Section 4 - R20 - Asset Allocation to AIs (HF, PE, Real Assets, MVO) Flashcards

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1
Q

Functional Role of AI (List)

A
  • Capital Growth (CG)
  • Income Generation (I)
  • Risk Diversification (RD)
  • Safety (S)
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2
Q

Hedge Funds (Roles)

A
  • RD (Short Bias, Event-Driven)
  • CG (Long Short, Global Macro, Mgd Futures)
  • From risk reduce to return enhancement
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3
Q

Real Assets (Roles)

A
  • CG (increase in price)
  • I (crop, rent, income)
  • RD (many have inflation hedge)
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4
Q

Private Credit (Roles)

A
  • I (Coupon)
  • CG (MTM)
  • Concentrated
  • Distressed (Equity-Like) and Direct Lending (Similar Credit Profile Behavior)
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5
Q

Private Real Estate (Roles)

A
  • CG (appreciates)
  • I (rent)
  • RD (hedge to unanticipated inflation)
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6
Q

Private Equity (Roles)

A
  • CG
  • I
  • Concentrates with risks as volatility is non observable
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7
Q

Risk Conception (difference between short term and long term)

A

Short Term: Volatility
Long Term: Underperformance

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8
Q

Volatility Reduction in Short Term (Concept)

A
  • Unsmoothing where (i) appraisal indexes, (ii) survivorship or (iii) back-fill biases underestimate risk
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9
Q

Justify and describe limitations in usage of bonds to mitigate equity risks

A
  1. Bonds have exhibited negative correl with equities (which is good), but
  2. Correlation may increase in turbulent times and/or high inflation environment
  3. Correlation is temporary
  4. Heavy allocation to bonds reduce probability of achieving long-term returns
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10
Q

HFs to mitigate equity risks (limitations)

A
  1. If beta is lower than 1, it will reduce overall beta
  2. Higher expected returns than equity may help the portfolio in achieving returns
  3. Levered strategies that should be used with attention
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11
Q

Approaches to Asset Classification (List)

A
  1. Liquidity: REITs, Infra, PE, Real Estate
  2. Marketability/Private
  3. Based in E(R) during different regimes: Capital Growth (CG), Inflation Hedge (commodities), Deflation Hedge (govt bonds)
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12
Q

Risk Based Approaches to Asset Classification (List)

A
  1. Equity Market Return
  2. Size
  3. Value
  4. Liquidity
  5. Duration
  6. Inflation
  7. Credit Spread
  8. Currency
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13
Q

Traditional Based Approaches to Asset Classification (Pros and Cons)

A

Pros:
Simple and Easy to Communicate

Cons:
- Overestimate diversification
- Grouping different assets in the same classification (eg. HY and IG Bonds are classified as FI)
- Sensitive to historical look back period.
- Implementation Shortfalls.

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14
Q

Traditional Based Approaches to Asset Classification (Pros and Cons)

A

Pros: Easier to communicate, relevance for liquidity management and operational considerations

Cons: Overestimate asset diversification, obscured primary drivers of risk (as it lists many)

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15
Q

Factors to Consider in AI (List)

A
  1. Define risk
  2. Establish E(R)
  3. Select appropriate investment vehicle
  4. Operational Liqudity Issues
  5. Expenses and Fees
  6. Tax Considerations
  7. Dilemma: build or buy
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16
Q

MVO in AI (Concept)

A

It does NOT address the characteristics of most AI classes. Standard Deviation is an unidimensional view.

Reason: assets face illiquidity, it may take several years to extract return, modeled valuation may apply.

17
Q

Types of Investment Vehicles (List)

A
  1. Direct Investment in LP: Asset owner is a LP. Limit’s the investor’s liability to the amount invested in equity. GPs have broad discretion to asset allocation.
  2. FoFs: Pools operational risk, diversifies, but loses profitability in fees. Charges additional fees to its services.
  3. SMAs / Exclusive Funds: PB clients who want an unique strategy.
  4. Mutual Funds / ETFs: Mitigate costs, risk based investment approach, passive income. Scale and liquidy. Tax Efficient