Alternative Investments Overview
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Questions and Answers

Which of the following is a characteristic of alternative investments?

  • High liquidity
  • Consistent regulatory oversight
  • Market risk dependency
  • Illiquidity (correct)

What type of return do traditional investments typically provide?

  • Delta return
  • Gamma return
  • Alpha return
  • Beta return (correct)

Which of the following groups is considered an alternative investor?

  • High Net Worth Individuals (correct)
  • Small businesses
  • Mutual fund managers
  • Retail investors

What does market segmentation refer to in alternative investments?

<p>Concentrating on specific submarkets (A)</p> Signup and view all the answers

What is a common feature of alternative investments concerning returns?

<p>They can provide absolute returns regardless of market conditions. (B)</p> Signup and view all the answers

Which of the following best describes hedge funds?

<p>They involve various specific strategies of investment. (A)</p> Signup and view all the answers

Which return factor is not generally associated with alternative investments?

<p>Beta return (C)</p> Signup and view all the answers

What is a key distinguishing feature of modern alternative investments compared to traditional investments?

<p>Lower liquidity (B)</p> Signup and view all the answers

What is one characteristic of investment managers in relation to their funds?

<p>They have a dual investment in the fund. (A)</p> Signup and view all the answers

Who are considered as target investors for hedge funds?

<p>High Net Worth Individuals (HNWI) and institutions. (D)</p> Signup and view all the answers

What change occurred in the interest of institutions investing in hedge funds?

<p>They started investing after observing the returns and regulatory implementations. (D)</p> Signup and view all the answers

What is a key trait of High Net Worth Individuals (HNWI) as investors?

<p>They can afford to lose money and recover from it. (B)</p> Signup and view all the answers

Why is it challenging to find information about hedge funds?

<p>They usually forbid marketing to individual investors. (D)</p> Signup and view all the answers

What motivates institutions to invest in hedge funds?

<p>High money inflow from larger institutions. (B)</p> Signup and view all the answers

What type of investments do HNWIs typically pursue?

<p>The most-risky investments available. (C)</p> Signup and view all the answers

What is one consequence of institutions investing in hedge funds?

<p>It encourages more institutions to participate. (B)</p> Signup and view all the answers

What does maximum drawdown measure in investments?

<p>The difference between the highest and lowest values (C)</p> Signup and view all the answers

Which of the following is NOT a source of return in long/short equity strategies?

<p>Interest on long positions (B)</p> Signup and view all the answers

What is a disadvantage of long/short equity strategies?

<p>Consistent net long bias (A), Lag in bull markets (B)</p> Signup and view all the answers

What is meant by 'beta neutral' in equity market neutral strategies?

<p>The average beta of the portfolio is zero (B)</p> Signup and view all the answers

Which approach focuses on sectors that are undervalued or overvalued?

<p>Sector based strategy (D)</p> Signup and view all the answers

What does 'dollar neutral' refer to in market-neutral equity strategies?

<p>Nominal value of long and short positions is equal (C)</p> Signup and view all the answers

Which characteristic is typical for long/short equity strategies in a bull market?

<p>They usually incur losses (A), They maximize long positions over short positions (B)</p> Signup and view all the answers

What type of approach ranks positions based solely on numerical data?

<p>Quantitative based approach (C)</p> Signup and view all the answers

What is a characteristic of hedge funds that differentiates them from traditional funds?

<p>Illiquid investments (B)</p> Signup and view all the answers

What type of fee is unique to hedge funds that is contingent upon the fund's performance?

<p>Performance fee (C)</p> Signup and view all the answers

What does the 'high water mark' in hedge funds imply?

<p>The fund must recover previous losses before performance fees are applied (B)</p> Signup and view all the answers

How do hedge funds generally differ from traditional funds in terms of legal structure?

<p>They involve a variety of complex legal structures (B)</p> Signup and view all the answers

Why might investors face limitations when withdrawing funds from a hedge fund?

<p>They have a high water mark system in place (B)</p> Signup and view all the answers

What is often the reason hedge funds have higher fees compared to traditional funds?

<p>Exclusive investment strategies (C)</p> Signup and view all the answers

What feature of hedge funds contributes to their limited transparency?

<p>Their operational details are less accessible to investors (A)</p> Signup and view all the answers

Which statement reflects the nature of liquidity in traditional funds?

<p>They provide daily subscriptions and redemptions (D)</p> Signup and view all the answers

What does the term 'gate for redemption' refer to in hedge funds?

<p>A restriction on daily redemption opportunities (C)</p> Signup and view all the answers

Which of the following fees is typically not associated with traditional funds?

<p>Performance fee (D)</p> Signup and view all the answers

What strategy involves buying one share while selling short another within the same or different sectors?

<p>Pairs trading (A)</p> Signup and view all the answers

Which trading strategy focuses primarily on numerical analysis and market data rather than on the fundamental approach?

<p>Statistical arbitrage (C)</p> Signup and view all the answers

Which trading strategy is known for having a high frequency of transactions and aims for short-term gains?

<p>High-frequency trading (A)</p> Signup and view all the answers

What is the potential maximum drawdown percentage for high-frequency trading strategies?

<p>5.5% (B)</p> Signup and view all the answers

What is the rate of positive months typically associated with high-frequency trading strategies?

<p>76% (A)</p> Signup and view all the answers

Distressed securities are primarily characterized by their:

<p>High probability of default and low price (A)</p> Signup and view all the answers

What can cause a significant drop in stock prices due to excess selling pressure?

<p>Downgrading of credit ratings (D)</p> Signup and view all the answers

Which of the following is true regarding distressed equities?

<p>They are often linked with poor repayment ratings. (C)</p> Signup and view all the answers

What is the primary advantage of engaging in a restructuring process for investors?

<p>Possible acquisition of valuable assets (A)</p> Signup and view all the answers

Which of the following best describes a passive investment strategy?

<p>Holding shares for a long time without actively participating in management (B)</p> Signup and view all the answers

What is a significant risk associated with the restructuring process?

<p>Possibility of corporate liquidation (D)</p> Signup and view all the answers

How can the insider trading law impact an active investment strategy?

<p>It prohibits the use of confidential information (B)</p> Signup and view all the answers

What defines the global macro strategies in hedge fund investments?

<p>Emphasis on structural macroeconomic trends (A)</p> Signup and view all the answers

What characteristic of ETFs makes them less risky compared to derivatives?

<p>They usually do not involve leverage. (B)</p> Signup and view all the answers

What is a common outcome of utilizing restructuring strategies in investments?

<p>Experiencing drawdowns and flat return periods (D)</p> Signup and view all the answers

What role does the judge play in the context of investments in the US, UK, and Australia?

<p>They are typically the most important figure in legal cases. (C)</p> Signup and view all the answers

Flashcards

Alternative Investments

Investments beyond traditional assets like stocks and bonds, offering potential for higher returns but with increased risk and potential for diversification. Examples include commodities, hedge funds, and real estate.

Illiquid Investments

They are investments that are less liquid and often subject to significant price fluctuations, but they can offer diversification benefits. Examples include real estate, commodities, and hedge funds.

Due Diligence Process

The process of evaluating and analyzing investments to understand their risks and potential returns, vital in making informed investment choices.

Alpha Return

The return that exceeds the market benchmark or average return, generated by superior investment strategies or expertise.

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Absolute Return Strategies

The strategy of producing returns regardless of market conditions, aiming for consistent performance even in periods of market decline.

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Market Segmentation

Investing in specific segments of the market, focusing on niche industries or particular market trends.

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Concentrated Portfolio

Investing in a limited number of assets or securities. It can lead to higher returns but also increased risk.

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Liquidity

The ability of investments to change quickly into cash without significant losses in value, important for managing risk.

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Hedge Fund Risk/Return

Hedge funds aim for higher returns than traditional funds, but they typically involve higher risks.

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Hedge Fund Liquidity

Hedge funds are often illiquid, meaning investors can't easily access their money. They may have lock-up periods where withdrawals are restricted and require gates for redemption, meaning they're only allowed to withdraw funds under specific conditions.

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Hedge Fund Fees

Hedge funds charge a management fee, which is a fixed percentage of the fund's assets, regardless of its performance. They may also charge a performance fee, which is a percentage of the fund's profits above a certain hurdle rate.

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Hurdle Rate

The hurdle rate is the minimum return a hedge fund needs to achieve before investors start earning a performance fee.

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High Water Mark

The high water mark is a benchmark that prevents hedge funds from charging performance fees on profits that have already been realized. It ensures that fees are only charged on new profits.

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Hedge Fund Legal Structure

Hedge funds often have different legal structures than traditional funds, as they are often organized as private companies. However, they are usually still subject to regulatory oversight.

