Investment Choices, Underlying Funds and Asset Allocation
What the exam tests
This domain tests whether you can match underlying funds and asset allocation to a client's objective and risk tolerance, and explain how fund performance, currency and switching affect policy value. It is not a stock-picking test; it is about suitability and risk.
Fund types and risk
Underlying funds may be SFC-authorized funds or internal funds of the insurer. Common categories are money market, bond, balanced, equity, sector/regional, index-tracking and guaranteed funds. Risk generally rises from money market to bond to balanced to equity; within each class, credit quality, duration, concentration and currency matter. A "guaranteed fund" carries the insurer's or a guarantor's credit risk, not a market guarantee. Fund-level fees (management, custodian) reduce returns and are separate from policy charges.
Asset allocation
Strategic asset allocation sets the long-term mix of asset classes; tactical allocation makes shorter-term deviations. Diversification across asset classes, regions and sectors reduces unsystematic risk but not market risk. Correlation matters: a 60/40 equity/bond mix usually has lower volatility than the weighted average of the two funds. Time horizon, liquidity needs, currency of liabilities and the client's capacity for loss should drive the mix.
Switching and rebalancing
Switching moves units from one available fund to another within the same policy; it is not a new policy. Insurers may limit free switches per year, charge a switching fee and apply a bid-offer spread. Switching for short-term market timing is usually unsuitable. Regular-premium clients may use dollar-cost averaging; automatic rebalancing can restore the target mix.
Worked example
A client with a 15-year horizon and medium risk tolerance is offered Fund A (equity, expected 7%, volatility 15%) and Fund B (bond, expected 3%, volatility 5%). A 60/40 mix has an expected return of 5.4%, but because the funds are not perfectly correlated, portfolio volatility is below the weighted average of 11%. If the client's risk profile permits medium risk, the mix may be suitable; a 100% allocation to Fund A would not be, despite higher expected return. If the client switches HK$50,000 after one year and the switch fee is 1%, HK$500 is deducted before new units are bought.
Traps
Do not recommend a fund solely on past performance. Do not ignore policy currency versus fund currency. Do not treat a guaranteed fund as capital-protected at policy level. Do not forget that fund fees compound. Do not assume all switches are free or immediate. Do not let a client's speculative preference override a documented low risk tolerance without escalation.