Chapter 22 Flashcards
1
Q
This states that an asset cannot be sold to realize a capital loss and then purchased again within 30 days of the sale.
A
superficial loss rule
2
Q
It is a contract provision preventing a hedge fund manager from collecting a performance fee until the highest previous net asset value is exceeded.
A
high-water mark
3
Q
It is the minimum return a fund must make before a performance fee can be taken.
A
hurdle rate
4
Q
It is roughly defined as the total value of securities bought and sold in relation to the overall net assets of the portfolio.
A
portfolio turnover
Given that trading costs are ultimately paid for by the fund’s investors, a higher turnover will result in greater expenses and may lower overall return.
5
Q
This legal document states the objectives, risks, and terms of investment involved with a private placement
A
Offering memorandum
6
Q
It is a debt instrument issued by a bank in the form of a deposit note. the interest rate is tied to the performance of an underlying asset, such as a portfolio of stocks, an index, or one or more mutual funds or ETFs.
A
principal-protected note
7
Q
It is a service that combines several managed investment products into a single account controlled by a single authority.
A
overlay management
8
Q
It is a pool of capital/assests gathered and invested in a portfolio of individual securities by a professional money manager according to a specific investment mandate
who recieves a fee for their service
A
managed products
definition goes beyond the management of a single product
as it usually includes “managed assets” where there is often more than one investment under management.
9
Q
These are designed to achieve a specific client goal, such as principal protection, tax management, or inflation indexation
A
outcome-based investments
10
Q
This type of wrap fund invesets in portfolios of other managed products, usually mutual funds.
A
fund of funds
11
Q
These are portfolios of managed products wrapped together and sold as a single wrap product
A
wrap fund
12
Q
These are accounts for which a qualified portfolio manager is authorized to select securities and execute trades on behalf of a client.
A
Wrap account
13
Q
The classification of mutual funds in Canada is carried out by this committee which comprises Canada’s major mutual fund database and research firms
A
Canadian Investment Funds Standards Committee (CIFSC)
14
Q
This type of wrap fund target investors with higher levels of investable assets (typically 150k+). Accounts are managed on a segregated basis, thereby enabling the client to own individual securities.
A
separately managed wraps (aka individual wrap accounts)
15
Q
These ETFs are constructed with derivatives such as swaps to achieve the return effect of the index.
A
Synthetic ETFs
16
Q
This type of commodity ETFs invest in the commodity directly and tends to closely match the spot price
A
Physical-based ETFs
17
Q
This type of commodity ETFs invest in futures contracts of different commodities, with an underlying portfolio of money market instruments to cover the full value of the contracts.
may be subject to “roll yield loss”
A
Future-based ETFs
18
Q
This type of commodity ETFs invest in public listed companies that are involved in exploration and development or in the processing or refining of a commodity.
A
Equity-based ETFs
May not closely match the spot price of the underlying commodity because these ETFs are built using equities
19
Q
The normal, upward-slope condition of Commodity ETFs is known as
and the premium of a deferred month over a prior month is known as the
A
Contango
Roll Yield
20
Q
Exchange-traded funds that employ swaps are exposed to _____________ risk since you are swapping with another party directly.
A
counterparty risk
21
Q
inverse and leveraged ETFs are suitable investment vehicles for the individual investor in only two specific applications:
A
hedging a current portfolio exposure and day trading.
22
Q
Hedge Fund Service Providers
Supplies services to the hedge fund in the implementation of trading strategies.
A
Prime Broker
23
Q
Hedge Fund Service Providers
- Processes subscriptions and redemptions and calculates the hedge fund’s NAV.
- verifying/pricing securities independently of the prime broker
- for more illiquid securities like OTC derivatives, possibily using a marking to model approach
A
Fund Administrator
24
Q
Hedge Fund Service Providers
Responsible for
* holding and tracking all of the assets.
* transferring securites/cash to/from prime broker
* possibily offering extra services (like acc statements and year end slips)
A
Custodian
25
Do leverage, inverse, and regular ETFs have resets?
