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CAIA > CAIA - 32 - Funds of Hedge Funds and Multi-Strategy Funds > Flashcards

CAIA - 32 - Funds of Hedge Funds and Multi-Strategy Funds Flashcards

1
Q

What are the 3 approaches to investing in hedge funds?

A
  1. Direct
  2. Delegated
  3. Indexed
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2
Q

What is the main disadvantage to investing directly with hedge funds?

A

It requires minimum capital levels and financial sophistication.

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3
Q

What are the 3 advantages to investing directly in hedge funds?

A
  1. Cost savings
  2. Access to cost effective, experienced consultants
  3. Greater control and transparency
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4
Q

What is the delegated approach to investing in hedge funds?

A

Investing in a fund of funds

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5
Q

What are the 5 services provided by the delegated, or fund of funds approach?

  1. S
  2. D
  3. S
  4. P
  5. R
A

What are the 5 services provided by the delegated, or fund of funds approach?

  1. Sourcing
  2. Due diligence
  3. Strategy and selection
  4. Portfolio Construction
  5. Risk management and monitoring
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6
Q

Why is sourcing an advantage to fund of funds?

A

They can provide access to higher quality hedge funds

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7
Q

Does academic research suggest that Fund of Fund’s additional layer of fees justify the operational due diligence they perform?

A

Yes - Large FoFs outperform small FoFs by a significant margin, indicating fees are justified.

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8
Q

Has the value proposition of FoFs increased, decreased or stayed the same? Why?

A

Decreased as investors have become more sophisticated.

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9
Q

What idiosyncratic risk can be reduced through the FoF structure in case of an underlying hedge fund failure?

A

Headline risk

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10
Q

How are hedge fund index products typically sold?

A

Certificates or principal guaranteed notes

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11
Q

What products have recently become available that provide hedge fund exposure without the drawbacks?

A

Liquid Alternative Funds

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12
Q

What are the 3 advantages to liquid alternative funds?

A
  1. Daily liquidity
  2. Lower fees
  3. Improved transparency
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13
Q

What has historically been the hedge fund of fund fee structure and how has that changed?

A

1% and 10% but those fees have been declining due to poor performance

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14
Q

what is a typical fund of fund fee for large allocations now?

A

50-100 bps with no incentive fee

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15
Q

What are the typical lock up and liquidity provisions of a fund of fund?

A

1 year lock up, quarterly redemptions with between 90 and 180 days notice and monthly subscriptions

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16
Q

Hedge fund flows have been skewed toward what type of managers lately?

A

Larger managers

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17
Q

What did Xiong et. al (2009) conclude?

A

FoF performance, fund flows, and asset size are positively correlated.

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18
Q

What are the 4 different methods of FoF diversification?

A
  1. Diversified
  2. Concentrated
  3. Single-strategy
  4. Tactical
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19
Q

How many funds are typically in a diversified hedge fund of fund?

A

30-50

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20
Q

How many funds are typically in a concentrated FoF strategy?

A

5-10

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21
Q

What is a single strategy fund of funds?

A

A FoF that allocates across several funds that follow the same strategy

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22
Q

How many funds are typically in a tactical FoF?

A

5-15

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23
Q

Are fund of fund databases exposed to the same biases as individual hedge fund databases?

A

They are exposed to very little if any

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24
Q

What are the 3 biases present in individual hedge fund databases that have very little, if any presence in FoFs databases?

A
  1. Survivorship bias
  2. Selection bias
  3. History (backfill) bias
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25
Q

What has the general performance history of FoFs been?

A

Good performance in the 90s followed by declining performance in the 2000s in both absolute and risk-adjusted performance. 2008 was the worst year.

26
Q

What is the standard approach to constructing a FoF

A

AUM-weighted

27
Q

What are the different ways to construct a fund of funds portfolio?

  1. A
  2. E
  3. E
  4. M
  5. M
A

What are the different ways to construct a fund of funds portfolio?

  1. AUM-weighted
  2. Equal-weighted
  3. Equal-risk weighted
  4. Mean-variance optimization (MVO)
  5. MVO with higher moment constraints
28
Q

What is the most objective and simple to implement approach to portfolio construction?

A

Equal-weighted

29
Q

What are the unrealistic assumptions that can make implementing an equal-weighted approach difficult?

A

No transaction costs or liquidity contraints

30
Q

What portfolio construction approach has the highest volatility?

A

Equal weighted

31
Q

What is the easiest portfolio construction approach to maintain?

A

Equal risk

32
Q

What are the 4 key drawbacks of using an equal risk weighted approach?

A
  1. Use of historical data
  2. Not accounting for cross correlations
  3. Being highly dependent on time period used
  4. Volatility in crisis may be different than long-term
33
Q

What portfolio construction approach has the lowest return?

A

Equal risk weighted

34
Q

What portfolio construction approach has the most unfavorable skew and kurtosis?

A

Equal risk weighted

35
Q

Equal Risk Weighted Calculation

36
Q

What is the drawback to using standard deviation in equal risk weighted portfolios and how may this be mitigated?

