CFA Level 1 - May Flashcards
What is an alternative investment
Types of alternative investment structures include hedge funds, private equity funds, and various types of real estate investments. Alternative investments typically are actively managed and may include investments in commodities, infrastructure, and illiquid securities.
“Asymmetric information” is
a term that refers to when one party in a transaction is in possession of more information than the other.
Venture capital
funds invest in young, unproven companies at the start-up or early stages in their life cycles.
Derivative
Key Takeaways. Derivatives are financial contracts, set between two or more parties, that derive their value from an underlying asset, group of assets, or benchmark.
A fund’s term sheet
describes its investment policy, fee structure, and requirements for investors to participate.
Equity Coinvesting
Investing in a fund but also purchasing the same positions outside of the fund.
Side Letters
Special terms that apply to one limited partner but not to others can be stated in side letters. They are agreements between fundraisers and investors that provide certain rights, privileges, and obligations outside of the standard investment document’s terms.
most-favored-nation clause
This Most Favored Nation (MFN) clause for private equity fund (PEF) side letter is to be used when an investor requests written assurance that it will have the same rights as some or all of the other investors in the PEF.
Dry Powder
o Committed capital that has not yet been drawn down is referred to as dry powder.
o For private equity funds, the management fee is calculated as a percentage of committed capital, not invested capital.
Catch Up Clause
A catch-up clause in a partnership agreement is based on a hurdle rate and is similar in its effect to a soft hurdle rate. Consider a fund with returns of 14%, a hurdle rate of 8%, and a 20% performance fee. A catch-up clause would result in the first 8% of gains going to the LPs and the next 2% going to the GP, allowing the GP to “catch up” to receiving 20% of the first 10% of gains. After the catchup, further gains are split 80/20 between the LPs and the GP.
Soft and Hard Hurdle Rates
For example, consider a fund with a hurdle rate of 8% that has produced a return of 12% for the year. We will use a performance fee structure of 20% of gains. If the 8% is a soft hurdle rate, the performance fee will be 20% of the entire 12%, or 2.4%. If the 8% is a hard hurdle rate, the performance fee will be 20% of the gains above the hurdle rate (12% – 8% = 4%), which would be 0.8%.
High Water Mark
Another feature that is often included is a high-water mark, which means no performance fee is paid on gains that only offset prior losses. Thus, performance fees are only paid to the extent that the current value of an investor’s account is above the highest net-of-fees value previously recorded (at the end of a payment period).
The basic whole-fund model distribution waterfall (European Style)
requires investors to recover their total capital contributions to the fund and receive a specified preferred return before the manager receives any carried interest.
American Waterfall
In an American waterfall, the General Partner is entitled to carried interest at the same time as the Limited Partners.
What is a 3-and-15 fee structure?
Hedge fund fee structures indicate management fees as a percentage of assets under management and incentive fees as a percentage of gains in value. A 3-and-15 fee structure means a fund charges a 3% management fee and a 15% incentive fee.
