Topic 7: Accessing Alts Flashcards

1
Q

Define Exposure Inertia

A

Slower speed that common views change over time\

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2
Q

Define View Commonality

A

Views tend to cluster into common themes

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3
Q

Define Netting in the context of risk

A

Paying incentive fees for profitable funds and offsetting reductions from non-profitable funds

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4
Q

Name some of the benefits unique to hedge funds replication

A
  • liquidity
  • transparency
  • lower fees
  • flexibility
  • hedging opp
  • lower due d and monitoring risks
  • diversification
  • benchmarking
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5
Q

Describe efficiently inefficient markets

A

Markets that are efficiently inefficient are inefficient enough to compensate money managers and investors for costs and risks, but not so inefficient so as to provide numerous managers with arbitrage opportunities that are easy to exploit. These markets are neither perfectly efficient nor completely inefficient.

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6
Q

What is the fund bubble hypothesis?

A

Increased supply of investment capital results in more less-qualified managers entering the industry.

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7
Q

Using a factor-based replication approach to replicate hedge fund returns, how should we estimate the weights of the risky assets in the portfolio?

A

As BETAS in the regression equation for return

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8
Q

What is the capacity constraint?

A

Alpha is a zero-sum game such that per-capita alpha is decreased as allocation to investment capital to hedge fund increases

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9
Q

Describe the classic convertible arbitrage strategy

A
  • buy convertible bond
  • short sell common stock
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10
Q

To replicate hedge fund using factor based approach involves the following steps:

A
  1. Benchmark
  2. Set of factors
  3. Length of estimation period
  4. Number of factors
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11
Q

Steps of a factor-based replication program

A
  1. Estimate weight of risky assets in replicating portfolio (beta of regression equation)
  2. Estimate weight of cash
  3. Invest in different areas (determine out of sample returns)
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12
Q

What is stepwise regression?

A

Step-by-step iterative construction of a regression model that involves the selection of independent variables to be used in a final model.

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13
Q

In an underpriced call option, the implied volatility of the underlying stock is LESS/MORE than expected volatility.

A

In an underpriced call option, the implied volatility of the underlying stock is LESS than expected volatility.

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14
Q

What products give rise to alternative betas?

A
  • currency
  • volatility
  • commodity
  • CTA
  • structured products
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15
Q

In a delta hedged position, if the stock in the underlying convertible bond increases in value, how can we maintain delta neutrality?

A

Increase the # of stocks shorted

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16
Q

What is a return source for traditional convertible bond arbitrage strategy?

A

Positive gamma
Volatility that exceeds market expectations (embedded in the convertible bond’s original price)

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17
Q

What does the Liew et al’s bifurcated fund analysis model evaluate?

A

1) mean variance of returns
2) rankings from peer group scoring method

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18
Q

What are the 3 challenges associated with constructing an asset weighted hedge fund portfolio?

A
  1. Declining Alpha
  2. AUM may fluctuate
  3. Style drift
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19
Q

Empirical evidence of hedge fund returns from 1998 to 2018

A
  1. returns generally declined
  2. returns not driven / fully explained by equity market returns
  3. returns lower than EQ returns
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20
Q

Alternative mutual funds restrictions

A
  1. max 15% of AUM can be invested in illiquid securities
  2. max 33% leverage
  3. Daily liquidity
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21
Q

Advantage of ETFs over mutual funds

A
  1. traded throughout day
  2. daily disclosure
  3. tax advantages (due to LOWER turnover and in-kind redemption)

*In Kind redemption: deliver securities increased in value in exchange for ETF shares

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22
Q

Equal weighted hedge funds + rebalance when returns mean reverting = performance is

A

good

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23
Q
  • Individual fund strategy INDICES tended to exhibit about ___ of the TOTAL risk and about ____ of the SYSTEMATIC risk of the equity INDICES.
  • Average hedge fund returns tended to exhibit about ___of the equity indices’ total risk.
  • Average hedge fund returns tended to exhibit about ____the equity indices’ systematic risk.
A
  • Individual fund strategy indices tended to exhibit about HALF of the TOTAL risk and about ONE-THIRD of the SYSTEMATIC risk of the equity indices.
  • Average hedge fund returns tended to exhibit about one-third of the equity indices’ TOTAL risk.
  • Average hedge fund returns tended to exhibit about one-sixth the equity indices’ SYSTEMATIC risk.
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24
Q

What is the risk parity approach?

