Podcast
Questions and Answers
Which of the following asset classes is NOT typically classified as an alternative investment?
Which of the following asset classes is NOT typically classified as an alternative investment?
- Equities (correct)
- Commodities
- Real estate
- Private equity
What is a key characteristic of alternative strategy funds compared to conventional mutual funds?
What is a key characteristic of alternative strategy funds compared to conventional mutual funds?
- They only invest in fixed income securities.
- They are more heavily regulated.
- They have fewer restrictions on using leverage. (correct)
- They typically only invest in liquid assets.
Which strategy involves profiting through exploiting discrepancies in related financial instruments?
Which strategy involves profiting through exploiting discrepancies in related financial instruments?
- Relative value strategies (correct)
- Hedge fund strategies
- Event-driven strategies
- Diversification strategies
What type of investments do alternative strategy funds typically invest in?
What type of investments do alternative strategy funds typically invest in?
Which of the following describes event-driven strategies?
Which of the following describes event-driven strategies?
Private equity falls under which category of investments?
Private equity falls under which category of investments?
Which investment strategy distinguishes hedge funds from liquid alternative funds?
Which investment strategy distinguishes hedge funds from liquid alternative funds?
What is a primary characteristic of hedge funds compared to conventional mutual funds?
What is a primary characteristic of hedge funds compared to conventional mutual funds?
During periods of market distress, what happens to the returns of liquid alternative funds compared to hedge funds?
During periods of market distress, what happens to the returns of liquid alternative funds compared to hedge funds?
What does the term 'risk' refer to in the context of a portfolio?
What does the term 'risk' refer to in the context of a portfolio?
Which factor typically influences investors' choice between hedge funds and liquid alternative funds?
Which factor typically influences investors' choice between hedge funds and liquid alternative funds?
What is a significant benefit of diversification within alternative investments?
What is a significant benefit of diversification within alternative investments?
How do hedge funds generally compare to liquid alternative funds in terms of risk-adjusted returns?
How do hedge funds generally compare to liquid alternative funds in terms of risk-adjusted returns?
What indicates that a manager has successfully added value to a portfolio?
What indicates that a manager has successfully added value to a portfolio?
What distinguishes the fee structures of hedge funds compared to conventional mutual funds?
What distinguishes the fee structures of hedge funds compared to conventional mutual funds?
How does a well-diversified portfolio impact leverage?
How does a well-diversified portfolio impact leverage?
What is indicated by an alpha value of zero for a portfolio manager?
What is indicated by an alpha value of zero for a portfolio manager?
Which of the following is NOT a benefit of adding alternative investments to a portfolio?
Which of the following is NOT a benefit of adding alternative investments to a portfolio?
What is a common structure that attracts skilled managers to alternative investment funds?
What is a common structure that attracts skilled managers to alternative investment funds?
In periods of stock and bond market volatility, what should typically happen to a balanced portfolio?
In periods of stock and bond market volatility, what should typically happen to a balanced portfolio?
What type of risk is systematic risk primarily associated with?
What type of risk is systematic risk primarily associated with?
Which type of strategies are significantly affected by first-order risk?
Which type of strategies are significantly affected by first-order risk?
What defines second-order risks as opposed to first-order risks?
What defines second-order risks as opposed to first-order risks?
Which of the following is NOT classified as a second-order risk?
Which of the following is NOT classified as a second-order risk?
How does higher leverage affect risk in investment positions?
How does higher leverage affect risk in investment positions?
What is a characteristic of liquidity risk?
What is a characteristic of liquidity risk?
Which risk primarily affects the ability to implement arbitrage strategies?
Which risk primarily affects the ability to implement arbitrage strategies?
What can second-order risks be attributed to?
What can second-order risks be attributed to?
Which is a potential consequence of liquidity risk?
Which is a potential consequence of liquidity risk?
What distinguishes second-order risks from first-order risks in the context of an alternative strategy fund?
What distinguishes second-order risks from first-order risks in the context of an alternative strategy fund?
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Study Notes
Alternative Investments
- Alternative Investments include asset classes outside the traditional portfolio of equities, bonds, and cash.
