Overview of the Level III CFA® exam

How do you prepare for the Level III CFA® exam?  Based on my experience with thousands of Level III CFA® candidates and over 25 years of teaching, the key to success is to prepare using the CFA® Program curriculum.  That seems overwhelming especially if you aren’t used to using the curriculum before.  I get that.  That is why I created this video series.  I walk you through each page of the candidate curriculum. I point out and work through white text examples & bliueboxes, concepts and important details while also connecting concepts from one study session to another.  This video below will help give you a taste of things to come, to understand how to use the candidate curriculum and where to focus your efforts as you prepare to make it “One & Done!”

Order Flow of the Level III CFA® exam

Since the mid 1990s the flow of the Level III curriculum went like this: behavioral finance, private wealth, institutional investor, economics, asset allocation, fixed income, equity, alternatives, risk mgt, trading, performance evaluation and GIPS.  Notice how Wealth and Institutional Investor are upfront.  In 2020 the CFA Institute changed the order flow to place Private Wealth and Institutional toward the back of the curriculum.  There are a few risks associated with this approach:

  1.  Leaving the two biggest exam topics (PWealth and Inst) toward the end (April and May) gives you less time to review the topics before the exam
  2. You may not get to these topics if you started late.  In prior years some candidates scramble to finish Perf Eval and GIPS because they ran out of prep time before the exam and just “winged” the topics.

Private wealth and Institutional are the largest topics on the morning essay exam and giving yourself plenty of time to prepare would be prudent.  Lastly, there is noting in the later curriculum you need before you cover those two topics, they can be covered first.

How to Prepare for the Level III CFA® exam

This next video is a 40-minute clip about How to Prepare for Level III. It has been on the Analyst Forum web site and a few candidate have asked where it was located so I popped it into the site here. Let me just say this…this video has some really important data included about the exam and how to best prepare. Be sure to catch the outtakes of candidates that passed last year in the last four minutes.

Derivatives & Fixed Income

Alternative Investments for Portfolio Management

This topic has two readings:  Hedge Fund Strategies and Asset Allocation to Alternative Investments. These readings are new for 2020.  HF Strategies is all about the difference between traditional assets classes and the characteristics that make HFs different.  We then move to the 6 classifications of hedge funds and we review each keeping in mind how the strategies work, liquidity (important for an institutional investor case study tie in) if they use leverage and the types of returns they provide (correlated or uncorrelated).  The reading then moves to the difference between funds of funds and multi manager strategies. Pay close attention to these differences and the impact of fees on each new return.  The readings final two topics are very important:  Conditional FactorModels where we time series regress various HF returns with 4 primary factors (equity, interest rates, currency and volatility) to determine their exposure in normal periods and crisis periods.  Being able to understand the factor loads is a very testable topic.  Lastly the impact of adding a 20% equal weighted mix of HFs to a traditional 60% equity 40% fixed portfolio and analyze the impact to Sharpe, Sortino, and max drawdown is a very practical analysis I’d want to be able to understand and justify on an exam. This reading has 15 Bluebox examples, I’d say 12 of them are of critical learning importance for possible exam questions.

Alternative Investments for Portfolio Management

Asset Allocation to Alternative Investments is new for 2020 and the summary will soon be posted.

Trade Strategy & Execution

This new reading in 2020 discusses trading and execution from the portfolio manager’s perspective.  The reading has two big topic areas (1) the qualitative material through sections 1-4 and then the quantitative material in the later sections.  The qualitative material is all about motivations for trading, inputs for trading, trading strategy prices before, during and after the trade, and finally trading benchmarks.  The later parts of the reading covers trade evaluation after the trade and we discuss implementation shortfall down three ways (1) paper less actual portfolio return (2) execution + opportunity and fess and (3) we break out execution costs into delay costs + trading costs + opportunity + fees.  I/S has been on the CFA exam many times over the years so please master that core body of knowledge.  Evaluating trade execution evaluates trades relative to a benchmark such as arrive prices, VWAP, TWAP, MOC or closing prices, the calculations would also be good to master as well. Finally the last part of the reading covers ethics in trading, best execution and what a firm should do to ensure ethical trading policies.

Manager Selection

Manager selection is about the complex and detailed process involved in selecting an investment manager to follow the mandate of the client’s IPS.  The primary focus of the reading is understanding how the investment results were obtain, whether they will be consistent and repeatable in the future.

The first section of the reading covers defining the investment universe for manager selection.  This can be achieved by looking to a benchmark managers use to manage their assets, third party consultants and hybrid techniques are used to narrow down and define a field of managers to evaluate.  The second part of this section covers the two types of errors that could be made in the manager selection.  Type I errors are hiring or retaining managers that don’t add value and fail to meet expectations.  Type II errors are not hiring or selecting a manager that does add value.  In determining the effects of these choices the size, shape, mean and dispersion of the manager’s returns will determine the cost of these mistakes.  Also pay close attention to the effect of mean reverting markets on these Type I and Type II errors.

The second section of this reading is all about the quantitative elements of manager selection.  As we discussed in Equity Portfolio Management two methods used to identify manager style is Returns Based Style Analysis (RBSA) looks at historical returns and portfolio holdings while Holdings Based Style Analysis (HBSA) evaluates current portfolio positions but is susceptible to window dressing.  Making sure you understand how each works, the advantages and the disadvantages of each approach is key for the exam. Also know that neither approach is better than the other.  Another “review” topic in this section is capture ratios and drawdown.  Capture ratios and drawdown were covered in detail in the Performance Evaluation reading.

The next section is the qualitative elements of the investment process, people and investment portfolio.  A rigors evaluation of the investment philosophy determining is the inefficiencies of the market arising from behavioral or structural inefficiencies.  Other investment philosophy elements include is the approach clear and consistent, what are the strategy assumptions, how have things changed over time and is the approach credible and does it have capacity to earn alpha in excess of fees and is it repeatable.  A look into the investment personnel and the investment decision making process is also explored.  Operational due diligence and evaluation of the firm itself, the investment vehicles offered (SMA or pooled), liquidity and important;y management fees.  Please pay close attention to the fee calculation replicated from the practice problems 21-26.

Case Study in Portfolio Management: Institutional

Global Investment Performance Standards (GIPS)

Last study session ever has one reading: Overview of the Global Investment Performance Standards.

Last Words of Wisdom

Hey!  Don’t let me scare you ;-))