CAIA Level II

In an engagement strategy,

an investor with a long position in the stock starts a dialogue with the company with a specific agenda on how to improve the ESG standing of the company.

beneficiaries,

or descendants who receive a share of the family wealth

Unlisted Manager-Investor Relationships - Key Person Triggers and Process to Remove:

(1) A "key person" or "for cause" event should result in a suspension of the investment period; (2) in the event of an investment period suspension triggered by the key person provision, the GP should not otherwise use fund assets; and (3) any such vote to reinstate the investment period or to remove the GP should exclude the LP interests held by the GP or its affiliates.

What are the three most typical external credit enhancements from credit card receivables?

(1) Cash collateral accounts, (2) third-party letters of credit, and (3) collateral invested amounts.

What are the three key observations behind the financial economics of delta-hedging between an option and its underlying asset?

(1) Delta-hedging is not a directional speculation on the stock price, (2) if a stock is efficiently priced, all trading strategies on that stock have an NPV of zero, and (3) delta-hedging is part of a speculation on volatility.

Unlisted Manager-Investor Relationships - Fund Term Extensions:

(1) Extensions should be in 1-year increments and require majority approval of the LP Advisory Committee or the LPs; and (2) the GP should be required to liquidate the fund within one year of the expiration of the term of the fund.

Unlisted Manager-Investor Relationships - Fiduciary Duty:

(1) GPs should clear all potential conflicts of interest with the LP Advisory Committee (LPAC); and (2) as a general rule, GPs shouldn't undertake action that constitutes or could potentially constitute a conflict of interest between the fund, a portfolio investment, and/or a portfolio manager on one hand and the GP, key persons, affiliates, etc. on the other, without prior written approval from the LPAC.

Unlisted Manager-Investor Relationships - Vehicles Investing Alongside the Fund:

(1) Investments by such additional vehicles should be made at the same time as the fund and should be sold at the same time; and (2) investment results of any alternative vehicles should be aggregated with the investment results from the fund for the purpose of determining distributions.

Unlisted Manager-Investor Relationships - Time and Attention:

(1) Key persons should devote substantially all their business time to the fund, its predecessors and successors within a defined strategy, and its parallel vehicles; and (2) key persons for the fund, as identified in the LPA, must not act as a GP for a separate fund managed by the same firm with substantially equivalent investment objectives until after the investment period ends.

Unlisted Manager-Investor Relationships - LPAC Best Practices:

(1) The mandate of the LPAC should be clearly disclosed and should generally include matters specific to evaluating conflicts of interest as presented by the GP; (2) GPs should be able to articulate the rationale for how LPAC members are selected; (3) LPACs should meet regularly on a pre-agreed cadence, with the option to attend remotely via telephone or video; (4) the cost of LPAC participation in LPAC meetings should be borne by the fund; (5) simultaneously with each closing, the list of LPAC members should be disclosed to all LPs in the fund, and (6) the GP or the LPAC should appoint a rotating chair to chair LPAC meetings

What are two major shortcoming of an empirical study that examines performance persistence of funds by comparing the correlation of returns in an earlier period with returns in a subsequent period when returns are based on appraised values?

(1) The results could be driven by serial correlation in returns that does not reflect true performance correlations, and (2) the returns are not risk-adjusted.

three (The Institutional Limited Partners Association) ILPA guiding principles:

(1) alignment of interest; (2) governance; and (3) transparency. The following sections summarize some of the key elements considered to be especially important by limited partners. The Principles have received quite limited endorsement by GPs.

Five areas commonly included in background investigations:

(1) criminal searches; (2) civil searches; (3) regulatory searches; (4) media searches; and (5) factual information searches

The alternative investment ODD process employed by investors typically has seven primary steps and an eighth step (ongoing monitoring) in the event that an investment is made:

(1) document collection; (2) document analysis; (3) onsite visit; (4) service provider reviews and confirmations; (5) investigative due diligence; (6) process documentation; (7) operational decision; (8) ongoing monitoring (if the investment is made).

List the three major advantages of investing directly with hedge funds.

(1) the cost savings from avoiding an extra layer of fees charged by a fund of hedge funds, (2) access to cost-effective, experienced consultants to assist implementing the approach, and (3) the ability to have improved control and transparency in the asset allocation and due diligence process.

The six sentiment indicators are:

(1) the discounts on closed-end funds; (2) the turnover of New York Stock Exchange (NYSE) shares; (3) the number of initial public offerings (IPOs); (4) the average first-day returns on IPOs; (5) the equity share in new issues; and (6) the dividend premium.

The two primary adverse effects of multicollinearity are:

(1) the estimates of the slope coefficients for each of the correlated independent variables may be highly inaccurate; and (2) the standard errors for the correlated independent variables may be inflated (large).

two exemptions from SEC registration that many fund managers may rely upon are:

(1) the exemption for any adviser solely to one or more venture capital funds (venture capital fund adviser exemption); and (2) the exemption for any adviser solely to private funds with less than $150 million in assets under management (private fund adviser exemption).

The potential advantages of secondary market PE purchases are:

(1) the potential discount at which a transaction may take place; (2) the shorter period during which the invested capital is locked in and management fees are paid; and (3) the portfolio diversification properties of secondaries.

Cornerstone describes three phases of the impact of adverse ESG events:

1)In the emerging, or "pre-financial" phase of an ESG life cycle, a shift (subtle or overt) commences that ultimately has environmental, social, and/or governance consequences for a sector. 2)In the "transitional" phase, the ESG shift becomes increasingly visible, but neither its timing nor its ultimate financial impact are particularly clear. 3)In the ultimate phase of the life cycle—the "financial" phase—the full financial impacts of the ESG event are felt

A vertical spread is a

combination of long calls and short calls (or short puts and long puts) having the long options with one strike price (the long leg) and the short options with a different strike price but with the same expiration dates. The spread is intra-asset when it involves options from the same asset. The vertical spread is a type of skew spread. At expiration, a vertical spread will have a minimum value of zero, when both options expire out-of-the-money. The maximum value will be equal to the difference between strike prices when both options are in-the-money.

Panel data sets

combine the two approaches by tracking multiple subjects through time and can also be referred to as longitudinal data sets and cross-sectional time-series data sets.

Pro rata allocation is a

common allocation method by which a firm allots shares in the securities purchased to different funds and accounts based on predetermined proportionate amounts, such as assets under management, or a fund's predetermined target allocation size.

What are some of the ways in which private equity GPs can create wealth?

GPs can create wealth through (1) assembling a top management team, (2) selecting portfolio companies with high return potential, (3) working with or replacing the management teams of those portfolio companies, (4) tapping the GP's networks to bring in personnel and contacts to optimize the potential success of each portfolio company, and (5) assisting the successful portfolio companies to perform exits that maximize the creation of wealth.

Describe the goals of the Global Reporting Initiative (GRI) and the Global Reporting Initiative Standards.

GRI seeks to help businesses and governments worldwide understand and communicate their impact on critical sustainability issues such as climate change, human rights, governance and social well-being. The GRI standards are meant to enable all organizations to report publicly on their economic, environmental, and social impacts - and show how they contribute towards sustainable development. The standards also serve as a reference for policy makers and regulators.

The consultant replies that "...Empirical evidence shows that newer investors pursuing access to top managers (in alternative investments), especially in venture capital, are expected to underperform when the top managers allow commitments only from those investors who participated in their earlier funds." Is the consultant's reply correct?

The consultant's reply is correct.

Value Creation

The opportunity for private equity can be expressed as the difference between the cost of sound ESG management and its resulting impact on costs, profitability, revenue and the balance sheet. Measures might include EBITDA during the holding period, exit multiples and the ease of exit. Possible benefits: Improved ESG performance can create operating efficiencies that translate into cost savings and improved financial performance Energy efficiency or employee / workplace plans can have a positive financial impact, with a short payback period that can be measured from the financial accounts Development of new products and improved innovation Compliance with environmental / social law reduce possibility of fines and penalties.

What is the difference between a risk parity portfolio and a minimum volatility portfolio?

The risk-parity approach proposes that the portfolio allocation to each asset class should be set so that each asset class has the same marginal contribution to the total risk of the portfolio. By doing so, the risk parity portfolio recommends an equalization of the risk contributions of each asset class in the portfolio. In turn, the minimum volatility portfolio is constructed using mean-variance optimization, with the goal of assigning positive weights to create a portfolio with minimum standard deviation (when used as a measure of total risk), regardless of mean returns.

trade blotter

The running list of all trades desired and completed during each trading day is commonly referred to as a trade blotter. After trading instructions are received by the centralized trading function, trades can then be executed with brokers or counterparties via either electronic interface or telephone. Funds may record these telephone conversations in case there is a discrepancy regarding the actual executed trade and the instructions provided by the fund. For electronic trading, different technology protocols, such as the Financial Information eXchange (FIX) protocol, may be used.

In terms of correlations between real estate and other asset classes, what is the effect of using the XYZ RE Index returns (original smoothed data) versus the unsmoothed version of this index returns?

The use of XYZ RE Index returns (original smoothed data) understates the correlation of the (smoothed) returns to the returns of other asset classes. In a mean-variance framework, the combination of low volatility (already discussed in the previous exercise) with the low correlation of smoothed returns would assign weights to real estate that can be substantially higher than those corresponding to unsmoothed data.

the consultant cautions that, during times of market turmoil "...Endowments that invest in leveraged hedge funds must be prepared for the potentially large drawdowns in these strategies, as well as the potential for the erection of gates." Is this advice by the consultant correct?

This advice by the consultant is correct and consistent with events that occurred during the recent financial crisis.

hurt money

This capital contribution by GPs, also known as hurt money, should be contributed in cash rather than through waiving of management fees (or through surplus from the management company's budget). Typically, the GP's contribution to the fund is a significant share of his or her personal wealth, whereas the LPs' investment, although in absolute terms far higher, represents an immaterial share of the institution's overall assets.

the consultant comments that "...In the case of traditional investments, security selection and market timing of pension plans explained a very large percentage of the variance in pension fund returns. The remaining portion of fund returns can be explained by strategic asset allocation." Is this comment by the consultant correct? Explain.

This comment by the consultant is incorrect. In the case of traditional investments, studies indicate that the strategic asset allocation of pension plans accounted for between 91.5% and 93.6% of the variance in fund returns. The remaining portion of fund returns, between 6.4% and 8.5%, is explained by security selection and market timing.

For natural resource investors, compliance with health and safety standards for workers, customers, and surrounding communities would most likely fit into which component of ESG: Environmental, Social, or Governance?

This issue would fall under Social considerations.

Can a family office eliminate the potential conflicts of interest to which a wealthy family is subject to when it allocates capital to different financial advisers and managers? Explain.

When a wealthy family allocates capital to different financial advisers and managers, it usually encourages competition among outside money managers and creates incentives that can be detrimental to the family. A family office removes these possible conflicts by producing structures where the interests of the total family, external money managers, and the family office are aligned toward common objectives. For example, by combining the money of the family members, the family office can negotiate fee breaks and other beneficial conditions that a single family member may not be able to achieve. Finally, by taking more asset management in-house family offices mitigate external conflicts of interest and have a greater power to negotiate fees.

Closed-end real estate mutual funds (CEMFs)

are exchange-traded mutual funds that have a fixed number of shares outstanding and that represent only a small portion of the listed real estate industry. Shares in closed-end real estate mutual funds are traded on stock exchanges; therefore, they should be classified as a listed real estate investment. CEMFs invest in REITs and real estate operating companies and offer the possibility of gaining a diversified exposure to the real estate asset class with just a small amount of capital. Real estate closed-end mutual funds usually liquidate their real estate portfolios and return capital to shareholders after an investment term (typically 15 years), the length of which is stated at the fund's inception.

Prepaid forward contracts

are fully collateralized forward contracts for delivery. Thus, a commodity exchange traded note is economically equivalent to a prepaid forward contract on the index value.

Program-related investments (PRI)

are investments offering ESG impact and no financial return or offering a combination of ESG impact as well as a subcompetitive risk adjusted financial return.

Mission-related investments (MRI)

are investments viewed as offering a combination of ESG impact as well as financial return. MRIs are often further defined as offering competitive risk-adjusted returns along with ESG impact.

Estate taxes

are levied by governments in many jurisdictions on accumulated wealth after the death of its owner. While assets distributed to family members are often subject to these taxes, the estate tax law in many jurisdictions allows the distribution of assets outside of the family for charitable purposes on a pre-tax basis.

Counterparty Risk can be

difficult to detect and dangerous to investors. Fund managers frequently establish positions in over-the-counter derivative instruments. The counterparty to such trades is often a large investment house or a large money center bank. When a fund manager establishes these derivatives, the fund takes on the credit risk that the counterparty might fail to fulfill its obligations under the derivative contract by declaring bankruptcy. A counterparty is most likely to fail during periods of enormous market stress and when its derivative positions have large unrealized losses.

Co-integrated stock prices

exist when a linear combination of the two is a stationary process.

Herd behavior is the

extent to which people are overly eager to adopt beliefs that conform to those of their peers.

A related concept is that of

extreme mortality risk. Extreme mortality risk arises because of the threat of very high mortality rates due to natural disasters, pandemics, and terrorist attacks rather than idiosyncratic causes of death.

In an overcommitment strategy,

future anticipated distributions (or other anticipated cash inflows) are forecast as being available to honor the capital calls to new funds.

In the case of a private equity fund, a subscription-secured line of credit (SLOC)

is a borrowing facility that is collateralized with the capital commitments to the fund from its investors.

A conditional correlation

is a correlation between two variables under specified circumstances. For example, an analyst may estimate the correlation coefficient between a hedge fund's returns and the returns of an equity index during only those months in which the stock market rose by 1% or more.

The funded status of a pension plan

is a measure of the plan's current assets compared to its projected benefit obligation (PBO) or accumulated benefit obligation (ABO).

The Global Reporting Initiative (GRI)

is a nongovernmental organization (NGO) that promotes improved reporting principles and disclosure of ESG-related issues through the development of the GRI Standards.

An objective

is a preference that distinguishes an optimal solution from a suboptimal solution.

A common investment objective of pension funds

is a return target X% above the liability discount rate.

Risk parity

is an asset allocation approach that identifies asset allocations based on balancing the contribution of each asset to portfolio risk without regard for expected return.

The commitment-weighted IRR

is an average calculated by weighting the rates of return by commitment. The commitment-weighted IRR does not capture the true weight of each fund's actual value. However, it might be useful for measuring the LP's skill in selecting and allocating the right amount to funds.

Cross-sectional momentum

is defined and measured by the relative performance of a security within a group of securities, such as classifying a stock as having positive momentum if its recent performance is in the top 50% of all stocks. The cross-sectional approach is traditionally used to indicate momentum in factor return studies, including those of Fama and French.

The dividend premium

is defined as the difference between the average market-to-book-value ratios of dividend payers and nonpayers.

Return on assets (ROA)

is profit before financing costs (and taxes), expressed as a percentage of assets.

Reserve adequacy

is the estimated size for stabilization fund reserves that is considered necessary before starting to invest in risky assets and moving funds into a total return portfolio.

Charity

is the giving of money or time to social causes, typically to meet more immediate needs and without accountability on behalf of the recipient. For example, a donor may make a charitable gift to a homeless shelter that feeds and houses those with immediate need, without seeking to overcome the situation of poverty through counseling or job training.

The volatility anomaly

is the idea that low-volatility stocks are underpriced and therefore offer higher expected risk-adjusted returns and may be justified by market imperfections and the leverage aversion theory.

The breadth (BR)

is the number of independent forecasts (or "bets") that the manager can skillfully make during a given period of time (e.g., 1 year).

Multicollinearity

is when two or more independent variables in a regression model have high correlation to each other. A primary method of detecting multicollinearity is to examine the correlations between the independent variables.

Authorized PUTs (APUTs) are

issued in the UK and are intended mainly for retail investors and offer exemption from capital gains tax on disposals of investments in the fund. Furthermore, there is no extra tax liability for exempt or corporate investors on distributions from the fund, but credit for any tax paid into the fund is not available.

A dispersion trade combines a

long (short) position in an index option with short (long) positions in the options of the index's constituent assets. Note that the value of a portfolio of options on individual assets is higher than the value of an option on a portfolio (index) of those same assets (assuming that the options all have the same expiration dates and that the strike price of the index option is equal to the sum of the strike prices of the individual asset weighted by the index's weights). Therefore, if there are no changes in volatilities or correlations over the lives of the options, then the trader who is long the option on the index (portfolio) and short a portfolio of options will make money.

Pension plans (also known as pension schemes or superannuation plans)

manage assets that are used to provide employees with a flow of income during their retirement years.

Fund capacity refers to the

maximum amount of assets under management that allows the fund manager to implement the investment strategy effectively. Fund managers might dilute their skill by allowing a greater amount of capital into the fund than is optimal from the perspective of the existing investors. Too much money chasing a limited-capacity investment idea moves the price of the security away from the investor, cutting into the alpha that might have otherwise come from the idea.

Graphically, the minimum volatility portfolio

may be envisioned in a mean-variance framework as the leftmost point on a mean-variance efficient frontier where the frontier is tangent to a vertical line.

Posting is a term commonly used to refer to the

process by which trades are logged internally at a fund, whether through order management or through fund accounting systems.

Subordinated debt with payment-in-kind (PIK) interest is a type of obligation that does not

provide any cash flows (interest or principal repayment) from the borrower to the lender prior to the maturity of the loan (or the refinance date), but rather accrues an increasing debt balance. This means that both interest and principal payments become due in one balloon (bullet) payment when the debt matures.

An excess return index

provides returns over cash and is linked to the price movements of a basket of commodity futures contracts.

In the duration matching approach,

the duration of the hedging bucket is matched to the duration of the liabilities. The approach is simple to implement but requires careful monitoring as changes in the yield curve and credit spreads will impact the duration of assets and therefore the portfolio will have to be rebalanced.

A viatical settlement is a

transaction in which a sick policyholder sells his or her life insurance policy at a discount to its face value. The buyer obtains the face value of the policy when the original policyholder passes away. It is sometimes difficult to distinguish viatical settlements from life settlements. However, the transaction is a viatical settlement if the life expectancy of an insurance policyholder is less than 2 years.

The chief financial officer (CFO) is

typically the investor's most important link of investors to the fund manager because the CFO is ultimately responsible for reporting the fund's performance numbers. Consequently, the investor should make sure that the CFO has a strong background in accounting for investments, preferably including a major professional accounting designation.

This lack of rebalancing results in a drifting asset allocation,

where the allocations to asset classes change based on returns of each asset class with the highest-returning asset classes growing as a share of the portfolio.

conservative investment opportunity cost,

where the longer conservative assets are left in cash, the greater the lost returns relative to what could have been earned on a balanced portfolio that includes investments in risky assets.

An advertisement includes

any written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, that offers any analysis, report, or publication regarding securities; any graph, chart, formula, or other device for making securities decisions; or any other investment advisory services regarding securities.

Community foundations

are based in a specific geographical area, concentrating the charitable giving of the region's residents.

The effective tax rate

is the actual reduction in value that occurs in practice when other aspects of taxation are included in the analysis, such as exemptions, penalties, and timing of cash flows.

in the case of unequally volatile assets with equal return correlations between pairs of assets,

only the risk-parity and inverse-volatility strategies generate the same allocations.

Real Net Investment Returns Formula

(1+Rreal)=(1+RNominal)/(1+Inflation rate)

A constraint

is a condition that any solution must meet.

A matching contribution

is a voluntary contribution made by an employee that is augmented by additional contributions by the employer.

the home member state

is the EU country where the AIFM is authorized.

The Securities and Futures Commission (SFC)

is the regulator responsible for overseeing the SFO in Hong Kong.

A top-up fund

is used to co-invest in one or more future investments of the main fund.

The four areas commonly overseen by the compliance department are:

(1) initial and ongoing personnel training on compliance-related matters; (2) testing of the implementation of compliance policies; (3) monitoring and managing conflicts of interest; and (4) ensuring adherence with regulatory requirements in the jurisdictions in which the firm operates.

Unlisted Manager-Investor Relationships - ESG Policies and Reporting:

(1) GPs should consider an ESG policy.

Describe the three assumptions of a Geometric Brownian Motion (GBM).

(1) a constant variance through time, (2) are normally distributed, and (3) are uncorrelated through time.

The primary equity investor motivations of designing fund legal structures are:

(1) to facilitate the implementation of tax efficiency; and (2) to limit liability among the entities involved. For tax efficiency, the fund manager may invest the fund's assets through an offshore master trust account or fund, discussed later. For limited liability, the funds are organized through partnerships with outside investors as limited partners.

put-call parity,

+Stock+Put−Call=+Bond the put and call are both European options with identical expiration dates and strike prices. Intuitively, the long position in a put (+Put) removes the downside risk exposure from being long the underlying asset (+Stock), whereas the short position in the call (−Call) gives up the profit potential from price increases in the underlying asset. The combination removes all risk, creating the equivalent of a long position in a riskless bond (+Bond).

Credit enhancements of credit card receivables can be internal, external, or a combination of both, and are required if the structure is to receive higher credit ratings. The three most typical external credit enhancements from credit card receivables are:

1 Cash collateral accounts: These are accounts funded when a series is issued and created by the securitization trust, which can be used to fund principal and/or interest on the certificates and other trust expenses when the excess spread turns negative. 2 Third-party letters of credit: These are backed by external institutions that provide protection against losses from defaults. 3 Collateral invested amounts (also known as CIAs): These consist of privately-placed ownership interests in the securitization trust, and are subordinate in payment rights to all investor certificate holders.

PRI principles for private equity

1 We will incorporate ESG issues into investment analysis and decision-making processes. 2 We will be active owners and incorporate ESG issues into our ownership policies and practices. 3 We will seek appropriate disclosure on ESG issues by the entities in which we invest. 5 We will work together to enhance our effectiveness in implementing the Principles. The PRI defines responsible investment as a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership. In the private equity market, Limited Partners (LPs) - who are stewards of capital - have a fiduciary duty to ensure that committed capital is managed appropriately and in line with their interests & policies. To that end, responsible investment is a systematic approach to evaluate and integrate material ESG risks, opportunities and issues into asset selection & ownership and portfolio construction.

Portfolio liquidity demands

1. GP Capital Calls: An obligation that an LP must fulfill based on total initial committed capital amounts, but the timing and amount of each capital call are not under the LP's control; 2. Rebalancing: Shift portfolio allocation between public stocks and public bonds at quarter ends to maintain policy or target weights; 3. Dry Powder Creation: A tactical move into higher beta assets (i.e., stocks) during market downturns (i.e., at the end of each month if the public equity market experiences a large drawdown) to provide market support or to take advantage of the market dislocation; and 4. Dry Powder Reversal: When a market recovery occurs (i.e., when a drawdown is less than -5% following a recovery in the equity market) there is a need to adjust public stocks and bonds back to their initial relative target weights.

Describe the differences between a P-measure and a Q-measure.

A Q-measure is a probability-like value or other related variable within a model derived for modeling purposes under the assumption that risk-neutrality holds when it is likely that the world is not risk-neutral. A P-measure, however, is a statistical probability that represents the likelihood of an outcome in the real world.

correlation trade

However, if the location spread is made without sufficient time to make settlement through delivery, then the trade is a correlation trade. In other words, the trade will have an outcome that is driven by the statistical correlation between two values.

In the context of operational risk, what is a fund culture?

A fund culture is a generally shared set of priorities and values within the fund's organization. One of the strongest protections against operational risk is a fund culture that fosters competence, honesty, and diligence.

There are four primary factors related to this loss of family wealth over time:

A growing number of descendants as the number of generations increases, which dilutes wealth among a larger number of people. A lack of skill or interest in the family business by members of the younger generations. A lack of education and planning with how to prepare younger generations to be productive and understand how to handle their share of the family wealth. An intentional focus on philanthropy, where the assets are distributed to benefit broader society rather than being left for descendants.

personal account dealing

A key fund compliance policy, which is known as personal account dealing, relates to the trading of securities by employees of the firm for their own accounts. The policies implemented in this regard typically apply not only to employees but also to their significant others as well as other immediate family members.

Suppose that October calls on a certain stock with strike prices of $60 and $70 are available. Explain how a pure vertical spread and a ratio spread can be created.

A pure vertical spread would be long October 60 strike calls and short the same number of contracts of October 70 strike calls. A ratio spread would be long October 60 strike calls and short a different number of contracts of October 70 strike calls.

Explain how a short position in an iron condor can be created.

A short position in an iron condor is created when a trader sells an out-of-the-money bull spread and an out-of-the-money bear spread. A bull spread is created shorting a call and going long another call having a strike price that is lower than that of the long call. A bear spread is created shorting a call and going long another call having a strike price that is greater than that of the long call. Bull and bear spreads can also be created using put options. ??? Correct???

Compare a factor with an arbitrage opportunity.

A source of return that is a legitimate factor should perform poorly during "bad" times and "good" during normal times. If a source of return performs well in both "bad" and "good" times, it's an arbitrage opportunity.

Suppose that company XYZ is set to release earnings in a few days, and the implied volatility of one-month options has risen considerably more than the implied volatility of two-month options. A trader anticipates that the spread between the two implied volatilities will narrow after the earnings announcement due to a decline in the volatility of the one-month option. What options strategy should the trader implement?

A trader may sell one-month options and buy two-month options in anticipation that the spread between the two implied volatilities will narrow after the earnings announcement (due to the expected decline in the volatility of the one-month option). Notice that the trader profits when the spread between the implied volatilities of the two options narrows following the announcement, but only if the price movement of the stock does not cause larger losses due to the position's negative gamma.

Describe the difference between a value-based commodity index and a quantity-based index.

A value-based index has fixed-component weights expressed as percentages of the value of the index, while a quantity-based index holds a fixed quantity of contracts for each commodity.

What pattern of trading orders is believed to have caused Knight Capital Group's demise?

According to an analysis by Nanex, a Knight algorithm appeared to have been repeatedly buying at the offer and selling at the bid, causing Knight to lose a small amount of money (the spread) on each trade -losing huge sums due to the trades being repeated over and over again.

Five classic issues are related to virtually any use of past data to predict the future:

Accuracy Representativeness Stationarity Gaming Appropriateness

the decumulation phase

After retirement, the ability to earn income declines substantially, and the investor enters the decumulation phase, where assets are drawn down to support spending during retirement.

Which of the following types of actions should be reviewed in an administrative review: civil, criminal, and regulatory actions?

All three type of actions (civil, criminal and regulatory actions) should be reviewed in an administrative review.

Unsupervised Learning

An algorithm explores input data without being given an explicit output variable (eg, explores customer demographic data to identify patterns) When to use it-You do not know how to classify the data, and you want the algorithm to find patterns and classify the data for you

Annuity

An annuity is often defined as any fixed stream of cash flows. Annuities also refer to specific insurance products that contain features that enable payouts in the form of a stream of cash flows.

restricted gifts,

An endowment fund may have specific restrictions on the capital that may require that the university maintain the corpus, the nominal value of the initial gift, while spending the income generated by the gift to benefit the stated purpose.

exposure diagram floor

An exposure diagram relates the dollars invested in stocks to total assets; it depicts the decision rule underlying a strategy. Its floor is how much the investor can lose? Constant-mix strategy floor is 0. The floor value grows at the riskless rate for OBPI, as it does with CPPI and buy-and- hold strategies.

How does the investment due diligence process differ when evaluating and analyzing quantitative managers vs. discretionary managers?

Analysis of quantitative investment processes focuses on the software that captures the fund's investment strategy, while analysis of discretionary investment processes focuses directly on the judgment and skill of individuals.

Regarding factor investing, list the three important observations as described by Ang (2014).

Ang (2014) observes that: factors matter, not assets; assets are bundles of factors; and different investors should focus on different factors.

philanthropy

Franklin describes philanthropy as the giving of money or time with the intent of making a lasting change. In the example of the homeless shelter, a philanthropic gift would seek longer term benefits to permanently improve the situation of the homeless by providing the counseling, education, and job training needed to reintegrate the homeless back into productive society.

net-of-fee excess returns for private equity and public equity

As we assume constant fees for PE (5.7%) and public equities (10bps), this is a constant -5.6%. we estimate a real ER for US PE of 9.6% gross and 3.9% net-of-fee.35 In comparison, our US public equity real return estimate is 3.1%, net of a 10bps fee for passive investing.36 We thus expect PE to have a roughly 80bps higher net-of-fee ER.As mentioned earlier, we do not interpret this outperformance of PE as an illiquidity premium, but the warranted risk premium given the higher equity risk of PE.

How is behavioral finance related to fund failures?

Behavioral finance attempts to explain the potential influence of cognitive, emotional, and social factors in opposition to evidence and reason. For example, these factors can lead fund managers to take enormous risks to try to offset losses in the face of evidence that a strategy is not working. These biases can also lead investors with overconfidence to select managers that are more likely to commit fraud because the managers are playing to the emotions of the investors.

Investors can access commodities through derivatives or through physical ownership. Why might ESG investors avoid buying physical commodities?

Buying physical commodities with limited supply can have a large impact on the demand for that commodity and more directly impact the price/volatility.

three potential cycles in the context of commodities and commodity returns

Commodity prices and the business cycle Commodity prices and supercycles Commodity supercycles versus short-term fluctuations - much longer (20-70yrs), broad/inputs for industrial production and urban development of an emerging economy

deep learning: convolutional and recurrent neural networks and list the business use cases

Convolutional neural network-A multilayered neural network with a special architecture designed to extract increasingly complex features of the data at each layer to determine the output Use it When you have an unstructured data set (eg, images) and you need to infer information from it Diagnose health diseases from medical scans Detect a company logo in social mediato better understand joint marketing opportunities (eg, pairing of brands in one product) Understand customer brand perception and usage through images Detect defective products on a production line through images Recurrent neural network-A multilayered neural network that can store information in context nodes, allowing it to learn data sequences and output a number or another sequence Use it When you are working with time-series data or sequences (eg, audio recordings or text) Generate analyst reports for securities traders Provide language translation Track visual changes to an area after a disaster to assess potential damage claims (in conjunction with CNNs) Assess the likelihood that a credit-card transaction is fraudulent Generate captions for images Power chatbots that can address more nuanced customer needs and inquiries

Supervised Learning: the decision tree and Naïve Bayes and list the business use cases

Decision tree-Highly interpretable classification or regression model that splits data-feature values into branches at decision nodes (eg, if a feature is a color, each possible color becomes a new branch) until a final decision output is made Use Cases-Provide a decision framework for hiring new employees -Understand product attributes that make a product most likely to be purchased Naive Bayes- Classification technique that applies Bayes theorem, which allows the probability of an event to be calculated based on knowledge of factors that might affect that event (eg, if an email contains the word "money," then the probability of it being spam is high) Use Cases-Analyze sentiment to assess product perception in the market -Create classifiers to filter spam emails

three key observations of delta-hedging

Delta-Hedging is not a Directional Speculation on the Stock Price If a Stock is EFFICIENTLY PRICED all Trading Strategies on that Stock Have a Net Present Value (NPV) of Zero Delta-Hedging is Part of a Speculation on Volatility

What are the eight core elements of the operational due diligence process?

Document collection Document analysis On-site visit Service provider review and confirmation Investigative due diligence Process documentation Operational decision Ongoing monitoring (if investment made)

What are the three challenges associated with empirical multi-factor models?

False identification of factors, factor return correlation vs. causation, and justifying why the CAPM may not be sufficient.

List of Hedge Fund Strategies

Global Macro Systematic Diversified ED: Merger Arb ED: Distressed/ Restructuring ED: Multi Strat RV: Convert Arb RV: Corporate RV: Multi-Strat Equity Mkt Neutral Activist RV: Vol Short Bias

IR equation with TC

IR=IC×√BR×TC

a valuation agent

In cases in which the manager directly prices a large portion of a fund's holdings, it is considered best practice for the fund to engage a third party, known as a valuation agent, to conduct an independent valuation of these positions.

variation margin

In futures markets, it is standard practice to settle all gains and losses in cash every day. These daily cash settlements of gains and losses are known as variation margin. The practice of making daily cash settlements produces an ongoing stream of small transaction costs.

visualization

In the context of models, visualization refers to the ability to understand the relations between the components of a model and is often substantially enhanced by expressing the model via a spreadsheet.

List the three major categories of factors that drive asset returns.

Macroeconomic factors, fundamental/style/investment/dynamic factors, and statistical factors.

life expectancy

Major improvements in human health and well-being have led to a drastic rise in global life expectancy — from approximately 48 years in 1950 to over 71 years in 2015.1 But with progress in extending life spans come new challenges for governments, private pension plans, and individuals trying to generate sufficient retirement income in an aging world.

In an operational risk context, what are meta risks?

Meta risks are all non-investment-related risks not covered by a particular category. An example would be the case of fund manager's expenditures of company funds on luxurious office decorations rather than on hiring additional employees. Another example would be a fund manager who is confrontational during an on-site meeting. Some investors may feel that such examples should be regarded as part of the overall evaluation of the fund manager. These types of risks are categorized as meta risks because they cannot be grouped precisely into any one specific operational risk category. Assigning values to meta risks is intrinsically subjective and can differ from one investor to another.

What factor is contained in the Fama-French-Carhart model that is not contained in the Fama-French model?

Momentum

a liquidity event

Much of the wealth that is managed by family offices is generated by a liquidity event such as the sale of the family business in a merger transaction or in an initial public offering.

List three reasons why the CAPM is an especially poor model with which to benchmark alternative investments.

Multiperiod issues, nonnormality, illiquidity of returns and other barriers to diversification

Water conservation, biodiversity, endangered species, and chemical usage are all environmental issues associated with which asset class?

Natural Resources

Were the losses to investors of Amaranth Fund to be expected given the high risks of the fund's investment strategy?

No, Amaranth was a multistrategy fund with a stated strategy that would not lead investors to expect such losses. For example, external investors would not expect that 50% of its capital was dedicated to one specific market/trade. Amaranth had very large, highly levered and concentrated positions but apparently had no formal stop-loss or concentration limits. This suggests that Amaranth's internal team likely severely underestimated the probability of long-term and large unidirectional price movements against its positions.

What is the common name for a comparison group of funds with similar risk and return objectives and characteristics?

Peer group (or comparison group)

Permissioned network

Permissioned blockchains allow certain members to control the confirmation of transactions. These permissioning members (consensus authorities) can exert control in various ways depending upon the network design. They could be responsible for explicitly approving transactions. Another option would be to designate the permissioning members as the sole members of the network able to participate in a cryptographic consensus mechanism.

Discuss the impact of price smoothing on fund returns, volatility, betas, and correlations with the market.

Price smoothing has little impact on fund returns but understates standard deviations, betas, and correlations with the market.

Describe principal component analysis (PCA).

Principal Component Analysis (PCA) is a linear statistical method that identifies the set of orthogonal factors from a dataset that maximize the percentage of explained variation.

key drivers for increased interest in ESG investment, including regulatory and legal developments, industry evolution, increased competition and complexity, reporting, and industry collaboration

REGULATORY AND LEGAL DEVELOPMENTS- recent supply chain regulation and legislation, including California's Transparency in Supply Chains Act, The Dodd-Frank Act and the UK's Modern Slavery Act, now require firms to account for and monitor specific human rights-related concerns in order to access certain markets.Several governing bodies require that LPs meet mandatory requirements for disclosure on responsible investing and are using the Task Force on Climate-related Financial Disclosures (TCFD) as a basis. The Ontario Pension Benefits Act of 2016 requires pension plan administrators to disclose whether, and how, they incorporate ESG factors into their investment practices. INDUSTRY EVOLUTION- Awareness and understanding of material ESG issues such as climate change, employee issues and board diversity continues to rise. A "Weinstein clause" is now added to many deals to preclude limited partners and general partners from any associated financial impacts of sexual misconduct. LPs now report that GPs engage in conversations around ESG issues more frequently than in the past and that the absence of an ESG policy is now unusual. INCREASED COMPETITION AND COMPLEXITY- Access to top performing funds is constrained due to rising allocations to private equity and record numbers of over- subscriptions. REPORTING-The development of industry guidelines such as SASB and the EU proposed taxonomy are two important changes in the market since the publication of the first guide. INDUSTRY COLLABORATION- collaborative cross industry initiatives enabled LPs to develop more sophisticated questioning, understanding and approach to due diligence beyond "do you have a responsible investment policy?" to "how is that policy implemented?" and "can you demonstrate performance?".

Explain why traders tend to prefer to model volatility using a GARCH model.

Realized volatility is not constant and exhibits mean-reversion and clustering. The GARCH model is able to model this.

the two steps in assessing the toolbox of investment actions to mitigate the impact of longevity

Reevaluate the portfolio's allocation to growth assets Address the elevated duration risks associated with longevity

Mr. Ahn finds that a technique used when constructing real estate indices has been criticized because only a few data points can be found to create an index when following this methodology.What is the technique that Mr. Ahn finds to be problematic?

Repeat-sales method.

List the five components of risk management in the context of: who, what, when, where, and how.

Risk Reporting (Who), Dimensions of Risk (What), Frequency of Data Collection (When), Investment/Position Level (Where), and Aggregation and Systems Development (How).

Describe the difference between risk and Knightian uncertainty.

Risk occurs when an investor understands the probabilities of various outcomes, but is unsure as to which outcome will occur. Knightian uncertainty occurs when the investor cannot form reasonable quantified estimates of either the possible outcomes or their associated probabilities.

Define roll return in the context of commodity futures investments.

Roll return, or roll yield, is the portion of the return to a futures contract that is due to the change in basis.

Mr. Troconis finds that properties that are transacted during a particular period and that are used to calculate these indices may not be representative of the underlying real estate market. Which bias does Mr. Troconis discover?

Sample selection bias.

Why might investors wish to participate in the secondary market over the primary market?

Some LPs are interested in secondaries as means of getting exposure to PE assets quickly without having to commit capital over a period of 10-12 years. Others seek a reduction of risks by using secondaries to diversify their vintage year exposure. Secondaries also tend to generate strong IRR performance and can counteract the J-curve effect of primary funds.

There are two primary advantages of the repeat-sales method:

The RSM calculates changes in home prices based on sales of the same property. Therefore, this method avoids the problem of trying to explain price differences in properties with varying characteristics. Thus, the repeat-sales method does not require detailed information on property characteristics. The RSM is relatively robust to specification error in the application of the model. Typically, this type of error arises when the wrong regression model is selected to explain variations in the dependent variables.

Contrast public and private networks

The bitcoin blockchain is an example of a public network: It is open to any user who wishes to transact, and all users can see all transactions on the blockchain. Private blockchains are only open to those participants that meet the membership criteria of the network, in contrast to public blockchains in which anyone is able to participate.

Describe the relationship between a fund's margin-to-equity ratio and the fund's volatility.

There is a close correlation between a fund's margin-to-equity ratio and the fund's overall volatility. As the margin-to-equity ratio increases, the volatility of the fund increases.

impact investing

The World Economic Forum (2014) defines impact investing as an investment approach that seeks to earn financial returns while generating measurable and positive social impact.

In terms of asset allocation, what is the consequence of using the XYZ RE Index (original smoothed data) versus the unsmoothed version of this index?

The XYZ RE Index (original smoothed data) wrongly and dangerously suggests a very low standard deviation of returns for real estate and thus, asset allocations based on these falsely low volatilities would substantially overweight real estate in a mean-variance optimization framework.

Why would an analyst use a rolling window analysis of the systematic risk exposures of an investment strategy rather than a single analysis based on the entire dataset?

The analyst is concerned about style drift (specifically, systematic risk exposures that change through time). By using a short-term analysis that moves through time the analyst can get estimates of the change in risk exposures through time.

What are two examples of bond factors? Describe both.

The credit risk premium and the term premium. The credit risk strategy takes long positions in bonds with low credit quality and short positions in bonds with high credit quality. The term strategy takes long positions in long-term bonds and short positions in short-term bonds.

crisis alpha

The potential for some strategies to generate superior return during periods of financial crisis can be termed crisis alpha.

Assume a core real estate index is expected to generate 6% over the next 10-years and the 10-year Treasury is currently yielding 1%. What is the risk premium of the core real estate index?

The risk premium is 5%.

representativeness bias

The term representativeness indicates that when investors are confronted with a new experience and need to make a judgment or decision about that situation, their brains automatically rely on past experiences and mental representations that seem similar to this new situation in an effort to guide their judgments and decisions.

subscriptions and redemptions

The third primary category of fund cash relates to cash used to process capital inflows and outflows, which are also called subscriptions and redemptions, respectively. Typically, the fund administrator is involved in processing the subscriptions and redemptions of investor funds subject to fund oversight

Theoretical models

Theoretical models tend to explain behavior accurately in more simplified situations where the relationships among variables can be somewhat clearly understood through logic

Suppose a CTA investor's account has a funding level of $100,000 and a notional level of $300,000. If the CTA returned 25% that year (on the trading level), what was the funding level return?

Using Equation 1 from the Margin Accounts and Collateral Management lesson, the trading level can be found as Trading Level=Funding Level+Notional Level Meaning the trading level is $400,000 ($100,000 + $300,000). A trading return of 25% would generate a dollar gain of $100,000, meaning an investment gain of 100% on the funding level ($100,000 gain / $100,000 funding level).

Two potential disadvantages of listed real estate funds are:

Volatility Relative to their Net Asset Value (NAV) High Correlation with equity market returns

The five determinants of Altman's Z-Score are:

Working Capital/Total Assets. Retained Earnings/Total Assets. Earnings before Interest and Taxes/Total Assets. Market Value of Equity/Book Value of Total Liabilities. Sales/Total Assets.

In finance, a market clientele is

a general type of market participant that dominates a particular market.

A limited liability shield or financial firewall is

a legal construct that prevents creditors from pursuing restitution from investors or other participants involved in an economic activity beyond the amount of capital that they have contributed. For example, the limited liability structure limits investor losses to the amount contributed, even when a highly leveraged hedge fund experiences losses greater than the value of the assets contributed by investors

A portfolio stress test or scenario analysis is A portfolio stress test or scenario analysis is

a simulation applied to a portfolio to determine how it will perform under different market scenarios. Commonly, these try to include extreme market events, both those historically encountered (e.g., the global financial crisis in 2008) and those based on simulated financial stress. This technique is often used in conjunction with VaR, since it examines scenarios in which volatility and correlations are assumed to change.

Most favored nation status is

a term from international trade that is used in private partnership negotiations to refer to the negotiated right of an LP to be treated with any and all benefits being offered to any other LP. The purpose of the clause in a side letter from a particular LP's perspective is to ensure that the interests of other LPs are not placed ahead of the LP with a most favored nation clause.

The timing of the completion of the reconciliation process depends on a number of factors, including whether a trade anticipated by the fund failed to execute, which is commonly known as

a trade break.

Information gathering indicates the

ability of the manager to create access to information or to have access to better information than do other managers. Thus, the manager's competitive advantage may not be in analyzing information but in developing a superior information set. The manager may have a wider or deeper information set that allows a competitive edge, or the manager may have a differentiated strategy or unique position that enables a focus on a specific segment of the market and the ability to gather better information. The advantage is a proprietary information set accumulated over time.

the realized return volatility of an asset is the

actual variation (typically measured as the standard deviation of returns) that occurs over a specified time period using a specified return measurement interval (e.g., daily or weekly return granularity). In practice, observed returns are discrete, not contin-uous, and all three of the properties of a GBM process (homoscedastic, normally distributed, and uncorrelated returns) are violated in practice.

Third-generation commodity indices

add yet another enhancement to second-generation commodity indices by including active commodity selection, which may be predicated on objective rules (such as using algorithms to assign weights based on specific criteria related to momentum, inventory levels, term structure signals, and so on) or could be discretionary.

the core portfolio

consists of passive and often low-cost investments that track the overall performance of an asset class.

A blind pool equity fund

aggregates capital obtained from its partners into a single fund (i.e., the main fund) that has a stated investment mandate but that generally does not involve limited partners in deal sourcing. Ways of investing in private equity outside of blind pool structures, include co-investing.

Opacity, in the context of investments, is the extent to which

an asset lacks clarity with regard to various characteristics, especially potential financial outcomes and their associated probabilities. Opacity is the opposite of transparency. In the context of delegated portfolio management, opacity can emanate from principal-agent problems and the incentive for managers to obscure the sources of return variability in order to reduce the likelihood of being perceived as an unskilled manager. Sato notes that, in theory, markets will evolve such that investment managers overseeing opaque investments can command higher fees than investment managers overseeing transparent investments.

A stop-limit order

becomes a limit order when the loss level is reached, and may not be executed if the market price has moved quickly beyond the stated limit.

A stop-loss order

becomes a market order when the loss level is reached. The market order may be partially or fully executed at a less favorable price if there are insufficient offsetting trade orders.

A plan is portable if

benefits earned at one employer can continue to be accrued at another employer, DB plans are not portable

A newer concept is positive screening, where

companies are added to the portfolio when they are perceived to do good in the world, such as producing helpful products and having high wages and benefits and good working conditions for their workers and suppliers worldwide, even in areas of extreme poverty.

Strategy drift (or style drift) is the

change through time of a fund's investment strategy based on purposeful decisions by the fund manager in an attempt to improve risk-adjusted performance in light of changing market conditions. Investment strategy drift includes moving into new markets, new investments, new position sizes and direction, and risk exposures that previously have not been experienced.

The Linaburg-Maduell Transparency Index

consists of the following 10 principles, where one point is assigned to a given fund for having satisfied its requirement. The SWFI recommends an index score of no less than an 8 (out of a maximum of 10) for a SWF to claim its transparency is adequate.The Linaburg-Maduell Transparency Index consists of the following 10 principles, where one point is assigned to a given fund for having satisfied its requirement. The SWFI recommends an index score of no less than an 8 (out of a maximum of 10) for a SWF to claim its transparency is adequate.

Exculpation is a

contractual term that relates to freeing someone from blame.

Pre-clearance of personal account trades is a process by which

employees must seek approval from compliance before executing a trade. Pre-clearance requests may be submitted in a number of formats, including via email or through a designated personal account dealing management system.

In the context of securities, complexity is the

degree of complication that may make precise estimation of probabilities and outcomes more difficult. Without any complexity, the benefits of analysis would be insignificant. Therefore, the existence of complexity and active management are complementary to one another.

The law and the limited partnership agreement (LPA) define and restrict the

degree of control LPs have over the activities of GPs, relating, for example, to waiving or accepting investment restrictions, extending the investment period or fund duration, handling key-person-related issues, or participating in an LP advisory committee.

adviser's legal obligation includes

delivering Form ADV Part 2 to its clients initially, annually, and when certain disclosure items are updated.

Commitment risk

describes the situation in which an LP may become a defaulting investor if the proceeds from exiting funds are not sufficient to pay the capital calls of newly committed funds. This can occur due to shortfalls in distributions from funds or to other factors such as exchange rate changes that have an adverse impact on the resources available to respond to capital calls.

Futures curve positioning

determines the time to expiration of a futures contract at the initiation of the position, and the length of time the contract will be held before rolling to a further-out contractFutures curve positioning determines the time to expiration of a futures contract at the initiation of the position, and the length of time the contract will be held before rolling to a further-out contract

Indemnification relates to a

duty to make good on a loss.

