CAIA - 11 - Private Equity Investment Process and Portfolio Management Set Flashcards Preview

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Flashcards in CAIA - 11 - Private Equity Investment Process and Portfolio Management Set Deck (41)
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1

___ ___ ___, which was pioneered by the economist Harry Markowitz, maintains that assets that are less than perfectly correlated can be combined to maximize return for a given level of risk.

Modern portfolio theory, which was pioneered by the economist Harry Markowitz, maintains that assets that are less than perfectly correlated can be combined to maximize return for a given level of risk.

2

Applying MPT to PE is challenging primarily due to the lack of ___ ___ ___. Thus, instead of optimal decision-making, portfolio management in PE typically involves "___," which is a term coined by the economist Herbert Simon, that is a heuristic that entails searching through available alternatives until an acceptable solution is found.

Applying MPT to PE is challenging primarily due to the lack of quality PE data. Thus, instead of optimal decision-making, portfolio management in PE typically involves "satisficing," which is a term coined by the economist Herbert Simon, that is a heuristic that entails searching through available alternatives until an acceptable solution is found.

3

Private equity has 3 key performance drivers:

 

1. ___ ___ consistent with targeted ___ and ___profile

2. Fund manager ___ and ___

3. ___ management

Private equity has 3 key performance drivers:

 

1. Portfolio design consistent with targeted risk and return profile

2. Fund manager selection and monitoring

3. Liquidity management

4

Distinguishing between ___ and ___can be useful for managing a PE investment program. While ___relates to being able to determine the probability of an event, ___relates to not being able to objectively determine the probability of an event.

Distinguishing between risk and uncertainty can be useful for managing a PE investment program. While risk relates to being able to determine the probability of an event, uncertainty relates to not being able to objectively determine the probability of an event.

5

Under modern portfolio theory, ___ and ___are the same since return distributions are assumed to be known. In contrast, investors in private markets are exposed to different degrees of ___.

Under modern portfolio theory, risk and uncertainty are the same since return distributions are assumed to be known. In contrast, investors in private markets are exposed to different degrees of uncertainty.

6

The first step of the private equity investment process is for the investor to establish and approve the ___.

The first step of the private equity investment process is for the investor to establish and approve the objectives.

7

___ ___is considered the main performance driver of well-diversified portfolios.

Asset allocation is considered the main performance driver of well-diversified portfolios.

8

The appropriate allocation to PE cannot be determined using standard risk-return optimization for several reasons:

 

1. Estimating ___ ___and ___is challenging

2. Analyzing ___requires adjustments

3. PE is ___, and desired investments may be unavailable

The appropriate allocation to PE cannot be determined using standard risk-return optimization for several reasons:

 

1. Estimating risk premium and correlations is challenging

2. Analyzing correlations requires adjustments

3. PE is lumpy, and desired investments may be unavailable

9

Some approaches of the endowment model are consistent with a ___ diversification approach.

Some approaches of the endowment model are consistent with a naive diversification approach.

10

Under the endowment model, the portfolio (is/is not) regularly rebalanced back to the original asset class weightings.

Under the endowment model, the portfolio is regularly rebalanced back to the original asset class weightings.

11

Under the ___ ___, rebalancing involves selling PE positions in the secondary market when prices have risen and buying when prices have declined.

Under the endowment model, rebalancing involves selling PE positions in the secondary market when prices have risen and buying when prices have declined.

12

The naive private equity allocation is estimated by analyzing four factors:

 

1. ___ size

2. ___ size to overall portfolio

3. Composition of ___ ___ portfolio

4. ___ needs

The naive private equity allocation is estimated by analyzing four factors:

 

1. Absolute size

2. Relative size to overall portfolio

3. Composition of existing PE portfolio

4. Liquidity needs

13

Monitoring PE investments involves six activities:

 

1. Tracking ___ vs ___strategy

2. Review ___, ___, and ___information

3. Analyzing the effect of relevant ___ ___

4. Assessing ___investment and overall ___ ___

5. ___/___performance

6. Verifying ___and ___compliance

Monitoring PE investments involves six activities:

 

1. Tracking planned vs implemented strategy

2. Review investmentdivestment, and valuation information

3. Analyzing the effect of relevant market trends

4. Assessing individual investment and overall portfolio risks

5. Measuring/benchmarking performance

6. Verifying legal and tax compliance

14

___ ___can increase the portfolio's transparency and provide signals of overexposure.

Stress tests can increase the portfolio's transparency and provide signals of overexposure.

