This question assesses understanding of the Capital Market Line (CML) and its implications for portfolio performance. The CML represents the set of most efficient portfolios, which are combinations of the risk-free asset and the market portfolio of risky assets. Any portfolio that lies on the CML is considered optimal because it offers the highest possible expected return for a given level of total risk (measured by standard deviation).

The slope of the CML is the Sharpe ratio of the market portfolio, which represents the best possible risk-adjusted return. A portfolio that plots below the CML is, by definition, sub-optimal or inefficient. This means that for its level of standard deviation, it is generating a lower return than could be achieved by a portfolio on the CML. Consequently, the line drawn from the risk-free rate to this sub-optimal portfolio will have a gentler slope than the CML itself. Since the slope of this line represents the portfolio’s Sharpe ratio, a portfolio below the CML must have a Sharpe ratio that is lower than the market portfolio’s Sharpe ratio. It is important not to confuse the CML, which uses total risk (standard deviation), with the Security Market Line (SML), which uses systematic risk (beta).

According to Modern Portfolio Theory, the efficient frontier represents the set of portfolios that offer the highest expected return for a defined level of risk. However, the efficient frontier contains numerous portfolios, each with a different risk-return profile. To select the single optimal portfolio for a specific individual, one must consider the investor’s personal risk tolerance and return expectations. These preferences are graphically represented by indifference curves. An indifference curve maps out combinations of risk and return that provide an investor with the same level of satisfaction or utility. The optimal portfolio for that investor is located at the point where their highest possible indifference curve is tangent to the efficient frontier. This tangency point represents the portfolio that maximizes the investor’s utility, perfectly aligning the available market opportunities (the efficient frontier) with their individual risk preferences.

This question tests the understanding of how to calculate the time required for an investment to double using both simple and compound interest methods.

Statement I is correct. For simple interest, the interest earned each year is based solely on the initial principal. To double the investment, the total interest earned must equal the principal. The formula is: Years = 1 / Interest Rate. In this case, Years = 1 / 0.06 = 16.67 years. So, it would take approximately 16.7 years.

Statement II is correct. The ‘Rule of 72’ is a widely used shortcut to estimate the number of years required to double an investment with compound interest. The formula is: Years ≈ 72 / Interest Rate (as a percentage). In this case, Years ≈ 72 / 6 = 12 years.

Statement III is incorrect. As calculated for Statement I, the doubling time under simple interest is 16.67 years, not 12 years. This statement incorrectly applies the compound interest approximation (Rule of 72) to a simple interest scenario.

Statement IV is incorrect. The fundamental difference between simple and compound interest is that compounding accelerates returns, causing the investment to grow faster. Therefore, the time required to double an investment is significantly shorter under compound interest (approx. 12 years) than under simple interest (16.67 years). Therefore, statements I and II are correct.

An active fixed income manager adjusts a portfolio based on forecasts for interest rates and the yield curve. Statement I is correct because when interest rates are expected to fall, bond prices are expected to rise. By increasing the portfolio’s duration (its sensitivity to interest rate changes), the manager can amplify the positive price impact of falling rates. Statement II is also correct. A flattening yield curve where long-term yields fall more than short-term yields means that long-dated securities will experience greater price appreciation and thus outperform. Shifting allocation to these securities is a classic active yield curve strategy. Statement III is incorrect; cash matching is a liability-driven investment strategy, typically more passive in nature, designed to meet specific future liabilities, not to capitalize on market forecasts. Statement IV is incorrect as reducing sensitivity to interest rates (i.e., shortening duration) is the appropriate strategy when rates are expected to rise, not fall. Therefore, statements I and II are correct.

Strategic Asset Allocation (SAA) is a long-term investment strategy. Statement I is correct as SAA involves establishing a base policy mix and maintaining it over an extended period, reflecting a static, long-term philosophy. Statement II is also correct; a key activity within SAA is rebalancing the portfolio periodically. This is not for active trading but to bring asset allocations that have drifted due to market movements back to their original target weights. Statement III is incorrect as it describes Tactical Asset Allocation (TAA), an active strategy that involves making short-term adjustments to capitalize on perceived market inefficiencies or trends, which is contrary to the passive nature of SAA. Statement IV is correct because the infrequent trading and ‘buy-and-hold’ nature of SAA lead to lower portfolio turnover, which in turn results in lower transaction costs compared to active management strategies. Therefore, statements I, II and IV are correct.

