETF

a) 1 and 2 b) 2 and 3 c) 3 and 4 d) 4 and 1 Options 2 and 3 would be most appropriate for a traditional IRA account. Real Estate Investment Trust (REITs) usually pay dividends, however, these dividends are not qualifying dividends therefore they are taxed as ordinary income tax rates. Although, zero coupons bonds do not pay interest, investors must pay taxes on the accrued interest each year until maturity. Option 1 is incorrect. Some limited partnerships are managed in a highly tax efficient manner however the existence of UBTI and its adverse consequences make this choice unacceptable; Option 4 is incorrect. Equity index funds are typically managed in a tax-efficient manner and therefore acceptable in a taxable account.

Which of the following is/are risk(s) of investing in hedge funds? 1. They have less liquidity than most traditional investments 2. They are prone to numerous reporting biases 3. They are unregulated unlike traditional investments 4. They may carry unintended tax consequences

a) 1, 2, and 3 b) 2, 3, and 4 c) 3, 4, and 1 d) 4, 1, and 2 Options 1, 2 and 4 are all accurate regarding alternative investments. Option 3 is incorrect. Although hedge funds are "less" regulated than most traditional pooled accounts (e.g., mutual funds), hedge funds are actually regulated.

Certain investments include: 1-rules and procedures requiring an investor wait a year or more before requesting a redemption; and 2-performance fees based on net profits (profits after any losses in prior years are recovered). What are these two specific characteristics called?

a) 1-redemption policy, 2-maximum drawdown b) 1-withdrawal fee, 2-hurdle rate c) 1-lock-up period, 2-high water mark d) 1-subscription policy, 2-loss recovery provision Lock-up periods and high water marks are specific terms used to describe these hedge fund characteristics.

According to research, the active manager alpha hurdle rate for an investor to justify selecting an actively managed domestic, large capitalization portfolio strategy over a firm that applies a quantitative tax-aware methodology that emphasize tax-loss harvesting, the active manager needs to produce an alpha or return above the index of up to __% when the impact of taxes and fees are taken into account.

a) 1.5% b) 2.0% c) 2.5% d) 3.0% See article on "The Search for Persistent After-Fee and After-Tax Alpha" - Rogers.

Your client would like to utilize tax-loss harvesting opportunities available to him. Given no other information, which of the following investments should be placed in a taxable account to achieve this goal?

a) EAFE index fund b) large cap U.S. stock fund c) emerging markets stock fund d) global value fund See pages 3 of your reading for LO 5.05, CCH Investment Answer Book - select readings on tax harvesting. The strategy here is to place more volatile investments in a taxable account in order to capture tax loss harvesting opportunities due to regular price fluctuations.

Which of the following tax lot methods is assumed if your client does NOT name a specific method in writing before a transaction takes place?

a) FIFO - first in first out b) average cost method c) specific lot method d) LIFO - last in first out See page 6 of your reading for LO 5.04, Investment Answer Book - select readings on tax-aware investing.

Rank the following tax-aware strategies/services in order from basic to elite. I. using tax-lot information II. maintaining lower turnover III. loss harvesting throughout the year IV. providing after-tax reporting V. using the best accounting method

a) I, II, III, V, IV b) V, IV, III, I, II c) II, I, V, III, IV d) IV, V, II, III, I See Table 2 in the article on "The Search for Persistent After-Fee and After-Tax Alpha" - Rogers.

Match the following investment strategy descriptions with their titles: I. strategy that provide exposure to an underlying asset(s) or allocation while guaranteeing principle at some level II. strategy that actively adjusts asset allocation based on what can be numerous factors including valuation, momentum, risk metrics, etc. III. strategy that implements an asset allocation with target asset weightings and seeks to maintain these allocations IV. strategy that buys and sells assets in an attempt to predict market prices through fundamental, technical, or macro-factor analysis

a) I. tactical asset allocation, II. market timing, III. strategic asset allocation, IV. dynamic asset allocation b) I. tactical asset allocation, II. strategic asset allocation, III. dynamic asset allocation, IV. market timing c) I. dynamic asset allocation, II. market timing, III. strategic asset allocation, IV. tactical asset allocation d) I. dynamic asset allocation, II. tactical asset allocation, III. strategic asset allocation, IV. market timing See select readings on "managing portfolio risk" in the Investment Answer Book - pages 9-13.

