www.ebook3000.com www.ebook3000.com Alternative Investments www.ebook3000.com The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more For a list of available titles, visit our website at www.WileyFinance.com Founded in 1807, Wiley is the oldest independent publishing company in the United States With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding www.ebook3000.com Alternative Investments CAIA Level II Third Edition HOSSEIN B KAZEMI KEITH H BLACK DONALD R CHAMBERS www.ebook3000.com Cover image: © iStock & Shutterstock Cover design: Zoe Design Works Copyright © 2009, 2012, 2016 by The CAIA Association All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993, or fax (317) 572-4002 Wiley publishes in a variety of print and electronic formats and by print-on-demand Some material included with standard print versions of this book may not be included in e-books or in print-on-demand If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com For more information about Wiley products, visit www.wiley.com ISBN 9781119016397 (Hardcover) ISBN 9781119016366 (ePDF) ISBN 9781119016380 (ePub) Printed in the United States of America 10 www.ebook3000.com Contents Preface xvii Acknowledgments xxi About the Authors xxiii PART Asset Allocation and Institutional Investors CHAPTER Asset Allocation Processes and the Mean-Variance Model 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 Importance of Asset Allocation The Five Steps of the Asset Allocation Process Asset Owners Objectives and Constraints Investment Policy Objectives Investment Policy Constraints Preparing an Investment Policy Statement Implementation Conclusion Notes References CHAPTER Tactical Asset Allocation, Mean-Variance Extensions, Risk Budgeting, Risk Parity, and Factor Investing 2.1 2.2 2.3 2.4 2.5 2.6 Tactical Asset Allocation Extensions to the Mean-Variance Approach Risk Budgeting Risk Parity Factor Investing Conclusion Notes References CHAPTER The Endowment Model 3 9 17 18 22 33 34 34 35 35 45 50 55 62 68 69 69 71 3.1 Defining Endowments and Foundations 71 v www.ebook3000.com vi CONTENTS 3.2 3.3 3.4 3.5 3.6 Intergenerational Equity, Inflation, and Spending Challenges The Endowment Model Why Might Large Endowments Outperform? Risks of the Endowment Model Conclusion Note References CHAPTER Pension Fund Portfolio Management 4.1 4.2 4.3 4.4 4.5 4.6 4.7 Development, Motivations, and Types of Pension Plans Risk Tolerance and Asset Allocation Defined Benefit Plans Governmental Social Security Plans Contrasting Defined Benefit and Contribution Plans Annuities for Retirement Income Conclusion Notes References CHAPTER Sovereign Wealth Funds 5.1 5.2 5.3 5.4 5.5 5.6 5.7 99 99 101 105 113 114 117 122 122 122 125 Sources of Sovereign Wealth Four Types of Sovereign Wealth Funds Establishment and Management of Sovereign Wealth Funds Emergence of Sovereign Wealth Funds Governance and Political Risks of SWFs Analysis of Three Sovereign Wealth Funds Conclusion Notes References CHAPTER The Family Office Model 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 74 76 78 84 96 96 96 125 128 131 134 136 138 141 142 142 145 Identifying Family Offices Goals, Benefits, and Business Models of Family Offices Family Office Goals by Generations Macroeconomic Exposures of Family Offices Income Taxes of Family Offices Lifestyle Assets of Family Offices Family Office Governance Charity, Philanthropy, and Impact Investing Ten Competitive Advantages of Family Offices Conclusion Notes References www.ebook3000.com 145 145 150 155 157 160 164 167 170 172 172 173 vii Contents PART Private Equity CHAPTER Private Equity Market Structure 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 Main Strategies of Private Equity Investment Main Differences between Venture Capital and Buyout PE Funds as Intermediaries PE Funds of Funds as Intermediaries The Relationship Life Cycle between LPs and GPs Limited Partnership Key Features Co-Investments Conclusion Notes References CHAPTER Private Equity Benchmarking 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 205 The Valuation of PE Assets Measuring Performance of PE Funds Benchmark Types Asset-Based Benchmarks Peer Groups What Is an Appropriate Benchmark? Example for Benchmarking PE Funds Portfolio of PE Funds Conclusion Notes References CHAPTER Fund Manager Selection and Monitoring 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 177 177 178 181 184 187 190 198 202 202 203 Performance Persistence Manager Selection and Deal Sourcing Decision-Making and Commitment Principles of Fund Monitoring Monitoring Objectives Information Gathering and Monitoring Actions Resulting from Monitoring The Secondary Market Conclusion Notes References CHAPTER 10 Private Equity Operational Due Diligence 10.1 The Scope and Importance of Operational Due Diligence www.ebook3000.com 206 206 212 213 215 218 220 226 231 232 232 235 235 241 244 245 246 248 251 253 259 260 262 265 265 viii CONTENTS 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 Eight Core Elements of the Operational Due Diligence Process Private Equity Operational Due Diligence Document Collection Process Analyzing Private Equity Legal Documentation during Operational Due Diligence Operational Due Diligence beyond Legal Document Analysis On-Site Manager Visits Evaluating Meta Risk Fund Service Provider Review and Confirmation Ongoing Private Equity Monitoring Considerations Conclusion Notes References and Further Readings CHAPTER 11 Private Equity Investment Process and Portfolio Management 11.1 11.2 11.3 11.4 11.5 Investment Process Private Equity Portfolio: Design Private Equity Portfolio: Construction Risk-Return Management Conclusion Notes References CHAPTER 12 Measuring Private Equity Risk 12.1 12.2 12.3 12.4 12.5 12.6 Four Significant Risks of Private Equity Modeling Private Equity What Is the Value of a Private Equity Asset? Applying the VaR Concept to Private Equity Calculating VaR Based on Cash Flow at Risk Conclusion Notes References CHAPTER 13 The Management of Liquidity 13.1 13.2 13.3 13.4 13.5 13.6 13.7 13.8 268 269 272 278 282 284 285 286 287 288 288 289 290 293 297 300 306 307 308 309 309 311 313 315 315 320 321 321 323 Identifying Illiquidity and Managing Cash Flows Private Equity Cash Flow Schedules Five Sources of Liquidity Investment Strategies for Undrawn Capital Modeling Cash Flow Projections Three Approaches to Forming Model Projections Overcommitment Conclusion Notes References www.ebook3000.com 323 327 328 330 330 331 337 339 340 340 1062 Funds of hedge funds, 897–930 added value from, 919–925 and approaches to accessing hedge funds, 897, 900–902 background on, 903 benefits offered by, 914–916 biases of, 904–905 characteristics of, 901, 903–905 CTA diversification benefits for investors in, 688 disadvantages of, 916–917 diversification approaches of, 903–904 estimating risk and return for, 869–870 growth of, 897–899 and hedge fund indices, 925–929 hedge fund ODD for, 955 multistrategy funds vs., 917–920 performance of, 904, 905–907 portfolio construction, 907–913 portfolio manager selection for, 913–914 Funds of one, 917 Funds of real estate funds, 425 Futures contract dollar risk, 674 Futures contracts (futures) See also Commodity futures; Managed futures agricultural, 508 CBOE Volatility Index, 845, 849–851 real estate, 419, 420 Futures curves, storage and, 578–579 Futurization, 650 Gains taxation, 459–460 Gamma exposure, 684–685 Gap financing, 537 Gatekeepers, 237 Generalists, 756 General partners (GPs), 184, 195, 235–241 See also Limited partner–general partner (LP–GP) relationship Geographical location, infrastructure investment, 485, 495 Geometric mean returns, 587, 600 Germany, 472–473, 774, 818 GGM (Gordon’s growth model), 754, 754–755 Global macro hedge fund strategies, 769–785 and currency trading models, 776–784 for directional currency trades, 772–775 discretionary vs systematic, 770 in emerging markets, 775–776 multistrategy global macro funds, 771 overview, 769 INDEX risk management for, 784–785 sources of return for, 771 Global macro managed futures strategies, 655–656 Global program for real estate investing, 470–474 Goals: of family offices, 146, 