Investment Advice and Portfolio Construction
The Investment Advice and Portfolio Construction domain tests whether you can translate a suitability decision into a portfolio, and defend the allocation, implementation and monitoring choices. Questions probe diversification, correlation, rebalancing mechanics, benchmark selection and the effect of costs and tax.
Allocation
Strategic asset allocation sets long-term weights from the client's objectives, horizon and capacity for loss; it explains most of the variability of returns over time. Tactical tilts are deliberate, time-limited deviations with a stated rationale and a review date. Risk budgeting asks how much of the portfolio's volatility each holding contributes, which is not the same as its capital weight.
Diversification and correlation
Diversification reduces unsystematic risk; it does not remove market risk. Correlations are unstable and tend to rise in stress, so a portfolio that depends on negative correlation for protection can fail exactly when protection is needed. Check concentration by issuer, sector, geography and currency, not just by fund holding.
Rebalancing, benchmarks, costs and tax
Set a policy: calendar (annually), threshold (for example ±5% of target weight) or a blend. Rebalancing enforces selling what has risen and buying what has fallen, but it has costs, so very tight bands can cost more than they add. The benchmark must match the mandate and the client's risk level; comparing a domestic equity fund to a global index is meaningless. Net-of-fee returns are what the client keeps. Place tax-inefficient assets in tax-sheltered wrappers where the rules allow, and weigh the tax cost of realised gains before rebalancing.
Worked example
Target 60/40 on a £500,000 portfolio. After a strong equity year the equity sleeve is £340,000 and bonds £160,000, or 68/32. With a ±5 percentage point band the portfolio has breached policy. Sell £40,000 of equity and buy bonds, returning to £300,000/£200,000. Check the gain on the sale against the client's annual exemption before trading.
Traps
Confusing strategic and tactical. Rebalancing on headlines rather than policy. Assuming historical correlations hold. Confusing volatility with permanent loss of capital. Adding funds without adding diversification. Ignoring the tax and transaction cost of the trade.