Browse Analysis of Managed and Structured Products

21. Alternative Investments: Strategies And Performance

Learn about alternative investment strategies, performance measurement tools, due diligence process, and the suitability of these strategies for various investor groups.

Strategies and Performance

Chapter Overview

In this chapter, you will learn about a variety of alternative investment strategies and performance measurement tools. It will cover the comprehensive due diligence process required for these investments and finish with a brief discussion about the suitability of alternative strategies for different investor groups.

Learning Objectives

Upon completing this chapter, you will be able to:

  1. Explain how the various types of alternative investment strategies work, including those in the relative value, event-driven, and directional strategy classifications.
  2. Identify the strategies most likely to be used in alternative mutual funds.
  3. Discuss risk measures and risk-adjusted return measures pertinent to alternative strategy fund investments.
  4. Detail benchmarking methods for assessing alternative investment performance.
  5. Describe the due diligence process when contemplating investment in an alternative strategy fund.
  6. Identify investor groups for whom liquid alternative investments might be most suitable.

Key Terms

Key terms are defined in the Glossary and appear in bold text throughout the chapter.

  • absolute risk
  • convertible arbitrage strategy
  • directional strategies
  • distressed security strategy
  • emerging markets alternative funds
  • equity market-neutral strategy
  • event-driven strategies
  • fixed-income arbitrage strategy
  • global macro strategy
  • high-yield bond strategy
  • kurtosis
  • maximum drawdown
  • merger strategy
  • relative value strategies
  • risk arbitrage strategy
  • short bias strategy
  • skew
  • time to recovery

Chapter Outline

  1. Introduction to Alternative Investment Strategies

    • Describe various alternative investment strategies.
    • Strategies within relative value, event-driven, and directional categories.
  2. Use of Strategies in Alternative Mutual Funds

    • Highlight alternative strategies in mutual funds portfolios.
  3. Risk and Performance Measurement

    • Risk measures
    • Risk-adjusted return measures
    • Performance metrics
  4. Benchmarking of Performance

    • Standard benchmarks
    • Customized benchmarks
  5. Due Diligence Process

    • Steps to conducting thorough due diligence.
  6. Suitability of Alternative Strategies

    • Identify appropriate investor groups for liquid alternative strategies.

Detailed Content Analysis

1. Introduction to Alternative Investment Strategies

  • Relative Value Strategies: Positions may exploit pricing inefficiencies.

    • Convertible Arbitrage: Shorting securities while being long on their convertible counterparts.
  • Event-Driven Strategies: Profiteering from company-specific events.

    • Merger Arbitrage: Take advantage of the price difference before, during, and after mergers.
    • Distressed Debt: Investing in companies nearing default due to underperformance.
  • Directional Strategies: Predict movements of the market or sector.

    • Long/Short Equity: Balancing long positions with short positions to mitigate risk.
    • Short Bias: Predominantly hold short positions betting against assets.
    • Global Macro: Capitalizing on expected macroeconomic trends and geopolitical events.

2. Use of Strategies in Alternative Mutual Funds

  • Identify which strategies are care likely to be observed within mutual funds.
  • Describe how these funds optimize returns and minimize risks.

3. Risk and Performance Measurement

  • Performance metric relevance, such as the Sharpe Ratio
    $$ (Sharpe\ Ratio = \frac{R_{p} - R_{f}}{\sigma_{p}}) $$
    where
    • $R_{p}$ is the return of the portfolio.
    • $R_{f}$ is the risk-free rate.
    • $\sigma_{p}$ is the standard deviation of the portfolio’s excess return.
  • Risk measures such as Maximum Drawdown and Time to Recovery.

4. Benchmarking of Performance

  • Use standard indices designed for alternative strategies.
  • Option to create customized benchmarks specific to certain investment characteristics.

5. Due Diligence Process

  • Essential for investment funds to evaluate performance metrics, fund management, compliance, and operational capabilities.
  • Elements like historical performance and strategy sustainability play crucial roles.

6. Suitability of Alternative Strategies

  • Describing investor risk tolerance and investment goals
  • Liquid alternatives being recommended for retail investors seeking exposure to alternative investments without the lock-up periods.
    • Investor Groups: Low to moderate-risk tolerance willing to explore non-conventional investments.

Frequently Asked Questions

  1. What is an absolute risk?

    • Absolute risk is the unmitigated risk level inherent in a security or investment portfolio.
  2. How can an investor benefit from a merger strategy?