Leveraged ETFs have resets
Inverse ETFs (non-leveraged) may or may not have resets
Regular ETFs (long, non-leveraged) do not reset
26
Refers to a portfolio construction strategy that uses broad-based ETFs as a passive core holding. The satellite assets are intended to boost returns above the core asset returns.
Essentially you hold two ETFs. One core broad-based ETF like VOO, and one satellite ETF such as a smaller ETF representing a particular sector, syle funds, or country ETFs that have a bit of risk to increase returns.
Core and Satellite
27
HEDGEFUNDS
are services, such as analyst reports, that the fund receives in exchange for business rendered to its supplier.
Soft-dollar arrangements
28
The open source code that powers Bitcoin?
Blockchain
29
Members of the peer-to-peer bitcoin platform independently confirm the transactions using high-speed computers through a process called
bitcoin mining
30
Hedge funds targeted toward high-net-worth and institutional investors are usually structured as
limited partnerships or trusts, and are issued by way of private placement.
31
is a piece of code that represents ownership of a digital concept (a bitcoin) with financial value
Bitcoin as a token
32
is the distributed network, or blockchain, that maintains the ledger of balances of bitcoin the token.
Bitcoin the protocol (capital B)
33
The Role of **Managed Products** in Investment Management.
The following should be considered
* **Portfolio size**: Smaller portfolios may not have enough to adequately diversify without the use of a managed product.
* **Transaction costs** for individual investments are higher for smaller transactions. Managed products could be more *cost effective*
* **Foreign investments**: Managed products make it *easier* to invest in foreign markets
34
How Mutual Funds Work
* big pot of money to which many investors contribute
* Each investor obtains units/shares of the fund itself based on how much money (capital) they contributed
* The fund manager uses the money in the pot to invest and is paid a management fee their professional services
* Once you have selected an appropriate fund (or group of funds), you can sit back and let the fund manager do his or her job.
* Investors profit/lose money based on how the fund performs and how many units they own.
35
Mutual funds can be structured as "__________" or "____________"
"trusts" or "corporations". If the fund is structured as a trust, it issues units. If the fund is structured as a corporation, it issues shares.
36
Most mutual funds are in a continuous state of distribution and are referred to as ______________
"open-ended funds"
37
A _______________ issues units only for a certain time period
"closed-end fund"
38
The process of filling a request for purchase or a request for redemption based on the price at the next valuation is known as ________ and this is how all ________ are priced
forward pricing, mutual funds
39
Processing a purchase or redemption request based on a previous net asset value per share (NAVPS) is known as _________________
"backward pricing" and is illegal!
40
________________ are found in Canada on the NEO exchange and include both mutual funds and investment funds. They are traded at the fund's end-of-day NAVPS (or NAVPU) and allow dealers to make bulk trades in the fund across multiple accounts.
"Platform-traded funds" (PTFs)
## Footnote
This helps simplify the administration process for the fund company and dealer, resulting in lower fees.
41
Wrap products (aka ____________) include wrap funds and wrap accounts
portfolio solutions
42
______________ have become very popular because they allow advisors to spend less of their time researching and selecting investments and more time providing value-added solutions such as retirement, tax, and estate planning.
Wrap products
## Footnote
(the wrap account manager does it)
43
There are two basic types of wrap products:
1. Funds of funds (FoFs)
2. Separately managed wraps (individual wrap accounts)
44
Investors have ____________ over which funds go into the FoF.
no direct control
45
makeup of the ________________ is determined by the fund manager, and it will usually have a specific risk profile as a target.
FoF
46
In _________________________ the client is usually charged an annual management fee, which is based on the value of the assets under management (rather than paying for each individual transaction).
Separately Managed Wraps (Individual Wrap Accounts)
47
This is an individual account for which the portfolio manager is authorized to select and execute trades on behalf of that specific client.
Separately Managed Wraps (Individual Wrap Accounts)
48
"diworsification"
(unnecessary diversification).
