Asset Allocation & Diversification Flashcards

The primary goal of strategic asset allocation (SAA) is to:

Answer: Establish long-term target weights for asset classes aligned with investor objectives

SAA sets long-term target allocations across asset classes based on an investor's goals, risk tolerance, and time horizon, forming the foundation of the portfolio.

Tactical asset allocation (TAA) differs from strategic asset allocation in that it:

Answer: Makes short-term adjustments to exploit perceived market opportunities

TAA involves temporary deviations from the SAA targets to capitalize on short-term market inefficiencies or changing economic conditions.

The efficient frontier represents portfolios that:

Answer: Offer the maximum expected return for a given level of risk

The efficient frontier, from Modern Portfolio Theory, shows the set of optimal portfolios that deliver the highest expected return for each level of risk.

Which of the following is the primary benefit of international diversification?

Answer: Reduction of portfolio risk by including assets with low correlation to domestic holdings

International diversification reduces total portfolio risk when foreign assets have low correlations with domestic assets, though it does introduce currency and geopolitical risks.

In a mean-variance optimization framework, which input has the greatest impact on portfolio construction outcomes?

Answer: Expected return estimates

Mean-variance optimization is highly sensitive to expected return estimates; small changes in return assumptions can lead to dramatically different optimal portfolio weights.

Which of the following asset classes typically provides the best inflation hedge in a long-term portfolio?

Answer: Real assets such as real estate, commodities, and TIPS

Real assets like commodities, real estate, and TIPS (Treasury Inflation-Protected Securities) have returns that tend to rise with inflation, providing effective long-term inflation protection.