15

In order to keep the program fully invested in the PE fund, ___-___strategies are used.

In order to keep the program fully invested in the PE fund, over-commitment strategies are used.

16

A ___-___ portfolio construction process involves examining all investment opportunities in the targeted PE market and selecting the best fund manager.

bottom-up portfolio construction process involves examining all investment opportunities in the targeted PE market and selecting the best fund manager.

17

Bottom-up portfolio construction involves the following steps:

 

1. Investment ___

2. ___and ___ ___

3. ___and ___

4. ___

 

Bottom-up portfolio construction involves the following steps:

 

1. Investment identification

2. Analysis and due diligence

3. Structuring and commitment

4. Monitoring

18

An issues with a bottom-up approach is that, since it strives to exploit opportunities, it can result in an ___ portfolio that is ___than intended.

An issues with a bottom-up approach is that, since it strives to exploit opportunities, it can result in an unbalanced portfolio that is riskier than intended.

19

A ___-___ PE portfolio construction approach takes a big-picture approach that involves examining macroeconomic conditions and determining the strategic asset allocation.

top-down PE portfolio construction approach takes a big-picture approach that involves examining macroeconomic conditions and determining the strategic asset allocation.

20

The top-down portfolio construction approach involves the following steps:

 

1. General ___ ___

2. ___ asset allocation

3. ___ planning

4. ___ ___ projections

The top-down portfolio construction approach involves the following steps:

 

1. General economic analysis

2. Strategic asset allocation

3. Commitment planning

4. Cash flow projections

21

The main drawback of the ___-___approach to investing in private equity is that strict allocations are not possible in practice.

The main drawback of the top-down approach to investing in private equity is that strict allocations are not possible in practice.

22

Most investors use a ___ approach to PE portfolio construction.

Most investors use a mixed approach to PE portfolio construction.

23

The ___- ___approach combines passive investing with active management aimed at outperforming a benchmark.

The coresatellite approach combines passive investing with active management aimed at outperforming a benchmark.

24

The ___ portfolio relates to investors' strategic asset allocation and consists of passive, often low-cost investments that track an asset class's overall performance.

The core portfolio relates to investors' strategic asset allocation and consists of passive, often low-cost investments that track an asset class's overall performance.

25

The ___ portfolio aims to add alpha via tactical asset allocation and consists of actively managed, higher-cost investments that require monitoring.

The satellite portfolio aims to add alpha via tactical asset allocation and consists of actively managed, higher-cost investments that require monitoring.

26

There are a number of advantages to the core-satellite approach:

 

1. ___ without foregoing potential for high returns from actively-managed strategies

2. Flexibility to tailor the portfolio to ___ ___

3. Ability to target ___ ___

4. Ability to focus more effort on the ___portfolio and less on the benchmarked, lower-return ___ portfolio

There are a number of advantages to the core-satellite approach:

 

1. Diversification without foregoing potential for high returns from actively-managed strategies

2. Flexibility to tailor the portfolio to specific objectives

3. Ability to target specific risks

4. Ability to focus more effort on the satellite portfolio and less on the benchmarked, lower-return core portfolio

27

In general, investors have larger satellites with:

 

1. ___ time horizon

2. ___resources

3. ___changes in PE market

In general, investors have larger satellites with:

 

1. Longer time horizon

2. More resources

3. More changes in PE market

28

PE fund return distributions exhibit large ___ skewness

PE fund return distributions exhibit large positive skewness

29

PE diversification has two key effects on portfolios:

 

1. Reduces portfolio ___ if assets are not perfectly ___

2. Makes the return distribution closer to a ___ ___

PE diversification has two key effects on portfolios:

 

1. Reduces portfolio risk if assets are not perfectly correlated

2. Makes the return distribution closer to a normal distribution

30

For most assets, adequate diversification is achieved using about ___ positions.

For most assets, adequate diversification is achieved using about 20 positions.

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