LM 2: Alternative Investment Performance & Returns

Question 1

Describe the 3 stages of an investment cycle for alternative assets?

Answer 1

1. Capital Commitment (investors commit capital)
2. Capital Deployment (managers begin to buy assets with committed capital)
3. Capital Distribution (returns from the assets bought by manager get distributed to investors)

Question 2

Describe the outflows and inflows of cash in the 3 different life cycle stages of alternative asset classes.

Answer 2

1. Capital Commitment (large outflows and small inflows)
2. Capital Deployment (larger outflows to buy assets and increased inflows as you buy assets)
3. Capital Distribution (Larger inflows and small outflows as assets begin cash flowing)

Question 3

What is the J curve for private equity & real estate?

Answer 3

J curve of return and time.

it starts below at 0 the goes down below 0 when capital commitment is called & slowly increases as inflows start to exceed outflows & profits are realized & positions sold

Question 4

What is the multiple of invested capital (MOIC) & formula?

Answer 4

is a metric used to describe the value or performance of an investment relative to its initial cost

MOIC = (realized value of investment + unrealized value of investment) / total amount of investment

Question 5

What is a prime broker?

Answer 5

Bundle of services provided to hedge funds (a bank for hedge funds in which they deposit cash as collateral)

Question 6

What is funds rate of return formula using borrowed funds?

Answer 6

rL = (r (Vc + Vb) - rb(Vb))/ Vc

rL= leveraged return
r= fund rate of return
Vc = funds own capital
Vb = borrowed funds
rb = cost of borrowed funds

Question 7

What are the 3 levels assets can be classified into categories for valuation purposes, and describe them?

Answer 7

Level 1: assets valued on public exchange.
Level 2: assets valued based on quotes from brokers
Level 3: assets valued using internal models (mark to model instead of market prices)

Question 8

What are redemption fees?

Answer 8

fee charged to discourage redemptions and offset some transaction costs

Question 9

What are notice periods?

Answer 9

period before investment redemption can be made to give manager heads up

Question 10

What are lockup periods?

Answer 10

minimum period investors are required to keep their money in hedge fund

Question 11

What are liquidity gates?

Answer 11

limit or restrict redemptions for a period

Question 12

What are 3 common custom fee arrangements apart from 2/20?

Answer 12

1. Fee based on liquidity terms, asset size, and investment horizon (larger amounts, longer lockup periods)
2. Founder shares (lower fees to early participants)
3. Either/or fees (arrangement of either higher performance fee or management fee)

Question 13

What are 3 common ratio approaches to performance appraisal?

Answer 13

1. sharpe ratio
2. sortino ratio
3. calmar ratio

Question 14

What is sharpe ratio and formula for a portfolio?

Answer 14

portfolios return in excess of risk free rate

sharpe ratio = portfolio return - risk free rate / portfolio return standard deviation

Question 15

What is sortino ratio and formula?

Answer 15

portfolios return in excess of risk free rate however tries to eliminate upside and downside volatility

sortino ratio = portfolio return - risk free rate / portfolio return downside deviation (SD of downside)

Question 16

What is calmar ratio and formula?

Answer 16

focuses on worst case scenario

calmar ratio = average annual compound return (period) / maximum drawdown (period)

Question 17

What is maximum drawdown and formula?

Answer 17

maximum observed loss from a peak to a trough before new peak is reached

MDD = Peak - trough

Question 18

What is MAR ratio and formula?

Answer 18

same thing as calmar ratio except it focuses on since inception instead of period

MAR ratio = average annual compound return (since inception) / maximum drawdown (since inception)

Question 19

What is cap rate and formula?

Answer 19

the annual gross expected return of an investment

cap rate = annual rent earned / purchase price of priperty

Question 20

What is capital loss ratio used by private equity managers formula?

Answer 20

capital loss ratio = % loss of all investments valued below cost / total invested capital divided

Question 21

What is the difference between survivorship bias & back fill bias for alternative investments?

Answer 21

Survivorship bias: hedge funds no longer in business not included in indexes

Backfill bias: when funds are only added to an index after an initial period of success (can choose when to and when not to… in good years report in bad years don’t.)

Question 22

When using the calmer ratio, how low long of returns do you usually use?

Answer 22

Usually use 3 years of performance