Alternative Investments

Question 1

Long/short

Answer 1

• a strategy in which the manager holds long positions in some assets and short positions in others; the approach is different than “market neutral” in that long/short managers generally are not concerned with their overall amount of beta or delta
• a common long/short strategy is the 130/30 strategy where the fund is long assets 130% and short assets 30%)

Question 2

Merger Arbitrage

Answer 2

Strategy that seeks to capitalize on price arbitrage of companies merging or being bought or sold.

Question 3

Kinds of investors

Answer 3

Accredited Investor:
$200/$300k income/year; OR net worth > $1M
employee benefit plan or trust assets > $5M

Qualified Purchaser:
Individual with $5M investments; institution w $25M; family-owned company w $5M investments; trusts w < $25M with trustee and all contributors qualified purchasers

Not tested recently

Question 4

Backfill Bias

Answer 4

Hedge funds report returns only if they choose to, and they may choose to do so only when their prior performance is good

Question 5

Survivorship Bias

Answer 5

Failed funds drop out of the database

Hedge fund attrition rates are more than double those for mutual funds

Question 6

High water mark of hedge fund

Answer 6

–The fee structure can give incentives to shut down a poorly performing fund
•If a fund experiences losses, it may not be able to charge an incentive unless it recovers to its previous higher value
•With deep losses, this may be too difficult so the fund closes

Question 7

A problem with a fund of funds

Answer 7

Pay an incentive fee to each underlying fund that outperforms its benchmark even if the aggregate performance is poor
•Diversification can hurt the investor in this case

Question 8

Portable Alpha

Answer 8

1.Invest wherever you can find alpha
2.Hedge the systematic risk of the investment to isolate its alpha
3.Establish exposure to desired market sectors by using passive products such as indexed mutual funds, ETFs, or index futures
–
Transfer alpha from the sector where you find it to the asset class in which you ultimately establish exposure

Question 9

Absolute Return strategy

Answer 9

an absolute return strategy is one that employs multiple strategies (e.g., long/short, leverage, arbitrage, etc.) in order to achieve positive absolute returns, thus the portfolio should make money no matter the type of market (e.g., bull or bear)

Question 10

Arbitrage

Answer 10

an opportunity to earn profit without risk and with no net investment of money; a set of transactions that produces riskless profits, hence the price changes while risk does not; gains are made based on price inconsistencies (or mispricing)

Question 11

Managed Futures

Answer 11

an alternative investment strategy where the fund manager invests in commodity futures and cash equivalents

Question 12

Dedicated Short Bias

Answer 12

• an investment strategy (popularized by hedge funds) in which long and short positions may be used but where a net short exposure is maintained
• a short bias is considered a directional strategy

Question 13

Market Neutral

Answer 13

an alternative strategy in which both long and short positions are employed, and market direction is not predetermined

Question 14

Event Driven

Answer 14

strategies used by investment managers (including hedge fund managers) that attempt to capture market mispricing by investing around events such as merger announcements, restructuring, and acquisitions

Question 15

Reinsurance

Answer 15

Generally speaking, reinsurance is insurance that insurers buy to protect against unexpected losses

These strategies may demonstrate very low correlation to the stock market.

Question 16

Global Macro

Answer 16

• a hedge fund strategy in which the manager relies on macro economic analysis to determine investment positions
• a strategy that allows a manager the freedom to undertake most any investment approach in any part of the world, using any asset class

Question 17

Style Analysis for Hedge Funds

Answer 17

•The equity market neutral funds
–Have low and insignificant betas
•Dedicated short bias funds
–Have substantial negative betas on the S&P index
•Distressed firm funds
–Have significant exposure to credit conditions
•Global macro funds
–Show negative exposure to a stronger U.S. dollar

Question 18

Convergence (trading strategy)

Answer 18

–Trading strategy where one asset is bought, and another similar asset is sold at a higher price.
–Expectation is that profit may be made by the prices of the two assets moving closer together by the time the assets must be delivered.
–Common strategy in arbitrage.

Question 19

Divergence (trading strategy)

Answer 19

Strategies that bet on the price or valuation of assets or investments, or spreads (e.g., yield spreads) moving away from each other.

Question 20

Alternatives asset performance during crisis Oct 2007- Dec 2008

Answer 20

Hedge funds, market neutral, EM, event, long/short all had very negative performance

Managed futures were up 17.6% during this period

Question 21

Hedge fund structure

Answer 21

Hedge funds may be structured as partnerships, limited liability companies, registered fund, closed end fund, or hedge fund like mutual funds. Different structures may offer different liquidity

Question 22

Terminal Value (of an asset)

Answer 22

the present value of cash flows and value at some specific point in time in the future (note: we must be able to assume a stable growth rate). TV is commonly used to project the value of an asset that is expected to be sold at some future date.

Question 23

Hedge Fund Strategies

Answer 23

• Directional
– Bets that one sector or another will outperform other sectors
• Non directional
– Exploit temporary misalignments in relative valuation across sectors
– Buy one type of security and sell another
– Strives to be market neutral