Portfolio Management CFA Level 1 Notes

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It is no surprise that portfolio management is the most famous career that CFA candidates are interested in exploring further. Well, here we are going to share information about CFA Level 1 Portfolio Management.

Overview

Portfolio management is the main focus of the CFA program. They start you light and gentle in CFA Level 1 with a broad stroke’s introduction, gradually increasing in difficulty and topic weight when you advance to Level 3. Thus, building a solid foundation in CFA Level 1 Portfolio Management is important to get your CFA charter. By referring to the CFA curriculum’s Learning Outcome Statements (LOS), we highlight the absolute key concepts and formulas you need to know for each topic. With several tips at the end tool, you are able to use the Cheat Sheets during your practice sessions to refresh your memory on crucial concepts.

CFA Level 1 Portfolio Management

Portfolio management is the end game for the CFA program. But, this topic’s weighting in CFA Level 1 is deceptively light. Portfolio Management will become more crucial exponentially when you advance in the CFA program, particularly in CFA Level 3 where it accounts for 35-40% of the entire exam.

CFA Level 1 Portfolio Management’s topic weighting is 5 to 8 percent. It means that 9-14 of the 180 questions of CFA Level 1 exam are centered around this topic. It is covered in 2022’s Study Sessions 17-18 that includes Reading 48-55.

Below is a summary of CFA Level 1 Portfolio Management chapter readings:

Reading Number Sub-topic Description
48 Portfolio Management: An Overview What portfolio investing is, how it is done, who invests, pension plans and mutual funds.
49 Portfolio Risk and Return: Part I How to measure the performance of a portfolio, calculate and understand risk metrics (mean, covariance, variance, standard deviation).
50 Portfolio Risk and Return: Part II Learn about the CAL (Capital Allocation Line), Capital Market Line or CML, systematic and unsystematic risk, beta, CAPM or Capital Asset Pricing Model, SML or Security Market Line.
51 Basics of Portfolio Planning and Construction
  • An introduction to what will be explored in detail in CFA Level 3.

You are going to learn about:

  • IPS or Investment Policy Statements which is sort of a strategy document of how each individual investor have decided to invest,
  • How the investors can have different skills and willingness to take on risk, and
  • Other aspects of portfolio planning, such as investment constraints (timelines, liquidity, tax, regulation), asset classes and asset allocation.
52 The Behavioural Biases of Individuals
53 Introduction to Risk Management All about risk management: What it is, the risk management frameworks, how to identify different types of risks, and how to manage them.
54 Technical Analysis An introduction to technical analysis principles, kinds of the charts and how to interpret them.
55 Fintech in Investment Management A descriptive chapter on what fintech, artificial intelligence, machine learning, big data, and distributed ledger technology are.

After you have learned to value individual securities, then evaluating them as a combined portfolio is important to your capability as an asset or wealth manager. Not only that, but knowing how to tailor the combination of securities to suit different clients’ risk profiles is crucial to being a good financial advisor.

In short, the CFA Level 1 Portfolio Management readings will teach you:

  • How to invest via building a portfolio works
  • How to measure how well you do
  • How to be aware of the scale and type of risks you are taking
  • How to adapt portfolio investment strategies to different kinds of investor profiles

Reading 48: Portfolio Management

Here are steps in portfolio management process:

  • Planning: Create client’s objectives and constraints in IPS
  • Execution: This will include asset allocation, security analysis and portfolio construction.
  • Feedback: This will include monitoring and performance measurement and reporting.

Types of Investors

Client Investment horizon Risk tolerance Income needs Liquidity needs
Individual investor Varies by individual Depends on the ability and willingness to take risk Depends on investment rationale Varies by individual.
Defined benefit pension plans long term High for longer investment horizon High for mature funds (pay-outs soon), low for growing funds. Varies by plan maturity
Endowments and foundations Very long term high To meet spending commitments Quite low
Banks Short term Low Pay interest on deposits and operational expenses High, to meet daily withdrawals
 Insurance companies Short term for property and casualty (P&C), long term for life insurance Low Low High to meet claims
Investment companies Varies by fund Varies by fund Varies by fund High to meet redemptions
Sovereign Wealth Funds Varies by fund Varies by fund Varies by fund Varies by fund

Defined benefit vs Defined Contribution Pension Plans

  • Defined benefit plan is where a firm promises to make predefined future benefit payments to the employees. The firm bears the investment risk.
  • Defined contribution plan is where a firm contributes an agreed amount to the plan and employees invest part of their wages to the plan. In a Defined contribution plan, investment and inflation risk is borne by the employee.

 CFA Level 1 Portfolio Management Tips

Know your terms and definitions

There are a range of definitions to be learned in Portfolio Management. Investment policy statement (IPS) objectives and constraints, risk kinds, asset classes. Ensure you note and memorize them, because exam questions can clearly ask about any term.

Know your lines (CML, SML, CAL) and CAPM

The SML (Security Market Line) and how it relates to CAPM or Capital Asset Pricing Model calculations is a famous question topic, so ensure you are very familiar with that. Also, you have to be sure to know how to explain the CAL or Capital Allocation Line and the CML or Capital Market Line, and how the SML is derived from the CML.

Calculation, Calculation, Calculation 

Portfolio management questions contain calculation-heavy questions, typically centering around risk or return calculations. Ensure you get lots of practice on calculating and comparing returns such as expected return, as well as calculating risk metrics such as covariance, variance, standard deviation, and beta.

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