This question assesses the candidate’s understanding of active fixed income management, specifically the yield curve strategy. An active manager seeks to add value by adjusting the portfolio based on economic forecasts. When a manager anticipates a change in the shape of the yield curve, they will reposition the portfolio’s maturity structure. A flattening yield curve, where long-term interest rates are expected to fall more than short-term rates, means the spread between them narrows. Bond prices have an inverse relationship with interest rates. Furthermore, bonds with longer maturities (and thus longer duration) are more sensitive to changes in interest rates. Therefore, a forecast of falling long-term rates implies that the prices of long-dated bonds are expected to rise significantly. To capitalize on this view, the manager should increase the portfolio’s exposure to long-dated securities to benefit from the anticipated price appreciation. Reducing duration is a strategy for when interest rates are expected to rise. Shifting to cash is a defensive move, not one designed to profit from this specific forecast. Focusing on credit spreads is a different active strategy (sector-spread strategy) that is not directly related to the forecast about the government bond yield curve’s shape.

Statement I is correct because under the Securities and Futures (Professional Investor) Rules, an individual can be classified as an Individual Professional Investor if they have a portfolio of not less than HK$8 million. Mr. Chan’s portfolio of HK$10 million exceeds this threshold. Statement II is correct because the private bank is acting as an intermediary between the fund provider (the third-party asset manager) and the end customer (Mr. Chan). This arrangement is a classic example of an indirect distribution channel. Statement III is incorrect; a common disadvantage of managed funds is that financial institutions generally have a poor regard for their use as collateral for loans, unlike more traditional assets like property or listed shares. Statement IV is incorrect because ‘Institutional Professional Investors’ are specifically defined entities such as banks, insurance companies, and authorized funds. A manufacturing business, while it could potentially qualify as a ‘Corporate Professional Investor’ if it meets certain asset or portfolio thresholds (e.g., total assets of HK$40 million), is not an ‘Institutional Professional Investor’ by definition. Therefore, statements I and II are correct.

Statement I is correct. An upward-sloping, or normal, yield curve signifies that yields on longer-term bonds are higher than on shorter-term bonds. This is the typical state of the curve and reflects investors’ demand for a higher premium to compensate for the greater risks (such as inflation and interest rate uncertainty) associated with lending money for a longer duration. Statement II is incorrect. Standard fixed-coupon bonds are generally poor hedges against inflation. Because their coupon payments are fixed, their real value (purchasing power) is eroded when inflation rises. Index-linked bonds are specifically designed to provide inflation protection. Statement III is correct. There is an inverse relationship between bond prices and interest rates. If prevailing market interest rates fall, newly issued bonds will offer lower yields. Consequently, existing bonds with higher fixed-coupon rates become more valuable, and their market price will increase. Statement IV is incorrect. A downward-sloping, or inverted, yield curve occurs when short-term interest rates are higher than long-term rates. This market condition typically signals that investors expect a future fall in interest rates, which is often associated with an anticipated economic slowdown or recession, not an expansion. Therefore, statements I and III are correct.

To answer this question correctly, one must understand the specific investment objectives and risk profiles of different MPF fund types as defined under the Mandatory Provident Fund Schemes Ordinance. An MPF Conservative Fund’s primary objective is capital security. It is designed for members with very low risk tolerance and invests almost exclusively in low-risk, short-term assets like Hong Kong dollar bank deposits and high-quality money market instruments. Its expected return is benchmarked against prescribed savings rates, reflecting its focus on preservation over growth. In contrast, a Guaranteed Fund also aims for capital security but does so by offering a conditional guarantee on capital or a minimum return, often involving a more diverse portfolio that may include bonds and a small equity component, and typically incurs a specific guarantee charge. The Age 65 Plus Fund, a component of the Default Investment Strategy (DIS), is a low-risk mixed asset fund but still maintains a target allocation (e.g., 20%) to higher-risk assets like global equities, meaning it is not solely focused on capital preservation. A Bond Fund seeks to generate a stable income stream and is subject to interest rate and credit risks, which can cause its value to fluctuate, making its primary objective income generation rather than pure capital preservation.