150–155 of on-site manager visits, 283–284 Good-leaver clause, 196 Gordon’s growth model (GGM), 754, 754–755 Governance: family office, 164–167, 171 hedge fund, 952–954 in investment policy statements, 19 private equity fund, 191–192, 251–252 sovereign wealth fund, 136–138 Government actions, as credit events, 790 Governmental social security plans, 113–114 Government Pension Fund Global (Norway), 138–140 Government subsidies, 513–514 GPs See General partners Granger-causality analysis, 520 Grants, film production, 536 Greeks, 728–729, 838 Growth annuities, 120–122 Growth approach, 752, 752–753 Hammer prices, 542 Hard call, 722 Hardship exemption, 943 Hartzell, D., 416–417 Harvesting period, 328 Hedge fund administrators, 939–942 Hedge fund indices, 901, 923–929 Hedge fund industry, 871–872, 897–899 Hedge fund operational due diligence, 933–956 and cash management in hedge funds, 936–938 compliance considerations in, 942–945 decision making and allocations based on, 946–948 documentation of, 945–946 external parties in, 938–942 for funds of hedge funds, 955 and hedge fund governance, 952–954 insurance coverage in, 954–955 and investigative due diligence, 948–950 operational steps in, 934–936 private equity due diligence vs., 933 resource allocation for, 950–952 Hedge fund prime brokers, 938, 938–939 Hedge fund replication products, 867, 867–895 with algorithmic approach to replication, 885–890 alternative mutual funds as, 890–893 benefits of, 868–876 exchange-traded funds as, 893–894 with factor-based approach to replication, 877–882 overview of, 867–868 with payoff-distribution approach to replication, 882–885 Hedge funds: accessing, 897, 900–902 Asian financial regulations on, 979–982 cash in, 936–938 commodity-based, 626–628 distressed debt investments in, 812 governance of, 952–954 registration of, 960–962 selecting, 900, 921, 923 and tax efficiency of family offices, 160 U.S regulations on, 958–966 Hedging: by commodity producers, 613 currency, 915 with funds of hedge funds, 915 with listed real estate funds, 441–442 longevity risk, 1031–1032 market risk, 835 as replication benefit, 876 tail risk, 94–96, 864–865 with volatility derivatives, 835 Hedging risk, 829 Hedonic pricing method (HPM), 386, 386–389 Heterogeneity: of farmland returns, 516–519 of infrastructure investments, 493 of real estate investments, 345–346 Higher moments, 14, 31–32, 912–913 Higher-order autocorrelation, unsmoothing, 371–372 High-quality assets, 749 Ho and Lee model, 997, 997–999 Hong Kong, 980 Horizontal spread, 856, 856–857 Hotelling theory, 563, 563–564 Housing price derivatives, 416 Housing real estate, 348, 348–349, 390 HPM (hedonic pricing method), 386, 386–389 Humped curve, 580 1063 Index Hurdle rate, 28, 28–29 See also Preferred return Hurt money, 195 Hybrid convertibles, 728 Hybrid operational due diligence approach, 951 Hybrid products See Mezzanine debt IDD (investment due diligence), 266 Illiquid assets, 30–31, 155, 324–325 Illiquidity See also Liquidity mean-variance optimization adjustment for, 46–48 of patent assets, 551 for private equity funds, 323–327 Illiquidity risk, 325–327 See also Liquidity risk ILSs See Insurance-linked securities Immediate annuities, 120 Impact alpha, 169 Impact first, 169 Impact investing, 168, 168–170 Implicit leverage, 689, 689–690 Implied volatility premium, 65 Implied volatility structure, 842 Improvement provisions, patent, 548 Incentives, with PE investments, 181–183, 187 Income, retirement, 117–122 Income approach, 380, 382–383 Income growth, agricultural products and, 506 Income return, 581 Income statement, 275 Income taxes, 157–160, 457–461 Increased allocation to active funds hypothesis, 870 Indemnification, 274 Indemnity trigger, 1025 Independent foundations, 72–74, 73 Independent service providers, 942 Indexed approach to accessing hedge funds, 901 Index-linked futures contracts on commodities, 626 Indirect commodity investments, 620, 620–628 bonds issued by commodity firms, 622 commodity-based hedge funds, 626–628 commodity-based mutual funds, 623 commodity index swaps, 620–621 commodity-linked investments, 625–626 commodity trade and production financing, 628 exchange-traded products, 623–624 public and private commodity partnerships, 624–625 public commodity-based equities, 621–622 Indirect real estate See Public real estate investment Individually managed accounts, Industry loss trigger, 1025 Inelastic demand, 486 Inflation: and commodity investments, 563, 584, 597–599 and endowments, 74 and infrastructure investments, 493 and intellectual property investments, 552 and spending rates, 85–87 and timberland investments, 522 unanticipated, 353 Inflation beta, 87 Inflation hedges, 526, 582–584, 597–598 Inflation-indexed cash flows, 488 Inflation-protected bonds, 112 Inflation rate, anticipated, 352, 352–353 Informal PE market, 177 Information: asymmetry of, 464 with PE funds-of-funds, 186 for private equity fund monitoring, 248–251 Informational market efficiency, 746–748, 813–814 Information-based global macro managers, 771 Information ratio, 925 Information technology (IT) documentation review, 281 Infrastructure assets, 479–489 attributes of, 486–489 classification of, 479–480 demand for, 480–482, 486 distinguishing, 479 geographical location of, 485 other assets vs., 496–497 stage of maturity of, 483–485 supply of, 482–483 Infrastructure funds, 490, 491, 493–496 Infrastructure investments, 479–501 accessing, 489–493 agricultural, 520–521 assets underlying, 479–483 attributes of, 486–489 geographical location for, 485 historical performance of, 499–501 investments in other assets vs., 496–497 and public-private partnerships, 497–499 regulation of, 499 sector scope for, 485–486 stage of maturity for, 483–485 Inheritance, 166, 166–167 In-kind distributions, 182 Insider trading, 943, 943–944 Instant history bias, 217, 905 Insurance: AIFMD requirements for, 973 and hedge fund ODD, 954–955 VIX futures as, 850–851 Insurance-linked securities (ILSs), 1021, 1021–1037 catastrophe bonds, 1021–1030 longevity risk-related, 1030–1032, 1034–1035 mortality risk-related, 1033–1037 Integrated asset-liability risk management, 102 Intellectual property, 533–534, 552–553 Intellectual property investments, 533–555 characteristics of assets underlying, 533–534 and characteristics of real assets, 552–553 in film production and distribution, 534–541 in patents, 546–552 in research and development, 546–547 in visual works of art, 541–546 Intensification, 521 Intensity, default, 801, 801–804 Inter-asset option spreads, 857–859 Interest (business): alignment of, in family offices, 171 attachment of security interest, 829 conflicts of interest, 201 perfect the security interest, 829 Interest (financial): carried, 193, 194, 276, 277 payment in kind, 1040, 1043–1045 short, 732 Interest rate cap, 999, 999–1001 Interest rate derivatives, 999–1013 callable bonds, 1001–1005 interest rate caps and floors, 999–1001 interest rate swaps, 1005–1013 Interest rate floor, 1000, 1000–1001 Interest rate risk, 731, 1011–1012 Interest rates, 562, 992–998 See also Term structure Interest rate swap, 1005, 1005–1013 risks associated with, 1011–1013 valuation of, 1007–1011 Intergenerational equity, 74 Intermediaries, private equity investments as, 181–187 Intermediation, 186 1064 Internal constraints, 17, 17–18 Internal rate of return (IRR), 207–209, 221, 227, 227–229 Internal settlement, 934 International real estate investments, 451–476 and agency relationships, 462–464 challenges with, 462–470 diversification benefits from, 454–457 domestic vs., 348 establishing a global program for, 470–474 exchange rate risk with, 466–469 expected returns on, 453–454 information asymmetries with, 464 legal risks with, 470 leverage with, 460–462 liquidity and transaction costs with, 464–465 opportunities with, 453–462 overview of, 451–453 political and economic risks with, 465–466 tax benefits of, 454–457 International REITs, 430–434, 470–474 In-the-money, 722 Intra-asset option spreads, 855–857 Intramarket relative value strategies, 612 Intrinsic value (fundamental value), 526, 713 Investability: of benchmarks, 219 of hedge fund indices, 