Summary Flashcards
Decentralised Exchanges
Facilitate transactions without the involvement of n intermediary. Examples include decentralized order book exchanges, constant function money maker, peer-to-peer protocols, and smart contract-based reserve aggregation.
Six Benefits for ESG inclusion in LPA
1) Lower negotiating costs
2) Reduced number of side letters
3) Demonstrated concern for LPs
4) Increase in goodwill for GPs
5) Greater transparency for all investors
6) Enhanced relationship building
Digital Asset Custody (Bitcoin)
Holders of digital assets may establish ownership via third party custody.
Benefits: Institutional grade trading, relatively low costs and capital efficiency opportunities.
Challenges: Gaps in technical knowledge and experience, fragmented liquidity and integration with traditional assets.
Private Placement in Passive Funds (Bitcoin)
Investors who want long-only exposure to bitcoin may use private placement in passive bitcoin funds.
Benefits: Familiarity and convenience as well as ability to account for investments at fair value.
Challenges: Relatively high costs and varying redemption mechanisms and frequencies.
Publicly Traded Shares (Bitcoin)
Open-ended private trusts provide investors with bitcoin exposure through publicly traded shares which represent ownership in the trust.
Futures (Bitcoin)
Cash-settled or physical-settled futures can add long exposure, establish risk-neutral exposure and create hedge spot exposure.
ETFs (Bitcoin)
The SEC has not approved ETF applications in the US due to concerns on:
Custody
Market Size
Surveillance
Market Manipulation
Private Equity Factor Tilts
Equity Risk
Illiquidity Premium
Size Premium
Value Premium
Poor Private Equity Returns Since 2006
1) More capital committed to PE
2) Lower levels of leverage following regulatory changes
3) Greater competition for deals
LTI Advantages
1) Idiosyncratic Advantages (goals / objectives)
2) Longer Time Horizon
3) Organizational Ambidexterity (Innovative Flexible)
LTI Environmental Enablers
Culture
Board (Governance)
Technology
LTI Product Input Metrics
People
Processes
Capital (Leverage)
Information
LTI Intermediate Output Metrics
Alignment
Commitment
Knowledge Management
LTI Investment Result Metrics
Investment Performance
Longevity Risk Measurement Steps
1) Accurately measure mortality
2) Use updated longevity expectations to adjust plan liabilities
3) Engage in stress testing
Longevity Risk Management
1) Pension plans can purchase longevity insurance
2) Buy Out (transfers all assets and liabilities to insurance company)
3) Buy In (transfers some of the risk for some of the participants)
Consensus Mechanism (Bitcoin)
Proof-of-Work ensures that all participants agree on each transaction (e.g., miners validate transactions)
Advantages of Crypto
1) Portfolio diversification
2) Payment promises attached to transactions (coloured coins)
3) Smart contracts
4) Data integrity
Disadvantages of Crypto
1) Forks in the blockchain
2) Computational power (cost and energy)
3) Bitcoin price volatility
Loyalty to Clients (3)
(PCR)
Priority of clients over the firm,
Client confidentiality,
Refusal of inappropriate business relationships and gifts.
Investment Process
(FARS)
Reasonable care and judgement
Fair dealing
Sufficient due diligence
Avoiding manipulation of securities price and volume
Trading
(TEMP C)
Not using material non-public
Prioritization of clients over the firm
Proper use of client commissions
Best execution
Fair an equitable trade allocation
Risk Management, Compliance and Support
Detailed policies and procedures to comply with the AMC
Performance and Valuation
(ART C)
Use of fair market prices or commonly used valuation methods.
Data that is Accurate, Relevant, Timely and Complete.
Disclosures
(TACU FIIP)
Ongoing and Timely communication with clients.
Truthful, Accurate, Complete and Understandable Communication.
All material facts regarding the Firm, Personnel, Investments and the Investment Process.
Advisors Act (I - VI)
I) Advisor Agreement Terms
II) Performance Fees
III) Client Solicitation
IV) Political Contributions
V) Trading Practices
VI) Advertising
Advisors Act (VII - XII)
VII) Recordkeeping
VIII) Personal Securities Reporting
IX) Custody
X) Proxy Voting
XI) Compliance Program
XII) Gifts and Entertainment
AIFM Requirements
(ACIL)
Required to be authorized subject to any applicable exemptions.
Caps on compensation for senior management and those in a position to gain.
AIFM must establish a maximum threshold for leverage.
Oversight duties for liquidity risks and stress tests.
EU AIFMs Requirements (6)
(ACRID C)
Meet Initial and subsequent capital requirements.
Establish Compensation guidelines who may significantly affect AIMF’s risk profile.