This question assesses the understanding of Strategic Asset Allocation (SAA) and its core discipline: rebalancing. SAA is a long-term investment strategy that establishes a target asset mix (policy weights) based on long-term expectations for risk and return. A key principle of SAA is to maintain this target mix. When market movements cause an asset class to significantly outperform others, its weighting in the portfolio increases. This is known as a technical breach or a drift from the policy weight. The appropriate action under SAA is to rebalance the portfolio by selling a portion of the outperforming asset class and reallocating the proceeds to the underperforming asset classes. This brings the portfolio back in line with its original long-term strategic targets. Taking no action because the allocation is still within a pre-defined range misses the point of rebalancing to the target weight. Actively increasing the allocation to ride momentum is a feature of tactical asset allocation, not SAA. Proposing a permanent change to the policy weights is a fundamental strategic shift, not a routine rebalancing procedure. This discipline is crucial for fund managers to adhere to the investment strategy disclosed to investors, as required by the SFC’s Fund Manager Code of Conduct.

This question assesses the understanding of the fundamental structural differences between a Mandatory Provident Fund (MPF) constituent fund and an Investment-Linked Assurance Scheme (ILAS). An MPF Conservative Fund is a straightforward, low-risk investment fund under the MPF system, regulated by the MPFA. Its primary objective is capital preservation, and its fee structure is relatively simple, mainly consisting of a management fee. In contrast, an ILAS is a life insurance policy that includes an investment component. This dual nature means it has a more complex structure. It is subject to regulation by both the Insurance Authority (IA) and the Securities and Futures Commission (SFC). Crucially, an ILAS involves insurance-related costs (such as cost of insurance, policy fees, administration charges) in addition to the investment management fees of the underlying funds. These additional layers of fees are a key distinguishing feature that directly impacts the net return to the policyholder and must be clearly explained during the sales process. Furthermore, early surrender of an ILAS policy typically incurs significant financial penalties (surrender charges), which is another critical point of disclosure.

This question assesses the understanding of the SFC’s requirements for presenting performance data in marketing materials for collective investment schemes, as outlined in the Advertising Guidelines and the Fund Manager Code of Conduct (FMCC).
Statement I is incorrect. Presenting a single, exceptional short-term performance figure in isolation is considered misleading. The SFC requires performance data to be presented in a fair and balanced manner, typically including cumulative returns over various periods (e.g., 1, 3, and 5 years) and/or annualized returns for periods longer than one year.
Statement II is incorrect. The SFC generally prohibits the use of simulated or back-tested performance data in advertisements for funds authorized for public distribution in Hong Kong. Such data is considered hypothetical and potentially misleading to the investing public.
Statement III is correct. To provide a true representation of an investor’s potential returns, performance data must be calculated on a Net Asset Value (NAV) to NAV basis. This means the calculation must account for the deduction of all recurring fees and charges, such as management fees and trustee fees, though it may exclude initial or subscription charges.
Statement IV is correct. It is a mandatory requirement under the SFC’s guidelines that any advertisement containing past performance figures must include a clear and prominent warning that past performance is not indicative of future results. This is a crucial risk disclosure for investors. Therefore, statements III and IV are correct.

This question assesses understanding of the specific requirements for SFC-authorised fund of hedge funds (FoHFs) under the Code on Unit Trusts and Mutual Funds. Statement I is incorrect because an FoHF may not invest more than 30% of its total net asset value in any one underlying fund. Statement II is correct; the fund meets the requirement for at least one dealing day per month and the redemption payment timeline of 60 days is well within the maximum 90-day limit. Statement III is correct; the SFC requires that where an FoHF invests in underlying funds managed by the same management company or its connected persons, all initial charges on such underlying funds must be waived. Statement IV is incorrect because the requirement is more specific: the management company must ensure that each of the key personnel of the underlying fund’s management company has at least two years of experience in the relevant hedge fund investment strategy, not just any SFC-regulated activity. Therefore, statements II and III are correct.

The core distinction lies between hedging and speculation. Hedging is a risk management technique used to reduce or eliminate an existing risk exposure. Speculation, in contrast, involves taking on risk to profit from an anticipated change in an asset’s price, either in its direction or its volatility.

Statement I describes a classic hedging scenario. The manager has an existing risk (the equity portfolio) and enters an opposing position (selling index futures) to offset potential losses from a market downturn. The objective is risk reduction, not profit generation.