927–929 of international real estate, 452 and risk factors, 66–67 Investigative due diligence, 948–950 Investment Advisers Act of 1940, 958, 959, 964 Investment decision-making authority model, 948 Investment due diligence (IDD), 266 Investment horizon, for commodities, 597–598 Investment limitations, in Singapore, 981 Investment managers See also Fund managers; Portfolio managers costs of replacing, 39–40 European regulations on, 970–971, 979 large endowment, 80–81 macro managers, 771 selection of, 19 for sovereign wealth funds, 131–134 value long/short, 752 Investment period, cash flow schedule, 327–328 INDEX Investment policy constraints, 17–18 Investment policy objectives, 9–17, 19 Investment policy statement (IPS), implementing, 22–33 (see also Mean-variance optimization) preparing, 18–21 Investment process, with fundamental equity long/short strategy, 765–768 Investment products: for distressed debt investing, 812–813 mezzanine debt, 1041–1049 Investment staff, at large endowments, 83–84 Investors: accredited, 960 alternative mutual fund, 892–893 CTA, 669–671 defaulting, 245 distressed debt, 811–812 60/40, 687–688 total return, 85 Invitation-only funds, 200 IPSs See Investment policy statements Iron butterfly, 837, 837–838 Iron condor, 837–838 IRR See Internal rate of return Italy, 774, 775 IT (information technology) documentation review, 281 Japan, 982 J-curve, 200, 210, 210–212, 427 Job mobility, 105–106 Joint experience, 242, 242–243 Jump process, 846 Jump risk, 846 Junior directors See Associate directors Junk convertibles, 727, 727–728, 730–731 Jurisdictional risk, 823 Kealhover, McQuown, and Vasicek model See KMV model Key-person provisions, 195–196 KMV model, 798, 798–801 Knowable benchmarks, 218 Knowledge transfer, 915 Kurtosis, 32 See also Higher moments Lagged structures, 365–366 Large endowments, 78–84 Large hedge fund advisers, 967 Large liquidity hedge fund advisers, 967 Large private equity advisers, 967 Large-scale mean-variance optimization, 31 Law of one price, 783 LDI (liability-driven investing), 112, 112–113 Legal counsel, document reviews by, 275–276 Legal documents: in operational due diligence, 269–278 valuation analysis in context of, 278–288 Legal risk(s): in asset-based lending, 829–830 in distressed debt investing, 823 with infrastructure investments, 484 with international real estate investments, 470 with longevity swap contracts, 1032 with patent assets, 552 with timberland investments, 524 Lemons, 199 Lenders, asset-based, 827–828 Lending: asset-based, 824–830 patent, 550–551 Leverage: AIFMD requirements on, 973 with funds of hedge funds, 916 implicit leverage vs., 689–690 with multistrategy funds, 919 with real estate investments, 427, 460–462 sensitivity of Merton model to, 798 Leverage aversion theory, 58, 58–59, 748, 748–749 Leverage costs, 732 Leverage risk, 715 Leveraged note, 629, 629–630 Leveraged structures, commodity investments with, 628–631 Liability(-ies): for defined benefit plans, 106–107 and diversification with commodities, 594 managing assets with risk aversion and growing, 16–17 mean-variance optimization with growing, 24–26 and pension plan risk, 102–103 Liability-driven investing (LDI), 112, 112–113 Licensing requirements, South Korea, 981 Life cycle: of films, 535 of GP–LP relationship, 187–190, 188 Life insurance-linked securities, 1030–1037 Life insurance settlements, 1034, 1034–1035 1065 Index Lifestyle assets, 160, 160–164, 172 Lifestyle wealth storage costs, 161–162 Limited partner-general partner (LP–GP) relationship, 187–190 Limited partners (LPs), 184, 201, 275–276 Limited partnership agreement (LPA), 190, 190–193, 196 Limited partnerships, 190–198, 329 Linaburg-Maduell Transparency Index, 137 Liquidity See also Illiquidity and agricultural investments, 528 AIFMD requirements on, 973 and appraisal vs market-based indices, 444–446 and hedge fund investments, 915, 927 of infrastructure investments, 493 as internal constraint, 17 of managed futures, 670 for private equity funds, 328–330 and real estate investments, 429, 464–465 as replication benefit, 874–875 Liquidity-driven investing, 88, 88–89 Liquidity event, 152 Liquidity line, 329 Liquidity management for private equity funds, 323–340 cash flow modeling in, 324, 330–337 and cash flow schedules, 327–328 identifying illiquidity for, 323–327 and overcommitment, 337–339 and portfolio design, 296 and sources of liquidity, 328–330 undrawn capital investment strategies in, 330 Liquidity penalty function, 46, 46–47 Liquidity preference hypothesis, 577, 579 Liquidity premiums, 64, 83, 170 Liquidity risk See also Illiquidity risk in commodity markets, 567 with distressed debt investing, 822–823 for endowments, 83, 87–91 in pairs trading strategies, 740–741 with private equity, 309–310 Listed PE index, 213 Listed real estate funds, 427–435 See also Market-based real estate indices; Public real estate investments advantages and disadvantages of, 429–430 ETFs based on real estate indices, 428–429 hedging with, 441–442 REITs, 427, 430–435 REOCs, 427–428 Listed real estate securities, 475 Litigation strategies, patent, 548–550 Loans: asset-based, 824, 824–830 convertible, 1048–1049 DIP, 821–822 non-recourse, 1017 recourse, 1017 term, 827 Loan-to-own, 819, 819–820 Location, for on-site manager visits, 282 Location spreads, 611 Lockbox, 824 Longevity risk, 115, 119–120, 1030, 1030–1032 Longevity risk-related ILSs, 1030–1032, 1034–1035 Longevity swap contract, 1031, 1031–1032 Long-maturity index-linked futures contracts on commodities, 626 Long-only futures contracts, 700 Long-run returns, on commodity prices, 563–564 Long/short strategy See Fundamental equity long/short strategy Long-term capital gains, 159, 159–160 Long-term management of investment commitments, 330–331 Long volatility, tail risk funds and, 863–864 Long volatility funds, 860–861 Long volatility strategies, 838–839 Loss: credit, 791–792 forgone loss carryforward, 38–39, 39 industry loss triggers, 1025 Loss aversion, 715, 751 Low volatility premium, 65 LP advisory committee (LPAC), 191 LPAs See Limited partnership agreements LP–GP (limited partner-general partner) relationship, 187–190 LPs See Limited partners Macroeconomic exposures, 155–157, 552 Macroeconomic factors: in farmland returns, 515–516 in intellectual property investments, 552–553 Macro-prudential regulation, 974 Majority, qualified, 191 Managed accounts, 706–708, 874 Managed futures, 649–676 See also Commodity trading advisers (CTAs) capital at risk for, 693–694 core dimensions of investment strategies, 651–658 foundations of, 658–666 industry structure for, 649–652 maximum drawdown for, 696–697 and omega ratio, 698–700 in portfolio construction, 671–675 and simulation analysis, 697–698 size of market for, 670 Management fees, 192–193, 276 Management of company, long/short strategy and, 766–767 Margin accounts, 690–693 Marginal convenience yield, 571 Margin and volume risk, 567 Margin-to-equity ratio, 692, 692–693 Market access, of CTAs, 670 Market allocation, in futures portfolios, 674–675 Market-based real estate indices: accurate pricing and risk estimation with, 439 arbitrage and returns on, 439–443 described, 392 histograms of U.S returns, 436–437 liquidity and returns on, 444–446 returns on appraisal-based indices vs., 435–448 segmentation and returns on, 445 volatilities of, 437–439 Market capacity weighing, 675 Market clientele, 443 Market conditions, returns on risk factors and, 65–66 Market data, in projection models, 331 Market divergence, 660–665, 681–683 Market divergence index (MDI), 663, 663–665 Market efficiency: and adaptive markets hypothesis, 659 informational, 746–748, 813–814 and relative value arbitrage, 716–717 Market expectations, forward curves and, 576–577 Market frictions, 715, 715–716 Marketing materials, 963, 973–974 Market liquidity risk, 46, 567 Market risk, 309, 834, 835 Market size, 733, 741 Market stress, 683 Market timing, 79 1066 Market-timing approach, 306 Market value of equity/book value of total liabilities ratio, 807 Market volatility, 683–684 Mark-to-market risk, 823 Marriage, 189 MAS (Monetary Authority of Singapore), 981 Masterpiece effect, 542 Matching contribution, 114 Matriarch model, 164–165 Mature intellectual property, 533, 533–534 Maturity: and infrastructure investments, 483–485, 494–495 and returns on commodity indices, 633–634 sensitivity of Merton model to, 797 Maximum drawdown duration, 696, 696–697 MD See Mezzanine debt MDI (market divergence index), 663, 663–665 Mean reversion, 586–587, 599–600, 845 Mean-variance optimization (MVO), 22–33 Black-Litterman approach to, 32–33 error maximization with, 29–30 estimation risk adjustment for, 48–50 expected return maximization in, 1053 extensions to, 45–50 factor exposure adjustment for, 48 and FoF portfolio construction, 912–913 with growing liabilities, 24–26 higher moments in, 31–32 hurdle rate for, 28–29 with illiquid assets, 30–31 illiquidity adjustment for, 46–48 issues in using, 29 large-scale, 31 with multiple risky assets, 26–28 portfolio variance minimization in, 1053 risk and return in, 22–23 with risky and riskless assets, 23–24 Measurable benchmarks, 219 Median performance measures, 227 Merger arbitrage strategy, 886–887 Merton credit risk model, 793–798 Meta risks, 284–285, 285 Mezzanine debt (MD), 1037–1050 benefits and disadvantages of, 1039–1040 investment products involving, 1041–1049 INDEX overview of, 1038–1039 and project finance, 1049–1050 real estate, 475, 475–476 terms and yields of, 1040–1041 Mezzanine IP lending, 551 Middle East, 819 Minimum royalty provisions, 547 MIRR (modified internal rate of return), 208–209 Mixed approach, 297, 299–300 Mixture model, 847 Model-based global macro managers, 771 Modeled trigger, 1026 Model risk, 741 Modern portfolio theory (MPT), 289 Modified internal rate of return (MIRR), 208–209 Modular operational due diligence approach, 951 Momentum, in adaptive markets hypothesis, 660–661 Momentum crash, 66 Momentum managed futures strategies, 653–655, 889–890 Momentum models for currency trading, 782–783 Momentum premium, 64 Monetary Authority of Singapore (MAS), 981 Monetary neutral, 736 Money multiple See Total value to paid-in (TVPI) ratio Monitoring: with co-investing, 200 in delegated approach to hedge fund investing, 901 of electronic communications, 944–945 of funds of hedge funds, 914 of private equity funds (see Private equity fund monitoring) Monitoring phase, 235 Monitoring risk, 876 Monopolies, 486 Monte Carlo simulations, 230–231, 334–335 Moral hazard, 790–791 Morality tables, 118 Mortality risk, 1033, 1033–1034 Mortality risk-related ILSs, 1033–1037 Mortgage REITs, 392–396 Motivations: of buyers and sellers in secondary PE market, 256–257 for establishing SWFs, 131 for making farmland investments, 503 and replication benefits, 873–874 for trading correlation swaps, 854 Moving average crossover strategy, 654, 654–655 MPT (modern portfolio theory), 289 MSFs (multistrategy funds), 917–920 Multi-CTA funds, 708 Multistrategy CTAs, 658 Multistrategy funds (MSFs), 917–920 Multistrategy global macro funds, 771 Mutual funds, 623, 890893 MVO See Mean-variance optimization Naăve diversification, 305, 305306 National Council of Real Estate Fiduciaries (NCREIF) See entries beginning NCREIF National Futures Association (NFA), 650 National pension funds, 7, 7–8 NAV J-curve, 211, 211–212 NCREIF Property Index (NPI), 381–382 NCREIF real estate styles, 401–415 and cap rates/expected returns, 408–409 defining, 402–404 differentiating, 404 purpose of analyzing, 404–406 and real estate style boxes, 407–408 risk and return expectations based on, 409–415 Negative pickup deal, 537 Negative screening, 169 Negative volatility risk premium, 834 Negotiated terms, funds of hedge fund, 915 Net leverage covenant, 827 Netting risk, 916, 916–917 Network effect, 82 NFA (National Futures Association), 650 Noise, transaction, 362 Noise traders, 714, 714–715 Noise traders’ risk, 740 Noncore real estate assets See Opportunistic real estate; Value-added real estate Non-discretionary investment consultant, 84 Non-exchange-traded real estate See Private real estate equity investments Noninvestable hedge fund indices, 927–928 Noninvestable real estate, 452 Non-life insurance-linked securities (ILS) See Catastrophe bonds Non-marketed funds, 972 Non-recourse loan, 1017 Non-traded REITs, 434, 434–436 Normal backwardation, 577 1067 Index Normalization, of vega risk, 859–860 Norway, 138–140 Norway model, 139 Notes, 420, 625–626, 629–631 Notional funding, 691 Notional level, 692 NPI (NCREIF Property Index), 381–382 Objectives, investment policy, 9–17, 19 for limited partnerships, 192 and private equity investments, 246–248, 291–292 Obsolescence, patent asset, 551 OCIO (outsourced CIO) model, 84 ODD See Operational due diligence Offering memorandum, 273, 273–278 Off-farm storage of grain, 521 Omega ratio, 698, 698–700 One price, law of, 783 On-farm storage of grain, 521 On-site manager visit stage, 282–284 Open-end real estate funds, 423, 423–424 Operating cash flows, 487 Operating costs, 487 Operating foundations, 72, 72–74 Operating risk, 552 Operational benchmarking, 947 Operational diversification, 613 Operational due diligence (ODD), 265 See also Hedge fund operational due diligence; Private equity operational due diligence core elements of, 268–269 investment due diligence vs., 266 and operational risk, 265–266 scope and importance of, 265–267 Operational hedging, 613 Operational restructuring, 810, 810–811 Operational risk, 265, 551, 567 Operational risk profile, 269 Operational scalability, 287 Operational signaling effect, 942 Operational sophistication, 267 Operational threshold issue, 947 Opinion letter, 280 Opportunistic real estate, 412–415 Opportunity costs, conservative investment, 133 Optimization: mean-variance (see Mean-variance optimization [MVO]) robust, 49 Options: on CBOE Volatility Index, 852 real estate, 419, 420 Options-based volatility strategies, 835–845 horizontal intra-asset option spreads, 856–857 and implied volatility structures of derivatives, 841–842 inter-asset option spreads, 857–859 long, 838–839 mean reversion in, 845 realized volatility in, 839–841 recovery of returns on, 845 and risk management with Greeks, 838 short, 835–838, 842–844 vertical intra-asset option spreads, 855–856 and volatility risk premium, 842–845 Options volatility surface, 842, 843 Orderly Liquidation Authority, 959 Orderly Liquidation Fund, 959 Organized PE market, 177 OTC (over-the-counter) market, 650 Out-of-court restructuring, 815, 815–816 Outside clients, of family offices, 147, 150 Outsourced CIO (OCIO) model, 84 Overadvance, 825–826 Overcommitment ratio, 337, 337–338 Overcommitment strategy, 89, 337–339 Overconfidence, 715, 750 Overfitting, 43 Overlay approach, 105 Over-the-counter (OTC) market, 650 Owned benchmarks, 219 Owners, asset, 7–9 Ownership of commodities: direct, 619–620 indirect, 620–628 PAIFs (property authorized investment funds), 424 Pairs trading, 733–741 and equity market-neutral strategy, 735–737 framework and steps for, 737–738 implementation of, 738–739 market size and performance of funds using, 741 risk and return in, 739–741 Parametric trigger, 1025, 1025–1026 Parity, 722 Participation note, 630 Partnerships: commodity, 624–625 limited, 190–198, 329 public-private, 483, 497–499 Passion assets, 160 See also Lifestyle assets Passive management, of infrastructure funds, 494 Patent pooling, 551 Patents, 546–552 Patent sale license-back (SLB) strategy, 550 Patriarch model, 164–165 Payers, infrastructure classification based on, 479–480 Payment(s): balance of, 775 bonus, 1041 coupon, 731 current, 1040 deferred, 1040, 1041 dividend, 732 face value, 731 failure to make, 790 Payment in kind (PIK) interest, 1040, 1043–1045 Payoff-distribution approach, 882, 882–885 Payout, convex, 680 Pay promote, 199 PBOs (projected benefit obligations), 106, 106–107 PD (probability of default), 791 Peer-group-based benchmark, 212 for commodity trading advisers, 700–701 for private equity, 215–218 Peer-group cohort, 215 PE funds See Private equity funds Penalties, 46–47, 978 Pension fund portfolio management, 99–122 and annuities for retirement income, 117–122 with defined benefit plans, 105–117 with defined contribution plans, 114–117 and governmental social security