Оглавление
Hossein Kazemi. Alternative Investments
Preface
Foundation
Benefits
The CAIA Programs and the CAIA Alternative Investment Analyst Series
Acknowledgments
About the Authors
PART One. Introduction to Alternative Investments
CHAPTER 1. What Is an Alternative Investment?
1.1 Alternative Investments by Exclusion
1.2 Alternative Investments by Inclusion
1.2.1 Real Assets
1.2.2 Hedge Funds
1.2.3 Private Equity
1.2.4 Structured Products
1.2.5 Limits on the Categorizations
1.3 Structures among Alternative Investments
1.3.1 Structures as Distinguishing Aspects of Investments
1.3.2 Structures and the Four Alternative Investment Types
1.3.3 Limits on Categorization
1.4 Investments Are Distinguished by Return Characteristics
1.4.1 Diversification
1.4.2 Illiquidity
1.4.3 Inefficiency
1.4.4 Non-Normality
1.5 Investments Are Distinguished by Methods of Analysis
1.5.1 Return Computation Methods
1.5.2 Statistical Methods
1.5.3 Valuation Methods
1.5.4 Portfolio Management Methods
1.6 Investments Are Distinguished by Other Factors
1.7 Goals of Alternative Investing
1.7.1 Active Management
1.7.2 Absolute and Relative Returns
1.7.3 Arbitrage, Return Enhancers, and Risk Diversifiers
1.8 Overview of This Book
Review Questions
CHAPTER 2. The Environment of Alternative Investments
2.1 The Participants
2.1.1 The Buy Side
2.1.2 The Sell Side
2.1.3 Outside Service Providers
2.2 Financial Markets
2.2.1 Primary Capital Markets
2.2.2 Secondary Capital Market
2.2.3 Third and Fourth Private Markets
2.3 Regulatory Environment
2.3.1 Five Primary Forms of Hedge Fund Regulation
2.3.2 U.S. Hedge Fund Regulations
2.3.3 Non-U.S. Hedge Fund Regulations
2.4 Liquid Alternative Investments
2.4.1 The Spectrum of Liquid Alternatives Products
2.4.2 Growth and Growth Factors in Liquid Alternatives
2.4.3 Three Constraints against Achieving Alternative Investment Benefits through Liquid Products
2.4.4 Four Factors Determining Performance of Liquid Alternatives Compared to Private Placements
2.4.5 Empirical Analysis of Liquid Alternative Investment Performance
2.5 Taxation
2.5.1 Income Taxation
2.5.2 Other Taxes and Withholding
Review Questions
CHAPTER 3. Quantitative Foundations
3.1 Return and Rate Mathematics
3.1.1 The Compounding Assumption
3.1.2 Logarithmic Returns
3.1.3 The Return Computation Interval and Aggregation
3.2 Returns Based on Notional Principal
3.2.1 The Challenge of Returns on Positions with Zero Value
3.2.2 Notional Principal and Full Collateralization
3.2.3 Partially Collateralized Rates of Return
3.3 Internal Rate of Return
3.3.1 Defining the IRR
3.3.2 Computing the IRR
3.3.3 Interim Valuations and Four Types of IRRs
3.4 Problems with Internal Rate of Return
3.4.1 Complex Cash Flow Patterns
3.4.2 Comparing Investments Based on IRRs
3.4.3 IRRs Should Not Be Averaged
3.4.4 IRR and the Reinvestment Rate Assumption
3.4.5 Time-Weighted Returns versus Dollar-Weighted Returns
3.5 Distribution of Cash Waterfall
3.5.1 Terminology of Waterfalls
3.5.2 The Compensation Scheme
3.5.3 Incentive-Based Fees
3.5.4 Aggregating Profits and Losses
3.5.5 Clawbacks and Alternating Profits and Losses
3.5.6 Hard Hurdle Rates
3.5.7 Soft Hurdles and a Catch-Up Provision
3.5.8 Incentive Fee as an Option
Review Questions
CHAPTER 4. Statistical Foundations
4.1 Return Distributions
4.1.1 Ex Ante and Ex Post Return Distributions
4.1.2 The Normal Distribution
4.1.3 Log Returns and the Lognormal Distribution
4.2 Moments of the Distribution: Mean, Variance, Skewness, and Kurtosis
4.2.1 The Formulas of the First Four Raw Moments
4.2.2 The Formulas of Central Moments
4.2.3 Skewness
4.2.4 Excess Kurtosis
4.2.5 Platykurtosis, Mesokurtosis, and Leptokurtosis
4.3 Covariance, Correlation, Beta, and Autocorrelation
4.3.1 Covariance
4.3.2 Correlation Coefficient
4.3.3 The Spearman Rank Correlation Coefficient
4.3.4 The Correlation Coefficient and Diversification
4.3.5 Beta
4.3.6 Autocorrelation
4.3.7 The Durbin-Watson Test for Autocorrelation
4.4 Interpreting Standard Deviation and Variance
4.4.1 Standard Deviation and Typical Deviations
4.4.2 Standard Deviation of Normally Distributed Returns
4.4.3 Properties of Variance
4.4.4 Properties of Standard Deviation
4.5 Testing for Normality
4.5.1 Why Are Some Returns Markedly Non-Normal?
4.5.2 Moments-Based Tests for Normality with Data Samples
4.5.3 The Jarque-Bera Test for Normality
4.5.4 An Example of the Jarque-Bera Test
4.6 Time-Series Return Volatility Models
Review Questions
CHAPTER 5. Measures of Risk and Performance
5.1 Measures of Risk
5.1.1 Semivariance
5.1.2 Semistandard Deviation
5.1.3 Shortfall Risk, Target Semivariance, and Target Semistandard Deviation
5.1.4 Tracking Error
5.1.5 Drawdown
5.1.6 Value at Risk
5.1.7 Strengths and Weaknesses of VaR
5.2 Estimating Value at Risk (VaR)
5.2.1 Estimating VaR with Normally Distributed Returns
5.2.2 Estimating VaR with Normally Distributed Underlying Factors
5.2.3 Two Primary Approaches to Estimating the Volatility for VaR