Statement II is an example of directional speculation. The manager forms a view that a stock is overvalued and uses put options to profit if that view proves correct. This action creates a new position to capitalize on a price movement, which is the essence of speculation.

Statement III illustrates volatility trading, a form of speculation. The manager is not sure of the price direction but believes the price will move significantly. By buying a straddle (a call and a put), the manager profits from high volatility. This is a speculative bet on the magnitude of a price change.

Statement IV is another form of directional speculation. The manager is using derivatives to efficiently gain exposure to a new asset class (commodities) to profit from an expected price increase. This is an investment decision aimed at generating returns, not hedging an existing risk. Therefore, statements II, III and IV are correct.

This question assesses the understanding of fundamental classifications of managed funds, specifically their legal structure and redemption mechanisms. Statement I is correct because it accurately distinguishes between a unit trust, which is established under a trust deed and managed by a trustee for the benefit of unitholders, and a mutual fund, which is a corporate entity (a limited liability company) where investors purchase shares and become shareholders. Statement II is also correct. It properly describes the core operational difference between open-end and closed-end funds. Open-end funds create new units/shares for incoming investors and redeem them for exiting investors, with transactions typically based on the daily net asset value (NAV). In contrast, closed-end funds issue a fixed number of shares during an initial public offering, which are then traded among investors on a stock exchange, with prices determined by market supply and demand, which can result in the shares trading at a premium or discount to the NAV. Statement III is incorrect as it creates a false linkage. The legal structure (unit trust vs. mutual fund) and the redemption mechanism (open-end vs. closed-end) are independent classifications. A fund can be structured as an open-end unit trust, a closed-end unit trust, an open-end mutual fund, or a closed-end mutual fund. Statement IV is incorrect because a fund’s classification as open-end or closed-end is a structural feature related to its capitalisation and redemption process, not its investment policy. While the liquidity of the underlying assets (e.g., private equity vs. public equities) might influence the choice of structure, the investment policy itself (e.g., equity vs. fixed income) does not define it as open or closed. Therefore, statements I and II are correct.

This question assesses the understanding of capital market efficiency theories, the random walk hypothesis, and recognized market anomalies.

Statement I is correct. The ‘random walk’ theory posits that successive share price changes are independent of one another. If this holds true, past price movements (the basis of the analyst’s strategy) cannot be used to predict future movements, making it highly improbable to consistently generate abnormal returns through such technical analysis. This aligns with the concept of weak-form market efficiency.

Statement II is correct. Market anomalies, such as the ‘small firm effect’ (where smaller companies have historically earned higher risk-adjusted returns) and the ‘January effect’ (higher returns in January), are well-documented empirical findings. These patterns represent potential deviations from the efficient market hypothesis and suggest that some predictable elements may exist, which a quantitative strategy might seek to exploit.

Statement III is incorrect. This statement misinterprets the different forms of market efficiency. In a semi-strong form efficient market, all publicly available information (including past prices, earnings announcements, and economic data) is already reflected in share prices. Therefore, acting on a public takeover announcement would not yield abnormal returns. The ability to profit from such information before it becomes public relates to the strong-form efficiency, and using such non-public information would constitute market misconduct (insider dealing) under the Securities and Futures Ordinance (SFO).

Statement IV is incorrect. This statement describes the opposite of what event studies typically conclude. Empirical evidence from event studies generally shows that the market reacts very quickly to the public announcement of significant events like share splits or takeovers. As a result, the information is rapidly incorporated into the share price, making it extremely difficult to earn abnormal returns by trading after the announcement has been made. Therefore, statements I and II are correct.

Statement I is correct. Tracking error is defined as the standard deviation of the excess returns of a portfolio relative to its benchmark. In this context, the excess returns are referred to as ‘alphas’, so the standard deviation of the weekly alphas represents the weekly tracking error. Statement II is correct. To annualize a volatility measure calculated from weekly data, one must multiply it by the square root of the number of weeks in a year, which is √52. Statement III is incorrect. If the tracking error were calculated from monthly data, the annualization factor would be the square root of 12 (√12), not 12. Multiplying by 12 would be an incorrect application of the annualization principle. Statement IV is incorrect. A high tracking error indicates a high volatility of the fund’s excess returns compared to the benchmark. It signifies that the fund’s performance deviates significantly from the benchmark, but this deviation could be positive (outperformance) or negative (underperformance). It does not exclusively imply underperformance. Therefore, statements I and II are correct.

