Portfolio Management Strategies

The whole unit on one sheet: the allocation strategies, the selection styles, and the risk-and-return techniques the exam loves to contrast.

Which One-Liners Win Points?

• Strategic allocation sets long-term target weights (goals, risk tolerance, time horizon); the TARGET only changes when the CLIENT changes, not the market, though the portfolio's holdings still shift with rebalancing.
• Rebalancing returns the portfolio to its targets, typically by selling the overweight asset and buying the underweight one (a natural buy-low, sell-high discipline), though new contributions can also do it without sales.
• Tactical allocation deliberately moves AWAY from targets to exploit short-term opportunities (market timing, sector rotation), then returns.
• Buy and hold typically minimizes transaction costs and defers or reduces realized capital gains taxes in a taxable account; it does NOT guarantee profit.
• Active management tries to beat a benchmark (typically higher fees, higher turnover, less tax-efficient in taxable accounts); passive typically replicates it with lower turnover, consistent with the Efficient Market Hypothesis (EMH).
• Growth buys above-average earnings growth at high price-to-earnings (P/E) and price-to-book (P/B); value buys below intrinsic value (low P/E, low P/B) with a margin of safety.
• Income investing targets regular cash flow (bonds, preferred stock, dividend payers, real estate investment trusts (REITs)); capital appreciation accepts low income for long-term growth.
• Diversification substantially reduces unsystematic (company-specific) risk but NEVER eliminates systematic (market) risk.
• Dollar-cost averaging (DCA) invests a fixed dollar amount at set intervals, buying more shares when prices are low; produces a lower average cost than average price whenever prices fluctuate.

Which Numbers Matter Most?

How Do the Management Styles Compare?

• Active vs. passive: active managers may have more opportunity in less efficient markets (small-cap, international, emerging), though results vary by category and period; passive tends to win in highly efficient markets (large-cap U.S. stocks). Most active funds underperform their benchmark after fees over the long run.
• Growth vs. value: growth reinvests profits and typically runs higher volatility; value often pays dividends and tends to be less volatile but requires patience (beware value traps).
• Income vs. appreciation: income suits retirees needing cash flow; appreciation suits long horizons that do not need current income.

Which Techniques Must You Know Cold?

• Sector rotation: cyclical sectors (technology, consumer discretionary, industrials) have tended to lead in expansion; defensive sectors (utilities, healthcare, consumer staples) have tended to hold up in contraction.
• Protective put: own stock plus buy put; insurance that establishes a downside floor, upside stays open (minus premium).
• Covered call: own stock plus sell call; earns premium income but caps upside and provides only a small premium cushion, not a downside floor.
• Collar: own stock plus buy put plus sell call; caps both sides. A zero-cost collar is when the call premium exactly offsets the put premium.
• Leveraging: margin amplifies BOTH gains AND losses; margin interest must be overcome before profiting; suitability depends on the client's full profile, and low risk tolerance is a strong reason against it.

Which Gotchas Trip Students Up?

• Rebalancing is NOT tactical allocation. Rebalancing returns to the original targets; tactical deliberately moves away to chase short-term opportunities.
• "Defensive" sectors are not defense/military companies: they provide essentials (electricity, medicine, food) and resist economic cycles.
• DCA yields a lower average COST per share than the average PRICE whenever the price fluctuates, but it does NOT guarantee a profit; a steadily falling market still loses money, and lump-sum usually beats DCA in a rising market.
• The two rebalancing methods are calendar-based (fixed intervals) and threshold-based (drift beyond a set percentage). Know both by name.
• Inverse strategies (short sales, puts, inverse funds and ETNs) profit when a market falls and can hedge a long position without selling it. An unhedged short carries theoretically unlimited loss; a long put's loss is capped at the premium.
• A daily-reset inverse product does not deliver the inverse of the period return: daily compounding pulls the result away from the index in a volatile market, so these are short-horizon tools.
• High frequency trading is algorithmic, latency-driven trading that supplies a large share of displayed liquidity and has narrowed quoted spreads, but that liquidity can withdraw quickly under stress. Treat it as market structure an adviser should understand, not a technique for a retail client's portfolio.

One-Breath Recap

Strategic asset allocation sets long-term target weights from goals, risk tolerance, and time horizon, then rebalances back to them, while tactical allocation deliberately deviates to time the market. Active management chases a benchmark while passive replicates it, growth pays a premium for future earnings while value buys a discount to intrinsic value, and income prioritizes cash flow while capital appreciation prioritizes long-term growth. Diversification substantially reduces unsystematic but never eliminates systematic risk, sector rotation rides cyclical versus defensive sectors through the cycle, and dollar-cost averaging locks in a lower average cost than average price whenever prices fluctuate. Options round it out with the protective put (a downside floor), covered call (income, capped upside, a cushion not a floor), and collar (both sides capped), while leverage under Regulation T's 50% initial margin magnifies gains and losses alike.

Need more than the recap? Read the full Portfolio Management Strategies unit.