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

A manager wants to hold a portfolio of 1,500 index constituents but finds that full replication is costly because many holdings are illiquid. The manager instead buys a smaller subset chosen to match the index's key risk characteristics, such as sector weights and market capitalization. The technique is best described as:

The technique is stratified sampling. The manager divides the index into groups by characteristics such as sector and size, then holds a representative subset to match those exposures. This reduces costs and illiquid holdings but accepts some tracking error, unlike full replication, which holds every constituent.

  1. Astratified samplingCorrect
  2. Bfull replication
  3. Cenhanced indexing through leverage

Explanation

Stratified sampling holds a subset of securities selected so the portfolio matches index characteristics. This lowers trading costs and avoids illiquid names, at the price of some tracking error. Full replication holds all constituents, which the manager is avoiding.

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