I am stuck on this, and I’m not even sure if its important. 2 sectors A and B. Sector A ~ expected return 10.8% ~ standard deviation 3% ~ Benchmark weight 65% Sector B ~ expected return 13.2% ~ standard deviation 5% ~ Benchmark weight 35% Annual active risk of sector rotation strategy = 17.32% Annualized active return of sector rotation strategy = 12% IC ~ 0.20 Historical correlation ~ 0.30 Analyst correct 60% of time. IF ANALYST FEELS THAT SECTOR A WILL OUTPERFORM SECTOR B OVER THE NEXT MONTH, AND ACTIVE RISK LIMIT IS 5.20%…WHAT IS THE ALLOCATION TO SECTOR A? HELP PLEASE
What are the answer choices? Is breath included in the question?
No, but sweat is.
Annualized active risk is 17.32% with the sector rotation strategy. Because you only want 5.2% active risk, you divide 5.2 with 17.32 which gets you 30% (5.2/17.32)
30% is the composition you could do to hit your limit of 5.2 active risk.
If you believe sector A outperforms, that would be 65+30 = 95% for A, and 35-30 = 5% for b.
If you believe sector B outperforms, then you would allocate 35+30 = 65% to B, and 65-30 = 35% to A.
I did have to sweat a bit on that one. Is it important question? You may get 1 question out of the 120 in the exam!
Hi @125mph Thank you for the reply.
I just got your post now.
Is it possible to explain this a bit more? I understand that the active risk for this rotation strategy is 17.32%, but we are only able to take on 5.2% of active risk. So I get the 30% allocation. But wouldn’t investing an additional 65% in sector A, and 5% in sector B increase our active risk over the limit?
lol, nice one
The question is a bit confusing but it lists the benchmark weights of 65 and 35. Deviating from the benchmark weight of 30% for sector A, and -30% for sector B puts the allocation at 95/5 from the benchmark 65/35. That would be your active rotation strategy. If you were to allow total risk of 17.32 (not limited to 5.2%), you would allocate 165% to sector A and -65% (35-100) to sector B.
ohhhhhhhhhhhhhhhhhhhhhh. Got it. Thank you very much.