49
There is no requirement that each company have the same weight or value within an ______ so two similarly-named ________ may in fact be very different.
etf, etfs
50
A ________ is a special over-the-counter (OTC) derivative contract between two different parties (known as "counterparties") who agree to exchange a series of payments that are usually based on the difference between fixed and variable interest rates.
swap
51
For _____________ the interest rates are calculated on the notional value of a reference asset.
swaps
52
_______________ can be thought of as a "series of forward contracts" and will consist of similar pricing components such as the cost of carry.
swaps
## Footnote
For example, if a swap contract is based on a precious metal commodity such as gold, then the gold will include costs of carry such as financing costs, insurance costs, and even storage costs ("FIS" costs).
53
The cost of carry includes
1. financing costs
2. insurance costs
3. storage costs.
54
Since a swap is an OTC obligation without a central clearinghouse, ETFs that use swaps are exposed to ____________________
counterparty risk
## Footnote
the risk that the counterparty cannot meet its financial obligations and may default.
55
______________ ETFs investing borrowed capital to increase returns.
Leveraged ETFs
## Footnote
will track a reference index
56
An _______________ will simply provide the opposite, or "inverse", return of the underlying index and will be either leveraged or unleveraged,
Inverse ETFs
57
Both __________ ETFs and _______________ ETFs are often reset daily (due to the effects of compounding), making them unsuitable for retail investors with time horizons that are longer than one trading session (a single day).
inverse, leveraged
58
Synthetic ETFs, leveraged ETFs, and inverse ETFs can all be constructed using _________________
derivative contracts such as swaps.
59
There are three types of "commodity ETFs",
1. **Physical-Based ETF**
* Invests directly into a commodity.
* Tends to closely match the "spot price".
* Generally limited to non-perishable commodities, such as gold or silver (as opposed to things such as pork or grains, which are perishable and not suitable for physical ETFs).
* Invests in futures contracts of different commodities.
2. **Futures-Based ETF**
* May be subject to "roll yield loss" (the loss that can occur when a maturing futures contract is rolled over into a new futures contract at a higher price).
3. **Equity-Based ETF**
* Invests in the shares of listed public companies.
* May not closely match the spot price of the underlying commodity because these ETFs are built using equities.
* Usually companies that do exploration and development or processing/refining of a commodity.
60
_________________ is the loss that can occur when a maturing futures contract is rolled over into a new futures contract at a higher price
roll yield loss
61
________________ May not closely match the spot price of the underlying commodity because these ETFs are built using __________.
Equity-based ETF, equities
## Footnote
Equity-based ETFs are built using stocks so may not closely match the spot price of the underlying commodity. Investment strategies relying on movements in commodity prices are better advised to use physical- or futures-based ETFs.
62
The _____________ is the price at which the underlying commodity can be bought or sold in that day's market for immediate delivery.
spot price
63
Although all ETFs will issue _______, not all ETF's will rely on the purchase of ___________ for their underlying reference assets.
units, stocks
64
The creation and redemption process of the following types of ETFs are:
________________: Based on over-the counter (OTC) swap contracts.
Synthetic ETFs
65
The creation and redemption process of the following types of ETFs are:
_________________ based on the exchange of cash rather than securities.
Leveraged ETFs and Inverse ETFs
66
The creation and redemption process of the following types of ETFs are:
_______________ typically based on an in-kind change of commodities but may use cash when the reference assets are various derivatives.
Commodity ETEs
67
The loss that can occur when a maturing futures contract is rolled over into a new futures contract at a higher price.
Risk of Roll Yield Loss
68
A normal forward-pricing curve has an _____________
upward slope
## Footnote
This is because the price is normally expected to be higher in the future, usually due to the costs of financing, insurance, and storage costs (FIS), discussed earlier
69
the spot price is usually lower than the futures price; this is known as a ___________ or ________________, where the forward-pricing curve is upwards sloping.
"contango", or normal market,
70
futures price can change at any time, which may result in a change in the _____________
forward-pricing curve
71
front-running of trades ahead of ______________________ (whereby maturing futures contracts are rolled over into a new futures contract at a higher price) is legal and allowed because the ____________ rollover dates are publicly-known information contained in the ETF prospectus.
commodity ETF rollovers, commodity futures
72
_______________ will buy into the new contracts ahead of the commodity ETF rollover period and attempt to profit from the price volatility that occurs when the large follovers transact. This creates risk for investors who hold the ETF because its market value will change.
front-running trader
## Footnote
This creates risk for investors who hold the ETF because its market value will change.