Create an Independent risk management group.
Provide Disclosures to investors of specific information initially and on a continuing basis.
Satisfy the Regulatory requirements of the competent authority of the home member country.
Produce an Annual report of the AIF.
ESG: Risk and Return
Return: Less support that ESG leads to higher returns.
Risk: Less systematic risk (operational controls). Less volatility.
PRI Principles
1) Incorporate ESG issues into the investment analysis and decision-making processes.
2) Be active owners and incorporate ESG issues into ownership policies and practices.
3) Seek appropriate disclosure on ESG issues by the entities invested.
4) Promote acceptance and implementation of the principels with the investment industry.
5) Work together to enhance effectiveness in implementing the principles.
6) Report on activities and progress toward implementing the principles.
Normative vs Positive
Normative: How people should behave.
Positive: How people actually behave.
Theoretical vs Emprical
Theoretical: Draw conclusions form existing observations of underlying behaviour.
Empirical: Makes predictions when behaviour is complex.
Applied vs Abstract
Applied: Solve actual real world problems in the present day.
Abstract: Solve hypothetical real world problems set in the future.
Ho-Lee Model
Arbitrage free model structured in a way that arbitrage opportunities do not exist.
Derived from the current yield curve.
Fixed-income derivatives priced with this model will reflect current bond prices.
KMV Model
Structural model that calculated volatility of equity through a structural relationship between firm’s equity market values and its assets, as well as relationship between volatilities of firm’s equity and it’s assets, uses a default trigger to model default.
Altman’s Z Score.
Financial Statement + Market Value of Equity:
Liquidity
Profitability
Leverage
Solvency
Activity
Multi-Factor Models
Allow for declining marginal utility and permit different investors to asses an economic situation as good or bad relative to their own vantage point.
Common Factors
Value
Size
Momentum
Liquidity
Credit Risk,
Term
Implied Volatility
Low Volatility
Carry Trade
Roll Premiums
Liquidity Risk
Market: No market for the asset.
Funding: Borrow is forced to liquidate holdings to cover loan obligations.
Risk Budget
Aggregate risk constraint at the portfolio level. Asset allocators can categorize exposures into risk buckets and then seek optimization of returns after risk constraints have been met.
Risk Parity
Balances risk between constituent assets so that their marginal risk contributions are equal.
Estimation Challenges in Alternative Assets (3)
1) Shorter history
2) Increased participation in alternative assets by investors diminishes the amount of alpha
3) New alternative asset classes have no historical track record
IPS
Stating the client’s long-term investment objectives together with the methodology to achieve them, advising the client and accounting for investment beliefs when determining risk tolerance and overseeing the investment strategy.
Types of Foundations
1) Operating
2) Community
3) Corporate
4) Independent
Large Endowment Outperformance (6)
Aggressive tactical allocation
Superior manager selection
First-mover advantage
Network alumni effect
Liquidity risk premium
Sophisticated investment staff
Pension Plan Risk Drivers (4)
1) Interest Rates
2) Inflation
3) Retirement Cycle
4) Mortality
Plan Sponsor Risk Tolerance (5)
1) Funded Status of the Plan
2) Fund Size
3) Expected Future Contributions Relative to the Sponsors Expected Cash Flows
4) Sponsor’s General Financial Position
5) Participant Demographics
PV Growth Annuity
[Initial Payment / (r-g) ] x {1-[(1+g)/(1+r)]^n}
Stabilization Funds
Smooth Volatility
Savings Funds
Benefit Future Generations
Reserve Funds
Meet Specific Future Liabilities
Development Funds
Promote Economic Development
Sterilization Methods to Offset Dutch Disease
1) Buy foreign currency and sell local currency.
2) Invest sovereign assets in foreign countries.
Section 1256 Contracts
60% of gains at long-term rate (20%)
40% of gains at short-term rate (~40%)
Includes futures
Advantages of Family Offices (I-V)
I) Aggressive asset allocation
II) Capturing liquidity premiums
III) Decision making speed
IV) Direct investment opportunities
V) Asset governance and management
Advantages of Family Offices (VI-X)
VI) Alignment of interests
VII) Lower costs and higher returns
VIII) Centralized risk management
IX) Cenralized provision of services
X) Management of lifestyle assets in portfolio context.