A portfolio that is monetary neutral has

equal long and short exposures to a specified currency. For example, consider a portfolio that has equal euro exposure in long and short positions. This euro-neutral strategy is approximately self-financing, as the proceeds from the short positions can, in principle, be used to fund the long positions.

Transaction-based real estate indices are

estimated based on actual contemporaneous property sales of sample properties that trade in each period.

A look-back option

has a payoff that is based on the value of the underlying asset over a reference period rather than simply the value of the underlying asset at the option's expiration date. Fung and Hsieh estimate that 90% of the return variation in diversified portfolios of hedge funds can be explained by the seven factors. However, individual hedge fund returns are not so well explained.

A value-based index

has fixed-component weights expressed as percentages of the value of the index. The number of futures contracts in the index changes dynamically to maintain constant value weights. An index that consists of 60% stocks and 40% bonds is value-based.

A dispersion trade that is short index options and long options on the components of the index (and delta-hedged) will benefit from

high dispersion (i.e., low correlation among the returns of the index's components). consider the case of a dispersion trade based on call options that is short an index call option and long call options on the components. This dispersion trade benefits when dispersion is high among the returns of the index components because the profits from call options on the individual stocks that rise will more than offset the losses from the call options on the individual stocks that fell (due to positive gamma).

A quantity-based index

holds a fixed quantity of contracts for each commodity, so that the index weights change each day in terms of percentage of value as futures prices change. For example, the S&P 500 Index on US equities is quantity-based, since the number of shares of each company in the index changes only when the index constituents are changed, whereas the percentage of the index attributable to a particular constituent changes when the market price of that constituent changes.

risk averse

if an investor's utility function is concave, which in turn means that the investor requires higher expected return to bear risk.

Short-sale risk could arise

if the investor is forced to cover the short positions at unattractive prices because the shares have been called in by the lenders perhaps due to a short squeeze. The investor could face a short squeeze if a large number of investors are forced to cover their short positions. A short squeeze tends to be firm specific and therefore its risk can be diversified away.

Maximum number of trades

in a given time frame may also be imposed to avoid individuals from trading excessively.

The sales comparison approach,

in which a real estate asset is evaluated against those of comparable (substitute) properties that have recently been sold. Value adjustments may be made for characteristics such as square footage, date of sale, location, and amenities.

There is growing use of the outsourced CIO (OCIO) model,

in which the endowment gives discretionary authority to an external consultant who may make and implement prespecified decisions, such as manager selection and asset allocation decisions, without taking those decisions to a vote.

Lifestyle assets or passion assets

include art, homes, wine, airplanes, cars, and boats, where the purchase and collection follows from the lifestyle preferences or the passions of one or more family members. Lifestyle assets can become a significant part of an UHNWI's overall wealth.

Fund prime brokers are

institutions that facilitate fund trading by aggregating a portion, or all, of a fund's cash and securities as well as providing services for leverage and short selling. As part of the ODD process, fund investors focus on solvency of prime brokers, noting prime broker failures in the past in which funds were unable to reclaim cash balances held at the institution in a timely manner. In part to diversify the risk of prime broker insolvency, it is now common for funds to use two or more prime brokers.

Sentiment, in the context of investment analysis,

is broadly defined as beliefs about future cash flows and risks that are not justified by an objective analysis of the facts.

Property unit trusts (PUTs) are the

main open-end investment product used by pension funds and insurance funds in the UK to obtain a diversified exposure to the UK real estate market. The values of these unlisted investment vehicles are calculated using the appraisal method.

independent foundations

most are funded by an individual or a family

a regime change occurs when an

observed behavior of a financial series experiences a dramatic shift. For example, a major macroeconomic shift, such as a new central bank policy target combined with severe tightening of monetary policy, could cause changes in the behavior of interest rates through time that might be described as a regime change.

A capital account surplus

occurs in a country when the amount of imported capital exceeds the amount of exported capital.

An options volatility surface is a volatility structure that

plots implied volatility for a wide variety of options in a given instrument across both expiration dates and strike prices. Example of a Volatility Surface, would essentially combine the information from the previous exhibit across all expiration dates for a given asset.

The fund screening process involves

reducing the universe of potential investments into a much smaller subset on which full due diligence can be performed.

Co-investment

refers to the practice of investors being invited by the sponsors of private equity funds (typically GPs) to make investments into one or more pre-specified portfolio companies using structures other than a main private equity fund. Institutions increasingly invest in companies directly or alongside main PE funds in the form of co-investments.

Fund performance persistence

refers to the tendency of a fund's under- or overperformance in one time period to be likely to be followed be similar under- or overperformance.

The liquidity penalty function

reflects the cost of illiquidity and the preference for liquidity.

Capital at risk (CaR)

represents the total loss that would be incurred should each position hit its stop-loss price level on that day.

Catastrophe bonds (cat bonds) are

risk-linked debt securities that represent the largest portion of the ILS market, are typically structured as private placements, and are designed to transfer specific risks from issuers—typically insurance or reinsurance companies—to investors. These specific risks are usually those having to do with natural disasters, such as hurricanes and earthquakes in the United States, Europe, or Japan.The occurrence of major catastrophic events in the early 1990s led to the development of the cat bond market in the second half of the decade. The cat bond industry grew exponentially from a few hundred million dollars in bonds outstanding at the end of the 1990s to around $13 billion by 2007. The growth in cat bond issuance came to a stop after the 2008-9 global financial crisis and the bankruptcy of Lehman Brothers. Eventually, the market resumed its growth, and by 2019, the total amount of bonds outstanding reached a record $39 billion.

Fund advisory committees serve as a

source of objective input for fund managers. An advisory committee is composed of representatives from the fund and investors in the fund. The advisory committee may provide advice on the valuation of particular investments, especially illiquid investments. The advisory committee may also advise the fund manager as to whether the fund should be opened up to new investors and how much more capacity the fund manager should take. Although advisory committees serve as useful devices for control by limited partners, they are more common in the private equity world than in hedge funds.

The main problems of transaction-based indices are

that each individual property is unique and each individual property is sold infrequently and at erratic time intervals. Nevertheless, transaction-based real estate indices can serve as a good basis for real estate valuation under the following three conditions: They are based on enough data and rigorous econometric methods. Any differences in properties trading in different periods are controlled for. Statistical noise is minimized.

A lock-step provision in a co-investment agreement specifies

that the terms and conditions of the co-investor-GP relationship is the same as the terms and conditions of the LP-GP relationship.

A parametric trigger offers coverage when a certain threshold is surpassed based on previously specified natural parameters. According to Edesess (2014), a parametric trigger is based on

the occurrence of a specific natural event, such as wind speed exceeding 120 km/hr (in a specified location), a category 5 hurricane, or an earthquake exceeding 7.0 on the Richter scale. While this poses basis risk to the issuer, it is advantageous to the investor because little or no waiting time is required before settlement of the bond following a triggering event, resolution of losses is rapid and transparent, and the danger of moral hazard is low.

retirement income-replacement ratio

the pension benefit as a portion of final salary

Security selection, the second component to portfolio returns, is defined as

the return within asset classes relative to a benchmark such as the return to the domestic fixed-income portfolio when compared to the domestic fixed-income benchmark.

The investment strategy or mandate of a fund refers to

the sets of objectives, principles, techniques, and procedures the fund uses to construct and modify its portfolio.

The strategy of bottom-up fundamental analysis is

to estimate the value of a company's stock based on firm-level forecasted sales, expenses, earnings, and other data linked economically to the eventual cash distributions of a firm in an attempt to enhance portfolio returns.

The growth approach

to fundamental long/short equity investing is to overweight companies perceived as having higher potential to deliver large increases in revenues, earnings, and/or cash flows. Long/short growth managers are attracted by top-line growth numbers and are willing to look past weak current earnings in the presence of aggressive sales growth.

Life insurance settlements, or life settlements, consist of the

transfer of the ownership of an existing life insurance policy (including the sale, bequest, or assignment of an existing life insurance policy or the benefits of such policies) by its owner to a third party. The buyer of the policy becomes its beneficiary and becomes responsible for payments of any remaining premiums.

the holdup problem is a situation in which

two parties (in the case of private equity, a GP and an LP) refrain from cooperating due to concerns that they might give the other party increased bargaining power and thereby reduce their own profits. Incentives are designed so that the fund manager's focus is on maximizing terminal wealth and performance, and ensuring that contractual loopholes are not exploited (e.g., by claiming to have produced overly optimistic interim results).

Transportation strategies

use spot commodity markets to execute location trades by moving commodities when the benefits of price differentials exceed transportation costs. The strategy involves leased transportation services, such as tankers, bulk shipping, or pipelines, to physically move a commodity from a location where the commodity's price is relatively low (presumably due to a local surplus) to a location where the price is higher (presumably due to a local shortage).

While a vertical spread that is created using the same number of long and short options is a pure vertical spread, a ratio spread is a

vertical spread with unequal numbers of long and short option positions. For example, a pure vertical spread would be long 10 March 100 strike calls and short 10 March 120 strike calls, while a ratio vertical spread may be long 10 March 100 strike calls and short 20 March 120 strike calls.

the first principle of depreciation and returns:

when accounting depreciation either is not allowed for tax purposes or is allowed at a rate that is slower than the true economic depreciation, the after-tax IRR will be less than the pre-tax IRR reduced by the tax rate.

Trading level is

simply the base amount or denominator used in calculating returns of leveraged positions and is the amount of capital that is traded in the active risk account. It is also: (1) the account value that the CTA uses to calculate management and incentive fees; (2) the mutually agreed upon amount to be traded that determines the size of the actual positions that the CTA takes in futures markets, depending on the CTA's leverage goals; and (3) the account value that the CTA uses to translate profits and losses in futures contract trading into percentage returns.

the discount rate for the depreciation tax shield

should take into account the uncertainty of the investor having adequate future profits or other mechanisms of utilizing the taxation benefits of the depreciation and should exceed the riskless rate to the extent that the uncertainty exists.

Unlisted Manager-Investor Relationships - Information Access and Fund Audits:

(1) The fund auditor has ultimate responsibility to ensure that financial reports are free from fraud.

A top-down approach

analyzes the macroeconomic environment and then determines the weights and the combination of industry sectors, countries, and so on that best meet the program objectives under the likely scenarios.

Illiquidity Adjustments for Mean-Variance approach

1)The penalty function, ϕ, is a positive number that reflects the investor's disutility for illiquidity. 2)Each asset is assigned an illiquidity level, Li, that reflects the asset's market illiquidity from 0 (fully liquid) to 1 (maximum illiquidity). 3)The product of ϕLi for each asset i serves to penalize (lower) the expected return of that asset within the mean-variance optimization. The optimal allocation to each asset will be inversely related to illiquidity (Li) assuming that ϕ ˃ 0.

The US Internal Revenue Service specifies three characteristics of a program-related investment:

The primary purpose is to accomplish one or more of the foundation's exempt purposes, Production of income or appreciation of property is not a significant purpose, and Influencing legislation or taking part in political campaigns on behalf of candidates is not a purpose.

A completion portfolio

A completion portfolio is a collection of assets that is managed with the objective of diversifying the aggregated risks of the concentrated portfolio. The assets purchased should have a low correlation to the assets held in the company stock portfolio (the concentrated portfolio).

What is the primary vehicle used by institutional investors to obtain indirect commodity exposure?

The primary vehicle used by institutional investors for obtaining exposure to commodity indices is commodity index swaps.

Aiko Yamaguchi is an entrepreneur who owns a substantial stake in a Japanese-based construction company. Explain the concepts of a completion portfolio and a concentrated portfolio applied to her case.

A completion portfolio is a group of assets that is managed with the objective of diversifying and managing the aggregated risks of the concentrated portfolio (i.e., construction company stock in the case of Aiko), and the completion portfolio. The assets purchased by Aiko for the completion portfolio should have a low correlation to the assets she holds in the construction company stock. For example, she could invest in sovereign debt or foreign stocks from sectors other than the construction sector. This should gradually lead to a more diversified portfolio, even when counting the construction company stock she holds.

List four major lessons from the chapter's cases in tail events.

A consistent theme across many of the cases is the danger of using large amounts of leverage. Over-confidence of traders can lead to high risk and high losses. Highly quantitative financial systems using high-tech capabilities may contain risks that are difficult to predict, and The large fees and assets of the hedge fund world attract both geniuses and charlatans.

Internally gathered or determined valuations should always be supported by the following:

The use of a knowledgeable but disinterested party in performing the valuation. Documentation and justification for the valuation method used. Documentation of all inputs and assumptions. Review, if not approval, of the final value by yet another knowledgeable, independent party.

Supervised Learning

An algorithm uses training data and feedback from humans to learn the relationship of given inputs to a given output (eg, how the inputs "time of year" and "interest rates" predict housing prices) When to us it-You know how to classify the input data and the type of behavior you want to predict, but you need the algorithm to calculate it for you on new data

importance of monitoring and disclosure when evaluating responsible investing in private equity

As private equity is a trust-based system, LPs rely on GPs to monitor ESG issues within the portfolio, and furthermore that the responsibility and knowledge to manage these issues lies largely with the portfolio company management. But as stewards of their capital, LPs are entitled to monitor GPs' performance in line with their responsible investment strategies and beliefs.

dominate

another portfolio if it offers a higher expected return with the same level of risk, a lower risk with the same expected return, or both higher expected return and lower risk.

A cross-margin benefit

is available when a CTA has multiple positions in contracts traded on the same exchange, which allows the total amount of margin that the CTA must post to be smaller than the sum of the margin amount of each contract.

Operational fraud from the perspective of an investor is

any intentional, self-serving, deceptive behavior in the operational activities of a fund that is generally harmful to the investor. Operational fraud can be reduced through separation of duties, checks and balances, third-party audit, etc.

What is the difference between Capital at risk (CaR) and Value at Risk (VaR) for managed futures?

Capital at Risk represents the total loss that would be incurred should each position hit its stop-loss price level on that day. Value at Risk measures the potential loss in an investment portfolio given a particular holding period, with no changes to the portfolio during the holding period.

Supervised learning: Gradient-Boosting Trees

Classification or regression technique that generates decision trees sequentially, where each tree focuses on correcting the errors coming from the previous tree model. The final output is a combination of the results from all trees Use cases-Forecast product demand and inventory levels -Predict the price of cars based on their characteristics (eg, age and mileage)

concierge services

Closely related to lifestyle assets is a growing part of family office management known as concierge services, where the family office will attend to mundane details that most people have to deal with in their daily lives such as personal shopping and travel arrangements.

Why might it benefit a GP to engage in a co-investing strategy?

Co-investing can allow a GP to make larger investments without dedicating too much of the main fund's capital to a single transaction. This also increases diversification benefits.

Why should an investor who exits a fraudulent scheme before it collapses be concerned about the losses of the investors who did not exit prior to the collapse?

Courts can order investors who are enriched by a fraud to return the profits as restitution to those who suffered losses, even if the investors were unaware of the investment's fraudulent nature.

Second-generation commodity indices

attempt to enhance returns through forward curve positioning to spread the roll period across points along the forward curve or target different segments of the curve.

Deep Learning

Deep learning is a type of machine learning that can process a wider range of data resources, requires less data preprocessing by humans, and can often produce more accurate results than traditional machine-learning approaches. In deep learning, interconnected layers of software-based calculators known as "neurons" form a neural network. The network can ingest vast amounts of input data and process them through multiple layers that learn increasingly complex features of the data at each layer. The network can then make a determination about the data, learn if its determination is correct, and use what it has learned to make determinations about new data. For example, once it learns what an object looks like, it can recognize the object in a new image.

Four key points regarding delta-neutral option portfolios hedged with the underlying asset of the option(s) are as follows:

Delta-neutral portfolios that are long options are long vega and gamma and generate performance that is driven by the relation between the realized volatility of the underlying asset and the implied volatility of the options when the positions are established and the nature of this variation. The time interval selected for rebalancing a hedge back to delta neutrality will not affect the expected profitability of the position (in the absence of trading costs) if the underlying asset's price changes form a random walk. Note that no sequence of trades can generate an expected risk-adjusted profit for any asset with returns that form a random walk. Rebalancing the portfolio more frequently to maintain delta neutrality will tend to enhance expected returns (prior to transactions costs) if the returns of the option's underlying asset are mean reverting and will detract from the portfolio's expected returns if the returns of the option's underlying asset tend to trend. Hedging activities (rebalancing) will tend to lower directional risk and accelerate the recognition (not generation) of profits (unless mean reverting).

List the five categories of qualitative information that allocators may find helpful to calculate, compile, and review on a regular basis.

Descriptive information, key information, other information, watch or focus list summary, and activities log.

Four potential advantages of listed real estate funds are:

Diversification Liquidity and Divisibility Constant Exposure High Information Flow

List the three weighting measures for IRR and IIRR in regards to a multi-manager portfolio. Why might an investor want to consider all three?

Equally-weighted IRR, Commitment-weighted IRR, and Pooled IRR. An investor should consider all three because there is no perfect measurement, and the analysis of IRRs and IIRRs should include a variety of metrics and examination of their relationships to the individual funds.

Three important differences between PCA and FA as typically applied are summarized below in the context of analyzing security returns:

FA typically makes specific statistical and modeling assumptions about the return process, while PCA does not require a definite model because it simply maximizes explained variance. FA generates different factor scores when different numbers of factors are allowed in the model, while PCA's loadings do not change as the number of components considered is increased. PCA can identify a factor driven almost entirely by one security (e.g., one stock or bond with a very volatile and unusual risk profile), while FA seeks factors that drive at least two securities.

Suppose that a manager experienced a drawdown of 30%, and has been replaced by a new manager. Assuming a 15% performance fee, how much will the new manager have to earn for the investor to break even?

First, the next 42.86% return [i.e., (1/0.7) − 1] generated by the new manager will be passed on to investors gross of performance fees. Assuming a 15% performance fee, the new manager will have to thus earn 50.42% [i.e., 0.4286/(1 − 0.15) = 0.5042] for the investor just to break even.

List the three responsibilities of asset owners

First, they are responsible for framing the investment strategy, whether directly (relying on the skills and expertise of the board and executives) or indirectly (relying on intermediaries that specialize in these activities). Second, asset owners are responsible for oversight of the implementation of their chosen strategy, including assessment of asset managers' performance and commitment. Third, asset owners are responsible for orchestrating the investment process by matching up the various asset managers that make up the process of producing risk- adjusted rates of return. Some asset owners take on these responsibilities themselves, whereas other asset owners outsource these responsibilities.

Suppose a three-year cat bond covering U.S. wind has just been issued. Based on the equation estimated by Bodoff and Gan (2009), calculate the total coupon rate (%) to investors for this bond, assuming an expected loss of 1.20% per annum, and that three-year LIBOR is 1.30% per annum. Note: Bodoff and Gan (2009) obtained the following equation, which approximates the spread, when issued, of any cat bond that covers U.S. wind: Spread = 3.33% + 2.40 × Expected Loss (%)

First, using Equation 2 from the Cat Bond Valuation, Performance, and Drawbacks lesson, the spread should be equal to: Spread (%) = 3.33% + 2.40 × 1.20% = 6.21% Then, the total coupon rate to investors should be equal to: Total Coupon Rate to Investors = LIBOR + Spread Total Coupon Rate = 1.30% + 6.21% = 7.51%

There are three major ways a family office can increase tax efficiency with hedge funds:

Focus more on strategies that have a long-term (12-month) horizon to them. This would be equity long/short and event driven. Invest with hedge fund managers who trade more in Section 1256 securities, such as futures contracts. Select tax-efficient managers by checking the trading and tax records of hedge fund managers to determine how much of their total return is short-term capital gain and how much is long-term gain.

What are some of the qualitative elements of risk management typically associated with alternative investments?

For alternative investments, qualitative risks are typically reviewed in the areas of business operations, legal, regulatory, and compliance.

how the temporal and geographic reach of the asset owner are related to the decision to insource or outsource

For many asset owners, the mismatch of interests with external asset managers is due to different time horizons. Some asset owners can look out as far as 80 years or beyond, whereas the business models of many external asset managers are founded on short time horizons. This mismatch affects both performance and commitment. By contrast, many asset owners have a single "home," whereas the largest investment managers collect assets and distribute returns on a global basis. Lacking capabilities and resources, an asset owner may be hostage to the short termism of asset managers and dependent on the local industry for investment services. The same type of organization may, by happenstance, be located in a global financial center and have access to global investment products. On the other hand, with the long-term perspective, a larger asset owner investment organization may be able to convert its long-term perspective from a local focus into a global focus, thereby realizing its performance and commitment goals. Just as importantly, a small investment group with a long-term horizon may use re-intermediation to realize its global ambitions.

fund's net asset value (NAV)

Fund administrators help produce the fund's net asset value (NAV), which is the value of the fund after liabilities have been subtracted and is used in the production of investor statements to report the value of investors' holdings in the fund at different points in time and to calculate fees, redemptions, and subscriptions.

While liquidity could be considered a benefit of alternative mutual funds, it is perhaps its biggest risk as well. Why?

Funds may find themselves facing unforeseen redemption requests, which could require them to sell assets that have low liquidity.

When it comes to strategy and fund selection, why have institutions historically relied on funds of hedge funds, and how has this changed over time?

Funds of hedge funds historically had preferred access to hedge funds, experienced insight regarding which strategies are likely to outperform going forward, and have reduced the risk of negative headlines should one of the underlying hedge fund investments "blow up." However, the dissemination of hedge fund knowledge and expertise has reduced the value proposition of funds of hedge funds.

Under what circumstance should an investor opt to invest in liquid structures relative to private structures?

Generally, investors should invest in listed structures when managers with unremarkable skill or limited investment opportunities exist.

Explain why high grade bonds of commodity producing firms offer weaker exposure to commodities than high yield bonds of commodity producing firms.

High grade bonds of commodity producing firms have low sensitivity to the underlying commodity markets. High yield bonds, where the default or political risk is high, are more correlated with the prices of commodities produced by the issuing firms.

List the seven categories of quantitative information that allocators may find helpful to calculate, compile, and review on a regular basis.

Historical performance, historical risk measurement review, asset allocations and capital balances, gross contribution, various activity reports, fixed income reports, and CTA and managed futures exposures.

Operational scalability

IT raises concerns regarding scalability that are especially critical. Operational scalability refers to the firm's ability to build on existing systems in order to continue to support growth in an organized manner, including via the addition of new resources, without material disruption. The concept extends beyond IT. For example, operational scalability would be a concern if sufficient fund account personnel were not added to support new fund launches.

Four Mechanics of Fundamental Strategies

Idea Generation, Optimal Idea Expression, Sizing the Position, Executing the Trade

The implementation of a pairs-trading strategy consists of the following four typical steps:

Identify the candidate pairs Identify pairs with a divergent spread Construct and size the portfolio Exit strategy

Describe the tradeoffs between an LP having too much or too little liquidity on hand regarding cash commitments to GPs.

If a large part of capital remains uninvested or parked in low-returning assets such as Treasury bills, there can be a large performance drag. However, too little liquidity could lead to an increased probability of not meeting a cash commitment.

Discuss the importance of rebalancing, even if stocks follow a random walk.

If stocks follow a random walk, then rebalancing does not change the expected value of a portfolio, it only alters the risk.

Modeling the cash flows of private equity investments (or other private investments) is an important part of the liquidity management process and potentially allows one to do the following:

Improve investment returns for the undrawn capital. Increase the profit generated by the private equity allocation through overcommitment. Calculate an economic value when a discount rate is available. Monitor the cash flows and risk-return profiles of a portfolio of private equity funds.

Modern portfolio theory (MPT)

is based on Nobel Prize-winning economist Harry Markowitz's insight that because they have unique risk and return characteristics, less than perfectly correlated assets can be combined in a way that maximizes return for any given level of risk

The bottom-up approach

is based on fund manager or security specific research, in which the emphasis is on screening all investment opportunities and picking the perceived best.

There are three reasons that agency relationships are especially important in the selection and management of real estate relative to the management of other investments, such as passive public equity funds:

Inefficient Markets for Managers: In an efficient market, buyers get what they pay for. To the extent that the market for real estate managers is inefficient, an investor's ability to select superior managers with appropriate compensation levels and schemes should be taken into consideration when determining allocations to real estate. Private Access Requires Greater Diligence: In the case of public equity investing, an investor can remain passive, becoming involved in issues only in limited cases of shareholder activism. Most real estate ownership requires greater contact with real estate managers over the life of the project. Therefore, an investor's ability to have effective ongoing relationships with managers can justify higher allocations to real estate. Alpha is a Key Performance Driver: In a perfectly efficient market, managers cannot consistently generate abnormal profits. Real estate properties often trade in relatively inefficient markets wherein superior managers can consistently generate superior performance.

Why were the closing market prices of Lancer's positions argued to be unreliable?

It is alleged that Lancer manipulated the market price of thinly traded shares by placing trades at key points in time to print ("paint") high prices in the stock's trading record and thereby justifying placing high values on the fund's holdings. Not only were the public shares not regularly trading at these prices but also the restricted shares held by Lancer were likely to be worth even less than the registered shares.

insourcing and explain why it is a response to concerns about the industry

Insourcing has been one response by asset owners to mediate the costs and consequences of being unable to observe commitment. Other strategies include the re-intermediation of the investment process via con- tracts that seek to ensure the alignment of interests between asset owners and asset managers. In many cases, asset owners have combined insourcing with re- intermediation in part because it (insourcing) involves organization-building, not just strategic interventions in the market for financial services.

the four modules of the PRI reporting and assessment framework

Integrating ESG into the investment process Module I covers elements such as investment policies and approaches and how responsible investment can be integrated. Module II discusses different points where responsible investment intersects with governance. Module III looks at the investment process focusing on diligence process and fund terms. Module IV is concerned with the monitoring during the life of the fund and exit

the interaction of longevity risk with interest rates, inflation, and duration

Interest rate, inflation, and longevity risk all compound each other. When rates fall, the measured impact of longevity onthe liability value increases.16 Similarly, when life expectancy increases, interest rate risk (duration) increases. This compounding of changes in rates and longevity means the combined effect is greater than the sum of the parts and is magnified for cost-of-living-adjusted or inflation-linked plans. It is therefore critical that plan sponsors measure and manage longevity risk, inflation risk, and interest rate risk in an integrated framework.

How does investment process risk differ from market risk?How does investment process risk differ from market risk?

Investment process risk comes from the imperfect application of the investment mandate, resulting in errors or purposeful decisions that result in exposures that do not match the investment mandate. Market risk measures the risk of the overall market, not the risk of an investment strategy being improperly implemented.

The following are five examples of key considerations during a review of BCP/DR documentation:

Is testing described from a personnel perspective, technology perspective, or both? How is employee contact information shared and updated throughout the firm so that employees may remain in touch in the event of a disaster? How frequently is it anticipated that testing will be performed? If any issues arise during the testing process, which GP groups will review the testing results? How frequently will the firm revise its BCP/DR?

The Risk Alert noted four "warning indicators or awareness signals" regarding investments that "led advisers to conduct additional due diligence analysis, to request that the manager make appropriate changes, or to reject (or veto) the manager or the alternative investment."

Manager unwillingness to provide transparency. Investment returns inconsistent with the investment strategy. Lack of clarity in the investment process. Lack of controls and segregation of duties.

Dispersion matters because the

dispersion (the degree to which the returns are uncorrelated) among the returns of the portfolio's assets drives the total risk of a portfolio relative to the total risks of the underlying assets. The implied volatilities of options on the portfolio depend on the total risks of their underlying assets.

How might market segmentation impact performance divergence between listed REITs and private properties?

Many institutions may have limited need for liquidity throughout their entire portfolios and may view their investments with longer-term horizons. Invetors with shorter-term horizons and a higher need for liquidity may perceive listed REITs as providing the liquidity they desire with low transaction costs.

The historical performance of private equity relative to public equity after accounting for leverage and factor tilts

Leveraged, small-cap indices are more appropriate as benchmarks. over the period 1986 to 2017, PE outperformed large-caps by 2.3%, looking at arithmetic means. But when compared to a 1.2× leveraged small-cap index, this falls to just 0.7%, and PE actually underperformed a basket of small-cap value stocks by 1.6%. This is corroborated by Stafford (2017), who found that the long-run average excess returns of PE over public equity can be matched by a leveraged, small-cap value strategy. Thus, it appears that the PE industry, on average, has offered scant illiquidity premium beyond these typical factor tilts.

Eight unique benefits that hedge fund replication products can potentially provide

Liquidity as a Replication Benefit Transparency as a Replication Benefit Flexibility as a Replication Benefit Lower fees as a Replication Benefit Hedging as a Replication Benefit Lower Due Diligence and Monitoring Risks as a Replication Benefit (less costs and less style drift) Diversification as a Replication Benefit Benchmarking as a Replication Benefit

Barber, Morse, and Yasuda's findings on private equity funds (venture capital and growth equity) that intentionally and explicitly asserted a dual purpose of financial return and ESG-related goals

Lower IRRs for Impact Funds Lower IRRs Accepted by Some Investors Lower IRRs Accepted by Particular Types of Investors

Contrast permissioned and permissionless networks

Many see broad accessibility and a lack of a need for centralized control as two of blockchain's permissionless network's key benefits relative to traditional database architectures. However, for applications in financial markets where 1) there are trusted intermediaries, 2) complete transparency is not always desirable, and 3) participants must comply with regulatory requirements, this decentralized system has shortcomings. It is likely that applications of blockchain technology in financial markets will instead use private and permissioned blockchains. Some argue that a permissioned blockchain removes "a major benefit of the blockchain system: the system works between parties that do not need to trust each other. If the concept is to implement permissioned distributed ledgers between trusted parties why would you use blockchain technology when more efficient alternatives are available?" However, permissioned blockchains retain many key features and benefits of permissionless blockchains, including the decentralized storage of the database and the (near) real-time reconciliation of all copies of the database. They also alleviate some of the problems posed by the permissionless system, including its need for substantial computing resources to confirm transactions.

Explain why equity of firms that derive a significant part of their revenue from the sale of physical commodities might offer weak exposure to the underlying commodities.

Many such firms hedge their principal commodity exposures, which can significantly affect the degree of commodity exposure the firm provides to investors. Furthermore, there is evidence that commodity producers engage in selective hedging, in which they actively alter their hedge ratios based on their views of future commodity prices. Furthermore, public commodity-based equities are subject to significant market risk and business risk.

List and discuss the five metrics used to measure performance and commitment

Metric (1): the risk-adjusted rate of return of the organization over the short-, medium-, and long-term, whereby the long-term is conceptualized in terms of beneficiaries' welfare (e.g., an adequate pension). Made explicit in this metric is the link between operational goals and the ultimate purpose of the organization. Metric (2): measures the commitment of staff to the long-term mission of the organization by taking into account the recruitment and retention of staff, the effectiveness of the institution's investment decision-making process, and the quality of the information systems that underpin the investment function. Metric (3): the risk-adjusted rate of return of the unit or asset-class-specific investment team is assessed both in terms of its industry peers (medium-term) and in terms of its contribution to the long-term performance of the organization. Metric (4): the skills and expertise of investment staff, taking into account the particular requirements of the organization at any point in time, as well as the long- term quality of the investment staff in relation to its expected size, scope, and reach. Metric (5): the long-term direct and indirect costs of the investment department being measured in terms of staff costs, infrastructure costs, space and running costs, and the costs of shared services (within the organization) relative to performance and commitment and the observed or imputed costs of outsourcing these services.

The three steps of calculating a hedonic price index using transaction prices are:

Model the value of real estate properties as being a function of specified characteristics of the properties that can be observed and for which data are available. Use a sample of prices observed from recent transactions to fit the parameters of the real estate valuation model; that is, determine the implicit price of each attribute. Use the estimated valuation parameters for the various characteristics to estimate the values of the properties that are within the index but did not transact.

Enviropreneurship

is an emerging branch of entrepreneurship that deals with a mixed motive of profit-seeking and concern regarding ESG-related issues, specifically using entrepreneurship to address environmental issues. Enviropreneurship tends to emanate from opportunities created by entrepreneurs rather than directed by investors or governments.

Nevins' commitment model

Nevins, et al. (2004) provided a commitment model that uses four parameters: 1) rate of capital calls; 2) rate of distribution; 3) rate of return on public assets; and 4) rate of return on private assets.

An analyst is describing the concepts of option vegas to his colleagues while at work. He makes four observations. First, he claims that vega is typically negative for long positions in call or put options. Is this correct?

No, the statement is not correct. Vega is always positive for a long position in a call or put option because all three terms on the right side of Equation 1 from the Volatility and the Vegas, Gammas, and Thetas of Options lesson are positive.

A leveraged note

is an indexed note that offers leveraged exposure (e.g., 3×) to a specified commodity index. Because these notes can lose 100% of their value when a daily decline of more than 33% in the index is experienced, the issuer and investor can be viewed as having or needing options.

Financial Industry Regulatory Authority (FINRA):

Overseen by the SEC, FINRA is a nongovernmental, self-regulatory organization (SRO) that supervises and regulates the broker-dealer industry to ensure that it operates fairly and honestly, including writing and enforcing rules governing the activities of all registered broker-dealer firms and registered brokers in the US.

How does ESG adoption in private equity differ from other alternative investments?

PE firms can require portfolio companies to make certain commitments that comply with shared ESG objectives. Additionally, PE firms can institute longer horizon ESG goals and objectives for portfolio companies.

ABC is a small country that derives 70% of its income from oil exports. Explain the four common motivations which may lead to the establishment of a sovereign wealth fund (SWF) by country ABC.

Protect the economy and fiscal budget of country ABC from a possible decline or volatility in income from oil; Assist the central bank to offset redundant liquidity; Build up the level of savings for future generations, especially considering that country ABC is mainly an oil exporting country, and thus the situation that caused the surplus is at a reasonable risk for depletion or reversal; and/or Invest the money saved in infrastructure or projects that promote economic growth today to strengthen a sector of the economy or grow a specific industry, and thus help diversify away from oil revenues.

Tactical asset allocation

is the process of making portfolio decisions to alter the systematic risks of the portfolio through time in an attempt to earn superior risk-adjusted returns.

In the U.K., what are property unit trusts (PUTs)?

Property unit trusts (PUTs) are unlisted investment vehicles comprised of a portfolio of properties held in the name of a trust. PUTs are the most important open-end investment product used by pension funds and insurance funds to obtain exposure to the U.K. real estate market. The prices of PUTs are calculated using appraisals.

Why might quantitatively focused standards be problematic regarding manager selection and retention?

Quantitatively focused standards and watch lists are generally discouraged as a means of monitoring managers as this could put the asset owner in a position of being forced to prematurely terminate a manager. Instead, manager selection should be driven by a variety of considerations, both quantitative and qualitative.

Describe some of the differences in risk and return regarding co-investments and direct investments.

Research has found that direct investments have significantly outperformed co-investments and industry-standard benchmarks. Co-investments may be associated with higher risk deals.

When controlling for industry, vintage year, fund sequence, and geography, how have impact funds performed on an IRR basis relative to traditional venture capital funds?

Research has shown that the IRR on impact funds is lower than traditional venture capital funds.

In the context of data collection frequency and data reporting, what are some examples of data collected on a monthly basis and how are those data points reported?

Some examples of data collected on a monthly basis might be position and manager changes and non-investment qualitative risks such as business, legal, regulatory, and compliance. These translate to reporting outcomes such as position and manager turnover, top positions, exposures, cash, cash flow, illiquid/miscellaneous positions and qualitative risks reports.

What are some of the key rationales behind ESG adoption amongst hedge fund managers?

Some of the key drivers behind the shift in adoption by hedge funds include regulation, risk management, client demand, and new potential sources of alpha

balancing portfolios

Sometimes these two buckets (wealth growth and wealth transfer) are referred to as balancing portfolios, which are used as counterweights to a pool of assets that, for some reason, cannot be adjusted itself. In this case, the lifestyle assets are never expected to be sold or rebalanced.

Unsmoothing a return series containing autocorrelation involves three steps:

Step 1: Specifying the form of the autocorrelation. Step 2: Estimating the parameter(s) of the assumed autocorrelation process. Step 3: Inserting the estimated correlation coefficient in place of ρ in Equation 3 from the previous lesson, Modeling Price and Return Smoothing (or a model with a different autocorrelation specification) along with two reported returns.

Describe the three key empirical findings regarding private equity performance.

Studies tend to indicate three key findings regarding PE fund performance: 1) Venture capital fund performance tends to exceed that of buyout funds, 2) Private equity outperformance and performance persistence have generally been lower in more recent years (since 2000) and 3) Risk-adjustment of returns and netting of fees tended to lower private equity performance to unattractive levels.

List the three potential reasons an actual investment strategy may differ from the stated investment strategy.

Style drift, operational errors, or fraud.

tax efficiency

Taxable investors are concerned with tax efficiency, which is the efficacy with which wealth is managed so as to maximize after-tax risk-adjusted return.

the elevated duration risks associated with longevity

Technically, the recognition that retiree pension payments will stretch further into the future increases the duration of the liabilities, heightening the interest rate sensitivity of the plan. This trend would naturally call for longer-duration investments.

An endowment investor is in the process of finalizing a side letter as part of their limited partnership agreement with a private equity GP. In the agreement, the investor is requesting to be treated with all other benefits offered to any other LP in the private equity fund. Additionally, the LP has requested anonymity as an investor in the fund. What are the names of these two terms the LP has requested in the side letter?

The LP is requesting a most favored nation status and including a use of name clause in the side letter, respectively.

How does the fund bubble hypothesis explain a general rise in the beta of hedge fund indices and the corresponding decline in their alphas?

The fund bubble hypothesis assumes that skilled hedge fund managers can earn substantially superior returns than successful fund managers in the traditional space. This hypothesis asserts that the number of less qualified managers in the hedge fund industry increases with the supply of capital to hedge funds. The correspondingly inferior returns provided by these new hedge funds dilute the aggregate industry performance.

What are the functions of a chief risk officer?

The chief risk officer (CRO) oversees the fund manager's program for identifying, measuring, monitoring, and managing risk.

A potential investor in 123 Fund has read the ODD report that XYZ Due Diligence produced on this fund. The investor concludes that 123 Fund "carries an unacceptable level of operational risk." Should this investor decide to allocate assets to 123 Fund?

The common conclusion for an investor in this case would be to make no immediate investment with the hedge fund. However, this decision may be reevaluated to make an allocation in the future if 123 Fund makes operational improvements.

In the context of a dummy variable approach to dynamic risk exposures, what is a "down market beta"?

The down market beta, bi,d is the responsiveness of the fund's return to the market return when the market return is less than the riskless rate (i.e., when the market's excess return is negative or "down").

The consultant comments that "...Everything else being the same, evidence suggests that funds with long lockup periods normally provide a higher rate of return to investors." Is this comment by the consultant correct? Explain.

The consultant's comment is correct. A long lockup period helps managers to decrease the cost of liquidity risk. For instance, during the recent financial crisis, funds with long lockup periods had the advantage of not being under pressure to sell their assets at fire sale prices.

new money

The first generation of wealth creation (new money) is more likely to be concerned with wealth preservation—keeping the newly created wealth intact.

What are some of the potential motivations for ESG adoption amongst institutional investors?

The goals and motivations are as follows: Increasing risk-adjusted returns Reducing reputational risk Address stakeholder concerns Doing the right thing or improving the planet

What is the rationale for the existence of the good-leaver termination clause?

The good-leaver termination clause offers a clear framework for closing a partnership that is not functioning well, or when the confidence of the limited partners is lost. This without-cause clause allows limited partners to stop funding the partnership with a vote requiring a qualified majority (generally more than 75% of the limited partners).

In an investment committee meeting, a portfolio manager proposes that the firm consider ESG issues when conducting investment decisions. She makes two cases for special consideration of ESG issues: "investment managers have a duty to protect shareholders from ESG-related risks such as litigation or penalties" and "investment managers who have higher allocations to ESG-compatible investments contribute to a better world". What is third primary justification for special consideration of ESG issues?

The historic total returns from portfolios of listed securities based on ESG concerns and adjusted for risk based on single-market-factor methods appear to be equally attractive, and perhaps in some cases or jurisdictions more attractive, than portfolios that ignore or eschew ESG concerns.

List and describe the steps in modules III: Investment Processes

The implementation of your responsible investment practice leading up to and executing the investment decision. Challenges, tools and resources are highlighted in this module. Fund Due Diligence will establish standard or benchmark from which LPs and GPs can built a solid understanding. PRI Limited Partners' Responsible Investment Due Diligence Questionnaire. If the GP is a PRI signatory, LPs can review their latest public Transparency Report on the PRI website. A focus on fund terms and commitments will help to establish alignment of interest. Fund reporting will enable clients to clearly understand how policy or goals align with practice. The PRI has provided guidance on incorporating RI guidance into PE fund terms.

synthetic or indirect commodity investments

The most common method of obtaining commodity exposure is through synthetic or indirect commodity investments involving equity, fixed income, and derivative instruments. These exposures can be as simple as owning traditional stock or bond investments in companies that are involved in the production, transportation, and marketing of commodities, or they can be one of a number of more specialized commodity-based investments

How does gaming relate to a historical performance review?

The performance review is an analysis of past investment results that forms the heart of many due diligence reports. The due diligence review should ascertain whether financial performance has been gamed. Gaming in this context is investment activity that is driven by a desire to generate favorable measures of performance rather than truly enhanced performance. An example would be smoothing of returns that masks true volatility levels.

A portfolio manager is tasked with periodically re-hedging a delta-neutral portfolio. If the portfolio manager decides to infrequently re-hedge, what is his view on the underlying asset's autocorrelation?

The portfolio manager is making a bet on positive autocorrelation. Without rebalancing, a delta-neutral, long gamma portfolio will benefit greatly from volatility that is directional or trending but will have little or no benefit from volatility that is mean reverting.

Explain some considerations an ESG investor might have when allocating to commodity derivatives.

The presence of non-commercial (or speculative) investors can lead to increased price volatility. This can be problematic for food-related products, especially for poor economies that rely heavily on agriculture.

What is the primary benefit of obtaining commodity exposure through derivatives contracts rather than direct physical ownership?

The primary benefit of obtaining commodity exposure through derivatives contracts is the ability to benefit from price changes in the commodity without the need to store it.

What was the primary premise of Long Term Capital Management's trading strategies?

The primary premise of Long Term Capital Management's trading strategies was the expectation that the spread in prices or rates between two similar securities would converge over time. LTCM would buy the cheaper security and short the more expensive security (while applying tremendous leverage) and wait for the spread between the two similar securities to narrow before closing the trades.

multiple expansion

The principle of mean-reversion suggests that PE multiple expansion is more likely if it has an initial discount versus the market. Hence, we estimate the return from multiple expansion as the annualized return if PE multiples converged partly, say 20% of the way, toward the initial public market multiple, over the lifetime of the deal, assumed to be six years. We floor this return at zero; that is, we do not allow for multiple compression, as there is evidence that PE GPs delay exits so as to sell at higher multiples. Given the arbitrary nature of our estimate, our general skepticism around multiple expansion for any asset class, and the noise in data on PE purchase multiples, we choose to apply only a conservative, partial convergence towards the market multiple. Multiple expansion differential: As we assume zero multiple expansion for public equities, this equals PE expected multiple expansion.this is just a small component of the return differential.

Explain the purpose of PCA and how its use can help with the research process.

The process of PCA reduces the dimensionality of a matrix of multiple asset classes. Rather than relying on potentially hundreds or thousands of inputs, PCA seeks to find a few factors that explain most of the data's variation.

Describe the three models of risk management structure. Why might it make sense for the CIO to serve as the risk manager in an organization?

The three models of risk management are as follows: 1) CEO/President as Risk Manager, 2) COO/CFO as Risk Manager, and 3) Chief Investment Officer as Risk Manager. It might make sense for the CIO to be Risk Manager because the CIO has a complete understanding of the risks associated with the investments.

What is the underlying assumption behind the factor-based approach?

The underlying assumption behind the factor-based approach is that a set of asset-based factors can explain a significant portion of a fund's returns.

immutability of records on a blockchain

The way in which blocks are added to the ledger also creates an essentially immutable database. Since blocks of transactions are chained together, the older the transaction is, the more difficult it becomes to fraudulently change it. To fraudulently change a block, an actor would have to replace that block with a new block and regenerate all of the subsequent blocks in the chain. The consensus mechanisms ensure that regenerating blocks is difficult, either due to the oversight of permissioning members or to the time and energy required to create a block (in a permissionless system).

Describe the relationship between price stickiness and the need to currency hedge an asset.

To the extent that assets have barriers to international trade, substantial transportation costs, high trading costs, and substantial taxation, the prices of those assets may deviate from those predicted by the law of one price for substantial periods of time. If prices are stickier, then currency hedging may be more necessary.

the impact of changes in accounting standards and actuarial tables on the funded status of pension plans

US accounting rules do not prescribe the longevity and discount rate assumptions that must be used for pension cost accounting leading to variation in the longevity risk across different plans. Actuarial tables had been updated every 10 years or so, but the SOA recently pledged to provide updates more frequently going forward so that plan sponsors can more accurately project the impact of longevity improvements on their liabilities which normally increases. The SOA questioned the use of higher discount rates and suggested use of default free rates to which would be more accurate.

A CTA manager has a stated monthly target return of 5%. Over the next 12 months, they generate monthly returns of 10%, 3%, 6%, 2%, -1%, 3%, 15%, -5%, 6%, 7%, 2%, 0%. What is this CTA manager's Omega ratio?

We can calculate the Omega ratio of this manager. In order to calculate the ratio, we must find the difference between each of the monthly returns the manager generated and the manager's monthly return objective. Therefore, we must subtract 5% from each of the following monthly returns: 10%, 3%, 6%, 2%, -1%, 3%, 15%, −5%, 6%, 7%, 2%, 0%. All positive numbers end up as upper partial movements, while any negative numbers end up as lower partial movements. This results in the following upper partial moments: 5%, 1%, 10%, 1%, 2% And results in the following lower partial moments: 2%, 3%, 6%, 2%, 10%, 3%, 5% The Upper Partial Moments sums to 19% and the Lower Partial Moments sums to 31%. Therefore, the Omega ratio is 19% / 31% = 0.61

List the three important questions in a risk management review.

What are the types and levels of risk involved in the fund manager's strategy? What risks are measured, monitored, and managed? How are risks measured, monitored, and managed?

How does depreciation impact the after-tax IRR relative to the pre-tax IRR reduced by the current tax rate?

When accounting depreciation either is not allowed for tax purposes or is allowed at a rate that is slower than the true economic depreciation, the after-tax IRR will be less than the pre-tax IRR reduced by the tax rate. When depreciation for tax accounting purposes matches true economic depreciation in timing, the after-tax return generally equals the pre-tax return reduced by the stated income tax rate. When depreciation for tax accounting purposes is accelerated in time relative to true economic depreciation, the after-tax return generally exceeds the pre-tax return reduced by the stated income tax rate.

long volatility

When an investment's value tends to rise with increases in the volatility level of market returns, the position is said to be long volatility (i.e., long vol). A key aspect of long and short volatility is that it is a description of an empirically observed correlation or tendency.

Primary input variables an index provider can use to determine individual commodity or commodity-sector weights:

World production—for example, the S&P GSCI is a quantity-based, world production-weighted index. Liquidity—for example, the BCOM uses a combination of liquidity and production measures to assign weights to individual commodities. Open interest—the nominal value of the open futures contracts.