73
________________ is the risk that the other party in a contract cannot meet their financial obligations and may default.
"Counterparty risk"
| Counterparty Risk in Derivatives
74
Since a derivative swap contract is an OTC obligation without a central clearinghouse, ETFs that use swaps as their underlying investments are ______________________
exposed to counterparty risk.
75
ETEs designed to give double the daily return of a reference asset With not provide exactly double the return over the course of a month because they are ___________________
"path dependant"
## Footnote
the longer the holding period, the greater the potential difference between the return that is expected and the return that is realized. Essentially, the use of leverage makes the ETF's return more sensitive to the returns of the market.
76
Frequent resetting is accompanied by compounding, and this ultimately leads to ________________ and is generally calculated as the difference between the return on the ETF and the return on the underlying index.
Tracking error,
77
Inverse and leveraged ETFs are often reset __________ (due to the effects of compounding) making them unsuitable for retail investors with time horizons that are longer than one trading session (a single day).
daily
78
inverse and leveraged ETFs are really only suitable in two situations:
1. As a way to hedge exposure in a portfolio.
2. Day trading.
79
some market regulators were considering limiting the contract sizes and positions on certain commodities but the result is that _________________
prices of ETFs moved away from their NAV
## Footnote
which posed risk for investors holding ETF units based on these commodities It is suggested that investors avoid buying ETFs at a premium to their NAV to protect themselves from potential losses.
80
Deposits of foreign currency ____________ covered by CDIC protection.
are not
81
__________________ is an interest-bearing bank deposit with a fixed date of maturity, much like a term deposit. However, foreign currency time deposits do not have CDie protection.
time deposit
82
The following concerns and tips for trading ETFs should be considered:
Sudden price movements
* Use limit orders, such as stop loss or stop buy.
Large trades
* Place large ETF trades at once so the designated broker will create new units to meet demand if needed.
Trading at open and close
* less market liquidity in first and last 15 minutes of a trading day, avoid trading ETFs at these times if possible.
Closed exchange
* Avoid trading ETFs if the market exchange that trades the underlying security is closed.
Widening spreads
* Avoid trading ETFs when underlying securities are halted due to news or corporate events.
83
Leveraged and inverse ETFs may post returns that are significantly different than what is expected due to the_____________________
strategies employed and resetting process.
84
Due to the inherent risks, dealer member firms should have additional and specific KYC requirements in place with respect to these types of ETFs.
Leveraged and inverse ETFs
## Footnote
Registrants must have the required training to deal with leveraged and inverse ETEs, and an appropriate supervision system must be in place to ensure they are acting in accordance with IIROC rules.
85
# for swaps, exchange traded futures, and options
Risk: Counterparty risk
**Swaps:**
- More risk.
- Relies on the creditworthiness of the counterparty (no guarantee).
**Exchange-Traded Futures and Options:**
- Less risk.
- A central clearinghouse is the counterparty and guarantor.
86
# for swaps, exchange traded futures, and options
Risk: Costs
Swaps:
- Non-standard features.
- More expensive.
Exchange-Traded Futures and Options:
- Standard terms.
- Less expensive.
87
# for swaps, exchange traded futures, and options
Risk: Tracking error
Swaps:
- Custom contracts.
- Higher tracking error risk.
Exchange-Traded Futures and Options:
- ETFs using futures have less tracking error risk.
88
# for swaps, exchange traded futures and options
Benefit: Flexibility
Swaps:
- Customization to specific needs of the counterparties.
- Very flexible (custom maturity dates).
Exchange-Traded Futures and Options:
- Standard terms.
- Less flexible (pre-determined maturity dates).
89
# for swaps, exchange traded futures and options
Benefit: Disruption of trading
Swaps:
- No daily price fluctuations.
Exchange-Traded Futures and Options:
- Daily mark to market.
