_A comprehensive overview of the key asset classes and their role in portfolio implementation at the CFA Level III_
Introduction to Asset Classes
At CFA Level III, the focus shifts from individual asset valuation to portfolio implementation and management. This involves understanding the different asset classes and how they contribute to the overall portfolio strategy. The key asset classes covered at this level include equities, fixed income, derivatives, alternative investments, and currency.
Equities at CFA Level III
In the context of CFA Level III, equities are not just about valuation but about making informed decisions regarding portfolio implementation. This includes choosing between passive index exposure and active managers, considering factor tilts such as value or quality, and addressing home-country bias. Additionally, candidates must think about hedging foreign-equity currency exposure and evaluating the cost-benefit of derivatives overlays.
Fixed Income and Derivatives
Fixed income at CFA Level III is centered around liability-driven investing and yield-curve strategies. This involves managing duration to immunize pension liabilities, using key-rate duration for sizing butterfly trades, and considering credit spread when the term premium is thin. Tax-exempt municipals are also relevant, particularly for high-net-worth clients in the US. Derivatives, on the other hand, are utilized as tools for hedging and income generation, such as overlaying a put-spread collar or writing covered calls.
Alternative Investments and Currency
Alternative investments, including hedge funds, private equity, real estate, commodities, and infrastructure, offer uncorrelated exposures and access to illiquidity premia. However, they come with trade-offs such as illiquidity, fees, and limited transparency. These investments are suitable for portfolios with a long horizon and the governance to evaluate managers. Currency, often overlooked, is a critical asset class, especially in relation to foreign-currency exposure in unhedged foreign-asset positions. The decision to hedge, partially hedge, or use currency as a return source is a key aspect of portfolio management.
Evaluating Asset Classes
Every asset class is judged by how it fits the Investment Policy Statement (IPS), rather than its standalone Sharpe ratio. This approach ensures that the portfolio is aligned with the client's risk tolerance and return objectives.
Frequently Asked Questions
- Q: What is the focus of equities at CFA Level III?
A: The focus shifts from valuation to portfolio implementation, including decisions on passive vs. active management and factor tilts.
- Q: How are derivatives used at CFA Level III?
A: Derivatives are used as tools for hedging and income generation, rather than as standalone investment problems.
- Q: Why are alternative investments considered at CFA Level III?
A: Alternative investments provide uncorrelated exposures and access to illiquidity premia, but come with trade-offs such as illiquidity and fees.
Watch the Full Lesson
For a more in-depth understanding of the asset classes covered at CFA Level III and how they are integrated into portfolio management, [watch the full lesson](/courses/cfa-level-3/cfa-l3-overview-08).