In a modeled trigger, the coverage is based on claims generated by

a computer model, developed by an independent modeling company. Catastrophe modeling software is used to estimate an exposure portfolio, which provides estimates of losses given various severities of a natural disaster. If a catastrophic event takes place, the event parameters are compared with the exposure portfolio, and the bond will be triggered if the modeled losses surpass a previously specified threshold. Therefore, given that involved parties do not have to deal with a company's actual claims, loss resolution after a triggering event can be faster, although the issuer preserves some basis risk.

A revolver, or a revolving line of credit, is

a credit line with a preapproved limit that's available for a prespecified period. As the borrower takes out some capital, the amount of available credit is reduced by that amount. Unlike a term loan, the borrower can repay the amount of borrowing at any time before the end of the period, and the same amount will again become available for future borrowings. The borrower typically uses the revolver to finance working capital needs. As the need for working capital fluctuates over time, the revolver structure allows the borrower to access more credit as the business needs grow and to repay the loan (and free up future capacity) as cash comes in or business slows down.

In the context of private equity, promote is

a fee based on profits that is similar to carried interest but is typically associated with more specific duties such as the creation and marketing of a specific investment opportunity. Not all co-investment deals come without fees and carried interest. Some LPs co-invest by paying promote rather than carried interest.

The fund's board of directors is

a group of individuals who are responsible for fulfilling regulatory obligations, exercising legal rights, and providing limited independent oversight of funds. These individuals may be standalone professionals or may work for third-party professional directorship companies that specialize in providing directors for hire.

The cat bond attachment point of the trigger is

a numerical value indicating the point at which at least a fraction of principal must be "attached" to cover claims.

Three-tiered functional model of investment management

a three-tiered functional model of investment management reflects recent initiatives by asset owners, especially pension funds. Tier 1, defines how these types of organizations manage themselves in relation to their goals and objectives and in relation to similar organizations and the market for investment services. Tier 2, refers to capabilities and resources of asset owners recognizing that human capital is a key ingredient in the process of producing risk-adjusted rates of return along with systems of management and information that sustain the integration of the production process. Tier 3 takes us to market and nonmarket relationships across the global financial services industry, recognizing that these relationships can provide asset owners preferred access to investment opportunities involving other parties.

Risk measurement includes

all the steps associated with gathering and reporting the information required to capture an investor's exposure to uncertainty. Risk measurement is effective only to the extent that the measurements associated with each investment are accurate. Therefore, risk management starts with risk measurement, and risk measurement starts with the performance reporting process.

Single-strategy funds of hedge funds

allocate assets across several hedge funds (typically 5 to 15) following the same strategy, theme, or group of strategies. Their goal is to provide exposure to a particular subset of the hedge fund universe. Examples of single-strategy funds of hedge funds include funds that allocate exclusively to equity hedge funds, managed futures funds, emerging markets, or emerging managers.

Quality spreads

are similar to substitution spreads, except that the spread is across different grades of the same commodity. A common quality spread executable in futures markets involves spring wheat and hard red winter wheat. Most other quality spreads involve OTC transactions. For example, there is a liquid OTC market in jet fuel, which is very similar to diesel fuel/heating oil. Similarly, there are many grades of coffee that are traded OTC but only a few grades that are listed on futures exchanges.

Free ports

are specialized, climate-controlled repositories for art and other valuable goods belonging to the very wealthy—similar to a custody bank for stock certificates. Not surprisingly, the best-known free ports are in Geneva and Zurich, Switzerland, home to many of the oldest and most private of wealth management firms. Additional free ports exist in Beijing, Singapore, and Luxembourg.

Corporate foundations

are sponsored by corporations, with gifts provided by the corporation and its employees.

Cause exams

are triggered by tips, complaints, and referrals.

complexity arbitrage arises because these securities are difficult to price and may trade in markets that are not entirely efficient. Complexity arbitrage is the process of

attempting to earn short-term, very low-risk profits from pricing discrepancies attributable to highly complicated investment features. The authors caution that alpha strategies will be difficult to implement because many of them are costly to execute and constrained by their small size.

Adverse selection within funds takes place

before a transaction is completed, when the decisions made by one party (e.g., a GP or LP) cause less desirable parties to be attracted to the transaction. For example, if an LP decides to seek GPs that charge very low fees and offer funds with very favorable terms, the LP is likely to attract unskilled GPs that claim to be skilled.

In its simplest form, a carry trade consists of

being short one rate (e.g., borrowing in a low-interest-rate currency) and being long another rate (e.g., lending in a high-interest-rate currency) in an attempt to earn the spread without hedging the risk that the spread will change. The goal of such a trade is to capture the rate differential, such as an interest rate differential.

buy-and-hold concave payoff curves

buy-and-hold strategy is characterized by an initial mix (e.g., 60/40 stocks/bills) that is bought and then held. Buy and-hold strategies are "do nothing" strategies: No matter what happens to relative values, no rebalancing is required. "Do nothing" strategies (buy-and-hold) give payoff diagrams that are straight lines. A Buy-and-hold policy tends to be superior if there is a major move in one direction. There is a simple and straightforward relation- ship between the shape of a payoff diagram and the slope of the exposure diagram (which here corresponds to the multiplier, m). Strategies with slopes less than one give rise to concave payoff diagrams, while strategies with slopes greater than one give rise to convex payoff diagrams. Concave and convex strategies may be seen as mirror images of one another on either side of buy-and-hold strategies.

A horizontal spread is a

combination of long calls and short calls (or short puts and long puts) having the long options with one expiration date (the long leg) and the short options with a different expiration date but with the same strike prices. The spread is intra-asset when it involves options from the same asset. The horizontal spread is a type of skew spread.While vertical spreads tend to have relatively significant exposures to directional moves in the underlying assets, horizontal spreads have much lower directional exposures. Horizontal spread returns are driven by changes in relative implied volatilities between options of different tenors, which in turn are often driven by the timing of new information such as an event.

market segmentation refers to

differences in market characteristics (especially valuation) emanating from differences in the clienteles (i.e., participants) using the markets. Financial market segmentation can lead to price differences (and especially differences in risk premiums) for similar assets trading in different markets typically attributed to the differences in the clienteles that participate in the markets, such as having different risk preferences. Equity markets are segmented between private and listed access.

A hard lockup period

disallows withdrawals for the entire duration of the lockup period.

Castelli and Scacciavillani (2012) describe sovereign wealth development funds as

investment holding companies that have socio-economic objectives such as economic diversification, the development of strategic industries, or poverty alleviation.

Volatility risk is the

economic dispersion caused by changes in volatility.

Investment process risk is

economic dispersion caused by imperfect application of the decisions, activities, policies, and procedures within the front office and ensuing errors or purposeful decisions that result in exposures that are inconsistent with the investment mandate, such as inappropriate levels of leverage and inappropriate levels or types of asset risk.

The loss aversion/disposition

effect captures the notion that investors typically prefer to avoid losses more than to acquire gains.

the mixed approach

either starts with a bottom-up strategy, to which increasing top-down optimization is added, or starts as an iterative short process cycle, in which bottom-up screenings are followed by top-down analysis and then by bottom-up screenings.

Volatility derivatives are

engineered to provide pure plays on volatility with returns that are driven substantially, explicitly, and directly by exposure to the volatility factor.

Related to attachment point is the attachment probability, which, typically based on historical information about natural disasters, indicates the

estimated probability that the cat bond's attachment point will be reached.

The DuPont model

evaluates a firm based on a company's gross value rather than its net value, and breaks a firm's ROE into three major components: profit margin, asset turnover, and leverage. The relation is as follows: ROE=Profit Margin×Asset Turnover×Leverage or ROE=(Net Income/Revenues)×(Revenues/Assets)×(Assets/Book Equity)

Nassim Taleb defines a black swan as an

event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict. Market events with large impact, such as the failure of Long-Term Capital Management or Lehman Brothers, tend to fit this definition of a black swan. Tail risk funds purportedly provide constant protection against black swans, while long volatility funds may not always be providing this protection.

January 1990-December 2019 show that the implied volatility of S&P 500 options

exceeded realized volatility in over 88% of all calendar quarters studied. If so, options are frequently "overpriced" (relative to a risk-neutral world). If so, option writers consistently earn returns in excess of the riskless rate because the implied volatility priced into the options they are selling consistently exceeds the realized volatility.

An exception report

filters data to describe only those instances in which risk measures and other data are outside predetermined bands deemed to be appropriate for further analysis at a more senior level.

The Principles for Responsible Investment (PRI)

formerly known as the UN PRI or United Nations Principles for Responsible Investment, is a nonexhaustive set of six proposals designed to "provide a global standard for responsible investing as it relates to environmental, social, and corporate governance (ESG) factors."

Information filtering is the

fund manager's ability to use data available to others but to be better able to glean tradable insights from it. Generally speaking, quantitative, computer-driven equity managers access the same information set as everyone else, but the successful managers have better algorithms to extract more value. These successful managers are able to process generally available information more quickly or more effectively.

Directional strategies

have intentional exposures to a market's direction from either a net long or a net short exposure. While directional strategies can be implemented with traditional assets, such as exchange-traded funds (ETFs), when actively traded they often use listed derivatives (futures and options) and over-the-counter (OTC) derivatives. Directional strategies can be differentiated in several ways, including the market in which the positions are focused and the method used to select positions (such as technical analysis versus fundamental analysis).

Operating foundations

have the greatest similarity to endowments, as the income generated by an endowment is used to fund the operations of the charitable organization.Operating foundations have the greatest similarity to endowments, as the income generated by an endowment is used to fund the operations of the charitable organization.

Subordinated debt with warrants differs from a convertible bond because

in the case of convertibles, the option is exercised by handing over the underlying bond rather than being exercised independently of the debt security. Subordinated debt with warrants offers two distinct advantages to issuers: lower interest costs and less restrictive covenants compared to most other bonds.

Open-end real estate funds allow

investments and redemptions (usually after an initial lockup period) at any time, have an indefinite life, and can cause performance problems due to using stale redemption prices. The redemption price is calculated based on the quarterly appraisal value of the portfolio of properties, making the redemption price a stale price since appraisals are performed with a lag and a tendency towards smoothing.

Risk management

includes the decisions and actions associated with overseeing and controlling exposure to uncertainty.

An indemnity trigger is a type of trigger that

initiates principal reductions based on the level of actual excess claims paid by the issuer.

sin stocks

inlcude firms profiting from gambling, tobacco, or alcohol sales.

Dynastic wealth

is an amount of wealth so large that is has substantial potential to be maintained for a large number of generations.

The pension surplus

is the amount of assets in excess of a pension plan's projected pension benefit (PBO).

another class of insurance-linked securities, life ILS. Life ILS introduce

longevity risk and mortality risk.

Investors can often request to enter into what is known as a side letter to

negotiate such terms, which is an agreement between an investor and the fund that amends the OM/PPM to afford a specific investor with certain negotiated provisions. Examples of common items negotiated in side letters could be additional fund transparency or beneficial redemption rights. It should be noted that side letters do not apply to all LPs in a pooled fund structure—just those designated in the side letter.

Dutch disease

occurs when large currency inflows (such as from the sale of large quantities of commodities) damage the long-run health of a country's other sources of economic prosperity (such as the country's manufacturing sector).These results reduce the competitiveness of the country's manufacturing and export sectors, leading to its de-industrialization.

Confirmation bias

occurs when one selectively employs evidence that supports a given claim or belief and minimizes contradictory evidence (aka "selective hearing").

The reserve account

of a central bank consists of the central bank's holdings of foreign currencies and is operated by the central bank to conduct transactions involving foreign currencies. A country's balance of payments measures the inflows and out-flows of currency that facilitate each country's foreign transactions.

A volatility structure with a smile or a smirk is where

out-of-the-money put options have higher levels of implied volatility than other options. OTM call options tend to have a lower implied volatility than put options a similar distance from the current market price. In equity index options, the graph for a single expiration date seems to look like a smile or a smirk. These smiles or smirks may be generated by negatively skewed return distributions, institutional demand for the downside risk-protection offered by long positions in equity put options, or perhaps the negative correlation between returns and changes in volatility.

Some funds will use a third-party administrator. In those cases, a three-way reconciliation (or triangular reconciliation), is

performed between the trading counterparties, the fund itself, and the administrator.

Mortality risk is the risk of a

person (or group of individuals) passing away sooner than expected. Such an event could create financial distress at the individual level if the deceased is the family wage earner and passes away without life insurance.3 This risk is also borne by companies writing life insurance if a large number of sooner-than-expected mortalities occur. Mortality risk is the opposite of longevity risk.

Longevity risk is any

potential risk that arises from a higher realized average life expectancy of pensioners and policyholders than initially projected. Longevity improvements around the world are attributable to declining infant mortality rates, improved living conditions, and better medical care. Life insurance companies and pension funds are, among other institutions, affected by longevity risk. Governments' fiscal balance sheets can also be severely affected by longevity risk. The most relevant measure of longevity risk is life expectancy at pensionable age.

Excuse rights

potentially allow LPs to opt out of particular investments in the main fund with three main areas for negotiation of excuse rights: (1) legal requirements (based on jurisdictions); (2) LP internal policy requirements (e.g., ESG); and (3) religious (e.g., Shari'ah).

In such synthetic secondaries,

portfolio companies are packaged up and sold to another manager, usually with the backing of a secondary fund specialist. Here, it is the GPs who want or are under pressure to sell, mainly as their fund is approaching the end of its contractual lifetime. In fact, dedicated secondary direct strategies have only recently become recognized as independent strategies requiring highly specialized fund managers. This market is attractive due to its inefficiencies, but such opportunities are hard to value, and the due diligence is complex.

Short-Selling Risk brings the

potential for massive losses along with the complexities involved with implementing a short-selling strategy. The potential losses are theoretically unlimited because the asset being shorted typically has no upper bound on its price. The complexities of short-selling include the potential for the security lender to demand the return of the securities and the potential of a short-squeeze.

A synergistic risk effect is the

potential for the combination of two or more risks to have a greater total risk than the sum of the individual risks. Fluctuations in market prices are a source of risk. However, when the level of operational errors is positively related to the volatility of market prices, there is a synergistic effect that deserves careful consideration.

Asset stripping rules

prevent an AIF from making a controlling private equity investment, having the nonlisted company take a loan, and then distributing the loan proceeds to themselves, and thereby creating leverage that may or may not create unnecessary risk.

An industry loss trigger is a trigger in which

principal reductions in the cat bond are based on index estimates made by an independent third party of the total industry losses due to the occurrence of an insured event. For example, a triggering event that takes place when total industry losses exceed $8 billion, investors are accountable for the percentage of the industry that corresponds to the cat bond's issuer's share.

External constraints

refer to constraints that are driven by factors that are not directly under the control of the investor.

A peer-group cohort

refers to a group of private equity funds or investments that share some important characteristics.

A real estate operating company (REOC) is similar to a REIT, except that a REOC

reinvests its earnings into the business rather than passing them along to shareholders (and hence they do not get the same tax advantage enjoyed by investors in REITs). REOCs reinvest their earnings because their goal is to search for capital gains rather than passive cash flows. Furthermore, REOCs are more flexible than REITs in terms of the kinds of real estate investments they can make.

The VIX term structure is the

relation between the prices of VIX futures contracts and their settlement dates, usually expressed as a graph.This exhibit depicts a typical example of the relation between the futures contract rates on the 30-Day S&P 500 VIX futures contract and their settlement dates.

Information-based global macro managers

rely primarily on collecting micro-level information to better understand the global macro picture. Their hypothesis is that an information gap is created by the delay in the release of official macroeconomic statistics. This gap then opens the door for pricing inefficiencies, which will persist until the macro information has been disseminated into the public domain.

Model-based global macro managers

rely primarily on financial models and economic theories to analyze market movements, detect policy mistakes of central banks and governments, or extract implied market expectations and compare them to sensible estimates.

Storage strategies

seek to profit from changes in the benefits and costs of commodity storage and often use leased storage facilities to hold physical commodities for delivery at a later date, when the return on storing a commodity exceeds its costs. These strategies are more complex than futures-based strategies and are both labor and capital intensive. Storage strategies are typically hedged transactions, involving a simultaneous purchase of the physical asset in the spot market and the sale of the commodity in the futures or OTC forward market for future delivery. A storage strategy is equivalent to a calendar spread in that the transaction involves holding the same commodity over time.

Processing spreads

seek to take advantage of the relative price difference between a commodity and products the commodity can be used to produce. Two popular processing spreads are crush spreads and crack spreads.

A momentum strategy

seeks to generate superior risk-adjusted performance by identifying assets more likely to continue the unusually high (or low) previous performance rather than to reverse a past trend. There are two primary methods of implementing momentum strategies: cross-sectional (relative) and time series (absolute).

A hybrid operational due diligence approach refers to

some combination of the dedicated, shared, and modular approaches. An example is employing a full-time ODD analyst (dedicated framework) while leveraging off in-house domain experts as needed (modular framework).

Terms regarding redemptions and withdrawals are

specified in the subscription agreement. Some funds provide monthly liquidity (i.e., transfers are made at or immediately after the end of each month), but the norm is quarterly or semiannual redemption rights. This allows for controlled cash flows to and from the fund, especially for the purpose of matching redemptions and subscriptions to minimize the impact of investor flows on the fund.

A transition matrix is a

square matrix that denotes the frequency (or probability) of subsequent outcomes based on prior outcomes. Each prior outcome (i.e., in this case performance of an original private equity fund in a prior time period) is matched with each subsequent outcome (i.e., in this case performance of a follow-on private equity fund in a subsequent time period). The goal is to indicate the historic rates at which particular levels of performance in a prior period are associated with subsequent performance

The purpose of the master trust is

tax neutrality, not evasion. In Bermuda, for example, master trust funds pay only a corporate licensing fee, not corporate income tax. This ensures that there are no tax consequences to the fund investors at the master trust level and no double income tax. Instead, the tax consequences for the investors occur at their country of domicile through the feeder funds. Investors in the onshore, or US-based, feeder fund are subject to the US Internal Revenue Code, whereas investors in the offshore feeder fund are subject to the tax codes of their respective domiciles—including the United States, if a US investor has chosen to invest through the offshore vehicle.

An established management team is a

team that has been able to generate a top-quartile performance for most of its funds (more than three funds) through at least two business cycles.

A blue chip management team is a

team that has been able to generate a topquartile performance for all of its funds through at least two business cycles (i.e., a sequence of more than three funds)

An emerging management team is a

team with limited joint history but with all the characteristics to become an established team.

Seasonal overadvance is a

temporary allowance by which the lender allows for a higher advance rate to account for seasonal effects in which the working capital need of the borrower is higher. For example, retailers' busiest season is typically in November and December, and in preparation for that season, they usually need to build inventory. The need to purchase more goods will lead to higher working capital needs, and a seasonal overadvance provides some flexibility to allow higher borrowing.

the cash-and-call strategy or participation note,

the most common Principal-guaranteed commodity notes in which the principal guarantee comes from the issuer purchasing maturity- and principal-matched zero-coupon bonds, while the commodity-linked upside exposure comes through the issuer purchasing call options.

Fund culture refers to

the principles, professionalism, ethics, character, and governance exhibited by and integrated within fund management. Charles Ellis, founder of Greenwich Associates and renowned author, has written much on the topic. Ellis views the fund's culture as an important factor in identifying managers who will provide superior active management. Evidence of the true culture of a fund can be found by examining its systems of risk management and methods of performance valuation, performance reporting, and employee compensation.

Over-the-counter (OTC) variance swaps can be used to take a position with payoffs driven by

the realized variance of returns observed for its underlying asset. In a variance swap one party (the variance swap buyer) receives the annualized variance realized by a specified asset and pays a predetermined variance (the variance strike rate).

the third component to portfolio returns, market timing or tactical asset allocation is measured as

the return earned from the variation of asset class weights versus the policy or target asset class weights.

A slack variable is

the variable in an optimization problem that takes on whatever value is necessary to allow an optimum to be feasible but, while doing so, does not directly alter the value of the objective function. Option traders often take bets with respect to volatility and view positions in the underlying asset as the slack variable that is used to control delta. In this case, the position in the underlying asset keeps the portfolio from being affected by directional moves in the market (i.e., controls the delta) but is not a direct source of alpha and does not affect gamma or vega.

Typically, a multi-family office pools assets of a small number of ultra high-net-worth families,

those with over $30 million in assets.

noise traders refers to those investors who

trade securities for reasons not related to the fundamental value of securities. For instance, some investors may sell securities in order to meet liquidity needs, while others may decide to buy securities simply because their prices have been increasing in recent days. That is, they follow a momentum strategy.

The algorithmic factor replication approach (i.e., the bottom-up approach) attempts to

trade the underlying securities in a manner consistent with the trading approach taken by most active managers within a particular strategy. To the degree that tracker products are designed to track benchmarks based on active managers, factor-based and algorithmic approaches are meant to capture a substantial portion of the common strategy return and to reflect fund managers' common exposures to various traditional and alternative betas.

Concentrated funds of hedge funds

typically allocate assets to a relatively small number of hedge funds compared to diversified fund of hedge funds (typically 5 to 10).

Unauthorized PUTs are

unregulated unit trusts that may be offered only to institutional investors in the UK. All issued units are purchased by these investors, who are completely exempt from capital gains tax or corporation tax (e.g., pension funds and charities).

Mark to model means the

use of valuation models to estimate the likely prices at which illiquid securities would transact. This valuation may be subjective, biased, and unreliable. Even third-party models designed to be objective and unbiased can generate highly erroneous indications of prices at which transactions would take place during periods of extreme illiquidity and turmoil. Mark-to-model accounting has been the source of numerous investment disasters. Many fund managers mark to model.

the fourth principle of depreciation and returns:

when all investment outlays can be fully and instantly expensed for tax accounting purposes, the after-tax return generally equals the pre-tax return.

the third principle of depreciation and returns:

when depreciation for tax accounting purposes is accelerated in time relative to true economic depreciation, the after-tax return generally exceeds the pre-tax return reduced by the stated income tax rate.

the second principle of depreciation and returns:

when depreciation for tax accounting purposes matches true economic depreciation in timing, the after-tax return generally equals the pre-tax return reduced by the stated income tax rate.

View commonality refers to the fact that

when the views of individual hedge fund managers (measured by their exposures) are aggregated in a hedge fund index, they tend to cluster into common themes that drive the overall performance of the index. For instance, if most equity long/short hedge fund managers have positive views on energy stocks, they may attempt to exploit this view by allocating assets to various companies that have exposure to the energy sector. In the index, these views are aggregated and are represented by increased exposure of the index to the energy sector, which could be captured by the replication product through increased allocations to an energy ETF.

Some investments are impact first,

where investors have a greater focus on the social good of their investments and may accept projects with higher financial risk or lower financial returns.

This is a progressive system,

where lower paid workers get relatively higher benefits than those earned by higher paid workers when measured by a percentage of salary.

proxy voting

where shareholders vote on issues put up for election by management, typically focused on routine elections of board members and service providers

his asset allocation would be regularly rebalanced by the fund manager, following a glide path

where the allocation becomes more conservative over time.

What is the difference between an initial public offering (IPO) and an initial coin offering (ICO)?

An initial public offering (IPO) sells shares of a company for the first time, while an initial coin offering (ICO) sells ownership of an asset as tracked through a coin or a digital token.

What is entailed within asset stripping rules and how long do the rules apply after acquiring control of a non-listed company?

Asset stripping rules prevent an AIF from making a controlling private equity investment, having the non-listed company take a loan, and then distributing the loan proceeds themselves. The rules are in effect for two years.

What advantage do multi-factor models have over single-factor models, such as the Capital Asset Pricing Model?

Multi-factor models tend to explain systematic returns much better than do single-factor models. By doing so, multi-factor models are generally believed to produce better estimates of idiosyncratic returns.

Normative economic models

Normative economic models tend to be most useful in helping explain underlying forces that might drive rational financial decisions under idealized circumstances and, to a lesser extent, under more realistic conditions.

In theory, an investor could passively allocate to several factors that could produce attractive results, but how might they implement a more sophisticated approach to multi-factor investing?

Not all factor premiums are the same, so a sophisticated strategy would take advantage of these differences by allocating higher weights to factors that are believed to be offering more attractive risk premiums.

principles-based disclosure requirements

SEC regime which are intended to provide investors with the material information they need about companies and their securities offerings to make informed investment decisions.

European Systemic Risk Board (ESRB):

The ESRB is an independent body within the EU responsible for macro-prudential oversight of the financial system within the EU.

National Futures Association (NFA):

The NFA was designated a registered futures association in 1981 and charged with the role of a self-regulatory organization (SRO). The NFA is responsible for the regulation of firms and individuals that engage in futures trading with and for investors.

US Commodity Futures Trading Commission (CFTC):

The derivatives market is overseen by the CFTC. The CFTC oversees individuals and organizations, including commodity pool operators and futures commission merchants, and seeks to protect market users and their funds, consumers, and the public from fraud, manipulation, and abusive practices related to derivatives.

What are the two main disadvantages of the Ho and Lee model?

The main disadvantages of the Ho and Lee model are that interest rates can be negative and that it assumes a very simple binomial process for bond prices.

Name the two methods available to fund managers to engage in the marketing of AIFs by AIFMs.

The two methods are as follows: Using a marketing passport available under the AIFMD Marketing in a specific EU member country in accordance with that country's private placement regime

In the United States, a firm manages a hedge fund with $50 million in assets under management and operates in a state that does not require the registration of investment advisers. Is national registration still required, and who is the firm's regulator?

Yes, registration is required, and the regulator is the Securities and Exchange Commission (SEC).

Cybersecurity concerns include

a broad range of risks such as threats through cyber intrusion, denial of service attacks, manipulation, misuse by insiders, and other cyber misconduct.

Abstract models

also called basic models, tend to have applicability only in solving real-world challenges of the future. Abstract models tend to be theoretical models that explain hypothetical behavior in less realistic scenarios. For example, a model might be constructed that describes how two people with specific utility functions might bargain with regard to prices in a world with only two people and two risk factors.

Cross-sectional models

analyze relationships across characteristics or variables observed at a single point in time such as when investment returns are used to explain the differences in risk premiums.

The Financial Investment Services and Capital Markets Act (FSCMA)

and its regulations are the primary legislation for the regulation of asset management activity in South Korea.

Applied models

are designed to address immediate real-world challenges and opportunities. For example, Markowitz's model, which is an applied model, provides useful insights for accomplishing diversification efficiently.

Collective investment schemes (CIS)

are either a UCITS or an AIF.

Qualified opportunity zones

are geographical areas in the US designated for special income tax breaks for investors funding private equity projects and real estate developments in those zones.

Positive economic models

are often used to try to identify mispricing of securities by recognizing patterns in actual price movement. Technical trading strategies are based on positive economic modeling. For example, a strategy based on point-and-figure charts is a positive strategy.

The Financial Instruments and Exchange Act (FIEA) and The Act on Investment Trust and Investment Corporation (ITIC)

are the primary legislation for the regulation of asset management activity in Japan.

Sweep exams (or theme inspections)

are used to review a compliance issue that the SEC considers a risk across multiple firms.

Illegal insider trading refers

generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security, and may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.

The Chief Compliance Officer (CCO)

has the role of being primarily responsible for overseeing and managing regulatory compliance issues.

National private placement rules

impose rules for selling non-EU funds in the EU at an EU level, but also each EU member country may impose their own requirements on any sale of fund interests within their own border

Blue sky laws

in the US are a state's own set of securities laws designed to protect state interests and prevent fraudulent activities within its borders.

Anti-fraud prohibitions

include that it is unlawful to employ any device, scheme, or artifice to obtain money or property by using material misstatements or omission, or to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.

Access persons

include the adviser's directors, officers, partners, and supervised persons who have access to nonpublic information regarding securities transactions.

accredited investor

includes a natural person who either has a net worth (along with his or her spouse) that exceeds $1 million, excluding the value of the person's primary residence; or income in excess of $200,000 (or joint income in excess of $300,000 with spouse) in each of the prior 2 years with a reasonable expectation of reaching the same income level in the current year.accredited investor includes a natural person who either has a net worth (along with his or her spouse) that exceeds $1 million, excluding the value of the person's primary residence; or income in excess of $200,000 (or joint income in excess of $300,000 with spouse) in each of the prior 2 years with a reasonable expectation of reaching the same income level in the current year. The definition also provides for various entities such as trusts.

an investment adviser

is any person or firm that, for compensation, is engaged in the business of providing advice to others or issuing reports or analyses regarding securities.

The Financial Supervisory Service FSS

is responsible for inspection of financial institutions as well as enforcement of relevant regulations as directed by the FSC.

The Securities and Futures Ordinance (SFO)

is the primary legislation for the regulation of asset management activity in Hong Kong.

The Securities and Futures Act (SFA)

is the primary legislation for the regulation of asset management activity in Singapore.

The Financial Services Commission (FSC)

is the primary regulator in South Korea and directs the Financial Supervisory Service (FSS).

The Kanto Local Finance Bureau of Ministry of Finance Japan (KLFB)

is the regulator for the purposes of disclosure in Japan under the FIEA.

The Monetary Authority of Singapore (MAS)

is the regulator responsible for administering the SFA. The MAS regulates all financial institutions in Singapore including fund managers.

A collective investment scheme (CIS)

is the statutory term used in Singapore to describe an investment fund.

SEC registration requirements for non-US hedge funds

is triggered for funds with more than 15 US clients and investors with assets under management of more than $25 million unless exempted for an adviser solely advising private funds with less than $150 million in assets under management (i.e., the private fund adviser exemption).

The SEC

oversees the key participants in the US securities markets, including securities exchanges, securities brokers and dealers, investment advisers, and mutual funds. As the primary overseer and regulator of the US securities markets, the SEC's responsibilities include: protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation

A marketing passport

permits marketing across the EU as a single marketplace for the marketing of AIFs to professional investors.

public interest theory of regulation

proposes that people act through government for the benefit of the society and seek to prevent and control problems associated with free markets such as imperfect competition, environmental damage, and other market failures with potential dangers to the public.

The Investment Advisers Act of 1940 (Advisers Act):

provides for the registration and regulation of persons and entities who are engaged in providing advice to others regarding securities investments by the SEC and defines the role and responsibilities of an investment adviser. In the US, an investment adviser is any person or firm that, for compensation, is engaged in the business of providing advice to others or issuing reports or analyses regarding securities.

The Securities Exchange Act of 1934 (Exchange Act):

provides governance of securities transactions on the secondary market (i.e., after the initial public offering) and regulates the exchanges and broker-dealers in order to protect the investing public.

The AIFMD sovereignty exception

provides that member states may refuse to cooperate if "cooperating adversely affects the sovereignty, security, or public order of the member state addressed."The AIFMD sovereignty exception provides that member states may refuse to cooperate if "cooperating adversely affects the sovereignty, security, or public order of the member state addressed."

host state

refers to the EU country (other than the home country) where the AIF is being marketed.

The Alternative Investment Fund Managers Directive (AIFMD)

regulates alternative investment managers—meaning any whose regular business is managing one or more alternative investment funds (AIFs).

The Investment Company Act of 1940 (40 Act):

regulates the organization of companies, including mutual funds, that engage primarily in investing, reinvesting, and trading in securities, and whose own securities are offered to the investing public.

The Securities Act of 1933 (Securities Act):

requires registration of securities with the SEC, unless an exemption is available, to ensure that investors receive financial and other significant information concerning the securities being offered and prohibits deceit, misrepresentations, and other fraud in the sale of securities.

A code of ethics

sets forth standards of conduct and requires compliance with federal securities laws and is required to be established in writing, maintained, and enforced in the US for any fund manager registered under the Advisers Act, and must include requiring access persons to: (1) report personal securities transactions and holdings periodically; and (2) obtain the adviser's preapproval before investing in reportable securities, including but not limited to IPOs or limited offerings (such as interests in hedge funds).

Empirical models

tend to explain complex behavior relatively well when there are many data points available and when the relative behavior of the variables is fixed or is changing in predictable ways. For example, an empirical model might be better than a theoretical model in the case of a frequently traded but extremely complex security with many overlapping option features.

Undertakings for Collective Investments in Transferable Securities (UCITS)

the main European framework covering collective investment schemes. UCITS funds must be open-ended and liquid and typically invest in securities listed on public stock exchanges and regulated markets.

AIFMD key features include, among others:

(1) AIFMs managing AIFs must be authorized, unless an exemption is available; (2) restrictions are placed on the levels of remuneration for senior management and risk-takers; (3) AIFMs are required to set a maximum level of leverage for each AIF; and (4) AIFMs are required to manage and monitor liquidity risks and conduct regular stress tests.

twelve matters regulated under the Advisers Act are:

(1) advisory agreement terms; (2) performance fees; (3) client solicitation; (4) political contributions; (5) trading practices; (6) advertising; (7) record-keeping; (8) personal securities reporting; (9) custody; (10) proxy voting; (11) compliance program; and (12) gifts and entertainment.

two tests for the private investment fund exemption:

(1) it must have no more than 100 beneficial owners; and (2) it must not make or propose to make any public offering.

three types of SEC exams:

(1) regular periodic inspections; (2) cause inspections; and (3) sweep inspections.

Marketing of AIFs by AIFMs is allowed by:

(1) using a marketing passport available under the AIFMD that provides that once a fund is approved in one EU member country, the AIF can be marketed to professional investors located in other EU countries; and (2) marketing in a specific EU member country in accordance with that country's private placement regime, subject to certain conditions being met.

Private interest theories of regulation

view regulation as primarily emanating from self-interested motivations of various parties including legislators and other government employees as well as business competitors and industry groups.

The Dodd-Frank Act

was enacted to promote the financial stability of the US by improving accountability and transparency in the financial system, to end "too big to fail," to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.

initial coin offerings (ICOs),

which sell ownership of an asset as tracked through a coin or a digital token, may be securities offerings and thus the securities laws would apply, such as registration of the securities with the SEC (unless an exemption is available).

Spoofing

is the placing of large orders to influence market prices with no intention of honoring the orders if executed.

There are two types of commodity substitutes:

production substitutes and consumption substitutes.

What is the traditional difference indicated by the use of "a" to denote an intercept rather than α?

"a" is used to represent variables estimated in and outputted from a statistical procedure, in this case the y-intercept. α is used to represent the true and unobservable variables, in this case α = Rp - [Rf + (Rm - Rf) β].

The pension plan's PBO can be compared to a short position in corporate bonds, which will change in value by the approximate amount of:

%Change in Liabilities=−Modified Duration×Change in Yield

old money

It is successive generations (old money) that turn to generating wealth growth with an established pool of assets.

List some of the challenges faced by institutional investors regarding ESG.

The following are challenges: ESG Adoption Lack of Standards Cost

the new investment model,

investments are allocated with flexibility and in the explicit context of alpha and beta management.

On the other hand, in a nonrecourse loan,

the lender can collect only the collateral at hand.

The income approach,

which is similar to the discounted cash flow method used for valuing stocks and bonds. Several years of net operating income are projected for a specific property or portfolio of properties and then discounted using an appropriate discount rate. This approach is particularly useful when valuing income-producing real estate assets, such as commercial real estate.

depletion,

which is the rate of extraction of a commodity relative to the remaining in-ground stocks.

the PME ratio,

which uses future values calculated by compounding cash flows forward through time using the annual returns of a public market index and then adding in the NAV at time T to form a ratio of value received to value paid out.

the Public Market Equivalent (PME) Method

which was introduced in Level I of the CAIA curriculum for investments involving only two cash flows: an initial cashflow into the investment and one liquidating cashflow out of the investment.

Option Sensitivities and Put-Call Parity

δ = delta of a call option, γ = gamma of a call option, and ν = vega of a call option

If an option's gamma is positive for a simple call, will the option's vega also be positive?

Yes.

consider four very strong assumptions: (1) the portfolio is equally weighted; (2) the variance of the returns of each individual asset is the same; (3) the return correlations between each pair of assets, ρaverage, is the same and positive; and (4) the number of assets in the portfolio, N, is very large so that we can approximate ((N − 1)/N) as equaling one. Under these assumptions the pairwise correlation coefficient, ρAverage, will be (recognizing that it is an approximation to the true correlation):

ρ average ≈ σ2p/σ2i

meta risks, which are defined as

"the qualitative risks beyond explicit measurable financial risks. They include human and organizational behavior, moral hazard, excessive reliance on and misuse of quantitative tools, complexity and lack of understanding of market interactions, and the very nature of capital markets in which extreme events happen with far greater regularity than standard models suggest." In an operational risk context, meta risks is the catch-all category used to account for all noninvestment-related risks that are not covered by a particular category, with examples ranging from a fund manager's expenditures on expensive office decorations, or a fund manager who is confrontational or defensive during an onsite meeting.

Unlisted Manager-Investor Relationships - Clawback:

(1) Actual and potential clawback liabilities should be determined and clearly disclosed to the LPs as of the end of every reporting period. (2) All clawback amounts should be gross of taxes paid and paid back no later than 2 years following recognition of the liability. (3) The clawback period must extend beyond the term of the fund, including liquidation and any provision for LP giveback of distributions. (4) LPs should have robust enforcement powers, including the ability to directly enforce the clawback against individual GPs.

Unlisted Manager-Investor Relationships - Fees and Expenses:

(1) All fees charged to portfolio companies should be 100% offset against the management fee and accrue to the benefit of the fund; and (2) the presentation of allocable and charged fees and expenses should be consistent with provisions in the limited partnership agreement and side letters and should be presented such that it can be referenced within that pre-agreed language.

Unlisted Manager-Investor Relationships - Other Policy Disclosures and Notifications:

(1) Any policy or event with a significant effect on the fund or its investors should be disclosed to all LPs upon their issuance or modification.

Unlisted Manager-Investor Relationships - Identification and Changes to Key Person(s):

(1) Any significant change in that team should allow LPs to reconsider their decision to commit through the operation of the key person provisions; and (2) LPs should be notified in a timely manner of any personnel changes, not solely key persons, with the potential to impact fund performance, and immediately notified when key person provisions are tripped.

Unlisted Manager-Investor Relationships - Waterfall Structure:

(1) Best practice is for full return of investor contributions and preferred returns first; (2) enhance investor protections under the deal-by-deal method.

Unlisted Manager-Investor Relationships - Calculation of Carried Interest:

(1) Calculate carried interest on a net after-tax profit basis; (2) calculate preferred return from the capital contribution date to the distribution date; (3) carried interest should ideally utilize a "hard hurdle."

Unlisted Manager-Investor Relationships - Capital Calls and Distributions:

(1) Capital calls and distributions should be consistent with the ILPA Standardized Reporting format.

Unlisted Manager-Investor Relationships - Reasonable Organization and Partnership Expenses:

(1) Costs related to the formation of the fund should be reasonable and capped at an amount appropriate to the size of the fund. (2) GPs should seek whenever possible to include provisions common across the majority of a fund's side letters into the LPA itself. (3) Expenses shared between the GP and the Partnership include: broken-deal expenses, technology, cyber security and software upgrades, and specific LP expenses. (4) Expenses allocable to the Partnership include: LPAC meetings/annual investor meeting, third-party administration, travel, interest expenses and fees, audits, legal expenses, indemnification, insurance, and litigation expenses, and regulatory expenses. (5) Expenses covered under the management fee include: consultants' fees, ESG-related expenses, placement agent fees, operating partners/consultants, and unforeseen expenses.

the top ten ESG metrics sought by private equity fund investors are:

(1) Does the firm have an ESG Policy? (2) Is there an individual or team that is specifically assigned to administer ESG policy? (3) Is there a Corporate Code of Ethics? (4) Presence of litigation. (5) People diversity. (6) Net employee composition (e.g., percentage of full-time to part-time workers, etc.). (7) Environmental policy. (8) Estimation of CO2 footprint. (9) Data and cybersecurity incidents. (10) Health and safety events.

Unlisted Manager-Investor Relationships - Changes to the Fund:

(1) For any changes to the fund requiring an LP vote, "no responses" should be treated as abstentions and excluded from both the numerator and denominator; (2) super majority interests are recommended for LPA amendments, dissolving the fund without cause, and GP removal; and (3) simple majority interests are recommended for investment period suspensions and reinstatement of the investment period.

Unlisted Manager-Investor Relationships - Financial Disclosures, Annual:

(1) GP annual reporting should include: concentration risk, foreign exchange risk, leverage, realization, and ESG risk at the fund level, and leverage, realization, strategy, reputational, ESG risk at the portfolio company level; and (2) annual reports and audited financial statements should be provided within 90 days of year-end.

Unlisted Manager-Investor Relationships - Co-Investment Allocations:

(1) GPs should disclose to all LPs in advance a framework for how co-investment opportunities, interests, and expenses will be allocated among the fund and any participating co-investors; and (2) any parallel vehicles or any affiliates of the GP should be permitted to participate in co-investment opportunities, but only in the same securities and on the same terms as the LPs in the fund.

Unlisted Manager-Investor Relationships - GP-LED Secondary Transactions:

(1) GPs should engage the LPAC at the earliest opportunity around the objectives and logic for the transaction, process of the transaction, and terms and framing of the deal; (2) GPs should ensure processes are fair and transparent; and (3) GPs should engage an experienced adviser to solicit bids at the cost of the GP and not the fund.

Unlisted Manager-Investor Relationships - Cross-Fund investments:

(1) GPs should seek to limit the number of overlapping investments between funds.

Unlisted Manager-Investor Relationships - Other Financial Information, Quarterly:

(1) LPs should receive quarterly: unaudited profit and loss statements, information on material changes in investments and expenses, a summary of all capital calls and distribution notices, management comments about changes during the quarter, and an explanation of quarter-to-quarter valuation changes.

Unlisted Manager-Investor Relationships - Management Fees:

(1) Management fees should not exceed reasonable operating expenses and salaries; and (2) full disclosure of the economic arrangement between the GP and its placement agents.

Unlisted Manager-Investor Relationships - Fund Marketing Materials:

(1) Marketing materials for a fund should include: values for each unrealized portfolio company in prior funds, explanations for valuations that deviate from audited statements, performance of prior funds on a gross and net basis, and description of any pending or threatened litigation, political contributions made by the manager or any associated individuals.

Unlisted Manager-Investor Relationships - Fee Income Beyond the Management Fee:

(1) No fees should be charged to portfolio companies.

Unlisted Manager-Investor Relationships - Financial and Performance Reporting:

(1) Performance figures should be displayed both gross and net of accrued carried interest, as well as the methodology used; and (2) at the end of a fund's life, LPs should be provided with a detailed breakdown of each historical cash flow.

Unlisted Manager-Investor Relationships - GP Removal and Replacement:

(1) Provisions that exculpate or indemnify GPs in advance for material breaches of the agreement or fiduciary duties should be precluded, and (2) termination of GPs for cause should require only a majority of LPs.

Unlisted Manager-Investor Relationships - Subscription Lines of Credit:

(1) Quarterly and annual reporting should include a schedule of fund-level leverage; and (2) subscription facility terms should be disclosed or available to LPs on request.

What are the four most common internal credit enhancements from credit card receivables?

(1) Senior/subordinated certificates, (2) spread accounts, (3) excess finance charges, and (4) overcollateralization.

Unlisted Manager-Investor Relationships - Portfolio Company Information:

(1) Sensitive portfolio company information should be provided separately from fund-level reporting; and (2) valuation information should be disclosed on a quarterly basis.

Unlisted Manager-Investor Relationships - Investment Management Considerations:

(1) The GP should diversify across industry and time periods; (2) the GP should accommodate LP exclusion policies; and (3) the GP should commit to directing all appropriate investment opportunities to the fund during the investment period.

Unlisted Manager-Investor Relationships - General Partner Commitment and Ownership:

(1) The GP's equity commitment to the fund should be substantial; (2) the GP's equity should not be transferable; and (3) the GP should not co-invest only in selected deals.

Unlisted Manager-Investor Relationships - Recycling Distributions:

(1) The amount of total distributions that are subject to recycling provisions should have either a mutually agreed cap, or a monitoring threshold.

Unlisted Manager-Investor Relationships - Auditor Independence and Scope of Fund Audit:

(1) The auditor of a private equity fund should be independent and focused on the best interests of the partnership as a whole, rather than the interests of the GP.

A qualified purchaser is either

(1) a natural person with at least $5 million in investments; (2) an institutional investor with at least $25 million in investments; or (3) an entity of which each beneficial owner is a qualified purchaser

A common strategy is to use vertical spreads in equity securities while hedging delta risk. The strategy commonly sells (writes) ATM puts and buys OTM puts. The two puts generate:

(1) a profit equal to the difference between the initial put prices if the underlying asset is above both strike prices at expiration (since they both expire worthless); (2) a somewhat limited loss if the underlying asset falls well below the lowest strike price at expiration; and (3) a bullish exposure to the value of the underlying asset near expiration when the value of the underlying asset is between the two strike prices. To create a pure volatility play, the entire position can be delta-hedged to remove the trader's exposure to changes in the underlying asset. The bullish exposure to the underlying asset can be hedged with a short position in the underlying asset.

Fee collection in advance:

This refers to fees being collected at the beginning of the period in which they are due (e.g., the beginning of the month).

Warrants are similar to equity options, but they differ in that they:

(1) are generally issued by unlisted firms and are thus regarded as OTC securities; (2) are dilutive when issued by the firm itself since their exercise is satisfied by additional shares of common stock; (3) tend to have much longer maturities (often years) than traditional equity options (which usually have maturities measured in months); and (4) are not standardized securities.

The three main elements of mortality rates are:

(1) baseline mortality; (2) the terrorism element (effect of terrorist acts on mortality rates); and (3) the pandemic component (effect of major epidemics of severe infectious diseases on mortality rates). Pandemics are the main cause of potential jumps in mortality rates. Most life insurance policies do not include war as a covered cause of death.

According to Krutov (2010), five factors affect mortality rates. The five mortality rate factors are:

(1) catastrophic events; (2) random fluctuations; (3) misestimation of mortality trends; (4) miscalculation of claim levels; and (5) data issues.

Foundations are similar to endowments but tend to differ in a number of ways:

(1) foundations are grant-making institutions, whereas endowments tend to be funds established by educational, healthcare, or religious organizations; (2) foundations tend to be finite lived, whereas endowments tend to be perpetual; (3) foundations are more subject to minimum spending requirements; and (4) foundations are less likely to be funded from ongoing donations.

Donating stock reduces donors tax burden in two ways:

(1) from the forgiven capital gains taxes on the stock's appreciation; and (2) from the tax deduction on the current market value of the charitable donation.

The two paradoxes of informational market efficiency are:

(1) if financial asset markets are perfectly efficient, no one will have an incentive to collect information and so there would be no mechanism to keep markets informationally efficient; and (2) if financial asset markets are perfectly efficient, then fees paid to active managers of financial assets imply that the markets for asset management are highly inefficient.

