NASAA Series 65, Uniform Investment Adviser Law ExaminationClient Investment Recommendations and StrategiesMedium
An investment adviser is reviewing a client's portfolio, which consists primarily of large-cap domestic equities. The adviser recommends adding a small allocation to emerging market bonds. What is the primary portfolio management strategy being employed by the adviser in this recommendation?
- ADiversification
- BSector rotation
- CTactical asset allocation
- DMarket timing
Show answer & explanationAnswer & explanation
Correct answer: A. Diversification
Adding emerging market bonds to a portfolio dominated by large-cap domestic equities aims to reduce overall portfolio risk by investing in assets with different risk-return characteristics and low correlation, which is the core principle of diversification.
Why the other options are wrong
- B. Sector rotation involves moving between different industries within the equity market, not asset classes.
- C. Tactical asset allocation involves short-term shifts based on market outlook, not structural portfolio changes.
- D. Market timing involves predicting market movements to buy low and sell high, which is not implied by adding a new asset class for risk reduction.
Diversification
A strategy designed to reduce unsystematic risk by investing in a variety of assets with different risk-return characteristics and low correlations.
- Reduces portfolio risk.
- Combines different asset classes or securities.
- Aims to smooth out returns.
Memory trick: Don't put all your eggs in one basket.