My goal is to post a simple/short question every day on this thread…so, feel free to answer, and check back daily for others’ answers and feedback. My hope is that over the next 30 days or so, some piece of info on here will stick with you and give you that extra edge on test day (just another avenue of recalling this massive amount of info in the curriculum)…. Hopefully these aren’t too easy, or too hard (and short enough so you’re not “wasting time” on here).
This will help you pass....
- Thread starter JuniorCk8
- Start date
- Thread starter
- #2
Question 1. (4 minutes)
A portfolio manager has been given a mandate of managing a Russell 2000 (small cap) index fund for a large foundation. The manager has the choice between a Full Replication Strategy or Stratified Sampling for managing the portfolio.
Recommend which of the two approaches is preferable. Justify with two reasons.
*note: this is a variation of a BB example in the CFAI text - very testable I think.
A portfolio manager has been given a mandate of managing a Russell 2000 (small cap) index fund for a large foundation. The manager has the choice between a Full Replication Strategy or Stratified Sampling for managing the portfolio.
Recommend which of the two approaches is preferable. Justify with two reasons.
*note: this is a variation of a BB example in the CFAI text - very testable I think.
sachin_patel
New member
- Jun 18, 2026
- 0
- 0
Stratified sampling is preferable.
Reasons
(1) The number of stocks are large in russell 2000 which will require a extensive rebalancing.
(2) small cap stocks are less lequid and hence have higher transaction costs than large cap. rebalancing costs are high in such case.
Reasons
(1) The number of stocks are large in russell 2000 which will require a extensive rebalancing.
(2) small cap stocks are less lequid and hence have higher transaction costs than large cap. rebalancing costs are high in such case.
sachin_patel
New member
- Jun 18, 2026
- 0
- 0
yes agreed, my both points consider rebalancing which is not correct with respect to full replication.
So the two reasons would be (1) transaction costs due to large number of securities. and (2) higher transaction costs due to limited liquidity of small cap?
So the two reasons would be (1) transaction costs due to large number of securities. and (2) higher transaction costs due to limited liquidity of small cap?
- Thread starter
- #10
Good points…unless the benchmark type is noted (ie value weighted etc), rebalancing costs only clouds an answer.
Reason 1: when there are more than 1000 securities, full replication should not be used as it is costly and time consuming. Therefore, stratified sampling should be used.
Reason 2: when are a significant of small cap stocks, full replication would be inefficient and trading costs may be high as small stocks tend to be more illiquid. Optimization will enable them to closely match the exposures to the index without having to purchase every security, most likely reducing trading costs.
Reason 1: when there are more than 1000 securities, full replication should not be used as it is costly and time consuming. Therefore, stratified sampling should be used.
Reason 2: when are a significant of small cap stocks, full replication would be inefficient and trading costs may be high as small stocks tend to be more illiquid. Optimization will enable them to closely match the exposures to the index without having to purchase every security, most likely reducing trading costs.
sachin_patel
New member
- Jun 18, 2026
- 0
- 0
C
tries to mimic benchmark and also adds room for activemanagement so it will give manager a chance to add true active return.
(guesswork)
tries to mimic benchmark and also adds room for activemanagement so it will give manager a chance to add true active return.
(guesswork)
sachin_patel
New member
- Jun 18, 2026
- 0
- 0
do you mind putting in reading number as well? so if we don’t know, we can go back and review easily..
vicky_cool400
New member
- Jun 18, 2026
- 0
- 0
B for sure
A is correct. The point of completness fund is to reduce the concentrated position (large active return and risk) by buying other assets that mimic the investors benchmark (not the manager) to have a diversify portfolio. Doing this Will reduces total active return( misfit and true active ) as well as total active risk (misfit + true active risk). B is wrong because it will not eliminate the misfit risk because it still contain assets that were concentrated and following the manager style) c. This is opposite of the purpose of completness fund.
I’m going B
A completeness fund will likely reduce active return, but it will also reduce active risk, so the effect on the information ratio is undetermined. C is not the aim of the completeness fund and the opposite will likely happen.
I don’t like the word ‘eliminate’ but surely a completeness fund can be buiilt with computers to completely mitigate misfit risk, even if it’s only 0 at one point in time. I believe the CFA text states that this is actually a disadvantage of the completeness fund as some misrit risk may be optimal due to tactical allocation.
A completeness fund will likely reduce active return, but it will also reduce active risk, so the effect on the information ratio is undetermined. C is not the aim of the completeness fund and the opposite will likely happen.
I don’t like the word ‘eliminate’ but surely a completeness fund can be buiilt with computers to completely mitigate misfit risk, even if it’s only 0 at one point in time. I believe the CFA text states that this is actually a disadvantage of the completeness fund as some misrit risk may be optimal due to tactical allocation.
In other word, if you mange the portfolio actively and your benchmark is A , your true active return must increase as well as truce active risk too. The sponser might have concern about the misfit active return and instruct you to add some assets to your portfolio to mimic the sponser(investor benchmark. Which is Benchamrk B. If you listen to him you will reduces active misfits return and misfit active risk. So if we hold the true active and true risk constant this will reduces both total active return and total active risk. Make sense ?
- Thread starter
- #20
great dialogue everyone.
the correct answer is B. (i used the word “eliminate” and “most likely” because this is verbiage the CFAI likes to use).
as someone noted above, one main disadvantage of adding a Completeness Fund to a portfolio tends to reduce/eliminate misfit risk, which is the part of active risk they were looking to gain exposure to.
A is not correct. There is nothing in the question that makes a suggestion that adding the Fund will “most likely” increase the IR. It may increase the IR, it may decrease the IR. It is likely that adding the Fund will actually reduce the IR.
C is not correct, for similar reasons as A. There is no information on the returns/risk of this Completeness Fund, so it is not “most likely” that adding it will do anything to the mgr’s true active return. In fact, it is more likely that the addition of a Completeness Fund will REDUCE the true active return as the completeness fund will bring the portfolio returns more in line with the benchmark.
*Hopefully this is helpful… and hopefully for all our sakes, a question just like this will be on the exam - sparking this dialogue is a different way of “learning” and it will definitely help some remember this minutae material on test day. I’ll post another question later today/tonight (I’m in US Eastern time zone).
the correct answer is B. (i used the word “eliminate” and “most likely” because this is verbiage the CFAI likes to use).
as someone noted above, one main disadvantage of adding a Completeness Fund to a portfolio tends to reduce/eliminate misfit risk, which is the part of active risk they were looking to gain exposure to.
A is not correct. There is nothing in the question that makes a suggestion that adding the Fund will “most likely” increase the IR. It may increase the IR, it may decrease the IR. It is likely that adding the Fund will actually reduce the IR.
C is not correct, for similar reasons as A. There is no information on the returns/risk of this Completeness Fund, so it is not “most likely” that adding it will do anything to the mgr’s true active return. In fact, it is more likely that the addition of a Completeness Fund will REDUCE the true active return as the completeness fund will bring the portfolio returns more in line with the benchmark.
*Hopefully this is helpful… and hopefully for all our sakes, a question just like this will be on the exam - sparking this dialogue is a different way of “learning” and it will definitely help some remember this minutae material on test day. I’ll post another question later today/tonight (I’m in US Eastern time zone).