Chapter 30 CAIA Flashcards - Investment Process, Operations and Risk
Style Drift
Style drift (or strategy drift) is the change through time of a fund’s investment strategy based on purposeful decisions by the fund manager in an attempt to improve risk-adjusted performance in light of changing market conditions.
Investment Process Risk
Investment process risk is economic dispersion caused by imperfect application of the stated investment strategy by the investment team.
Three Categories of a Fund
A fund’s activities or functions are often classified into three categories: investment, operational, and business.
Investment Activities
Investment activities span the investment process, involving all aspects of determining and implementing investment decisions. As discussed in Chapter 2, these activities are often described as front office activities.
Operational Activities
Operational activities include the direct support of investment activities, often described as middle office and back office operations. Operational activities include data entry, data processing, data management, record keeping, and trade reconciliation and documentation.
Business Activities
Business activities include the indirect support of the investment activities of the fund, including all of the normal activities of running any similarly sized organization, such as human resources management, technology, infrastructure, and facility maintenance.
Synergistic Risk Effect
A synergistic risk effect is the potential for the combination of two or more risks to have a greater total risk than the sum of the individual risks. Fluctuations in market prices are a source of risk.
Operational Errors
Operational errors are inadvertent mistakes made in the process of executing a fund’s investment strategy. Operational errors range from minor errors with inconsequential losses to major errors that can cause a fund to fail. In a fund failure, all or nearly all of the assets under management are lost. Losses due to operational errors can be exacerbated by market risk.
Rogue Trader
A rogue trader intentionally establishes substantial positions well outside the investment mandate. Rogue trading is most often caused by strong incentives or pressures to generate performance, combined with losses that jeopardize a trader’s career if not recouped. A rogue trader can single-handedly cause the collapse of a fund or even a large bank. However, well-designed operational systems (including carefully monitored position limits) can reduce or even eliminate a rogue trader’s ability to establish dangerously large positions.
Gaming
Gaming refers to strategic behavior to gain benefits from circumventing the intention of the rules of a particular system.
Operational Fraud
Operational Fraud from the perspective of an investor is any intentional, self-serving, deceptive behavior in the operational activities of a fund that is generally harmful to the investor. Operational fraud can be reduced through separation of duties.
Risk Limits
Risk limits are the maximum levels of measured risk that are allowed in a portfolio, in terms of both individual risks and aggregated risks. Risk may also be controlled through position limits.
Position Limits
A position limit is a specific restriction on the size of the holdings of a particular security or combination of securities.