A

Weights are selected so that each fund makes the same contribution to the portfolio’s total volatility

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25
Q

____ FoFs pursue opportunistic exposure to a specific market factor and are typically composed of 5-15 hedge fund

A

Tactical FoFs pursue opportunistic exposure to a specific market factor and are typically composed of 5-15 hedge fund

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26
Q

Which commodity investments are also referred to as prepaid forward contracts

A

ETNs. Exchange-traded commodity index-linked notes that are economically equivalent to fully collateralized forward contracts for delivery of the index value (hence the term prepaid forward contracts).

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27
Q

Are non-traded US REITs available to retail investors?

A

Yes, shares are available to retail investors who meet suitability standards.

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28
Q

Advantages of SWAPs to FUTURES

A
  1. A commodity index can be selected to meet their needs (when appropriate futures are unavailable).
  2. Long-term swaps are available (vs. long-term futures that may not be unavailable or illiquid).
  3. Investors maintain control of and can manage their cash and earn more than the risk-free rate (i.e., the collateral returns from futures positions).
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29
Q

Benefits of ETNs

A
  • little tracking error since the issuing firm promises to pay the return on an index.
  • ETNs can qualify for long-term capital gains tax treatment if they are held for long enough (generally for more than one year).
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30
Q

Characteristics of long-biased hedge funds in commodity futures markets?

A

Short lock up

High transparency

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31
Q

Arnold et al.’s study on the performance of closed-ended private equity real estate (PERE) funds found which of the following relationships between fund size and vintage volume and PERE fund performance

A

Bigger fund size = higher international PERE fund returns

Higher vintage volume = worse PERE fund returns.

32
Q

Characteristics of real estate MLPs

A
  • stable cash flows (because they have high barriers to entry), but equity-like volatility and drawdowns in stressed markets (mainly because they are mostly held by retail investors who tend to react severely to bad news).
  • MLPs must generate at least 90% of their income from “qualified sources”.
  • MLPs do not have required distribution minimums (in contrast to REITs).
  • MLPs are exempt from income tax at the corporate level (not at the investor level).
33
Q

Which has collateral requirements? - Swaps
- Futures
- Exchange-traded notes

A
  • Futures
  • Exchanged traded notes
34
Q

PERE funds ____performed equity REITs in the vintage years with ____ vintage volume.

A

PERE funds UNDERperformed equity REITs in the vintage years with LARGE vintage volume.

35
Q

What are the 3 guidelines for GP-led secondary transactions?

A
  1. Engage LP advisory committee around objectives, logic, process, terms and financing
  2. Ensure processes are fair and transparent
  3. Experienced advisor to solicit bids at the cost of the GP (not fund)
36
Q

The three Institutional Limited Partners Association (ILPA) guiding principles

A
  1. alignment of interest
  2. governance
  3. transparency
37
Q

In private equity, what is the overcommitment strategy?

A
  • pledge to invest more funds that investor has currently available
  • purpose to increase investment and avoid idle cash
  • in overcommitment strategy, anticipated distributions are forecasted as being available to honour capital calll
38
Q

In private equity, what does most favoured nation status mean?

A

Letter is to be used when an investor requests written assurance that it will have the same rights as some or all of the other investors in the PEF.

39
Q

How should performance figures of private fund be disclosed?
- gross
- net
- both

A

both

40
Q

When extending the term of a private fund, what are the ILPA guiding principles?

A
  1. Extensions should be in 1-year increments and require MAJORITY approval of the LP Advisory Committee or the LPs.
  2. The GP should be required to liquidate the fund within ONE year of the expiration of the fund’s term.
41
Q

In private equity, what does excuse rights mean?

A

Allow an LP to opt out of participating in a particular investment if the investments fall within previously agreed upon restrictions

42
Q

What is considered best practice for the waterfall structure of a private fund?

A
  • Return investor contributions in full
  • Pay preferred return
43
Q

What are the ILPA guiding principles wrt clawbacks?

A
  1. liabilities determined and disclosed to LPs at end of every reporting period
  2. clawback amounts GROSS of taxes paid, repaid no later than TWO YEARS
  3. clawback periods must extend beyond fund’s terms
  4. ability to directly enforce clawback against individual GPs
44
Q

ILPA guidelines for calculating carried interest

A
  1. Calculate carried interest on a NET AFTER profit basis.
  2. Calculate preferred return from the capital contribution date to the distribution date.
  3. Ideally use a HARD hurdle.
45
Q

How frequently should valuation information about a private fund’s portfolio companies should be disclosed

A

Quarterly

46
Q

In the PE market, what is the denominator effect?