5.2.4 Two Approaches to Estimating VaR for Leptokurtic Positions
5.2.5 Estimating VaR Directly from Historical Data
5.2.6 Estimating VaR with Monte Carlo Analysis
5.2.7 Three Scenarios for Aggregating VaR
5.3 Ratio-Based Performance Measures
5.3.1 The Sharpe Ratio
5.3.2 Four Important Properties of the Sharpe Ratio
5.3.3 The Treynor Ratio
5.3.4 Four Important Properties of the Treynor Ratio
5.3.5 The Sortino Ratio
5.3.6 The Information Ratio
5.3.7 Return on VaR
5.4 Risk-Adjusted Return Measures
5.4.1 Jensen's Alpha
5.4.2 M2 (M-Squared) Approach
5.4.3 Average Tracking Error
Review Questions
CHAPTER 6. Foundations of Financial Economics
6.1 Informational Market Efficiency
6.1.1 Further Definitions of Informational Market Efficiency
6.1.2 Forms or Levels of Informational Market Efficiency
6.1.3 Six Factors Driving Informational Market Efficiency
6.1.4 Factors Influencing Informational Efficiency in Alternative Asset Markets
6.2 Single-Factor and Ex Ante Asset Pricing
6.2.1 Single-Factor Asset Pricing
6.2.2 Ex Ante Asset Pricing
6.2.3 Ex Post Asset Pricing
6.3 Multifactor and Empirical Models
6.3.1 Multifactor Asset Pricing
6.3.2 Theoretically versus Empirically Derived Multifactor Return Models
6.3.3 Fundamentals of Empirical Models
6.3.4 The Fama-French Model and the Fama-French-Carhart Model
6.3.5 Three Challenges of Empirical Multifactor Models
6.4 Arbitrage-Free Models
6.4.1 Underlying Concept of Arbitrage-Free Models
6.4.2 Applications of Arbitrage-Free Models
6.4.3 Arbitrage-Free Pricing in Spot Markets
6.4.4 Carry Trades with and without Hedging
6.4.5 Forward Contracts and Hedging
6.4.6 Cost-of-Carry Models
6.4.7 Binomial Tree Models
6.5 The Term Structure of Forward Contracts
6.5.1 The Two Determinants of Forward Prices on a Risky Financial Security
6.5.2 Three Factors Differentiating the Pricing of Forward Contracts on Financial Securities from That of Commodities
6.5.3 Four Cases of the Cost-of-Carry Model for Pricing Forward Contracts on Financial Securities
6.6 Option Exposures
6.6.1 Option Risk Exposure Diagrams
6.6.2 Long and Short Positions in an Underlying Asset
6.6.3 Call and Put Exposures
6.6.4 Covered Call and Protective Put Exposures
6.6.5 Exposures of Two Position Spreads
6.6.6 Exposures of Two-Position Combinations
6.6.7 Put-Call Parity and Option Collars
6.7 Option Pricing Models
6.7.1 An Option on a Portfolio
6.7.2 The Black-Scholes Call and Put Option Formulae
6.7.3 The Black Forward Option Pricing Model
6.7.4 The Currency Option Pricing Model
6.8 Option Sensitivities
6.8.1 The Five Most Popular Sensitivities
6.8.2 Unlimited Sensitivities
6.8.3 Using Option Sensitivities for Risk Management
Review Questions
CHAPTER 7. Benchmarking and Performance Attribution
7.1 Benchmarking
7.1.1 Types of Benchmarks
7.1.2 A Numerical Example of Simple Benchmarking
7.1.3 Three Considerations in Benchmarking
7.2 Types of Models
7.2.1 Normative versus Positive Models
7.2.2 Theoretical versus Empirical Models
7.2.3 Applied versus Abstract Models
7.2.4 Cross-Sectional versus Time-Series Models
7.2.5 Importance of Methodology
7.3 Performance Attribution
7.3.1 Single-Factor Market Model Performance Attribution
7.3.2 Examining Time-Series Returns with a Single-Factor Market-Based Regression Model
7.3.3 Application of Single-Factor Benchmarking
7.3.4 Multifactor Benchmarking
7.4 Distinctions Regarding Alternative Asset Benchmarking
7.4.1 Why Not Apply the CAPM to Alternative Assets?
7.4.2 Reason 1: Multiperiod Issues
7.4.3 Reason 2: Non-Normality
7.4.4 Reason 3: Illiquidity of Returns and Other Barriers to Diversification
Review Questions
CHAPTER 8. Alpha, Beta, and Hypothesis Testing
8.1 Overview of Beta and Alpha
8.1.1 Beta
8.1.2 Alpha
8.2 Ex Ante versus Ex Post Alpha
8.2.1 Ex Ante Alpha
8.2.2 Ex Post Alpha
8.3 Inferring Ex Ante Alpha from Ex Post Alpha
8.3.1 Two Steps to Empirical Analysis of Ex Ante Alpha
8.3.2 Lessons about Alpha Estimation from a Fair Casino Game
8.4 Return Attribution, Alpha, and Beta
8.4.1 A Numerical Example of Alpha
8.4.2 Three Types of Model Misspecification
8.4.3 Beta Nonstationarity
8.4.4 Can Alpha and Beta Be Commingled?
8.5 Ex Ante Alpha Estimation and Return Persistence
8.5.1 Separating Luck and Skill with Return Persistence
8.5.2 Interpreting Estimated Return Persistence
8.6 Return Drivers
8.6.1 Beta Drivers
8.6.2 Passive Beta Drivers as Pure Plays on Beta
8.6.3 Alpha Drivers
8.6.4 Product Innovators and Process Drivers
8.7 Using Statistical Methods to Locate Alpha
8.7.1 Four Steps of Hypothesis Testing
8.7.2 Four Common Problems Using Inferential Statistics
8.7.3 Type I and Type II Errors
8.7.4 An Example of Erroneous Conclusions with Statistical Testing
8.8 Sampling and Testing Problems
8.8.1 Unrepresentative Data Sets
8.8.2 Data Mining versus Data Dredging
8.8.3 Backtesting and Backfilling
8.8.4 Cherry-Picking and Chumming
8.9 Statistical Issues in Analyzing Alpha and Beta
8.9.1 Non-Normality and the Cross-Sectional Search for Alpha
8.9.2 Outliers and the Search for Alpha
8.9.3 Biased Testing and the Search for Alpha
8.9.4 Spurious Correlation, Causality, and Beta Estimation
8.9.5 Fallacies of Alpha and Beta Estimation
Review Questions
CHAPTER 9. Regression, Multivariate, and Nonlinear Methods
9.1 Single-Factor Models and Regression
9.1.1 Simple Linear Regression and the Single-Factor Market Model
9.1.2 Ordinary Least Squares Regression
9.1.3 Outliers
9.1.4 Autocorrelation
9.1.5 Heteroskedasticity
9.1.6 Interpreting a Regression's Goodness of Fit
9.1.7 Performing a t-Test on Regression Parameters
9.2 Multifactor Models and Regression
9.2.1 Selecting Factors for Multifactor Regression
9.2.2 Multicollinearity
9.2.3 Selecting the Number of Factors and Overfitting
9.3 Three Dynamic Risk Exposure Models
9.3.1 The Dummy Variable Approach to Dynamic Risk Exposures
9.3.2 The Separate Regression Approach to Dynamic Risk Exposures
9.3.3 The Quadratic Approach to Dynamic Risk Exposures
9.4 Two Approaches to Modeling Changing Correlation
9.4.1 Conditional Correlation Modeling Approach
9.4.2 Rolling Window Modeling Approach
9.5 Four Multifactor Approaches to Understanding Hedge Fund Returns
9.5.1 Understanding Style Analysis and Fund Groupings Based on Asset Classes
9.5.2 Understanding Funds Based on Strategies
9.5.3 Understanding Funds Based on Marketwide Factors
9.5.4 Understanding Funds Based on Specialized Market Factors
9.6 Evidence on Fund Performance Persistence
Review Questions
PART Two. Real Assets
CHAPTER 10. Natural Resources and Land
10.1 Natural Resources Other Than Land
10.1.1 Economic Roles and Vehicles of Natural Resources
10.1.2 Natural Resources as Exchange Options
10.1.3 Moneyness as a Crucial Factor in Natural Resource Development
10.1.4 Moneyness Differences and Natural Resource Development
10.1.5 Why Some In-the-Money Options Should Not Be Exercised Immediately
10.1.6 Implications of Moneyness for Risks of Natural Resources
10.2 Land
10.2.1 Land in Anticipation of Development
10.2.2 Land as an Option
10.2.3 Example of Land as a Binomial Option
10.2.4 Risk and Return of Investing in Land
10.3 Timber and Timberland
10.3.1 Timberland Risk and Return
10.3.2 Methods of Timberland Ownership
10.4 Farmland
10.4.1 Financial Analysis of Farmland
10.4.2 Farmland Prices and Returns
10.4.3 Three Factors of Multiple Use Option Prices
10.4.4 Methods of Farmland Exposure
10.5 Valuation and Volatility of Real Assets
10.5.1 The Impact of Smoothing on Observed Volatility
10.5.2 Managed Returns and Volatility
10.5.3 Appraisals and Smoothing
10.5.4 Smoothed Returns Compared to Market Returns
10.6 Historical Risks and Returns
Review Questions
CHAPTER 11. Commodity Forward Pricing
11.1 Forward Contracts versus Futures Contracts
11.1.1 Trading Differences between Forward Contracts and Futures Contracts
11.1.2 The Mechanics of Marking-to-Market
11.1.3 Marking-to-Market and Counterparty Risk
11.1.4 Marking-to-Market and the Time Value of Money Effect on Risk
11.1.5 Marking-to-Market and the Time Value of Money Effect on Prices
11.1.6 Futures Trading and Initial Margin
11.1.7 Marking-to-Market and Maintenance Margin
11.2 Rolling Contracts
11.2.1 Futures Contracts with Different Settlement Dates
11.2.2 Rollover Decisions Alter Long-Run Returns
11.3 The Term Structure of Forward Prices on Commodities
11.3.1 Costs of Carry for Commodity Contracts
11.3.2 Arbitrage-Free Forward Pricing for Physical Assets
11.3.3 Two Limitations to Arbitrage-Free Forward Pricing for Physical Assets
11.3.4 Harvests, Supply Elasticity, and Shifts in Supply and Demand
11.4 Backwardation and Contango
11.4.1 Terminology Regarding the Forward Curve Slope
11.4.2 Backwardation and Contango Reflect Cost of Carry in an Efficient Market
11.4.3 Normal Backwardation and Normal Contango
11.4.4 Normal Backwardation and Normal Contango in an Informationally Efficient Market
11.4.5 Normal Backwardation and Normal Contango in an Informationally Inefficient Market
11.5 Returns on Forward Contracts
11.5.1 Forward Returns, Alpha, and Beta
11.5.2 Alpha and the Shape of the Term Structure
11.5.3 The Basis of a Forward Contract
11.5.4 Calendar Spreads on Forward Contracts
11.5.5 The Return on a Calendar Spread
11.5.6 The Risks of a Calendar Spread
Review Questions
CHAPTER 12. Commodities: Applications and Evidence
12.1 Commodity Investing for Diversification
12.1.1 Four Explanations of Commodities as Diversifiers
12.1.2 Commodities as Diversifiers in a Perfect Market Equilibrium
12.1.3 Commodities as Diversifiers in the Presence of Market Imperfections
12.1.4 Commodities as Diversifiers against Unexpected Inflation
12.2 Commodity Investing for Return Enhancement
12.2.1 Return Enhancement: Alpha
12.2.2 Return Enhancement from Beta in Equilibrium
12.2.3 Return Enhancement from Beta in Disequilibrium
12.2.4 Return Enhancement from Providing Insurance through Commodity Futures
12.3 Investing in Commodities without Futures
12.3.1 Investing in Physical Commodities
12.3.2 Investing in Commodity-Related Equities
12.3.3 Exchange-Traded Funds
12.3.4 Commodity-Linked Notes: Overview and an Example
12.4 Commodity Exposure through Futures Contracts
12.4.1 Why Returns on a Futures Contract Can Differ from the Spot Return
12.4.2 Why Returns on Futures Contracts with Different Settlement Dates Can Differ
12.4.3 Components of Futures Return
12.4.4 Two Interpretations of Rolling Contracts
12.4.5 Roll Yield and the Slope of the Forward Curve
12.4.6 Spot Prices, Futures Prices, and Convergence
12.4.7 Roll Yield, Carrying Costs, the Basis, and Alpha
12.4.8 The Impact of Rolling Contracts on Benchmarking and Alpha
12.4.9 Three Propositions Regarding Roll Return
12.5 Commodity Futures Indices
12.5.1 Construction and Uses of Commodity Futures Indices
12.5.2 Popular Commodity Futures Indices
12.5.3 Comparison of Weighting Methods of Commodity Futures Indices
12.6 Commodity Risks and Returns
12.6.1 Four Commodity Market Event Risk Attributes
12.6.2 Commodities as a Defensive Investment
12.6.3 Slow Acceptance of Commodity Futures by Institutions
12.7 Historical Risks and Returns
Review Questions
CHAPTER 13. Operationally Intensive Real Assets
13.1 Commodity Producers
13.1.1 Natural Resource Prices as a Driver of Operating Firm Performance
13.1.2 Evidence on Commodity Prices and the Equity Prices of Operating Firms
13.1.3 Commodity Prices and Operating-Firm Equity Return Correlations
13.2 Liquid Alternative Real Assets
13.2.1 Structure of MLPs and the MLP Sector
13.2.2 Tax Characteristics of MLPs
13.2.3 MLP Valuations and Distribution Rates
13.3 Infrastructure
13.3.1 Seven Elements That Help Identify Investable Infrastructure
13.3.2 Types of Infrastructure
13.3.3 Governmental Influence on Infrastructure Investments
13.3.4 Infrastructure Investment Vehicles
13.3.5 Risk, Reward, and Categorization of Infrastructure Investments
13.4 Intellectual Property
13.4.1 Characteristics of IP
13.4.2 Intellectual Property Returns and Financial Analysis
13.4.3 A Simplified Model of Intellectual Property
Review Questions
CHAPTER 14. Liquid and Fixed-Income Real Estate
14.1 Real Estate as an Investment
14.1.1 Five Potential Advantages of Real Estate
14.1.2 Three Potential Disadvantages of Real Estate
14.1.3 Real Estate Styles
14.2 Residential Mortgages
14.2.1 Fixed-Rate Mortgages
14.2.2 Interest-Only Mortgages
14.2.3 Variable-Rate Mortgages
14.2.4 Other Types of Mortgages
14.2.5 Residential Mortgages and Default Risk
14.3 Commercial Mortgages
14.3.1 Commercial Mortgage Characteristics
14.3.2 Commercial Mortgage Default Risk
14.3.3 Financial Ratios for Commercial Mortgages and Default Risk
14.4 Mortgage-Backed Securities Market
14.4.1 Residential Mortgage Prepayment Options
14.4.2 Measuring Unscheduled Prepayment Rates
14.4.3 Pricing RMBS with PSA Rates
14.4.4 Commercial Mortgage-Backed Securities
14.5 Liquid Alternatives: Real Estate Investment Trusts
14.6 Historical Risks and Returns of Mortgage REITs
Review Questions
CHAPTER 15. Real Estate Equity Investments
15.1 Real Estate Development
15.1.1 Real Estate Development as Real Options
15.1.2 An Example of a Real Estate Project with Real Options
15.1.3 Decision Trees
15.1.4 Backward Induction and Decision Trees
15.2 Valuation and Risks of Real Estate Equity
15.2.1 Cash Flows for the Income Approach
15.2.2 Discount Rate for the Income Approach
15.2.3 Taxes and Financing Costs in the Income Approach
15.2.4 Valuations Based on Comparable Sale Prices
15.3 Alternative Real Estate Investment Vehicles
15.3.1 Private Equity Real Estate Funds
15.3.2 Commingled Real Estate Funds
15.3.3 Syndications
15.3.4 Joint Ventures
15.3.5 Limited Partnerships
15.3.6 Open-End Real Estate Mutual Funds
15.3.7 Options and Futures on Real Estate Indices
15.3.8 Exchange-Traded Funds Based on Real Estate Indices
15.3.9 Closed-End Real Estate Mutual Funds
15.3.10 Equity Real Estate Investment Trusts
15.4 Real Estate and Depreciation
15.4.1 Real Estate Example without Taxation
15.4.2 After-Tax Returns When Depreciation Is Not Allowed
15.4.3 Return When Accounting Depreciation Equals Economic Depreciation
15.4.4 Return When Accounting Depreciation Is Accelerated
15.4.5 Return When Capital Expenditures Can Be Expensed
15.4.6 Summary of Depreciation and Taxes
15.5 Real Estate Equity Risks and Returns
15.5.1 Real Estate Indices Based on Appraisals
15.5.2 Data Smoothing and Its Effects
15.5.3 Real Estate Indices Based on Adjusted Privately Traded Prices
15.5.4 Real Estate Indices Based on Financial Market Prices
15.6 Historical Risks and Returns of Equity REITs
Review Questions
PART Three. Hedge Funds
CHAPTER 16. Structure of the Hedge Fund Industry
16.1 Distinguishing Hedge Funds
16.1.1 Three Primary Elements of Hedge Funds
16.1.2 Six Investment Flexibilities of Hedge Funds
16.1.3 Growth of the Hedge Fund Industry
16.1.4 Industry Concentration
16.2 Hedge Fund Fees
16.2.1 Computation of Hedge Fund Fees
16.2.2 Hedge Fund Fees through Time
16.2.3 Incentive Fees and Manager Behavior
16.2.4 The Present Value of a Hedge Fund Fee Annuity
16.2.5 Hedge Fund Fees and Option Theory
16.2.6 Hedge Fund Fees and Managerial Behavior
16.3 Hedge Fund Classification
16.4 Hedge Fund Returns and Asset Allocation
16.4.1 Grouping Strategies by Systematic Risk
16.4.2 Equity Strategies
16.4.3 Event-Driven and Relative Value Strategies
16.4.4 Absolute Return Strategies
16.4.5 Diversified Fund Strategies
16.5 Evaluating a Hedge Fund Investment Program
16.5.1 Opportunistic Hedge Fund Investing
16.6 Do Hedge Funds Adversely Affect the Financial Markets?
16.7 Hedge Fund Indices
16.7.1 Management and Incentive Fees
16.7.2 Inclusion of Managed Futures
16.7.3 Asset Weighted versus Equally Weighted
16.7.4 The Size of the Hedge Fund Universe
16.7.5 Representativeness and Data Biases
16.7.6 Strategy Definition and Style Drift
16.7.7 Index Investability
16.8 Conclusion
Review Questions
CHAPTER 17. Macro and Managed Futures Funds
17.1 Major Distinctions between Strategies
17.1.1 Discretionary versus Systematic Trading
17.1.2 Fundamental and Technical Analysis
17.1.3 Organization of the Chapter
17.2 Global Macro
17.2.1 Illustrations of Global Macro Fund Investing
17.2.2 Three Primary Risks of Macro Investing
17.3 Returns of Macro Investing
17.4 Managed Futures
17.4.1 Futures Contracts and Futures Markets
17.4.2 Regulation, Background, and Organizational Structures
17.5 Systematic Trading
17.5.1 Derivation of Systematic Trading Rules
17.5.2 Three Questions in Evaluating a Systematic Trading System
17.5.3 Validation and Potential Degradation of Systematic Trading Rules
17.6 Systematic Trading Strategies
17.6.1 Trend-Following Strategies
17.6.2 Weighted Moving Averages and Exponential Moving Averages
17.6.3 An Illustration of a System Using Two Moving Averages
17.6.4 Breakout Strategies
17.6.5 Analysis of Trend-Following Strategies
17.6.6 Non-Trend-Following Strategies
17.6.7 Relative Value Strategies and Technical Analysis
17.7 Evidence on Managed Futures Returns
17.7.1 Evidence on Managed Futures Alpha
17.7.2 The Evidence on Downside Risk Protection
17.7.3 Why Might Managed Futures Provide Superior Returns?
17.7.4 Six Potentially Important Risks of Managed Futures Funds
17.8 Analysis of Historical Returns Conclusion
Review Questions
CHAPTER 18. Event-Driven Hedge Funds
18.1 The Sources of Most Event Strategy Returns
18.1.1 Insurance-Selling View of Event Strategy Returns
18.1.2 Binary Option View of Event Strategy Returns
18.2 Activist Investing
18.2.1 Background on Corporate Governance
18.2.2 Five Dimensions of Shareholder Activists
18.2.3 Why Managers Are Not Viewed as Maximizing Shareholder Wealth
18.2.4 Corporate Governance Battles
18.2.5 Activist Agenda 1: CEOs, Compensation, and Boards of Directors
18.2.6 Activist Agenda 2: Capital Structure and Dividend Policy Issues
18.2.7 Activist Agenda 3: Mergers or Divestitures
18.2.8 Historical Risk and Returns of Activist Funds
18.3 Merger Arbitrage
18.3.1 Stock-for-Stock Mergers
18.3.2 Third-Party Bidders and Bidding War Risks
18.3.3 Risks of Merger Arbitrage
18.3.4 Regulatory Risk
18.3.5 Financing Risk
18.3.6 Historical Risk and Returns of Merger Arbitrage Funds
18.4 Distressed Securities Funds
18.4.1 The Bankruptcy Process
18.4.2 Short Sales of Equity as Writing Naked Call Options
18.4.3 Buying Undervalued Securities and Estimating Recovery Value
18.4.4 Distressed Activists
18.4.5 Capital Structure Arbitrage
18.4.6 Buying the Firm Using Distressed Securities
18.4.7 Historical Risk and Returns of Distressed Restructuring Funds
18.5 Event-Driven Multistrategy Funds
Review Questions
CHAPTER 19. Relative Value Hedge Funds
19.1 Overview of Relative Value Strategies
19.2 Convertible Bond Arbitrage
19.2.1 Defining and Pricing Convertible Bonds
19.2.2 Busted, Hybrid, and Equity-Like Convertibles
19.2.3 Delta, Gamma, and Theta
19.2.4 Stylized Illustration of Convertible Arbitrage
19.2.5 Background on Short Selling
19.2.6 Convertible Bond Arbitrage Background
19.2.7 Four Sources of Returns to Convertible Bond Arbitrage
19.2.8 Components of Convertible Arbitrage Returns
19.2.9 Details Regarding Convertible Bond Arbitrage
19.2.10 Return Drivers of Convertible Bond Arbitrage
19.2.11 Historical Return of Convertible Bond Arbitrage Funds
19.3 Volatility Arbitrage
19.3.1 Volatility and Vega Overview
19.3.2 Instruments Used by Volatility Arbitrage Funds
19.3.3 Risks of Exchange-Traded versus OTC Derivatives
19.3.4 Volatility Arbitrage Strategies
19.3.5 Market-Neutral Volatility Funds
19.3.6 Challenges of Estimating Dispersion
19.3.7 Tail Risk Strategies
19.3.8 The Dispersion Trade
19.3.9 Historical Return Observations
19.4 Fixed-Income Arbitrage
19.4.1 The Core of Fixed-Income Arbitrage Strategies
19.4.2 Types of Fixed-Income Arbitrage Strategies
19.4.3 Fixed-Income Arbitrage Strategies: Sovereign Debt
19.4.4 Asset-Backed and Mortgage-Backed Securities Strategies
19.4.5 Prepayment Risk and Option-Adjusted Spreads
19.4.6 Risks of Asset-Backed and Mortgage-Backed Securities Arbitrage
19.4.7 Historical Return Observations for Fixed-Income Arbitrage Strategies
19.5 Relative Value Multistrategy Funds
Review Questions
CHAPTER 20. Equity Hedge Funds
20.1 Sources of Return
20.1.1 Providing Liquidity
20.1.2 Providing Informational Efficiency
20.1.3 Identifying Factors That Can Create Profit Opportunities
20.2 Market Anomalies
20.2.1 Market Efficiency Tests as Joint Hypotheses
20.2.2 Predicting Persistence of Market Anomalies
20.2.3 Accounting Accruals and Market Anomalies
20.2.4 Price Momentum and Market Anomalies
20.2.5 Earnings Momentum and Market Anomalies
20.2.6 Net Stock Issuance and Market Anomalies
20.2.7 Insider Trading and Market Anomalies
20.3 The Fundamental Law of Active Management
20.3.1 Breadth and the Information Coefficient
20.3.2 FLOAM and Trade-Offs Regarding the Information Ratio
20.3.3 FLOAM and Nonactive Bets
20.4 Implementing Anomaly Strategies
20.4.1 Integrating Anomalies Using Factor Models
20.4.2 Integrating Anomalies Using Pairs Trading
20.4.3 Short Selling and Reducing Risk versus Increasing Alpha
20.4.4 The Limits to Arbitrage
20.5 The Three Equity Strategies
20.5.1 Mechanics of Short Selling
20.5.2 The Basics of Short-Bias Funds
20.5.3 Historical Return Observations for Short-Bias Funds
20.5.4 The Basics of Equity Long/Short Funds
20.5.5 Historical Return Observations for Equity Long/Short Funds
20.5.6 The Basics of Equity Market-Neutral Funds
20.5.7 Historical Return Observations for Equity Market-Neutral Funds
20.6 Equity Hedge Fund Risks
Review Questions
CHAPTER 21. Funds of Hedge Funds
21.1 Overview of Funds of Hedge Funds
21.1.1 Benefits and Costs of Diversification
21.1.2 Four Functions of Fund of Funds Management
21.1.3 Eleven Benefits to Investing in Funds of Funds
21.1.4 Six Disadvantages to Investing in Funds of Funds
21.1.5 Three Major Ways for FoF Managers to Add Value
21.1.6 How Many Hedge Funds Provide Reasonable Diversification?
21.1.7 Identifying Funds for an Institutional Portfolio or Fund of Funds
21.2 Investing in Multistrategy Funds
21.2.1 Incentive Fees as a Potential Advantage of Multistrategy Funds
21.2.2 Flexibility and Transparency
21.2.3 Managerial Selection and Operational Risks
21.3 Investing in Funds of Hedge Funds
21.3.1 Funds of Hedge Funds as Diversified Pools
21.3.2 Funds of Hedge Funds Have Varying Investment Objectives
21.3.3 Funds of Funds as Venture Capitalists
21.4 Investing in Portfolios of Single Hedge Funds
21.5 Multialternatives and Other Hedge Fund Liquid Alternatives
21.5.1 Emergence of Liquid Alternatives
21.5.2 UCITS Framework for Liquid Alternatives
21.5.3 Funds Registered under the ’40 Act
21.5.4 Availability of Liquid Alternative Strategies
21.5.5 Engineering Illiquid and Leveraged Strategies into Multialternatives
21.5.6 Performance of Liquid Alternative Vehicles
21.6 Historical Returns of Funds of Funds
Review Questions
PART Four. Private Equity
CHAPTER 22. Introduction to Private Equity
22.1 Private Equity Terminology and Background
22.2 Private Equity as Equity Securities
22.2.1 Venture Capital
22.2.2 History of Venture Capital
22.2.3 Overview of Buyouts
22.2.4 History of Buyouts
22.2.5 Merchant Banking
22.3 Private Equity as Debt Securities
22.3.1 Mezzanine Debt
22.3.2 Distressed Debt
22.3.3 Growth of the Distressed Debt Marketplace
22.3.4 Leveraged Loans
22.3.5 Growth of Leveraged Loans
22.4 Private Equity Liquid Alternatives
22.4.1 Business Development Companies
22.4.2 Business Development Companies as Closed-End Funds
22.4.3 Extending Closed-End Fund Pricing to Illiquid Alternatives
22.4.4 Are Liquid Private Equity Pools Diversifiers?
22.4.5 Are Liquid Private Equity Pools Return Enhancers?
22.4.6 Other Liquid Investments in Private Equity
22.5 Trends and Innovations in Private Equity
22.5.1 The Private Equity Partnership Secondary Markets
22.5.2 Private Investments in Public Equity
22.5.3 Hedge Funds and Private Equity
Review Questions
CHAPTER 23. Equity Types of Private Equity
23.1 Contrasts between Venture Capital and Buyouts
23.2 The Underlying Businesses of Venture Capital
23.2.1 Securities Used in Venture Capital
23.2.2 The Payout of Venture Capital
23.2.3 Venture Capital Plans
23.3 Venture Capital Funds
23.3.1 How Venture Capitalists Obtain Financing
23.3.2 Venture Capital Fund Fees
23.4 The Dynamics of Venture Capital
23.4.1 Life Cycle of a Venture Capital Fund
23.4.2 Stages of Financing
23.4.3 Venture Capital as a Compound Option
23.4.4 The J-Curve for a Start-Up Company
23.5 Venture Capital Risks and Returns
23.5.1 Three Main Risks and the Required Risk Premiums for Venture Capital
23.5.2 Access and Vintage-Year Diversification
23.5.3 Historical Return Analysis
23.6 Types of Buyouts
23.6.1 Leveraged Buyouts (LBOs)
23.6.2 Management Buyouts (MBOs)
23.6.3 Other Types of Private Equity Buyouts
23.6.4 Agency Issues of Buyouts
23.7 Leveraged Buyout Details
23.7.1 LBO Fund Structures
23.7.2 Fees
23.7.3 Agency Relationships
23.7.4 Five General Categories of LBOs That Can Create Value
23.7.5 The Portfolio of Companies
23.7.6 The Appeal of a Leveraged Buyout to Targets
23.7.7 A Stylized Example of an LBO
23.7.8 Five LBO Exit Strategies
23.7.9 Four Spillovers of Corporate Governance to the Public Market
23.7.10 Auction Markets and Club Deals
23.7.11 Three Factors Driving Buyout Risks Relative to VC Risks
Review Questions
CHAPTER 24. Debt Types of Private Equity
24.1 Mezzanine Debt
24.1.1 Mezzanine Debt Structures
24.1.2 Stylized Example of Mezzanine Debt Advantage
24.1.3 Mezzanine Financing Compared with Other Forms of Financing
24.1.4 Seven Basic Examples of Mezzanine Financing
24.1.5 Investors in Mezzanine Debt
24.1.6 Eight Characteristics of Mezzanine Debt
24.2 Distressed Debt
24.2.1 Describing Distressed Debt
24.2.2 The Supply of Distressed Debt
24.2.3 The Demand for Distressed Debt
24.2.4 Three Distressed Debt Investment Strategies
24.2.5 Distressed Debt and the Bankruptcy Process
24.2.6 Risks of Distressed Debt Investing
Review Questions
PART Five. Structured Products
CHAPTER 25. Introduction to Structuring
25.1 Overview of Financial Structuring
25.2 Major Types of Structuring
25.2.1 Hedging with Credit Derivatives
25.2.2 Structuring with Tranches
25.2.3 Creating Structured Products
25.3 The Primary Economic Role of Structuring
25.3.1 Completing Markets as an Economic Role
25.3.2 States of the World within Structured Products
25.3.3 Structured Products as Market Completers
25.4 Collateralized Mortgage Obligations
25.4.1 Prioritization of Claims within CMOs
25.4.2 Structuring of Sequential-Pay CMOs
25.4.3 Longevity Characteristics of CMO Tranches
25.4.4 Other CMO Structures and Tranches
25.4.5 Motivations of Structured Mortgage Products
25.4.6 Valuing Default-Free CMOs
25.4.7 Systemic Risk and the History of Structured Mortgage Products
25.4.8 Commercial CMOs and Default Risk
25.5 Structural Model Approach to Credit Risk
25.5.1 The Intuition of Merton's Structural Model
25.5.2 The Conflict of Interest Regarding Risk in Structuring
25.5.3 The Mechanics of Merton's Structural Model
25.5.4 Valuing Risky Debt with Black-Scholes Option Pricing
25.5.5 Binomial Trees and Structured Product Valuation
25.5.6 Advantages and Disadvantages of Structural Model Applications
25.6 Introduction to Collateralized Debt Obligations
25.6.1 A Stylized CDO
25.6.2 Attachment Points, Detachment Points, Calls, and Puts
25.6.3 Three Option Strategies Similar to a Mezzanine Tranche
Review Questions
CHAPTER 26. Credit Risk and Credit Derivatives
26.1 An Overview of Credit Risk
26.2 Reduced-Form Modeling of Credit Risk
26.2.1 Intuition of Reduced-Form Credit Risk Models
26.2.2 Expected Loss Due to Credit Risk
26.2.3 Two Key Characteristics of the Risk-Neutral Modeling Approach
26.2.4 Pricing Risky Bonds with a Risk-Neutral Approach
26.2.5 Credit Spreads
26.2.6 Applying the Reduced-Form Models Using Risk Neutrality
26.2.7 Advantages and Disadvantages of Reduced-Form Models
26.2.8 Distinguishing between Structural and Reduced-Form Credit Models
26.3 Credit Derivatives Markets
26.3.1 Three Economic Roles of Credit Derivatives
26.3.2 Three Groupings of Credit Derivatives
26.3.3 Stages of Credit Derivative Activity
26.4 Credit Default Swaps
26.4.1 Credit Default Swaps and Total Return Swaps
26.4.2 Mechanics of a Credit Default Swap
26.4.3 Valuing CDS Contracts
26.4.4 Unwinding a CDS Transaction
26.4.5 Participants in Credit Derivatives Markets
26.4.6 Five Motivations for Credit Default Swaps
26.5 Other Credit Derivatives
26.5.1 Terminology of Credit Options
26.5.2 Credit Put Option on a Bond Price
26.5.3 Call Option on a CDS
26.5.4 Credit-Linked Notes
26.6 CDS Index Products
26.7 Five Key Risks of Credit Derivatives
Review Questions
CHAPTER 27. CDO Structuring of Credit Risk
27.1 Overview of CDO Variations
27.1.1 Credit-Related Motivations for CDOs
27.1.2 General Structure of CDOs
27.1.3 Terminology and Details of CDOs
27.2 Balance Sheet CDOs and Arbitrage CDOs
27.3 Mechanics of and Motivations for an Arbitrage CDO
27.4 Cash-Funded CDOs versus Synthetic CDOs
27.4.1 Cash-Funded CDOs and Regulatory Capital
27.4.2 Mechanics of Synthetic CDOs
27.4.3 Comparison of Synthetic and Cash-Funded CDOs
27.5 Cash Flow CDOs versus Market Value CDOs
27.6 Credit Enhancements
27.6.1 Subordination
27.6.2 Overcollateralization
27.6.3 Spread Enhancement
27.6.4 Cash Collateral or Reserve Account
27.6.5 External Credit Enhancement
27.7 Developments in CDOs
27.7.1 Distressed Debt CDOs
27.7.2 Hedge Fund CDOs
27.7.3 Single-Tranche CDOs
27.8 Risks of CDOs
27.8.1 Risk from the Underlying Collateral
27.8.2 Financial Engineering Risk
27.8.3 Correlation Risk
27.8.4 Risk Shifting
27.8.5 The Effects of Risk Shifting and Correlation on Tranches
27.8.6 Other CDO Risks
27.8.7 Modeling Credit Risk in CDOs
Review Questions
CHAPTER 28. Equity-Linked Structured Products
28.1 Structured Products and Six Types of Wrappers
28.2 Four Potential Tax Effects of Wrappers
28.3 Structured Products with Exotic Option Features
28.3.1 Structured Products with No Exotic Options
28.3.2 Structured Products and Asian Options
28.3.3 Structured Products and Binary Options
28.3.4 Structured Products and Barrier Options
28.3.5 Characteristics of In versus Out and Up versus Down Barrier Options
28.3.6 Structured Products and Spread Options
28.3.7 Structured Products and Look-Back Options
28.3.8 Quantos and Other Structured Products
28.4 Global Structured Product Cases
28.4.1 A U.S. – Based Structured Product with Multiple Kinks
28.4.2 A French-Based Structured Product with Floors
28.4.3 A German-Based Structured Product with Leverage
28.4.4 Absolute Return Structured Products in the United Kingdom
28.4.5 A Swiss-Based Structured Product Based on Absolute Returns
28.4.6 A Japan-Based Structured Product Based on Multiple Currencies
28.4.7 Liquid Structured Products
28.5 Structured Product Pricing
28.5.1 Pricing Structured Products with PDEs
28.5.2 Pricing Structured Products with Simulation
28.5.3 Pricing Structured Products with Building Blocks
28.5.4 Two Principles from Payoff Diagram Shapes and Levels
28.5.5 Evidence on Structured Product Prices
28.6 Motivations of Structured Products
Review Questions
PART Six. Risk Management and Portfolio Management
CHAPTER 29. Cases in Tail Events
29.1 Problems Driven by Market Losses
29.1.1 Amaranth Advisors, LLC
29.1.2 Long-Term Capital Management
29.1.3 Carlyle Capital Corporation
29.1.4 Declining Investment Opportunities and Leverage
29.1.5 Behavioral Biases and Risk Taking
29.2 Trading Technology and Financial Crises
29.2.1 Quant Crisis, August 2007
29.2.2 The Flash Crash of 2010
29.2.3 Knight Capital Group, 2012
29.3 Failures Driven by Fraud
29.3.1 Bayou Management
29.3.2 Bernie Madoff
29.3.3 Lancer Group
29.4 Four Major Lessons from Cases in Tail Events
Review Questions
CHAPTER 30. Investment Process, Operations, and Risk
30.1 Investment Strategy and Process
30.1.1 Stated and Permitted Investment Strategies
30.1.2 Deviation of Actual Strategies from Stated Strategies
30.1.3 The Investment Process
30.2 Investment Process and Market Risk
30.2.1 Investment Process Risk
30.2.2 Process Risk of Implementing a Strategy
30.2.3 Investment Process Risk and Leverage
30.2.4 Investment Process Risk from Style Drift
30.2.5 Process Risk and Market Volatility
30.3 The Three Internal Fund Activities
30.4 Operational Risk
30.4.1 Operational Errors
30.4.2 Agency Conflicts
30.4.3 Operational Fraud
30.5 Controlling Operational Risk
30.5.1 Incentives Can Increase Operational Risk
30.5.2 Internal Control Procedures
30.5.3 Valuation Procedures
30.5.4 Custody of Assets
30.5.5 The Culture of the Fund
30.6 Controlling Risk of Portfolios with Options
30.6.1 Option Sensitivities and Put-Call Parity
30.6.2 Using Option Sensitivities to Hedge Risk
30.6.3 Viewing Options as Volatility Bets
Review Questions
CHAPTER 31. Due Diligence of Fund Managers
31.1 Due Diligence Evidence and Organization
31.2 Screening with Three Fundamental Questions
31.2.1 Investment Objective
31.2.2 Investment Process
31.2.3 Nature and Source of Value Added by the Fund Manager
31.3 Structural Review
31.3.1 Fund Organization
31.3.2 Fund Manager Organization and Ownership
31.3.3 Registrations
31.3.4 Outside Service Providers
31.4 Strategic Review
31.4.1 Investment Markets and Securities
31.4.2 Benchmarking a Fund Manager
31.4.3 Competitive Advantage
31.4.4 Current Portfolio Position
31.4.5 Source of Investment Ideas
31.4.6 Capacity
31.5 Administrative Review
31.5.1 Civil, Criminal, and Regulatory Actions
31.5.2 Employee Turnover
31.5.3 Investor Relations
31.5.4 Business Continuity Management
31.6 Performance Review
31.6.1 List of Funds and Assets under Management
31.6.2 Drawdowns
31.6.3 Statistical Return Data
31.6.4 Statistical Return Analysis Horizon
31.6.5 Volatility in Assets under Management
31.6.6 Portfolio Pricing
31.7 Portfolio Risk Review
31.7.1 Risk Management
31.7.2 Leverage
31.7.3 Chief Risk Officer
31.8 Legal Review
31.8.1 Type of Investment
31.8.2 Fees
31.8.3 Lockups and Redemptions
31.8.4 Subscription Amount
31.8.5 Advisory Committee
31.9 Reference Review
31.9.1 Service Providers
31.9.2 Other Investors
31.10 Evidence on Operational Risk
31.10.1 Conclusions Based on Operational Defaults
31.10.2 The Omega-Score and Bankruptcy Prediction
31.10.3 Costs and Benefits of Due Diligence
Review Questions
CHAPTER 32. Portfolio Management, Alpha, and Beta
32.1 Alpha and Smart Beta
32.2 The Estimation of Alpha and Beta
32.3 The Separation of Alpha and Beta
32.4 Portable Alpha
32.4.1 Transferring Systematic Risk with Derivatives
32.4.2 Applying Portable Alpha
32.4.3 Numerical Illustrations of Portable Alpha
32.4.4 Challenges with Porting Alpha
32.5 Alpha, Beta, and Portfolio Allocation
32.5.1 Traditional Asset Allocation
32.5.2 The New Investment Model
32.5.3 Active Risk, Active Return, and Traditional Investment Products
32.5.4 Is Alpha a Zero-Sum Game?
Review Questions
APPENDIX. Data Sources
Computations and Explanations
Index
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