- Price limits (upper and lower) may be imposed.
90
Broad-Based International ETFs
* Have the broadest investment mandates out of all international ETFs.
* Designed to passively track popular international equity indexes.
* Best method for getting well-diversified exposure to international investments.
* Most popular international ETF.
91
Regional ETFs
* Give exposure to a specific region or group of international equity markets.
* Typically target more developed or emerging economies.
* Examples include Asian-based and European-based ETFs, such as iShares MSCI BRIC.
92
Individual Country ETFs
* Provide diversified exposure to the equity markets of a specific country.
* Usually include only larger-capitalization benchmarks.
* Example: iShares MSCI Germany ETF (symbol: EWG).
93
Foreign-Style ETFs
* Target investors seeking exposure to international equity with specific investment styles.
* Can include various company sizes or valuations.
* example: iShares MSCI EAFE Small-Cap ETF (symbol: SCZ).
94
International Bond ETFs
* Provide a fixed income component for portfolios.
* Offer benefits of fixed income investments while getting exposure to international markets.
* Example: Bloomberg Barclays International Bond ETF
95
Foreign Dividend ETFs
* Invest in equities that offer an income stream from dividends.
* Provide potential returns beyond just capital gains or coupons from international bond ETFs.
96
An argument can be made that a country's currency is a more accurate measure of its economy than its equity market returns.
These ETFs allow for investors to place a "bet" on a country's future performance by investing in its currency.
Foreign Currency ETFs
97
These ETFs invest directly or indirectly in commodities or in the companies that produce commodities. This type of ETF can be a great diversification strategy and can be a "bet" on the direction of global or regional economies (for example, iShares S&P/TSX Global Gold Index ETF).
Commodity-Themed ETFs
98
# tax treatment for holders of...
Canadian-listed ETF with US-listed Stock Dividends
Taxable Accounts (Non-Registered):
- Withholding tax at source.
- Foreign tax credit available.
Retirement Accounts (RRSP, RRIF, etc.):
- Exempt.
Non-Taxable Accounts (TFSA, etc.):
- Withholding tax at source.
- **No tax credit.**
99
# tax treatment for holders of...
US-listed ETF with US-listed Stock Dividends
Taxable Accounts (Non-Registered):
- Withholding tax at source.
- Foreign tax credit available.
Retirement Accounts (RRSP, RRIF, etc.):
- Exempt.
Non-Taxable Accounts (TFSA, etc.):
- No withholding tax.
100
US estate taxes may need to be paid on US assets if:
* The investor's worldwide estate has a value greater than $11,180,000 (USD), and
* US assets are valued greater than $60,000 (USD).
101
Form T1135 - Foreign Income Verification
The CRA requires that Canadians who own certain types of foreign property with a total cost of $______________ or more be required to complete and submit tax form T1135.
However, _________________ that may hold foreign securities are exempt.
100,000 (CAD), Canadian-listed ETEs
102
Investment Strategies Using ETFs
* Core and Satellite
* reblancing
* Tactical Asset Allocation
* Cash Management
* Simplified Exposure to Once Hard-to-Access Asset Classes or Strategies
* Tax Loss Harvesting
103
________________ are usually passive ETs that will provide most of the returns.
Core holdings
104
_______________________ are usually focused on riskier sectors to provide extra returns ("alpha") over and above the rate of return of core holdings.
"Satellite holdings"
105
Rebalancing
* can be made easy when holding ETFs across different asset classes.
* By increasing/reducing investment in one ETF rather than in one or more individual securities, rebalancing can occur more easily.
106
Cash Management
Money can be parked in an ETF with stock market exposure until the investor decides what to do with it.
107
Tax Loss Harvesting
* investor sells a specific asset to realize a capital gain or loss for tax purposes but wants to keep exposure to that specific asset class or sector.
* An ETF with exposure to the specific asset class or sector can accomplish tax loss harvesting.
108
it is better to think of a hedge fund as a type of ___________ rather than a specific ___________________
fund structure, investment strategy
109
Unlike mutual funds, hedge funds can:
* Short sell securities.
* Use derivatives to speculate.
* Employ leveraging strategies.
## Footnote
These are often called "alternative investment strategies".
110
These funds are usually structured as limited partnerships or trusts, and are issued by way of private placement.
Hedge funds
111
Instead of issuing a prospectus, these funds issue an "offering memorandum" which is a legal document stating the objectives, risks, and terms of investment
Hedge funds
112
To purchase these funds, the investor must be considered an "accredited investor" Which onese he or she must meet certain minimum requirements for income, net worth, and usually investment knowledge. These requirements vary from province to province
Hedge funds
113
# Track record
A general guideline is to recommend only hedge funds that have a minimum track record and asset size:
* **Single-strategy hedge funds:** At least two years and $25 million
* **Fund of hedge funds:** At least three years and $100 million
114
Hedge funds may be located, or "domiciled", for legal and/or tax purposes either locally (known as "onshore") or in a foreign jurisdiction (known as "offshore").
* If the hedge fund is domiciled offshore, this may ________________________
make the due diligence process more difficult and make the hedge fund and its activities and operations a lot less transparent.
115
# Hedge Fund Trading Models
systematic vs discretionary
* Systematic: This method tends to be better because it removes emotions from trading, or
* Discretionary: This method relies on the fund manager's skills and experience, or
* A combination of the two.
## Footnote
However, neither method is better than the other. Many professionals consider trading to be an art or a gut feeling that cannot be achieved by formulas or algorithms.
116
OTC derivatives generally subject to
* liquidity risk (he or she cannot easily exit the contract)
* default risk (the counterparty may not be able to make good on their obligation).
117
An independent party should calculate the net asset value (NAV) for the fund.
hedge fund
118
The way a hedge fund is offered can impact the investor's rights. If the fund is issued by ________________, the investor would have certain rights (eg. right of withdrawal) that may not be available if the fund is issued under a different structure.
prospectus
119
fund should avoid concentration risk by having a __________ client base.
diverse
120
______________ is identified by reviewing the fund's largest 5 to 10 clients.
"Concentration risk
121
_______________ are services that are provided to a hedge fund by, say, a
brokerage firm but are not actually paid for by the hedge fund directly. Instead, the fund may agree to place enough trades through the brokerage firm to generate commissions to the firm that offset the cost of the research.
"Soft-dollar"
arrangements
122
The traditional role of prime brokers has been to provide services for:
* Trade execution.
* Financing for leveraged and short positions.
* Collateral (to ensure that capital coverage for the financing is sufficient).
123
prime broker may also provide
1. **Market flow information** (data and commentary on the overall market or a certain security).
2. **Pricing and risk measurement** (pricing will allow fund managers to determine the overall value of the fund).
3. **Capital introductions **(the introduction of high-net-worth individual investors or institutional investors to the hedge fund).
124
Risk measurement can take different forms. Some prime brokers may stress-test portfolios for
* "liquidity analysis" (how many days it is estimated to take to liquidate the portfolio),
* "beta analysis" (the exposure to the overall market)
* "scenario analysis" (such as large interest rate movements or large declines in equity values).
125
approach whereby a security's value is defined by modelling how the price moves between trading periods.
"marking to model"
126
usually provides an independent assessment with an annual audited report that investors can review.
The Accounting/account Firm
127
The custodian ________ be a different provider from the prime broker.
may
128
The legal advisor does the following:
* Creates the offering memorandum or prospectus.
* May assist in securities registration for management and/or the fund.
* Possibly adds credibility to the hedge fund by his or her own reputation.
129
Tracing the Flow of Money between the investor, the hedge fund, and various service providers (4 key steps)
1. An investor will complete a subscription to a hedge fund. This involves completing KYC information and the deposit of a cheque or transfer of cash (a transfer of securities would be very rare). The subscription documents will go to the administrator while the cheque or cash will go to the custodian.