Statement I is correct because standard deviation measures the dispersion or volatility of returns around the mean. A higher standard deviation implies a wider range of potential outcomes, which is interpreted as higher risk. Statement II is correct as it highlights a key limitation of standard deviation: it is a symmetrical measure that treats positive deviations (upside potential) and negative deviations (downside risk) equally. For a risk-averse investor, who is primarily concerned with potential losses, this can be an unsatisfactory measure of ‘true’ risk. Statement IV is correct and reflects best practice. Given the limitations of standard deviation, a licensed person should use a range of risk measures (such as Value-at-Risk, Sortino ratio, or downside deviation) to provide a more comprehensive risk profile that better aligns with the client’s risk concerns. Statement III is incorrect because standard deviation is a measure of the typical dispersion of returns, not a deterministic predictor of the maximum possible loss. It is a probabilistic measure, and a fund with lower standard deviation could still theoretically experience a larger maximum loss due to an extreme, low-probability event (a ‘tail risk’). Therefore, statements I, II and IV are correct.

This question assesses the understanding of the fundamental differences between open-end and closed-end funds, which are key classifications for managed funds.

Statement I is correct. Open-end funds, which include most unit trusts and Open-Ended Fund Companies (OFCs) in Hong Kong, are characterized by their ability to create new units for incoming investors and cancel units for redeeming investors. Transactions are done directly with the fund management company at the prevailing Net Asset Value (NAV) per unit, calculated at the end of the trading day.

Statement II is incorrect. Closed-end funds have a fixed number of shares issued during an initial public offering (IPO). After the IPO, these shares trade on a secondary market, like a stock exchange, between investors. The fund itself does not redeem these shares from investors. The idea of redeeming at NAV at specific intervals is more characteristic of certain alternative or semi-liquid funds, not a general feature of closed-end funds.

Statement III is correct. Because shares of a closed-end fund are traded on an exchange, their price is determined by market forces of supply and demand. This market price can, and often does, differ from the fund’s underlying NAV per share, resulting in the shares trading at a premium (above NAV) or a discount (below NAV).

Statement IV is incorrect. This statement presents a false dichotomy. While many unit trusts are open-end, the legal structure does not strictly dictate the redemption mechanism. Hong Kong has a specific corporate fund structure called an Open-Ended Fund Company (OFC), which is a limited liability company but is, by definition, open-ended. Therefore, statements I and III are correct.

Performance attribution is a critical component of the investment management review process. It is a quantitative technique used to analyze a portfolio’s performance and identify the specific sources of its returns relative to a benchmark. The primary goal is to decompose the portfolio’s excess return (alpha) into distinct components, most commonly the asset allocation effect and the security selection effect. The asset allocation effect measures the manager’s skill in overweighting outperforming sectors or asset classes and underweighting underperforming ones compared to the benchmark. The security selection effect measures the manager’s ability to choose individual securities within those sectors that perform better than the sector average. By isolating these effects, the analysis provides valuable feedback to the fund manager, management, and clients, clarifying whether the performance was due to strategic market timing, superior stock-picking skills, or a combination of both. This helps in refining the investment process and assessing the manager’s adherence to their stated strategy. It is distinct from simply calculating risk-adjusted return metrics like the Sharpe ratio, which measures overall performance efficiency but does not explain its underlying drivers.

The Mandatory Provident Fund (MPF) system was established in Hong Kong based on a framework recommended by the World Bank in its 1994 report, ‘Averting the Old-Age Crisis’. This framework proposed a multi-pillar approach to ensure comprehensive retirement protection. The first pillar is a publicly managed, often tax-financed, social safety net designed to provide a basic level of support. The second pillar consists of mandatory, privately managed, and fully funded contribution schemes, where both employers and employees contribute. The third pillar encompasses voluntary personal savings and insurance, allowing individuals to supplement their retirement income. The MPF system, which requires mandatory contributions from employers and employees to privately managed funds, directly aligns with the definition and purpose of the second pillar.