Cases in Tail Risk
1) Leverage
2) Over-Confidence
3) Risk Systems
4) Greed
Bailey (Benchmark) Criteria
Specified in Advance
Unambiguous
Measurable
Opinion (Reflective of current)
Investable
Style (Same as portfolio)
Agreed (by Manager)
CAPM vs Alts
Poor:
Multi-period non-stationarity
Non-normal returns
Illiquidity
CTA Corrleations
Low:
Traditional Asset Classes
Long Only Commodity Indexes
Variation Margin
Daily Settlement of Gains /Losses in Futures market
Margin-to-Equity Ratio
Percentage of assets held for margin relative to NAV
Unsmoothing Returns
R(t, true) = R(t, reported) - p R(t-1, reported) / (1 - p)
Delta Hedging
1) Not directional
2) Pursues superior returns through mispricing
3) Partly a bet on volatility
Rebalancing (3)
1) Enhance returns and decrease risk when mean-reverting
2) Helped when assets have high volatility and low correlation
3) Suited to commodities
Components of Risk Measurement
1) Risk Reporting (Who)
2) Dimensions of Risk (What)
3) Aggregation and Systems Development (How)
4) Frequency of Data Collection (When)
5) Investment / Position Level (Where)
Historical Key Measurement Reviews
Compare key metrics to benchmarks / min and max values / returns / standard deviation / ratios
SEC Best Practice Risk Managers (Cyber) (6)
(CITE IT)
1) Maintain a complete inventory of data, information and vendors
2) Detail Cyber security related instructions
3) Maintain prescriptive processes for testing data integrity and vulnerabilities
4) Establish and enforce controls to access data and systems
5) Provide mandatory employee training
6) Engage senior management
PCA
Uses factor loading vector vectors that are orthogonal; process can be repeated and the marginal percentage of variance explained will decrease without altering the percentage explained by previous factors.
Non-linear exposure
Occurs when value of the investment position changes based on magnitude of change in market values.
Returns can be estimated with dummy variables, separate regressions and quadratic variables.
Four Approaches to Return Analysis
1) Asset classes
2) Strategies
3) Market-wide factors
4) Specialised market factors
Commodity RV Strategies (4 x Spreads)
Location, correlation, time
1) Calendar Spreads
2) Processing Spreads
3) Location Spreads
4) Substitution Spreads
Appraisal-based indices
1) Sales comparison
2) Cost approach
3) Income approach
Hedge Fund Replication Products
1) Return enhancers
2) Risk diversifiers
3) Benchmark information sources
Benefits of Replication Products (9)
Liquidity
Transparency
Flexibility
Lower Fees
Hedging
Lower Due-Diligence Costs
Reduced Monitoring Risks
Diversification
Benchmarking
Beta Increase / Alpha Decrease Explanations
1) Fund Bubble Hypothesis (Terrible managers)
2) Capacity Constraint Hypothesis (Alpha zero sum game)
3) Increased Allocation to Hedge Funds (Traditional investors enter space)
Factor-Based Replication Approach (4 Steps)
1) Chose an appropriate benchmark.
2) Choose a set of investible factors.
3) Determine the estimation period.
4) Identify factors to include.
Payoff-Distribution Approach
Creates a portfolio to match ad desired return distribution. May match higher moments, but mean returns are lower.
Algorithmic (Bottom-Up) Strategies
Use a simplified version of the actual trading strategies implemented in the hedge funds. Only works for well defined systematic trading strategies (merger arb, convertible arb, momentum)
View Commonality
Dominant factor exposure when individual managers are aggregated.
Exposure Inertia
As number of hedge fund managers in index increases, time for common view to change increases.
Hedge Fund Access (3 Methods)
1) Direct Approach
2) Delegated Approach
3) Indexed Approach
Non-Traded REIT advantage (4)
7-10 year lifespan
Diversification
Access to skilled managers
Targeted exposure
Listed Real Estate advantage (4)
Diversification
Liquidity
Constant exposure
High information flow
Unlisted Real Estate advantage (4)
Diversification of RE Specific Risk
Access to Skilled Managers
Targeted Exposure
Tax-Advantaged Income
Direct Commodity Exposure
Pure Play
Requires Storage and Transportation –> Large initial capital ammounts.
Indirect Commodity Products (5)
Mutual Funds
ETFs
MLPs
Private Partnerships
Commodity Linked ETNs
Listed Assets Advantages (7)
Increase Liquidity
Lower Management Fees
Easier Diversification
Price Transparency
Regulatory Oversight
Enhanced Access to Financing
Tax Simplification
Unlisted Assets Advantages (7)
Illiquidity Premiums
Incentivized Management
Ability to Target Holdings
Smoothed Values
Enhanced Investor Oversight
Managerial Flexibility
Tax Benefits
ILPA Guiding Principles
Alignment of Mutual Interests
Governance
Transparency
Special Rights for LPs x 8
(MEETS CCC)
Partnership Agreement:
___
Most-favoured nation
Excuse rights
ESG
Transferability of ownership stakes
Special reporting requests
Confidentiality protections
Co-investment rights
Capital call enforcement
Illiquidity of Assets
(2 Measurements)
1) Time needed to close position if price is unaffected
2) Price at which position is closed if it must be done quickly
Market Segmentation
Investors with a long time horizon and minimal liquidity needs may prefer predictable cash flows and relatively low volatility of private real estate.