2. The administrator will notify the hedge fund manager of the new client and the deposit. The custodian will make the cash available to the hedge fund for use,
3. The hedge fund manager will decide how to invest the new cash in the hedge fund.
4. The prime broker will execute the trades required by the hedge fund manager.
130
Advisors should use the following steps to incorporate or add hedge funds into a portfolio:
1. Assess investor suitability (goals, objectives, risk profile, etc.).
2. Determine the relative weight in the portfolio (but only if the hedge fund is suitable for the investor).
3. Select a specific hedge fund. *
4. Monitor performance.
## Footnote
The question often arises, "Which step is most important?" Since hedge funds are subject to less regulation than more traditional investments, the assessment of investor suitability is very important.
131
The Asset Allocation of Hedge Funds
Hedge funds can be treated two different ways in a portfolio:
1. As their own separate asset class.
2. Integrated within the existing asset classes.
## Footnote
The decision as to how to treat the hedge fund often comes down to how much exposure to market direction it has.
132
The __________ the correlation to market direction, the more the hedge fund can be considered its own asset class.
lower
133
The __________ the correlation to market direction i.e. to traditional investments such as stocks and bonds), the more the hedge fund should be integrated within the existing asset classes.
greater
134
"_________-" represents how much a portfolio moves in
comparison to the market.
beta
135
# Hedge Funds as a Separate Asset Class
The "______________" of the portfolio is built using more traditional investments and asset classes.
core
136
# Hedge Funds as a Separate Asset Class
The bulk of the asset allocation will be towards the _____. Since the _________ may be more sensitive to market exposure, it will represent the _________ portion of the portfolio.
core, core, beta
137
# Hedge Funds as a Separate Asset Class
The _______________ or complementary, portion of the portfolio will consist of a smaller allocation that is often for "_________", or positive-return-generating, assets.
"satellite", alpha
## Footnote
Remember,
"alpha" represents how much growth a portfolio realizes over and above its benchmark.
138
Hedge funds that have a ___________ correlation to market exposure can serve to lower the portfolio's ____________ and add positive returns.
lower, beta
139
The ____________ correlation of the hedge fund to market direction will reduce the portfolio's overall beta and generate some _______ for growth.
lower, alpha
140
Hedge fund strategies can be divided into three main categories:
* Relative value strategies
* Event-driven strategies
* Directional strategies
141
142
Major Hedge Fund Strategies by Market Exposure
Relative Value Strategies
Low exposure to market direction
143
Major Hedge Fund Strategies by Market Exposure
Event-Driven Strategies
Medium exposure to market direction
144
Major Hedge Fund Strategies by Market Exposure
Directional Strategies
High exposure to market direction
145
• Attempting to profit from price anomalies (abnormalities) between related interest rate securities (such as bonds) and derivatives of those securities. Highly leveraged.
Fixed Income Arbitrage
146
• Designed to identify and exploit mispricing(s) between convertible securities and the underlying shares.
• Involves buying lower-priced convertible securities issued by a company and short selling common shares from the same issuer to hedge the underlying equity risk.
Convertible Arbitrage
147
• Attempting to exploit market inefficiencies and opportunities by creating long and short positions of approximately the same dollar amounts.
• The goal of this strategy is to generate returns that do not depend on the direction of the stock market.
Equity-Market-Neutral
148
• Taking long and short positions in companies involved in a merger or acquisition.
• The manager will go long on (buy) the company being acquired and go short on (short sell) the acquirer. The idea behind this is that the merger will benefit the company being taken over in the short run and will be a drag on the acquirer's resources, and therefore its performance, in the short term.
Merger or Risk Arbitrage
149
Bonds that are below investment grade, also known as
"junk bonds".
150
Bonds that are below investment grade, also known as
"junk bonds".
151
______ face greater credit risk (the risk the company may default on the bond). As a result, the maturities are often kept low in portfolios, sometimes as little as three years or less.
High yield bonds
152
• Investing in the equity or debt securities of companies that are in financial difficulty and could face bankruptcy or reorganization.
• Many institutional accounts (i.e. pensions) are not allowed to own distressed securities and therefore dump them. This could result in the market value of the securities being pushed well below their true value.
Distressed Securities
153
• While this is the most publicized hedge fund strategy, it represents only a small percentage of the strategies employed by hedge fund managers.
