CFA Topic Test: "Equity Portfolio Management- Dodson" QUESTION!

CFA Level III Equities
#1

My question is in regards to the CFA Topic Test #2 for Equity Portfolio Management. The topic test is called “Equity Portfolio Management- Dodson”

Can somebody help clarify the answer to question #3 below?

My thoughts- The client wants to create a portable alpha strategy that will earn the alpha of the Canadian equity portfolio and meet the new benchmark allocation to US midcap stocks. Given this fact, wouldn’t the client go Long the S&P/TSX futures to earn the alpha of the Candadian equity portfolio? I am confused why the answer is going short the S&P/TSX futures in order to shed exposure on the Canadian equity….

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#2

Can anybody help out with my question above? Thanks!

#3

Initial position: long position in Canadian Equities index --> exposed to Canadian Alpha & Beta

Short position in Canadian futures --> remove Canadian Beta

Long position in US futures --> add US beta

End position: Exposed to Canadian alpha and US beta

#4

ah that makes perfect sense. Thank you!

#5

Hey I was just looking at this and I’m slightly confused because the client didn’t have an initial position in Canadian Equities.

Was this an assumption that we were supposed to make?

#6

I dont have this in front of me but here is the point of it. You go long the futures of the Mid Caps - that gives you the required beta exposure to the mid caps.

Then you go long the manager that adds alpha in the Canadian market. To make thus position “beta neutral” to Canadian equities you go short the TSX contracts. Thus you are only left with alpha exposure to the Canadian market. Make sense?

#7

@kevinsfl,

This is the best description I’ve seen of Portable Alpha / alpha-beta separation – thank you. I think the initial position is long the TSX manager though, right, not the index?

#8

You are correct. The initial position is the position of the long-only portfolio manager’s Canadian equities portfolio, not the index.

#9

can anyone clarify part 5 of this question? I picked full replication because the only clue I got from reading the vignette was that they wanted to minimize trading costs. however, the answer states:

The portfolio contains small-cap stocks, which indicates an approach other than full replication…

is full replication not a suitable strategy for small-cap stocks? I completely missed this when reading the text.

EDIT: eek…I realized my mistake. Full replication = lowest tracking error not lowest costs. apologies for wasting everyone’s time with this question.

#10

Small cap stocks = illiquid stocks. Thus stratified sampling is the best approach.

#11

Thank you Flashback! :slight_smile:

#12

You’re Welcome.:slight_smile: