© CFA Institute For candidate use only Not for distribution ALTERNATIVE INVESTMENTS AND PORTFOLIO MANAGEMENT CFAđ Program Curriculum 2020 ã LEVEL I ã VOLUME â CFA Institute For candidate use only Not for distribution © 2019, 2018, 2017, 2016, 2015, 2014, 2013, 2012, 2011, 2010, 2009, 2008, 2007, 2006 by CFA Institute All rights reserved This copyright covers material written expressly for this volume by the editor/s as well as the compilation itself It does not cover the individual selections herein that first appeared elsewhere Permission to reprint these has been obtained by CFA Institute for this edition only Further reproductions by any means, electronic or mechanical, including photocopying and recording, or by any information storage or retrieval systems, must be arranged with the individual copyright holders noted CFA®, Chartered Financial Analyst®, AIMR-PPS®, and GIPS® are just a few of the trademarks owned by CFA Institute To view a list of CFA Institute trademarks and the Guide for Use of CFA Institute Marks, please visit our website at www.cfainstitute.org This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service If legal advice or other expert assistance is required, the services of a competent professional should be sought All trademarks, service marks, registered trademarks, and registered service marks are the property of their respective owners and are used herein for identification purposes only ISBN 978-1-946442-81-9 (paper) ISBN 978-1-950157-05-1 (ebk) 10 © CFA Institute For candidate use only Not for distribution CONTENTS How to Use the CFA Program Curriculum Background on the CBOK Organization of the Curriculum Features of the Curriculum Designing Your Personal Study Program Feedback vii vii viii viii x xi Alternative Investments Study Session 17 Alternative Investments Reading 50 Introduction to Alternative Investments Introduction Alternative Investments Categories of Alternative Investments Returns to Alternative Investments Portfolio Context: Integration of Alternative Investments with Traditional Investments Investment Structures Hedge Funds Hedge Fund Strategies Hedge Funds and Diversification Benefits Hedge Fund Fees and Other Considerations Hedge Fund Valuation Issues Due Diligence for Investing in Hedge Funds Private Equity Private Equity Structure and Fees Private Equity Strategies Private Equity: Diversification Benefits, Performance, and Risk Portfolio Company Valuation Private Equity: Investment Considerations and Due Diligence Real Estate Forms of Real Estate Investment Real Estate Investment Categories Real Estate Performance and Diversification Benefits Real Estate Valuation Real Estate Investment Risks Commodities Commodity Derivatives and Indexes Other Commodity Investment Vehicles Commodity Performance and Diversification Benefits Commodity Prices and Investments Infrastructure Categories of Infrastructure Investments Forms of Infrastructure Investments indicates an optional segment 5 10 12 13 14 15 16 20 20 27 28 30 31 32 36 38 39 40 41 42 45 46 48 48 50 50 51 52 55 55 56 ii © CFA Institute For candidate use only Not for distribution Contents Risk and Return Overview Other Alternative Investments Risk Management Overview Investment and Risk Management Process Risk–Return Measures Due Diligence Overview Summary Practice Problems Solutions 56 57 57 57 59 60 62 65 70 Study Session 18 Portfolio Management (1) 77 Reading 51 Portfolio Management: An Overview Introduction A Portfolio Approach to Investing Historical Example of Portfolio Diversification: Avoiding Disaster Portfolios: Reduce Risk Portfolios: Composition Matters for the Risk–Return Trade-off Historical Portfolio Example: Not Necessarily Downside Protection Portfolios: Modern Portfolio Theory Steps in the Portfolio Management Process Step One: The Planning Step Step Two: The Execution Step Step Three: The Feedback Step Types of Investors Individual Investors Institutional Investors The Asset Management Industry Active versus Passive Management Traditional versus Alternative Asset Managers Ownership Structure Asset Management Industry Trends Mutual Funds and Pooled Investment Products Mutual Funds Types of Mutual Funds Separately Managed Accounts Exchange- Traded Funds Hedge Funds Private Equity and Venture Capital Funds Summary Practice Problems Solutions 79 79 80 80 82 85 85 88 89 89 90 92 93 93 94 99 100 101 101 101 104 104 106 107 108 108 109 110 112 114 Reading 52 Portfolio Risk and Return: Part I Introduction Investment Characteristics of Assets Return 115 115 116 116 Portfolio Management indicates an optional segment Contents Reading 53 © CFA Institute For candidate use only Not for distribution iii Other Major Return Measures and their Applications Historical Return and Risk Other Investment Characteristics Risk Aversion and Portfolio Selection The Concept of Risk Aversion Utility Theory and Indifference Curves Application of Utility Theory to Portfolio Selection Portfolio Risk Portfolio of Two Risky Assets Portfolio of Many Risky Assets The Power of Diversification Efficient Frontier and Investor’s Optimal Portfolio Investment Opportunity Set Minimum- Variance Portfolios A Risk-Free Asset and Many Risky Assets Optimal Investor Portfolio Summary Practice Problems Solutions 130 133 137 140 140 141 146 149 149 157 158 163 164 165 166 169 175 177 185 Portfolio Risk and Return: Part II Introduction Capital Market Theory Portfolio of Risk-Free and Risky Assets The Capital Market Line Pricing of Risk and Computation of Expected Return Systematic Risk and Nonsystematic Risk Calculation and Interpretation of Beta The Capital Asset Pricing Model Assumptions of the CAPM The Security Market Line Applications of the CAPM Beyond the Capital Asset Pricing Model Limitations of the CAPM Extensions to the CAPM Portfolio Performance Appraisal Measures The Sharpe Ratio The Treynor Ratio M2: Risk-Adjusted Performance (RAP) Jensen’s Alpha Applications of the CAPM in Portfolio Construction Security Characteristic Line Security Selection Implications of the CAPM for Portfolio Construction Summary Practice Problems Solutions 191 191 192 192 196 204 204 206 213 213 215 217 219 219 220 222 222 223 224 225 228 228 229 230 233 235 241 indicates an optional segment iv © CFA Institute For candidate use only Not for distribution Contents Study Session 19 Portfolio Management (2) 245 Reading 54 Basics of Portfolio Planning and Construction Introduction Portfolio Planning The Investment Policy Statement Major Components of an IPS Gathering Client Information Portfolio Construction Capital Market Expectations The Strategic Asset Allocation Steps Toward an Actual Portfolio ESG Considerations in Portfolio Planning and Construction Alternative Portfolio Organizing Principles Conclusion and Summary Practice Problems Solutions 247 247 248 248 249 262 265 266 266 274 278 279 280 283 287 Reading 55 Introduction to Risk Management Introduction The Risk Management Process Risk Governance An Enterprise View of Risk Governance Risk Tolerance Risk Budgeting Identification of Risks Financial Risks Non- Financial Risks Interactions between Risks Measuring and Modifying Risks Drivers Metrics Methods of Risk Modification Summary Practice Problems Solutions 289 289 291 299 299 301 303 306 307 308 312 315 316 317 321 329 332 335 Reading 56 Technical Analysis Introduction Technical Analysis: Definition and Scope Principles and Assumptions Technical and Fundamental Analysis Technical Analysis Tools Charts Trend Chart Patterns Technical Indicators Cycles Elliott Wave Theory 337 337 338 338 340 342 342 353 355 366 384 385 indicates an optional segment Contents Reading 57 © CFA Institute For candidate use only Not for distribution v Intermarket Analysis Summary Practice Problems Solutions 388 390 393 398 Fintech in Investment Management Introduction What Is Fintech? Big Data Sources of Big Data Big Data Challenges Advanced Analytical Tools: Artificial Intelligence and Machine Learning Types of Machine Learning Data Science: Extracting Information from Big Data Data Processing Methods Data Visualization Selected Applications of Fintech to Investment Management Text Analytics and Natural Language Processing Robo- Advisory Services Risk Analysis Algorithmic Trading Distributed Ledger Technology Permissioned and Permissionless Networks Applications of Distributed Ledger Technology to Investment Management Summary Practice Problems Solutions 401 401 402 403 404 406 406 408 409 409 410 411 411 413 415 415 416 418 418 420 422 424 Glossary G-1 indicates an optional segment © CFA Institute For candidate use only Not for distribution © CFA Institute For candidate use only Not for distribution How to Use the CFA Program Curriculum Congratulations on your decision to enter the Chartered Financial Analyst (CFA®) Program This exciting and rewarding program of study reflects your desire to become a serious investment professional You are embarking on a program noted for its high ethical standards and the breadth of knowledge, skills, and abilities (competencies) it develops Your commitment to the CFA Program should be educationally and professionally rewarding The credential you seek is respected around the world as a mark of accomplishment and dedication Each level of the program represents a distinct achievement in professional development Successful completion of the program is rewarded with membership in a prestigious global community of investment professionals CFA charterholders are dedicated to life-long learning and maintaining currency with the ever-changing dynamics of a challenging profession The CFA Program represents the first step toward a career-long commitment to professional education The CFA examination measures your mastery of the core knowledge, skills, and abilities required to succeed as an investment professional These core competencies are the basis for the Candidate Body of Knowledge (CBOK™) The CBOK consists of four components: ■■ A broad outline that lists the major topic areas covered in the CFA Program (https://www.cfainstitute.org/programs/cfa/curriculum/cbok); ■■ Topic area weights that indicate the relative exam weightings of the top-level topic areas (https://www.cfainstitute.org/programs/cfa/curriculum/overview); ■■ Learning outcome statements (LOS) that advise candidates about the specific knowledge, skills, and abilities they should acquire from readings covering a topic area (LOS are provided in candidate study sessions and at the beginning of each reading); and ■■ The CFA Program curriculum that candidates receive upon examination registration Therefore, the key to your success on the CFA examinations is studying and understanding the CBOK The following sections provide background on the CBOK, the organization of the curriculum, features of the curriculum, and tips for designing an effective personal study program BACKGROUND ON THE CBOK The CFA Program is grounded in the practice of the investment profession Beginning with the Global Body of Investment Knowledge (GBIK), CFA Institute performs a continuous practice analysis with investment professionals around the world to determine the competencies that are relevant to the profession Regional expert panels and targeted surveys are conducted annually to verify and reinforce the continuous feedback about the GBIK The practice analysis process ultimately defines the CBOK The © 2019 CFA Institute All rights reserved vii viii © CFA Institute For candidate use only Not for distribution How to Use the CFA Program Curriculum CBOK reflects the competencies that are generally accepted and applied by investment professionals These competencies are used in practice in a generalist context and are expected to be demonstrated by a recently qualified CFA charterholder The CFA Institute staff, in conjunction with the Education Advisory Committee and Curriculum Level Advisors, who consist of practicing CFA charterholders, designs the CFA Program curriculum in order to deliver the CBOK to candidates The examinations, also written by CFA charterholders, are designed to allow you to demonstrate your mastery of the CBOK as set forth in the CFA Program curriculum As you structure your personal study program, you should emphasize mastery of the CBOK and the practical application of that knowledge For more information on the practice analysis, CBOK, and development of the CFA Program curriculum, please visit www.cfainstitute.org ORGANIZATION OF THE CURRICULUM The Level I CFA Program curriculum is organized into 10 topic areas Each topic area begins with a brief statement of the material and the depth of knowledge expected It is then divided into one or more study sessions These study sessions—19 sessions in the Level I curriculum—should form the basic structure of your reading and preparation Each study session includes a statement of its structure and objective and is further divided into assigned readings An outline illustrating the organization of these 19 study sessions can be found at the front of each volume of the curriculum The readings are commissioned by CFA Institute and written by content experts, including investment professionals and university professors Each reading includes LOS and the core material to be studied, often a combination of text, exhibits, and in-text examples and questions A reading typically ends with practice problems followed by solutions to these problems to help you understand and master the material The LOS indicate what you should be able to accomplish after studying the material The LOS, the core material, and the practice problems are dependent on each other, with the core material and the practice problems providing context for understanding the scope of the LOS and enabling you to apply a principle or concept in a variety of scenarios The entire readings, including the practice problems at the end of the readings, are the basis for all examination questions and are selected or developed specifically to teach the knowledge, skills, and abilities reflected in the CBOK You should use the LOS to guide and focus your study because each examination question is based on one or more LOS and the core material and practice problems associated with the LOS As a candidate, you are responsible for the entirety of the required material in a study session We encourage you to review the information about the LOS on our website (www cfainstitute.org/programs/cfa/curriculum/study-sessions), including the descriptions of LOS “command words” on the candidate resources page at www.cfainstitute.org FEATURES OF THE CURRICULUM OPTIONAL SEGMENT Required vs Optional Segments You should read all of an assigned reading In some cases, though, we have reprinted an entire publication and marked certain parts of the reading as “optional.” The CFA examination is based only on the required segments, and the optional segments are included only when it is determined that they might ... 55 56 ii © CFA Institute For candidate use only Not for distribution Contents Risk and Return Overview Other Alternative Investments Risk Management Overview Investment and Risk Management. .. ethically grounded investment professionals We rely on candidate and investment professional comments and feedback as we work to improve the curriculum, supplemental study tools, and candidate resources... Alternative Investments by Terri Duhon, George Spentzos, CFA, FSIP, and Scott D Stewart, PhD, CFA © CFA Institute For candidate use only Not for distribution © CFA Institute For candidate use