Portfolio Management and Asset Allocation
Portfolio process
This domain tests asset allocation, diversification and performance evaluation for portfolios that may hold Mongolian equities, bonds, deposits and foreign assets. The exam emphasizes risk tolerance, constraints and the investment policy statement (IPS).
Core concepts
- Strategic allocation follows long-term objectives; tactical tilts exploit short-term views within limits.
- Diversification depends on correlation, not just the number of holdings.
- The IPS records return objective, risk tolerance, time horizon, liquidity, taxes, legal constraints and rebalancing policy.
- Performance should be measured against a suitable benchmark and adjusted for risk.
Worked example
A portfolio is 60% equity with expected return 12% and 40% bonds with expected return 6%. Expected return is 0.6 × 12% + 0.4 × 6% = 9.6%. If inflation is 8%, the approximate real return is about 1.5% (1.096 / 1.08 − 1). If the client needs 5% real, the allocation is insufficient unless returns rise or spending falls. The reasoning links arithmetic to the client’s objective.
Traps
- Confusing arithmetic and geometric average returns.
- Ignoring currency risk when holding foreign assets.
- Treating a concentrated Mongolian equity portfolio as diversified because it has many names.
- Rebalancing without considering costs and liquidity.
- Comparing return with a benchmark of inappropriate risk.