In a cat bond transaction, payment depends on the occurrence of a triggering event (Edesess 2014; NAIC 2012). There are four basic types of triggers:

(1) indemnity triggers, which are based on the actual claims incurred by the sponsoring insurance company or companies; (2) industry loss triggers, which are based on an industry-wide index of claims; (3) parametric triggers, which are based on assumed claims from an actual physical event (such as the magnitude of an earthquake or the wind speed of a hurricane); and (4) modeled triggers, which are based on estimated claims generated by a computer model.

the three most common document types that are typically collected and reviewed during the operational due diligence (ODD) process:

(1) legal documentation; (2) financial documentation; and (3) information technology documentation. There are three primary sources of documentation for investors during an ODD review: (1) fund managers themselves; (2) fund service providers; and (3) regulatory filings.

The three dimensions of commodity relative value strategies are:

(1) location; (2) correlation; and (3) time. The location dimension refers to the same commodity having potentially different prices at different locations in the world. The correlation dimension refers to relative prices of two similar commodities possibly diverging from historical norms. The time dimension refers to prices of the same commodity possibly being different based on when the commodity is scheduled for delivery.

The transfer coefficient (TC):

(1) measures the ability of the manager to implement her recommendations; (2) has an upper limit of one and a lower limit of zero; and (3) indicates the correlation between the forecasted active returns and the active weights.When TC is equal to one, it means the manager is able to implement all her recommendations—meaning that she is able to assign high weights to those assets appearing to offer high alpha. A TC of zero indicates no correlation between the portfolio weights and the perceived alpha associated with each weight.

List the four implications of conflicts of interest in fund asset valuation.

(1) obscure or delay losses, (2) smooth returns by shifting performance between reporting periods, (3) vary risks to recoup losses or lock in profits, and (4) inflate valuations to increase fees.

Four implications from potential conflicts of interest are manager attempt to:

(1) obscure or delay losses; (2) smooth returns by shifting performance between reporting periods; (3) vary risks to recoup losses or lock in profits; and (4) inflate valuations to increase fees.

There are five common operational fund committees:

(1) operations committee; (2) valuation committee; (3) business continuity and disaster recovery committee; (4) best execution committee; and (5) compliance committee.

Common duties of fund board members include these six:

(1) overseeing the enforcement of any redemption gates; (2) reviewing and approving the audited financial statements of a fund; (3) approving amendments to legal documentation; (4) approving the fund manager's use of certain mechanisms or altering the original terms of the mechanisms; (5) reviewing fund manager valuations and overseeing the enforcement of valuation practices and procedures; and (6) reviewing the ongoing performance of fund service providers and approving new fund service provider appointments. An example of a mechanism in the fourth duty indicated above is an audit holdback.

Assets with similar realized return volatilities may have experienced tremendously different returns. Note these three limitations on realized volatility:

(1) realized volatility does not describe the shape of the return distributions; (2) assets with identical realized volatilities may differ with respect to whether their underlying returns exhibited trending, mean-reversion, or minimal autocorrelation; and (3) realized volatility does not describe whether the dispersion primarily occurred near a particular price of the underlying asset or during a particular time period within the sample.

Three alternative co-investing structures involve:

(1) the LP invests directly into one or more of the portfolio companies of the main fund; (2) one or more LPs use a GP-controlled fund created apart from the main fund for the purposes of investing in one or more of the same portfolio companies selected for the main fund; and (3) making investments in co-investment programs in which the specific investments are identified and decisions on whether to co-invest are made on an ongoing and deal-by-deal basis.

SEC staff had observed advisers using quantitative analysis to detect aberrations in returns that might identify "falsified or otherwise manipulated" returns and their managers. The following three measures of returns were noted:

(1) the bias ratio, which attempts to indicate when returns have been manipulated and thus do not exhibit a distribution consistent with competitive markets; (2) indications of serial correlation (i.e., correlation of returns between different time periods); and (2) measures of skew (i.e., the tendency of a return distribution to have higher tail risk.

The three main criticisms of nonlisted REITs are:

(1) their illiquid nature may give investors a misleading sense of low return volatility; (2) they command high fees, and often involve significant conflicts of interests; and (3) they often use leverage to fund current dividend payments, a practice that may divert attention from their potential inability to generate future dividends.

Tactical Asset Allocation

(1) there are short- to medium-term inefficiencies in some markets; and (2) a systematic approach can be designed to exploit these inefficiencies while overcoming the risks and costs that are associated with active portfolio management.

Four Procedures within the Fundamental Investment Process

(1) understand the business of the company; (2) study the company's management; (3) read and digest the financials; and (4) create and defend the valuation of the company.

The three key empirical findings regarding PE fund performance are:

(1) venture capital fund performance tended to exceed that of buyout funds; (2) private equity outperformance and performance persistence have generally been lower in more recent years (e.g., since 2000) than in early years (e.g., prior to 2000); and (3) risk-adjustment of returns and netting of fees tended to lower private equity performance to unattractive levels except for venture capital returns in earlier years and especially for those investors who enjoyed an "early mover advantage" and access to the best managers.

The one credit metric that ABL lenders tend to be most focused on is the fixed charge coverage covenant. The fixed charge coverage ratio is a ratio equal to

(EBIT + fixed charge)/(fixed charge + interest) where fixed charges include rent/lease payments, utilities, insurance, and salaries. The key to this calculation is determining what constitutes a fixed charge. Fixed charges are inserted into the formula as a positive number which in the case of the numerator means adding back in the fixed charges to EBIT that were subtracted out of revenue to calculate EBIT. The fixed charge coverage covenant is a restriction on the minimum amount by which the measure of cash flow in the numerator covers the fixed charges (plus interest) in the denominator. A ratio of less than one means that the firm is not generating enough cash to pay the fixed costs, while a ratio of greater than one indicates more than enough cash to pay the fixed costs.

The GRI standards

(formerly known as the G4 Sustainability reporting Guidelines) are designed to "enable all organizations to report publicly on their economic, environmental and social impacts - and show how they contribute towards sustainable development"4 and to serve as a "reference for policy makers and regulators."

Lerner, Schoar, and Wang (2008) explain that endowments' ability to select top managers may be related to the first-mover advantage:

(i.e., benefits emanating from being an initial participant in a competitive environment): large endowments invested in many alternative asset classes years earlier than pension funds and smaller endowments did, and may therefore have an advantage.

Swensen sought to aggressively rebalance:

(i.e., transact so as to cause portfolio weights to return to prespecified values) to strategic asset allocation weights by selling outperforming asset classes and buying underperforming ones.

The legal documentation supporting an investment in a fund,

(the private placement memorandum, subscription agreement, and side letter agreement) sometimes contains terms negotiated between the fund's attorneys and the attorneys of prospective investors rather than standardized across all investors. Therefore, due diligence includes careful analysis of the legal documents that need to be signed to invest in a fund.

In contrast to endowments, which typically have flexibility in their spending rate

(which is the fraction of asset value spend each year.), US law requires that foundations spend a minimum of 5% per year on operating expenses and charitable activities.

five actions LPs can take when building capacity to apply the PRI principles for private equity

-1.START A DIALOGUE WITH YOUR GP'S- The intent of this dialogue is to learn from the GP's own responsible investing journey and become familiar with their existing responsible investing practices. -Asking for the GP's opinions on ESG standards, e.g., SASB guidance, or industry standards - A review of any of the GP's existing responsible investing-related documents or policies - Raise questions at the Limited Partner Advisory Committee (LPAC) 2.LEVERAGE THE WORK ACROSS AN ORGANISATION- Mainly an internal exercise for LPs who belong to larger investment organisations managing different asset classes. Knowledge sharing may either be informal (interaction between investment teams) or formal (official committees such as a responsible investing committee including all asset classes). 3.ENGAGE WITH INDUSTRY PEERS AT OTHER LPS- the number of LP PRI signatories exceeds 350, investing $1.1 trillion via externally managed private equity funds. Building a responsible investing relationship with fellow LPs may have the advantage of building stronger coalitions on LPACs. It may also afford you the advantage of knowing about emerging initiatives and the opportunity to take part. 4. REVIEW RESOURCES AND LEVERAGE EXISTING TOOLS-PRI and Institutional Limited Partners Association ('ILPA') are two main resources for RI in private equity. These complementary industry initiatives cover topics such as governance and provide tools and practices which might be tested with investment teams. 5. IDENTIFY AND BUILD CURRENT ESG PROCESSES- Engagement of internal personnel in the responsible investing discussion, Demonstrate that ESG can be a good investing practice, Explain terminology. Investors may have preconceived ideas of responsible investing and may require effort to understand what practices fit into a responsible investing program.

Professional Code F: Disclosures - Managers must:

-Communicate with clients on an ongoing and timely basis. -Ensure that disclosures are truthful, accurate, complete, and understandable and are presented in a format that communicates the information effectively. -Include any material facts when making disclosures or providing information to clients regarding themselves, their personnel, investments, or the investment process.

Managers must disclose:

-Conflicts of interests generated by any relationships with brokers or other entities, other client accounts, fee structures, or other matters. -Regulatory or disciplinary action taken against the Manager or its personnel related to professional conduct -The investment process, including information regarding lock-up periods, strategies, risk factors, and use of derivatives and leverage. -Management fees and other investment costs charged to investors, including what costs are included in the fees and the methodologies for determining fees and costs -The amount of any soft or bundled commissions, the goods and/or services received in return, and how those goods and/or services benefit the client -The performance of clients' investments on a regular and timely basis -Valuation methods used to make investment decisions and value client holdings. -Shareholder voting policies. -Trade allocation policies -Results of the review or audit of the fund or account. -Significant personnel or organizational changes that have occurred at the Manager -Risk management processes.

List the four key concepts of risk-neutral modelling.

-There is often an infinite number of sets of values that are consistent with a particular value for a financial derivative. -Expected risk premiums in a risk-averse world are generally unobservable. -The derivative's value obtained from Q-measures is identical to the no-arbitrage values that must exist in a risk-averse world using P-measures. -Since Q-measures are tractable, they are used in risk-neutral modeling under those conditions in which actual derivative prices must match risk-neutral model prices.

six attributes of the endowment model which may provide advantages that explain the past excellent returns earned by large endowments in recent years:

1) An aggressive asset allocation. 2) Effective investment manager research. 3) First-mover advantage. 4) Access to a network of talented alumni. 5) Acceptance of liquidity risk. 6) Sophisticated investment staff and board oversight.

List three alternative co-investing structures.

1) The LP invests directly into one or more of the portfolio companies of the main fund, 2) one or more LPs use a GP-controlled fund created apart from the man fund, and 3) making investments in co-investment programs in which the specific investments are identified and decisions of whether to co-invest are made on an ongoing and deal-by-deal basis.

Six Benefits to a Thoughtfully Developed IPS

1)Articulates the investor's long-term investment objectives and outline policies and procedures to help meet those objectives. 2)Provides guidance around the risk tolerance and investment beliefs of the investor and governing bodies. 3)Monitors the investment program and measures outcomes against objectives. 4)Helps new staff, board, and investment/finance committee members get up to speed on the investments. 5)Allows the investor to maintain focus on important strategic issues and take a holistic view of how the investment program ties back to goals and activities. 6)Serves as a road map for the fiduciaries and provides guidance through all phases of a market cycle.

asset management firm through its organizational framework, capabilities and resources, and market and non-market relationships

1)This level sets the parameters for the organization, including how it manages itself in relation to its goals and objectives and the boundaries of the organization in relation to similar organizations and the market for investment management services. High-performing asset owners are able to motivate long-term commitment through a framework that combines culture, governance, and knowledge management, thereby enabling effective decision-making across time and space. This type of framework is a necessary condition for performance and commitment but is not sufficient as the only driver of effective investment decision-making. 2)The human capital of employees is a key ingredient in the mix, and can be highly differentiated both in terms of measurable attributes and in terms of their fit with the mission of their fund.It has been suggested that the capabilities of an asset owner are to be found in the quality of its staff, the process of investment decision-making, and the information systems that allow an asset owner to understand its place in financial markets and design and implement investment strategies that are both timely and effective. 3)First, the boundaries between asset owners are often blurred by what asset owners can or cannot do on their own account given the advantages of specialization. Second, as asset owners reach into the future and across space, they often do so through partnerships with others either better placed or more proficient in terms of their project-specific capabilities and resources. Re-intermediation, which involves the alignment of interests between asset owners and market providers, is fundamental to best practice in this regard. Three elements underwrite the longer-term performance and internal commitment of these types of investment relationships: the alignment of interests, access to investment opportunities, and symmetrical and flexible terms and conditions.

Describe the four practical implications of an adaptive view on markets.

1)tradeoff between risk and return is not stable over time and risk premiums can be predicted based on technical and fundamental variables 2)Market efficiency is a relative concept instead of an absolute one; market displays varying degrees of efficiency depending on the point in time and the participant. 3)It is necessary to use adaptable investment approaches to handle changes in the market environment. 4)With time, alpha becomes beta due to innovation and competition.

Fee collection in arrears:

This refers to fees being collected at the end of the period in which they are due (e.g., the end of the month).

four common motivations which may lead to the establishment of a SWF:

1. To protect a nation's economy (and fiscal budget) from a potential decline or volatility in revenues. 2. To help monetary authorities to counter unwanted liquidity. 3. To grow the level of savings for future generations, particularly if the condition that drove the surplus is at a reasonable risk for depletion or reversal. 4. To invest the money in infrastructure or economic growth projects today in order to strengthen a sector of the economy or grow a specific industry, especially to diversify away from commodity revenues.

What are the three key differences between PCA and factor analysis?

1.Factor analysis makes specific statistical and modeling assumptions about the return process while PCA does not require a definite model because it simply maximizes explained variance. 2.Factor analysis generates different factor scores when different numbers of factors allowed in the model, while PCA's loadings do not change as the number of components considered is increased. 3.PCA can identify a factor driven almost entirely by one security (e.g., one stock or bond with a very volatile and unusual risk profile) while FA seeks factors that drive at least two securities.

Yield-based approach

3rd approach to PE ER estimation. Apply the discounted cash flow frame-work we use to forecast 5-10 year expected returns of public equities and bonds in our Capital Market Assumptions editions of AQR Alternative Thinking. Each input is debatable as data limitations on PE necessitate many simplifying assumptions. PE firms can employ multiple levers to boost returns compared to public equity: higher starting yields through deal selection; higher earnings growth rates through operational improvements; multiple expansion through opportunistic timing of entries/exits; and financial leverage. Expect yields and growth rates for PE to be at least loosely anchored to those for public equities. First, estimate unlevered ER ru using the dividend discount model: ru ≈ yu + gu, where yu = dividend yield and gu = real earnings-per-share growth rate. Then, estimate the theoretical required levered return to equity rl by plugging in leverage D/E and the cost of debt kd, to which we finally add expected multiple expansion m to arrive at gross PE ER rg. Yield assumption: We assume the income yield of PE to be half of its unlevered earnings yield, along the lines of our methodology for public equities. We define PE's unlevered earnings yield as its EBIT-to-EV, which we somewhat crudely estimate as half of its EBITDA-to-EV, based on historical averages observed for public equities. We average EV/ EBITDA purchase multiples from several sources, as data on PE purchase multiples often covers only a small subset of the deal universe and can thus be noisy. until the mid-2000s, PE yields were almost always higher than public equity yields.

Suppose that the value of the parameter alpha for the following equation is 0.40. Pt,reported=αPt,true+α(1−α)Pt−1,true+α(1−α)2Pt−2,true+⋯ How much of the current reported price depends on the current true price, how much depends on the true price of the previous observation date, and how much depends on the true price of the observation date from two periods before?

40% (i.e., alpha = 0.40) of the current reported price depends on the current true price, 24% (i.e., 0.40 × 0.60) depends on the true price of the previous observation date, and 14.4% (i.e., 0.40 × 0.60 × 0.60) depends on the true price of the observation date from two periods before. (1/0.50) = 2 ➔ True price changes should be estimated based on a price change that is 2 times larger than the most recent reported price change.

eigenvalue

A primary output of PCA is eigenvalues. An eigenvalue is a number that, in the case of a principal components analysis of investment returns, can be used to indicate the proportion of the return variance that is explained by each factor.

Pay-to-Play and Lobbyist Registration laws

A private fund adviser that solicits US state or local government entities may be subject to registration and reporting obligations under applicable state or municipal statutes.

A U.S. real estate investor purchases a lot of land in Canada for 50,000,000 Canadian dollars ($C). The spot exchange rate is $C 1 = USD 1. If the price of this lot of land is expected to increase 8% per year (in $C) and the Canadian dollar is expected to lose 5% per year with respect to the U.S. dollar, calculate the expected value of the property two years from now from the U.S. investor's point of view. Ignore any transaction costs. The investor has decided not to hedge the currency risk of this investment.

A U.S. investor would consider the value of the land in U.S. dollars. Therefore, from the U.S. investor's point of view, two years from now the property is expected to be worth (applying a slightly modified version of Equation 1 from the Traditional View of Currency-Hedging for Cross-Border Real Estate Investing lesson to a two-year setting): $C 50,000,000 × (1 + r)2 × (1 + fx)2 = $C 50,000,000 × (1 + 0.08)2 × (1 − 0.05)2 = USD 52,633,800

Distributed ledger technology (DLT)

A blockchain database has a network of users, each of which stores its own copy of the data, giving rise to another term for blockchain technology: distributed ledger technology (DLT). Basic elements of a DLT network are: a digital ledger, a consensus mechanism used to confirm transactions, and a network of node operators. Generally speaking, the terms DLT and blockchain are used interchangeably in position papers and popular media, though DLT is considered by some to be a more general term.

Briefly describe the following four types of teams: Blue chip, established, emerging, and re-emerging.

A blue-chip team is a team that has been able to produce top-quartile performance for all of its funds through at least two business cycles (i.e., a sequence of more than three funds). An established team is a team that has been able to generate a top-quartile performance for most of its funds (more than three funds) through at least two business cycles. An emerging team is a team with a thin joint history, but with all the features to become an established team. A re-emerging team is a previously blue-chip or established team that has been through a restructuring (after experiencing recent poor performance or some significant operational issues), and has the potential to re-emerge as an established or blue-chip team.

What primary issue could a prospective investor have researched in order to avoid losses from investing in Bayou Fund?

A prospective investor could have researched the background of the principals of the fund, which would have uncovered evidence of dishonesty. In addition, the prospective investor could have researched the auditing firm and found that Richmond-Fairfield had only one employee, a Bayou employee, and only one client, Bayou.

What are desk reviews? Why aren´t they considered best practice?

A desk review is an ODD review based exclusively on documents collected, and possibly conference or video calls. LPs may argue in favor of desk reviews because of their lower costs (compared to on-site visits), shortened overall review time, and a belief that the quality of information collection is the same for desk reviews as it is for on-site visits. Desk reviews are not regarded to be best practice because they generally produce a less comprehensive review, thus exposing investors to higher levels of operational risk. Even though LPs can still collect compromise documentation when they conduct a desk review, they nonetheless miss the opportunity to review documentation on-site with the manager. Finally, the problem is compounded by the inherent illiquidity of private equity investing (the long lockup period of PE funds prevents redemption for many of the problems that may come up after the capital has been committed).

Unsupervised learning: Gaussian Mixture Model

A generalization of k-means clustering that provides more flexibility in the size and shape of groups (clusters) Use cases-Segment customers to better assign marketing campaigns using less-distinct customer characteristics (eg, product preferences) -Segment employees based on likelihood of attrition

Private asset commitment strategy

A good private asset commitment strategy is crucial to balance several investment objectives including performance, risk and liquidity. The challenge for the investor is how to structure the portfolio in a way that maximizes expected portfolio performance while keeping liquidity events under control, in terms of both frequency and severity: 1) How to formulate a private asset commitment strategy to manage private asset exposure and the uncertainty in timing and magnitude of their cash flows over time? The CFM commitment strategy aims to build a private asset portfolio whose distributions received in the previous quarter should fund all capital calls in the next quarter. The commitment amount at the beginning of each quarter is determined so that the projected net cash flow (distributions minus capital calls) two quarters ahead (based on reported NAV at the end of last quarter) is zero. The Target NAV strategy tries to achieve and maintain a target NAV% of the overall portfolio.The commitment amount at the beginning of each quarter is determined by multiplying a fixed portion (f) by the total amount of uncommitted capital at the end of the prior period.

liquidity events and their severity

A liquidity event occurs whenever an investor must move down the waterfall to find liquidity. For example, a liquidity event would occur if the investor, having exhausted the "liquid passive reserve" portion of the portfolio, must sell liquid active alpha assets. Another liquidity event would occur if the investor also exhausts the liquid active alpha assets and is still unable to fulfill the liquidity demand (if illiquid assets cannot be sold).For example, if one simulation run encounters twelve Rebalancing Liquidity Shortage (1B_RB) events andone level 1A Capital Call Liquidity Shortage (1A_CC) event, the severity score for this simulation run is 14 (= (1 × 12) + (2 × 1)). The portfolio liquidity severity score is the average of the 5,000 severity scores across all simulation runs.

Suppose that 100 contracts are entered on the long side of a futures contracts on the VIX at a price of 18.00. If the contract settles at 18.90, how much will the trader be required to pay or receive?

A long position in a single futures contract over the life of the contract will receive $1,000 for every point by which the VIX at the settlement date exceeds the price at which the contract was entered, or will pay $1,000 for every point by which the VIX falls short of the contract price. The trader is long and will thus receive: 100 contracts × $1,000 per point × (18.90 points − 18.00 points) = $90,000 on a mark-to-market basis if the contract settles at 18.90.

How might the dimensions of risk differ in terms of strategy when evaluating a systematic managed futures strategy relative to a long/short equity strategy?

A long/short equity strategy might be subject to strategy risk in the form of macro analysis, sector, idiosyncratic security selection risk, and dispersion risk. A systematic managed futures strategy, however, might be subject to risks such as model risk, trade execution, lack of volatility/trend or trend reversals, and leverage.

Gwartney et al. (2003) explain that a country's currency is likely to appreciate when the country has:

A lower inflation rate than its trading partners. Higher real interest rates than its trading partners. Policies that attract an inflow of capital. Slower income growth versus trading partners that reduces the demand for imports. A competitive or comparative advantage in export-oriented industries.

how the scope and scale of the asset owner are related to the decision to insource or outsource

A relatively small organization able to begin insourcing the production of investment returns may well do so at first on a limited basis, concentrating its skills and expertise on ensuring that those activities make a significant contribution to its performance. At a certain point, management can then vary the mix between insourcing and re-intermediation so as to impose discipline on its external asset managers, while building up its skills and expertise for crossing over from its core activities to other activities that are complementary rather than competitive with its existing commitments. By contrast, a large organization with the internal capabilities and management resources consistent with a wide scope of activities can create investment teams across all asset classes and investment strategies, thereby internalizing the entire production process. In between, there are large investment asset owners that focus on a relatively limited scope of activities concentrating on superior performance in those activities, while using their market positions— for skills and expertise and for the services of external asset managers—to sustain control over their own organizations and asset managers. There are some relatively small organizations that can maintain a wide scope of investment activities reflecting the maturity of the local market for investment services and/or, in other situations, the overreach of senior managers (given compensation and incentives). In either case, these may be relatively efficient organizations in that they are able to effectively manage performance and commitment against the outsourced option.

artificial intelligence

AI is typically defined as the ability of a machine to perform cognitive functions we associate with human minds, such as perceiving, reasoning, learning, and problem solving. Examples of technologies that enable AI to solve business problems are robotics and autonomous vehicles, computer vision, language, virtual agents, and machine learning.

How might an activist hedge fund manager fit into an ESG framework?

Activist hedge fund managers can urge or pressure management to take a more positive position when working with stakeholders such as employees, communities, customers, and suppliers.

Actuarial tables

Actuarial tables released in 2014 by the Society of Actuaries (SOA), which US corporations must account for in their financial statements, quantified what many suspected — that pensions underestimated liabilities by an average of 5% to 8%. The tables previously had been updated every 10 years or so, but the SOA recently pledged to provide updates more frequently so plan sponsors can more accurately project the impact of longevity improvements on their liabilities. In fact, the 2015 update and the recently announced 2016 update led to a downward adjustment in plan liabilities due to a decrease in life expectancy. However, over the long-term, when the SOA's tables are used, projected pension liabilities increase significantly.

How did the Dodd-Frank Act in the United States close the regulatory gap between hedge funds and mutual funds?

After the Dodd-Frank Act, many hedge fund managers had to register as investment advisers. Since a U.S. mutual fund manager must also be registered as an investment adviser, a hedge fund manager can easily launch a U.S. mutual fund once registered.

cutting the NAV

After the administrator and the fund are both satisfied with the valuations obtained for a fund during a particular period (e.g., monthly), a final NAV is agreed on, which is known as cutting the NAV. The administrator prepares and distributes individual investor account statements.

how a blockchain consensus mechanism works

All blockchains have a consensus mechanism that is used to add new blocks to the database. If the blockchain is permissioned, the degree to which participants in the network are willing to trust one another also has an effect on the consensus mechanism. In a permissioned blockchain, once the transaction is submitted by the two parties involved, it would then be confirmed by a permissioning member of the blockchain or by some cryptographic consensus mechanism accessible only by permissioning members. Permissionless blockchains rely on their network of participants to confirm transactions, using a variety of algorithms to ensure the validity of transactions. One implementation of a permissionless blockchain, the bitcoin blockchain, uses a Proof of Work consensus mechanism. On the bitcoin blockchain, individuals known as miners compile submitted transactions into blocks, confirm that those spending bitcoins in each transaction received those bitcoins from some earlier transaction recorded on the blockchain and race to solve a difficult computer problem; the first miner to solve the problem confirms their block and adds it to the blockchain.

An institution has a positive network effect

when it has built relationships with successful people and businesses that may be difficult for others to emulate

the cash flow matching and target NAV strategies relative to portfolio performance and liquidity

Although CFM and Target NAV1.375 have similar horizon returns, the average horizon return for those simulation runs that encounter 1A_CC events is much higher under CFM (9.0%) than that under Target NAV1.375 (5.5%). This difference arises from the more severe public market environments in which 1A_CCs occur under Target NAV1.375 compared to CFM. Under CFM, 1A_CCs could happen regardless of the market environment (Figure 10). However, under Target NAV1.375, all 1A_CCs occur when the market performs below average suggesting that capital call liquidity shortages occur when investor's may most need liquidity. Since CFM tries to produce a zero net cash flow irrespective of the market environment, investors who target a higher horizon NAV%, and also want to avoid liquidity events in a bad economy, might wish to favor CFM over Target NAV1.375. Figure 11 compares the three commitment strategies. The investor can select the appropriate strategy to match their objectives. While Target NAV1.0 is suitable for maintaining an existing private allocation, CFM or Target NAV1.375 may be more suitable for buildingup an allocation. Of the latter two, CFM may be better suited if liquidity is an investor's major concern. Otherwise, if a stable commitment pattern and / or low dispersion of horizon NAV growth is more desirable, then Target NAV1.375 may be the better choice.

There are six primary challenges to the performance persistence hypothesis:

Ambiguities regarding definition of "top performance" Comparing Heterogenous Funds Is the performance luck or skill? The effect of changes in fund size through time Secular market trends Performance dispersion is heterogeneous in the pe market

Reinforcement Learning

An algorithm learns to perform a task simply by trying to maximize rewards it receives for its actions (eg, maximizes points it receives for increasing returns of an investment portfolio) When to use it-You don't have a lot of training data; you cannot clearly define the ideal end state; or the only way to learn about the environment is to interact with it

Compare and contrast engagement strategies and proxy voting in the context of ESG investing methods.

An engagement strategy is when an investor takes a long position in the stock of a company and seeks to influence the company's agenda on how to improve the ESG standing of the company. Proxy voting, however, is more passive than an engagement strategy. Proxy voting deals with issues specifically put for election by management and does not go beyond the agenda of management.

Why do long volatility products have a negative market beta and carry a negative risk premium?

An investor establishing a long position in the VIX contract enjoys the hedging benefit of a negative equity beta but pays for that protection through the negative risk premium. In other words, products that generate hedging benefits by having returns that are positively correlated to volatility offer a negative volatility risk premium, which means they tend to have expected returns less than the riskless rate.

negative risk premium

An investor establishing a long position in the VIX contract enjoys the hedging benefit of a negative equity beta but pays for that protection through the negative risk premium. In other words, products that generate hedging benefits by having returns that are positively correlated to volatility offer a negative volatility risk premium, which means they tend to have expected returns less than the riskless rate.

Why might an investor's relationship with real estate managers be particularly important in the case of direct property ownership through partnerships with a small number of investors?

An investor's relationship with real estate managers may be particularly important in this case, because the real estate investor cannot rely on other investors to control and monitor the real estate manager. Compare this situation to the case of public equity investing, where an investor can remain passive in most cases.

Under what two circumstances would an issuer of a callable bond exercise that underlying option?

An issuer would typically call a bond after a pre-specified date when the bond trades at a premium to a pre-determined price level outlined in the terms of the bond.

a desk review

An onsite visit is considered to be part of best practice, although due diligence without an onsite visit, called a desk review, is sometimes used.

There are three primary disadvantages of appraisal-based models:

Appraisals are inherently subjective and backward-looking, thus introducing errors in prices. Typically, properties are fully reappraised only periodically. This causes a "stale appraisal" effect (i.e., dated appraisals), which adds to the lag. Appraisal-based indices are smoothed compared with actual changes in real estate market values. Thus, measures of volatility of the value of commercial real estate assets are underestimated using appraisal-based indices. Fortunately, unsmoothing techniques help mitigate this problem. Appraisal methods tend to rely on data from comparable properties so the quality of the appraisal will depend critically on the quality of available data and may not be accurate in situations in which comparable properties cannot be identified (e.g., the current property is rather unique) or there is a significant time lag between the time the data has become available and the time the appraisal takes place.

The Five Steps of Implementing Impact Investing

Articulating Mission and Values Creating Impact Themes or Theses Developing Impact Investment Policy Generate and Evaluate Deal Flow Portfolio Construction and Management

Levered growth differential

As we make the simplifying assumption of constant unlevered growth rates for both private and public equity, the difference in the levered growth rates is driven entirely by the time-varying leverage of PE. The near-steady decline we see is due to the declining trend in PE leverage.

What are the three components of the expected return on all asset classes?

Asset class return = Short-term real riskless rate + Expected inflation + Risk premium

Asymmetry of expertise

Asset owners often lack the skills and expertise of asset managers. In large part, this is because each component part in the chain of intermediation is highly specialized, requiring a combination of domain-specific expertise along with relevant experience through which to judge the importance or otherwise of issues related to realizing superior risk- adjusted rates of return. At the same time, the apparent rewards for specialization reinforce the segmentation of the industry within and between service providers and reinforce the premium on orchestration.

Why is it difficult to hedge risks in the case of asset-based lending (ABL) strategies?

Asset-based lending strategies are usually long-only strategies. Hedging is difficult because borrowers tend to be small, due to the unique features of the specific ABL facility, and because the nature of small businesses is highly idiosyncratic. Furthermore, hedging a long portfolio constituted by small issuers with a short portfolio of larger bond issuers (because of the difficulty in finding borrowers for middle market bonds) creates basis risk.

how transactions are added to a blockchain

At its most basic level, a transaction on a blockchain is simply a change in the registered owner of an asset. For person A to transfer an asset to person B, it is first necessary to determine if A is the rightful owner of that asset. This can be done by referencing past transactions in the blockchain and finding that, at some point, A received the asset and has not yet sold it. Once this is done, A and B can agree to the transaction (step 1). A block is created with the details of the new contract (step 2), and then A and B agree to the contract by adding their unique digital signatures (steps 3 and 4). Once both parties have signed the transaction, a cryptographic hash is calculated that will be used to link this new transaction to the chain of previous transactions (step 5). The cryptographic hash is a string of characters associated with a given block that is difficult to calculate but easy to verify. This makes it simple to verify a legitimate block, but difficult to engineer and insert into the chain a block recording illegitimate transactions. Next, the transaction is confirmed using the blockchain's consensus mechanism (step 6).

the challenges for investors and the three important questions for private asset investors

At one extreme, holding just cash may give an investor full flexibility to meet unexpected liquidity demands, but will likely hurt performance. At the other extreme, holding illiquid (but expected high performing) assets might give the investor little room to meet liquidity demands and may ultimately hurt performance if these illiquid assets must be sold prematurely, often at a discount, to meet cash needs. The challenge for the investor is how to structure the portfolio in a way that maximizes expected portfolio performance while keeping liquidity events under control, in terms of both frequency and severity. several important questions: 1) How to formulate a private asset commitment strategy to manage private asset exposure and the uncertainty in timing and magnitude of their cash flows over time? 2) What should be the desired allocations (public vs. private, public passive vs. public active) given the investor's liquidity risk tolerance? 3) How would various market scenarios impact the portfolio's liquidity and performance?

restitution

Authorities in the Madoff scandal are seeking restitution, meaning restoration of lost funds, from both Madoff and his profitable investors. Courts can order investors who are enriched by a fraud to return the profits as restitution to those who suffered losses, even if the investors were unaware of the investment's fraudulent nature.

Roles and Responsibilities to articulate in and IPS

Board, Investment committee, Internal staff, Investment adviser(s) and/or outsourced chief investment officer (OCIO), Trustee/custodian

Equity risk, illiquidity premium, size, and value and the role of each as a driver of private equity returns

Based on economic intuition and empirical evidence, which we describe later, we expect PE to have the following factor tilts over public equities: equity risk, Illiquidity premium, size, and value: Equity Risk: The principles of corporate finance dictate that all else equal, companies with greater debt-to-equity (D/E) should have higher volatility and equity beta, as the required interest payment to debt holders increases the riskiness of the remaining cash flow to equity holders. Studies indicate that PE firms take on 100%-200% debt for every dollar of equity (down from the 300%-400% D/E ratios in the 1980s), whereas publicly listed firms, on average, add 50% of debt for every dollar of equity. This suggests PE's equity beta is well above 1. (Il)liquidity Premium: In principle, locking up capital for a 5-10 year window warrants a significant illiquidity premium, however, even if such a fair illiquidity premium existed, it may, in practice, be largely offset by investor willingness to overpay for the return-smoothing described earlier. Investors averse to the price swings that come with regular trading may be content with net-of-fee PE returns that are merely on par with public equity, instead of setting the bar higher at returns that adequately compensate them for the higher equity beta and illiquidity of PE. The limited partners may also unknowingly overpay if they underestimate the equity beta of PE, making them attribute the higher returns of PE to an illiquidity premium or alpha, instead of the equity risk premium. Size: Buyout targets tend to have smaller capitalizations and, therefore, provide exposure to the size factor.This implies that a more appropriate benchmark would be a leveraged small-cap index that accounts for both the higher leverage and small-cap bias. Value: Over and above a small-cap bias, buyout targets have tended to trade at lower valuation multiples than the market, though venture capital targets are more likely to be growth companies. Broader evidence is mixed. The PE industry, overall, no longer has the valuation discount versus public equities it used to have. Although this may be partly due to a changing industry composition of buyout targets, it is unclear whether PE's historical value bias will persist.

Principal-agent problem

Bolton and Dewatripont defined the principal-agent problem as: "the principal hires the agent to perform a task: the agent chooses her 'effort intensity' a, which affects 'performance' q. The principal cares only about performance." Following Ross (1973), in their account, the principal- agent problem is resolved by focusing on performance and leaving the issue of monitoring "effort intensity" or "commitment" to the agent. By contrast, it is noted in this article that asset owners are increasingly concerned about commitment, partly because they can't directly observe the effort expended on their behalf by asset managers and partly because they are unable to determine whether long- term performance is due to luck, happenstance, or skill and expertise.

Why might environmental stewardship be such a large consideration for an ESG investor in real estate?

Buildings and construction activity account for 36% of global final energy use and are responsible for 39% of global carbon emissions. Both also can create significant amounts of waste.

How could Carlyle Capital Corporation suffer large losses from a strategy dominated by long positions in AAA-rated securities?

Carlyle Capital Corporation used significant leverage in order to initiate its long positions in AAA-rated securities. When the creditworthiness of AAA-rated mortgage securities came under question, the value of the AAA-rated mortgage securities decreased and Carlyle Capital Corporation received margin calls from its creditors that it could not fulfil. It is alleged that the AAA-ratings were undeserved.

Three potential disadvantages of unlisted real estate funds are:

Cash drag Larger fees Leverage and the J-curve effect

The ways in which funds deal with cash can be grouped into four primary categories:

Cash for fund expenses. Cash to facilitate trading. Cash flows to and from investors. Unencumbered cash.

Change in foundation value formula

Change in foundation value = Income from gifts − Spending + Net investment returns

Four Primary Issues in Constructing a Factor-Based Replication Product

Choice of benchmark Choice of factors Length of estimation period Number of factors

Supervised learning: AdaBoost

Classification or regression technique that uses a multitude of models to come up with a decision but weighs them based on their accuracy in predicting the outcome Use cases-Detect fraudulent activity in credit-card transactions. Achieves lower accuracy than deep learning -Simple, low-cost way to classify images (eg, recognize land usage from satellite images for climate-change models). Achieves lower accuracy than deep learning

What impact does co-investing have on the J-curve?

Co-investments are viewed as leading to a reduction of the J-curve effect and improved capital deployment and returns.

Discuss the Coase theorem in the context of shareholders and victims of negative externalities.

Coase asserts that whether the law sides with shareholders who claim a right to generate negative externalities or with the victims of negative externalities will not interfere with the ability of the parties to negotiate the most efficient resolution to the dispute so that they can share in the net benefits (or least costs).

three potentially key economic variables that influence commodity returns:

Commodities and interest rates-high interest rates reduce the potential demand for storable commodities (or increase the potential supply) through three channels: (1) by increasing the incentive for extraction today rather than tomorrow; (2) by decreasing firms' desire to carry inventories; and (3) by encouraging investors to shift out of commodity contracts into fixed-income instruments. Commodities and central bank policies - benefits of holding long commodity positions are during the times when the US Federal Reserve Bank is tightening monetary policy (USD strong/commodities weak) Commodities, inflation, and commodity price patterns- While demand and inflation impacts tend to dominate the pricing relations for various forms of energy—and, to a lesser extent, industrial metals—interest rate effects tend to dominate the pricing relationship for many agricultural and live-stock commodities, which may provide a business cycle hedge rather than an inflation hedge

The Risk Alert noted four "warning indicators or awareness signals" regarding risk management that "led advisers to conduct additional due diligence analysis, to request that the manager make appropriate changes, or to reject (or veto) the manager or the alternative investment."

Concentrated positions. Insufficiently knowledgeable investment personnel. Investment strategy drift. Overly complex or opaque investment descriptions.

short volatility

Consider a very broad equity-market index and options on that index. When an option or any other investment has returns that are negatively correlated with the volatility level of the market index, the position is said to be short volatility or "short vol" (i.e., short the volatility of the market or other specified asset). Long positions in at-the-money equity options are generally viewed as being long volatility with respect to the volatility of their underlying assets (and short positions in at-the-money options are viewed as being short volatility with respect to the volatility of their underlying assets). a long position in a deep in-the-money call option is short volatility. This is because the effect of declining equity market prices on the value of a deep-in-the-money call option on equities through its positive delta will tend to dominate the value-increasing effect of the increased volatility on the value of the deep in-the-money option through its positive vega

importance of due diligence when evaluating responsible investing in private equity

Considering the diverse nature of the private equity asset class, an LP should also discuss with the GP how their approach to ESG integration is influenced by their investment strategy, by establishing responses to the following types of questions: How does your approach to integrating ESG factors vary depending: On whether you make a minority or control investment? Upon the sector or stage of company growth cycle that you might target? Different funds will have different exposures to ESG- related risks and opportunities, and different GPs will have different capacities, leverage and management approaches for addressing ESG issues. An LP should take these considerations into account when assessing the GP's responses to the LP Responsible Investment DDQ and during the ensuing dialogue.

Constant Mix

Constant-mix strategies also represent special cases of the constant-proportion formula. They have floors of zero and multipliers with values between zero and one. For a constant-mix strategy, the multiplier corresponds to the percentage invested in stock. Strategies that "buy stocks as they fall..." give rise to concave payoff curves (which increase at a decreasing rate as one moves from left to right). They generally do very well, however, in flat (but oscillating) markets.

constant-proportion portfolio insurance constant mix

Constant-proportion strategies take the following form: Dollars in Stocks = m (Assets - Floor), where m is a fixed multiplier. Constant-proportion portfolio insurance (CPPI) strategies are constant- proportion strategies with multipliers greater than one. Think of the difference between assets and the floor as a "cushion," then the CPPI decision rule is simply to keep the exposure to equities a constant multiple of the cushion. A CPPI strategy sells stocks as they fall and buys stocks as they rise. The market can fall by as much as 1/m with no rebalancing before the floor is endangered. Buy-and-hold strategies are constant-proportion strategies with a multiplier of one and a floor equal to the value invested in bills. Constant-mix strategies are constant-proportion strategies with floors of zero and multipliers with values between zero and one. CPPI strategies that "sell stocks as they fall..." give rise to convex payoff curves (which increase at an increasing rate as one moves from left to right). They tend to do very poorly in flat (but oscillating) markets. But they tend to give good downside protection and to perform well in up markets.

ABC is a small country that derives 70% of its income from oil exports. Suppose that oil companies working in country ABC have recently discovered vast amounts of new oil reserves. The government of country ABC is worried that this discovery will cause country ABC to suffer from a case of the "Dutch disease." Explain the meaning of the concept "Dutch disease" applied to the case of country ABC.

Dutch disease occurs when large currency inflows from oil exports harm the long-run strength of country ABC's other sources of economic growth (e.g., manufacturing sector). In particular, the discovery of vast amounts of new oil reserves will have two major impacts. First, it will increase local wages and cause a shift in workers from other sectors of the economy to the oil sector. Second, the value of the local currency will increase due to large inflows of cash, even if they have not yet occurred but are expected to take place. These two results reduce the competitiveness of country's ABC manufacturing sector, leading to its de-industrialization.

List and describe the steps in module II: Governance

ESG considerations in specific governance constructs- LPs are encouraged to seek guidance on private equity fund governance best practice from the Institutional Limited Partners Association's (ILPA) recently published Private Equity Principles 3.0 (2019).9 The third edition of the ILPA Principles now reflects ESG considerations as a standard part of LPAC procedure and fund disclosures. The ILPA Due Diligence Questionnaire (DDQ) The ILPA PortCo Metrics Template

four ways in which commodity-based exchange traded notes (ETNs) are different from commodity-based exchange traded funds (ETFs)

ETNs are zero coupon instruments The return to the ETN is subject to the credit-worthiness of the issuer The price of the ETN is based on a contractually designated relationship with the underlying index ETNs may qualify for capital gains tax treatment if held for a sufficiently long period of time

List and discuss the characteristics of effective metrics

Effective metrics are consistent (not in conflict) across the organization such that the performance of each part of the organization can be understood through its overall performance. Effective metrics are function- and/or task-relevant, being framed with respect to the organization and the goals and mandates of its constituent functions. Effective metrics are transparent, erring on the side of simplicity and clarity such that debate over their applicability, meaning or relevance is minimized. Effective metrics are relatively few in number, being focused on key activities and resources such that overlaps are minimized and staff members are conscious of their responsibilities. Effective metrics are flexible and/or adaptive given market risk and uncertainty. That is, there is a process whereby metrics are adapted and revised in relation to investment experience.

Is it possible to identify top-tier hedge fund managers a priori, and do hedge fund managers display significant performance persistence?

Empirical evidence (both from the academia and from the industry) provides mixed results on these issues. For instance, some of the studies suggest that top-tier hedge funds do exhibit return persistence. However, the outperformance of these top-tier hedge funds tends to disappear as time passes and as capital flows to these top-performing funds. Other researchers have not found performance persistence among hedge fund managers, and if they find any, it tends to erode after only a few months.

According to empirical evidence, how do funds of hedge fund (FoFs) compare to single hedge funds in terms of drawdowns, standard deviation of returns, and average returns?

Empirical evidence presented in the book indicates that FoFs have fairly low drawdowns and standard deviations, and lower drawdowns and standard deviations than the average individual hedge fund. However, during the same period (1990-November 2011) average returns on FoFs were only a little more than half of those of individual hedge funds. These results can be explained by the double layer of fees charged by FoFs and by the upward bias in the reported performance of individual hedge funds caused by survivorship bias.

What do empirical studies suggest regarding the correlation of commodity sectors with each other (e.g., the correlation between energy sector and metals sector commodities)?

Empirical evidence suggests that commodity sectors have a low correlation with each other. Therefore, commodities can offer uncorrelated or low correlation investment opportunities across various commodity markets. Energy sector commodities do not have high positive correlations with other sectors, because higher energy prices can weigh on economic growth and therefore slow down demand for other commodities.

Describe some common differences between the investment objectives of an endowment relative to a short-term foundation.

Endowments have long-term objectives, but a foundation created for a very targeted and/or shorter-term purpose would state an investment objective focused less on maintaining purchasing power and more on preserving capital to support specific goals.

List and describe the steps in module I: Responsible Investment Policy, Beliefs, and Goals

Establishing how the organisation views ESG issues and the goals of their responsible investment practice is helpful in sending a consistent message to the organisation and investment partners Leveraging off existing industry goals or practices has the advantage of: Being able to position your organisation as a "fast follower" Leveraging work that has clear reasoning and credibility Alignment with industry consensus

Critique the following statement: "Hedge replication products cannot provide alpha because they are not managed by skilled managers."

First of all, and by definition, a replication product will capture the alpha offered by the benchmark (this should be true at least in an extreme case where a replication product can perfectly replicate the return properties of the benchmark). Further, replication products bear lower fees than actively managed portfolios and therefore enhance the possibility of providing alpha to investors who invest in these products. In the end, whether replication products can provide alpha is an empirical question.

They are having a preliminary meeting intended to estimate the operational risk of 123 Fund, a long/short equity hedge fund dedicated to large and mid-size U.S. stocks that was founded in 2011.At the beginning of the meeting, Ms. McGraw points out to Mr. Williams that she is concerned about 123 Fund's delays in reporting its NAV to investors.Are the concerns expressed by Ms. McGraw justified?

First, NAVs are typically distributed to investors within a number of days of the end of each month. This delay arises because the production of the final NAV is subject to independent valuations for positions, and can also be caused by other reasons such as personnel turnover (at either the hedge fund or the administration firm). Having said this, in the case of 123 Fund, it seems to be somewhat difficult to justify distributing NAVs to investors three weeks or more after the end of the previous month, as can be seen it happened in the previous six months. Furthermore, 123 Fund is a long/short equity fund dedicated to large and mid size U.S. stocks and thus, in principle, one would think that their positions would be relatively easy to value, and that there is no need for delays of three weeks or more. Perhaps more worrisome is the tendency for 123 Fund's NAVs to be distributed to investors with larger delays each month, indicating the presence of an operational signaling effect. In summary, Ms. McGraw's concerns are justified, and XYZ Due Diligence should perform further due diligence in an attempt to further investigate any undiagnosed problems.

the factors leading to underestimation of longevity

First, forecasters often misjudge and undershoot actual increases in human life spans, and these small annual forecasting errors compound over time to become significant.5 Second, demographic forecasts do not include the sharp, unanticipated increases in longevity that may result from significant medical breakthroughs. Third, pension plans may not always apply the most conservative set of assumptions when analyzing funded status.

Describe two potential ways the asset allocation guidelines for defined benefit plans can be customized.

