Level III Alternative Investments Portfolio Management www.ift.world Graphs, charts, tables, examples, and figures are copyright 2017, CFA Institute Reproduced and republished with permission from CFA Institute All rights reserved Contents Introduction Alternative Investments: Definitions, Similarities and Contrasts Real Estate Private Equity/Venture Capital Commodity Investments Hedge Funds Managed Futures Distressed Securities www.ift.world Introduction www.ift.world Alternative Investments: Definitions, Similarities and Contrasts Common Features of Alternative Investments  informationally less efficient www.ift.world www.ift.world www.ift.world www.ift.world Major investors in alternative investments: High net worth individuals Institutional investors (some might have restrictions) Factors: Illiquidity might be an issue for some investors; others might benefit from illiquidity premium Due diligence costs are often high www.ift.world www.ift.world www.ift.world 10 CTA Performance, 1996–2015 Survivorship bias alert 70 Correlations of CISDM CTA Universe Strategies, 1996–2015 71 Investment Characteristics and Roles • Derivatives are a zero-sum game; hence for CTAs to earn a return above the risk free rate there must be enough hedgers who will accept a return less than the risk free rate • Arbitrage when the opportunity exists • Most actively managed derivative strategies follow momentum strategies • Easy to take short position; hence can earn positive excess return in falling markets • A randomly selected equally weighted portfolio of 8-10 CTAs has a standard deviation similar to the population from which it is drawn www.ift.world 72 Managed Futures Performance in Portfolios, 1996–2015 www.ift.world 73 Example 14: Adding Managed Futures to the Strategic Asset Allocation Using data from this exhibit, determine whether the addition of managed futures to a portfolio comprising US equities, US bonds, and alternative investment strategies would improve the risk/return profile of that portfolio Justify your response with reference to two statistics provided in the exhibit www.ift.world 74 Example 14 (Cont…) “Are there other statistics besides those given that could be potentially useful as predictors of the persistence of performance of CTA managers?” Research has indicated that the relative riskiness of a CTA (i.e., the commodity trading adviser’s beta with respect to an index of CTAs) is a good predictor of future relative returns Thus, past CTA performance may be valuable in forecasting CTA and multi-adviser CTA portfolio return and risk parameters, especially at the portfolio level www.ift.world 75 Example 14 (Cont…) “If managed futures are a subset of hedge funds, including them in the portfolio may be redundant if we also invest in other hedge funds We won’t gain any diversification benefits.” Critique the statement and justify your response with reference to data in the exhibit www.ift.world 76 Distressed Securities • Securities of companies that are in financial distress or near bankruptcy • Securities could be equity or debt • Investment strategies exploit fact that…  many investors are unable to hold below investment grade securities  few analysts cover distressed securities www.ift.world 77 www.ift.world 78 Distressed securities managers can trade in many types of assets… www.ift.world 79 Benchmarks and Historical Performance • In the context of hedge funds, distressed securities investing is often classified as a sub-style of event-driven strategies • All major hedge fund indices have a sub-index for distressed securities Monthly Returns of High-Yield and Distressed Securities, 1998–2015 www.ift.world 80 Distressed Securities Performance, 1998–2015 Risk measured by standard deviation is probably understated Distressed securities strategies have high correlation with the business cycle Performance data does not capture event risk www.ift.world 81 Major Risks Do Example 16 from the curriculum 82 Summary • Covered types of alternative investments: Real Estate, Private Equity, Commodity Investments, Hedge Funds, Managed Futures, Distressed Securities • For each type understand:      What it means and the market Benchmarks, along with limitations Investment characteristics Role in a portfolio (includes understanding the risks) Due diligence www.ift.world 83 Conclusion • Examples • Curriculum Summary • Learning Objectives • Practice Problems www.ift.world 84 ... Securities www.ift.world Introduction www.ift.world Alternative Investments: Definitions, Similarities and Contrasts Common Features of Alternative Investments  informationally less efficient www.ift.world...Contents Introduction Alternative Investments: Definitions, Similarities and Contrasts Real Estate Private Equity/Venture Capital Commodity Investments Hedge Funds Managed Futures... less efficient www.ift.world www.ift.world www.ift.world www.ift.world Major investors in alternative investments: High net worth individuals Institutional investors (some might have restrictions)