Alternatives Flashcards
Global macro strategies
Global macro investing may introduce natural benefits of asset class and investment approach diversification, but they come with naturally higher volatility in the return profiles typically delivered. because of either unforeseen contrary factors or global risks that simply do not materialize; macro managers tend to produce somewhat lumpier and more uneven return streams than other hedge fund strategies.
Calculating convertible bond arbitrage strategies
current conversion price of the AVC convertible bond is €1,000 × (Price at par/100)/conversion ratio = €23, VS the current AVC share price is €28. Thus, by purchasing the convertible bond, selling short the shares, exercising the conversion option, and selling the shares at the current market price, a profit of €5 can be locked in regardless of changes in the share price.
To access and extract the relatively cheap embedded optionality of the convertible, the manager hedges away other risks that are embedded in the convertible security. These include interest rate risk, credit risk, and market risk. These risks can be hedged using a combination of interest rate derivatives, credit default swaps, and short sales of an appropriate delta-adjusted amount of the underlying stock or, alternatively, the purchase of put options.
Credit issues may complicate valuation since bonds have exposure to credit risk. When credit spreads widen or narrow, there would be a mismatch in the values of the stock and convertible bond positions that the convertible manager may or may not have attempted to hedge away.
Convertible arbitrage strategies have performed best when convertible issuance is high (implying a wider choice among convertible securities as well as downward price pressure and cheaper prices), general market volatility levels are moderate, and the liquidity to trade and adjust positions is sufficient. Extreme market volatility typically implies heightened credit risks. Convertibles are naturally less-liquid securities, so convertible managers generally do not fare well during such periods.
Reinsurance strategies
- ongoing premium payments to keep the policy active are relatively low,
- life settlements where the surrender value offered to the insured individual is also relatively low
- probability that the designated insured person is likely to die earlier than *predicted by standard actuarial methods is relatively high.
real estate
private real estate provides only moderate diversification against public equity, whereas absolute return hedge funds have a greater potential to do so. The primary advantage of private real estate is income generation.
Public real estate has had a fairly high, positive correlation with equities, as well as a high, positive equity beta. In contrast, fixed income has broadly had a negative correlation with equity and a small but negative equity beta. Switching from fixed income to real estate will likely decrease portfolio diversification and increase return volatility.
Advantages of long-short stratgies
Although a lower beta to equity markets is a characteristic of long–short managers, it is not one of the attractive features of long–short strategies. If an investor wishes to have exposure to a strategy with lower equity beta, there are cheaper long-only approaches to accomplish this goal.
Dedicated short-bias managers typically have low levels of leverage.
approaches to asset allocation
risk factor-based approaches to asset allocation can be applied to develop more robust asset allocations.
Risk factors are sensitive to the historical period examined for the estimation procedure; therefore, risk factor sensitivities are not stable over time.
A traditional approach has been used to define the opportunity set based on different macroeconomic conditions. The primary limitations of traditional approaches are that they overestimate the portfolio diversification and obscure the primary drivers of risk.
equity market-neutral strategies, Event-driven strategies, opportunistic strategies
- equity market-neutral strategies do use a relative value approach.
- Event-driven strategies, such as merger arbitrage, tend to be exposed to some natural equity market beta risk
- opportunistic strategies do have risk exposure to market directionality, also called trendiness.
Tax inefficiency
Tax inefficiency is seen frequently with many hedge fund strategies, especially those funds and fund companies where tax-exempt investors dominate the client base. The fund manager may be insensitive to tax considerations for a taxable investor
Hedge fund expected NAV
Expected NAV = [Prior-year NAV × (1 + Growth rate) + Capital contributions – Distributions)] × (1 + Growth rate)
FoF
FoF investors always face netting risk, whereby they are responsible for paying performance fees due to winning underlying funds while suffering return drag from the performance of losing underlying funds. Even if the FoF’s overall performance is flat or down, FoF investors must still pay incentive fees due to the managers of winning funds.
