NASAA Series 65, Uniform Investment Adviser Law ExaminationClient Investment Recommendations and StrategiesMedium
An investment adviser is constructing a portfolio for a client who is concerned about the potential for a significant market downturn. The client wants to reduce portfolio volatility and limit downside risk, even if it means sacrificing some upside potential. Which portfolio management strategy would be MOST suitable?
- AMomentum investing, focusing on stocks with strong recent price trends.
- BPassive index investing in a broad market ETF.
- CBuy and hold strategy with a high allocation to growth stocks.
- DRisk parity, allocating capital based on the risk contribution of each asset class.
Show answer & explanationAnswer & explanation
Correct answer: D. Risk parity, allocating capital based on the risk contribution of each asset class.
Risk parity aims to equalize the risk contribution of different asset classes in a portfolio, which can reduce overall portfolio volatility and limit downside risk, making it suitable for a client concerned about market downturns.
Why the other options are wrong
- A. Momentum investing is typically high-risk and aims for capital appreciation, not volatility reduction or downside protection.
- B. Passive index investing tracks the market and doesn't explicitly aim to reduce volatility or limit downside risk during downturns beyond diversification.
- C. A buy and hold strategy with growth stocks would likely experience significant volatility during a market downturn, contrary to the client's objective.
Risk Parity Strategy
An investment strategy that allocates capital to different asset classes such that each asset class contributes equally to the overall portfolio risk.
- Aims to achieve a more balanced risk profile across the portfolio.
- Often involves leveraging lower-volatility assets to achieve target risk contributions.
- Can lead to better risk-adjusted returns and reduced downside volatility.
Memory trick: Risk parity: every asset pulls its risk weight.