plans, 113–114 risk tolerance and asset allocation in, 101–105 Pension funds, 7–8 Pension plans, 99 defined benefit, 105–117 defined contribution, 114–117 development of, 99 motivations for using, 99–101 strategic asset allocation for, 104–105 types of, 101 Pension plan sponsors, risk tolerance of, 103–104 Pension reserve funds, 130 Pension surplus, 108 Perfect markets, 363 Perfect the security interest, 829 1068 Performance See also Returns business cycle phases and commodity, 598–599 of catastrophe bonds, 1026–1028 of commodity futures, 586–590 of commodity indices, 637–639 of commodity trading advisers, 669, 677–685 and convertible arbitrage, 733 of directional hedge fund strategies, 785–786 in factor investing, 67–68 of funds of hedge funds, 904, 905–907, 923–925 of hedge fund indices, 923–925 of infrastructure investments, 499–501 of large endowments, 78–84 and pairs trading, 741 of real estate indices, 393–398 Performance drag, 864, 864–865 Performance measures: for PE funds, 206–212 for private equity portfolios, 226–229 and real estate styles, 405, 406 Performance persistence hypothesis, 235–241 Permanent cropland, 518 Permanent crops, 509 Perpetual growth model, 754, 754–755 Persistence, in price smoothing, 363–364 Personal allocation biases approach, 913 Personal trading, 943 Philanthropy, 167, 167–168 Physical real estate See Private real estate equity investments PIK (payment in kind) interest, 1040, 1043–1045 Platforms, 707, 708 PME See Public market equivalent PME ratio, 214, 214–215 Point value, 674 Political risks, 136–137, 465–466, 484 Pooled investments in direct real estate investments, 474, 474–475 Pooled IRR, 228, 228–229 Pooled performance measures, 228–229 Pooling: of patents, 551 of securities, 440 Population growth, agricultural products and, 505–506 Portability, 105 of defined benefit plans, 105–106 of defined contribution, 114–115 INDEX Portfolio construction: commodity trading advisers in, 703–704 funds of hedge funds in, 907–913 global macro hedge fund strategies in, 784–785 hedge funds in, 900–901 managed futures in, 671–675 private equity in, 297–300 with risk parity approach, 56–57 Portfolio design, private equity, 293–297 Portfolio management: and exposure to volatility, 835–845 for lifestyle assets, 162–163 private equity fund monitoring for, 246–247 Portfolio managers, funds of hedge fund, 913–914 Portfolio optimizers, 29–30, 32 Portfolio reallocation costs, 40–42 Position sizing, 672–674, 758, 921 Position verification, 942 Positive risk premiums, 600–601 Positive screening, 169 Positive skewness, 601–602 Post-clearance, 943 Posting, 934 Postproduction (stage), 535 PPP (purchasing power parity), 783–784 PPPs (public-private partnerships), 483, 497–499 PPS (profit participation scheme), 1045–1048 Pre-clearance, 943 Preferred habitat hypothesis, 579 Preferred return, 193–195 See also Hurdle rate Premium(s) See also Risk premium(s) conversion, 722–723 dividend, 749 Prepackaged filing, 816 Prepaid forward contracts, 626 Preproduction (stage), 535 Preroll strategies, 636 Price modeling, for correlation swaps, 854 Price risk, 613 Price smoothing, 362–368 and arbitrage, 363 and estimation of first-order autocorrelation parameter, 366–367 models for, 365–368 persistence in, 363–364 problems resulting from, 364 in real estate indices, 367–368 reported and true prices with, 365–366 Price speculation, 568, 568–570 Price unsmoothing, 368–369, 371 Pricing: market- vs appraisal-based indices and accuracy of, 438, 439 real estate, 362–369, 371, 378–379 regulated, 480, 486–487 in secondary PE market, 257–259 stale, 217 underpricing of convertible bonds, 718–720 unregulated, 480 Primary real estate market, 351 Prime brokers, 938–939 Principal-guaranteed notes, 630, 630–631 Principal photography/production (stage), 535 Private commodity partnerships, 624 Private defined benefit funds, Private defined contribution funds, Private equity assets, 206, 313–315, 812 Private equity benchmarks, 205–232 appropriate, 218–220 asset-based, 213–215 peer-group-based, 215–218 in PE fund benchmarking example, 220–226 and performance measures for PE funds, 206–212 for portfolio of PE funds, 226–231 types of, 212–213 and valuation of PE assets, 206 Private equity financial risk, 310 Private equity fund intermediation, 181–184 Private equity fund managers, 235–245 commitment of, 244–245 deal sourcing by, 243–244 and GP performance persistence, 235–241 selection of, 241–243 Private equity fund monitoring, 245–253 actions resulting from, 251–253 in control system, 245–246 information gathering for, 248–251 objectives of, 246–248 and portfolio design, 296–297 in private equity ODD, 286–287 trade-offs in, 246 Private equity (PE) funds See also liquidity management for private equity funds benchmarking example, 220–226 corporate governance in, 191–192 European regulations on, 976 growth calculation for, 318–320 1069 Index as intermediaries, 181–184 market for, 184 performance measures for, 206–212 selection of, 294–295 size and term of, 192 strategies for investing in, 177–178 U.S regulations on, 968–969 value of investments in, 313–315 Private equity funds-of-funds, 184–187, 220 Private equity investment process, 289–293 asset allocation in, 292–293 for co-investments, 201–202 and portfolio objectives, 291–292 in secondary market, 257 Private equity investment strategies, 177–178 Private equity legal structures, 272–273 Private equity managers, for venture capital vs buyouts, 180–181 Private equity market, 177–203 co-investments in, 198–202 core-satellite approach and changes in, 302 life cycle of GP–LP relationship in, 187–190 and limited partnerships, 190–198 PE funds in, 181–184 PE funds of funds in, 184–187 and performance persistence hypothesis, 238 secondary, 253–260 strategies of PE investment, 177–178 venture capital vs buyout transactions in, 178–181 Private equity operational due diligence, 265–288 advisory committee analysis for, 279 audited financial statement review in, 280–281 BCP/DR documentation review in, 281–282 benefits of, 267 and core elements of ODD, 268–269 document analysis stage, 272–278 document collection stage, 269–272 hedge fund ODD vs., 933 IT documentation review in, 281 meta risk evaluation in, 284–285 ongoing monitoring considerations for, 286–287 on-site manager visit stage, 282–284 scope and importance of ODD, 265–288 service provider review and confirmation in, 285–286 valuation analysis in context of documentation for, 278–288 Private equity portfolios, 293–306 benchmarks for, 226–231 construction of, 297–300 design of, 293–297 monitoring for management of, 246–247 objectives of, 291–292 risk-return management for, 300–306 value at risk for, 315 Private equity risk, 309–321 modeling of, 311–312 and peer-group-based benchmarks, 218 types of, 309–310 and value of private equity assets, 313–315 and VaR for private equity, 315–320 Private infrastructure funds, 490 Private-placement memorandum, 273 See also Offering memorandum Private real estate equity investment, 349, 349–352, 442–444 See also Unlisted real estate funds Private sector, infrastructure assets from, 481, 482 See also Public-private partnerships (PPPs) Probability of default (PD), 791 Processing spreads, 608, 608– 609 Producers, commodity, 613 Productivity, of agricultural infrastructure, 521 Profitability: of agricultural products, 512–513 of film production and distribution, 537–539 of spread trading, 607–608 Profit participation scheme (PPS), 1045–1048 Profits, AIFMD requirements on, 973 Progressive system, 114 Projected benefit obligation (PBO), 106–107 Project finance, 483, 1049, 1049–1050 Property authorized investment funds (PAIFs), 424 Property derivatives, 416–417 Property market (four-quadrant model), 355 Property market rent, 354 Property unit trusts (PUTs), 424 Pro rata allocation, 935 Protectionist policies, 136 Public commodity-based equities, 621–622 Public commodity partnerships, 624–625 Public equity indices, 213–215 Publicly-traded infrastructure companies, 491, 492 Publicly-traded infrastructure funds, 491 Public market equivalent (PME), 213, 213–215, 223–226 Public offerings, authorization for, 980 Public policy, 499 Public-private partnerships (PPPs), 483, 497–499 Public real estate investments, 349, 349–351 See also Listed real estate funds Purchasing power parity (PPP), 783–784 Purely random error, 378 Purely random noise, 378 PUTs (property unit trusts), 424 Qualified audit opinions, 280 Qualified majority, 191 Qualified purchaser, 960 Quality effect, 544 Quality spreads, 611 Quantitative directional strategies, 604 Quantity-based index, 634 Ratio spread, 855 RAUM (regulatory assets under management), 961 R&D (research and development), 546–547 Real assets, 525–526, 552–553 Real estate derivatives, 415–421 Real estate funds, 423–435 listed, 427–435 unlisted, 423–427 Real estate funds of funds, 425 Real estate index notes, 420 Real estate indices, 361 appraisal-based, 379–383 causes of differences in returns for, 439–448 derivatives of, 420, 421 exchange-traded funded based on, 428–429 major, 390–392 market-based vs appraisal-based returns for, 435–439 non-traded, 434, 434–436 performance of, 393–398 price smoothing for, 367–368 transaction-based, 384–389 unsmoothing data from, 372– 378 1070 Real estate investments, 343–358 advantages of, 343–344 asset allocation for, 345–347 attributes of, 343–345 categories of, 347–352 disadvantages of, 344–345 drivers of returns on, 352–354 forms of, 474–476 four-quadrant model for, 354–358 infrastructure investments vs., 496–497 styles of (see NCREIF real estate styles) Real estate investment trusts (REITs): advantages and disadvantages with, 429–430 corporate debt of, 476 debt, 392 equity, 396–398 global/international, 430–434, 470–474 as indicators of private real estate values, 442–444 as listed real estate funds, 427 mortgage, 392–396 non-traded, 434, 434–435 performance of, 393–398 Real estate market, 351, 356–358 Real estate mezzanine debt, 475–476 Real estate operating company (REOC), 427–428 Real estate pricing: noisy, 378–379 smoothing, 362–368 unsmoothing, 368–369, 371 Real estate returns: causes of differences in, 439–448 drivers of, 352–354 market- vs appraisal-based, 435–439 smoothing, 366 unsmoothing, 368–378 Real estate style boxes, 407, 407–408 Real estate styles See NCREIF real estate styles Real estate system, 354 Realization risk, 310 Realizations, 182, 329 Realized return See Distribution to paid-in (DPI) ratio Realized roll return, 641 Realized volatility, 839–841, 848–849 Real options embedded in commodity markets, 580 Reasonableness, of hedge fund indices, 926 Rebalancing, 79 with commodity futures, 586–588, 599–600 by endowments, 79, 91–93 INDEX Rebalancing yield, 586 Rebates, on short interest, 732 Receivables, credit card, 1016, 1016–1017 Recency bias, 306 Reconciliation, 935 Record keeping, 963–964 Recourse loan, 1017 Recovery of returns, to volatility strategies, 845 Recovery rate, 803–804 Redemption gates, 952, 952–953 Reduced-form credit risk models, 801–805 Reemerging team, 243 Reflective of current investment opinion (benchmark criteria), 219 Regime change, 846, 846–848 Regime switching model, 847 Registration: European regulations on, 971–973 U.S regulations on, 960–962 Regulated pricing, 480, 486–487 Regulations, 957–987 on alternative investments in Europe, 969–979 on alternative investments in United States, 958–969 on alternative mutual funds, 892 as external constraint, 18 foundational principles for, 957–958 on funds of hedge funds, 915 on hedge funds in Asia, 979–982 on infrastructure investments, 486–487, 499 Regulatory assets under management (RAUM), 961 Regulatory risk, 552 REITs See Real estate investment trusts Relative purchasing power parity, 783 Relative return, 212 Relative value arbitrage, 576, 576–577 in derivative pricing, 712 limits to, 711–717 and market efficiency, 716–717 opportunities for, 713–714 Relative value strategies, 711–743 for commodity investments, 605, 612 convertible arbitrage, 717–733 for managed futures, 656–657 pairs trading, 733–741 Relative value volatility funds, 860–862 Remuneration, AIFMD requirements on, 973 REOCs (real estate operating companies), 427, 427–428 Repeat-sales method (RSM), 384, 384–386, 388–389 Replacement capital, 178 Replicability, of hedge fund indices, 926 Replication: algorithmic approach to, 885–890 factor-based approach to, 877–882 payoff-distribution approach to, 882–885 Reported prices, 365–366 Reported returns, 366 Reporting: by chief compliance officers, 962–963 in investment policy statements, 19 requirements on, 966–968, 975–976 Reporting lag, 928 Reporting obligations, with patents, 548 Representativeness, 715, 926 Rescue (strategy), 178 Research and development (R&D), 546–547 Reservation of rights provisions, 547 Reservation price, 378, 378–379 Reserve (hedge fund), 953 Reserve account, 125–128 Reserve adequacy, 133, 133–134 Reserve investment funds, 130 Residential real estate, 348, 348–349, 390 Residual value to paid-in (RVPI) ratio, 210, 222–223 Resilience, of infrastructure assets, 487 Resistance levels, 655 Resources: in core-satellite approach, 302 for hedge fund ODD, 950–952 PE funds-of-funds as, 186 Restricted list, 943 Restructuring, 810–811, 815–816, 818 Retained earnings/total assets ratio, 806–807 Retirees, risks for, 118–120 Retirement: financial phases relative to, 118 Retirement income, 117–122 Retirement income-replacement ratio, 105 Return(s) See also Performance; specific types on agricultural assets, 508–514 characterizing real estate based on, 351–352 on commodity futures, 581–582 1071 Index on commodity indices, 631–634, 639–644 on commodity spot prices, 563–564 in convertible arbitrage strategies, 731–733 on CTAs, 667–669, 677–680 in distressed debt investing, 813–815 for family offices, 171 on farmland investments, 514–520 on film production and distribution, 538–541 from fundamental equity long/short strategy, 761–765 for funds of funds, 869–870 on global macro hedge fund strategies, 771 on hedge funds, 870–871 in mean-variance optimization, 22–23 for noncore real estate assets, 412–415 in pairs trading, 739–741 for PE funds, 206–207 predicting, 42–43 on risk factors, 65–66 and strategic asset allocation, 19–21 on timberland investments, 523–524 utility function for evaluating, 10–11 on visual works of art, 542–546 on volatility derivatives, 833–835 on volatility hedge funds, 860–861 on volatility products, 855 from volatility strategies, 845 Return attribution, 639–640, 763–765 Return factor exposure, 833–834, 914 Return on equity (ROE), 767 Return smoothing, 366, 411–412 Return target, 75, 75–76 Return to commodity beta, 619 Return unsmoothing: example of, 372–378 method for, 368–372 Revenues, film, 534–535 Reverse cash-and-carry arbitrage, 574 Revolver, 826 See also revolving line of credit Revolving line of credit, 826, 826–827 ρ (first-order autocorrelation coefficient), 369–370, 374 Risk(s) See also specific types with agricultural assets, 526 with alternative mutual funds, 891–893 with asset-based lending, 828–830 characterizing real estate based on, 351–352 and commodity speculation, 569–570 with core real estate, 411–412 and endowment model, 84–96 estimation of, 439 for funds of funds, 869–870 with intellectual property investments, 553 with interest rate swaps, 1011–1013 in mean-variance optimization, 23 and NCREIF real estate styles, 409–415 in pairs trading, 739–741 with patents, 551–552 with PE fund intermediation, 181 and pension plan liabilities, 102–103 for retirees, 118–120 and strategic asset allocation, 19–21 with timberland investments, 524 utility function for evaluating, 10–11 with viatical settlements, 1036–1037 Risk-adjusted returns, 489 Risk allocation, 67, 688, 689 Risk arbitrage, 714 Risk assignment, 273–274, 274 Risk aversion, 12, 15–17, 25 Risk budgeting, 50, 50–55 Risk control model, 948 Risk factor(s): analysis of, 62–63 asset allocation based on, 67–68 description of, 63–65 exposure to, 119–120, 680–685 and investability, 66–67 market conditions and returns on, 65–66 risk allocation based on, 67 risk budgeting with, 54–55 and risk premiums, 65 volatility as, 834–835 Riskless assets, 23–24 Riskless rate, Merton model and, 798 Risk management: by commodity producers, 613 for commodity trading advisers, 689–700 in convertible arbitrage strategies, 731 in defined benefit plans, 102 in delegated approach to hedge fund investing, 901 and European regulations on alternative investments, 974–975 by family offices, 171–172 of first-generation wealth, 150–152 for global macro hedge fund strategies, 784–785 with Greeks, 838 with long/short strategy, 759–760 for private equity portfolios, 300–306 with real estate derivatives, 416 Risk measurement risk, 476 Risk parity, 55, 55–62 economic rationale for, 58–59 equally risk-weighted approach vs., 911 and equally weighted vs volatility-weighted portfolios, 60–62 implementing, 55–56 portfolio construction with, 56–57 unsupported rationales for, 59–60 Risk premium(s): and adaptive markets hypothesis, 659 and asset allocation to commodity futures, 600–601 credit, 64 positive, 600–601 and returns on noncore real estate assets, 413–414 and risk factors, 65 roll, 65 with short volatility strategies, 842–844 size, 64 term, 64 value, 64 volatility, 65, 834, 842–845 Risk tolerance, pension plan sponsors’, 103–104 Risky assets, 23–24, 26–28, 878 Risky debt, 795–796 Robust optimization, 49 ROE (return on equity), 767 Roll method, 635 Rollover, 403 Rollover entry points, 639 Rollover exit points, 639 Rollover risk, 1032 Roll premium, 65 Roll return, 632 Rotation age, 525 Roundtrip costs, 453 Row cropland, 518 Row crops, 509 RSM See Repeat-sales method Rule 206(4)-7, 962 1072 Russia, 819 RVPI (residual value to paid-in) ratio, 210, 222–223 Sales, of patents, 551 Sales comparison approach, 380, 382 Sales/total assets ratio, 807 Sample biases, 389 Santiago Principles, 137–138 Satellite portfolio, 301 Savings funds, 129, 129–130 Scaling down, 186 Scaling up, 186 Scarcity, of inputs, 526, 553 Scenario analysis, 697 See also Stress tests Scenarios, cash flow modeling based on, 336–337 Schedule of investments, 280 Scheme of arrangement, 817, 817–818 Seasonal overadvance, 825 Secondary private equity market, 253–260 Secondary real estate markets, 351 Secondary transactions, 253 Secondary transactions in private equity, 184 Second generation, family office in, 152–155 Second-generation commodity indices, 637, 638 Section 13(d), 966 Section 13(f), 966, 966–967 Section 13(g), 967 Section 13(h), 967 Section 16, 967 Section 1256 contracts, 159 Sector limits, 18 Sector neutral, 736 Sector risk, 552 Sector scope, 485–486, 495–496 Sector specialists, 756, 756–757 Sector-specific approach to long/short strategy, 756–757 Secular market trends, 238 Securities Act of 1933, 958, 958–960 Securities and Exchange Commission (SEC), 958 enforcement of financial regulations by, 958–969 inspections by, 964–966 regulations on family offices, 147, 150 Securities and Exchange Surveillance Commission (SESC), 982 Securities and Futures Commission (SFC), 980 Securities Exchange Act of 1934, 958, 960, 966–967 Securitization, 440, 550 Security interest, 829 INDEX Security selection, 3, 79 Segmentation, 443 Selection bias, 217, 905 Selection skills, fund managers’, 186–187 Selective hedging, 613 Sellers, motivations of PE, 256–257 Selling straddles, 93 Selling strangles, 93 Sell-off of limited partnership shares, 329 Senior secured debt, 536 Sentiment, 749, 749–750 Service provider review and confirmation, 285–286 Settlement(s): internal, 934 life insurance, 1034–1035 viatical, 1035–1037 Shared operational due diligence approach, 951 Short interest, rebates on, 732 Short-sale risk, 741 Short straddle, 836 Short strangle, 837 Short-term capital gains, 158, 158–159 Short-term interest rates: in Cox, Ingersoll, and Ross model, 994, 995 in Ho and Lee model, 997–998 and Vasicek’s model, 992–993 Short-term price fluctuations, in commodities, 565 Short volatility funds, 860–863 Short volatility position, 834 Short volatility strategy(-ies), 835–838 iron butterflies and condors as, 837–838 option writing as, 835–836 risk premium with, 842–844 straddles and strangles as, 836–837 Side letter, 275 Signal observation period, 662, 662–663 Signal-to-noise ratio (SNR), 661, 661–663 Simple average performance measures, 226–227 Simulation analysis, 697–698 Singapore, 141, 980, 981 Single-strategy FoFs, 904 60/40 investors, CTAs for, 687–688 Size premiums, 64 Skewness, 32, 601–602, 680 See also Higher moments Skew option spreads See Intra-asset option spreads Skews, volatility, 843, 856 Slate equity financing, 536 Smile, 842 Smirk, 842 Smoothed series, 362 Smoothing: price, 362–368 return, 366 and unsmoothing, 368–378 Social infrastructure assets, 480 Social security plans, 113–114 Soft call, 722 Solo deals, 219 South Korea, 980–982 Sovereign wealth, 125–128 Sovereign wealth funds (SWFs), 125–142 as asset owners, 8–9 in China, 140–141 emergence of, 134–136 governance of, 136–138 management of, 131–134 motivations for establishing, 131 in Norway, 138–140 in Singapore, 141 and sources of sovereign wealth, 125–128 types of, 128–131 S&P 500 Short-term VIX Futures Index, 851 S&P 500 VIX Short-Term VIX Futures Index, 851–852 Specialization, 521 Specified in advance (benchmark criteria), 219 Speculation, in commodity markets, 568–570 Speed of investment, by family offices, 171 Spending rate, 74, 74–75, 85–87 Spillover effects, 534 Spinouts, 188, 188–190 Spoilage costs, 572 Spot commodity markets, 561–565 Spot returns, 632–633, 640 Spread risk, 567 Spreads: commodity, 605, 605–611 credit, 795–796, 803–804 divergent, 737 horizontal, 856, 856–857 ratio, 855 vertical, 855, 855–856 Stabilization fund, 128–129, 129 Stale pricing, 217 Standard deviation, 10, 25 Start-up stage, 177 Statement of assets and liabilities, 280 Statement of cash flows, 280 Statement of changes, 280 Statement of operations, 280 Statistical arbitrage See Pairs trading Steering committee, 814, 814–815 Step-up rates, subordinated debt with, 1042–1043 1073 Index Sterilization policy, 133 Stock market-based property return indices (SMPRIs), 421 Stock-out, 578 Stocks See also Equity investments (equities) and convertible bonds and prices of, 727–728 correlation with commodity futures of, 593–597 Storage, 570–571, 578–579 Storage costs, 161–162, 572 Storage strategies, 612 Story rights acquisition (stage), 535 Straddles, 836–837 Strangles, 836–837 Strategic asset allocation (SAA): adding value to funds of hedge funds with, 919, 920, 922 for pension plans, 104–105 and risk/return, 19–21 tactical asset allocation vs., 35–36 Strategic commitment steering, 330 Stress, market, 683 Stress test, 697, 697–698 Structural credit risk models, 793–801 Structural illiquidity, 325 Structured products, 991–1018, 1021–1051 asset-backed securities, 1013–1017 fixed-income derivatives, 1001–1005 insurance-linked securities, 1021–1037 interest rate derivatives, 999–1013 mezzanine debt, 1037–1051 term structure models, 991–999 Style drift, 247–248, 406 Subordinated debt, 1042–1048 Subsidies, government, 513–514 Substitution spreads, 609, 609–611 Substitution test statistic, 609–610 Sub-threshold funds, 972 Succession planning, 167 Supercycles, 564, 564–565 Super gap financing, 537 Supply: of agricultural products, 505 of infrastructure assets, 482–483 Supporting directors See Associate directors Support levels, 655 Surpluses, 108, 126, 571 Surplus risk, 108, 108–109 Surrender value, 1034 Survivorship bias, 217, 905 Sustainability, of family wealth, 165 Swap contracts (swaps): commodity index, 620, 620–621 correlation, 853, 853–855 interest rate, 1005, 1005–1013 longevity, 1031, 1031–1032 total return property, 417, 417–419 variance, 848–849 Swap rate, 1007 Swap rate curve, 1007 Sweep inspections, 966 SWOT analysis, 753 Synchronization risk, 740 Synthetic put, 730 Synthetic secondaries, 254, 254–255 Synthetic weather derivative, 606 Systematic global macro hedge fund strategies, 770 Systematic managed futures strategies: portfolio construction using, 671–675 returns for discretionary vs., 677–680 risk factor exposure for discretionary vs., 680–681 Systematic risk See Beta(s) T+1 basis, 935 Tactical asset allocation (TAA), 35–45 advantages of, 40–42 cost of actively managing alternative assets, 37–40 by endowments, 93–94 fundamental analysis underlying, 43–44 and Fundamental Law of Active Management, 36–38 and funds of hedge