Reading 42: Monitoring and Rebalancing －LOS a investment, justify

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 15: Monitoring and Rebalancing
Reading 42: Monitoring and Rebalancing
LOS a: Explain and justify a fiduciarys responsibilities in monitoring an investment portfolio.

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Which of the following choices best describes the reason(s) why a fiduciary must monitor a portfolio?

I. The risk tolerance of the investor may change over time.
II. Economic conditions are likely to change over time.
III. The investors liquidity requirements may change over time.
IV. The client portfolio may need to respond to legal or regulatory changes.

A) I only.

B) I and III only.

C) II only.

D) I, II, III, and IV.

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Answer and Explanation

The initial construction of an investors portfolio is based upon the clients circumstances and long-term capital market expectations at the time of construction. The reason why a fiduciary must monitor the portfolio is because both of these broad categories are subject to change. Changes in the investors circumstances (risk tolerance, liquidity, establishment of a trust, or other factors) or changes in economic conditions or capital market expectations may necessitate changes to the clients portfolio which should be carried out by the portfolio manager.

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Darrell Woolaver is the founding principal for Woolaver Capital Management. In his marketing materials, Woolaver makes it a point to tell clients the two primary responsibilities he has as a fiduciary when it comes to portfolio management.

Responsibility 1: Construct each clients portfolio so that it offers the maximum return per unit of risk.

Responsibility 2: Regularly monitor the investors portfolio to make sure it continues to meet the clients needs.

With respect to his statements about the responsibilities Woolaver has as a fiduciary when it comes to portfolio management, Woolaver is:

A) correct with respect to Responsibility 1, and correct with respect to Responsibility 2.

B) incorrect with respect to Responsibility 1, and incorrect with respect to Responsibility 2.

C) correct with respect to Responsibility 1, but incorrect with respect to Responsibility 2.

D) incorrect with respect to Responsibility 1, but correct with respect to Responsibility 2.

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Answer and Explanation

Woolaver is incorrect with respect to Responsibility 1. The portfolio manager has a fiduciary duty to construct the portfolio to meet the needs of the client as specified in the investment policy statement. Although seeking the maximum return per unit of risk is as admirable goal, the clients goals with respect to risk tolerance, liquidity, legal considerations, or other factors may not be fully considered under Woolavers first statement. Responsibility 2 is correct. The portfolio manager has a fiduciary duty to monitor the portfolio to be sure it continues to meet the clients needs. This means monitoring the clients circumstances and capital market conditions, and making changes to the portfolio as necessary.

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Heidi Burke was recently hired by Beekley Capital Advisors as a portfolio manager. On her first day on the job, Cynthia Beekley, owner and founder of the firm, asks Burke to write down the fiduciary responsibilities of a portfolio manager as they pertain to monitoring a clients portfolio. Burke writes down the following items and hands the paper to Beekley.

Item 1:	Watch for changes in client objectives that may necessitate changes to the portfolio.
Item 2:	Construct the investors portfolio to meet the needs of the client as specified in the IPS.
Item 3:	Identify changes in capital market conditions and asset class risks.
Item 4:	Look for changes in client constraints that could cause changes in the clients allocation.
Item 5:	Avoid trying to make tactical timing changes to a client portfolio because evidence shows that market timing increases risk without increasing return.

Which of the following most accurately describes Burkes statements?

A) Only Items 1 and 4 address Beekleys question, while Items 2 and 5 are a fiduciary duties not related to monitoring.

B) Only Items 1, 3, and 4 address Beekleys question, while Item 2 is a fiduciary duty not related to monitoring.

C) Only Item 3 addresses Beekleys question, while Items 1 and 4 would be part of a clients investment policy statement.

D) Items 3 and 5 would be part of a clients investment policy statement while Item 2 is a fiduciary duty not related to monitoring.

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Answer and Explanation

Since the portfolio manager is in a position of trust, he has the fiduciary duty to construct the needs of the client as specified in the IPS and the duty to monitor the portfolio to be sure it continues to meet the client needs. The monitoring process includes monitoring a clients objectives and constraints as well as changes in market conditions. Therefore, Item 2 is a fiduciary duty not related to monitoring, while Items 1, 3, and 4 address fiduciary duties related to monitoring. Item 5 is not necessarily true since a skilled manager could use tactical asset allocation to reduce risk and/or increase returns.