A

When the portfolio grows, so illiquid asset size grows bigger

47
Q

risk-adjusted real estate returns of private real estate funds is typically ___ than returns on listed REITs

A

LOWER

Because private funds have higher fees

48
Q

Describe on-the-run Treasury securities

A

Treasury securities that have most recently been issued by the U.S. government are referred to as on-the-run securities.

49
Q

Describe Fundamental Law of Active Management (FLOAM)

A

Information Ratio = Information coefficient x square root of Breadth

50
Q

Describe the information coefficient

A

correlation between a manager’s forecasted asset returns and actual returns of those assets

51
Q

What happens when you incorporate transfer coefficient into the formula?

A

Transfer coefficient (TC) is typically less than one, thus incorporating will lower the information ratio

52
Q

What is the transfer coefficient?

A

The transfer coefficient (TC) measures the manager’s ability to implement her recommendations. Relaxing the long-only constraint would increase her TC.

53
Q

What are the two factors that sound tactical asset allocation models should have?

A

1) economically meaningful signals
2) no data mining
3) no overfitting

54
Q

What is the foregone loss carry forward?

A

Money is taken from an investment that is under its high watermark and thus does not pay the manager performance fees

55
Q

What is the information ratio as defined by FLOAM

A

In the original FLOAM framework, a manager’s information ratio is a function of his SKILL (represented by his information coefficient) and the number of independent FORECAST he has made (represented by his breadth). Specifically, the information ratio equals the product of the information coefficient and the square root of breadth.

56
Q

3 key questions to ask in performance review of fund manager selection

A
  1. PM experience
  2. consistent performance?
  3. how do strategies compare and contrast
57
Q

Takeaway of 3x3 transition matrices

A

Manager performance persistence

Results confirm the existence of performance persistence: a top-performing private equity fund (i.e., in the upper third of performance) has a 42% chance of having a top-performing follow-on fund, and a fund in the lower third of performance has a 43% chance of having a follow-on fund in the lower third of performance

58
Q

What’s the difference between:
1. Established
2. Blue Chip
3. Emerging
4. Re-emerging

A
  1. established: top-quartile performance for most of its funds (> 3 funds) for at least 2 business cycles
  2. blue chip: top-quartile performance for all of its funds for at least 2 business cycles
  3. emerging: limited joint history; with all the characteristics to become an established team
  4. re-emerging: previously good, restructured
58
Q

Define transition matrix

A

probabilities (or frequency) of subsequent outcomes based on previous outcomes

59
Q

In the context of portfolio management, what does gaming mean?

A

Self-serving management of returns to increase performance measures rather than managing returns to benefit investors

60
Q

Difference between Moral Hazard and Adverse Selection

A

Moral Hazard = one party’s behaviour changing to the detriment of another party due to incentives in a contract

Adverse Selection = decisions made by undesirable party to be attracted to the transaction

61
Q

3 questions to ask about a fund’s investment objective

A
  1. in what markets and assets
  2. general strat
  3. benchmark
62
Q

Feffer and Kundro, what has been a cause of about half of fund failures

A

Operational Risk

63
Q

Name the four standard hedge fund operational due diligence framework for allocating resources

A
  1. dedicated: 1 employee
  2. shared: those responsible share the responsibility
  3. hybrid: mix
  4. modular: components spares out to specialists then ops generalist combines the work
64
Q

what is the hardship exemption?

A

allows employees to sell teh position within min. holding period

65
Q

best practice for reconciliation of a hedge fund’s trading process

A

three way recon: HF, trading counterparts, third party admin

66
Q

Define meta risks

A

Qualitative risks beyond measurable financial risks.

67
Q

What is a trade break?

A

A trade break is a trade that fails to execute.

68
Q

how long does it take to reconcile highly liquid stocks

A

T+1

69
Q

Top factors that disqualify funds from investment:

A

returns, risk, compliance, experience, and operational risk.

70
Q

2 primary equity investor motivations

A
  • tax
  • limit liability among the entities
71
Q

Exculpation vs Indemnification

A

Exculpation: releases party from liability
Indemnification: compensating party for loss

72
Q

What can a qualified vs simple majority do?

A

Qualified: stop funding
Simple: good leaver

73
Q

Netting Risk

A

Paying incentive fees to profitable funds in a portfolio without offsetting losses incurred by unprofitable funds in the portfolio.

This adversely affects investors when profitable funds get paid when the aggregate fund return is negative (or zero).

74
Q

Headline Risk

A

Publicity Risk