CH20

Question 1

What are traditional assets?

Answer 1

Stocks, bonds, bills

Traditional assets are the primary forms of investment that most investors are familiar with.

Question 2

What are alternative assets?

Answer 2

Hedge funds, private equity, real assets, structured products

Alternative assets have gained popularity in recent years alongside traditional assets.

Question 3

What is a hedge fund?

Answer 3

Investment pools with net asset value (NAV) representing the investor’s stake

Hedge funds often employ diverse strategies to achieve high returns.

Question 4

What is private equity?

Answer 4

Investment pools aiming to generate value through direct impact

This includes angel investors, venture capital, and leveraged buyouts.

Question 5

What are real assets?

Answer 5

Real estate, natural resources, commodities

Real assets are tangible assets that have intrinsic value.

Question 6

Define structured products.

Answer 6

Combinations of securities and derivatives generating market-linked outcomes

Structured products are designed to provide customized risk exposures.

Question 7

What is the transparency level of traditional assets?

Answer 7

Subject to the Securities Act of 1933 and the Investment Company Act of 1940

Traditional assets have predictable strategies and regular updates on portfolio composition.

Question 8

What is the transparency level of alternative assets?

Answer 8

Limited information on strategy and portfolio composition

Hedge funds and private equity funds are less regulated than traditional assets.

Question 9

Who are typical investors in traditional assets?

Answer 9

Individuals, institutions

Traditional assets are accessible to a wide range of investors.

Question 10

Who are typical investors in alternative assets?

Answer 10

Accredited investors with net worth, income requirements, or professional certifications

Alternative assets often require more sophisticated knowledge and resources.

Question 11

What is a key investment strategy for traditional assets?

Answer 11

Avoid style drift, limited leverage, restricted derivative use

Traditional investment strategies focus on stability and predictability.

Question 12

What is a key investment strategy for alternative assets?

Answer 12

Opportunistic actions, flexibility in strategies

Hedge funds and private equity can adapt quickly to market changes.

Question 13

What is liquidity in traditional assets?

Answer 13

Higher liquidity, meeting liquidity needs

Traditional assets can typically be bought or sold quickly.

Question 14

What is liquidity in alternative assets?

Answer 14

Lock-up periods, redemption notices, structural illiquidity

Investors in alternative assets may face restrictions on when they can withdraw funds.

Question 15

What is the fee structure for traditional assets?

Answer 15

Management fees are a fixed percentage of assets under management

Traditional investment vehicles generally have simpler fee structures.

Question 16

What is the fee structure for alternative assets?

Answer 16

Management fees typically 1% to 2%, plus incentive fees around 20% of profits

Alternative assets often have more complex fee arrangements.

Question 17

What defines a directional strategy in hedge funds?

Answer 17

Speculation that one market sector will outperform others

Directional strategies rely on market predictions.

Question 18

What defines a nondirectional strategy in hedge funds?

Answer 18

Exploiting temporary misalignments in relative pricing

Nondirectional strategies aim to be market neutral.

Question 19

What is statistical arbitrage?

Answer 19

Use of quantitative systems to uncover pricing misalignments

This strategy seeks to ensure profit through statistical analysis.

Question 20

What is pairs trading?

Answer 20

Establishing long/short positions to exploit relative mispricing

Pairs trading involves analyzing correlated securities.

Question 21

What is a portable alpha strategy?

Answer 21

Invest in positive-alpha positions, hedge systematic risk, establish market exposure

This strategy allows the transfer of alpha across asset classes.

Question 22

What characterizes angel investors?

Answer 22

Wealthy individuals investing in early-stage business development

Angel investors often work through networks to fund startups.

Question 23

What is venture capital?

Answer 23

Professionally managed money investing in startups

Venture capitalists typically seek high returns by funding innovative companies.

Question 24

What are Angel Investors?

Answer 24

Wealthy individuals or families that invest in the earliest stages of business development

Often syndicated through angel networks

Question 25

What is Venture Capital (VC)?

Answer 25

Professionally managed money that invests in startups ## Footnote Two forms: Independent VC funds or corporate venture capital

Question 26

How are VC funds typically structured?

Answer 26

As limited liability partnerships ## Footnote General Partners control funds under management while Limited Partners provide capital

Question 27

Define Vintage Year in the context of venture capital.

Answer 27

The first year of the venture fund when raised capital is first deployed ## Footnote It influences expected fund performance

Question 28

What is a Term Sheet?