Which of the following account types (structures) would be most advantageous from a tax perspective to hold a high yielding asset with a very large potential for capital appreciation?

a) IRA Rollover b) Roth IRA c) TIC (tenants in common) account d) FLP (family limited partnership) See pages 186-188 of Private Wealth (Hallman) - - asset location issues. A Roth IRA would be best to hold an asset that generates regular income (high yield) and that may generate large capital gains as neither would be taxed given the Roth IRAs unique tax-free status. A rollover would only defer taxes. The TIC and FLP accounts do not offer tax shelter.

Which of the following best describes a long-short investment strategy where a manager shorts certain positions and uses leverage on others? These strategies are quantitative by nature and seek to maintain full exposure to a market.

a) absolute return strategy b) fund replication strategy c) market neutral strategy d) 130/30 strategy See page 13 of your reading for LO 5.08, Investment Answer Book - Alternative Investment Strategies.

A model that seeks to measure overall risk and value-at-risk by comparing many characteristics of an asset to the market is called:

a) asset optimization b) factor analysis c) risk budgeting d) low volatility investing See eCampus reading "Barra Risk Factor Analysis". LO 5.03.

Which of the following is NOT a criticism of mean variance optimized (MVO) portfolios as developed through Modern Portfolio Theory (MPT):

a) critics of MVO argue that one cannot reliably find the expected return and standard deviation of each asset class along with the correlation between each pair of assets needed in order to determine the optimal asset mix b) inputs used to develop MVO portfolios are based on historical data which can be incomplete and lead to faulty portfolio design c) MVO relies on the stability of the capital markets including the positive relationship between risk and return, time premium, rational investors, etc. d) opponents site the inability of MVO portfolios to navigate significant market drawdowns in an acceptable manner See select readings on "managing portfolio risk" in the Investment Answer Book - page 4.

An investor would like to participate in potential equity upside but would like to limit her potential losses. She buys a put option on an equity index that is out of the money and writes (sells) a call option on the same index with the same expiration date. What is this strategy called?

a) equity collar b) straddle c) strangle d) bull call spread See CBOE equity options strategies reading.

Standard deviation is a measure of _____________________ while Beta is a measure of______________________.

a) market risk and unsystematic risk b) systematic and idiosyncratic risk c) total risk and systematic risk d) systematic and market risk Standard deviation is a measure of total risk (both systematic and unsystematic risk). However, beta is a measure of volatility capturing market or systematic risk. See select readings on "investment risk" from the Investment Answer Book.

Risk parity strategies seek to:

a) minimize portfolio risk b) allocate risk not allocate capital c) optimize risk management without using leverage d) recalibrate portfolio dollar holdings given new risks See Wikipedia reading on "risk parity".

Choose the asset or strategy that belongs in the low cost, tax efficient portion of a core-satellite portfolio.

a) non cap-weighted products b) real estate c) emerging markets d) concentrated portfolios See reading "Incorporating Alternative Investments into High-Net-Worth Portfolios - page 2. Question

Each of the following assets or strategies belongs in the high alpha portion of a core-satellite portfolio except for:

a) non-directional alternatives b) managed futures c) private equity d) tax-enhanced index funds See reading "Incorporating Alternative Investments into High-Net-Worth Portfolios - page 2.

A more helpful metric for measuring after-tax efficiency for separate accounts is the:

a) portfolio turnover rate b) capital gains realization rate c) relative wealth measure d) Morningstar tax-cost ratio See page 4 in the article on "The Search for Persistent After-Fee and After-Tax Alpha" - Rogers.

Which of these methods is least effective for calculating after-tax returns?

a) review portfolio turnover b) use the tax realization method c) net out all taxes when paid d) use the fully liquidated approach See pages 3 and 13 of your reading for LO 5.04, Investment Answer Book - select readings on tax-aware investing.

Socially responsible investing strategies are now commonly categorized using these terms:

a) shareholder activism, negative screening, green investing b) human rights, governance, positive investing c) divestment, go-green funds, responsibility funds d) social funds, no-sin stocks, environment friendly Commonly used categories for SRI funds and strategies include: negative screening, positive influence or investing, green investing, divestment, shareholder activism or engagement.

Which of the following is true of studies following the performance of socially responsible investing?

a) socially responsible funds outperform equity market indexes on a pre-tax basis b) actively managed socially responsible funds outperform passively managed socially responsible funds c) performance attribution due to size and style are more significant than screening for social responsibility d) socially responsible funds underperform their respective indexes by one percent or more in over most periods studied See "Socially Responsible Investors and Their Advisors (Statman) - page 5.

The measurement of risk that quantifies a portfolio's maximum possible risk expected over a certain period of time is called:

a) standard deviation b) semi-standard deviation c) value at risk d) negative skewness See select readings on "investment risk" (covering Value at Risk - VaR) in the Investment Answer Book - pages 24-27.

All of the following statements regarding standard deviation are true except:

a) standard deviation measures total risk; it measures the uncertainty in an investment portfolio; it measures the dispersion of returns around a historical average or expected outcome b) standard deviation relies on the concept of normal distribution where the mean, mode, and median are all the same; graphically standard deviation can be illustrated using a bell-shaped curve where there is little or no skewness and/or kurtosis c) standard deviation has been criticized because it treats upside and downside variation, or risk, equally; an investment could have a very low standard deviation (i.e., be considered low risk) but have lost money over time d) standard deviations for individual securities are always higher than standard deviations of portfolios because of the diversification effect; standard deviations are higher for shorter time periods as compared to longer time periods See select readings from the Investment Answer Book - pages 4-8.

When reviewing Morningstar and comparable reporting services, an advisor should look for the following in order to make better tax-aware investment decisions:

a) tax lot information, unrealized gain/loss position, turnover rate b) tax rates, realized gain/loss position, tax-aware score c) tax-cost information, taxable portfolio turnover, tax history d) tax-cost information, unrealized gain/loss position, tax-aware score See page 4 in the article on "The Search for Persistent After-Fee and After-Tax Alpha" - Rogers.

All of the following insights accurately describe liability-driven investment (LDI) platforms except:

a) the emphasis should be on total returns, and consistent returns with low volatility b) underfunded plans not able to simply match interest rate exposure of liabilities to interest-rate exposure of assets c) the gap in interest rate risk between liabilities and assets is often difficult to address d) plan returns and volatility from stocks and bonds may be sufficient to improve funding ratios See pages 2-3 of "Perspective: Global Assets in a Liability-Driven Investing Platform" - general insights...While answer choice D can be considered controversial, it is important to acknowledge that one's skill in managing assets via asset allocation, security selection, and/or timing should not be considered the exclusive remedy for improving funding ratios.

Which of the following is most accurate in describing Value at Risk (VaR)?

a) value at risk is considered by many a more useful way to measure risk because it does not assume normal distribution like standard deviation and other risk metrics b) value at risk describes a potential loss in terms of amount (or percent), time period, and confidence level c) value at risk cannot be well modeled through Monte Carlo Simulation (MSC) because delta-normal models like VaR are incompatible with MCS d) value at risk is useful to advisors and investors because it estimates worst possible outcomes not revealed by other risk metrics See select readings on "investment risk" (covering Value at Risk - VaR) in the Investment Answer Book - pages 24-37.