Trustner AcademyTrustner AcademyCourses
Reading 1CFA L3 EquityFull chapter

Equity portfolio strategies

In this chapter: Passive replication methods · Factor investing (value, momentum, quality, low-vol) · Active fundamental strategies · Tax-loss harvesting

~3 min readLayer 4 · Professional CertificationsFree

Equity portfolios span passive (cheapest, market beta) → smart beta (factor tilts) → active (skill-based). CFA L3 tests selecting and combining these.

Foundation

**Passive replication**: - **Full replication**: hold all index members in same weights. Best for liquid, broad indices (S&P 500, Nifty 50). - **Sampling**: hold representative subset. Used when full replication impractical (Russell 2000, MSCI Emerging). - **Optimisation**: minimise tracking error subject to constraints. ETFs typically use one of these. Tracking error: full replication ~5 bps, sampling 20-50 bps. **Factor investing (smart beta)**: - Systematic exposure to factors that have historically earned premium. - Value, size, momentum, quality, low-volatility. - Implementation: rule-based weighting (e.g., weight by P/B for value, return for momentum). **Active fundamental**: - Discretionary stock-picking based on research. - Concentrated (20-40 stocks) or diversified (60-100). - High active share, high TE.

Deep Dive

Tax-aware investing: - Lot selection: sell highest-cost lot first (HIFO) for tax-loss harvesting. - Holding period: long-term gains taxed lower (10% vs slab in India). - Wash sales: avoid repurchasing within 30 days. - Asset location: tax-inefficient assets in tax-deferred accounts. Factor blending: - Single-factor strategies cyclical (value underperformed 2008-2020). - Multi-factor blends smooth performance. - Risk: factor crowding when many follow same recipe. ESG integration: - Negative screening (exclusions): cleanest, simplest. - ESG scoring: tilt toward high-rated names. - Engagement: vote shares, dialogue with management. - Impact: targeted investments for measurable outcomes.

Advanced

L3 essay: "Recommend equity strategy mix for high-net-worth client with $5m, 15-yr horizon, taxable account." Framework: - Core: 60% in tax-efficient passive (broad index ETF). Low fees, low turnover. - Smart beta: 20% in multi-factor (value + quality + low-vol). - Active: 15% in skilled active manager with proven IR. - Tax-aware overlay: 5% in tax-loss harvesting separate account. Rebalancing: tolerance bands, harvest losses opportunistically, hold for >1y for long-term gains.

Regulatory references
  • SEBI MF Regulations
  • CFA Institute Equity curriculum
Common mistakes & pitfalls
  • Treating smart beta as cheap active management — it's rule-based passive with factor tilt.
  • Ignoring tax in equity strategy choice.
  • Style drift in active managers undetected.

Frequently asked

Smart beta vs passive?
Both rule-based, low-fee. Smart beta intentionally deviates from cap-weight to capture factor premium. Passive is cap-weight pure.
Are factor returns persistent?
Long-run yes, short-run cyclical. Multi-factor blends reduce cyclicality. Survivorship and data mining risks remain.

Practice questions

Click each question to reveal the answer and explanation.

Q 1
Full replication best for:
  1. (a)Russell 2000
  2. (b)Nifty 50
  3. (c)MSCI World
  4. (d)Hedge funds
Correct: (b) Nifty 50
Liquid, narrow indices. Full replication has lowest TE but operationally heavier for broad indices.
Q 2
Sampling typically has TE:
  1. (a)<5 bps
  2. (b)20-50 bps
  3. (c)500 bps
  4. (d)0 bps
Correct: (b) 20-50 bps
Sampling: 20-50 bps TE typical. Less than full replication zero, more than fully active.
Q 3
Smart beta is:
  1. (a)Active management
  2. (b)Rule-based factor exposure
  3. (c)Algorithmic trading
  4. (d)Hedge fund
Correct: (b) Rule-based factor exposure
Smart beta = systematic factor tilt with rule-based weighting.
Q 4
Tax-loss harvesting requires:
  1. (a)Frequent trades
  2. (b)Selling losers, replacing with similar (not identical) security
  3. (c)Holding forever
  4. (d)Tax exemption
Correct: (b) Selling losers, replacing with similar (not identical) security
TLH: realise loss, replace with similar (avoid wash-sale rule). Reduces tax bill.
Q 5
ESG integration via "negative screening" means:
  1. (a)Buying ESG laggards
  2. (b)Excluding controversial sectors
  3. (c)Voting against management
  4. (d)Quantitative scoring
Correct: (b) Excluding controversial sectors
Negative screening: exclude tobacco, weapons, etc. Simplest ESG approach.
Educational purposes only. The numbers, returns, and examples used in this lesson are illustrative. Past performance does not guarantee future results. Mutual fund and securities investments are subject to market risks. This lesson is not investment advice; for advice tailored to your circumstances, consult a SEBI-registered Investment Adviser. Read our full disclaimer.