A

It penalizes upside and downside deviations equally. Semi-deviation may be a good alternative to use.

37
Q

What are the 3 drawbacks to MVO?

A
  1. It is error maximizing
  2. Assumes normal distribution
  3. Results in portfolios that are not practical or feasible
38
Q

What portfolio construction technique yielded the highest return and sharpe ratios?

A

Unconstrained MVO

39
Q

What is the difference in volatility, skewness and kurtosis of constrained vs unconstrained MVO portfolio construction?

A

They are about the same

40
Q

What portfolio construction processes had the lowest volatility?

A

Constrained and unconstrained MVO

41
Q

What index can be included to reduce a portfolio’sskew?

A

The CBOE Volatility Index (VIX)

42
Q

What are the 12 benefits of FoFs?

  1. E
  2. M
  3. I
  4. D
  5. E
  6. L
  7. A
  8. N
  9. K
  10. R
  11. C
  12. L
A

What are the 12 benefits of FoFs?

  1. Expertise
  2. Monitoring
  3. Immediate exposure
  4. Diversification
  5. Economies of Scale
  6. Liquidity
  7. Accessibility
  8. Negotiated fees
  9. Knowledge transfer
  10. Regulation oversight
  11. Currency hedging
  12. Leverage
43
Q

What are the 7 disadvantages to FoFs?

  1. D
  2. L
  3. L
  4. L
  5. N
  6. C
  7. A
A

What are the 7 disadvantages to FoFs?

  1. Double layer fees
  2. Lack of control
  3. Lack of transparency
  4. Lack of customization
  5. Netting risk
  6. Co-investor risk
  7. Administrative delay
44
Q

What is the risk of having exposure to economic loss resulting from paying higher total fees due to paying incentive fees for profitable funds without offsetting reduction from funds that generate losses?

A

Netting risk

45
Q

What is the risk that investors are jointly affected by cash inflows and outflows?

A

co-investor risk

46
Q

What are multi-strategy hedge funds?

A

Funds that have several portfolio managers, each hired to manage a portion of the assets

47
Q

What are the 4 key issues that should be considered when choosing between a multi-strategy hedge fund and a fund of fund?

  1. F
  2. L
  3. T
  4. C
A

What are the 4 key issues that should be considered when choosing between a multi-strategy hedge fund and a fund of fund?

  1. Fees
  2. Leverage
  3. Tactical moves
  4. Compensation
48
Q

Are fees typically lowest for multi-strategy funds or fund of funds?

A

multi-strategy funds

49
Q

are multi-strategy funds exposed to netting risk?

A

Historically no, but it is more common now for internal teams to be paid different incentive fees, which exposes the risk

50
Q

What is the risk of leverage in a multi-strategy fund?

A

Leverage can risk the entire fund instead of isolating it to 1 manager

51
Q

Which structure can move faster tactically: multi-strategy or fund of funds

A

multi-strategy

52
Q

What are the 3 ways that FoF managers add value?

A
  1. Strategic
  2. Tactical
  3. Fund selection
53
Q

What were the conclusions of the EDHEC-Risk institute study to quantify the impact of strategic, tactical and fund selection decisions?

A
  1. Strategic accounted for most variability and added value in both up and down markets, but more in down markets
  2. Tactical allocation had limited value
  3. Fund selection exhibits unfavorable regime dependency and underperforms in down markets
54
Q

What is funding bias?

A

It’s observed when hedge funds’ returns are upwardly biased compared to the hedge fund universe that would have existed if there were no FoFs.

55
Q

What was the conclusion of Ang, Rhodes-Knopf, and Zhao (2008)?

A
  1. FoFs generally deserve their layer of fees
  2. The find evidence of a constituency effect
56
Q

What did Ang, Rhodes-Knopf, and Zhao (2008) study?

A

Examined FoF performance against a benchmark that included both funded and unfunded hedge funds and incorporated due diligence costs

57
Q

What is a constituency effect?

A

Investors with lower wealth, less skill and greater risk aversion benefit from more FoFs and are thus more naturally clients

58
Q

What are the arguments against hedge fund indexing according to Liew (2003)?

A
  1. Only 1/3 managers have skill
  2. Diversification benefits disappear in extreme markets
  3. A portfolio of hedge funds can outperform most indices
59
Q

Hedge funds indices should have what 6 characteristics?

  1. R
  2. U
  3. V
  4. A
  5. R
  6. R
A

Hedge funds indices should have what 6 characteristics?

  1. Representative
  2. Unambiguous
  3. Verifiable
  4. Accountable
  5. Replicable
  6. Reasonable
60
Q

Are the properties of properly constructed hedge fund indices attainable?

61
Q

What are the issues that complicate tracking broad-based, non-investable hedge fund indices?

  1. L
  2. C
  3. I
  4. T
  5. R
A

What are the issues that complicate tracking broad-based, non-investable hedge fund indices?

  1. Lack of transparency
  2. Closed to investors
  3. Illiquidity
  4. Tracking error
  5. Reporting lag

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