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Hedge Fund Transparency

Although they are still considered less transparent than traditional funds, hedge funds have become more open about their operations in recent years. However, transparency remains relatively limited compared to publicly traded companies.

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Hedge Funds (HF)

Investment funds that are only accessible to a limited group of investors, typically institutions and high-net-worth individuals.

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Hedge Fund Managers

Investment managers who oversee hedge funds, managing the fund's assets and making investment decisions.

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High Net Worth Individuals (HNWI)

Individuals with significant wealth, typically possessing a high net worth and a strong appetite for risk.

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Institutions

Organizations with large pools of capital, such as pension funds, insurance companies, and university endowments.

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Investment in Hedge Fund

The ability to invest in a fund by contributing capital directly.

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Risky Investments

Investments that involve higher than average risk, often with the potential for higher returns.

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The Ability to Lose and Make Up Losses

The ability to lose a significant amount of money and recover from those losses.

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Herding Behavior

A situation where investors are drawn to an investment because others are already participating.

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Pairs Trading

An investment strategy that involves buying one security and selling short another, aiming to profit from the price spread between them. It can be employed within a single sector or across different sectors.

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Maximum Drawdown

The difference between the highest and lowest point of an investment's value. Represents the maximum possible loss an investor could have experienced.

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Long/Short Equity Strategy

A hedge fund strategy where the manager takes both long and short positions in the equity market, aiming to profit from the relative price movements of different stocks.

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Statistical Arbitrage

A quantitative trading style that relies solely on market data and statistical models to identify and exploit price discrepancies between similar assets.

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High-Frequency Trading (HFT)

A trading strategy that uses high-frequency algorithms to execute trades at very short intervals, aiming to capitalize on tiny price fluctuations.

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Net Exposure

The difference between the value of long positions (stocks bought to rise) and short positions (stocks borrowed and sold to be bought back later).

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Equity Market Neutral Strategy

A hedge fund strategy designed to generate positive returns regardless of the market's direction.

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Distressed Securities

Securities, typically equities or debt instruments, of companies experiencing financial distress or facing a high risk of default.

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Listed Distressed Securities

Distressed securities that are listed on stock exchanges and publicly traded.

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Dollar Neutrality

A type of market neutrality where the nominal value of short positions equals the nominal value of long positions. It aims to eliminate market risk.

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Private Distressed Securities

Distressed securities that are not publicly traded and are held privately.

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Beta Neutrality

A type of market neutrality where the average beta of the portfolio is zero, meaning it's not correlated to the market's overall movement.

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Excess Selling Pressure

An investment strategy that aims to profit from the excess selling pressure that often occurs when a company's credit rating is downgraded.

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Sector Neutrality

A type of market neutrality where the portfolio has no exposure to any specific sector, mitigating sector-specific risks.

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Downgrade-Induced Price Drop

The situation where a company facing financial difficulties experiences a significant drop in its stock price due to negative news or events.

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Factor Neutrality

A type of market neutrality where the portfolio is not influenced by specific factors like interest rate changes, mitigating risks related to those factors.

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Catching Falling Knives

A strategy where investors buy stocks that have recently declined, hoping they will rebound to their previous price levels.

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Active Restructuring Strategy

Involves buying and actively participating in restructuring processes of distressed companies, aiming to influence their turnaround.

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Assets Cherry Picking

Buying assets of a distressed company instead of its debt, hoping to gain value from the assets.

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Passive Investing

A strategy involving buying shares of a company and waiting for its value to increase over time without actively participating in its management.

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Global Macro Strategies

This strategy involves investing across various markets and asset classes, focusing on macro-economic trends rather than individual securities.

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Financial Risks in Distressed Investing

The potential for losses in distressed investments due to the uncertainty of the recovery process and its duration.

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Liquidation Risk

The possibility of a distressed company being liquidated without a successful restructuring process, leaving investors with minimal or no recovery.

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Liquidity Risk

The potential for a lack of buyers in the market for distressed securities, making it difficult for investors to sell their holdings quickly.

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Study Notes

Traditional vs Alternative Investments

  • Traditional investments include stocks, bonds, and cash.
  • Common alternative investments include private equity, commodities, real estate, hedge funds, managed futures, art, and crypto.
  • Commodities, like gold and silver, can have quick price increases followed by systematic decreases.
  • Hedge funds employ specific investment strategies.
  • Managed futures can be categorized as a type of hedge fund.
  • Alternative investments (like hedge funds) can be less liquid than traditional investments.
  • Characteristics common to alternative investments include risk/return characteristics, diversification, illiquidity, and due diligence processes.
  • Common investors in alternative investments include high net worth individuals, pension funds, and other institutional investors (e.g., insurers, foundations).
  • Alternative investments allow investors to gain exposure to various risk factors and specialized investment strategies.