Answer 28

The written agreement specifying the deal structure ## Footnote Includes stock type, dividends, voting rights, capital invested, ownership, liquidation preferences, and anti-dilution measures

Question 29

What determines required ownership per dollar invested in private equity valuation?

Answer 29

Value determined by a required capital multiplier ## Footnote Terminal ownership share = Initial Investment × Capital Multiplier

Question 30

How does an early-stage VC project terminal ownership share?

Answer 30

By using the formula: Terminal ownership share = Initial Investment × Capital Multiplier ## Footnote Example: $2,000,000 investment with a target exit multiple of 10×

Question 31

What is a Leveraged Buyout (LBO)?

Answer 31

LBO Funds take public companies private through invested equity and massive amounts of debt ## Footnote Typically involves 10% to 40% equity and 60% to 90% debt

Question 32

What is the typical exit strategy for LBOs?

Answer 32

Exit through IPO or acquisition, typically 10 years from initial purchase

Question 33

What performance metrics are commonly used to evaluate hedge funds?

Answer 33

Excess Sharpe ratio, alpha, and information ratio

Question 34

What is survivorship bias in hedge fund performance measurement?

Answer 34

Occurs when unsuccessful funds that cease operation stop reporting returns ## Footnote Leaves only successful funds in the database

Question 35

What are tail events?

Answer 35

Extreme but rare occurrences that fall into the far-left tail of the probability distribution

Question 36

What is Jensen’s alpha?

Answer 36

The average return on the portfolio over and above that predicted by the CAPM ## Footnote Given the portfolio’s beta and average market return

Question 37

What does the Information Ratio measure?

Answer 37

Divides the alpha of the portfolio by the nonsystematic risk of the portfolio

Question 38

What is the impact of industry specialization on VC performance?

Answer 38

Publicly traded companies backed by industry-specific VCs tend to perform better and survive longer ## Footnote Compared to those backed by generalist VCs

Question 39

What is grandstanding in venture capital?

Answer 39

The practice of bringing companies to public market too early ## Footnote May damage VC reputation in the long run

Question 40

What is the general trend in hedge fund performance since 2010?

Answer 40

General downward trend in excess Sharpe ratio and Information ratio, but alphas are still generally positive

Question 41

What is the typical capital structure of an LBO?

Answer 41

Equity (10% to 40%) and debt (60% to 90%)

Question 42

What is the performance comparison between VC-backed companies?

Answer 42

Companies backed by industry-specific VCs tend to perform better and survive longer than those backed by generalist VCs.

Question 43

What is the typical annual management fee for hedge funds?

Answer 43

1% to 2% of assets.

Question 44

What is the typical incentive fee for hedge funds?

Answer 44

20% of investment profits beyond a stipulated benchmark performance.

Question 45

How are incentive fees structured in hedge funds?

Answer 45

Incentive fees are effectively call options, where the manager gets the fee if the portfolio value rises but loses nothing if it falls.

Question 46

What does the strike price represent in hedge fund incentive fees?

Answer 46

Current portfolio value × (1 + benchmark return).

Question 47

What is a high-water mark in hedge fund management?

Answer 47

The previous value of a portfolio that must be reattained before incentive fees can be charged.

Question 48

What is the purpose of a high-water mark?

Answer 48

To give managers an incentive to shut down funds that have performed poorly.

Question 49

What are funds of funds?

Answer 49

Investment funds that invest in other funds rather than directly in securities such as stocks or bonds.

Question 50

What is the first distribution tier in private equity?

Answer 50

First distributions flow 100% to LP until invested capital is returned.

Question 51

What is a hurdle rate in private equity?

Answer 51

A promised rate (often 8%) entirely to the LP before any incentive fee is distributed.

Question 52

How do GPs collect carried interest in private equity?

Answer 52

Through use of a catch-up provision until 80%/20% parity.

Question 53

What happens to distributions after the hurdle rate is met?

Answer 53

Remaining distributions go 80% to LPs and 20% to GPs (incentive fee).

Question 54

What is a clawback provision in private equity?

Answer 54

Allows LPs to reclaim part of the GP’s paid carried interest in the event of severe losses.

Question 55

What are the typical management and incentive fees in private equity?

Answer 55

2% management fee and 20% incentive fee.

Question 56

Fill in the blank: A fund of funds has a hurdle rate for the incentive fee of a _______.

Answer 56

zero return.

Question 57

If a fund of funds has $1 million invested and an aggregate portfolio return of -5%, what incentive fees does it still pay?

Answer 57

$0.12 for every $3 invested.