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CFA Level I · CFA Level I Exam · Basics of Portfolio Planning and Construction

A client's portfolio contains a large holding of low-basis shares whose sale would trigger a significant capital gains tax. This constraint most likely affects the portfolio manager's decision to:

The tax constraint most likely leads the manager to evaluate expected returns on an after-tax basis before selling the shares. The capital gains tax reduces the net benefit of rebalancing, so it must be weighed against the gain from reaching target weights.

  1. Arebalance by selling the shares to reach target weights, ignoring after-tax outcomes
  2. Bevaluate expected returns on an after-tax basis before selling the sharesCorrect
  3. Cexclude the shares from the client's investment policy statement

Explanation

Taxes are an investment constraint, so decisions on selling appreciated assets should compare after-tax returns and costs of rebalancing. Ignoring taxes disregards the constraint, and the holding still belongs in the policy statement as a factor affecting portfolio construction.

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