PTF Manager in Perfeclty Efficient Market


I faced the following question in Schweser QBank and I don’t understand the explanation.

Which of the following statements least likely describes the role of a portfolio manager in perfectly efficient markets? Portfolio managers should:

A) construct a portfolio that includes financial and real assets.
B) construct diversified portfolios that include international securities to eliminate unsystematic risk.
C) quantify client’s risk tolerance, communicate portfolio policies and strategies, and maintain a strict buy and hold policy avoiding any changes in the portfolio to minimize transaction costs.

I replied A) thinking that a PTF manager is not forced to get both real or financial asset (nice to have but not forced).
But the real answer is C)

Explanation of Schweser: Adhering to a strict buy and hold policy would not be in the client’s best interest

However, the course is mentionning (and I quote):

In a perfectly efficient market, investors should use a passive investment strategy (i.e., buying a broad market index of stocks and holding it)

So it seems that from the course, C) is correct and not “least likely”.
Am I missing something obvious here ?

Thanks a lot !

The key to understanding why C is the “least likely” result is the end of the sentence there:

“and maintain a strict buy and hold policy avoiding any changes in the portfolio to minimize transaction costs.”

Perfectly efficient markets means that all information is built into market prices. It does NOT mean that market prices for a given stock will increase over time, or that stock prices won’t fall. For example, if a company suddenly becomes obsolete in the market, or an important government subsidy ends to an industry, or a natural disaster hits a company factory, or a civil war breaks out in a host country, then a perfectly efficient market will immediately factor in this new information and the price of the stock will start to plummet accordingly. You definitely do not want a strict buy and hold policy in such case. Minimizing transaction costs is not your main concern here. Selling junk off your books before taking a complete bath on the investment is your main concern. A portfolio manager is not the same as a private investor. A private investor can invest in a broad range of anything that strikes their fancy (such as a wide range of ETF funds). A portfolio manager, on the other hand, has to manage each fund according to its stated strategy and mandate. For example, an actively managed long-short fund that holds itself out as actively managed and taking long positions in equities that are undervalued, and short positions in equities that are overvalued (in accordance with the expertise of the portfolio manager and their research team) cannot be switched over entirely into ETFs and passively managed by the portfolio manager after collecting all the investors’ money based on the fact it’s an actively managed fund. If that happens, the manager is essentially violating their fund strategy and stated guidelines for what it can and cannot invest in and investors will be in an uproar because if they wanted a passively managed fund they wouldn’t have invested in that portfolio manager in the first place and agreed to pay their management fees and costs etc.

Likewise, say you as a portfolio manager hold a stock (or ETF) that’s gone up 10x in the past year and your research team now says it’s well above their target price and it lacks further upside in their professional view. In the case of an ETF, this would mean the core stocks comprising the ETF lack further upside according to your diligent research analysis. Your research analysts don’t see much upside in the stock (or ETF) anymore. In that case, you would want to sell that stock (or ETF) and capture the price value for your fund investors now, before it starts to drop down, and lock in the higher return on your fund’s initial investment. And you’d invest the proceeds in a new stock (or ETF) that your research team has identified as having higher upside potential - so long as that investment is consistent with your fund’s strategy/mandate. In this manner you’re making your investors money, not being married to stale investments that might be at the end of their rope nowadays.

Does this help? Simply put, leave the diamond hands to the crypto pumpers. The diamond hands concept doesn’t apply to investing unless it’s backed by a diligent and reasonable basis for holding. As you will learn in Level 3, the whole “hold forever” concept is essentially an emotional bias that portfolio managers (and investors) need to master and overcome. Stocks and individual ETFs can go down and sometimes stay down in any markets, perfectly efficient or otherwise. In which case you need to focus on making money not holding forever and riding those stocks or ETFs down into the proverbial toilet.

Cheers buddy you got this, good luck on your exam!