2017 CFAI Mock PM - Q9 (Philly Case)

CFA Level III Portfolio Management
#1

[…] her holdings in AutoPay are estimated to be more than 30% of her total portfolio. She believes that over the next several years AutoPay will put together an IPO, resulting in a huge windfall. She states that she has a significant portion of her portfolio in short-term bonds and money market funds to offset the risk of AutoPay shares.

Owen points out that her current portfolio is (1) subject to mental accounting, is (2) not constructed in layers , and (3) does not take into consideration covariance between assets.

Which one of the of these statements is wrong if any? The answer is (2) - apparently it’s constructed in layers. I’d offer some challengers to this:

  • if you have concentrated highly risky asset A and allocate to low risk asset B to control overall risk of your portfolio how is that mental accounting? You are taking a full portfolio approach to your risk.It’s the opposite of that.

  • given above, if you’re managing overall risk of your portfolio how is that layering? It’s not like she’s allocating to different buckets that each have their own goal.

-if you offset risk of asset A with asset B to control overall portfolio risk, how does that not take covariance between assets into account?

I think they were going after testing whether you know characteristics of multi-layer approach and did not describe this properly in the case…

Poorly worded question?

#2

Going through this question the first time, I had the same train of thought as you. Reading it more slowly again, it discusses the potential of a “significant windfall”, which might classify it into an aspirational bucket. If it wasn’t constructed in layers, she might not hold the asset. It’s a small detail and a bit of a stretch but that’s what I took it as

#3

Yep you’re probably right, but this is preposterous wording. Also, retaining significant upside potential should not by itself be considered aspirational bucket if it’s being managed in a portfolio context.

#4

I wholeheartedly agree here. This is just god-awful and confusing as all hell. I saw her portfolio–a portfolio with a large, illiquid, concentrated position offset by several low-risk, uncorrelated assets–as a form of completeness portfolio, where she is building the rest of her portfolio around the concentrated position that she cannot liquidate without incurring substantial cost. The idea of saying that this a form of “layered” portfolio is just ridiculous, especially when portfolio layering is most commonly associated with goals-based investing. Fortunately, I think the mock exams are intentionally difficult and obtuse. But yes, this question was quite frustrating.