First, the defined benefit's asset allocation can be de-risked as the funded status rises, or a hedge ratio policy could be put into place. A hedge ratio policy reduces the interest rate risk as the funded status improves.

What are the three main criticisms that non-traded REITs have received?

First, the illiquidity of non-traded REITs may give the false impression of low return volatility. Second, these types of REITs command high fees and frequently entail significant conflicts of interests. And third, leverage is often used to finance current dividend payments. This practice sometimes conceals their inability to generate future dividends.

What are the three steps of an empirical factor model?

First, the risk-free rate is subtracted from the returns of each security to form an excess return, which is used as the dependent variable; Second, the researcher selects a set of potential factors that serve as independent variables; Third, statistical analysis is used to identify those factors that are significantly correlated with returns.

ABC is a small country that derives 70% of its income from oil exports. Explain the three concerns that this country should have regarding tax revenues.

First, the volatility of oil prices can create a volatile income stream for country ABC. This is a concern for the country because government spending is likely more stable than oil prices. Second, it is unclear how long these oil revenues will continue, as the oil reserves of the country will not last forever (i.e., there is a concern regarding depletion). Third, the government of country ABC would like to have a diversified economy, ideally earning tax revenues from other industries, rather than depending almost exclusively on oil revenues.

the objective, commitment amount, pros and cons of two LP commitment strategies

For CFM, Project two quarters ahead as we assume the first capital call occurs two quarters after the commitment; and Use "no view" assumptions (i.e., the average value of calibrated vintage-level parameters) for the TA model parameters in cash flow projections. The CFM commitment strategy has a few limitations: 1) The strategy can lead to a volatile commitment pattern over time and may skip commitments over multiple periods - which may be undesirable for maintaining vintage diversification; 2) The strategy does not have control over how NAV will grow as a percentage of the overall portfolio; and 3) If one is starting a private capital investment program with no prior commitments and NAV, then cash flow matching is not possible until distributions start to arrive. For Target NAV, the commitment amount at the beginning of each quarter is determined by multiplying a fixed portion (f) by the total amount of uncommitted capital at the end of the prior period. The pool of uncommitted capital is continuously replenished by distributions from prior commitments. The idea of keeping track of uncommitted capital is appealing because it makes the private allocation a self- contained portfolio. A drawback of this strategy is that it does not necessarily balance cash flows (especially for f values greater than one), and therefore may require continuous interactions with other parts of the portfolio (e.g., active public asset strategies) - which must either be bought or sold to absorb or free up capital for private market-related cash flows.

Ten Principles of the Linaburg-Maduell Transparency Index

Fund provides history including reason for creation, origins of wealth, and government ownership structure. Fund provides up-to-date and independently audited annual reports. Fund provides ownership percentage of company holdings, and geographic locations of holdings. Fund provides total portfolio market value, returns, and management compensation. Fund provides guidelines in reference to ethical standards, investment policies, and enforcement of guidelines. Fund provides clear strategies and objectives. Fund clearly identifies subsidiaries and contact information, if applicable. Fund identifies external managers, if applicable. Fund manages its own website. Fund provides main office location address and contact information.

What is funding bias?

Funding bias exists when the returns to hedge funds available in databases are biased upward (compared to the case in which the full hedge fund universe would not have existed if there were no funds of hedge funds). In other words, FoFs discourage bad hedge funds from being launched or, if created, from remaining in business too long. Thus, this phenomenon creates an upward bias in hedge fund returns observed in databases. The existence of funding bias offers an important monitoring and due diligence service for the whole industry. Funding bias should not be confused with reporting biases.

how considerations differ by fund structures, including funds of funds, secondaries, and co-investments

Funds of funds are typically well- resourced and very experienced at investing in private equity, and therefore have the potential to more effectively oversee and influence a GP's approach to ESG integration. When investing in a fund of funds, an LP should have assurance that there is a thorough process in place to assess and monitor the underlying funds on their approach to responsible investment. An LP could ask that the fund of funds manager uses or completes the LP Responsible Investment DDQ as a basis for ESG due diligence on the underlying funds or during fundraising. Secondaries- ESG due diligence can be undertaken on underlying portfolio companies prior to investment because, unlikea primary fund investment, -- where capital is committed to a blind pool-- the portfolio is already known. When investing in PE secondary funds, an LP should have assurance that there is an appropriate process in place to screen for any material ESG risks before the secondary fund acquires stakes in existing portfolios, and that the secondary fund has a process in place to monitor its underlying investments on ESG risk. An LP could also ask secondaries fund managers to complete the LP Responsible Investment DDQ during fundraising (noting that Section 3 may not be applicable). Co-investments give an investor increased direct exposure to both the upside and downside of a private investment, and offer a greater level of insight and direct influence over ESG integration. The LP may participate directly in the due diligence process, may be able to appoint a board member and have better access to portfolio company information.

short-term capital gains

Gains from forward contracts or 6-month swap agreements are considered short-term capital gains in the United States, which are trading profits recognized on an investment held for less than 1 year. Short-term capital gains are typically taxed at ordinary income tax rates, the highest rate currently at 37% in the US (not including other potential state and local taxes). The tax rate on short-term capital gains is substantially higher than that of qualified dividends or long-term capital gains in the US.

illiquidity premiums,

which are higher returns earned by investing in less liquid assets that require long lockup periods.

the three steps in building a framework to measure and analyze the impact of longevity risk

Generate accurate, up-to-date, and customized measures of mortality rates Adjust plan liabilities based on updated longevity expectations, including the interactions with other investment risks Stress test portfolios based on different longevity improvement scenarios

the tradeoff between performance and liquidity in asset allocation

Given the assumptions used in the case study, the portfolios on this efficient frontier either have lower allocations to public active assets or higher allocations to private assets. This shows that private assets, given the case study's assumptions, are more efficient in generating performance compared to public active assets. Regardless, this result indicates the importance of the public passive allocation for liquidity purposes. Subject to the investor's specification of liquidity event severity values, their public asset (passive and active) risk and return assumptions, views on private assets performance and fund-selection skill, an investor can form a customized efficient frontier, on which they could move along to choose appropriate asset allocations - both public and private - given their desired level of portfolio liquidity risk.

NAV model

Given the contribution and distribution models, the NAV increases as additional capital contributions are made and as underlying investments appreciate (G). NAV declines as distributions are made. NAV t = NAV t-1× (1+G) + C t - D t Figure A4 plots the quarterly time series of uncalled capital, valuations and distributions based on the TA model for a $1 commitment using the parameter assumptions in Figure A5. The uncalled capital decays at the specified rate of contribution. The NAV initially rises and reaches a peak, and thereafter distributions are received causing valuations to decline. By the end of 12th year all cash flow activity ceases as the investment reaches the end of its lifespan.

Governance

Governance refers to the principles and practices of investment decision-making across the organization, whether that be found in a hierarchical set of procedures or some combination of deference and delegation by place in the organization which, taken together, provides a map of investment decision-making

List the seven major potential advantages of listed assets.

Greater liquidity, lower managerial fees, easier diversification, visible indications of market values, regulatory oversight, greater access to financing, and tax simplification.

seven advantages that tend to be more available to investors using listed assets rather than privately organized assets:

Greater liquidity: Can be traded on exchanges Lower managerial fees: usually less than the management and incentive fees of private partnerships Easier diversification: Can be purchased in small quantities to facilitate diversification Visible indications of market value: continuous Regulatory oversight: regulatory disclosure requirements may prevent fraud Greater access to financing: better debt and secondary equity funding Tax simplification: Income tax information

Ms. Peterman finds that a technique used when designing real estate indices uses observed transactions of some properties to estimate the prices of all properties, including those that did not transact, by directly modeling the heterogeneity of real estate properties.To which technique is Ms. Peterman referring?

Hedonic-price indices.

The Coase theorem asserts that

in competitive and frictionless markets, economically efficient production and distribution will occur regardless of how governments divide property rights

What two adjustments does IRR ignore and why might ranking investment opportunities by IRR not be the best way to evaluate the attractiveness of an investment?

IRR does not adjust for scale and timing. Ranking opportunities by IRR may not be the best way to select investments because of these adjustments. For example, an investment could have a high IRR, but the dollar amount is smaller than the other opportunities. Additionally, an investment could earn most of the positive cash flows earlier in the life of the fund, but not later, which could impact the IRR calculation.

Each European country has its own scheme for regulation and compliance. Therefore, an alternative investment manager must comply with the individual regulatory bodies in each country. Under what circumstance would there be an exception to this rule?

If a manager seeks to conduct business within the European Union, they are subject to a single regulatory scheme, as long as the manager is domiciled in one of its member states.

Five years ago, a company issued a 5-year convertible bond with a 5% coupon. Assume the company's convertible bond provides the option for the bondholder to convert their shares into three shares of stock. If the stock price is currently $300, would it make sense for the convertible bond shareholder to convert their shares to equity shares?

If the conversion ratio is 3.0, then the conversion value is currently $900. The currently value of the bond at maturity is expected to be $1,050 ($1,000 par + $50 coupon). Therefore, it does not make sense for the shareholder to convert their shares.

Assuming the value of the call option is positive, describe the relationship between a callable bond price and a non-callable bond price.

If the value of the call option is positive, then the non-callable bond price will be greater than the callable bond price.

seven advantages tend to be more available to investors using privately organized assets rather than listed assets:

Illiquidity Premium: expected return illiquidity premium More incentivized managers: performance-based fees attract better managers Greater asset targeting by investors: select partnerships for specific assets Appearance of Stable Values: appraisals and quarterly sent asset values smooths returns Greater investor oversight: rights of limited partners to terminate or otherwise control managers (and the low number of partners relative to the number of shareholders in a public company) reduce agency conflicts Greater managerial flexibility: managers have flexibility to maximize value creation Tax benefits: For taxable investors, private structures may better flow through tax advantages such as depreciation and depletion. For the general partners, carried interest may be taxed at highly preferred long-term capital gains rates in some jurisdictions.

the challenges of comparing private equity returns directly to public equity returns and list more appropriate benchmarks

Illiquidity and transparency. A leveraged small-cap public equity index may be a better benchmark for the performance of private equity than the large-cap indices generally used. Further, internal-rates-of- return (IRRs) can be especially misleading if they are compared against the time-weighted returns used for public market indices. PE also seems to have a value factor tilt.

List the seven major potential advantage of privately organized assets.

Illiquidity premium, more incentivized managers, greater asset targeting by investors, appearance of stable values, greater investor oversight, greater managerial flexibility, tax benefits.

the three-pronged approach to addressing longevity risk

Implement a robust framework to accurately measure and analyze the implications of longevity risk on plan outcomes. Assess the toolbox of investment and protection actions that can mitigate the impact of longevity risk on the plan. Evaluate the desirability, potential timing, and likely costs of risk transfer actions given the impact of longevity risk on plan liabilities and corporate balance sheet volatility.

The Sustainable Development Goals (SDGs)

In 2015, the United Nations published a list of 17 goals to improve the plight of the human race, seeking to improve incomes, living conditions, and reduce poverty and inequality worldwide while stalling or reversing the impact of climate change, meant to drastically improve global conditions by the year 2030.

What is the distinction between a hard lockup period and a soft lockup period?

In a hard lockup period, withdrawals are contractually not allowed for the entire duration of the lockup period. In a soft lockup period, investors may be allowed to withdraw capital from the fund before the expiration of the lockup period, but only after the payment of a redemption fee, which is frequently 1% to 5% of the withdrawal amount.

Why are stochastic discount factors important for a portfolio that includes alternative investments?

In a multi-factor portfolio that includes alternative investments, different pieces of the portfolio will require different types of multi-factor methods, such as recognizing that cash flows must be valued differently depending on good vs. bad times and differently based on time horizons, different liabilities, and illiquidity profiles.

An analyst is using a multi-factor return model to estimate the overperformance or underperformance of a fund. What would be the anticipated effect of omitting systematic risk factors to which the fund was negatively exposed in an "up" market?

In an "up market" (i.e., a market in which major indices outperformed the riskless rate), the omission of systematic risk factors will cause an analysis to overestimate the risk-adjusted performance of assets positively exposed to the omitted factors and underestimate the performance of assets negatively exposed to the omitted risk factors.

Explain the relationship between the effect of omitted systematic risk factors and the overall direction of the market in a performance attribution.

In an "up market" (i.e., a market in which major indices outperformed the riskless rate), the omission of systematic risk factors will cause an analysis to overestimate the risk-adjusted performance of assets positively exposed to the omitted factors and underestimate the performance of assets negatively exposed to the omitted risk factors. In a down market the anticipated effect would be the opposite. Most long-term studies are more likely to be up markets since risky assets on average outperform the riskless asset.

How are the time horizons of defined benefit plans similar to those of endowments or sovereign wealth funds? What are some of the additional considerations that play into the time horizon of a defined benefit plan?

In general, endowments, sovereign wealth funds, and defined benefit plans all have long time horizons. However, defined benefit plans are heavily influenced by spending needs, funded status, the duration of their liabilities, and whether the plan is open, closed, or frozen.

There are two primary advantages of appraisal-based models:

In general, they do not suffer from a small sample size problem (as does the repeat-sales method and, to a lesser extent the hedonic approach, both of which are discussed in previous sections of this session). All properties can be appraised frequently.

a simple distributed ledger

In its simplest form, each user can read from and write to the database; and each user's copy is updated to reflect the new state of the ledger after a transaction is confirmed through a previously agreed-upon consensus mechanism. Once a transaction is added, it cannot be updated or deleted. all the node operators have the same version of the ledger. Since all the versions of the ledgers are the same, consensus is achieved and the records are final. When a member of a blockchain network engages in a transaction, they submit the transaction to the network. The submission of the new transaction changes the state of the ledger, which is now in conflict with the state of other copies of the ledger. Once the new transaction is discovered by the network, the consensus breaks, forcing other operators to either validate and update their records with the latest change or reject the new addition to the ledger. A consensus mechanism then confirms the submitted transaction as valid and all ledgers are updated to reflect the new state.

long-term capital gains

In non-Section 1256 securities, the lower tax rate on long-term capital gains is levied only on investment gains in which assets are held for longer than 1 year.

smart contracts and digital assets

In order to achieve their full potential, implementations of blockchain technology will likely be accompanied by smart contracts. Smart contracts are legal contracts written in computer code that execute automatically once certain conditions, specified in the contract, are fulfilled. Smart contracts can be added to distributed ledgers to self-execute on the basis of information in the ledger. This will allow for the automation of processes that currently require manual interventions. Physical assets (real estate, stock certificates, gold, etc.) require a great deal of verification and examination every time they are traded, which prolongs the transaction and settlement time for each trade. DLT has the potential to transform the physical assets into a digital form for transactional and record- keeping purposes. Such digitized assets could essentially function as online financial instruments that change hands each time the owner of the asset recorded in a ledger changes.

Describe how a portfolio's vega can be interpreted in practice.

In practice, vega may be somewhat loosely viewed as measuring the response of the current price of a portfolio to a change in the market's anticipated volatility of the returns of the portfolio's underlying asset.

Are family offices in the U.S. allowed to operate under a "safe harbor" with the Securities and Exchange Commission (SEC)?

In the U.S., family offices were allowed to operate under a "safe harbor" with the SEC in the past. This safe harbor allowed family offices to accept up to 15 outside clients. However, with the 2010 passage of the Dodd-Frank Act by the U.S. government, this safe harbor was abolished from the U.S. securities laws. Therefore, if a family office accepts $1 from a non-family member, it may be required to register with the SEC.

the desirability, timing, and impact of risk transfer actions

In the US market, pension risk transfer remains the dominant option (the first longevity insurance transaction in all of North America was just completed in Canada in 2015). These distinguishing features enable buy-ins to fulfill unique objectives such as maintaining funding ratio, avoiding settlement accounting, and providing a phased approach to transferring risk. A buy-out settles the liability for the transacted population and shifts all associated uncertainty — including longevity-driven uncertainty — to the insurer. Administrative expenses associated with the pension plan are also reduced, including the elimination of Pension Benefit Guaranty Corporation premiums for covered participants in the US. A buy-out triggers settlement accounting because the sponsor is fully transferring the liability of certain covered participants to an insurer, accelerating recognition of any deferred losses or gains within its defined benefit plan.

Contrast European and Asian regulatory attitudes and implementation with those in the United States.

In the United States, the U.S. Department of Labor stated that fiduciaries may consider ESG issues while investing, but only if those issues are directly relevant to the return, risk, and economic outlook of each investment. In other words, financial risk and return comes first, ESG issues second. European regulation is increasingly supporting mandatory disclosure of ESG-related issues, but regulation beyond that is somewhat unclear. In Asia, there are also few requirements. Hong Kong is slightly ahead of other Asian countries, in that the Securities and Futures Commission announced The Hong Kong Strategic Framework for Green Finance in 2018.

the consultant expresses that "... To the extent that certain alternative investments have smoothed returns or net asset values that are reported with a time lag, liquid alternatives and traditional assets will decline in allocation rapidly during times of crisis." What is the underlying principle of this analysis?

In the case of relatively illiquid investments (e.g., certain alternative investments such as private equity and hedge funds), the net asset value adjusts slowly to changes in public market valuation. As a result, in periods of crisis, prices of liquid assets decline rapidly and investors may react by only rebalancing within the liquid assets, while slowly changing allocations to relatively illiquid alternative investments (by modifying the size of future commitments).

To a family office, what is the difference in taxation between cash dividends and capital distributions from a private equity fund?

Income taxes are a significant constraint for family offices. To a family office, there is a significant difference between cash dividends and capital distributions from a private equity fund. This is because, in most jurisdictions, cash dividends are considered ordinary income, and thus taxed at a higher tax rate than distributions from a private equity fund.

Describe the tradeoff investable hedge fund index providers face.

Index providers face a trade-off between including more funds to be more representative and using fewer funds to facilitate management.

What is the distinction between information gathering and information filtering?

Information gathering indicates the ability of the manager to create access to information or to have access to better information than other managers. Information filtering is the fund manager's ability to use data available to others but to be better able to glean tradable insights from it.

three observations on rebalancing delta-neutral option portfolios

Infrequent rehedging is a bet on positive autocorrelation Frequent rehedging is a bet on negative autocorrelation (mean-reversion) Rehedging is more effective when options are Short-dated and near-the-money options:

What is believed to be the cause of the Flash Crash in 2010?

Initially the SEC reported that a "backdrop of unusually high volatility and thinning liquidity" just as "a large fundamental trader (a mutual fund complex) initiated a program to sell a total of 75,000 E-Mini S&P contracts (valued at approximately $4.1 billion) as a hedge to an existing equity position." Subsequently, it has been alleged that the flash crash was caused by spoofing - the placing of intentionally deceptive offers designed to move markets by a trader (or group of traders) holding massive positions that hope to benefit from the market moves.

Briefly explain the major internal and external investment policy constraints.

Internal investment policy constraints are those that are imposed by the asset owner. The three main internal constraints are: Liquidity- the asset owner may have specific liquidity requirements that must be clearly acknowledged. Time horizon- the investment horizon of the asset owner can affect its liquidity needs. Also, investors with a short-term investment horizon should take less risk, as there is not enough time to recover from a potential large drawdown. Sector and country limits- an asset owner may wish to impose constraints on allocations to specific countries or sectors. External investment policy constraints are driven by factors that are not directly under the control of the asset owner. The two main external constraints are: Tax status- most institutional investors are tax exempt, and for that reason allocations to tax-exempt investment vehicles are not as attractive to institutional investors as they are for taxable investors. Regulations- some institutional investors are subject to rules and regulations regarding their investment strategies.

Parts of an IPS:

Introduction, Scope, and Purpose Roles and Responsibilities Investment Objectives Time Horizon Risk Tolerance Spending Policy Asset Allocation Guidelines Selection and Retention Criteria for Investment Managers or Funds Performance Measurement and Evaluation Additional Considerations (Responsible investing, Proxy voting, Brokerage and other investment-related expenses, Liquidity policy)

he LPA has two main categories of clauses:

Investor protection clauses cover investment strategy, including possible investment restrictions, key person provisions, termination and divorce, the investment committee, the LP advisory committee, exclusivity, and conflicts. Economic terms clauses include management fees and expenses, the GP's contribution, and the distribution waterfall. The distribution waterfall defines how returns are split between the LP and GP and how fees are calculated. LPAs are continuously evolving, given the increasing sophistication of fund managers and investors, new regulations, and changing economic environments.

Unsupervised learning: K-means and hierarchical clustering models and list the business use cases

K-means clustering-Puts data into a number of groups (k) that each contain data with similar characteristics (as determined by the model, not in advance by humans) Use cases-Segment customers into groups by distinct charateristics (eg, age group)— for instance, to better assign marketing campaigns or prevent churn Hierarchical clustering-Splits or aggregates clusters along a hierarchical tree to form a classification system Use cases-Cluster loyalty-card customers into progressively more microsegmented groups -Inform product usage/development by grouping customers mentioning keywords in social-media data

How can key person risk be mitigated?

Key Person risk can be mitigated by 1) constructing an investment process that is less reliant on one individual, 2) purchasing key person insurance policies, 3) using extraordinary redemption rights triggered by the departure of a key person, or 4) maintaining a "bench" of alternative investment opportunities and adequately diversifying the existing portfolio.

Knowledge Management Systems

Knowledge management systems are those that bind the investment process together, exploiting the separate knowledge of investment leaders in favor of the overall performance of the asset owner (Clark 2018b).

Risk mitigation

LPs generally remain at arm's length from their private equity investments which means making a fund commitment decision largely based on the GP's internal processes and systems. For LPs, it is therefore prudent to seek assurances that the GP will be able to manage future ESG risks within an investment or due diligence process. LPs make a blind pool commitment to a fund lifecycle of 7-10 years before the underlying assets are known so LPs must undertake diligence of a GP's responsible investment policies and procedures such as monitoring and reporting prior to fund commitments.A distinction can be made between influencing a decision and influencing a decision-making process. LPs should monitor and, where necessary, engage a GP about the policies, systems and resources used to identify, assess and make investment decisions with respect to ESG risk and opportunity. With an OCIO, LPs can address responsible investing during the selection process, in contracts, and regular engagements.Actively reviewing a GP's policies during the diligence phase can help to ensure ESG factors are incorporated into an investment process. LPs and GPs should also be prepared to change how ESG factors are managed, depending on prevailing market conditions and financial performance of portfolio companies when the capital is drawn down.

Briefly explain under which scenarios a country's currency is likely to depreciate as it pertains to: Inflation rate compared to its trading partners Real interest rates compared to its trading partners Policies that attract or discourage capital inflows Income growth versus trading partners

Like any other asset, currency prices are typically set by supply and demand. A country's currency is likely to depreciate when the country has: A higher inflation rate compared to its trading partners Lower real interest rates compared to its trading partners Policies that discourage capital inflows Higher income growth versus trading partners that increases the demand for imports

The main drawbacks of commodity index swaps are:

Limited access: commodity index swaps are available only to large, highly credit-worthy investors Limited exit: the secondary market for commodity index swaps is not liquid Additional risks: swaps experience greater counterparty risk than commodity futures markets

Supervised Learning: Linear regression and logistic regression and list the business use cases

Linear regression-Highly interpretable, standard method for modeling the past relationship between independent input variables and dependent output variables (which can have an infinite number of values) to help predict future values of the output variables Use cases-Understand product-sales drivers such as competition prices, distribution, advertisement, etc -Optimize price points and estimate product-price elasticities Logistic regression-Extension of linear regression that's used for classification tasks, meaning the output variable is binary (eg, only black or white) rather than continuous (eg, an infinite list of potential colors) Use cases-Classify customers based on how likely they are to repay a loan -Predict if a skin lesion is benign or malignant based on its characteristics (size, shape, color, etc)

An investor is attempting to quickly gain hedge fund exposure in their portfolios. The investor does not have the ability to directly invest in hedge funds at this time but would still like to gain exposure. What are some of the benefits of investing in liquid alternatives over direct hedge funds?

Liquid alternatives typically provide exposure to hedge funds without some of the major drawbacks of direct investing. Typically they have lower fees, better liquidity, and improved transparency.

the consultant asserts that "...As the longest-term investors charged with protecting the real value of endowment principal for future generations of students, universities are seeking to earn a premium by investing in privately-held vehicles with the idea that their perpetual nature allows them to easily handle this specific type of risk." What type of risk is the consultant most likely to be referring to?

Liquidity risk.

Asymmetry of information

Market data from around the world are available on a real-time basis, whether through cable channels that specialize in providing color-commentary, or through specialized data providers that organize it consistent with the immediate requirements of asset-specific and domain-specific investment teams, or through third-party entities like custodians and reporting agencies that deliver information tailored to asset owners' responsibilities. The demand for information, the delivery of information relevant to investment decision-making, and the screening of information such that it is relevant to asset owners' responsibilities presuppose asset owners have the expertise to identify and acquire the information they need for the tasks they must undertake. Otherwise, asset owners are provided information packages that meet tests of relevance but, more often than not, fail tests of decision-criticality.

The Yale endowment lost 25% of its value in the 12 months ending June 2009, a tail event:

in that the returns were at the extreme left tail of the endowment's return distribution.

Describe mission related investments (MRI) and program related investments (PRI). Between MRI and PRI, which one qualifies for tax advantages to charitable organizations in the United States?

Mission related investments (MRI) are investments viewed as offering a combination of ESG impact as well as financial return. MRIs are often further defined as offering competitive risk-adjusted returns along with ESG impact. Program related investments (PRI) are investments offering ESG impact and no financial return or offering a combination of ESG impact as well as a sub-competitive risk adjusted financial return. In the United States, PRIs quality for tax advantages to charitable organizations.

List and describe the steps in module IV: Monitoring

Monitoring and reporting of performance and initiatives at portfolio companies and GPs-Dialogue PRI's ESG Monitoring, Reporting and Dialogue in Private Equity guide. Purpose - What information do I need to monitor ESG within my fund(s)' portfolio(s)? Why is it important; What ESG information matters to my stakeholders? Frequency - what reporting frequency do I require from the GP? Feasibility - Is the ESG information requested unique? What additional resources might be required? Impact - How will the information be used for future investment decisions? What feedback will I provide to GPs? Change - How might expectations have changed since making the fund commitment? Published information - How will the information be published and reported? 1.Exception-based reportingFor more static information, some LPs would prefer that the GP reports any changes on a by-exception basis rather than on a regular schedule. 2. Using the LPAC and the Annual Investor Meeting LPs may use governance structures already in place to monitor GPs on ESG integration. This practice has the added advantage of engaging other investors in the fund on the topic of ESG integration. 3. Using monitoring templatesSome LPs and funds of funds send proprietary standardised reporting templates annually to their GPs. This allows them to consistently collect information and track progress. 4.Assessment and scoring of GPs-In assessing GP practices, many LPs use the information disclosed to them to rate or rank GPs annually on their ESG practices. 5.Using the PRI Reporting Framework-PRI Reporting Framework combines mandatory and voluntary reporting. LPs can request a GP's private Transparency Report and Assessment Report. 6.ESG incident monitoring-Most LPs expect to be notified by their GPs in an open and timely manner about incidents that could have serious reputational or financial implications for their organisation. 7.Reviewing GPs' internal ESG/CSR management and initiatives-Some LPs monitor GPs on their internal commitment to management of ESG issues or corporate responsibility. 8. GP Feedback-GPs have emphasised the value of having LP feedback on the ESG information that they report to give them a better understanding of their performance, support internal objective-setting and help them to better understand the LP's responsible investment objectives and priorities For exiting, Identification and management of material ESG issues reduces the possibility a buyer will negotiate a lower price due to unforeseen risks Setting KPIs at the beginning of the holding period generates data to track improvements Thorough management of ESG issues can indicate a well governed business. In the case of an IPO exit, public market expectations for shareholder rights, board structure and ESG reporting have developed and better management of ESG issues during private ownership can help reduce issues during the IPO.

two primary research results of efforts to test hypothetical factor-based replication products:

Most Hypothetical Factor-Based Hedge Fund Replication Products Performed Poorly Some factor-based replication products generate promising results

machine learning

Most recent advances in AI have been achieved by applying machine learning to very large data sets. Machine- learning algorithms detect patterns and learn how to make predictions and recommendations by processing data and experiences, rather than by receiving explicit programming instruction. The algorithms also adapt in response to new data and experiences to improve efficacy over time.

myths and facts of responsible investment in private equity

Myth: Responsible investing necessitates an exclusionary approach Fact: There are many responsible investing methods and strategies available outside of exclusionary screens, consistent with various investment strategies. The practice of identifying and assessing material risks, ESG or other, in a potential investment may lead a GP not to pursue a specific target which is a result of a systematic consideration of risk and return - not a value-based screen. Myth: We cannot do ESG because we invest in a sector that has negative ESG impacts Fact: Encouraging better practices in high impact sectors can result in mitigating or avoiding material risks. Myth: If I ask about a GP's ESG practices and principles, top quartile GPs won't want me as an LP Fact: One private equity survey reports that 81% of respondents report on ESG efforts to their board at least annually. When leading PE firms talk proactively about the value of their responsible investing approach, they help convince LPs that this is a standard part of excellence in private equity fund operations. From a global perspective, the TCFD has support from 833 organisations, including LPs. PRI signatories now number over 2,800 including 500 asset owners. Myth: Looking at ESG factors is not part of my fiduciary duty. My goal is to deliver a certain rate of return or pay pensions, not to deliver social change Fact: Various country specific opinions (eg. The Freshfields 2005 report, 2015 ERISA guidance from the U.S. Department of Labor) are summarised in PRI's 'Fiduciary Duty in the 21st Century'. These determine that integrating ESG considerations is "Failing to integrate ESG issues in investment decision-making is a failure of fiduciary duty". Myth: We are a small team and it takes a lot of resources to be a responsible investor Fact: There is no standard format to implement responsible investing and getting started can be as simple as collecting information and putting questions to GPs. Additionally, there are many action items that can be done with minimal resources that leverage processes, people and relationships already in place.

An LP is describing co-investing to one of her colleagues. She states that a blind pool equity fund is the best way to directly invest in a single portfolio company, because it provides a level of anonymity from the management of the portfolio company. Is this a correct statement?

No, she incorrectly defined a blind pool equity fund, which aggregates capital obtained from its partners into a single fund. Typically, this investment mandate does not involve limited partners in deal sourcing.

Third, he claims the vega of an option approaches 1.0 as the time to expiration approaches zero. Is this correct?

No, the statement is not correct. The vega of an option approaches zero as the time to expiration approaches zero.

Fourth, and finally, he claims the vega of an option approaches zero as the value of the underlying asset approaches zero and approaches 1.0 as the value of the asset approaches infinity. Is that correct?

No, the statement is not correct. While the first part of the statement is correct, the vega of an option also approaches zero when the underlying asset value approaches infinity.

Is there academic consensus about the relationship between companies that exhibit positive ESG characteristics (high ESG scores) and equity market performance? What about high ESG scores and risk?

No, there is no consensus in empirical research. While some academic papers have identified a positive relationship between high ESG scores and performance, others have found the opposite or that ESG scores can be explained by common equity factors (as identified by Rabener). Giese and Lee (2019) found that ESG characteristics had a positive effect on risk (i.e., dampening risk), in particular mitigating tail risk.

A modular operational due diligence approach is one whereby the

ODD process is classified into functional components and divided among specialists with relevant domain-specific knowledge. Domain experts typically have responsibilities in addition to their ODD duties and collaborate on their ODD work through the leadership of an operational generalist who serves as an information aggregator.

Unsupervised learning: Recommender System

Often uses cluster behavior prediction to identify the important data necessary for making a recommendation Use cases-Recommend what movies consumers should view based on preferences of other customers with similar attributes -Recommend news articles a reader might want to read based on the article she or he is reading

succession planning

Once the children have proven themselves both externally as well as in the management of the family business and family office, the succession planning process starts, which is the process of naming a new leader of the family business and potentially a new governance structure after the death or retirement of the founder or current leader of the business. Succession planning is important, as Daniell and McCullough (2013) state that 92% of family businesses do not last three generations and there is less than a 30% probability of maintaining family wealth across three generations.

At the board meeting of a publicly-traded company, a large shareholder stood up and made the argument that the board and management should focus solely on one thing - maximizing shareholder value by focusing on total return. What additional goal might an ESG investor advocate for that would conflict with this shareholder's view?

One of the goals of ESG advocates would be for equitable distribution of returns amongst stakeholders of a company, not just maximizing shareholder return.

front running

One of the key concerns is front running, or trading ahead, in which employees or others attempt to trade for their own accounts in advance of the firm's trading for client accounts. Front running places the interests of the firm's employees ahead of its investors.

inheritance

One of the key questions is determining a strategy for inheritance, which is the distribution of assets after the death of members of the older generation.

A tax-transparent investment vehicle

One of the main advantages of limited partnerships is that they are tax-neutral (i.e., tax-transparent) investment vehicles. A tax-transparent investment vehicle is nontaxable and simply flows through all accounting information to its investors.

What are some of the motivations behind opacity in the context of delegated portfolio management?

Opacity can emanate from principal-agent problems and the incentive for managers to obscure sources of return variability in order to reduce the likelihood of being perceived as an unskilled manager.

multiplier option-based portfolio insurance

Option-based portfolio insurance (OBPI) strategies begin by specifying an investment horizon and a desired floor value at that horizon. While not stated explicitly, OBPI strategies implicitly involve a floor value at every time prior to the horizon. For example, if the horizon is one year and the floor at year-end is $82.50, then the floor at any prior time is the present value of $82.50 discounted using the riskless rate of interest. OBPI strategy consists of a set of rules designed to give the same payoff at the horizon as would a portfolio composed of bills and call options. The bills have face value equal to the floor (e.g., $82.50). The cushion is invested in the calls. With OBPI, the exposure diagram (hence the decision rule) depends very much on the time remaining before the horizon is reached. OBPI can be considered a variation of the CPPI approach in which the multiplier is changed as the cushion changes. One instant prior to the horizon, OBPI involves investing entirely in bills if the assets equal the floor, and entirely in stocks if the assets exceed the floor. With more than just an instant to go before "'expiration," the exposure diagram is a curve. OBPI strategies are thus "'sell stocks as they fall..." strategies and provide convex payoff diagrams. Over any period ending prior to the horizon, such payoff diagrams will plot as curves. At the horizon, the diagram plots as two straight lines, but with a shape that is convex overall. For the long-term investor whose true horizon extends beyond the horizon specified in the OBPI strategy, this is a drawback. The asset mix just before expiration (either 0/100 or 100/0) will typically be vastly different from the mix as reset just after expiration. It is difficult to imagine circumstances in which it is sensible to effect dramatic changes in mix merely because one calendar period has ended and another has begun.

Outsourcing

Over the past 50 years, it has been standard practice to outsource the investment process subject to accepted theories of investment management (see Litterman et al. 2004) and industry norms and conventions that govern their practice. The second assumption is that asset owners lack the skills and expertise to produce their own rate-of- return target net of costs; outsourcing the investment management process involves, in part, the purchase of specialized investment management services that carry a premium in the marketplace. Outsourcing each element of the production process to asset managers carries with it the problem of orchestrating the component parts of a decentralized production system, wherein each part may well demand a domain-specific contract consistent with the market for skills and expertise. Likewise, outsourcing carries with it the problem of reconciling very different sources of information with the goals of the organization

Five Conclusions from Evidence on CTA Benchmarking

Passive trend-following indices, such as the MLM Index, can provide a reasonable benchmark for trend-following CTAs. Less than half of the historical excess return earned by trend-following CTAs is due to their beta exposure to passive trend-following indices. More than half of the returns cannot be captured by such passive indices. Trend-following CTAs display low exposures to traditional asset classes as well as long-only commodity indices. The same low exposure is provided by passive trend-following indices. Discretionary CTAs display low exposures to traditional asset classes as well as long-only commodity and passive trend-following indices. Peer groups appear to be the most suitable benchmark for discretionary CTAs.

painting the tape

Placing transactions to record high or low prices on the transaction records of public markets is a fraudulent activity often termed painting the tape, in reference to the historical use of ticker tape to broadcast prices.

three risks that, among others, should be considered when considering the challenging and potentially attractive opportunities to invest in diverse assets throughout the world.

Political Risks: This is because real estate is part of the heritage of a country, and local governments are key actors in such areas as zoning, taxes, and tenant protection. Some examples of political risk faced by foreign real estate investors are the establishment of new limits on nondomestic property ownership, land and property expropriations, and excessive taxes on foreign investors. The illiquidity of directly held real estate investments makes it difficult to escape a rise in political risk. Economic Risks: Economic risk in this context is the likelihood that macroeconomic conditions (e.g., changes in monetary and tax policies) and government regulation in a country will affect an investment. In the case of government regulation, there may be restrictions in place on foreigners owning real estate assets. There may also be barriers to the repatriation of profits, an obstacle that may be particularly harmful for foreign direct real estate investments. Some of these issues are gradually becoming less important, especially within trading blocs. Legal Risks: Investors in real estate need to verify that, when they purchase a property, they are obtaining a good title, free of encumbrances and liens. In theory, title insurance in the US can often provide protection against the legal risks of property acquisition. However, legal risks vary from country to country. For example, Girgis (2007) documents that real estate fraud became a very real menace in specific jurisdictions. Specifically, as a result of identity theft, homeowners' titles have been illegally transferred and mortgages have been registered against those titles, all without the homeowners' knowledge or consent. The management of real estate legal risks is closely related to many aspects of the real estate due diligence process.

An analyst has created two delta-neutral portfolio by being long put options and long the underlying asset. While both portfolios are delta-hedged, both have positive gamma and vega. The underlying volatility of the first portfolio is 15% while the volatility of the second is 30%. Based on those volatility statistics, which portfolio should stand to benefit more?

Portfolios with positive gamma and vega exposure in a portfolio will benefit from high volatility, so the second portfolio should stand to benefit more.

how changes in leverage, fundraising activity, and private company purchase multiples have influenced the excess returns of private equity since 2006

Post-2006 decline in PE's realized excess returns may have been caused by the relative richening of PE and a gradual decline in PE leverage (D/E).Second, many academic studies show that PE fund returns tend to be lower after hot-vintage years characterized by high fundraising activity or capital deployment, attractive financing conditions, and easy leverage.

The stated investment strategy of a fund is the

investment strategy that a diligent investor would expect the fund to pursue, based on a reasonable analysis of information made available by the fund.

6 voluntary and aspirational PRI principles

Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes. Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices. Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest. Principle 4: We will promote acceptance and implementation of the Principles within the investment industry. Principle 5: We will work together to enhance our effectiveness in implementing the Principles. Principle 6: We will each report on our activities and progress towards implementing the Principles.

Describe the arguments for and against hedge fund managers implementing short selling as part of their process.

Proponents of short-selling claim that it provides a vital function in the marketplace, as it dampens the potential for over-priced securities or prevents and punishes corporate fraud and mismanagement. Arguments against short-selling claim that short-sellers hope for price declines, which is harmful to market sentiment and could potentially increase market volatility.

Describe some of the proprietary and other confidential information that could be lost if a firm does not maintain strong cybersecurity methods.

Proprietary investment methods (algorithms, models, analytics, and research), confidential information on individuals and organizations, investments, sales and distribution, and business management.

Investors using commodity indexes should note that the weighting scheme of each index can have a substantial impact on its returns due to roll return and that:

Roll return for a particular commodity changes over time with changes in interest rates, storage costs, and convenience yields. A commodity's forward curve may flip from backwardation to contango with changes in the cost of carry. Commodities in backwardation typically exhibit high volatility due to their low inventory levels. Focusing strictly on roll return may negatively impact the degree of diversification of the commodity index, as commodities that tend to all be in backwardation or all in contango may share significant correlation with one another.

Section 1256 contracts

Securities that qualify for this special income tax treatment are known as Section 1256 contracts, and as such, trading in these securities in the US can be used as a major advantage for high-net-worth investors because 60% of the gains are favorably taxed at the long-term capital-gain tax rate, typically about 20% (i.e., just over half the ordinary income tax rate). For example, any gains from an exchange-traded futures contract are treated as having 60% long-term capital gains and 40% short-term capital gains, regardless of its holding period.

Why did such a mismatch occur between the complexity of the new CMO products and the sophistication of the portfolio managers?

Sell-side financial institutions developed innovative securities that passed popular interest rate risk stress tests while purporting to have attractive expected returns. Extrapolating from Sato's theses, the institutions created these opaque financial derivatives because there were unattractive fees on CMOs that offered transparency. By creating complexity and opacity, the institutions could compete for market share. It is quite difficult to contend that the enormous complexity of the most highly engineered CMOs "completed the market" in a valuable way when, in fact, they had dangerous features that escaped detection when analyzed using the conventional stress tests of the era.

The four most common internal credit enhancements from credit card receivables are:

Senior/subordinated certificates: These refer to the internal credit enhancement to more senior tranches from the existence of less senior tranches that incur losses first. Spread accounts: If certain performance indicators fall below specific thresholds, any "excess spread" earned on the collateral will be deposited into an account for the benefit of the CCR holders. Excess finance charges: These are defined as the difference between the gross yield on the pool of securitized receivables and the cost of financing those receivables and serve to strengthen credit. Overcollateralization: This occurs when the total quantity of receivables (assets) is greater than the sum of the nonequity tranches which strengthens the credit of the nonequity tranches.

Describe the relationship between the probability of default and the credit spread with respect to the following four important properties of the Merton model: 1. Sensitivity to maturity, 2. Sensitivity to asset volatility, 3. Sensitivity to leverage, and 4. Sensitivity to the riskless rate.

Sensitivity to maturity: The probability of default increases, at a decreasing rate, as the time to maturity increases. The credit spread increases with maturity initially but then begins to decline slightly as maturity increases. Sensitivity to asset volatility: The probability of default increases, at a decreasing rate, as the volatility of the asset increases. The credit spread will also increase as the volatility of the asset increases. Sensitivity to leverage: As leverage increases, both the probability of default and the credit spread increase. Sensitivity to the riskless rate: As the riskless rate increases, the mean return on the firm's assets (which under Merton's model is implicitly assumed to be equal to the riskless rate plus a constant risk premium) increases, reducing the probability of default and the credit spread.

the potential of blockchain to reduce the post-trade settlement period

Settlement periods can be drastically reduced with the swift record of submissions and their confirmation on a blockchain. This may foster greater liquidity in certain types of trades that currently face lengthy settlement cycles and may promote better capital usage. At present, the title to most financial assets can only be settled against payment when banks are open for business. If there were one blockchain that accounted for the ownership of money and another that accounted for the ownership of securities, then, assuming that buyers had sufficient funds and sellers had sufficient shares, a settlement versus payment of funds could occur at any time on any date in a matter of seconds, with legal finality and certainty.

technical and business challenges posed by blockchain technology

Since the ledger is distributed among all participants in the blockchain, any protocol changes must be approved by all. There is also a lack of standardization of blockchain network designs. Incomparability of blockchain platforms with their existing internal systems. The need to increase the scale of distributed ledger systems, especially for permissionless blockchains that use a race to solve a computer problem in order to confirm a transaction. trade-offs between the efficiency of a blockchain and its ability to avoid relying on trusted parties. Trades that regulators demand be reversed, can only be changed by submitting an equal and offsetting trade, which the parties involved in the original trade will both need to accept. Legal uncertainty in cases of fraud, bankruptcy, and other failure scenarios. The more participants in the network, the more points of attack there are for cybercriminals to target. funds and assets must be in proper form and location for such expedited settlement. The number of blockchain-related patents filed doubled between January and November 2016. Existing regulations Central banks will have to find ways to maintain control over digitized currencies.

convex payoff curves decision rule

Strategies giving convex payoff diagrams represent the purchase of portfolio insurance (sell stocks as they fall), while those giving concave diagrams represent its sale (buy stocks as they fall). Constant-mix and CPPI strategies are perhaps the simplest examples of concave and convex strategies, respectively. Every "buyer" of a convex strategy is a "seller" of a concave strategy, and vice versa. When the portfolio of one who buys a convex strategy is combined with the portfolio of the seller of that strategy, the result is a buy-and- hold position. An exposure diagram relates the dollars invested in stocks to total assets; it depicts the decision rule underlying a strategy. It is apparent that the basic shape of the payoff diagram is not so much dependent on the specific decision rule underlying the strategy as it is on the kind of rebalancing required.

Supervised Learning: support vector machine and random forest and list the business use cases

Support vector machine-A technique that's typically used for classification but can be transformed to perform regression. It draws an optimal division between classes (as wide as possible). It also can be quickly generalized to solve nonlinear problems Use cases-Predict how many patients a hospital will need to serve in a time period -Predict how likely someone is to click on an online ad Random forest-Classification or regression model that improves the accuracy of a simple decision tree by generating multiple decision trees and taking a majority vote of them to predict the output, which is a continuous variable (eg, age) for a regression problem and a discrete variable (eg, either black, white, or red) for classification Use cases- Predict call volume in call centers for staffing decisions -Predict power usage in an electrical- distribution grid

Takahashi-Alexander (TA) Model

Takahashi and Alexander's cash flow model (i.e., the Yale model) is among the earliest work formalizing a deterministic predictive model that captures the stylized pattern of LP capital contributions, distributions and NAVs. The TA model uses intuitive relationships to capture cash flow dynamics and generate cash flows that are continuous over time. The TA model has three equations to simultaneously model contributions (i.e., capital calls), distributions and NAVs.

the five major components of the asset allocation framework

The 1 component generates public returns based on an investor's capital market assumptions. The 2 and 3 components produce private asset cash flows based on the investor's views on private asset performance, fund-selection skill, and the commitment strategy. The interaction of the returns and private cash flows with the investor's portfolio structure (the 4 component) determines the portfolio's liquidity and expected performance (the 5 component).

PE reporting initiatives

The ESG Disclosure Framework for Private Equity was a cross-industry initiative that established Limited Partner (LP) objectives for ESG disclosure during (i) fundraising, and (ii) during the lifetime of the fund PRI: Due Diligence Questionnaire; an adaptable list of questions that LPs can give to General Partners (GPs) when fundraising ILPA: Due Diligence Questionnaire PRI: ESG Monitoring and Reporting Framework for disclosing ESG information to LPs during the lifetime of a fund ILPA: Portfolio Company Metrics Template PRI: 'Using SASB to implement PRI monitoring and disclosure resources for private equity'

Describe the role of the Financial Supervisory Service (FSS) in South Korea.

The Financial Supervisory Service (FSS) in South Korea is responsible for inspection of financial institutions as well as enforcement of relevant regulations as directed by the FSC.

There are three primary disadvantages of the HPM:

The HPM requires a large amount of data on several hedonic (both internal and external) variables. The collection of this data can be costly and time-consuming. As in the case of the repeat-sales model, the HPM may also suffer from sample selection bias when the properties that are sold are not representative of the universe of properties like if the owners of properties with rising values tend to sell their properties, while the owners of properties with falling values tend not to sell their properties. The HPM is exposed to specification error. That is, not all attributes of properties may have been included. For example, the model may not include the noise level of various localities situated near factories.

