IBBC CAPITAL ACADEMY / 2027
Build active portfolios within a risk budget
Independent IBBC Capital draft content for self-study. Not affiliated with or endorsed by CFA Institute. New lessons await subject-matter review. No CFA designation or official PSM credit is awarded.
Learning goals
- Diagnose the case using the stated constraints and quantitative evidence.
- Defend a conditional decision and identify what further evidence could reverse it.
Draft · approximately 65 minutes, excluding further revision.
Decision case · fictional facts
Benchmark weights are 50%,30%,20%; proposed portfolio 70%,20%,10%.A 100 m mandate caps individual holdings at 10 m and daily participation at 10% of volume. A candidate stock trades 2 m daily. The manager expects 2% alpha with 4% active risk.
Turn beliefs into position rules
A concentrated high-conviction philosophy requires different construction from diversified low-signal breadth. Optimizers translate expected returns, covariances and constraints into holdings but are sensitive to noisy inputs. Risk budgets allocate marginal or total risk contributions rather than dollars alone. Scenario-test correlated bets hidden behind different stock names.
Measure distinct forms of activeness
Active Share=half the sum of absolute portfolio-minus-benchmark weights; active risk depends on covariances of active positions. High Active Share need not imply high tracking error if securities are close substitutes. Information ratio is expected active return divided by active risk; higher modeled ratio is not credible without robust alpha and cost assumptions.
Capacity and portfolio architecture
AUM, turnover and liquidity constrain feasible position size. Long-only, long-extension, long/short and equitized market-neutral structures differ in gross exposure, financing, borrow recalls, short squeezes and market beta. Evaluate each net of costs against the mandate; an unconstrained theoretical portfolio is not implementable merely because it has an attractive optimizer score.
Philosophy determines which constraints are sensible
A high-conviction manager may need larger active positions and longer patience than a broadly diversified factor manager. Yet conviction does not justify an illiquid 50-day build when the signal lasts a week. Set limits on issuer, sector, factor, liquidity and drawdown consistent with the actual alpha mechanism, and document which constraints materially reduce expected return.
Formula and assumptions
Active Share=0.5Σ|wp−wb|;IR=alpha/active risk;days=trade size/(participation×daily volume)
Compare with the model response after drafting
- Active Share=0.5 ×(0.20+0.10+0.10)=20%; IR=2/4=0.5. A 10 m purchase at 0.2 m/day needs 50 trading days at the cap.
- Reduce position size or choose a staged execution plan consistent with alpha decay; check correlated exposures before accepting the risk budget.
Errors to catch
- Using Active Share as a substitute for covariance-based risk.
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Original knowledge check
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Sources and coverage status
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