CAIA Book 1 Flashcards
What are the three super asset classes?
- Capital Assets
- Assets that are used as inputs to create value
- Assets that are used as a store of value
What is asset allocation?
Asset allocation refers to the selection of asset classes for a portfolio. The four primary asset classes are equity, fixed income, cash and real estate
What is strategic asset allocation?
A portfolios long term policy allocation that is derived from the investors risk aversion and the long term risk/ return characteristics of the primary asset classes
What is tactical asset allocation?
Tactical asset allocation refers to the short term portfolio allocations that differ from the strategic asset allocation in order to take advantage of current market conditions. Alternative assets fit into tactical asset allocation
What is constrained investing?
Constrained investing has restrictions that limit their efficiency. After the end of the prolonged bull market in 2000, institutional investors sought out un constrained alternative investments in order to increase returns
What is the distinct difference between the returns for mutual funds and the returns for hedge funds?
Mutual fund returns are primarily based on asset location, while hedge fund returns are primarily based on trading strategy. Risk exposures for mutual funds relate to asset location, while risk exposures for hedge funds relate to trading strategy
What are the three primary differences between alternative assets and domestic equities that affect efficiency?
Alternative assets must be purchased from a financial intermediary (limited liability company or a limited partnership)
Alternative assets are less liquid than equities
Alternative assets are unconstrained, while typical equity investments face constraints
What are beta drivers?
Beta drivers are exposures to market risk factors
What are alpha drivers?
Alpha drives are exposures to Active Return factors
What investment products are beta drivers?
Passively managed index funds
Semi active index funds
Active long only investments
130/30 funds
What are the six major categories of alpha drivers?
Long/short investments Absolute return investments Segmented Markets Non linear return distributions Alternative Beta Exposure Portfolio Concentration
What are long/short investments?
Market neutral investments (zero beta)
Long/short investments not fully hedged (non zero beta)
Ability to short stocks
What are absolute return vehicles?
Not constrained, manager can pursue alpha wherever he thinks it exists.
Totally unconstrained investment style
What are Segmented Markets?
These are investments that investors normally avoid ie below investment grade securities. Sometimes investment restrictions prohibit an IM from investing in these type of securities in the normal investment universe
What are non linear return distributions?
Includes investments with non linear return distributions. ie options
What are alternative beta exposures (cheap beta)
Includes a category of systematic risk exposures beyond stocks and bonds. Risk exposures include currencies and commodities
What is portfolio concentration?
Large bet on fewer securities. Concentrated portfolios assume greater tracking error in an attempt to produce larger active returns
What are the types of beta investments?
Classical Beta Bespoke Beta Alternative Beta Fundamental Beta Cheap Beta Active Beta Bulk Beta
What is Bespoke Beta
Considered custom beta because it can be divided many ways……ie sector, style, size, country.
ETF’s is an example of Bespoke Beta
What is Classical Beta?
Measures the exposure of a security relative to a major market index. ie index mutual fund tracking S&P 500
What is Alternative Beta?
Measure of exposure to alternative systematic risks
Low correlation to stocks and bonds
ie ETF’s that invest in currency futures
What is fundamental beta?
Based on new concept that capitalization weighted indices create increased demand for large cap stocks to the exclusion of smaller capitalized weighted indices.
This has led to the theory that large cap stocks are overvalued and smaller cap stocks are undervalued. Therefore new indices created based on dividend payout etc
What is the result of differing index construction methods on fundamental beta?
Endogenous alpha
What is endogenous alpha?
Excess returns relative to a standard index that is realized as a result of differing index construction
What is exogenous alpha?
Excess returns realized through actively managing a Fund
What is cheap beta?
Convertible bonds have multiple systematic risk exposures (interest rate risk, equity market risk, credit risk, option volatility risk).
A convertible arbitrage hedge fund purchases convertible bonds and hedges exposure equity market risk, and option volatility risk leaving interest rate and credit risk.
These funds are selling expensive beta and retaining cheap beta
What is Active Beta?
Funds that use quantitative tools to earn excess returns from equity market anomalies.
ie 130/30 funds and TAA
What is Bulk Beta?
Includes standard actively managed funds. They offer a combination of systematic risk exposure (beta), and active risk exposure (alpha).
Linearly related to their benchmarks
What two conditions are necessary to compute an active manager’s alpha?
Returns in the regression should be excess returns
Factor returns should be returns available to investor with low to zero costs ( the benchmarks should be investable)
What are product innovators?
Investment managers that develop new and innovative alpha driven investment products
What are Process Drivers?
Process drivers are investment managers that attempt to refine processes and procedures for beta driven products to reduce costs
What do balanced mandate managers attempt to do?
Deliver beta and attempt to extract alpha from beta exposures.
What are the conditions necessary for multi factor models to work?
Work when the appropriate risk exposures are specified in the model
What are the implications for investment managers that use multi factor models?
Managers should distinguish between returns generated by alpha and beta
Investment managers should be open to investors about their investment process and how returns are generated
How can the alpha estimation process be improved?
Understanding of investment product or strategy being analyzed
What assumptions must hold for alpha to be a zero sum game?
Identical investment horizons Identical risk tolerances No market segmentation Homogeneous expectations about risk and return Zero taxes or equal taxes for all
Is alpha a zero sum game?
The determination of alpha being a zero sum game is dependent on those assumptions, Hereford alpha may not be a zero sum game
What are the three types of information asymmetry?
The level of investment manager skill is only known ex ante by the investment manager
Investors only receive periodic summaries of their portfolios, reducing the transparency of their investment product
The actual risk exposures of a fund are known by the investment manager, but may not be known by the investors
What are some asymmetries regarding incentives?
Alternative asset managers - the performance fee is a call option on the performance of the fund, which the fund managers are actually paid to hold via the management fee
Traditionally managed investment - since alpha receives higher compensation managers have an incentive to nit be clear about actual risk exposures of the fund
What is risk taking asymmetry?
Alternative asset managers have an incentive to engage in excessive risk taking
What are three ways that asymmetries can be addressed?
Products that deliver beta exposure should have minimal cost to reflect the limited skill required to capture beta
Alpha and beta should be separated so that the content of alpha and beta in products is transparent
Managers should have transparency in their investment management process
Thee is a trade off between alpha and transparency of the investment management process
Because of the incentives for managers to accept excessive risk, investors should require a certain level of transparency in risk exposures
What are some business models likely to be available in the future?
Firms with beta focused products
Firms with alpha focused products
Firms that provide investment solutions
Firms that provide a collection of specialized investment products
What is the information ratio?
A risk adjusted measure of an active manager’s return
What is the Sharpe Ratio?
Measures excess returns relative to a standard deviation (total risk), which is normally attributable to a benchmark
What are the two ways that the information ratio differs from the Sharpe Ratio?
The numerator is the mean return in excess of the benchmark, not returns in excess of the risk free rate
The denominator is the standard deviation of alpha, not the standard deviation of total returns
What is the information coefficientient?
The IC is a measure of the managers skill at forecasting