- Alternative Investments can be categorised into three groups:
- Alternative Strategy Funds
- Alternative Assets
- Private Equity
Alternative Strategy Funds
- Alternative Strategy Funds have fewer or no regulatory restrictions on short selling, leverage, and derivatives, unlike conventional mutual funds.
- They can also invest in illiquid investments.
Alternative Strategy Funds: Three Main Strategies
- Relative Value: Profits from price discrepancies between related stocks, bonds, or derivatives
- Event-Driven: Investments in firms undergoing corporate transactions (mergers, restructurings, etc.)
- Directional: Focuses on an alternative strategy fund manager's outlook for markets, interest rates, commodities, and currencies.
Diversification with Alternative Investments
- Diversification can mitigate the impact of volatility, as Alternative Investments can have low or even negative betas with traditional stocks or bonds.
Diversification Benefits
- Reduced volatility in portfolio net asset value (NAV)
- Downside protection during market stress, leading to reduced portfolio drawdowns
- Potential for higher expected returns through leverage
Alpha
- Alternative investment funds can attract highly skilled managers due to their pay-for-performance compensation structures.
- Alpha measures a manager's performance.
- Positive Alpha indicates outperformance, while Zero implies standard performance, and negative alpha indicates underperformance relative to the risk taken.
First-Order Risk
- First-Order risk is systematic risk, which cannot be reduced through diversification.
- It does not significantly affect Relative Value or Event-Driven strategies, but it does affect Directional strategies.
Second-Order Risk
- Second-Order Risk is not related to the market but to other aspects of trading, such as dealing, pricing, and implementing arbitrage structures.
- Examples of Second-Order risk include liquidity, leverage, deal break, default, counterparty, trading, concentration, pricing model, and trading model risks.
Key Differences Between Conventional Mutual Funds and Alternative Funds
- Regulatory Disclosures: Alternative funds have less rigorous regulatory disclosures compared to conventional mutual funds.
- Investment Objectives: Alternative funds invest in various asset classes and employ different strategies, whereas conventional funds have a limited scope.
- Strategy Allowances & Limitations: Alternative funds have greater flexibility in employing strategies like short selling, derivatives, and leverage.
- ** Liquidity:** Alternative funds typically have lower liquidity compared to conventional mutual funds.
- Fees: Alternative funds generally have higher management fees than conventional funds.
- Redemptions: Redemptions in Alternative funds are often subject to restrictions or lock-up periods.
- Permitted Investors & Initial Investment: Permitted investors and investment size vary among alternative and conventional funds.
- Regulatory Oversight: Alternative funds are subject to less stringent regulatory oversight compared to conventional mutual funds.
Hedge Funds vs. Alternative Mutual Funds
- Hedge funds generally experience higher after-fee returns due to greater risk-taking.
- Alternative mutual funds present investors with lower returns but lower levels of risk.
- During times of distress, the return difference between hedge and alternative mutual funds narrows as liquidity becomes more valuable.
Important Considerations with Alternative Investment Funds
- Management &/or Performance Fee Increases: Changes in fees may affect overall return and investment performance
- Changes in Fee Calculation Methodology: Variations in fee calculations impact returns and investment performance
- Changes in the Fund's Fundamental Investment Objective: shifts in the fund's investment objective may disrupt the expected returns and risk profile
- Change of Manager & /or Reorganization: Changes in management or fund structure bring uncertainties and potential performance variations
Proficiency Requirements for Dealings with Alternative Investment Funds
- For Mutual Fund Dealing Representatives: Canadian Securities Course, or Derivatives Fundamentals Course, plus other relevant courses
- For CIRO Registered Representatives: Additional requirements include Conduct and Practices Handbook, 90-Day Training, and Wealth Management Essentials
Hedge Fund Attributes that Contribute to Decreasing and Increasing Portfolio Risk
- Attributes that Decrease Risk
- Diversification
- Risk Management Techniques
- Skillful Investment Strategies
- Attributes that Increase Risk
- Leverage
- Illiquidity of Investments
- Potential for Counterparty Risk
- Complex Strategies
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