This question assesses the understanding of beta as a measure of systematic risk within the Capital Asset Pricing Model (CAPM). Beta reflects a security’s volatility in relation to the overall market. A beta greater than 1 indicates the security is more volatile than the market, while a beta less than 1 signifies it is less volatile. Two key factors influence a company’s beta: the cyclical nature of its earnings and its level of financial leverage (gearing). Companies in cyclical industries, such as property development, experience earnings that are highly sensitive to economic fluctuations, leading to higher betas. Conversely, companies in non-cyclical or defensive sectors, like utilities, have stable earnings regardless of the economic climate, resulting in lower betas. Furthermore, higher financial leverage increases the fixed cost of debt, which amplifies the volatility of net income available to shareholders, thereby increasing the stock’s beta. In an economic expansion, high-beta stocks are expected to outperform the market, while low-beta stocks are expected to lag the market’s performance.

This question assesses the understanding of key bond characteristics: duration, price sensitivity to interest rates, and the relationship between coupon rate, market yield, and bond price (premium/discount).

Statement I is correct. For two bonds with the same maturity, the bond with the lower coupon rate will have a higher Macaulay duration. This is because a larger proportion of its total cash flows is received at maturity (the final principal repayment), making the weighted-average time to receive cash flows longer.

Statement II is correct. Duration is a direct measure of a bond’s price sensitivity to changes in interest rates. Since Bond A has a higher duration than Bond B (as established in Statement I), its price will be more sensitive to interest rate fluctuations. Therefore, a rise in market yields will cause its price to decrease by a larger percentage.

Statement III is correct. A bond’s price is determined by discounting its future cash flows at the current market yield. If a bond’s coupon rate is higher than the market yield, it is more attractive to investors and will trade at a premium (above its par value). If its coupon rate is lower than the market yield, it will trade at a discount. Here, Bond B’s 6% coupon is above the 4% market yield, so it trades at a premium. Bond A’s 3% coupon is below the 4% market yield, so it trades at a discount.

Statement IV is incorrect. While maturity is a primary factor in determining interest rate sensitivity, it is not the only one. The coupon rate also significantly influences a bond’s duration and, consequently, its price sensitivity. As explained, the lower-coupon Bond A is more sensitive to interest rate changes than the higher-coupon Bond B, despite having the same maturity. Therefore, statements I, II and III are correct.

Performance attribution analysis is a critical tool used to evaluate the sources of a portfolio’s return relative to its benchmark. It deconstructs the excess return into two primary components: the asset allocation effect and the security selection effect. The asset allocation effect measures the portfolio manager’s skill in deviating from the benchmark’s asset class weights. A positive effect occurs when the manager overweights asset classes that subsequently outperform and underweights those that underperform. The security selection effect measures the manager’s ability to choose individual securities within an asset class that perform better than the asset class benchmark. In the given scenario, the manager’s decision to overweight equities (the better-performing asset class) generated a positive asset allocation effect. Conversely, the fact that the chosen stocks underperformed the equity index resulted in a negative security selection effect. Since the overall fund still outperformed, the positive contribution from the asset allocation decision must have been significant enough to overcome the negative impact of poor security selection.

This question assesses the understanding of the regulatory purpose behind using scenario analysis in client presentations, as mandated by the SFC’s Code of Conduct. Statement I is correct because showing a range of outcomes, including a ‘worst-case’ scenario, is a crucial tool for managing a client’s expectations and preventing an over-optimistic view of potential returns. Statement II is correct as the gap between the best and worst-case returns visually represents the volatility and risk level of a portfolio, which is fundamental to helping a client understand the risk-return trade-off and determine if a strategy aligns with their personal risk tolerance. Statement IV is also correct; disclosing potential downsides is a key component of the suitability process. It ensures the client makes an informed decision, fully aware of the risks they are undertaking, which is central to the principle of obtaining informed consent. Statement III is incorrect because scenario analysis is based on models and assumptions; it is not a guarantee of future performance. Market conditions can lead to outcomes outside the projected range, and licensed corporations are prohibited from guaranteeing investment returns. This practice aligns with General Principle 2 (Diligence), General Principle 6 (Information for clients), and the suitability obligations under paragraph 5.2 of the Code of Conduct. Therefore, statements I, II and IV are correct.

