In light of the fact that you have been reducing your risk along the way, do you need to make any adjustments to your positions when your capital is unexpectedly reduced?
This tends to be more of a dilemma for former proprietary traders than those who began their careers on the buy-side, because they have been trained to manage notional risk rather than capital. Once again though, the answer is clear. The portfolio should be adjusted in exactly the same way and for exactly the same reasons as discussed in scenario 1, with the same caveat regarding entry price but this time relative to the stop-loss. To make the argument that risk has already been reduced ahead of the capital reduction is to ignore that you are managing capital. Without a definitive speed bump procedure, the PM should manage the capital they are allocated without bias. While reducing your risk when your conviction is waning is a prudent decision, doubling it because an unwitting 3rd party attempted to reduce their exposure to your portfolio is not, and that is exactly what you will be doing if you don't cut your positions proportionally. If you argue that you cut your risk in anticipation of your capital being reduced at some point, then you are presenting evidence that you have been underinvested relative to your conviction, which begs the question, at what point did you actively cut your capital, and why didn't you notify the CIO at that time?
It's important to make a distinction between reducing risk due to waning conviction and reducing it because you are managing less capital. If you don't make and recognize that distinction in a deliberate manner, you make it easier for this bias to regularly affect your investment process.
Would your answer change if you were the only portfolio manager in the fund and rather than the reduction in capital coming from your CIO, it was the result of unexpected outflows?
No. Whether you are a portfolio manager independently managing capital allocated to you by your firm or directly invested with you by an investor, the decision making process should be identical. If your previous answer was riddled with uncertainty, but made clear when rephrased in Question 2b, you have a potential tool for improving your decision making going forward.