There are three primary advantages of the HPM:

The HPM uses all observations (transactions) and is not limited to repeat sales. This advantage is particularly useful when the length of the sample period is short. The HPM is versatile, as hedonic indices can be adapted to take into consideration the characteristics deemed relevant to the market being analyzed such as the presence of air pollution, scenic views versus industrial views, the perceived risk of only partially compensated expropriations, and the existence of open space and protected areas. The HPM avoids backward adjustments of historical returns when an index is re-estimated with "second sale" transactions data.

the Santiago Principles

The International Working Group of SWFs (2008) set out the Santiago Principles, which define the generally accepted principles and practices (GAPP) of good governance of SWFs. 24 governments have signed.

Of the following U.S. federal statutes, which one provides registration and regulation of persons and entities who are engaged in providing advice to others? The Securities Act of 1933 The Securities Exchange Act of 1934 The Investment Advisers Act of 1940 The Investment Company Act of 1940

The Investment Advisers Act of 1940

Regarding hedge fund governance and transparency, describe the rationale behind the Open Protocol Hedge Fund Reporting and describe its framework.

The Open Protocol Hedge Fund Report was created to bridge investors' needs for risk and portfolio metrics and the need of hedge funds to maintain some level of privacy around detailed data. The Protocol provides a standard and consistent framework around data and inputs, calculations and methods, timely and regular report, and protocols and standards.

Responsible investment

The PRI defines responsible investment as a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership. In the private equity market, Limited Partners (LPs) - who are stewards of capital - have a fiduciary duty to ensure that committed capital is managed appropriately and in line with their interests & policies. To that end, responsible investment is a systematic approach to evaluate and integrate material ESG risks, opportunities and issues into asset selection & ownership and portfolio construction.

Describe the duties of the Securities and Futures Ordinance (SFO) and the Securities and Futures Commission (SFC) in Hong Kong.

The Securities and Futures Ordinance (SFO) is the primary legislation for the regulation of asset management activity in Hong Kong. The Securities and Futures Commission (SFC) is the regulator responsible for overseeing the SFO in Hong Kong.

Target NAV strategy

The Target NAV strategy tries to achieve and maintain a target NAV% of the overall portfolio. It is useful to think of a private portfolio having three distinct pools of capital: 1) The capital that is "in the ground" also known as the NAV; 2) The "committed, but uncalled" capital, which is the capital that is committed but has not yet been called; and 3) The "uncommitted" capital, which is the capital initially allocated to private assets and distributions received from prior commitments that has not yet been committed. The commitment amount at the beginning of each quarter is determined by multiplying a fixed portion (f) by the total amount of uncommitted capital at the end of the prior period making the private allocation a self- contained portfolio. A target NAV can be achieved by selecting the appropriate f value. Ideally, while f should be set to a value that is less than one to pace out commitments for vintage diversification, f can be set to be greater than one to ramp up NAV. A drawback of this strategy is that it does not necessarily balance cash flows (especially for f values greater than one), and therefore may require continuous interactions with other parts of the portfolio (e.g., active public asset strategies) - which must either be bought or sold to absorb or free up capital for private market-related cash flows.

Which U.S. regulatory body is responsible for overseeing the derivatives market?

The U.S. Commodity Futures Trading Commission (CFTC)

What is the purpose of the United Nations' 17 Sustainable Development Goals (SDG)?

The United Nations published a list of 17 goals to "improve the plight of the human race," seeking to improve incomes, living conditions, and reduce poverty and inequality worldwide while stalling or reversing the impact of climate change.

While conducting mean variance optimization for a multi-asset portfolio, an analyst seeks to reduce the effects of estimation error by gathering historical return data, estimating the statistical parameters (means and variance-covariance matrix), and applying a Monte Carlo simulation to generate a large number of hypothetical returns. Which application of resampling is she using to reduce estimation error?

The analyst is using the hypothetical return method.

the endowment model

The asset allocation of major endowments and foundations, which typically includes substantial allocations to alternative investments and limited investments to listed stocks and bonds

Offer potential explanations for the finding that the autocorrelation of the all-equity FTSE NAREIT returns is substantially lower than that of XYZ RE Index returns.

The autocorrelation of the all-equity FTSE NAREIT returns is low, and its positive (although) small value may even have a spurious component arising from the extraordinary events that affected the real estate market in the years following 2007. This low value suggests that the market for REITs is informationally efficient. This REIT index can be considered a proxy of a true return series. On the other hand, the high value for the autocorrelation of XYZ RE Index returns is consistent with XYZ RE Index being based on appraisals, and thus subject to price smoothing.

What is the purpose of the bias ratio?

The bias ratio attempts to indicate when returns have been manipulated and thus do not exhibit a distribution consistent with competitive markets.

Regarding the decision-making parties in the investment policy statement, what is the role of the board relative to role of the investment committee?

The board is the highest governing body and is responsible for approving the investment policy statement and target asset allocation strategy. The investment committee makes investment recommendations and final decisions.

How does the capacity constraint hypothesis explain the general rise in the beta of hedge fund indices and the corresponding decline in their alphas during the past two decades?

The capacity constraint hypothesis asserts that alpha is essentially a zero-sum game and that, therefore, only a few managers can be expected to consistently deliver alpha. The per capita amount of alpha available in the marketplace has declined substantially with AUM growing almost exponentially since the early 1990s. According to this hypothesis, alpha will be expected to continue to decline unless new sources of alpha are discovered.

Asymmetry of market power

The concentration of the industry has had at least two significant effects on the relationship between asset owners and asset managers. In the first instance, the average asset owner is rarely able to give effect to a bespoke investment contract with a major asset manager. In many cases, the average asset owner is offered investment services on a take-it or leave-it basis. The average asset owner may also face asset thresholds such that any offer of an investment contract by a major asset manager comes with a minimum commitment. Furthermore, smaller asset owners may well be placed into queues according to their likely commitment, thereby privileging larger asset owners over smaller asset owners. In the second instance, the average asset owner may be required to sign a contract for services that is at a variance to the norms and conventions of the industry. The average asset owner has neither the resources, expertise, nor the information that would enable it to rewrite proffered contracts for services in their own interests.

Mr. Williams notices that 123 Fund has an internal compliance department, with a third-party compliance consultant to supplement the work of the internal compliance function. Mr. Williams is concerned that the coexistence of an internal compliance department and a third-party compliance consultant may not be best practice for a hedge fund, as each one of them would be superseding the other. Is the concern by Mr. Williams justified?

The concern by Mr. Williams is unwarranted. It is generally considered best practice for a hedge fund to use a third-party compliance consultant to supplement the work of the internal compliance function.

They are having a preliminary meeting intended to estimate the operational risk of 123 Fund, a long/short equity hedge fund dedicated to large and mid-size U.S. stocks that was founded in 2011. 123 Fund currently has $15 million in assets under management (AUM).Mr. Williams is worried because he found out that a month ago an employee working at 123 Fund took a long position on ETF ABC, which is based on diversified world stock markets, for his personal account. Mr. Williams is convinced that this is a case of front running. Is Mr. Williams's concern justified?

The concerns by Mr. Williams are not warranted. Personal account dealing is an example of a common hedge fund compliance policy. The policies implemented regarding personal account dealing usually apply to employees, their significant others, as well as other immediate family members. The majority of personal account dealing procedures defines a universe of securities (known as covered securities), to which the policies apply. In practice, most hedge funds typically exclude investments in exchange-traded funds from the universe of covered securities, because of the reduced likelihood that an employee would front-run anticipated hedge fund trades through ETFs. Furthermore, also notice that the relatively small amount of AUM of 123 Fund make it rather difficult to argue that an employee would be front running anticipated trades by the fund using an ETF that, to make the case even weaker, is based on world stock markets (and 123 Fund invests in large and mid-size U.S. stocks).

Contribution model

The contribution model states that the capital call amount in the next period will be proportional to the uncalled capital amount at the end of the current period (UCt-1): Ct = UC t-1 × RC(Age t-1), where rate of contribution (RC) is a piecewise constant function of Age of commitment.

The investment decision-making authority model approach

The investment decision-making authority model approach focuses on performing background investigations on those individuals who have authority to make investment decisions and act (i.e., trade) on such decisions. This generally includes portfolio managers, traders, and those involved with the investment process on a daily basis.

The core-satellite approach structures a portfolio in various sub-portfolios, which can then be assembled using one of the three construction techniques available (e.g., bottom-up, top-down, or mixed). List some of the advantages of the core-satellite approach.

The core-satellite approach aims to increase risk control, reduce costs, and add value. This may be an effective strategy, particularly for institutions desiring to diversify their portfolios without giving up the potential for higher returns generated by selected active management strategies. The flexibility it offers to customize a portfolio to meet specific investment objectives and preferences. This approach also offers the structure for targeting and controlling those areas in which an investor considers that she is better able to control risks, or is simply willing to take more risks. What constitutes core versus satellite depends on the investor's focus and expertise. Some see venture capital as satellite, while others view a balanced buyout and a venture capital funds portfolio as core. It facilitates dedicating more time to the satellite portfolio, which is expected to generate excess performance, and less time on the lower-risk core portfolio.

Describe the evolution of secondary market pricing in terms of discount to NAV since 2009.

The discount to NAV has decreased since 2009 across all strategies.

Distribution model

The distribution model states that the distribution amount in the next period will be proportional (rate of distribution (RD)) to the NAV that reflects the appreciation of the underlying investment by the growth rate G: Dt = NAVt-1 × (1+G) × RD(Age t-1, bow,L) RD = ( Age t-1/L )^bow G is the expected growth rate, and if the private investment develops as expected, then G equals the internal rate of return (IRR) over the specified lifespan. The rate of distribution is a function of age of commitment, expected lifespan of the private investment activity (L) and a bow parameter. The bow parameter controls the rate at which the distribution rate changes over time. The lower the bow, the faster the initial increase of the distribution and the slower the later acceleration.

diversification return

The enhanced average or expected geometric mean return from rebalancing (or other volatility reduction) is often termed diversification return.

What is the relationship between the existence of complexity and active management?

The existence of complexity and active management are complementary to one another.

Briefly describe the three approaches to benchmarking managed futures performance presented in the book.

The first approach consists of using an index of long-only futures contracts. Because CTAs are as likely to be long as to be short, this approach is not particularly helpful. The second approach is to use peer groups, where managed futures are usually benchmarked to indices representing active or passive futures trading. Active benchmarks of futures trading reflect the actual performance of a universe of CTAs. Unfortunately, there are a number of issues that arise when using hedge fund/CTA databases. Finally, CTAs may be compared to passive benchmarks of futures trading. These passive indices correspond to the performance of an individual trading system (as opposed to the performance of CTAs themselves).

What are the two competing explanations for the divergence in performance between listed REITs and private properties?

The first argument is that listed REITs accurately represents the true changes in the values of real estate properties adjusted for the effects of leverage. This argument asserts that property value fluctuations are delayed due to appraisal methods, which mute true fluctuations. The second argument is that listed REITs and their high volatility emanate from a contagion effect of public equity markets, which does not represent the underlying economic fundamentals of real estate. Therefore, the volatility of private properties better reflect the realities of the real estate market.

The life cycle of a nontraded REIT has four distinct phases, although in practice some of the phases may overlap to some extent:

The first phase is the capital-raising stage. Usually no additional new capital is available after this initial stage ends. In the second phase, the REIT acquires its portfolio of properties with the capital raised in the initial phase. In the third phase, the REIT manages the assets it owns, attempting to generate positive cash flows and to increase value (this is the asset management phase). The final stage is known as the disposition phase. During this stage, an exit strategy is executed to return the investors' original investment and any capital gains or losses that may result from the liquidity event.

What are the five ESG categories included on the SASB Materiality Map?

The five ESG categories are Environment, Social Capital, Human Capital, Business Model and Innovation, and Leadership and Governance.

A firm has a fixed charge coverage ratio of 2.0, EBIT of $15 million, and a fixed charge of $5 million. What is the firm's interest amount?

The fixed charge ratio can be calculated by finding (EBIT + fixed charge) / (fixed charge + interest). Since we already know the fixed charge ratio, we are simply solving for the fixed charge amount. Fixed charge coverage ratio = ($15 + $5) / ($5 + interest) = 2.0 Therefore, the interest amount is $5 million.

unencumbered cash

The fourth primary category of fund cash relates to cash that is not currently being used for trading but may be used in the future for either trading or another purpose; this type of cash is referred to unencumbered cash. Funds typically earn interest on unencumbered cash by depositing the cash in liquid vehicles, such as checking accounts or interest-bearing money market accounts. Best practices for ODD involve examining the procedures for managing these cash balances.

How does the increased allocation to active funds hypothesis explain the general rise in the beta of hedge fund indices and the corresponding decline in their alphas during the past two decades?

The increased allocation to active funds hypothesis argues that as investments in hedge funds becomes more popular; the aggregate performance of the industry will be adversely affected by the decisions of investors who have allocations to these funds as well as to traditional assets. In other words, the systematic risks or betas of hedge funds will increase as more capital flows into the industry. For instance, during periods of financial market turmoil, investors may be forced to liquidate both their traditional and their alternative investments, increasing the correlation between these two asset classes.

Hudson Investment Fund follows a contrarian approach and employs traditional valuation metrics (e.g., book-to-market, price-earnings ratios (P/E), and ratio of P/E to earnings growth rate) to search for undervalued companies. Which approach (e.g., value, growth, momentum, etc.) is most likely to categorize the investment style of Hudson Investment Fund?

The investment style of Hudson Investment Fund is most likely categorized as a value approach.

Consider the following two put options contracts: the first is 15% out-of-the-money and the second is 25% out-of-the-money. How could a bear put spread be created?

The investor could create a bear put spread by selling the put option that is 25% out-of-the-money (i.e., the contract that is farther out-of-the-money), and buying the put option that is 15% out-of-the-money.

An ESG investor is building a portfolio and has decided to avoid any company that deals in firearms and tobacco. What kind of screening method is the ESG investor employing?

The investor is engaging in a negative screening method.

List and discuss the three asymmetries in the asset management industry

The issues with the principal-agent problem are important because of evident asymmetries in the market, including asymmetries of expertise (favoring the sell side of the market), asymmetries of information (favoring the sell side of the market), and asymmetries of market power (favoring the sell side of the market).

Compare the liquidity profile of an ultra-high-net-worth individual (UHNWI) to that of a well-known university endowment.

The liquidity profile of a UHNWI can be more aggressive than a well-known university endowment. This allows UHNWIs to gain the liquidity premium inherent to illiquid assets. University endowments are constrained by the sum of the university budget that they must backfill. On the other hand, UHNWIs are in an advantageous situation because they don't have a university budget to which they must commit resources each year. Therefore, family offices can assign more of their wealth to long-dated assets (compared to a university endowment).

There are three primary disadvantages of the repeat-sales method:

The main disadvantage of the RSM is that the sample of properties (with two or more transactions) from which the price changes and index are calculated typically represents a small portion of all the properties that are transacted during a given period of time (i.e., transacted only once). This data scarcity problem/ sample selection bias can be severe when trying to apply this method during a short period of time or identify signs of real estate market movements. The RSM assumes that the property being traded does not experience changes, when in reality all properties depreciate and age, and some are renovated. When the RSM is updated, it generates backward adjustments in the historical series of returns, and thus previously estimated returns for certain years in the past may change. This problem occurs because a property recording a new "second sale" links back to the earlier "first sale" in estimation history.

covered securities

The majority of personal trading procedures specify a list of securities, known as covered securities, which are securities commonly held in client accounts and to which the policies apply. In practice, most funds typically exclude from the list of covered securities investments such as mutual funds and exchange-traded funds, and securities only traded in passively managed client accounts. The reason for these exclusions is the reduced likelihood that an employee would benefit from front running anticipated fund trades.

What are the potential benefits of replication products?

The most important benefit from investing in replication products is the enhancement of absolute and risk-adjusted portfolio returns (and hence they are also named return enhancers). This benefit can arise from earning alpha (typically measured relative to the performance of all underlying traditional or alternative beta exposures), or by investing in alternative beta exposures that are underweighted or not held in traditional portfolios. Liquidity risk is another source of return not available in traditional investments. Finally, a time-varying traditional source of beta (e.g., a dynamic beta that results from actively managing a portfolio) could be considered an alternative source of beta.

INTEGRATED ASSET-LIABILITY RISK MANAGEMENT:

The plan's funding status is considered with the plan sponsor's operations in an integrated approach to risk management. In this case, it is recognized that future short-falls in the plan's funding status are likely to require larger contributions by the plan sponsor. Therefore, everything else being the same, it will be desirable if there is a negative correlation between (At − Lt) and profitability of the plan sponsor. If a negative correlation is achieved, as a result, whenever there is a decline in (At − Lt), there is likely to be an increase in the firm's profitability, making it easier for the firm to contribute to the plan. In this context, an asset that is positively correlated with liabilities may be considered rather risky if it is positively correlated with the firm's operational strength as well.

ASSET-FOCUSED RISK MANAGEMENT:

The portfolio manager could consider the volatility of the rate of return on the plan's assets as a measure of its riskiness when the risk of a DB plan is measured using assets only. In this context, cash and cash equivalents are considered riskless. Subject to the plan sponsor's degree of risk tolerance and other constraints (e.g., liquidity needs), optimal allocations are created so that the portfolio can earn the maximum expected return.

What is the principal advantage of master limited partnership (MLP) structures in obtaining commodity exposure?

The principal advantage of master limited partnership (MLP) structures is in avoiding corporate taxation. Income from qualifying MLPs is distributed directly to investors.

Fung and Hsieh (2004) propose seven observable and tradable factors:

The return of the S&P 500 minus the risk-free return. Small-cap stock returns minus large-cap stock returns. The return of the 10-year Treasury bond minus the risk-free return. The return of Baa-rated bonds minus the return of the 10-year Treasury bond. The return of a portfolio of call and put options on bonds. The return of a portfolio of call and put options on currencies. The return of a portfolio of call and put options on commodities.

Define the return to commodity beta.

The return to commodity beta is defined as the fundamental risk-based return from holding a passive long position in a commodity.

ASSET-LIABILITY RISK MANAGEMENT PERSPECTIVE:

The risk of the DB plan is measured in terms of the volatility of its surplus from an asset-liability perspective. For example, suppose the plan's assets and liabilities at time t are given by At and Lt, respectively. Then the risk from an asset-liability framework can be measured using the standard deviation of (At − Lt). Everything else being the same, the standard deviation is lower as the correlation between assets and liabilities increases. Therefore, in this context, cash or cash equivalents are not risk-minimizing assets. An asset that is volatile but positively correlated with changes in liabilities is considered to have a lower risk.

How has the evolution of the secondary private equity market evolved in terms of the rationale for investor participation?

The secondary market was initially viewed as a market of last resort for LPs wishing to sell their PE fund interests. However, the market has matured and large institutions regularly exit from private equity as part of an overall portfolio management and reallocation strategy.

List the six advantages that may explain the excellent returns earned by large endowments in recent years.

The six advantages that may explain the exceptional returns earned by large endowments in recent years are: Aggressive asset allocation Effective research by the investment manager First-mover advantage Access to a network of talented alumni Acceptance of liquidity risk Sophisticated investment staff and board oversight

Assume the following scenario. In April, a spreader observes contango in the crude oil forward curve. July and December light sweet crude oil futures on the NYMEX are trading at $55.45 and $62.27, respectively. The size of the NYMEX light sweet crude oil contract is 1,000 barrels. The spreader anticipates a flattening of the curve and narrowing of the spread between the two maturities.

The spreader should go long July and short December light sweet crude oil futures.

the management problem as a tradeoff between commitment and performance

The standard model of management is typically conceptualized in terms of the principal-agent problem: asset owners (principals) contract with asset managers (agents) to produce risk-adjusted target rates of return. In some cases, asset owners can claim special status in the market for investment management services because, directly or indirectly, they "own" or have the exclusive right to represent the owners of the stock and flow of financial assets that comprise their funds.

Comment on the following statement: "Empirical evidence suggests that most top teams tend to give priority allocation to new investors."

The statement is incorrect. General partners typically reward their previous investors with access to future funds. However, while top teams give priority allocations to loyal limited partners, they may also decide to allocate a share of the new fund to newcomers who could add value, such as exit opportunities, deal flow, and industry expertise. Nonetheless, it must be said that access is far less a problem for limited partners who are financially strong and have shown that they are long-term players. For new investors, however, this is an important barrier to entry.

Levered yield differential

This differential depends on both unlevered yields, as well as leverage ratios (D/E). The relative richening of PE's unlevered yield, coupled with decreasing PE leverage, has led to a gradual decline in this component.

Describe the illiquidity premium and explain how it might be observed in U.S Treasuries and U.S. Equities.

The theory behind an illiquidity premium is that higher returns can be earned by an investor willing to take on the risk of illiquidity for an extended amount of time. It can be observed in U.S. Treasuries by observing higher prices of on-the-run government bonds vs. off-the-run government bonds of the same maturity. In U.S. equities, stock liquidity has improved over the recent four decades to the point that illiquidity is significantly priced only for the smallest common stocks.

What are the three methods for approximating short-term valuations for illiquid securities?

The three methods are as follows: capital statement valuations, discounted cash flow model-based calculations, and customized index-based calculations.

What are the four primary ways in which hedge funds deal with cash?

The ways in which hedge funds deal with cash can be grouped into the following four primary categories: Cash for fund expenses. These include frequent recurring expenses (e.g., office rent and salaries), and less frequent expenses (e.g., audit and legal bills). Cash to facilitate trading. Besides the usual expenses inherent to trading (e.g., brokerage commissions), hedge funds may also have positive cash balances on account with trading counterparties (e.g., with a swap counterparty). Cash flows to and from investors. This is cash arising from capital inflows (i.e., subscriptions) and outflows (i.e., redemptions). Unencumbered cash. This cash is not currently being used for trading but may be used in the future for either trading or for another reason. Hedge funds usually earn interest on this type of cash by depositing it in liquid assets (e.g., checking accounts or interest-bearing money market accounts).

concentrated wealth

There are special concerns that arise from concentrated wealth, which occurs when the vast majority of the assets are poorly diversified, such as being held in a single company. Concentrated wealth positions typically arise because the newly wealthy often earn their fortune from a privately held family business or from serving as an entrepreneur or chief executive of a public company.

ABC is a small country that derives 70% of its income from oil exports. Country ABC is considering engaging in sterilization policies to counter the effects of the recent discovery of oil reserves. Explain the two types of sterilization policies that country ABC may implement.

There are two types of sterilization policies that country ABC may implement. First, the central bank of country ABC may sell local currency and buy foreign currency to satisfy the higher demand for local currency by foreign importers of its products. This would lead to inflation as the money supply would be increasing. To sterilize the local economy from the impact of the intervention in the foreign currency markets, the central bank will need to sell bonds denominated in local currency to keep the money supply unchanged and inflation under control. Second, the central bank of country ABC may accumulate a significant amount of foreign reserves if the oil revenues are earned by companies that are completely or partially controlled by the government. If the government were to spend the revenues in the local economy, this could cause major disruptions in the local economy, especially in the case of a small country such as ABC, which most likely has a small economy compared to the size of the inflows. In this case, the government may choose to invest much of the oil revenues outside of the country, for example, investing much of its sovereign assets in dollar or euro denominated securities of other countries in order to not disrupt the local economy and to prevent the appreciation of the local currency.

Compare the consistency of credit rating organizations relative to ESG ratings organizations.

There has been criticism the heterogeneity of ESG-related ratings for the same firms across ratings agencies. For example, one study found that while the three biggest credit rating agencies (Moody's, S&P, and Fitch) have credit ratings correlations of 0.9, the ESG ratings of MSCI, Sustainalytics, and Reprisk have an ESG ratings correlation of 0.32.

an operational threshold issue

There is a general consensus that certain practices are no longer acceptable to the majority of investors. One example of this would be a hedge fund that self-administers its own funds. In some cases the issue of self-administration would be referred to as an operational threshold issue, meaning that it is an issue that must be satisfied in order to have a particular investor continue to consider allocating to a particular fund. Another example of an operational threshold issue for all types of funds, including private equity and real asset funds, would be to use an unknown or inexperienced auditor.

Why is multicollinearity an issue in a multiple regression model but not a single regression model?

There is only one independent variable in a single regression model, but two or more independent variables are needed to have multicollinearity. A multiple regression model is a regression model with more than one independent variable. Multicollinearity is when two or more independent variables in a regression model have high correlation to each other.

What are the major differences between Undertakings for Collective Investments in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs) in Europe?

These are the following differences: UCITS are generally for retail investors with small investment amounts while AIFs are for investors with higher investments UCITS are restricted to safe and liquid assets while AIFs have fewer investment restrictions UCITS limit leverage while AIFs can use reasonable levels of leverage

The six advantages of listed real estate funds are:

They help diversify real estate specific risk (similar to the case of unlisted real estate funds). These types of funds are liquid and divisible. They provide instant exposure to a real estate portfolio. They convey information to the investors. Some listed real estate funds allow the targeting of subsectors or regions (similar to the case of unlisted real estate funds). They provide tax benefits, such as exemption from corporate taxes (similar to the case of unlisted real estate funds).

Which of the three generations of commodity indices incorporates active commodity selection?

Third-generation commodity indices.

the consultant asserts that "...The value added by active managers in alternative investments can be quite substantial." Is this assertion by the consultant empirically sound? Explain.

This assessment is consistent with empirical evidence. Managers working in inefficient markets have a greater opportunity to profit from information, skill, and access to deal flow. Inefficient markets are inherent to many alternative asset classes.

two-way reconciliation

This reconciliation is typically performed as a two-way reconciliation, which is a reconciliation between the fund's trading records and the prime broker.

The consultant explains that "...Empirical evidence suggests that hedge fund managers who attended undergraduate colleges with higher average SAT scores recorded higher performance." Is this statement correct? Explain.

This statement is correct. Research shows that hedge fund managers who attended universities with higher average SAT scores earned higher returns with lower risk than the median fund managers.

The consultant states that "...When a small fraction of a fund's investors redeem their shares during periods of market turmoil, the cost of liquidity risk remains essentially the same for all investors, even in the case in which the underlying assets of the fund are less liquid than the liquidity provisions it offers to its investors." Is this statement by the consultant empirically sound? Explain.

This statement is not empirically sound. According to evidence presented in the Curriculum, when the underlying assets of a fund are less liquid than the liquidity provisions it offers to its investors, then the cost of liquidity risk increases for all investors, even if only a small fraction of the fund's investors decide to redeem their shares during periods of market turmoil.

a rule of thumb for the rate of capital commitment to private assets

To build up as well as maintain a desired allocation to the asset class, Cardie, et al., (2000) provided a rule of thumb: to commit half of the capital allocated to private assets each year. This is a deterministic rule that disregards any currently available information.

Risk transfer

To fully hedge against this longevity-driven uncertainty, an increasing number of sponsors are engaging in longevity insurance or pension risk transfers

Monitoring of illiquid partnerships is based on regular meetings with all parties involved and should include the following six activities:

Tracking the planned strategy of the partnership versus the implemented strategy. Reviewing the fund's financial investment, valuation, and divestment information. Analyzing the impact of relevant market trends. Assessing the risk of both individual investments and the overall portfolio. Measuring performance against the benchmark. Verifying each partnership's legal and tax compliance.

tasks of portfolio management

Trading and risk management are tasks of portfolio management that should be performed by different people to have the optimal reduction in operational risk. Due to the potential for manipulation and conflicts, it is considered best practice not only to segregate the investment and operational functions but also to balance separations among the various systems used in different functions of the trading process while still promoting process efficiency.

the impact of discount rate changes and increased longevity on the funded status of pension plans

US pension plan sponsors have recognized increasing liabilities as new mortality tables are released. The discount rate utilized will affect the calculation of a plan's liabilities.

List the disadvantages associated with co-investing.

Unbalanced portfolios, increased fiduciary risk, conflicts of interest, disagreements among LPs, allocation of fees.

Discuss the potential conflict between the principals of ESG and Fiduciary Responsibility in the United States.

Under the Investment Advisers Act of 1940, fiduciary duties cannot conflict with the clients' best interest. Therefore, there is a potential conflict in that ESG matters may not always result in a direct financial benefit, such as improved risk-adjusted returns. Unless explicitly directed by the investor, fiduciaries in the US are directed to only invest with the goal of maximizing returns relative to the financial risk constraints of the client.

the equity ownership model approach

Under the equity ownership model approach, an investigation would be performed on all personnel who have equity ownership in the management company of the fund organization. This is generally feasible from a cost and investigation-duration perspective for a small fund organization with two or three owners. In larger fund organizations, which typically have a large number of owners, such searches can become prohibitively expensive and lengthy.

Under which three situations would a fund manager not be required to obtain a capital markets services (CMS) license in Singapore?

Under the follow three situations: It carries on fund management in Singapore on behalf of not more than 30 qualified investors, (of which not more than 15 may be funds or limited partnerships). The total value of the assets managed does not exceed a specific amount set out in the regulations. It is registered with the Monetary Authority of Singapore (MAS) as a registered fund management company (RFMC).

the risk control model approach

Under the risk control model approach, background investigations are performed on all individuals, both investment and noninvestment focused, who control risk within an organization. These include portfolio managers and traders, as well as senior operational personnel, such as the chief financial officer and chief compliance officer, and those with authority to move cash.

Assume the following: interest rates are 0%, investors are assumed to be risk-neutral so that all risk premiums are set to 0%, and there is zero recovery assuming default. If a bond is priced at 75% of par, what is the implied probability of default?

Under these conditions, a bond priced at 75% of par infers a probability of default of 25%.

Four potential advantages of unlisted real estate funds are:

Unlisted real estate funds help diversify real estate specific risk Access to skilled managers Targeted exposures Tax-advantaged income

Why do unlisted real estate funds suffer from cash drag?

Unlisted real estate funds suffer from cash drag because cash invested by investors in these types of funds will most likely not be drawn by the fund manager right away. Instead, cash will be drawn from investors as it is required by the fund to buy real estate assets. As a result, investors will not attain immediate full exposure to real estate assets when they provide cash to unlisted real estate funds.

Consider an investor with a $30 million allocation to private equity that decides to commit to $45 million of new private equity investments over the next few years. Calculate the Overcommitment Ratio.

Using Equation 2 from the Secondary Market for PE Partnerships lesson, the Overcommitment Ratio = Total Commitments/Resources Available for Commitments. Therefore, the ratio is $45 million / $30 million = 150%.

Describe volatility clustering.

Volatility clustering occurs in a price series when large changes are likely to be followed by more large changes and periods of small changes are likely to be followed by more small changes.

Culture

We define culture as the norms and conventions that provide an asset owner's employees with guidelines as to their expected behavior and relationships with other employees. In effect, the culture of an organization is to be found in the informal terms and conditions that come with accepting employment in such an organization.

portfolio liquidity and performance during various types of market crises

We define two types of scenarios: a U-shape recovery (slow recovery) when the bad economic period lasts more than 4y and a V-shape recovery (quick recovery) when the bad economic period is relatively brief, lasting less than 1y. Figure 14 shows an example of both recoveries.The economic paths with one V-shape recovery leads to expected portfolio return (11.3%), much higher than the ones with U-shape recovery (6.6%). In addition, if within 10y there is a U-shape recovery, on average a capital call liquidity shortage (1A_CC) occurs 3 times over the 10y horizon, compared to no capital call event for economic paths with a V-shape recovery.

the impact of simulations for various commitment strategies on cash flows and allocations to private assets

We simulate the risk and returns of a multi-asset portfolio, including private and public markets. The process is flexible and can incorporate an investor's own capital market assumptions. We adopt the Takahashi and Alexander (TA) model and calibrate it to capture some empirical relationships between cash flows and public market performance. A cash flow model that is consistent and responsive to the underlying capital market environment allows investors to perform stress tests and tailor their liquidity analysis to forward-looking scenarios. Our framework also gives investors the flexibility to specify fund characteristics, incorporate their views on both public and private market performance and fund-selection skill.

What are the three fundamental screening questions regarding an investment process?

What is the investment objective of the fund? What is the investment process of the fund manager? What is the nature and source of any value added by the fund manager?

Q-measures

When an analyst assumes risk neutrality (knowing that it likely is unrealistic) and infers probabilities and other values from that assumption, the resulting values are known as Q-measures. Therefore, a Q-measure is a probability-like value or other related variable within a model derived for modeling purposes under the assumption that risk-neutrality holds when it is likely that the world is not risk-neutral.

Crowded trades

When large investors hold substantial positions in the same asset or similar assets, it is known as a crowded trade. Crowded trades are viewed as risky positions due to the relatively large potential for massive sell orders or buy orders placed by investors at approximately the same time. The pursuit of similar strategies across a set of very large hedge funds combined with rapid trading techniques facilitated by new technologies broadens the concern regarding crowded trades into concerns regarding crowded strategies.

XYZ Due Diligence has produced a brief summary memorandum that outlines only the key concerns from the operational due diligence (ODD) process conducted on 123 Fund. This is the only document that XYZ will provide to their clients on the ODD conducted on 123 Fund. Is this considered best practice?

While such summary memos are efficient for review, it is often considered best practice to generate a more detailed document. These detailed documents typically begin with an executive summary section, which summarizes the key findings from the operational due diligence review. It is also considered best practice to detail fund and firm strengths uncovered during the ODD process. The other sections of the report typically provide detailed analysis of each of the operational risk review areas covered during the ODD process.

pension risk transfers including longevity insurance, buy-outs, and buy-ins

With longevity insurance, the pension sponsor transfers the risk of further longevity increases to an insurance company, while the plan retains the assets and liabilities, so the interest rate, investment risk, and, in most cases, the inflation risk. Pension risk transfers can be conducted through a buy-in or a buy-out. Buy-ins are insurance contracts that enable sponsors to transfer interest rate, investment, and longevity risk to an insurer for a portion of a plan's participants. A buy-in contract is retained as a plan asset, leaving the plan ultimately responsible for providing pension benefits. A buy-out involves transferring the assets and liabilities of a pension plan to an insurance company, which guarantees payments to participants for life.

Second, he claims that the vega of a call and put with the same underlying asset, strike price, time to expiration, and implied volatility must be equal because they share the same formula for vega. Is this correct?

Yes, the statement is correct.

Ms. McGraw has been going through a batch of brokerage statements of employees from 123 Fund. The statements were provided to her by the fund's compliance department, which in turn received them directly from the employees. Ms. McGraw has just found out that an employee from the fund sold shares of a company from his personal account at a steep loss before the minimum holding period was reached. Are there any concerns from these findings?

Yes, there are a few concerns with this finding. First, it is considered best practice for the compliance department of a hedge fund to collect employee brokerage statements directly from brokers and independent of the employee. This is not what happened at 123 Fund, where statements were provided to the fund's compliance department directly by the employees. The fact that an employee from the fund sold shares of a company from his personal account at a steep loss before the end of the minimum holding period is acceptable if 123 Fund employs a hardship exemption procedure. This exemption is commonly allowed to limit excessive losses in employees' personal accounts.

In a collar,

a call option is sold above the market. While this limits the potential return from the equity-linked portion of the portfolio, the premium earned from the sale of the call option can offset the cost of the put options or a put spread.

Reconciliation refers to the process by which

a fund conducts another internal review to ensure that the internal details of the trade (buy/sell, security description, trade size, and price) are accurately matched with the details provided by the fund's counterparties.

Bailey et al. (1990) define the so-called Bailey criteria as

a grouping of seven characteristics or properties that an investment benchmark should possess in order to be a useful gauge: (1) unambiguous/knowable: the names and weights of entities that make up the benchmark should be clearly identifiable; (2) investable: there should be an option to forgo active management and simply hold all assets that make up the benchmark; (3) measurable: it is possible to frequently calculate the benchmark performance; (4) specified in advance: the benchmark is constructed and mutually agreed on before the manager's evaluation; (5) appropriate: the benchmark is consistent with the manager's investment style; (6) reflective of current investment opinion: this requires understanding a benchmark enough to have opinions about whether to deviate from it; and (7) owned: investment managers have to agree with their sponsor that they are being measured against this benchmark and are accountable for the results.

A restricted list is

a list of securities that the firm has prohibited employees from trading because the firm has received material nonpublic information regarding a particular security, which is commonly referred to as being conflicted out of a security. Restricted lists can also include names that are restricted based on an investment restriction due to environmental, social, or governance factors. During the ODD process, investors seek to gauge who is responsible for maintaining this list and what controls are in place to prevent employees from trading in restricted names.

An audit holdback is

a mechanism by which a fund manager retains a portion of an investor's redeemed capital until the finalization of a fund's audit to provide a capital buffer to the fund manager should the final financial figures be different from expectations.

Crush spreads

are a processing spread typically used as hedges by soybean processors, with its name derived from the physical crushing of soybeans into oil and meal. A typical crush spread would involve going long soybean futures (to ensure the processor against potential input price increases) and short soybean oil futures and soybean meal futures (to ensure against potential output price decreases).

Value at risk (VaR) is

a method of measuring the potential loss in an investment portfolio given a particular holding period, with no changes to the portfolio during the holding period, and at a particular confidence level. The most common confidence levels used are 95% and 99%. A portfolio's 1-day VaR of $3,000,000 at a 95% confidence level means that there is a 95% probability that losses sustained by the portfolio over the next day will not exceed $3,000,000 and, thus, a 5% chance that losses will be greater than $3 million. In other words, during 100 trading days, losses exceeding $3,000,000 are expected in only 5 trading days. If the value of the portfolio is $100,000,000, then the VaR could be expressed as 3%.

Re-intermediation of the investment process

a mix of insourcing and/or outsourcing. to mediate the costs and consequences of being unable to observe commitment. Other strategies include the re-intermediation of the investment process via contracts that seek to ensure the alignment of interests between asset owners and asset managers. a small investment group with a long-term horizon may use re-intermediation to realize its global ambitions.

The omega ratio is

a more general measure of risk that takes the entire return distribution of an investment (e.g., a CTA) into account.

Anchoring occurs when

a person is biased due to prior views and cannot properly integrate new information. In other words, during decision-making under uncertain circumstances, anchoring occurs when individuals over-rely on an initial piece of information to make subsequent judgments. In the stock market, anchoring may lead investors to believe that a stock that was trading for $100 a few weeks earlier and is now trading for $20 must be cheap, and therefore the investor may decide to buy the stock even though the fundamental value of the stock may now be $20 or lower

Compare the magnitude of changes in life expectancy to changes in the discount rate regarding their impact on the future liabilities of pension plans

a plan with 50% active participants (duration of 16 years when discounted at 5%) and 50% retirees (duration of 8 years when discounted at 5%). If the average life expectancy at birth over the next few decades were to unexpectedly increase by 4 or 5 years, then we might expect an increase in the range of 15%- 20% in the liability value of our sample plan. An increase in liability value of this magnitude would be comparable to the impact of a 150-basis-point drop in the discount rate.

An example of a trade using a horizontal spread occurs when

a stock is set to release earnings in the next week, and the implied volatility of 1-month options has risen substantially more than the implied volatility of 3-month options. A trader may sell the 1-month options and buy the 3-month options in anticipation that the spread between the two implied volatilities will narrow after the earnings announcement due to a decline in the volatility of the short-term option. The trader will profit if the spread between the implied volatilities of two options narrows following the announcement and if the price movement of the stock does not cause larger losses due to the position's negative gamma.

The underlying assumption of the factor-based replication approach is that

a substantial portion of a fund's returns can be explained by a set of asset-based factors such that construction of a portfolio composed of long and/or short positions in a set of suitably selected risk factors can minimize the tracking error with respect to a predefined benchmark. The benchmark may consist of a single manager or, more commonly, an equally weighted benchmark of multiple managers, such as a hedge fund index.

In a short position in an iron condor,

a trader sells an out-of-the-money bull spread and an out-of-the-money bear spread. in both a short condor and a short butterfly, the tails of the risk exposures have limited downside exposures to large directional moves (due to long options positions on each tail). The limited losses to short iron condors and short iron butterflies are in contrast to the potentially unlimited losses of short straddles and strangles.

In prospect theory,

agents underweight those outcomes that are probable vis-à-vis those outcomes that are certain. Such tendencies contribute to the risk aversion in choices involving sure gains and the risk-seeking preference in choices involving sure losses. One example is that many investors lock in small profits and fail to cut off losses quickly

side letters are

agreements between the GP and one or more LPs that specify special arrangements governing their relationship, often the granting of concessions or other favorable treatments to one or more of the LPs. One of the most important such arrangements can be with regard to co-investing

utility

as a measurement of the satisfaction that an individual receives from investment wealth or return.

Funding risk,

also referred to as default risk within the private equity industry, is the risk that an investor will not be able to meet capital commitments to a private equity fund in accordance with the terms of its obligation to do so. If this risk materializes, an investor can lose the full investment, including all paid-in capital, which is why it is of paramount importance for investors to manage their cash flows to meet their funding obligations effectively. The financial crisis in 2008 highlighted the importance of managing funding risk.

A term loan typically has either an

amortizing or a bullet structure to reduce and terminate the loan, and is secured against longer-term assets (real estate, or machinery).Often, term loans are provided against capital expenditures such as new machinery. A term loan typically makes up a third or less of the total ABL facility.

A dedicated operational due diligence approach is

an ODD framework in which an investment organization has at least one employee whose full-time responsibility is vetting the operational risks of fund managers.

Behavioral theory warns of a confirmation bias, whereby

an analyst tends to falsely interpret information as supporting previous beliefs or preferences. Since a performance review is more quantitative and objective in nature than other aspects of due diligence, there is a strong reason to believe that a performance review should be performed subsequent to the more subjective aspects of due diligence. The goal is to prevent confirmation bias, in which an investor first identifies historically successful funds and then subconsciously favors those funds throughout the due diligence process. This confirmation bias is especially dangerous to the extent that past performance is not indicative of future performance.

In certain cases, funds may employ a hardship exemption procedure, wherein

an employee is allowed, with permission, to sell a security, especially at a loss, even if it is within the minimum holding period. A hardship exemption is commonly permitted to allow employees to limit personal losses.

Chacko et al. discuss liquidity-driven investing,

an investment approach emphasizing the role of the liquidity of investments and the time horizon of the investor in the asset allocation decisions.

Asset verification refers to the process by which

an investor independently confirms a fund's level of asset holdings with third parties, such as fund administrators, prime brokers, and banks. Position verification refers to the process of confirming the holdings of actual fund positions with third parties, such as prime brokers and custodians.

In an immediate annuity,

an investor pays a lump sum to an insurance company for cash flows starting in the first year of the contract and guaranteed for some period.

In a deferred annuity,

an investor pays a lump sum to an insurance company for cash flows that are scheduled to start at some date in the future.

A subsequent version of screening was positive screening, where

an investor's portfolio was designed to focus on publicly-traded firms that were judged to have operations that performed in an exemplary manner on one or more ESG issue.

An operational risk profile is

an outline or summary of potential losses or other exposures of a fund due to errors or failures within the fund's functions other than those purely attributable to the fund's investment strategy.

The SASB Materiality Map

analyzes ESG-related issues along two major dimensions: ESG category (e.g., environment) and industry (e.g., consumer goods).

Risk assignment in the context of fund documentation refers to

anticipated ways for placing responsibility for different risks with different parties. Two common related legal terms contained in OM/PPMs that assign risk are exculpation and indemnification.Exculpation and indemnification clauses are used in OM/PPMs to outline a limited set of legal standards at which predefined parties would be liable for certain actions or losses. Common legal standards employed include gross negligence, fraud, willful malfeasance, bad faith, and dishonesty.

The co-integration

approach is a statistical technique that detects whether a linear combination of two nonstationary time-series variables is itself stationary. Co-integration is used by traders to specify how the prices of securities may be related through time.

The end result of the ODD process is to facilitate the development of an operational risk determination, sometimes referred to as an operational decision. An operational decision by an investor, or investment organization,

can typically result in a number of common allocation conclusions (no investment, reduced allocation, or originally anticipated investment)

Negative externalities

are adverse consequences on third-party entities caused by contracts or transactions controlled by two or more primary parties and can include pollution, noise, congestion, and other potentially deleterious consequences to parties that did not have control of the contract or transactionNegative externalities are adverse consequences on third-party entities caused by contracts or transactions controlled by two or more primary parties and can include pollution, noise, congestion, and other potentially deleterious consequences to parties that did not have control of the contract or transaction

hedge fund replication products (also called clones or trackers)

are created to capture the traditional and alternative betas underlying the expected return and risk of a hedge fund benchmark. Available replication products are based on statistical techniques (e.g., a factor-based) or bottom-up (algorithmic) trading models.

Appraisal-based indices

are derived from the asset values estimated by appraisers, which may track a particular subpopulation.

Sovereign wealth savings funds

are designed to bring intergenerational equity to a commodity-producing country by investing today's commodity revenues into a total return fund designed to benefit future generations.

sovereign wealth pension reserve funds

are designed to invest for high total returns in preparation for estimated future pension-like liabilities. In contrast to traditional pension funds that are funded with employer and/or employee contributions, pension reserve funds in the SWF category are funded with the proceeds of commodity or manufactured goods exports.

Market frictions

are impediments to costless trading—such as transaction costs, taxes, and regulations—that can create market imperfections and make it too costly or too risky to implement certain arbitrage strategies.

Sovereign wealth reserve investment funds

are included in a country's reserve accounting as part of its reserves, but the funds invest in a total return portfolio in order to overcome the opportunity costs of the cash and fixed income dominated stabilization funds.

Individually managed accounts

are no different from private savings plans, in which the asset allocation is directed entirely by the employee.

Substitution spreads

are positions across commodities that can serve as alternatives for one another in terms of either production or consumption.

Equity options hedges

are positions established in equity options for the primary purpose of reducing the equity risk of a portfolio, such as the purchase of a put option.

National pension funds

are run by national governments and are meant to provide basic retirement income to the citizens of a country.

Commodity spreads

are strategies that seek to take advantage of trading opportunities based on relative commodity prices that can be executed entirely in derivatives markets. These can involve futures contracts, forward contracts, OTC swaps, options, and swaptions.

Behavioral biases

are tendencies or patterns exhibited by humans that conflict with prescriptions based on rationality and empiricism. Behavioral biases are generally viewed as important explanations for some investment behavior and often conflict with rational long-term investment decision-making.Confirmation bias and anchoring are examples of behavioral biases.

assumed investor preferences

are that most investors dislike variance (λ1 ˃ 0), like positive skewness (λ2 ˃ 0), and dislike kurtosis (λ3 ˃ 0)

Location spreads

are trades that involve the same commodity but different delivery and storage locations. A common location spread involves Brent crude oil, delivered in the United Kingdom, and West Texas Intermediate (WTI) crude oil, delivered in the United States. Location spreads are primarily traded using OTC derivatives, though some location spreads can be executed using listed futures contracts.

The leverage aversion theory

argues that large classes of investors cannot lever up low-volatility portfolios to generate attractive returns and that, as a result, low-volatility stocks and portfolios are underpriced.

The purely random error or noise

arises because of the structure of the real estate market, where transactions involve negotiations between two parties and the resulting transaction price is one value from a range of prices that could have resulted from those negotiations.

Funding liquidity risk

arises when a borrower or investor is unable to immediately pay what is owed.

Market liquidity risk

arises when an event forces an investor to sell an asset that is not actively traded and there are a limited number of active market participants.