Investors with shorter time horizons may prefer low expenses and high liquidity of public real estate.
PE Performance Calculation Challenges (3)
Size
Timing
Variability of Cash Flows
Purpose of Private Equity Pools (5)
(FIMPP)
1) Pool Capital
2) Identify Potential High-Return Companies
3) Financing and Management Expertise
4) Monitoring to Portfolio Companies
5) Profitable Exits
Six Challenges of Performance Persistence
(CUSP DV)
Comparing dissimilar funds
Unclear definition of top performance
Secular market trends
Performance due to fund size growth and not manager skill
Distinguishing between skill and luck
Variable performance dispersions
Considerations when analysing past performance for mangers’ funds (3)
(LSC)
1) Length of time managing current and previous funds
2) Stability of returns over time and across funds
3) Comparison and contrast of fund investment strategies amongst the funds
Investment Process Risk
Refers to risk of errors and incorrectly applied decisions, policies and procedures in front office - resulting in incorrect asset exposures.
Independent Third Parties should value fund assets because fund managers have incentives to (4):
(HASI)
1) Hide or defer losses
2) Smooth returns
3) Alter risks to recoup losses or secure profits
4) Inflate asset values to generate more fees
Six Risk Alert Observations on Asset Values and Due Diligence
(VATE QQ)
More use of third-party Verification
Avoiding Ambiguity in valuations, performance reporting and measurement
More reliance on Transparency reports
Greater importance of External dealer quotes for valuations
More detailed Quantitative analysis and risk measurement
More use of Quantitative analysis in investment decisions
Investment Warning Indicators (4x)
(TIII)
Lack of willingness by the manager to be transparent
Investment returns incongruent given the investment strategy
Investment process that is unclear
Inadequate controls and segregation of duties
Trade Allocation
Distributing new positions among funds. A common allocation is on a pro rata basis.
Trade Execution
Completing a trade. Trades are usually listed on a trade blotter.
Trade Posting and Settlement
Internal logging of trades and completion of trade confirmations.
Trade Reconciliation
Confirming Details of Each Trade
PE ODD (8x)
[D-DOS-I-POO]
1) Document Analysis
2) Document Collection
3) On-site Visits
4) Service Provider Reviews and Confirmations
5) Investigative DD
6) Process Documentation
7) Operational Decision
8) Ongoing Monitoring
Warning Signals of Operational Risk (9)
CAVETTO AF
Conflicts of interest (evidence of undisclosed…)
Administrator (no qualified external administrator)
Valuation process (weak)
Employees (red flags in background checks of key employees)
Third party service providers (frequent changes)
Transparency (none)
Operating infrastructure and compliance systems (weak)
Auditor (unknown)
Financial Statements (red flags in audited)
Objectives of OM/PPM
Educating LPs
Disclosing Risk
Assigning Risk
Assigning Decision-Making Authority
Six Properties of Realized Volatility
1) Nonconstant and exhibits behaviour of slow mean reversion and clusters.
2) Normally low until a market shock occurs, which causes volatility to rise for an extended period.
3) Can spike in the short term, but long-term volatility levels are near long-term averages.
4) Negatively correlated with risks asset returns when volatility is high.
5) Higher in equity bear markets and lower in equity bull markets.
6) Has greater rate of increases in bear markets than rate of decreases in bull markets.
Variance Swaps (2x benefits)
Avoids high transaction costs of hedging
Avoids path dependence of options.
Volatility Hedge Fund Strategies
1) Relative Volatility
2) Short Volatility
3) Tail Risk
4) Long Volatility
Unpredictability
Unknown outcome with unknown probability
Ambiguity
Relates to unknown future returns and probabilities of financial asset.
Opacity
Occurs when characteristics of an asset are unknown.
Complexity
Makes it difficult to precisely estimate probabilities and outcomes of investment decisions.
Estate Complexities in Cross-Border Investing (6)
TREAT I
Transaction costs
Regulatory restrictions
Exchange Rate Risk
Access to Local Services
Taxation
Insufficient knowledge of agency costs
Real Estate Taxes Imposed on Foreign Investors
1) WHT
2) Sales Taxes
3) Property Taxes
4) Flat Taxes
International Real Estate Investment Risks
1) Political
2) Economic
3) Legal