funds, 920–921, 923 and investment policy statements, 21 with multistrategy funds, 919 and return prediction, 42–43 successful, 42–45 technical analysis underlying, 44–45 Tactical FoFs, 904 Tail risk, 94–96, 864–865 Tail risk funds, 859, 859–861, 863–865 Target-date fund, 117 Taxation: deferred, 459–460 depreciation tax shields, 457–459 estate taxes, 167 gains, 459–460 income taxes, 157–160, 457–461 and managed futures, 670 and market- vs appraisal-based indices, 443–444 Tax credits, film production, 536 Tax efficiency, 157–158, 158, 160 Tax status, as external constraint, 18 Technical analysis, 44–45 Technical default, 808 Technological risks, 484, 487, 551 Temasek Holdings (Singapore), 141 Temporal lag bias, 378 10-year Treasuries, 413–414 Tenor, 836 Terminated pension plan, 110 Termination, in limited partnerships, 196 Terming out debt, 811 Term loan, 827 Term premiums, 64 Term structure, 991–999 arbitrage-free models of, 996–999 of CBOE Volatility Index, 850–851 equilibrium models of, 992–996 modeling, 991–992 Tertiary real estate markets, 351 Theory of storage, 570–571 Third-generation commodity indices, 637, 637–639 Third-party compliance consultants, 945 Third-party equity, 536 Three-way reconciliation, 935 Timberland investments: characteristics of, 505 global trends in, 522–525 investment in other assets vs., 525–527 real estate indices of, 392 Time horizon: in core-satellite approach, 302 for infrastructure investments, 487–488 as internal constraint, 17–18 for managed futures investments, 658 for real asset investments, 526 Time-series momentum, 653, 653–654, 683 Top-down approach to portfolio construction, 297, 297–299 Top-down asset allocation, 346, 346–347 Top-down fundamental analysis, 753, 753–754 Top performance, 237–238 Total return, 641 See also Total value to paid-in (TVPI) ratio Total return index, 634 Total return investor, 85 Total return property swap, 417, 417–419 Total value to paid-in (TVPI) ratio, 207, 210, 221–222 Trackers See Hedge fund replication products Tracking error, 927–928 Track record, 242 Trade blotter, 934 Trade break, 935 Trade claims, 809 1074 Traders, noise, 714, 714–715 Trades: carry, 65 correlation, 611 directional currency, 772–775 dispersion, 854–855 execution of, 675, 758–759, 934 winning ratio of, 680 Trading: currency, 772–784 insider, 943, 943–944 pairs, 733–741 personal, 943 volatility, 730 Trading level, 691, 691–692 Trading-oriented distressed strategy, 820–821, 821 Trading risks, 566–567 Trading signals, 655 Traditional overadvance, 825, 825–826 Trailing stop, 655 Transaction-based price index, 367, 384–389 See also Market-based real estate indices Transaction costs, 464–465 Transaction noise, 362 Transaction price error, 379 Transaction price noise, 379 Transforming commodities, 566 Transition matrices, 239–240 Transparency: of funds of hedge funds, 916 of hedge fund indices, 927 of managed futures, 670 and private equity monitoring, 249–251 as replication benefit, 875 Transportation strategies, 612 Treasury investments, 329 Trend-following models for currency trading See Momentum models for currency trading True prices, 365–366, 371 True returns, 366, 370–371 Turnover, real estate, 444 TVPI ratio See Total value to paid-in ratio Two-way reconciliation, 935 UCITS (Undertakings for Collective Investment in Transferable Securities), 971, 971–972 Ultra-high-net-worth individuals, family offices of See Family offices Unambiguousness, 218, 926 Unanticipated inflation, 353 Unauthorized PUTs, 424 Unbiased expectation hypothesis, 576, 992 Unbundled intellectual property, 533 INDEX Uncovered interest rate parity, 780, 780–781 Underpricing, of convertible bonds, 718–720 Undertakings for Collective Investment in Transferable Securities (UCITS), 971, 971–972 Underwater (term), 39 Undrawn capital investment strategies, 330 Undrawn commitments, 313–315 Unencumbered cash, 938 United Kingdom: bankruptcy laws, 817–818 Exchange Rate Mechanism crisis, 774, 775 REITs, 471–472 United States: bankruptcy laws, 816–817 farmland/timberland investments, 504, 505 regulations on alternative investments, 958–969 REITs, 471–472 returns to farmland, 514–520 Unlisted real estate funds, 423–427, 441–442 See also Appraisal-based indices; Private real estate equity investments Unrealized return See Residual value to paid-in (RVPI) ratio Unregulated pricing, 480 Unsmoothing, 361 and market- vs appraisal-based indices, 447–448 price, 368–369, 371 return, 368–378 Upstream commodity producers, 613 Utility, 11 Utility function, 10–15, 11 Valuation: AIFMD requirements on, 973 in context of documentation, 278–288 of convertible securities, 723–727 of growth annuities, 120–122 of interest rate swaps, 1007–1011 in long/short strategy, 754–756, 768 of PE assets, 206 of private equity assets, 313–315 Valuation bias, 217 Valuation committee, 278, 278–279 Valuation risks, 822–823, 828–829 Value-added real estate, 412–415 Value approach, 752 Value at risk (VaR): from cash flow at risk, 315–320 for managed futures, 694–696 for private equity, 315–320 utility functions with, 14–15 Value-based index, 634 Value long/short managers, 752 Value models for currency trading, 783–784 Value premiums, 64 Value trap, 747 VaR See Value at risk Variance, 12–14, 374–375, 1053 Variance swaps, 848–849 Vasicek’s model, 992, 992–996 VC (venture capital) transactions, 178–181 Vega risk, 859–860 Venture capital (VC) transactions, 178–181 Verifiability, of hedge fund indices, 926 Verification, asset and position, 942 Vertical spread, 855, 855–856 Viatical settlement, 1035, 1035–1037 View commonality, 879 Visual works of art, 160–161, 541–546 VIX (CBOE Volatility Index), 849, 849–851 VIX products See CBOE Volatility Index products VIX term structure, 850, 850–851 Volatility(-ies), 833–865 cash flow, 316–318 and geometric mean returns, 600 implied, 841–842 managing portfolio exposure to, 835–845 of market- vs appraisal-based indices, 437–439 modeling of volatility processes, 845–848 of operating cash flows, 487 option-based strategies for trading, 855–859 realized, 839–841, 848–849 as return factor exposure, 833–834 returns on volatility derivatives, 833–835 as risk factor, 834–835 sensitivity of Merton model to, 798 Volatility anomaly, 59 Volatility asymmetry, 580 Volatility clustering, 847, 847–848 Volatility derivatives, 833–835, 834 Volatility diffusion, 846 Volatility exposure, managing, 835–845 Volatility hedge funds, 859859– 865 Volatility jump, 846 1075 Index Volatility models for currency trading, 784 Volatility process modeling, 845– 848 Volatility products, 848–855 Volatility risk premium, 65, 834, 842–845 Volatility skew, 842, 856 Volatility targeting, 671–672, 672 Volatility trading, 730 Volatility-weighted portfolios, 60–62 Volcker Rule, 959 Warrants, 1048 Wealth: concentrated, 150, 150–152 dynastic, 165 family, 165–166 sovereign, 125–128 (see also Sovereign wealth funds [SWFs]) Wealth management, 157–158, 165–166 Weighting: assets under management, 907–909 for commodity indices, 633, 635–636, 639 equal, 60–62, 909–911 for replication, 878, 879 risk, 909, 911 in tactical asset allocation, 921 volatility, 60–62 Winning ratio of trades, 680 Working capital/total assets ratio, 806 Working curve, 578, 578–579 Writing options, 835–837 Yield(s): agricultural, 509–512 collateral, 639 convenience, 570–574 crop, 509, 509–512 for infrastructure investments, 488 of mezzanine debt, 1040– 1041 rebalancing, 586 Yield curve See Term structure Z-score model, 806, 806–808 Z-scores, 806–808 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Appendix A Alternative Presentations of Mean-Variance Optimization 1053 Index 1055 Preface A lternative Investments: CAIA Level II is designed as the primary reading resource for the Level II exam... customers’ professional and personal knowledge and understanding www.ebook3000.com Alternative Investments CAIA Level II Third Edition HOSSEIN B KAZEMI KEITH H BLACK DONALD R CHAMBERS www.ebook3000.com... Chartered Alternative Investment Analyst (CAIA) Association’s Charter program To ensure that the material best reflects up-to-date practices in the area of alternative investments, the CAIA Association