Temporal lag bias

arises when transaction prices are related to past prices because of the structure of the market. For example, the reported transaction price may have been negotiated a few months before and therefore does not reflect the current market conditions

The increased allocation to active funds hypothesis argues that

as hedge fund investment becomes more popular, the risk-adjusted performance of hedge funds will be adversely affected by the trading decisions of investors who have allocations to both these funds and traditional assets. This causes the systematic risks or betas of hedge funds to increase as more capital flows into them and, during periods of financial stress, investors may be forced to liquidate both their traditional and their alternative investments. The liquidation in stressed markets increases the overall correlation between traditional and alternative asset classes since common correlation measures are heavily weighted towards extreme outcomes.

Developed Market exhibit shows that rental income taxes for foreigners across a group of developed countries can be

as low as 0.00% (Sweden) and as high as 48.56% (Switzerland). Similarly, capital gains taxes can be as low as 1.62% (Netherlands) and as high as 34% (Finland).

The G4 Materiality Principle

asserts that: "[An ESG-related] report should cover aspects that: reflect the organization's significant economic, environmental, and social impacts; or substantively influence the assessments and decisions of stakeholders."

In the Norway model,

asset allocations are dominated by highly diversified liquid assets that are managed at extremely low costs, which seem to be the opposite of the Yale model, which maximizes exposure to illiquid assets invested with external managers. In 2019, Norway had invested over 65% in global equities, 30% in global fixed income, and a target to grow to 5% in unlisted real estate investments.

A credit card receivable (CCR) is an

asset-backed security in which a pool of credit card receivables is used as collateral. The cash flows received by CCRs consist of annual fees, interest, and principal payments. CCRs are structured differently than other asset-backed securities (such as those based on auto loans and mortgages). This is because credit card receivables, which have a short-term life span and tend to be paid off within a year (i.e., much faster than an auto loan or a mortgage), support the outstanding certificates issued by the trust, which usually have maturities of 3, 5, or 10 years.

Feedback-based global macro managers

assume that markets are rational most of the time but that there can exist periods of severe irrationality because people have made money too easily and become complacent or because they have lost money too quickly and become stressed or distressed. Feedback-based global macro managers attempt to read the financial market's psychology, sell into bursting bubbles, and buy into post-crash recoveries.

The hedonic-pricing method (HPM)

assumes that each of these attributes has its own market price. Examples of these attributes include the number of rooms, the size of the lot, the number of bathrooms, and so on. In other words, properties can be viewed as bundles of attributes and characteristics.

Diversified funds of hedge funds

attempt to diversify a portfolio by allocating assets to a larger number of hedge funds (typically 30 to 50) that follow different strategies and are generally expected to have returns that have low correlations with one another.

A relative value strategy

attempts to identify two or more positions that have diverged from their predicted price relation and to seek superior risk-adjusted performance by establishing positions (typically long and short) that will gain if the assets move closer to the predicted relation (i.e., converge). In other words, relative value strategies take a combination of long and short positions in instruments that are perceived as having values or returns that are linked together and are predicted to have an attractive probability of converging values.

The investment goal of an endowment manager should be to maintain intergenerational equity,

balancing the need for spending on the current generation of beneficiaries with the goal of maintaining a perpetual pool of assets that can fund the operations of the organization to benefit future generations

For asset-based loans, structures such as a special purpose vehicle are formed to own the collateral. Lenders may also utilize a lockbox. A lockbox is a

bank account set up to protect the lender by receiving collections of accounts receivable so that the proceeds can be used to support the debt.bank account set up to protect the lender by receiving collections of accounts receivable so that the proceeds can be used to support the debt.

The S&P 500 Short-Term VIX Futures Index is a

benchmark index that mimics the performance of a hypothetical portfolio of VIX futures contracts with a fixed weighted time-to-settlement of 30 days, formed using a time-weighted combination of the prices of the front and second month VIX futures contracts.

Level 2 assets are

best valued based on nonactive market price quotes, active market price quotes for similar assets, or nonquoted values based on observable inputs that can be corroborated. A distressed debt security traded infrequently and/or valued based on market prices of similar securities would generally be considered a Level 2 asset.

two types of ABS: auto loans and credit card receivables. Credit cards and auto loans are recourse loans, which means that the

borrower is personally liable for repaying any outstanding balance on the loan. This implies that lenders are allowed to garnish wages or levy accounts to collect what is owed, even after they have taken collateral.

divergence

can be defined as the tendency or process of an asset, market index, or indicator to move in opposition to the movement or behavior anticipated by a particular model or expectation.

Pairs trading

generally refers to a simultaneous long and short position in two securities that share many similarities, such as bonds with similar ratings, equities in similar industries, and futures contracts with the same underlying but different delivery dates.

Knight (1921) made the distinction between two sources of unpredictability: risk and uncertainty. One source of unpredictability he termed risk—which occurs when an investor understands the probabilities of various outcomes but is unsure as to which outcome will occur. The other source of variability is Knightian uncertainty. Knightian uncertainty occurs when an investor

cannot form reasonable quantified estimates of either the possible outcomes or their associated probabilities.

Auto loan-backed securities (ALBS) receive

cash flows from customer payments assembled from a specific pool of automobile loans or leases. The loans can be issued by commercial banks, financial subsidiaries of auto companies, independent finance companies, or small financial companies dedicated to auto loans. Auto loan (and auto lease) asset-backed securities have historically represented between a fifth and a quarter of the asset-backed securities market in the United States. Auto loan-backed securities do not have government backing and are therefore subject to credit risk. Auto loans are typically classified as prime, near-prime, or subprime.

Some of thee earliest ESG investors focused on negative or exclusionary screening, which

chose not to invest in entire industries of publicly-traded companies due to the firm's involvement in activities deemed objectionable, often based on the morals or religion of the investor.

The cash flows of auto loan-backed securities are managed by servicers, which are paid a fixed fee (usually 0.5% to 2.0% of the pool's remaining collateral balance). Servicers

collect and process borrowers' payments to the loan pool and then pay investors in this asset-backed security. They also endeavor to collect payments due from delinquent borrowers. The credit rating of auto loan-backed securities is affected in part by the creditworthiness of the servicer and also by its experience.

Expert networks are

comprised of professionals and academics from various disciplines and industries that provide advice and consultations to funds conducting research, but in some cases have been found to use currently employed or recently retired employees from publicly traded companies to obtain MNPI. These types of networks typically impose prohibitions on their experts with regard to communication of MNPI.

The balance of payments

considers three accounts, which must offset each other in any given year as depicted in Equation: ΔReserve Account=ΔCurrent Account+ΔCapital Account

Public-private partnerships (PPPs) represent

cooperation between government and business jointly working toward a specific mutual target, assuming investment risks and sharing revenues and costs based on a predefined distribution. Projects are financed through a mixture of equity and debt financing, with debt financing in the neighborhood of 70% or more, and may often use mezzanine finance products. The public authority (public party) specifies its requirements in terms of outputs, which set out the public services that the facility (public infrastructure) is intended to provide but does not specify how these services or assets are to be provided. The private sector designs, finances, builds, and operates the facility to meet these long-term output specifications.

The strategic asset allocation (SAA)

creates a portfolio allocation that will provide the asset owner with the optimal balance between risk and return over a long-term investment horizon, serves as the basis for creating a benchmark that will be used to measure the actual performance of the portfolio, and serves as the starting point of the tactical asset allocation process.

A credit wrap is a

credit enhancement in which an insurance company guarantees the payment of interest and principal of a specific debt in exchange for an insurance premium. Wrapped bonds yield lower spreads because of the risk reduction that they achieve.

A key factor is the current level of interest rates relative to the rates being charged on the loans in the pool. Borrowers will have a greater incentive to refinance when

current loan rates are low relative to the rates on existing loans. Refinancing, however, is not an important factor explaining prepayments in the case of auto loans. Prepayments nonetheless can also originate due to the following factors: sales and trade-ins involving full loan payment, loss or destruction of an automobile, repossession and subsequent resale of a vehicle, and payoff of the loan by the borrower with cash. It is thus important that investors consider the speed of prepayments, which can be measured by the conditional prepayment rate (CPR).

Gamma is the

degree of nonlinearity of long positions in options with respect to the price of their underlying asset (i.e., is a measure of the degree of curvature) that provides call option owners (who are long gamma) with the highly desirable combination of experiencing increasing rates of gain as the underlying asset moves up and decreasing rates of loss as the underlying asset moves down. Put option owners experience the highly desirable combination of experiencing increasing rates of gain as the underlying asset moves down and decreasing rates of loss as the underlying asset moves up.

A pricing matrix

describes valuation of assets typically with labels for the types of asset (e.g., the labels Level l, Level 2, and Level 3, as one dimension), with descriptions of the valuation model-type as the other dimension and total aggregated asset values as the data entries.Level 1 assets are highly liquid with prices accepted as valuations with a high degree of confidence, Level 2 assets can be valued using observable inputs, while Level 3 assets are illiquid with values based on models resulting in relatively low degrees of confidence.

The algorithmic approach

does not rely on a predefined benchmark; it involves implementing a simplified/rules-based version of the actual trading strategy employed by funds that follow the particular strategy using the same types of positions without case-by-case discretionary judgment. For instance, basic merger arbitrage strategy involves taking long positions in target firms and short positions in acquiring firms. Similarly, basic convertible arbitrage involves taking a long position in convertible bonds of a firm and a specific short position in the equity of the same firm such that the equity risk of the convertible bond is hedged away.

There exists evidence that domestic investors earn higher returns than foreign investors when both invest in the same real estate market. This "home effect" might be explained by the fact that

domestic investors are closer to information, and they know more about the local real estate market and the legal and tax situation.According to Geltner et al. (2014, 626): The information costs (to foreign investors) can come in two varieties, both leading to underperformance. The first is that investors do not have the necessary information and therefore make mistakes. They buy lemons; they pay too much when they buy and get too little when they sell. Alternatively, they could try to solve the problem by buying information, for example from local brokers, or by establishing local offices and employing local people. However, that would simply translate the cost of the information disadvantage into the payment of fees and salaries, likewise eroding the return. In any event, these information costs imply that diversification, dubbed as the only free lunch in financial markets, is no longer free. According to Baum and Hartzell (2012), this is one of the reasons why foreign investors often decide to invest through a joint venture with a local partner.

Inflation-protected bonds

earn a nominal coupon while the principal value rises with the rate of inflation. Their total return tends to be low.

Fundamental risk

emanates from an unexpected change in the fundamental value of a security, causing an apparent arbitrage opportunity to generate losses on the part of the investor.

Value long/short managers

employ traditional valuation metrics, such as the book-to-market ratio, earnings-to-price (E/P) ratio, dividend yield, and the ratio of P/E to earnings growth rate (i.e., the PEG ratio), to look for undervalued companies.

Blackout periods are common practice in situations where

employees are able to trade names within firm portfolios, whereby employees cannot trade these securities within a specified number of days before or after a portfolio trades that security.

The complexity risk premium, if it exists, would be the

enhanced return offered to opaque investments to compensate the investors for the risk of increased losses and/or the added costs of financial analysis in evaluating complex products.

In the case of equally volatile assets with unequal return correlations between pairs of assets, the following strategies generate the same allocations:

equally weighted and inverse volatility-weighted. Note that minimum-volatility strategies and risk-parity strategies take into account correlations and so their solutions (portfolio weights) will depend on the correlations (and may differ from each other in the given case of equally volatile assets with unequal return correlations).

The common types of fund insurance coverage include

errors and omissions (E&O), directors' and officers' liability coverage (D&O), general partner liability coverage, and employment practices liability coverage.

The first section of the IPS:

establishes the context for the investment program. It should include a description of the asset owner, scope of the IPS, reference to appropriate fiduciary standards, and the purpose of the IPS and periodic review.

A commodity index swap is an

exchange of two cash flows in which one of the cash flows is based on the price of a specific commodity or a commodity index, whereas the other cash flow is fixed. Similar to other types of swaps, the contract specifies a term for the swap, the frequency of the payments, and leverage (both direction and magnitude). The buyer (i.e., receiver) of the swap will agree to make fixed payments on specific dates in exchange for payments that are tied to the value of a specific commodity or commodity index. The seller or payer of the swap pays the variable price and receives the fixed price.

Mean-reversion

exists when an asset's future value changes (returns) are more likely to reverse from unusually high or low previous performance by exhibiting the opposite performance in the future (i.e., exhibiting negative autocorrelations of returns). Mean-reversion is not a random walk. Mean-reversion is not a random walk.

"complexity crashes" in which highly complex securities, such as structured products,

experienced severe declines in market values due to a combination of adverse economic events and the opacity of the complex securities. Simply put, in a severe crisis it is difficult to be confident as to the value of a complex security and, under stressful market conditions, investors liquidating complex positions might need to offer steep discounts to attract buyers. The term "complexity crash" here is used analogously to the use of "momentum crashes." A momentum crash is a well-known term in financial markets to indicate a general and severe decline in assets with high exposure to momentum factors.

Overfitted models

explain the past well (i.e., the model explains the data used to fit the model), but they do not predict future relations well. Ideally, the analyst's knowledge should be used to limit the variables under consideration to those that make economic sense.

The Fundamental Law of Active Management (FLOAM),

explained by Grinold (1989), expresses the risk-adjusted value added by an active portfolio manager as a function of the manager's skill to forecast asset returns and the number of markets to which the manager's skill can be applied (breadth). the central relation of the FLOAM. is IR=IC×√BR The left side of the FLOAM is analogous to a Sharpe ratio of the manager's return-to-risk ratio in that it measures the estimated added expected return to an active strategy relative to the volatility of that potential added return. The right side of it asserts that the benefit-to-cost ratio of active management is a product of the manager's skill (IC) and the number of opportunities that the manager has to deploy that skill. Therefore, the FLOAM indicates that the value added by active management increases with the ability of the manager to forecast returns and the number of independent assets, sectors, or markets to which the forecasting skill can be applied.

Historical evidence is that the correlation implied by the relation between index option prices and individual option prices is typically higher than the average correlation actually realized by the underlying components. Accordingly,

exposures that are short realized correlation have tended to make money over the long term. Exposures that are long realized correlation (i.e., strategies that have large positive payoffs in "bad times," such as rising correlation in bear markets) have tended to lose money over the long term.

Alternative betas refer to

exposures to risk, risk premiums, and sources of return that are not normally available through investments in traditional assets—or, if they are available, are commonly bundled with other risks. For instance, publicly traded equities have exposures to a number of factors, including volatility and commodity price risks. These two risks are generally considered alternative sources of risk, but in the case of common stocks, they are bundled with pure equity risk, which dominates the behavior of common stocks. Other examples of alternative betas are risks associated with currency investments, momentum or trend-following strategies, and structured products, such as convertible bonds and certain tranches of asset-backed securities.

Short Volatility Risk reflects the

extent to which the fund manager may short volatility. Shorting volatility is a strategy whereby a fund manager: (1) sells (i.e., writes) call or put options, especially out-of-the-money options, without an offsetting (hedging) position; or (2) establishes positions in volatility derivatives that move inversely to volatility levels, in particular, equity volatility levels.

US Treasury Strips are

financially engineered zero-coupon securities formed by parsing a non-callable US Treasury note or bond into a set of securities with maturities corresponding to each of the promised coupon and principal payments. Thus, a 10-year Treasury note with 20 coupon payments and one principal payment could be divided into US Treasury strips serving as zero-coupon bonds with maturities ranging from 6 months to 10 years which were helpful for cash-flow matching liabilities, "completing the market". The prices of strips were quoted on the basis of the price per $100 of face value. Given high interest rates in the US in the early 1980s, it was not unusual to see long-term strips trading at $20-30 per $100 of face value. The complexity of zero-coupon bond returns masked the large reduction in return being caused by the enormous but opaque bid-asked spreads (when viewed as a percentage of price rather than face value).

Internal settlement refers to the

firm's or fund's process of reconciling third-party trade confirmations for executed trades with its internal systems and trade blotters, and transferring the cash and securities to complete the trade.

The LN PME method

focuses on computing two IRRs, one based on the actual cash flows of private equity and another based on hypothetical use of a public market index, and comparing them. Due in part to difficulties with IRRs, other PME methods have emerged that use other performance metrics.

A matched-bargain system

for trading securities functions by matching buy offers directly with sell offers rather than involving a market-maker who can provide liquidity.

The chief risk officer (CRO) oversees the

fund manager's program for identifying, measuring, monitoring, and managing risk. Larger funds often establish a senior executive who oversees risk across all funds and separate accounts. Often, especially with smaller funds, the CFO serves as the risk officer. This is a good solution, as long as the CFO is not also the chief investment officer (CIO).

the delegated approach to obtaining hedge fund exposure in portfolios

fund of hedge funds approach delegates management to another party and provides services: Sourcing managers Due diligence - Larger funds of hedge funds may outperform because their scale allows them to invest more in due diligence and risk management processes as well as potentially accessing managers with higher returns that require higher minimum investments. Strategy and fund selection Portfolio construction - sizing, correlation, liquidity Risk management and monitoring Fund of Hedge Funds AUM $1.9 million in 1990 to over $640 billion in 2019, peaking in 2007 at $798.6 million

The notice period is a

fund requirement, typically ranging from 30 to 90 days, for LPs to inform the GP in advance of a redemption to give the fund manager the ability to position the fund's portfolio and liquidity to meet the redemption request.

LPs can make decisions with either a simple majority (e.g., the decision to extend the investment period or the fund's duration) or a qualified majority (e.g., the decision to remove the GP without cause). A qualified majority is

generally more than 75% of LPs rather than the 50% required for a simple majority.

A beta neutral portfolio

generates returns that are not linearly correlated with the market risk associated with the specified beta. In this strategy, the equity market betas of long and short positions are equal to each other. Note that this does not mean that equal amounts are invested in long and short positions. For instance, if a long position consists of low-beta (e.g., value) stocks, and a short position consists of high-beta (e.g., growth) stocks, then the size of the long position needs to be levered up in order to match the high beta of the short position.

A sector neutral portfolio

generates returns that are uncorrelated with economic sectors, including industries or industry groups. For example, a fund manager may take long positions in the stocks of energy firms and short positions in the stocks of technology firms.

A target-date fund

has risks that are managed relative to a specified horizon date, which allows employees to choose a single investment option without needing to rebalance or change investments as the horizon date approaches.

A decay function

in a valuation method is a numeric construct that puts less weight on older valuations and more weight on more recent valuations.

In a short position in an iron butterfly, t

he trader sells a bull spread and a bear spread such that the two spreads share the same middle strike price. Both a short condor and a short butterfly, are concave near the middle strike prices; they generate losses when the price of the underlying asset moves substantially to the right or left, and therefore represent short volatility strategies. Note, however, that after the underlying asset in a short condor or butterfly position makes a large directional move, the position can be viewed as switching from being short volatility to being long volatility as can be seen from observing in the previous exhibit that the functions are convex on each tail (i.e., near the outside strike prices).

Use of name clauses

in a side letter provide limits to the disclosure of the identity of LPs by the sponsor to provide LPs with anonymity (subject to limits imposed on the sponsor such as requirements to disclose LP identities in reporting to regulators or other government authorities).

The specialized market factors

in a specialized market factor approach are specifically identified and selected to represent the returns to a specific fund rather than the overall market. The factors may be identified empirically by searching for historical correlations between a fund's returns and potential factors, or they may be identified through an understanding of the fund's strategy.

Business activities

include the indirect support of the investment activities of the fund, including all of the normal activities of running any similarly sized organization, such as human resources management, technology, infrastructure, and facility maintenance.

Business continuity planning

includes the development and management of an organization's overall strategies, practices, and procedures for maintaining the critical functions of the organization in the event of an unexpected business interruption. The letter "P" may refer to the words "plans" or "planning." The acronym BCP is sometimes shortened to BC.

A risk bucket

indicates the amount of a particular type of risk that can be tolerated.

degree of risk aversion

indicates the tradeoff between risk and return for a particular investor and is often indicated by a particular parameter within a utility function, such as λ in Equation

The cash surrender value of a life insurance policy is the price at which the

insurance company will buy back its commitments under the contract. If the price offered to the owner of a life insurance policy by a third party is greater than the cash surrender value of the policy, it is financially beneficial to the policyholder to sell the policy to a third party rather than surrender it to the insurance company. There are rational economic reasons for a policyholder to sell a life insurance policy (rather than surrender it) if the policyholder is unable to make required premium payments or if the policyholder otherwise perceives great benefits from immediate cash and has no other preferable options to obtain that cash.

Cat bonds are generally used by insurers as a substitute for traditional catastrophe reinsurance. Reinsurance is

insurance that is purchased by an insurance company from one or more other insurance companies, known as the reinsurer. The insurance company and the reinsurer enter into a reinsurance agreement, which details the conditions upon which the reinsurer would pay a share of the claims incurred by the insurance company. The goal of a reinsurance program is to diversify the risk, which enables the insurance company to offer insurance at competitive rates to its customers, and to maintain its financial viability in the face of substantial insurance claims resulting from major and widespread natural disasters.

An extreme example of a conflict of interest is a rogue trader who

intentionally departs from the investment mandate due to incentives to generate performance or to recoup losses that jeopardize a trader's career.

Fund governance is the

interconnected system of controls and procedures that determine oversight, independence, and transparency throughout the fund.

PIK toggle notes or bonds are a variant of a PIK bond that allows the borrower to pay

interest (partly or in full) in each period, or to accrue a part or the whole interest payment due. Usually, if the borrower pays only part or nothing at all, the overall interest rate is increased following certain rules (often between 25 and 100 basis points). PIK toggle notes usually stipulate specific cash flow triggers that would effectively trigger interest payments during a certain period. PIK toggle notes often come with light covenants.

Funding liquidity risk

introduces a risk associated with leverage that is not present in unlevered portfolios.Funding liquidity risk introduces a risk associated with leverage that is not present in unlevered portfolios.

Tactical funds of hedge funds

invest in a group of hedge funds (typically 5 to 10) to opportunistically gain exposure to a specific market factor. A recent example of this was the proliferation of credit-based strategic funds of hedge funds in 2009 to profit from the credit dislocation of 2008.

Real estate funds of funds

invest in other real estate funds rather than investing directly in real estate assets. While funds of funds in the UK (and the United States) are open-ended, in most of the rest of Europe they are closed-ended. Real estate funds of funds provide higher diversification than investing in only a few real estate funds, and are run by managers who are specialists in the real estate arena. The downside to investors in real estate funds of funds is that they are charged two fees: the first by the fund of funds manager, and the second by the managers of the underlying real estate funds.

the direct approach to obtaining hedge fund exposure in portfolios

investing directly in a number of single-manager hedge funds to create a portfolio which requires extensive research to determine the appropriate blend of strategies, styles (how each manager executes the same strategy), and funds. Smaller investors may face minimum investment or regulation hurdles. But benefits are: The cost savings from avoiding the extra layer of fees charged by a fund of hedge funds. Access to cost-effective, experienced consultants to assist implementing the approach. The ability to have improved control and transparency in the asset allocation and due diligence process.

gaming is

investment activity driven by a desire to generate favorable statistical measures of performance rather than to benefit investors. A survey in the spring 2010 issue of the Journal of Alternative Investments found that 27% of respondents believed that hedge funds engage in deliberate cheating by subjectively valuing securities to smooth returns and reduce volatility.

Property authorized investment funds (PAIFs) are

investment vehicles authorized by the UK's Financial Conduct Authority that can invest in real estate directly or indirectly (mainly though shares in UK REITs). The Financial Conduct Authority requires PAIFs to value their positions on a daily basis. APUTs can be converted to PAIFs if certain conditions are met.

the index approach to obtaining hedge fund exposure in portfolios

investor to select a representative hedge fund index and invest through a financial product that aims to replicate the performance of that index. Indexed financial products are typically sold as certificates or principal-guaranteed notes issued by a creditworthy financial institution whose returns are typically linked to the performance of a referenced fund of hedge funds or specific hedge fund index.Recently, other products (e.g., liquid alternative mutual funds and exchange-traded funds [ETFs]) have proliferated that claim to provide hedge fund exposure without some of the major drawbacks of direct investing in hedge funds. Advantages may include lower fees, better liquidity, and improved transparency.

Reactive deal sourcing, in which

investors evaluate a portion of the large number of general partners who contact them to ask for an investment, is not an efficient way of approaching selection. With this approach, literally hundreds of private-placement memoranda need to be checked as to whether they comply with the set wish-list characteristics or investment criteria. First-time teams often have to approach as many investors as possible, but top teams typically get referred to limited partners by word of mouth and therefore need to be actively sourced. For this purpose, teams have to be identified and approached even before they start their fundraising. This process requires establishing a calendar of when teams are expected to go to the market to raise capital for their next fund offering.

In negative screening,

investors intentionally eliminate companies from their portfolio that are deemed to have a negative impact on the world, such as from pollution, harmful products, or unfair employment practices.

The good-leaver clause enables

investors to cease additional funding of the partnership with a vote requiring a qualified majority, generally more than 75% of LPs. This "without-cause" clause provides a clear framework for shutting down a partnership that is not working, or when confidence is lost. The good-leaver clause sometimes provides for compensation amounting to 6 months to 1 year of management fees; the bad-leaver clause provides no such compensation and foresees no entitlement to carried interest. This contrasts with the good-leaver clause but includes a vesting schedule, so that part of the carry remains available to incentivize the new team being hired.

A soft lockup period allows

investors to withdraw capital from the fund before the expiration of the lockup period but only after the payment of a redemption fee, which is frequently 1% to 5% of the withdrawal amount, discouraging investors from causing liquidity disruptions by leaving the fund and allowing the fund manager to recoup some of the costs associated with liquidating a portion of the fund portfolio to redeem shares or to make up for the drag on performance from a cash balance that the fund manager maintains to fund investor redemptions.

A calendar spread

involves taking opposing long/short positions in the futures market for delivery at different times in the future. These trades can be designed to provide liquidity or insurance against an unforeseen event, or to express a view.

Cognitive psychology

is a broad category that attempts to capture the many types of deviations from full rationality to reflect how people think, including analysis of the emotional components that may affect investors' decision-making abilities. For example, market panics are events in which fear selling and herding behaviors are believed to occur.

A commodity exchange-traded note (ETN)

is a debt instrument that is traded on an exchange but is different from an ETF; instead of being a share in an actual portfolio of assets, the ETN is a note issued by a financial institution that promises to pay ETN holders the return on some index over a certain period of time, and then return the principal of the investment at maturity. This means that if the company issuing the ETN defaults, ETN holders could lose a portion or all of their investment.

A commodity index-linked note

is a debt instrument that pays a return linked to the performance of a commodity (e.g., natural gas or aluminum) or a basket of commodities over a defined period. The note may not pay any interim coupons, with the only payoff distributed on the maturity date, when the note pays the initial principal amount plus return, if any, based on the percentage change in the underlying commodity.

A circuit breaker

is a decision rule and procedure wherein exchange authorities invoke trading restrictions (even exchange closures) in an attempt to mute market fluctuations and to give market participants time to digest information and formulate their trading responses. Despite their intended purposes, circuit breakers have also been argued to heighten risk due to concerns over illiquidity when exchanges suspend trading.

A point and figure chart

is a diagram of X's and O's that denote upward and downward price movements through time (i.e., trends) in an attempt to discern tradeable patterns. Specifically, X's indicate that the price of the asset being studied has moved ("trended") upward by a threshold amount (e.g., $1.00), while O's indicate the asset has fallen by the same threshold amount. The X's and O's are placed on a grid with price level on the vertical axis and time along the horizontal axis

the investment policy statement (IPS)

is a document that describes the primary goals for an investment program and lays out a framework to achieve those goals.

A risk manager

is a duly qualified professional with trading and investment enforcement authority to be able to review, analyze, and understand the information derived from the risk measurement process to take action, as appropriate, to ensure risk exposures within the portfolio are as intended and in compliance with the investment mandates associated with each investment and the portfolio as a whole.

A Ponzi scheme

is a fraudulent program that returns deposits to investors and identifies the returned capital as a distribution of profit in order to overstate the profitability of the enterprise and to attract additional and larger deposits.

A total return index

is a fully collateralized investment strategy, with the collateralization generally taking the form of Treasury bills. In a total return index, the overall calculation of the index return includes the cash return from the collateral (i.e., collateral yield).

Cap and trade

is a government program regarding pollution or other externalities that specifies caps (allowances) on the activity for each entity but allows each entity to trade its rights (e.g., its allotment of pollution)

A return target

is a level of performance deemed necessary to satisfy the goals of the owners or beneficiaries of the associated assets.

Principal component analysis (PCA)

is a linear statistical method that identifies the set of orthogonal factors from a data set that maximize the percentage of explained variation.

Sterilization

is a macroeconomic policy in which a central bank or the government takes actions to counter the effects of an economic event (such as a commodity boom) and a balance of payments surplus on the country's economy. First, a country that is running a trade surplus may decide to intervene in the foreign exchange markets to prevent its currency from appreciating. Second, a country may accumulate a significant amount of reserves not because of intervention in the foreign currency markets, but rather because of the revenues generated through the sales of natural resources that are completely or partially controlled by the government.

the total value to paid-in (TVPI) ratio

is a measure of the cumulative distribution to investors plus the total value of the unrealized investments relative to the total capital drawn from investors.

The information coefficient (IC)

is a measure of the manager's skill, and represents the correlation between the manager's forecast of asset returns and the actual returns to those assets.

The pooled IRR or IIRR

is a measure that attempts to capture investment timing and scale, and is calculated by estimating all actual and projected cash flows, aggregating them, and treating all funds as if they were one composite fund. This composite fund's cash-flow series is then used to calculate the pooled IRR or IIRR. The advantage of this measure is that it takes the scale and timing of cash flows from various funds into account and may be indicative of LP's skills. A potential disadvantage is that larger cash flows will be given more weight, so in a composite portfolio of small early-stage funds and large later-stage or buyout funds, the larger funds will tend to dominate the results.

A fund style index

is a performance index based on a collection of fund managers operating with a similar strategy to the fund manager in question that can be used as a benchmark. For example, a macro manager can be benchmarked against a macro index. Red flags should arise for an investor when the risk or return of the fund differs wildly from that of the style benchmark.

An overcommitment

is a pledge to invest more in funds than the investor has currently available as resources. The purpose is to increase private investments and avoid idle cash.

A crack spread

is a processing spread that involves buying crude oil (in the spot or futures markets) while selling a combination of products derived from crude oil (heating oil and gasoline).

A multiple regression model

is a regression model with more than one independent variable.

Statistical pairs trading

is a relative value strategy trade with one long and one short position in securities with an observed long-term close statistical relation of returns and a recent observation of a marked but presumably short-term departure from that statistical relation.

Rolling window analysis

is a relatively advanced technique for analyzing statistical behavior over time, using overlapping subsamples that move evenly through time.A rolling window analysis chooses a time width for the window, such as 36 months, and performs the regression or correlation analysis for each contiguous 36-month period in the data. The subperiods use overlapping data as the window moves from the first 36 months of data to the last 36 months of data.

A common investment objective of endowments

is a return target X% above inflation, specifically connected to long-term spending needs.

A synthetic weather derivative

is a set of derivative positions with returns that are substantially driven by weather conditions. Speculators may implement synthetic weather derivative strategies as a potential source of returns by providing protection from the economic consequences of adverse weather occurrences to major commodity users or producers.

An optimal benchmark

is a standard that best differentiates whether the investment manager has generated superior or inferior returns through skill and in so doing provides evidence to the asset owner regarding which assets to own.

Factor analysis (FA)

is a statistical method that seeks to identify factors and their coefficients through optimization of a specified model with explicit statistical assumptions.

A P-measure

is a statistical probability (or an estimate of that probability) that represents the likelihood of an outcome in the real world.

A depreciation tax shield

is a taxable entity's ability to reduce taxes by deducting depreciation in the computation of taxable income. The present value of the depreciation tax shield is the present value of the tax savings generated by the stream of depreciation. Real estate equity investment tends to offer substantial depreciation tax shields to taxable investors.

Window dressing

is a term used in the investment industry to denote a variety of legal and illegal strategies to improve the outward appearance of an investment vehicle. For example, some funds might liquidate their holdings of a stock before the end of a reporting period if the stock has generated very bad headlines so that the report does not embarrass the fund managers by having the stock appear in their list of holdings. Other window dressing is clearly illegal, such as manipulating the closing prices of stocks that represent large holdings of a fund so that the fund's total valuations, which are typically calculated at the end of each calendar month using closing prices, are higher.

A joint hypothesis

is a test with results that depend on two hypotheses: (1) the hypothesis that the test method is valid; and (2) the hypothesis being tested, such as a null hypothesis that return persistence does not exist. A finding that the null hypothesis cannot be rejected indicates either: (1) that that the test was not valid (perhaps because the risk-adjustment method did not properly adjust for risk); or (2) that performance does not persist. For example, perhaps a factor-based model was used to adjust for risk and the factors were not well specified.

Stepwise regression

is an iterative technique in which variables are added or deleted from the regression equation based on their statistical significance. At each step, the variables with the greatest t-statistics are added to or retained in the model, and variables with insignificant t-statistics are deleted from the model.

An inflation beta

is analogous to a market beta except that an index of price changes is used in place of the market index, creating a measure of the sensitivity of an asset's returns to changes in inflation.

A cash balance plan

is basically a defined benefit plan, where the pension benefits are maintained in individual record-keeping accounts that show the participant the current value of his or her accrued benefit and facilitate portability to a new plan.

The nth order partial autocorrelation coefficient

is designed to denote the marginal or incremental autocorrelation contribution of only the return that is lagged n periods.

The appraisal error

is difference between a particular empirical appraised value and the unobservable true market value.

The information ratio (IR)

is equal to the ratio of the manager's estimated alpha (i.e., risk-adjusted expected outperformance) divided by the estimated volatility of that alpha.

The margin-to-equity ratio

is expressed as the amount of assets held for meeting margin requirements as a percentage of the net asset value (NAV) of the investment account. For example, if the equity invested in a futures portfolio is valued at $1,000,000 and the total margin required by various exchanges is $61,000, then the margin-to-equity ratio would be 6.1%.

Fraud

is intentional deception typically for the purpose of financial gain. Although fraud is often revealed during periods of market stress, market stress is inevitable. The true source of the problem is the fraud itself, and the fundamental underlying cause of investor losses to fraud is insufficient due diligence and controls.

A bear calendar spread

is long the distant (long-term) contract and short the nearby (near-term) contract. In markets in backwardation, the bear spread speculator wants the spread to narrow, whereas in contango markets the bear spread speculator wants the price difference to widen. In theory, it is possible to see a rise in the price of the near-term contract without a similar rise in the price of the long-term contract (e.g., due to a workers' strike or weather). Therefore, in principle, the potential risk in a bear spread could be unlimited or at least very large.

A bull calendar spread

is long the nearby (near-term) contract and short the distant (long-term) contract. In markets that are in backwardation, the investor is hoping for the spread to widen; in contango markets, the bull spread investor is hoping for the price difference to narrow. The losses of a bull spread investor tend to be limited because, in an efficient market, price differences cannot exceed carrying costs (adjusted for convenience yields).

A terminated pension plan

is no longer operated by the employer. Once a plan has been terminated, all assets leave the control of the employer and are either paid out in lump sums to employees or used to purchase annuities that will pay future benefits to retirees.

A defined contribution plan

is offered by employers, where the employer and/or employee make a specified contribution on behalf of each covered employee on a regular basis, such as a percentage of the employee's salary.

The term risk arbitrage

is often used by the investment industry to describe profit opportunities that involve enough risk that it is appropriate to explicitly indicate that the supposed arbitrage comes with nontrivial risk.

pure arbitrage

is often used to denote an arbitrage opportunity that involves a level of risk so near zero (or some might argue is "zero risk") that any risk can be ignored as inconsequential.

A frozen pension plan

is one where employees scheduled to receive defined benefit pension benefits will no longer continue to accrue additional years of service in the plan.

Return on equity (ROE)

is profit after financing costs, expressed as a percentage of equity. ROE can be expressed as a function of ROA, leverage (L, which is defined here as the ratio of assets to equity), and interest costs on the financing (r)

Alpha

is sought independently of beta. The professional investment staff can seek alpha from those investment products that are perceived to offer the best opportunities, even if those products fall outside the benchmark and traditional asset classes.

Beta

is sought through investment products that cost-effectively offer returns driven by beta so that the portfolio obtains efficient economic exposure to market risk and can earn the expected risk premiums associated with bearing systematic risks.

Expectation bias

is synonymous with confirmation bias and is a tendency to overweight those findings that most agree with one's prior beliefs. Thus, a confident manager is more likely to unknowingly accept and report erroneous data if those data portray the fund's performance favorably.

The notional funding

is the added exposure to the trading level that the CTA allows above and beyond the trading level. Notional funding gives investors the ability to leverage their managed futures account to a higher trading level than would exist with cash funding. Notional funding in managed futures is favored by investors because it capitalizes on the ease of acquiring leverage through futures markets. In addition, implicit leverage may carry a relatively low cost because the notionally funded amount is not borrowed or deposited; the funding level is a good-faith deposit for the full value of the account.

Recaptured depreciation

is the amount of the accumulated depreciation taken on an asset between the purchase and sales date that is recovered by the sales price exceeding the purchase price.

The market divergence index (MDI)

is the average signal-to-noise ratio for a group of submarkets. The MDI is found for a collection of M markets as an arithmetic average of the individual SNRs

The offering memorandum (OM) or private placement memorandum (PPM)

is the central controlling legal document for the fund. An offering memorandum seeks to accomplish four key functions: limited partner education; risk disclosure; risk assignment; assignment of decision-making authority.

Affinity fraud

is the commission of fraud against people or entities with which the perpetrator of the fraud shares a common bond, such as race, ethnicity, or religious affiliation.

The transaction price noise or transaction price error

is the difference between any given price observation and the unobservable true market value. Assuming, among other things, that all transaction price observations occur at the same point in time, this error will be unbiased.

An inverse volatility-weighted portfolio

is the direct approach to a low-risk portfolio obtained by weighting each asset (or asset class) inversely to its volatility.

The surplus risk of a pension plan

is the economic exposure to the spread between the assets and liabilities of a pension plan and can be measured as the volatility and tracking error of the difference between the value of the assets relative to the present value of the liabilities.

Impact investing

is the inclusion of ESG and related issues in the asset allocation and security decisions of the investor with the goal of generating positive environmental and social influence alongside financial returns.

The strategic asset allocation decision

is the long-term target asset allocation based on investor objectives and long-term expectations of returns and risk.

The reservation price

is the lowest price at which a potential seller is willing to sell a property, or the highest price a potential buyer is willing to pay for a property.

The hurdle rate

is the minimum expected rate of return that a new asset (i.e., an asset not already included in a portfolio) must offer in order to be a beneficial inclusion in an otherwise existing optimal portfolio.

The projected benefit obligation (PBO)

is the present value of the amount of benefits assumed to be paid to all future retirees of the firm.

The accumulated benefit obligation (ABO)

is the present value of the amount of benefits currently accumulated by workers and retirees.

Expected utility

is the probability weighted average value of utility over all possible outcomes.

the tragedy of the commons

is the problem that individuals or entities will tend to overconsume or undervalue natural resources and other assets that are available for common use (i.e., shared or nonexcludable) since the costs are borne by all

Family estate planning

is the process for planning the distribution of assets upon the death of preceding generations. The estate plan considers the goals of the family, the number and type of beneficiaries, the taxable nature of wealth upon death, as well as insurance and giving strategies.

shrinkage

is the process of implementing a statistical method designed to generate estimated statistical parameters (means, variances, and/or covariances of returns) that differ from those obtained from an unconstrained analysis of historical returns and that provide improved solutions with narrower confidence intervals.

Time-zero-based pooling (or time-zero pooling)

is the process of pooling or summing cash flows across funds of different vintages by treating the funds as if they all started on the same date. In other words, the n th annual cash flow of each fund would be summed to form the n th annual cash flow of the pooled data.

Style analysis

is the process of understanding an investment strategy, especially using a statistical approach, based on grouping funds by their investment strategies or styles. The key question in a style analysis is this: do investment funds of the same stated investment style have returns that can be explained by the same underlying return factors?

Roll return, or roll yield,

is the profit or loss from holding a futures contract due to the change in the basis (where basis equals spot price minus futures price).

ESG materiality

is the property of being likely to be considered important (i.e., potentially having a substantial impact) from the reasonable perspective of stakeholders in the context of ESG principles.

The fund performance persistence hypothesis

is the proposition that fund managers generate returns that contradict the weak-form efficient markets hypothesis by offering excess returns in two or more non-overlapping time periods that exhibit statistically significant correlation. When considering private equity's modus operandi and the observation that GPs have differential and proprietary skills, the performance persistence hypothesis appears to be highly plausible because distinct organizational capabilities could credibly explain the top-performing GPs' superior value creation.1 The lack of a public auction of initial offerings of the funds offered by top managers could inhibit informationally-efficient pricing.

The depreciation tax shield

is the prospective stream of reduced income taxation that a particular investor will experience as a result of being able to deduct depreciation. Equation 1 depicts the tax shield in year t.

The signal-to-noise ratio

is the ratio of a measure of a potential trend to a measure of all price changes during the same period.The signal-to-noise ratio can be viewed as the ratio of the magnitude of a trend (or overall price change) to the volatility of prices around that trend. The denominator of the formula (i.e., the "noise") for SNRt in Equation 1 is the sum of the absolute values of the price changes observed over n periods. The numerator (i.e., the "signal of a trend") is the total change in price over the last n periods expressed as an absolute value. Thus, the numerator is the absolute value of the netted sum of the same price changes—the same price changes used in the denominator to indicate the total variation that occurred.

Backward induction

is the recursive process of starting with the potential values of an asset in a final time period and working backwards through time finding the values in each previous period until the value at time 0 (i.e., the current value) is found.

a utility function

is the relationship that converts an investment's financial outcome into the investor's level of utility.

Serial correlation

is the same as autocorrelation: it is the correlation of a variable, such as return, in one time period (e.g., year) to the same variable in another time period. Further, although serial correlation of returns may be an indication of true skill persistence, it may also be due to the inaccuracy of smoothed or managed pricing.

The efficient frontier

is the set of all feasible combinations of expected return and standard deviation that can serve as an optimal solution for one or more risk-averse investors.

A stated rate of income tax

is the statutory income tax rate applied to reported income each period. The stated tax rate can differ from the effective tax rate.For example, a corporation with $100 million of taxable income that is taxed at a 10% statutory rate would experience a lower effective tax rate if the tax law granted the corporation the opportunity to pay the taxes several years later and without penalty.

Impact alpha

is the theory that ventures choosing to do the right things from a social perspective will ultimately be rewarded in the marketplace with above-market financial returns, or that ventures that have socially objectionable operations have substantial risks of generating below-market financial returns. For example, a firm with operations that are negative for the environment may be faced with substantial future cleanup costs that are not currently factored into the stock price.

Free cash flow to the firm (FCFF)

is the total cash flow that is available for distribution to shareholders and bondholders of the firm. The FCFF is considered to be available for distribution to all suppliers of capital, because the cash needed to support the firm's operations as well as investments is already accounted for.

Top-down fundamental analysis

is the use of economy-wide or industry-wide information to obtain enhanced abilities to predict levels and changes of key economic characteristics. The goal of a top-down fundamental analyst is to forecast how market values will be driven by a few broad investment and macroeconomic themes.

An annex fund

is used to co-invest in one or more pre-existing investments.

Accelerated depreciation

is when accounting depreciation for tax purposes writes off the value of an asset more quickly than it is actually declining in market value.

Closed-end real estate funds

issue an initial number of shares to investors before any real estate investments are made and are unlisted, and have a specific investment period (e.g., 3 years) and fund-termination period (e.g., 4 to 6 years before the termination period concludes), at which time the fund must distribute all cash flows to investors. Investors cannot redeem their positions through the fund structure but instead must liquidate their shares or units by trading them in the secondary market, which tends to be quite illiquid. In the United States, shares or units are tradable only on a matched-bargain basis.

To create asset-backed securities (ABS), an entity creates a special purpose vehicle (SPV) to which it sells the respective assets. The SPV is funded by

issuing financial securities to investors. Most asset-backed securities are issued in three separate classes of tranches (classes A, B, and C). The highest tranche (class A, or senior tranche) is typically the largest tranche, has the highest credit rating, and is supported by the junior tranches. The B and C tranches have lower credit ratings (or no credit ratings) and thus offer higher prospective yields to compensate investors for added risk. The lower tranches suffer most or all of the initial losses when a credit event occurs. However, if the losses are large enough, the A tranche will also experience losses. From an investor's perspective, the shorter duration and amortizing plans of asset-backed securities facilitate a reduction in the portfolio's interest rate and possibly credit risk.

Loosely speaking, a process is said to be stationary if

its statistical properties do not change through time; for example, its means and standard deviations remain the same.

The LPA (limited partnership agreement) is a

key document with details regarding important issues in the GP-LP relationship.

The structural review is a

key part of the due diligence process and involves analysis of the organization of the fund, the organization of the fund manager, registrations, and outside service providers.

Ambiguity in the context of investment risk, like Knightian uncertainty, is

lack of knowledge with regard to the potential future returns of an asset and their associated probabilities. Aversion to ambiguity implies that assets with ambiguity should offer risk premiums relative to otherwise equivalent assets without ambiguity.

Volatility clustering occurs in a price series when

large changes are likely to be followed by more large changes and periods of small changes are likely to be followed by more small changes. Because volatility clusters, the probability of staying within a current regime (either high or low volatility) is higher than the probability of switching to a new regime in the next time period.

A feeder fund is a

legal structure through which investors have access to the investment performance of the master trust. Onshore and offshore investors use separate feeder funds to access the master trust. Investors in both of these feeder funds benefit from the separation of funds because tax consequences flow appropriately to each investor. Together, the master trust and feeder funds are referred to as a master-feeder structure.

The master trust is the

legal structure used to invest the assets of both onshore investors and offshore investors in a consistent if not identical manner, so that both funds share the benefit of the fund manager's insights and avoid tax inefficiency. Investors access the master trust through feeder funds.

Traditional overadvance is typically used for a corporate transaction, such as an acquisition or a leveraged buyout (LBO). In a traditional overadvance,

lenders allow for a greater advance rate, and the additional borrowing is then amortized over several years and can be added to an existing term loan or as a separate facility.

a dynamic strategy, or constant proportion portfolio insurance (CPPI)

less common structure for principal-guaranteed notes that varies the size of the commodity investment based on the cost of insuring the principal guarantee. The "floor value" (zero-coupon bond value) changes over time, as rising yields reduce the cost of the zero-coupon bond, while the passage of time increases the cost of the zero-coupon bond, as there is less time remaining to earn interest. In the dynamic strategy, commodity investments are held as long as their value exceeds the cost of purchasing the zero-coupon bond to insure the portfolio.

The exhaustion point is the

level of claims loss at which the principal is "exhausted" and investors are not legally responsible for any additional claims.

the three types of assets by liquidity and which liquidity demands each can be used for

liquid passive assets are sub-divided into two levels with 1A representing a liquidity reserve for GP capital callsand 1B representing the main liquidity source for all other liquidity demands. Since LPs strive to meet GP capital calls, even if it is costly to do so, we assume that calls may draw liquidity from all liquid assets following the waterfall: First, reserve for capital calls (1A), including both "committed, but uncalled" and uncommitted capital, followed by liquid passive assets (1B) and finally liquid active alpha assets (2). The other three types of liquidity demands can source liquidity only from liquid passive assets (1B).

