CFA Level 1 - Alternative Investments
Alternative investments - Answer-Differ from traditional investments (publicly traded stocks, bonds,
cash) both in the types of assets and securities included in this asset class and in the structure of the
investment vehicles in which these assets are held. Includes assets such as real estate and commodities,
or special vehicles such as private equity funds, hedge funds, ETFs, giving managers flexibility to to use
derivatives and leverage, to make investments in illiquid assets, and to take short positions.
Alternative investments generally have:
-High fees
-Large size of investments
-Low diversification within the portfolio
-high use of leverage
-restrictions on redemptions
Compared to traditional investments, alternative investments exhibit:
-Less liquidity of assets held
-More specialization by investment managers
-Low correlation with traditional investments
-Less regulation and transparency
-More problematic and less available historical return and volatility data
-Different legal issues and tax treatments
, Integrating with traditional investments - Answer-Risk/return profile of a traditional portfolio can be
improved by adding alternative investments, however there are challenges:
-Getting reliable measures of risk and return
-identifying appropriate allocation
-selecting portfolio managers
Higher returns can be explained by tax advantages for REIT, exploiting mispricings, return premium for
illiquidity, significant use of leverage
Keep in mind:
-returns are averages which may not be representative of returns for subperiods
-volatility and correlation may be understated since values are estimated
-hedge fund index bias upward (self-selection, backfill, survivorship)
-Differences in weightings and constituents in index construction can impact results
Categories of alternative investments - Answer-Hedge funds
Private equity funds (LBOs, venture capital)
Real estate (REIT)
Commodities
Infrastructure
Other
Self-selection bias - Answer-Since disclosures of performance data to hedge fund indices is voluntary,
fund mangers tend to reveal their performance only if it's impressive
Alternative investments - Answer-Differ from traditional investments (publicly traded stocks, bonds,
cash) both in the types of assets and securities included in this asset class and in the structure of the
investment vehicles in which these assets are held. Includes assets such as real estate and commodities,
or special vehicles such as private equity funds, hedge funds, ETFs, giving managers flexibility to to use
derivatives and leverage, to make investments in illiquid assets, and to take short positions.
Alternative investments generally have:
-High fees
-Large size of investments
-Low diversification within the portfolio
-high use of leverage
-restrictions on redemptions
Compared to traditional investments, alternative investments exhibit:
-Less liquidity of assets held
-More specialization by investment managers
-Low correlation with traditional investments
-Less regulation and transparency
-More problematic and less available historical return and volatility data
-Different legal issues and tax treatments
, Integrating with traditional investments - Answer-Risk/return profile of a traditional portfolio can be
improved by adding alternative investments, however there are challenges:
-Getting reliable measures of risk and return
-identifying appropriate allocation
-selecting portfolio managers
Higher returns can be explained by tax advantages for REIT, exploiting mispricings, return premium for
illiquidity, significant use of leverage
Keep in mind:
-returns are averages which may not be representative of returns for subperiods
-volatility and correlation may be understated since values are estimated
-hedge fund index bias upward (self-selection, backfill, survivorship)
-Differences in weightings and constituents in index construction can impact results
Categories of alternative investments - Answer-Hedge funds
Private equity funds (LBOs, venture capital)
Real estate (REIT)
Commodities
Infrastructure
Other
Self-selection bias - Answer-Since disclosures of performance data to hedge fund indices is voluntary,
fund mangers tend to reveal their performance only if it's impressive
