Asset Allocation: CFA® Level III

It is 15–20% of the 2027 Level III exam. 48 learning outcomes across 5 learning modules.

60 practice questions and 8 formula cards on this topic in the app.

Capital Market Expectations, Part 1: Framework and Macro Considerations

• Explain what capital market expectations contribute to managing a portfolio and set out a structured process for building them
• Set out the obstacles an analyst meets when producing forecasts for capital markets
• Explain the ways in which unexpected outside events can shift the long-run growth path of an economy
• Explain how an assessment of trend economic growth feeds into long-run forecasts for asset returns
• Contrast the principal methods used to forecast the economy
• Explain how the stage of the business cycle shapes return expectations over short and long horizons
• Explain how inflation behaves across the business cycle and what it means for returns on cash, bonds, equities and real estate
• Explain how central bank and government budget policy influence the course of the business cycle
• Read the yield curve's slope as a signal about the economy, and explain how it reflects the combined stance of monetary and fiscal policy
• Recognise and interpret how economies are connected through growth, interest rates and currencies

Capital Market Expectations, Part 2: Forecasting Asset Class Returns

• Set out the methods for estimating expected returns on fixed income
• Explain the risks of investing in emerging market bonds and the tools of country risk analysis used to judge such economies
• Set out the methods used to form expected returns for equity markets
• Explain the risks particular to holding emerging market equities
• Explain how economic conditions and competition shape expected returns for real estate markets and individual property sectors
• Set out the main approaches used to forecast currency movements
• Set out the techniques used to forecast volatility and covariance
• Propose and defend reweighting a global portfolio in response to current and anticipated macroeconomic developments

Overview of Asset Allocation

• Set out what good investment governance looks like and how governance shapes asset allocation decisions
• Construct a client's economic balance sheet and draw out what it implies for how assets should be allocated
• Contrast what goals-based, liability-relative and asset-only allocation each set out to achieve
• Contrast how risk is defined when allocating on a goals-based, liability-relative or asset-only basis
• Explain how asset classes serve as building blocks for systematic risk exposures and set out the tests for defining an asset class
• Explain how risk factors are used in asset allocation and how they relate to allocation by asset class
• Propose an asset allocation suited to what the investor wants to achieve and the limits they face, and defend it
• Explain how the global market portfolio serves as a neutral starting point for asset allocation
• Set out the strategic choices in implementing an allocation, including how passive or active to be and which vehicles deliver each type of mandate
• Set out the strategic issues to weigh when rebalancing an asset allocation

Principles of Asset Allocation

• Explain how mean–variance optimisation is used to set an asset allocation and assess its strengths and weaknesses
• Select and defend an asset allocation using the results of mean–variance optimisation
• Analyse an asset allocation against a client's economic balance sheet and judge whether it fits
• Propose and defend an asset allocation that uses the global market portfolio as its reference point
• Explain how scenario analysis and Monte Carlo simulation are used to stress-test an asset allocation's robustness
• Explain how the liquidity of asset classes affects asset allocation decisions
• Explain risk budgets set in absolute and in relative terms, and how they guide choosing and carrying out an asset allocation
• Explain how a client's requirements and attitudes toward particular investment risks can be built into an asset allocation
• Explain how investment factors are used both to build an asset allocation and to analyse one
• Assess the features of liabilities that matter for asset allocation
• Set out the main methods for allocating assets relative to liabilities
• Propose and defend an asset allocation designed around a set of liabilities
• Propose and defend a goals-based asset allocation for an individual investor
• Assess heuristic and other rule-based methods of setting an asset allocation
• Explain what determines an appropriate rebalancing policy

Asset Allocation with Real-World Constraints

• Explain how portfolio size, cash flow needs, horizon, and regulatory and other limits constrain asset allocation
• Explain how taxes shape both the choice of asset allocation and the approach to rebalancing
• Propose and defend changes to an asset allocation after a shift in the investor's objectives or constraints
• Explain the role of temporary deviations from the strategic asset allocation
• Recognise the behavioural biases that affect asset allocation and propose ways to counter them