In a side pocket arrangement, i

lliquid investments held by a fund (e.g., commonly a hedge fund) are segregated from the rest of the portfolio commonly because they are difficult to value, can interfere with equitable treatment of investors entering and leaving the fund, and prevent future investors from participating in the returns to assets in the side pocket. Valuation of side pocket investments is typically performed on a less frequent and less accurate basis than is computation of the net asset value (NAV) of the liquid portion of the hedge fund. Investors must inquire as to the existence and nature of the fund's side pockets, how and when they are used, and whether the performance of side pockets is included in the fund returns.

Traders often analyze the volatility spread between options on two different assets. An inter-asset option spread involves a

long option position in one asset and a short option position in another asset. For example, the spread can be between two equities in the same sector, two currency pairs, or two commodities. The spread can be entered due to a catalyst in one leg of the trade—an earnings announcement, a central bank meeting, or an important geopolitical event—or the spread may be entered on the basis of analyzing past return relations between the two. Traders will establish long option positions on the asset with implied volatility that the trader expects will rise (relative to the implied volatility of the other asset) and will establish short positions in options on the other asset.

The shape of payoff (or profit loss) diagrams such as those in the exhibit indicate whether the positions are long or short volatility. Specifically, a payoff that forms a convex function to the value of the underlying asset (i.e., curves upward) is

long volatility because it tends to generate larger profits or smaller losses when the underlying asset makes large directional moves. Convexity indicates a positive second derivative (positive gamma). A payoff that forms a concave function to the value of the underlying asset (i.e., curves downward) in the exhibit is short volatility because it generates larger losses or smaller gains when the underlying asset makes large directional moves. Both diagrams in the exhibit are concave near the middle of the horizontal axis (near an inner strike price).

A longevity swap contract takes place when a pension plan administrator agrees to

make fixed payments to a counterparty based on specified mortality assumptions, while the counterparty agrees to make floating payments based on either the pension plan's actual mortalities (indemnity-based contract) or an agreed-upon mortality index (index-based contract). Thus, these contracts allow the counterparty to assume the longevity risk for a price.

A nondiscretionary investment consultant

makes recommendations to the endowment on asset allocation, manager selection, and a wide variety of other issues, but leaves the ultimate decision to a vote of the investment committee.

Synchronization risk arises when

market participants are slow to react to increased divergence between two stocks, leading the portfolio manager to consider closing the positions because the convergence has not taken place during a specific period. For example, empirical evidence has shown that speed of convergence for related stocks changes through time. This indicates that this risk likely affects a large set of pairs of stocks and therefore may not be fully diversifiable. However, it is not clear if this represents a systematic source of risk in which the investor is compensated for bearing this risk.

Efficiently inefficient markets occur when

markets prices are, on average, just informationally inefficient enough to compensate managers and investors for the costs and risks of pursuing skill-based strategies, but not too inefficient to present a large number of money managers with easy-to-exploit arbitrage opportunities. Therefore, the flow of capital to actively managed strategies is limited in a world that is efficiently inefficient. In such a world, competition among active money managers will result in markets that are almost efficient; however, inefficiencies do exist that reward those who can identify and exploit them well.

The collateral amount is reduced in a process called margining to estimate a borrowing base. The borrowing base is therefore the

maximum potential quantity of credit the lender is willing to extend after reducing collateral values considering the level of outstanding debt that would be senior to the loan. Collateral amounts are reduced to a borrowing base either through reduction by a discount factor or by application of an advance rate.

Anchoring

may be viewed in this context as a tendency to rely too heavily on previous beliefs.

Government social security plans

may provide retirement income to all previously employed citizens of a given country, regardless of whether the worker was employed in the public sector or in the private sector. The main requirements for earning benefits from these systems are that retirees must have worked for a minimum amount of time, such as 10 years over the course of a career, and paid contributions into the system.

Theta is a

measure of time decay—the decline in the value of an option caused by the passage of time while other values such as the price of the underlying asset and its anticipated volatility are stable. Note that θr=0 is negative since N′(d), σ and T are all positive. Also, note that θr=0 is high when N′(d) is high—which tends to occur when the option is near-the-money. Finally, note that θr=0 increases as T approaches zero (i.e., as the option nears expiration).

The investment process includes the

methods a manager uses to formulate, execute, and monitor investment decisions, and spans the range of investment activities including: the design and revision of the investment strategy; sourcing of ideas; determination of transactions; setting of leverage; and the placing, execution, and allocation of trades.

Subordinated debt with step-up rates is a

mezzanine debt product that is used in cases in which a firm cannot take on more debt with a fixed-rate scheme, because the current levels of senior and subordinated debt are exhausting the current cash flows. Interest rates in subordinated debt with step-up rates increase as the debt ages. The step-up schedule can be adapted to the firm's projected cash flows following a time-based or a criteria-based schedule or a hybrid.

Some investors model stock market volatility as a mixture model or a regime switching model, which

models equity market volatility as some mixture of two return distributions. That is, the model has no jump component. However, the model has two different versions of Equation 2, with one having a much higher value δ for and one having a much lower value of δ. It is assumed that volatility switches between these two processes in a random fashion.

The capacity constraint hypothesis argues that

most alpha is a zero-sum game and that increased supply of managers pursuing alpha dilutes superior performance. In this hypothesis, only a few managers can offer alpha on a consistent basis. In short, the growth in assets under management sharply reduces the per capita amount of alpha available in the marketplace. In addition, unless new strategies or sources of alpha are discovered, further declines in alpha can be expected.

Greenwashing

occurs when investment promoters mislead prospective investors with overstated claims regarding the likely social impact of an investment opportunity.

the enterprise value

of a firm is defined as the market value of its operating assets. The market value of a firm's operating assets is calculated using the free cash flow generated by the firm.

The forgone loss carryforward

of a fund with incentive fees is an opportunity cost potentially borne by every investor in a fund with an asymmetric incentive fee structure that arises from the inability to recapture incentive fees.Forgone loss carryforward arises when an existing investor loses the fee benefits of owning a fund below its high-water mark. The cost to the investor results from a managerial decision to liquidate a fund with a net asset value (NAV) below its high-water mark.

the accumulation phase

of a life when individuals are working, where they are saving a portion of their income and growing their assets to provide for a comfortable retirement.

A nonlinear exposure

of a position to a market factor is when the sensitivity of the position's value varies based on the magnitude of the change in the market factor's value.

The factor loadings

of each principal component are a vector of values (scores) with one loading for each asset (e.g., stock or bond) that inform the researcher of the responsiveness of each asset to each principal component.

For liquid securities, most reconciliations are typically completed on what is known as a T+1 basis, which means that

one business day after the trade date—referred to as T—the trade would be reconciled. Other securities, such as bank debt, do not generally settle as quickly and may not be reconciled for several days.

The operational risk of a fund may be viewed as having three sources:

operational errors; agency conflicts; and operational fraud. The primary purpose of ODD is to detect unacceptable levels of potential operational risk before investing in a fund.

A volatility skew indicates that

options that differ by moneyness have different implied volatilities. Graph illustrates a popular implied volatility structure that focuses on the relationship between implied volatilities and moneyness.

The distribution to paid-in (DPI) ratio,

or realized return, is the ratio of the cumulative distribution to investors to the total capital drawn from investors.

The residual value to paid-in (RVPI) ratio,

or unrealized return, is the ratio of the total value of the unrealized investments (as measured by NAV) to the total capital drawn from investors during the previous time periods.

In addition, lenders need to perfect the security interest. Perfecting the security interest occurs when the

party seeking to establish ownership of an asset takes the necessary actions in order to assure that no other party, such as another creditor or a bankruptcy trustee, will be able to claim the same asset as collateral in the event that the debtor becomes insolvent. For example, legal documents can be prepared to perfect a security interest, or the party can take possession of the collateral.

Interest on PIK loans provides the lender with three sources of cash flow: (1) an arrangement and/or a commitment fee; (2) the (accrued or compounded) interest; and (3) sometimes, a ticking fee. A ticking fee is a

payment paid by the borrower to the lender to account for the time lag between the commitment on a loan and the actual disbursement.

A number of biases, including those just discussed, can distort the due diligence process by causing the performance review to disproportionately influence the entire due diligence process, or may cause the performance review itself to be flawed. Leading these biases is the bias blind spot, which is

people's tendency to underestimate the extent to which they possess biases.A number of biases, including those just discussed, can distort the due diligence process by causing the performance review to disproportionately influence the entire due diligence process, or may cause the performance review itself to be flawed. Leading these biases is the bias blind spot, which is people's tendency to underestimate the extent to which they possess biases.

Noise traders' risk is

performance dispersion caused by idiosyncratic trading. In the same way that noise traders could create a spread between two co-integrated prices, they could cause the spread to widen even further. This would lead to losses, possibly forcing the manager to close the positions before the two prices had even begun to converge. This risk is mostly idiosyncratic and thus could be diversified away.

A sample list of concierge services includes:

personal shopping; art curation and purchase; travel arrangements; entertainment and sporting events; purchase and maintenance of transportation assets; and arranging medical services. Another part of concierge services is directly related to wealth management. These include tax preparation, administration of the assets, custody, estate planning, education, and philanthropy.

the satellite portfolio

positions are added in the form of actively managed and higher-cost investments.

Investment process risk is the

potential loss from failure to properly execute the stated investment strategy. Although investment process risk cannot be quantified, it may be related to measurable events, such as the loss of key personnel in key functions or breakdowns in communication and trading systems when algorithmic strategies are followed. In many cases, this can be reduced through the use of a key personnel clause. A key personnel clause is a provision that allows investors to withdraw their assets from the fund, immediately and without penalty, when the identified key personnel are no longer making investment decisions for the fund. Other sources of investment process risk can be addressed by having robust communication and algorithmic systems that have been stress tested.

A reemerging management team is a

previously blue chip or established team that has been through a restructuring following recent poor performance or some significant operational issues and has regained the potential to reemerge as an established or a blue chip team.

Trade execution refers to the

process by which a fund completes a securities trade. In practice, after the decision has been made to trade, an execution process commonly begins. The trades are typically communicated by investment personnel to a centralized trading desk. Some smaller funds may not maintain dedicated trading desks; in these cases, trades are typically executed by investment personnel. In the context of an ODD review, the separation of investment and trading activities is considered best practice in order to lessen the potential for conflicts of interest.

Vega normalization across options is the

process of adjusting the vegas of each option to represent identical relative changes. For example, the effects of the change in the implied volatility of one option from 10% to 10.1% might be modeled based on proportions such that this 0.1% shift would be viewed as being comparable to the change in the implied volatility of another option from 20% to 20.2% (since the changes are equal on a relative basis).

Operational benchmarking is the

process of comparing operational best practices to the actual procedures in place at a fund. Operational best practices may vary by strategy, as hedge funds have different procedures and regulations than private equity or real estate funds.process of comparing operational best practices to the actual procedures in place at a fund. Operational best practices may vary by strategy, as hedge funds have different procedures and regulations than private equity or real estate funds.

Operational due diligence (ODD) refers to the

process of evaluating operational risk to ensure that investors will not be subject to the financial or reputational risks of investing in funds (or the applicable fund advisers) that may experience losses and/or suspend redemptions for noninvestment reasons. A broad interpretation of operational risk is that it is any economic dispersion caused by operations within the investment, operational, or business activities. This session uses a narrower definition of operational risk that focuses on the view of a fund's operations and excludes the investment process and business activities.

In the context of investing, fund due diligence is the

process of performing a review of an investment fund with an appropriate level of competence, care, and thoroughness. Top-level oversight of traditional public investments requires little or no knowledge of day-to-day issues involving investment processes and operations underlying the assets of a portfolio. Issues regarding investment processes and operations, however, are essential to institutional investors in private investments, especially those with sophisticated or rapid trading technologies.

The payoff-distribution approach to replication aims to

produce a return distribution that matches a desired distribution (e.g., that of the benchmark). While this approach was first developed to match the distribution of a hedge fund benchmark, later developments employed this technique to create return distributions that possessed some desirable properties rather than matching a particular hedge fund strategy.

Gatekeepers are

professional advisers operating in the PE market on behalf of their clients:2 in particular, consultants and account managers, funds of funds, and placement agents. Gatekeepers market their benchmarking services for checking and comparing GPs' performance as well as their ability to sell access to these "top team" fund managers.

Tail risk funds are designed specifically to provide their investors with

protection against large, broad market declines. Long volatility strategies are a less aggressive variant of the tail risk strategy. While, as the name suggests, they should profit from increases in volatility, they may at times hold small or neutral volatility positions. Short volatility strategies chiefly are designed to extract the volatility or correlation risk premium inherent in stock indices and other assets. Relative value volatility strategies are designed to capitalize on volatility mispricings, and will buy volatility deemed undervalued and sell volatility deemed overvalued. While relative value volatility funds will hold long and short volatility positions, their overall position is often neutral.

Open Protocol

provides a standard and consistent framework around: (1) data and inputs; (2) calculations and methods; (3) timely and regular reporting; and (4) protocols and standards, where appropriate.

A gate is a

provision describing the terms under which the fund may limit investor withdrawals even when the investor has satisfied the lockup period. Although investors may desire to exit the fund, the hedge fund manager may lock the gates, preventing investor capital from leaving. Gating typically occurs during times of market turbulence and constrained liquidity, as the hedge fund manager may perceive that liquidating enough assets to fund investor withdrawals will have a substantially negative impact on the value of the fund and the fund's other investors.

A lockup period is a

provision preventing, or providing financial disincentives for, redemption or withdrawal of an investor's funds for a designated period, typically 1 to 3 years for hedge funds, and up to 10 years or more for real estate and private equity funds. During this period, the investor cannot redeem the investment. Lockup periods can refer to the time period immediately following an investor's initial investment, which means that every investor in the fund may be operating under a different timeline or can be triggered subsequently by events.

Technical directional strategies

purposefully take on exposure to one or more risk factors based on analysis of past trading information including past prices and volumes. At the heart of most technical directional strategies is the attempt to predict whether a particular asset or index is more likely to trend (exhibit momentum or positive return autocorrelation) or to mean-revert (exhibit negative return autocorrelation).

A quanto derivative is generically viewed as a

quantity-adjusted financial derivative in which payoffs are found as a quantity-adjusted product (i.e., the product of the change in the underlying asset price and another value such as an exchanged rate). As an example, a quanto option (quantity-adjusting option) contract might adjust the payoff of the option into a different currency using a prespecified (fixed) exchange rate. Thus, while a regular option may terminate with a payoff of $4, an otherwise identical quanto option might convert the payoff to euros at a prespecified exchange rate of $1.25 per euro for a payout of $5.

An advance rate is the

ratio of credit extended for every dollar of collateral (i.e., the borrowing base). The two terms, discount factor and advance rate, describe the same concept. For example, for an asset with an advance rate of 80%, if the asset is valued at $100, $80 of credit (borrowing base) can be extended. Alternatively, the exercise could describe a discount factor of 20% as lowering the $100 collateral amount to the $80 borrowing base.

Internal constraints

refer to those constraints that are imposed by the asset owner as a result of its specific needs and circumstances and may be a function of the owner's time horizon, liquidity needs, and desire to avoid certain sectors.

Risk budgeting

refers to a broad spectrum of approaches to portfolio construction and maintenance that emphasize the selection of targeted amounts of risk and the allocation of the portfolio's aggregate risk to those various categories of risk.

arbitrage

refers to a situation in which an investor is able to earn virtually riskless positive profits while making little or no investment. The simplest example is when the same asset is trading at different prices in two separate markets, and the cost of trading in these markets is rather negligible. In this case, a trader would short the asset in the market where the price is relatively high and use the proceeds to buy the same asset in the market where the price is lower. Assuming that the prices would eventually converge, the trader is expected to earn a riskless positive profit with little or no investment.

A listed PE index

refers to an index (such as the LPX 50) whose components are share prices of publicly traded PE firms. The primary listed private equity index opportunities in the US are indices of major global private equity firms or BDCs (business development companies) that are publicly listed. These firms include major PE firms such as KKR & Co. and Blackstone Group LP.

An equally weighted 1/N, or naïve asset allocation strategy

refers to constructing a portfolio with an equally sized allocation assigned to each asset (or sector).

Limits to arbitrage

refers to the idea that investment strategies that seek to earn superior risk-adjusted returns are limited in size by a constraint on investors with regard to the degree of leverage that they can cost-effectively arrange and the level of risk that they can tolerate.

The roll procedure

refers to the method by which the timing of the closing of the old position and the opening of the new position is determined.The roll procedure refers to the method by which the timing of the closing of the old position and the opening of the new position is determined.

The repeat-sales method (RSM)

regresses the percentage price changes observed in properties on a sequence of time-dummy variables.A repeat sale occurs when a specific property is traded at least two times during the sample period used. Differences in properties through time (e.g., additions) are controlled for by using price-change information only from properties that have not changed substantially.

Position-level transparency in the context of funds refers to

regular, prompt, and detailed disclosure by the fund manager of the fund's securities holdings and the ability of the fund advisers or investors to see the exact positions underlying their funds and the values as reported by the custodian. Although some managers are reluctant to provide position-level transparency (which may reveal their proprietary trading strategies), investors can benefit from position-level transparency by being better able to understand and manage their aggregate risks.

Covered interest rate parity

relates the spot and forward exchange rates to differences in short-term interest rates in the two currencies. Covered interest rate parity explains the parity of carry trades in an informationally efficient market.

An implied volatility structure is a

representation of the various implied volatilities of a set of options relative to their tenor, moneyness, or type.

Disaster recovery (DR)

represents the specific plans and processes to re-establish critical business functions in a crisis. Disaster recovery is sometimes referred to as DRP, indicating a focus on the actual disaster recovery plans.

Minimum holding periods are

requirements that prohibit an employee from purchasing a security and then selling it within a predefined period of time and have the goal of preventing employees from actively trading in their personal accounts.

vega is the

response of the value of an asset (usually an option) to changes in volatility (in the underlying asset) holding all other variables constant (especially holding constant the value of the option's underlying asset). All long option positions have positive vegas (assuming the options are simple options) and all short option positions have negative vegas.

An LP advisory committee (LPAC) has

responsibilities that are defined in the LPA and normally relate to dealing with conflicts of interest, reviewing valuation methodologies, and any other consents predefined in the LPA.

For a cash flow-based loan, one of the key covenants is the net leverage covenant, which is a

restriction on maximum leverage calculated as the amount of senior or total debt, net of cash, as a multiple of EBITDA. However, for an asset-based loan, there is typically no leverage covenant. This means that the ABL borrower has more flexibility in the amount of borrowing that it can incur, especially if the business has a volatile earnings stream. ABL lenders are more focused on ensuring that the borrower has enough liquidity in order to meet its cash needs. Liquidity can be measured as either available cash or unused capacity under the existing facility given the borrowing base.

The key traditional currency risk assumption is that the

return of a foreign investment to an investor expressed in the investor's home currency is subject to currency risk based on the belief that the nominal price of the foreign asset is non-negatively correlated with changes in the value of its currency. In the context of the example in Application A, the asset was assumed to rise in value by 4% in terms of US dollars irrespective of the strength or weakness of the US dollar in currency markets. This implied covariance of zero is consistent with the traditional assumption that foreign asset ownership adds currency risk.

A subordinated debt with profit participation scheme provides a

risk balance between debt and equity to mezzanine lenders, offering a level of downside protection and also a way to participate in the upside potential. The following example illustrates a profit participation scheme. There are annual cap and floors on payments.

Volatility jump risk is the

risk of potentially large periodic and sudden upward changes in the level of volatility.

In the case of equally volatile assets with equal return correlations between each pair of assets, the following strategies generate the same allocations:

risk parity, equally weighted, inverse volatility-weighted, and minimum volatility.

The illiquidity of real estate is driven by uniqueness and transaction costs, among other factors. Real estate transaction costs are relatively high. The costs of acquiring and eventually liquidating properties can include

sales commissions (agent fees) and legal fees that range between 2% and 7%, depending on the country and the amount of the sale, and other costs, including transfer taxes, search costs, and financing costs, approaching a total of 10%. Property transfer taxes, which are rare in the United States, can be relatively high in some countries. They can range from 1% or 2% in Turkey, China, and Mexico to 5% or even 7% in Australia, France, the Netherlands, and Spain.

An asset-based loan (ABL) is a

secured loan backed by various types of collateral pledged by the borrower. The value, type, and quality of the collateral determine the amount of the loan that can be extended, the advance rate, and the interest rate of the loan. Hedge funds and private equity funds making these loans are said to be part of the shadow banking system.A typical ABL candidate is a small to mid-size company and has an asset-rich balance sheet, with a significant amount (half or more) of its total assets in working capital, often in the form of inventory or accounts receivable.

genetic algorithms

seek to identify patterns in data using an approach modeled after the natural selection process found in biological evolution with various "genes" representing trading rules that survive within the model or perish based on the their estimated value in generating trading profits.

Artificial neural network software

seeks to identify patterns in data using an approach modeled after the learning process of the human brain with various "nodes" and "layers" forming connections and associations that are modified within the model (are "learned") to form trading rules that are included or omitted based on the their estimated value in generating trading profits.seeks to identify patterns in data using an approach modeled after the learning process of the human brain with various "nodes" and "layers" forming connections and associations that are modified within the model (are "learned") to form trading rules that are included or omitted based on the their estimated value in generating trading profits.

the Core-Satellite approach

seeks to merge passive investing with active management in an attempt to outperform a benchmark.

Liability-driven investing (LDI)

seeks to reduce surplus volatility by building a portfolio of assets that produces returns that are highly correlated with the change in the plan's liabilities.

A sovereign wealth stabilization fund

serves a countercyclical purpose through collecting excess commodity revenues during times of high commodity prices, and distributing saved wealth during times of low commodity prices.

Institutional real estate ownership typically involves agency relationships, which are important drivers of performance. Agents can fulfill two important functions:

serving as managers of the operations of each property; and serving as decision-makers in purchasing and selling properties.

A short straddle position contains a

short call option and short put option on the same asset and with the same strike price. A long option straddle contains a long position in a call option and a long position in a put option on the same asset with the same expiration date and strike price.

A short strangle position contains a

short call option and short put option on the same asset but with different strike prices. A strangle is analogous to a straddle except that the strike prices of the call and the put differ.

Actuaries calculate mortality tables, which

show the distribution of the expected age of death or probability of death for various current ages across a specified population.

The perfect market and law of one price discussions in the previous sections do not reflect price stickiness. Price stickiness is the extent to which some prices are

slow to respond to changes in economic circumstances. For example, the price changes of gasoline at local gas stations, gold jewelry at department stores, and beef at the local butcher shop may lag the price changes in global commodity market prices by several days or much longer. The prices and expected cash flows of corporate assets (and many other domestic assets) may also respond to changes in the value of its home currency on a delayed basis.

Project finance is capital intended to support a

specific purpose, such as real estate projects and infrastructure projects, either on a private basis or in a public-private partnership. The majority of the funding in project finance (around 75%) comes from debt products. The high long-term cost of using standard fixed-coupon, long-term bonds (10 to 15 years) would render many of these projects financially unfeasible. In these cases, lenders will be willing to fund projects only if they can provide senior, nonrecourse loans that are secured by all the assets of the project. PPP project financing is usually arranged by creating a special purpose vehicle and designing a risk-sharing, cash flow-based lending structure in which limits are set to liabilities and off-balance-sheet financing. The project company (private party) receives payments (from the public-sector party or from the general public as users of the facility) over the life of the PPP contract on a pre-agreed-upon basis, which are intended to repay the financing costs and give a return to investors. The facility remains in public-sector ownership, or it is reverted to public-sector ownership at the end of the PPP contract.

ESG

stands for environmental, social, and governance, and refers to the use of these three issues as key factors when making decisions including investment and business decisions.

resampling returns

strives to reduce estimation error and typically is executed by: (1) repeated analysis of hypothetical returns simulated from the statistical parameters estimated from the original sample of returns; or (2) repeated analysis of new samples of returns generated from the original sample using draws with replacement.

Principal-guaranteed commodity notes are

structured products that offer investors the upside opportunity to profit if commodity prices rise, combined with a downside guarantee that some, potentially all (depending on terms), of the principal amount will be returned at the maturity of the structure. Notes containing "contingent protection" clauses will not return the investor's principal unless the stated contingencies are met. In the event the issuer, or counterparty, of a note files for bankruptcy, the note's purchasers essentially become unsecured creditors and risk losing up to all of their investment. Two common structures: most common is the cash-and-call strategy or participation note and less common is dynamic strategy, or constant proportion portfolio insurance (CPPI)

Behavioral finance

studies the potential impacts of cognitive, emotional, and social factors on financing decision-making. For example, confirmation bias is the tendency to disproportionately interpret results that confirm a previously held opinion as being true.

During the entry and establish phase,

substantial entry barriers into the PE market exist for both GPs and LPs and, lacking a verifiable track record, new teams find it difficult to raise their first fund. Furthermore, analysis of historical benchmark data supports the hypothesis that new teams suffer from higher mortality than do established or institutional-quality fund managers. First-time funds note the importance of differentiation or innovation as applied to fundraising and thus often pursue specialized investment strategies.

The fund bubble hypothesis assumes that

successful hedge fund managers can earn substantially greater returns than successful fund managers in the traditional space, but that bubbles cause inferior managers to dilute overall industry performance. The fund bubble hypothesis simply states that as the supply of investment capital to the hedge fund space increases, so does the number of less qualified managers who enter the industry and provide inferior returns that dilute the overall performance of the hedge fund industry.

The unwind hypothesis

suggests that hedge fund losses began with the forced liquidation of one or more large equity market-neutral portfolios, primarily to raise cash or reduce leverage. The subsequent price impact of this massive and sudden unwinding caused other similarly constructed portfolios to experience losses. These losses caused other funds to deleverage their portfolios, leading to a vicious spiral reminiscent of Long-Term Capital Management in 1998.

The collateral amount is the

sum of available assets to support debt. However, lenders do not typically extend credit equal to the collateral amount considering the likely reductions that would occur in the event of a forced liquidation. The collateral amount is reduced in a process called margining to estimate a borrowing base.

First-generation commodity indices

tend to be heavily weighted in energy and hold long-only positions in front month contracts, rolling to the second month contracts at prespecified times regardless of the shape of the current term structure.

three dynamic risk exposure models

that can be used to estimate the effectiveness of market-timing strategies and other nonlinear exposures: a dummy variable approach, a separate regression approach, and a quadratic approach.

In the context of private equity financing, bridging is when

the GP makes an investment in the main fund while agreeing to sell that investment at a subsequent time to co-investors such that co-investors receive bridge-financing from the main fund between the time the investment is made and the time that the co-investor(s) takes ownership.

Portable alpha is

the ability to exploit alpha by investing in an alpha-producing strategy while simultaneously managing a target beta exposure. The manager can add the alpha of the strategy to the existing portfolio without substantially altering the final beta of the portfolio. Derivatives are the primary tool for controlling beta while porting alpha.

Time-series momentum is defined and measured by

the absolute performance of a security based on its own performance, such as classifying a stock as having positive momentum if its recent performance was positive. The time-series momentum approach is a form of trend following introduced by Moskowitz, Ooi and Pedersen 2012 in which momentum for a particular asset is measured based only on that asset's performance. For example, a simple time series momentum approach would be to go long each security that has risen in price over a given time period and to short each security that has declined over the same time period.

Rebalancing yield is

the additional observed or expected return produced by the periodic rebalancing of a portfolio to an initial set of weights. Returns can be enhanced by the tendency of commodity prices to be mean-reverting. The rebalancing yield of a fixed-weight portfolio is expected to provide a greater contribution to the returns of the portfolio when the portfolio constituents are volatile and have low correlations with each other.

The illiquidity of assets can be viewed in two primary ways:

the amount of time required to close a position at a price that is not affected by matters of urgency; or the amount of lost value from closing a position with urgency rather than with patience.

Permissionless network

the bitcoin blockchain public netowork is permissionless: New transactions are added to the blockchain through a cryptographic consensus mechanism requiring vast amounts of computing power to confirm transactions. The chief advantage of a permissionless network is that it does not require a central authority to confirm or deny specific transactions; individuals who do not trust one another or any single central authority can transact on the permissionless network, relying on a consensus mechanism to ensure the ledger's accuracy. This avoids the need for users to have their own database that they periodically reconcile against those of their counterparties. Each user stores a copy of the single database, so there is no single point of failure as exists with traditional relational databases. Once they are added to the blockchain transactions cannot be undone, making the ledger an immutable record of all previous transactions.

Secondary private equity market transactions refer to

the buying and selling of pre-existing limited partnership interests in private equity and other alternative investment funds. Kießlich (2004) suggests that the first secondary PE transaction took place in 1979, with David Carr buying Thomas J. Watson's stake in a venture capital fund when Watson had to exit after being appointed the new ambassador to the Soviet Union.

Moral hazard takes place after a transaction is completed and can be defined as

the changes in behavior of one or more parties as a result of incentives that come into play once a contract is in effect. For example, with asymmetric fee structures and without proper monitoring, a GP may take excessive risk in order to increase the potential performance fee. If management fees dominate the compensation, an unskilled manager may decide to take minimal levels of risk and just collect the management fee.

Post-clearance refers to the process by which

the compliance department collects employee brokerage statements and then attempts to reconcile them to pre-clearance requests. It is considered best practice for the compliance department of a fund to collect employee brokerage statements directly from brokers and independent of the employee. It is becoming more common for firms to engage a third-party software solution to automate the pre-clearance and post-clearance/reconciliation process.

In the context of a position in an asset or a portfolio of assets, asset illiquidity refers to

the difficulty of closing a position on a timely basis at a price that is minimally affected by the urgency with which the position is closed. A highly illiquid position can usually be closed quickly, but typically at an unfavorable price from the perspective of an urgent trader.

Insourcing

the direct production of risk-adjusted rates of return through internal skills and expertise, the orchestration of the production process by management, and the integration of information with each stage of the production process. Insourcing has been one response by asset owners to mediate the costs and consequences of being unable to observe commitment. It involves replacing supply contracts that link asset owners to external asset managers with employment contracts binding the institution's employees to the mission of the organization. Challenges include the effective management of the production process and the capacity of senior managers to observe and motivate employees.

In a defined benefit plan,

the employer takes all of the investment risk while offering a guaranteed, formulaic benefit to retirees.

The cap rate spread

the excess of the cap rate over the yield of a default-free 10-year bond (such as the 10-year Treasury rate in the United States)

In the cash flow matching approach,

the hedging portfolio is constructed such that its estimated future cash inflows match the expected outflows associated with liabilities at each prospective point in time.

Custody refers to

the holding of assets by a financial institution for the benefit of a customer. The investor in a fund has a direct ownership interest in a fund. The fund, in turn, places the fund's assets with a custodian. Thus, the fund is the direct owner of the assets being held by the custodian. When position-level data are provided, it should be reported directly from the fund's custodian or administrator, as this third-party verification makes it difficult for the manager to understate the risk of the fund.

Factor weighting in the context of ODD refers to

the importance (i.e., weight) that individual investors give to different operational risk considerations when coming to an overall operational decision. For example, some investors may choose to equally weight the various operational risk factors analyzed. Other investors may view certain items, such as fund accounting and valuations, as holding more operational risk, and therefore give those areas more weight when making operational decisions. Note that factor weights vary across strategy, where trading systems may be more important in managed futures and liquidity risk and leverage structure more important in fixed income arbitrage. factor weighting process is not necessarily quantitative in nature; qualitative weights, such as designating a particular operational risk area as "very important," may also take place.

E&O insurance (i.e., errors and omissions or professional liability insurance) covers

the insured against financial damages from mistakes, negligence, inaccuracies, and other professional failures (subject to exclusions and limits). E&O insurance, unlike the other insurances listed in the previous paragraph, is important to the prospective LP because E&O insurance often covers the risk that investment process and operational errors by the fund managers will directly imperil the value of the LP's investment. Note that most types of professional liability insurance specifically exclude the very coverage and risks most related to investment process and operational risks (e.g., negligence, errors, and omissions).

In a put spread,

the investor purchases one put option at perhaps 10% out-of-the-money, while selling a second put option at perhaps 25% out-of-the-money. This strategy can insure losses on the equity portfolio of up to 15%, but after the market has fallen 25%, the investor participates fully in market declines. The cost of a put spread may be 30% to 70% less than the cost of a long put option, depending on the implied volatility, strike price, and maturity of each option.

Managers are placed on a watch list when

the investor wishes to monitor the manager more closely with a concern that investment performance or organizational changes may soon warrant redemption.

The optimal overcommitment ratio is

the level of the overcommitment ratio that minimizes the sum of two discounted expected costs: (1) the opportunity cost of idle capital from excess liquidity; and (2) the costs of adverse events from inadequate liquidity including lost investment opportunities and forced liquidations. The opportunity costs of idle capital reflect the lower risk-adjusted return available to excess liquidity relative to the risk-adjusted returns expected from long-term private investments. The potential direct costs of adverse events include both the potential inability to take on attractive projects due to lack of liquidity and the potential losses from being forced to liquidate an existing investment at unattractive prices (due to an inability to fund capital calls or to generate cash for other purposes such as a spending rate).

An on-the-run issue is

the most recently issued Treasury security or other asset that is regularly issued with a given maturity. For example, the US Treasury offers bills, notes, and bonds on a weekly or quarterly or other basis, such as a 13-week bill or a 10-year note. Starting with the time that a security (e.g., a 10-year Treasury note) is issued, that security is "on-the-run" until another security with the same original maturity is issued (e.g., a new 10-year Treasury note). In other words, each on-the-run issue becomes off-the-run when a newer security is issued, with the newer security becoming the new on-the-run issue.

the corpus

the nominal value of the initial gift

Exposure inertia asserts that

the overall weights of an index consisting of actively managed portfolios can be empirically estimated because the overall exposures change relatively slowly through time. The idea here is that a large number of hedge fund managers underlying a hedge fund index can reduce the speed at which the common views or exposures change over time.

In the overlay approach,

the plan sponsor employs finance derivatives to create a hedging bucket. It is important to note that this could lead to leveraged positions which will increase the overall risk of the portfolio.

Exit value refers to

the price that the fund can receive when portfolio companies are sold through initial public offerings (IPOs) or strategic sales. Exit timing refers to the period during which portfolio companies are expected to be sold and exit values are realized. This analysis is generally based on a combination of GP guidance, investor insight, and market analysis.

unsmoothing:

the process of estimating a true but unobservable price or return series from an observable but smoothed price or return series.

A shared operational due diligence approach is a framework in which

the responsibility for ODD is shared by multiple individuals who have responsibility for investment due diligence but in which no full-time, dedicated ODD staff are employed.

The return to commodity beta may be defined as

the return from direct exposure to changes in commodity prices, which result from holding a passive long position in a commodity

Volatility diffusion risk is

the risk of volatility changes that represent the continuous accrual of small changes in the volatility of an asset through time.According to Nossman and Wilhelmsson (2009), there is a positive expected return to short positions in products that are tied to the implied volatility of options to compensate sellers for two volatility risk premiums: one for volatility diffusion and a second for volatility jump.

The build and harvest phase of PE funds is when

the size of the investments tends to grow, the profitability of the investments is strong, and both the GPs and LPs receive the greatest rewards. Since investors are mainly interested in the cash returned, the fund manager-investor relationship tends to be relatively stable throughout the build and harvest phase.

The funding level is

the total amount of cash or collateral that the investor posts or invests to support the trading level. The rock-bottom minimum funding level for any futures position or portfolio is the total value of margin collateral required by the various futures exchanges.

A country is said to have a current account deficit when

the value of its imports of goods and services exceeds the value of its exports, meaning that more currency is flowing out of the country to purchase these goods and services than is flowing in from selling goods and services.

gamma, γ, and vega, υ, are linked (γ = υ/σS2 T) such that

they always share the same sign.Thus, a portfolio that is long vega will be long gamma. The goal of being long vega in a portfolio using a delta-neutral hedging strategy is to benefit from the long gamma through realized volatility in the underlying asset that exceeds market expectations.

Portfolio information aggregators (risk aggregators) are

third-party service providers who collect and process information from various private investments to report and assess the combined risks to investment advisers.The Risk Alert discusses the trend among investment advisers to use third parties as sources of additional information, such as portfolio information aggregators (risk aggregators).

Level 1 assets are

those assets that can be valued based on an unadjusted market price quote from an actively traded market of identical assets. For example, a traditional equity traded in a large public market would generally be considered a Level 1 asset.

Similarly, high variability in income tax and capital gains tax rates applicable to foreign investors can be observed across major emerging markets. Roundtrip costs, which are the

total costs of buying and selling a residential property, including legal fees, sales and transfer taxes, registration fees, and real estate agents' costs and fees, also show a very high dispersion across countries. Overall, the exhibits make it clear that it is of the utmost importance for investors to understand the specific characteristics of each real estate market in which they might consider allocating funds.

Catastrophe bonds are a type of insurance-linked security. Insurance-linked securities (ILS) are

tradable financial instruments with payoffs and values affected by an insured loss event, such as a natural disaster, longevity risk, or life insurance mortality. ILS represent a convergence between capital and insurance markets. Institutional investors have increasingly regarded reinsurance as a new asset class, having invested around $50 billion in an array of insurance-linked securities over the past decade. ILS offer exposure to nonfinancial risks and thus are generally regarded as being uncorrelated with the general financial markets.

The CBOE Volatility Index (VIX) (less formally, the VIX Index or simply the VIX) is a

trademarked market-based approximation of the 30-day implied volatility of the S&P 500 that is calculated and disseminated in real time by the CBOE. The VIX Index serves as a direct underlier to futures contracts and to options.While much attention has been focused on the VIX for the S&P 500 equity index, VIX indices are now available on a host of popular indices throughout the world. The VIX computations discussed in this section are based on implied volatilities from the formula for variance swaps rather than from option pricing models.

Trade allocation refers to the process by which

trades are divided among the firm's various funds and/or accounts with best practice for a fund to maintain a predetermined trade allocation policy that does not favor one of the firm's funds or accounts at the expense of another.

A correlation swap is a derivative that

transfers the risk from the swap's seller to its buyer such that the actual average correlation among a specified set of individual stocks is higher than the swap's strike correlation. The net payment between the seller and the buyer is based on the difference between the average correlation rate and the strike correlation rate multiplied by the notional value of the swap. A correlation swap has a realized correlation received by the swap buyer (from the seller) and a fixed strike correlation received by the swap seller (from the buyer). Thus, a correlation swap buyer is "long" realized volatility.

A conditional empirical analysis approach to asset allocation

uses the current condition of the economy and markets (along with empirical measures such as means, volatilities, and correlations) within a TAA approach to form asset weights (tactical weights) that change with current conditions.

an unconditional empirical analysis approach to asset allocation

uses the historic means and volatilities (and correlations) within an SAA approach to form asset weights without regard to the current condition of the economy and markets. Note that the results of long-term historical analyses change slowly, so SAA weights also tend to change very slowly through time.

This so-called denominator effect

usually arises in periods of financial stress, when prices of marketable instruments decline much faster than valuations of illiquid investments, resulting in a higher-than-targeted share of the latter. Another strategic reason LPs may sell lies in an unintended overexposure to private equity.

Level 3 assets are

valued based on the estimated fair values for assets that are subject to the greatest uncertainty and may be valued based on models with ambiguous inputs such as volatility. Finally, an untraded structured product tailored to the tax rates and tax needs of a specific investor would generally be a Level 3 asset.

The shadow banking system consists of

various nontraditional lenders who fill a void in lending created when traditional lenders reduce credit availability due to increased capital requirements or other governmental policies.

In a secured transaction, attachment of security interest is vital. Attachment of security interest under US law consists of the

very important steps needed to make sure that the lender has the necessary legal rights to take possession of collateral in the event of default.

Implied return volatility is the

volatility over the remaining life of an option that is inferred from an option price under assumptions including risk-neutrality, the validity of the specified option pricing model, and the accuracy of the model's inputs other than volatility. Although the implied volatility is usually estimated using market prices, it is estimated with a specific option pricing model that contains assumptions about the underlying asset's return process. For example, in the derivation of the Black-Scholes option pricing model, the option's underlying asset is assumed to follow a Geometric Brownian Motion (GBM) in which the instantaneous returns of the asset: (1) have a constant variance through time; (2) are normally distributed; and (3) are uncorrelated through time.

The Hong Kong Strategic Framework for Green Finance

was announced by the Securities and Futures Commission in September 2018 to promote Hong Kong as an international green finance center.

Contrast IRR and PME as appropriate measures of private equity performance

we show internal-rate-of-return (IRR)-based returns for PE because they are commonly used, but caveat that IRRs for individual managers are notorious for their gameability. A better metric of relative performance is the public market equivalent (PME) that is strongly preferred by academics. The PME approach involves comparing the amount of capital generated by a PE strategy to that generated by a public market index (the benchmark) over the lifespan of the fund, assuming similar amounts were invested with the same timing. For example, Harris et al. (2014) found a long-run average PME of roughly 1.2 versus the S&P 500, which is in line with Kaplan and Sensoy (2015). A PME of 1.2 against the S&P 500 implies 20% outperformance by PE over the period capital is deployed. Assuming a typical investment period of six years, that implies PE has outperformed the S&P 500 by 3.1% annually, net-of-fees.

Nontraded REITs

were created in the United States in 1990, and even though they are registered with the Securities and Exchange Commission as public companies, their shares are not available on an exchange and are thus essentially illiquid (and therefore difficult to value). Investors can usually sell their shares after a year under a limited repurchase program. In the United States, they are registered and available to retail investors. The estimated life span of a nontraded REIT is usually 7 to 10 years, at which time it ends in a liquidity event. Nontraded REITs must pay out at least 90% of their taxable income to shareholders in order to preserve their status as being exempt from federal corporate income taxes. Nontraded REITs are available only to investors who meet suitability standards, and they represent about 20% of the total market capitalization for all publicly-registered REITs (in the United States).

The cost approach,

which assumes that a buyer will not pay more for a property than it would cost to build an equivalent one. A property's value can be estimated by adding the depreciated value of any improvements to the land value of the property. This approach is often suggested when valuing newer structures.

"betting against beta" anomaly

which has been documented with the observation that portfolios consisting of low-beta stocks have outperformed the market in the past on a risk-adjusted basis.

a cost of living adjustment (COLA)

which increases the benefits paid to employees along with the rate of inflation.

In the case of illiquid private partnerships such as private equity funds, LPAs may foresee a for-cause removal of the GP and include a bad-leaver clause,

which, if exercised (normally following a simple majority vote of the LPs), causes investments to be suspended until a new fund manager is elected or, in the extreme, the fund is liquidated.

A total return investor

who considers both income and capital appreciation as components of return may realize that a 5% current yield is not needed in order for the endowment to have a spending rate of 5%.

Finance first investors

would like to earn an investment return competitive with market returns and commensurate with the risk of the investment and place relatively less priority on social impact.

European Banking Authority (EBA).

The EBA has as its main objective to safeguard the integrity, efficiency, and orderly functioning of the banking sector.

Professional Code D: Risk Management, Compliance, and Support - Managers must:

-Develop and maintain policies and procedures to ensure that their activities comply with the provisions of this Code and all applicable legal and regulatory requirements -Appoint a compliance officer responsible for administering the policies and procedures and for investigating complaints regarding the conduct of the Manager or its personnel -Ensure that portfolio information provided to clients by the Manager is accurate and complete and arrange for independent third-party confirmation or review of such information -Maintain records for an appropriate period of time in an easily accessible format -Employ qualified staff and sufficient human and technological resources to thoroughly investigate, analyze, implement, and monitor investment decisions and actions -Establish a business-continuity plan to address disaster recovery or periodic disruptions of the financial markets -Establish a firmwide risk management process that identifies, measures, and manages the risk position of the Manager and its investments, including the sources, nature, and degree of risk exposure.

Professional Code C: Trading - Managers must:

-Not act or cause others to act on material nonpublic information that could affect the value of a publicly traded investment. -Give priority to investments made on behalf of the client over those that benefit the Managers' own interests. -Use commissions generated from client trades to pay for only investment related products or services that directly assist the Manager in its investment decision-making process, and not in the management of the firm. -Maximize client portfolio value by seeking best execution for all client transactions. -Establish policies to ensure fair and equitable trade allocation among client accounts.

Loyalty to Clients - Managers must

-Place client interests before their own. -Preserve the confidentiality of information communicated by clients within the scope of the Manager-client relationship. -Refuse to participate in any business relationship or accept any gift that could reasonably be expected to affect their independence, objectivity, or loyalty to clients.

Professional Code E: Performance and Valuation - Managers must:

-Present performance information that is fair, accurate, relevant, timely, and complete. Managers must not misrepresent the performance of individual portfolios or of their firm. -Use fair-market prices to value client holdings and apply, in good faith, methods to determine the fair value of any securities for which no independent, third-party market quotation is readily available.

Professional Code B: Investment Process and Actions - managers must

-Use reasonable care and prudent judgment when managing client assets. -Not engage in practices designed to distort prices or artificially inflate trading volume with the intent to mislead market participants. -Deal fairly and objectively with all clients when providing investment information, making investment recommendations, or taking investment action. -Have a reasonable and adequate basis for investment decisions. -Take only investment actions that are consistent with the stated objectives and constraints of that portfolio or fund. -for pooled funds, Provide adequate disclosures and information so investors can consider whether any proposed changes in the investment style or strategy meet their investment needs. -before managing separate accounts, evaluate and understand the client's investment objectives, tolerance for risk, time horizon, liquidity needs, financial constraints, ect, that would affect investment policy. and Determine that an investment is suitable to a client's financial situation.

Between a P-Measure and a Q-measure, which is typically based on an assumption of risk neutrality?

A Q-Measure in finance is typically based on an assumption of risk neutrality

European Insurance and Occupational Pensions Authority (EIOPA):

EIOPA is responsible for occupational pensions and insurance.

European Securities and Markets Authority (ESMA).

ESMA is responsible for safeguarding the stability of the EU's financial system by enhancing investor protection and promoting orderly markets and financial stability, and has the power to write technical standards and bring about systems of mutual recognition. ESMA's role in the AIFMD is one of legislation.

For what purpose was the Dodd-Frank Act enacted?

The Dodd-Frank Act was enacted to promote the financial stability of the U.S. by improving accountability and transparency in the financial system, to end "too big to fail", to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.

Describe a theoretical, normative, time-series model of equity returns that might be used by a hedge fund to guide a high frequency trading strategy.

Theoretical models tend to explain behavior accurately in more simplified situations where the relationships among variables can be somewhat clearly understood through logic. Normative economic models tend to be most useful in helping explain underlying forces that might drive rational financial decisions under idealized circumstances and, to a lesser extent, under more realistic conditions. Time-series models analyze behavior of a single subject or a set of subjects through time. For example, a model that hypothesized the impact of large orders in an equity market with risk-averse traders of limited capital in a world of informational asymmetries in which the large orders were driven by exogenous shocks to the institutions placing the orders would qualify.

Time-series models

Time-series models analyze behavior of a single subject or a set of subjects through time.