Library/CFA (Chartered Financial Analyst)/Portfolio Management — CFA Program Curriculum, 2026 • Level I • Volume 9/Learning Module 3 Portfolio Management: An Overview

Learning Module 3 Portfolio Management: An Overview

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Overview and Importance of a Portfolio Approach5 min

This chapter explains the portfolio perspective and the portfolio management industry. It begins by motivating why a portfolio approach is superior to investing in single securities: diversification reduces idiosyncratic risk, helping avoid catastrophic losses (illustrated by Enron and other firm-specific disasters) and producing lower volatility for similar expected returns. Portfolio benefits depend on correlation among assets and are greatest when combining uncorrelated or low-correlated assets. The reading shows empirical examples (sample HKSE equities, global indices) demonstrating risk reduction from simple equally weighted portfolios and the limits of diversification during periods of global market stress when correlations rise.

Key Points

Diversification reduces nonsystematic (idiosyncratic) risk but cannot eliminate systematic risk.
Correlation among assets drives the degree of diversification benefit.
Diversification effectiveness can decline during market crises when correlations increase.

Portfolio Management Process and Investment Policy Statement6 min

The chapter then presents the portfolio management process in three steps: planning (fact-finding and writing an investment policy statement or IPS that states objectives, constraints, and governance), execution (asset allocation, security analysis, and portfolio construction) and feedback (monitoring, rebalancing, and performance measurement). The IPS should document investor objectives (return requirements, risk tolerance—ability and willingness to take risk), constraints (liquidity, time horizon, taxes, legal/regulatory, unique circumstances including ESG or values), and implementation guidance (benchmarks, permitted investments, rebalancing policy). Risk tolerance combines capacity (objective: wealth, income, time horizon) and willingness (subjective: psychology and preferences); advisers often use validated questionnaires and client interviews to align objectives and constraints.

Key Points

IPS is a written plan documenting objectives and constraints and should be periodically reviewed.
Risk tolerance has two components: ability (capacity) and willingness (attitude).
The execution step emphasizes asset allocation, security analysis, and portfolio construction.

Strategic Asset Allocation and Capital Market Expectations6 min

The chapter explains strategic asset allocation (SAA) as the policy portfolio determined by IPS objectives and capital market expectations (expected returns, volatilities, correlations) and illustrates how efficient frontier analysis and investor indifference curves lead to an optimal SAA. Asset-class definition matters; managers may disaggregate equities (domestic vs international, by cap size), bonds (government, corporate, inflation-protected) and add alternatives (real estate, private equity, hedge funds, infrastructure). Asset allocation drift from policy weights happens and is managed via rebalancing rules and tactical asset allocation; the reading illustrates measuring TAA contribution.

Key Points

Strategic asset allocation is the principal determinant of long-term portfolio outcomes.
Capital market assumptions (returns, volatility, correlations) are inputs to optimization or simulation.
Rebalancing policy and tactical asset allocation affect realized outcomes and should be governed by the IPS.

Types of Investors and Their Needs4 min

The chapter reviews investor types: individual investors (including DC plan participants), institutional investors (defined benefit pension plans, endowments and foundations, insurers, banks, sovereign wealth funds), with differences in time horizon, liquidity needs, and risk tolerances. Global pension asset figures and asset allocations for endowments show heavy use of alternatives by some institutions (e.g., Yale).

Key Points

Different investor types have distinct objectives, constraints, and risk tolerances.
Pension funds, endowments, sovereign wealth funds, insurers, and banks have differing liquidity and regulatory requirements.
Endowments and some institutional investors allocate more to alternatives given long horizons and different spending rules.

The Asset Management Industry and Key Trends5 min

The asset management industry overview covers market size and regional distribution, active vs passive management (passive growth trend and fee implications), traditional vs alternative managers, ownership structures, and trends such as big data and robo-advisers. Passive indexing and ETFs have grown fast, while big data and machine learning are changing research and trading; robo-advisers automate advice and lower costs for mass-market clients.

Key Points

Passive management and ETFs have grown rapidly, exerting fee and product-structure pressure on active managers.
Big data and machine learning are changing both fundamental and quantitative investment processes.
Robo-advisers expand access to asset allocation and automated advice, especially for younger and mass-affluent investors.

Pooled Investment Products7 min

The chapter then describes pooled investment products: mutual funds (open-end vs closed-end, load vs no-load), money market funds, bond funds, equity funds, hybrid/target-date funds, ETFs (intraday trading and creation/redemption mechanics), separately managed accounts (SMAs), hedge funds (use of leverage, shorts, fees structure), and private equity/venture capital (limited partnership model, management fees, carried interest, illiquidity and long lock-ups). It covers practical considerations in manager selection and benchmarking, and highlights the need to select appropriate benchmarks for specialized mandates (ESG screens, illiquid asset classes).

Key Points

Structure of pooled products affects liquidity, taxation, fees, and suitability for investors.
ETFs provide intraday liquidity and are often tax-efficient but trade at market prices that may deviate slightly from NAV.
Hedge funds and private equity are less liquid and often charge performance fees and have lock-up periods.

Implementation, Monitoring, and Performance Evaluation5 min

The chapter outlines portfolio construction and trading execution, risk management considerations during implementation, monitoring and rebalancing triggers, and performance appraisal measures (earlier modules described Sharpe, Treynor, M2, Jensen). It stresses matching benchmarks to mandates and the pitfalls of mismatching (e.g., using S&P 500 to evaluate a real estate fund). Historical and illustrative examples show how managers and committees should interpret performance measures relative to objectives and whether managers are evaluated on total risk or systematic risk.

Key Points

Performance evaluation must use appropriate benchmarks and measures (total vs systematic risk).
Rebalancing rules and monitoring are essential to maintain policy exposures and to measure TAA impacts.
Governance and reporting support oversight and corrective action when portfolios drift from IPS objectives.

Questions

Question 1

Which of the following best captures the primary benefit of constructing a diversified portfolio rather than holding a single security?

Learning Module 3 Portfolio Management: An Overview

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