In the context of portfolio management, active return is generated through deliberate decisions aimed at outperforming a benchmark. This return has several components, including Tactical Asset Allocation (TAA), which involves making short-term adjustments to a portfolio’s asset mix to capitalize on anticipated market movements. When an asset management firm, particularly a Type 9 licensed corporation under the SFO, employs multiple specialist managers for different asset classes, implementing a cohesive TAA strategy can be operationally complex. A ‘TAA overlay’ is a specific implementation method designed to solve this problem. It involves appointing a separate manager to execute the TAA strategy, often using derivatives and a cash allocation, to adjust the fund’s overall market exposures without disrupting the underlying security selection activities of the specialist managers. This approach centralizes the market timing decisions while allowing the specialist managers to focus on their core competency of security selection within their designated asset class.

According to the SFC’s Code on Unit Trusts and Mutual Funds (UT Code), specific rules govern the structure and investments of authorized warrant funds to mitigate their inherent risks. A key requirement is the diversification of issuer risk. The UT Code stipulates that a warrant fund must not invest more than 10% of its Net Asset Value (NAV) in warrants issued by a single entity. This concentration limit is designed to protect investors from excessive exposure to the creditworthiness and operational stability of any single warrant issuer. In the scenario presented, an investment of HKD 60 million in warrants from one issuer, out of a total NAV of HKD 500 million, constitutes 12% of the fund’s assets (60m / 500m = 0.12). This allocation clearly exceeds the 10% regulatory threshold, representing a breach of the concentration limits. The other investment proposals are compliant: an allocation of HKD 45 million is 9% of the NAV, which is within the limit, and ensuring 92% of the underlying securities are listed on a stock exchange satisfies the minimum 90% requirement.

In the Hong Kong asset management industry, various participants play specialized roles. Asset consultants are independent firms that provide advisory services primarily to institutional investors like pension funds, endowments, and foundations. Their core functions include helping clients establish an investment policy statement (IPS), determining strategic asset allocation, conducting searches for suitable fund managers (manager selection), and performing ongoing due diligence and performance monitoring. This role is distinct from other participants. Custodians are responsible for the safekeeping of assets, not for providing investment advice or selecting managers. Discount brokers provide execution-only services, typically for retail or self-directed investors, and do not offer advisory services. Solicitors are legal professionals who handle the legal aspects of fund structuring, such as drafting trust deeds and prospectuses, and ensuring compliance with regulations like the SFC’s Code on Unit Trusts and Mutual Funds, but they do not advise on investment strategy or manager selection.

This question tests the understanding of regulatory requirements for presenting performance data in marketing materials for funds in Hong Kong, as governed by the SFC’s Fund Manager Code of Conduct (FMCC) and the Advertising Guidelines for Collective Investment Schemes.

Statement I is incorrect. While disclosing risk is mandatory and ‘maximum drawdown’ is a key risk indicator, it is not an explicitly mandatory disclosure item required in all marketing materials. The overarching principle is that risk disclosures must be prominent and sufficient to be fair and not misleading, but the specific metric is not prescribed for every document.

Statement II is correct. This is a fundamental requirement. Any advertisement or marketing material that contains past performance information must include a clear and prominent warning that past performance is not a reliable indicator of future performance. This is explicitly required by the SFC’s Advertising Guidelines.

Statement III is incorrect. Selectively presenting performance data, such as showing only periods of positive returns (‘cherry-picking’), is strictly prohibited as it is inherently misleading. Performance data must be presented in a fair, balanced, and complete manner for the relevant period.

Statement IV is correct. To avoid misleading potential investors, any performance data presented must be calculated on a net-of-fee basis, reflecting the actual returns an investor would have received after the deduction of all relevant fees and charges. Presenting gross performance would inflate the figures and be considered misleading. Therefore, statements II and IV are correct.

The explanation addresses the two components of the fund’s investment objective based on the asset modeling results. Statement I is correct because the scenario indicates a very high probability (99%) of capital preservation, meaning this part of the objective is likely to be met. Statement II is a valid recommendation; if the current asset mix is unlikely to meet the return target, a key fiduciary action for the fund manager is to consider altering the asset allocation to one with a higher expected return, while being mindful of the risk implications. Statement III is also a valid recommendation; if achieving the 5% return is not feasible without taking on unacceptable risk, the responsible course of action is to revise the objective to be more realistic and align with the fund’s strategy and risk profile. Statement IV is incorrect because the fact that the target return falls within the confidence interval does not mean the objective is met. The lower bound of 3.6% indicates a significant risk of underperformance relative to the 5% target, which requires action from the fund manager under their duties outlined in the SFC’s Fund Manager Code of Conduct. Therefore, statements I, II and III are correct.