Portfolio Management & Strategy Flashcards

A trustee is considering whether to use options strategies in a trust portfolio. Under UPIA, which condition must be met?

Answer: The strategy must be prudent in the context of the overall portfolio and serve a legitimate trust purpose

UPIA evaluates investments in the context of the total portfolio; options strategies like covered calls or protective puts can be prudent if they serve legitimate risk management or income purposes.

Which behavioral finance bias most commonly causes trustees to hold losing positions too long in a trust portfolio?

Answer: Loss aversion

Loss aversion causes trustees to hold declining positions hoping to 'break even,' avoiding the psychological pain of realizing a loss even when selling is economically rational.

A CES specialist evaluates a trust's investment manager using the Sharpe ratio. What does a higher Sharpe ratio indicate?

Answer: Better risk-adjusted returns per unit of total portfolio risk

The Sharpe ratio measures excess return per unit of standard deviation; a higher ratio indicates the manager is generating more return per unit of risk taken.

What is the primary advantage of using a directed trust structure in portfolio management?

Answer: It allows investment decisions to be directed by an investment advisor while separating administrative duties

A directed trust bifurcates investment and administrative functions, allowing a sophisticated investment advisor to direct the portfolio while the trustee handles distributions and administration.

A trust portfolio experiences 'sequence of returns risk.' When is this risk most damaging?

Answer: Early in the distribution phase when large withdrawals coincide with poor returns

Sequence of returns risk is most harmful when poor returns occur early in the distribution phase, as large withdrawals permanently deplete capital before recovery can occur.

Which metric best measures a portfolio manager's ability to generate excess returns after adjusting for both systematic and unsystematic risk?

Answer: Alpha (Jensen's Alpha)

Jensen's Alpha measures the portfolio's actual return minus the expected return predicted by CAPM, capturing true risk-adjusted outperformance attributable to manager skill.

A trustee must distribute income annually from a trust holding primarily growth stocks that pay minimal dividends. What planning technique addresses this mismatch?

Answer: Adopt a unitrust or power-to-adjust provision to permit principal distributions as income

A unitrust provision or power to adjust (available under the Uniform Principal and Income Act) allows trustees to reallocate capital gains to income, resolving the mismatch between growth portfolios and income distribution requirements.