Asset Allocation

CFA® Level III, published weight 15–20%. Capital market expectations, allocation principles, real-world constraints.

What the outline covers

Capital Market Expectations, Part 1: Framework and Macro Considerations
Capital Market Expectations, Part 2: Forecasting Asset Class Returns
Overview of Asset Allocation
Principles of Asset Allocation
Asset Allocation with Real-World Constraints

Sample questions

These 5 questions are free in the app too. Try each one before opening the answer.

Question 1

An analyst uses the Grinold–Kroner model with an expected dividend yield of 2.2%, expected share buyback of 0.8%, inflation of 2.0%, real earnings growth of 1.8% and no repricing. The expected equity return is closest to:

D/P 2.2% · −ΔS 0.8% · i 2.0% · g 1.8% · ΔP/E 0%

A. 4.8%
B. 6.0%
C. 6.8%
D. 8.6%

Show the answer

C. 2.2 + 0.8 + 2.0 + 1.8 + 0 = 6.8%. Net share buyback is added because it raises per-share claims on earnings.

Reading: Asset Allocation — Capital Market Expectations, Part 2

Question 2

An investor with several distinct, prioritised objectives and different time horizons is best served by:

A. Asset-only mean–variance optimisation
B. Liability-relative allocation
C. Goals-based allocation
D. A single risk-parity portfolio

Show the answer

C. Goals-based allocation builds a sub-portfolio for each goal with its own horizon and required probability of success.

Reading: Asset Allocation — Overview of Asset Allocation

Question 3

The principal criticism of unconstrained mean–variance optimisation is that it:

A. Cannot handle more than two assets
B. Produces highly concentrated portfolios sensitive to input estimation error
C. Ignores correlation between assets
D. Requires normally distributed returns to be computed at all

Show the answer

B. MVO is an error-maximiser: small changes in expected return inputs produce large swings in optimal weights, typically toward concentration.

Reading: Asset Allocation — Principles of Asset Allocation

Question 4

Which factor argues most strongly for a wider rebalancing corridor around a target allocation?

A. Higher asset class volatility
B. Higher transaction costs
C. Higher correlation with the rest of the portfolio
D. A shorter investment horizon

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B. Higher transaction costs make frequent rebalancing expensive, justifying a wider corridor. Higher volatility argues for a narrower one.

Reading: Asset Allocation — Asset Allocation with Real-World Constraints

Question 5

An analyst forecasts long-run returns using only the most recent five years of data during a strong bull market. This most likely reflects:

A. The ex post risk trap
B. Status quo bias
C. Data measurement error
D. Model uncertainty

Show the answer

A. The ex post risk trap treats a period of realised high returns and low volatility as representative, understating forward-looking risk.

Reading: Asset Allocation — Capital Market Expectations, Part 1

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