I was interested as a product manager interviewing UX designers, and wanted to give my take.

A portfolio is not enough, because:

1. The logic behind the design is more important than the design itself. When I ask designers about why they did something 2 years ago, they often don’t remember.
2. As you said, the interaction is cruicial. I’m not just lookong for output, I’m looking to see how we work together. An assignment is much better than starting actual work and then firing a bunch of people after 2 weeks.

It’s not exploiting. If a designer did something in the assignment that I would like to use, why on earth won’t I hire them?

I do try to make the assignment very short, 2-3 hours top, rough wireframes only. The design skills I can see from the portfolio, but not the thought behind them.