Risk and Risk Mgt. Flashcards
Active return
The deviation from the asset’s return from its benchmark
Fund style index
performance index based on the collection of fund managers operating a similar strategy
Bailey criteria
Seven characteristics a benchmark should have to be a useful gauge. US MAORI 1. Unambiguous 2. Specified in advance 3. Measurable 4. Appropriate 5. Owned 6. Reflective of current investment opinion 7. Investable
Hughen and Eckrich (2015) describe liquid alternatives are hard to benchmark why?
Low correlation of liquid alternatives to typical long only benchmarks. Solution is to create benchmarks for the underlying asset classes.
Three considerations in benchmarking
- Is the benchmark appropriate (similar return drivers)
- Was outperformance statistically/economicaly significant.
- Why did the fund outperform its benchmark
What do the empirical tests indicate if the CAPM describe returns perfectly?
(1) Intercept is statistically equal to zero
(2) Slope is statistically equal to the asset’s true beta
(3) Residual = idiosyncratic asset specific risks
Omission of systematic risk factors in an up market will result in
Overestimation of the risk-adjusted performance of assets positively exposed to the omitted risk factors
Four reasons not to apply CAPM to alternatives
- Multi-period issues (CAPM = single period)
- Non-Normality
- Illiquidity of Returns
- Investor specific assets or liabilities
Value-based index (60% equity/40% bonds)
fixed component weights expressed as percentage of value of the index
Quantity-based index (S&P 500)
fixed number of contracts for each commodity (index weights change daily)
Input variables to determine commodity weights
- World production (S&P GSCI)
- Liquidity (BCOM)
- Open interest (nominal value of open futures)
Total return index
Fully collateralized investment strategy whereby you include collateral yield (from T-bills)
Excess return index
Provides returns over cash and is linked to a basket of commodity futures contracts
Roll method choices
- Futures curve positioning (determine time to expiration)
2. Roll procedure (when to close/open positions)
Three generations of commodity indices
1st generation -> Heavily weighted in energy with long-only position in front-month contracts.
2nd generation -> Attempt to enhance returns through forward curve positioning.
3rd generation -> includes active commodity selection.
Private Equity Benchmarks: PME and LN PME method
- PME only contains 2 cashflows
- LN PME focuses on computing two IRRs
Cap rate spread
Cap rate - 10Y Default free bond
2 ways of benchmarking core real estate
Cap rates, Risk premium formula E(Ri)=RF+RP
Three approaches to benchmark non-core real estate
- Cap rates,
- Risk premium approach
- Use of absolute hurdle rates
CTA three describing levels of value
- Trading Level
- Funding Level (total amount of collateral posted)
- Notional Funding (exposure above trading level)
Trading Level = Funding Level + Notional
Capital At Risk
total loss if each asset hits its stop-loss on that day
Critical assumption VaR method
Normal distribution of daily returns
Omega Ratio
General measure of risk that takes into account the entire return distribution
Interpret Omega Ratio
If the Omega Ratio is less than one the asset failed to earn a summed return that exceeds the target level
Primary culprits as to why returns can’t be unsmoothed by arbitrageurs
- No true trading opportunities
2. Transaction costs
Portable alpha
Exploit alpha by investing in an alpha-producing strategy while simultaneously maintaining a target beta exposure
Rebalancing when a stock follows a random walk
Does not change the expected value only the risk
Rebalancing when a stock mean-reverts
increases expected value vs. a buy-and-hold strategy and alters the risk
Six activities of monitoring private partnerships
- Planned vs. implemented strategy
- Review FS, valuation, divestment information
- Analyze impact of market trends
- Assess individual investments and portfolio
- Measure performance against benchmark
- Verify each partnership’s legal/compliance/tax
Three substantial benefits from monitoring
- greater options to liquidate investment
- greater ability to exert control over management
- larger implication for portfolio’s other assets
Forms of active involvement inside and outside funds governance process
Inside: Renegotiation of fees; Termination with cause
Outside: Not-commit to follow-up funds; LP Default
Three ways to create value through monitoring
- Evaluate follow-on investments
- Enhanced awareness of other investment opport.
- Better liquidity management
Five components of risk management
- Investment Position (Where)
- Frequency of Data Collection (When)
- Aggregation and System Development (How)
- Dimensions of Risk (What)
- Risk reporting (Whom)
Categories of Quantitative Information
Historical returns, Historical risk mgt. reviews, Asset allocations and capital balances
Categories of Qualitative Information
Descriptive information, Key information, Activities log
