Alternative Investments

Question 1

What are Alternative Investments?

Answer 1

Alternative investment are alternatives to long-only stocks, bonds, and cast. Approximately 25% of global assets under management are classified as alternatives

Question 2

Characteristic of Alternative Investments:

Answer 2

• Narrow manager specialization
• Low correlation with traditional investments
• Limited regulation, transparency, and historical data
• Unique legal and tax issues
• High fees
• High use of leverage
• Concentrated positions
• Restrictions on redemption

Question 3

Categories of Alternative Investments

Answer 3

1. Hedge Funds
2. Private equity funds (many involve leveraged buyouts)
3. Real Estate
4. Commodities
5. Infrastructure (for example, via public-private partnership (PPP) approach)
6. Other: tangible assets (such as fine wine, art, antique furniture and automobiles, stamps, coins, and other collectibles) and intangible assets (such as patents and litigation actions)

Question 4

Hedge Fund Strategies

Answer 4

The most important characteristics of hedge funds are as follows:

1. legal/regulatory overview
2. flexible mandates - few investment constraints
3. large investment universe
4. aggressive investment styles
5. relatively liberal use of leverage
6. hedge fund liquidity constraints
7. relatively high fee structure

Question 5

hedge fund can be classified as:

Answer 5

• single-manager fund: a fund in which one portfolio manager or team of portfolio managers invest in one strategy or style
• multi-strategy fund
  
  • multi-strategy fund: in which teams of portfolio managers trade and invest in multiple different strategies within the same fund
• fund-of-fund: in which manager allocates capital to seperate, underlying hedge funds that themselves run a range of different strategies

Question 6

Single Manager Fund

Answer 6

It can be classifiied in various ways:
1. The instruments in which the managers invest (e.g., equities, commodities, foreign exchange, convertible bonds)
2. The trading philosophy followed by the manager (e.g., systematic, discretionary)
3. The types of risk the managers assume (e.g., directional, event-driven, relative value)

Question 7

Private Clients Investment Objective

Answer 7

Diverse investment objectives (may not be clearly defined or quantified)

Question 8

Institutional Clients Investment Objective

Answer 8

Specific, clearly defined investment objectives

Question 9

Private Clients Constraints

Answer 9

• A shorter time horizon
• Smaller (more limitations)
• Significant and Complex

Question 10

Institutional Clients Constraints

Answer 10

• Theoretically Infinite
• Larger
• Taxable income may be more favored by a tax-exempt institution

Question 11

Private Clients Other Distinctions

Answer 11

Investment Governance
* Less Formal Governance
structure
Investment Sophistication
* Emotional
Regulation
* Separate regulators or shared
regulatory structure
Uniqueness and Complexity
* Similar financial and objective,
different investment strategies

Question 12

Institutional Client Other Distinctions

Answer 12

Investment Governance
*Formal governance structure
Investment Sophistication
* A higher degree (more
investment resources)
Regulation
* None
Uniqueness and Complexity
* Similar objective, similiar
strategies

Question 13

Private Client Basic Tax Strategies

Answer 13

• Tax avoidance: contribute limited amounts to certain accounts that permit tax-free earnings and future withdrawals, wealth transfer techniques
• Tax reduction: tax-exempt bonds, tax-efficient asset classes
• Tas deferral: by deferring the recognition of certain taxes until a later date

Question 14

Private Client Risk Toleran ce

Answer 14

1. Risk Tolerance (willingness):
   a. increase: sufficient insurance, pension, healthy, big asset base
   b. decrease: high required return, important goal
2. Risk Capacity
3. Risk perception:
   a. how a client receives the riskiness of an investment decision or the investment climate

Question 15

Technical and soft skills for wealth managers

Answer 15

1. technical skills:
   a. capital markets proficiency
   b. portfolio construction ability
   c. financial planning knowledge
   d. quantitative skills
   e. technology skills
   f. language fluency
2. soft skills
   a. communication skills
   b. social skills
   c. education and coaching skills
   d. business development and sales skills

Question 16

Ethical considerations for private wealth managers include:

Answer 16

a. “know your customer” (KYC)
b. fiduciary duty and suitability
c. confidentiality
d. conflicts of interest.

Question 17

Updates to Capital Sufficiency Analysis

Answer 17

Return assumption, current value of the portfolio, anticipated future contributions to the portfolio and cash flow

Question 18

Total Investable Asset (TIA)

Answer 18

Return% = Cash flow needs / TIA + Asset (inflation compensation)

Cash flow needs = cash in - cash out

if expected return > 10%, 一 asset base

Assumption:
salary/expense
current portfolio

close-ended

Question 19

Capital Sufficiency Analysis

Answer 19

Also known as capital need analysis; the process by which a wealth manager determines whether a client has, or is likely to accumulate sufficient financial resources to meet his or her objective

Question 20

General Partner

Answer 20

The asset manager serves as the general partner, earning a management fee based on the size of the fund and an incentive fee based on returns

Question 21

High water marks

Answer 21

Reflect the highest cumulative return used to calculate an incentive fee, may be used so investors do not pay twice for the same performance gains.

Question 22

Risks associated with alternative investments

Answer 22

• Low liquidity, transparency, limited redemption availability, and the challenges of diversifying among managers.
• Because leverage is more commonly used by alternative asset managers, returns on these investments are more sensitive to market conditions.

Question 23

Sharpe Ratio

Answer 23

Standard deviation and, by extension, the Sharpe ratio, are often inappropriate for assessing alternatives because these measures assume that returns are normally distributed and punish upside volatility. The ratio equally penalizes upside and downside volatility, fails to capture non-symmetric distributions, and may not fully reflect tails in return distributions. The return distributions to alternative investments are typically non-symmetric and skewed, making the Sharpe ratio a less-than-ideal measure.

\frac{return- riskfree\ rate}{return\ standard\ deviation}

Question 24

Sortina Ratio

Answer 24

Analysts tend to use the Sortino ratio, which emphasizes downside risk, has downside deviation rather than standard deviation as its denominator.

\frac{mean\ realized\ return- target\ return}{standard\ deviation\ of\ the\ returns\ below\ the\ target\ return}

Note that using either of these measures to assess a hedge fund’s performance fails to consider the correlation between its returns and returns on traditional assets, a less-than-perfect correlation between investments reduces the standard deviation of a diversified portfolio below the weighted average of the standard deviations of the investments. Other downside risk measures, such as the chance of losing a certain amount of money in a given period, are also used in practice. (downside frequencies)