Alpha Drivers

  • Absolute return strategies deliver consistent returns regardless of market conditions.
  • Market segmentation involves targeting specific sub-market subgroups.
  • Concentrated portfolios focus on a smaller number of assets to potentially outperform benchmarks like the S&P 500.
  • Non-linear return distributions are often linked to derivatives (especially options).

Certain Points to Consider

  • Diversifying investments across asset classes.
  • Investing in assets where one has an informational edge.
  • Long-term perspectives are crucial in evaluating alternative investment returns; short-term outperformance is not the primary objective.

Core - Satellite Portfolio

  • Beta investments form the core, while alternatives serve as satellites.
  • Structured products—like Credit Default Swaps (CDS)—are complex financial instruments whose performance is linked to specific events.
  • The swap agreement involves two parties, with one providing credit protection to the other if a certain event occurs.

Collateralized Debt Obligations (CDOs)

  • CDOs are complex financial products created using various types of debt obligations.
  • Different tranches with varying degrees of risk are formed.
  • Senior bonds are typically considered the least risky, while subordinated tranches are viewed as more risky.
  • Risks associated with CDOs stem from defaults in underlying debt instruments.

Hedge Funds - History

  • Hedge funds experienced setbacks during significant market crises, like the 1997 Asian crisis and the 2008 Lehman crisis.
  • Traditional funds generally maintain an index as a benchmark; hedge funds can deviate from typical market returns (absolute returns versus beta return).
  • Hedge fund managers may employ various strategies and target specific rates of return or market conditions.

Hedge Funds vs. Traditional Funds

  • Hedge funds aim for absolute returns, while traditional funds often seek to match or beat market benchmarks.
  • Hedge funds can involve alternative strategies, often with more flexibility.
  • Traditional funds often utilize index-based or passively managed strategies.
  • Hedge funds may involve illiquidity, with unique terms for subscriptions and redemption.
  • Hedge funds frequently employ fees that are tied to the fund's performance.

High Water Mark

  • Hedge funds typically have different legal structures and lower levels of transparency compared to traditional funds.
  • Individuals may find it challenging to discern or evaluate hedge funds.

HF Strategies - Long/Short Equity

  • Hedge funds that utilize long/short equity strategies aim for returns regardless of the overall market trend.
  • The objective is to achieve market neutrality in terms of overall returns irrespective of the market direction.
  • Investment strategies in this arena can include sector-neutral or factor-neutral approaches.

HF Strategies - Emerging Markets

  • Emerging markets can exhibit significant volatility and liquidity challenges.
  • Growth potential in emerging markets can be substantial, but so can the risks.
  • The potential for higher returns is balanced by increased volatility and illiquidity.

HF Strategies - Fixed Income Arbitrage

  • Fixed income arbitrage involves strategies within the fixed-income markets.
  • This can include relative value, market neutrality, and directional styles.

HF Strategies - Convertible Arbitrage

  • Convertible arbitrage involves taking advantage of mispricing in convertible bonds.
  • Identifying mispricing opportunities where convertible bonds trade at a discount to their fair value.
  • Strategies aim to capitalize on the arbitrage associated with the bond's value as a straight bond or equity option.
  • Potential risks in this arena include interest rate fluctuations, creditworthiness issues, and timeliness of transactions.

HF Selection & Due Diligence

  • Key to the success of any hedge fund strategy is the proper selection of investments and due diligence.
  • The strategy must be well-defined, as well as the investor objectives and constraints.
  • There should be clear standards to assess the viability of a strategy and its viability and risks.
  • The due diligence of a hedge fund approach should investigate the management team, infrastructure, and investment process.

HF Case Study - LTCM

  • The Long-Term Capital Management (LTCM) case highlights the perils of excessive leverage and underestimating the risks associated with market liquidity.

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Traditional vs Alternative Investments PDF

Description

This quiz explores the characteristics and features of alternative investments versus traditional investments. It covers key concepts such as hedge funds, market segmentation, and the roles of various types of investors. Test your knowledge on what sets alternative investments apart in today's financial landscape.

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