Free CFA Level III: Portfolio Management Active Equity Investing Practice Questions

B is correct. Factor timing involves dynamically adjusting portfolio factor exposures based on predictions about which factors will perform well in different market regimes or economic environments. For example, a manager might increase value exposure when value spreads are wide (predicting mean reversion) and decrease it when spreads narrow.
A is incorrect because maintaining constant factor exposures describes a strategic factor allocation approach, not factor timing.
A is incorrect because eliminating factor exposures describes a neutralization strategy, not timing.

B is correct. Smart beta strategies use rules-based, transparent methodologies that weight stocks by factor characteristics (value, momentum, quality, low volatility, size) rather than market capitalization. They sit between fully passive cap-weighted indexing and fully active management.
A is incorrect because smart beta strategies are rules-based and systematic, not discretionary. Discretionary stock selection based on fundamental analysis characterizes traditional active management.
C is incorrect because smart beta strategies do not guarantee outperformance in all environments. Factor premiums are cyclical, and smart beta strategies can underperform cap-weighted indices for extended periods.

A is correct. The Fundamental Law of Active Management shows that IR = IC x sqrt(BR). To increase active return (IR x tracking error) without increasing tracking error, the manager must increase the information ratio. This can be achieved by improving the information coefficient (forecasting skill) through better research, data, or analytical methods.
B is incorrect because increasing position sizes in high-conviction holdings would increase tracking error along with expected active return.
C is incorrect because concentrating the portfolio reduces breadth and increases idiosyncratic risk (tracking error), which does not maintain constant tracking error.