• Rather than making bets on specific companies, the manager makes bets on major events that will impact entire economies, such as changes in government policy.
Global Macro
154
"_________" involves investing in a portfolio of futures that is actively managed by a "commodity trading advisor" (CTA).
managed futures strategy
155
commodity trading advisor" (CTA).
• CTAs advise and manage futures contracts.
• They also advise on pooled investment vehicles such as commodity pools and more specifically commodity futures or options.
156
commodity trading advisor" (CTA).
• CTAs advise and manage futures contracts.
• They also advise on pooled investment vehicles such as commodity pools and more specifically commodity futures or options.
157
Organizations that manage commodity pools are referred to as ______
commodity pool operators" (CPOs)
• CTAs (commodity trading advisors) and CPOs are regulated separately from traditional investment managers by the Commodity Futures and Trading Commission (CFRC) and the National Futures Association (NFA).
158
• This is the most popular strategy, which consists of more than 75% of hedge fund activity in Canada.
Long Short Equity
159
• While the fund can hold long and short positions, a _______ fund must constantly have a net short position (short positions must always exceed long positions).
dedicated short bias
160
Factors in Hedge Fund Allocation Decisions
1. Factors in Hedge Fund Allocation Decisions
2. Investment policy constraints must be taken into account.
3. Equity substitutions may provide significant volatility reduction.
4. Bond substitution may contribute downside protection
161
Replacing some of the stocks in a portfolio with hedge funds using a relative value strategy may serve to _______ the portfolio's volatility due to ______ correlation to market direction.
reduce, lower
162
Using a fixed-income arbitrage hedge fund to _____ some of the bonds in a portfolio may _______ risk and ______ returns.
Replace, reduce, increase
163
Commodity Futures Trading Commission
(CFTC) classifies bitcoin as a ____________. Like most ____________-, there is consistent demand but limited supply, which generally results in steady price increases over time
commodity, commodities,
164
165
In Canada bitcoin available via structured as __________, whereby they invest directly in bitcoin. Bitcoin can also be directly accessed via bitcoin ATMs, money service businesses, and peer-to-peer exchanges (both licensed and unlicensed).
physical-based ETFs
166
PPNs __________ issued via a prospectus and _____________ considered securities. As such, in most provinces, _____ special licence is required to sell them, and they are generally issued and distributed only by the big banks.
are not, are not, no
## Footnote
PPNs not garunteed by CDIC
167
___________________ usually require the fund to trigger capital gains in order to rebalance the fund to keep consistent with its underlying index.
Index-linked managed products
168
Skills Required for Successful Overlay Management
Wealth managers must have certain skills to succeed:
* Selecting investment managers though a due diligence process.
* Allocating managed products using asset allocation models.
* Accommodating overlay management (and managed products) in clients' investment policy statements (IPS).
* Ensuring accurate reporting of performance numbers.
* Assessing wholesaling support from the managed product manager.
169
For ____________ If the fund incurs a capital gain or earns income, the income is distributed to unit holders for tax purposes.
managed products
170
# Recent Trends in Overlay Management
Separately Managed Accounts (SMAs)
* In the 1980s and 1990s, overlay management was attempted with separately managed accounts (SMAs).
* problems became apparent: different managers may make similar decisions. This approach could result in a client's exposure to certain markets or investments exceeding what was allowable given the client's investment policy statement.
* This led to the development of unified management accounts (UMAs).
171
Unified Managed Accounts (UMAs)
involve data feeds and software tools that allow the manager to monitor the client's overall portfolio to ensure the big picture of the overall portfolio adheres to the client's investment policy statement
led to unified managed household accounts (UMHAs)
172
unified managed household accounts (UMHAs),
* appropriate for very affluent clients.
* Within one office, a team of professionals handles all of the client's financial affairs including investments, trust and estate services, legal services, tax planning, etc.
173
An aging demographic is shifting the focus for certain clients from saving and growth to preserving capital and generating income. This trend may result in a shift from relative performance (beating a benchmark) to _______________ such as principal protected notes, which can generate an income and at the same time protect the base capital that was invested.
outcome-based products
