Chartered Financial Analyst (CFA) Practice Exam Level 2

What does the term 'Active Weight' refer to?

1. Weight of securities in a passive portfolio

2. Difference between active and benchmark portfolio weights

3. Average market weight across sectors

4. Weight adjustment based on ETF performance

The correct answer is: Difference between active and benchmark portfolio weights

The term 'Active Weight' refers specifically to the difference between the weights of securities in an actively managed portfolio compared to the weights of those same securities in a benchmark portfolio. This concept is crucial for understanding how an active manager deviates from the benchmark in order to potentially achieve higher returns. When evaluating an active portfolio, the manager selects securities that they believe will outperform the benchmark, and the weights of these securities in the portfolio may differ significantly from their weights in the benchmark. The active weight illustrates this deviation, which is a core aspect of active management strategies. For instance, if a benchmark allocates 5% to a particular stock, but the active portfolio allocates 8%, the active weight for that stock is +3%. This approach allows investors to gauge the level of active risk being taken by the manager, as larger active weights can indicate a more concentrated investment strategy that may either lead to higher returns or greater volatility. Understanding active weight is essential for assessing the performance and risk profile of an active fund as compared to its benchmark.