    • Investors benefit by capitalizing on the expected price changes due to company mergers, acquisition scenarios, or buyouts.
  3. What benchmarks are commonly used for alternative investments?

    • Often used benchmarks include HFRX Global Hedge Fund Index and custom indices related to specific strategies.

Charts and Diagrams

Mermaid Sample Graph for Performance Metrics Evaluation Workflow

      graph LR
	    A[Investment Analysis] --> B[Risk Assessment]
	    B --> C[Performance Metrics]
	    C --> D[Benchmark Evaluation]
	    D --> E[Fund Due Diligence]

Glossary & Definitions

  • Absolute Risk: The non-diversifiable threat potential of an investment.
  • Kurtosis: Measure of the

📚✨ Quiz Time! ✨📚

🧐 Assess and Solidify Your Understanding

Welcome to the Knowledge Checkpoint! You’ll find 10 carefully curated quizzes designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you’re on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck! 🍀💪

## What are the three primary classifications of alternative investment strategies mentioned in the CSC curriculum? - [ ] Absolute, relative, and event-driven strategies - [x] Relative value, event-driven, and directional strategies - [ ] Macro, micro, and equity strategies - [ ] Hedge, index, and opportunity strategies > **Explanation:** The CSC divides alternative investment strategies into three primary classifications: relative value, event-driven, and directional strategies. Understanding the distinctions between these classifications is crucial for grasping the nuances of alternative investments. ## Which of the following strategies is part of event-driven strategies? - [ ] Long/short equity strategy - [ ] Convertible arbitrage strategy - [ ] Fixed-income arbitrage strategy - [x] Merger strategy > **Explanation:** Event-driven strategies take advantage of specific events that create pricing inefficiencies. Merger strategy is a prime example, where traders profit from the merger or acquisition announcements. ## What type of alternative strategies is most likely to be used in alternative mutual funds? - [ ] Directional strategies exclusively - [x] A mix of relative value, event-driven, and directional strategies - [ ] Only relative value strategies - [ ] Only empirical strategies single factor > **Explanation:** Alternative mutual funds typically employ a mix of relative value, event-driven, and directional strategies to provide diverse return profiles and manage risk effectively. ## Which risk measure is commonly used to assess downside risk in alternative investments? - [ ] Alpha - [ ] Beta - [x] Maximum drawdown - [ ] Standard deviation > **Explanation:** Maximum drawdown measures the maximum peak-to-trough decline in a portfolio's value, representing the largest loss an investor could face and is crucial for assessing downside risk. ## What is "time to recovery" in the context of alternative investing? - [ ] The time taken to achieve an all-time high - [x] The time it takes for a fund to recover from its highest drawdown to reach its initial value or peak - [ ] The time it takes to deploy all capital into investments - [ ] The renewable period for investments > **Explanation:** "Time to recovery" measures how long it takes for an investment to return to its previous value after experiencing a significant loss, a critical metric for evaluating the resilience of alternative strategies. ## What is the purpose of due diligence when evaluating an alternative strategy fund? - [ ] To validate solely the financial outcomes of the fund - [ ] To circumvent compliance requirements - [ ] To only measure historical performances - [x] To comprehensively assess the fund's investment strategy, management team, risk framework, and operational procedures > **Explanation:** Due diligence ensures that potential investments in alternative strategy funds are thoroughly vetted, covering aspects from strategy viability to managerial competency and risk infrastructure, thus mitigating potential risks. ## Why is benchmarking important in evaluating the performance of alternative investments? - [ ] It guarantees above-market returns - [ ] It provides a subjective performance measure - [x] It offers a relevant performance comparative that encapsulates similar risk and return profiles - [ ] It eliminates the need for performance analytics > **Explanation:** Benchmarking against relevant indices or peers helps to contextualize the performance of alternative investments, offering insights into how well the fund is performing relative to comparable investments. ## What is the significance of "kurtosis" in the context of alternative investments? - [ ] It measures the standard deviation - [x] It quantifies the "tailedness" of the return distribution of an investment, indicating the likelihood of extreme returns - [ ] It only applies to fixed-income investments - [ ] It refers to the average return > **Explanation:** Kurtosis measures the extent to which investment returns have heavy or light tails compared to a normal distribution, indicating the probability of extreme outcomes. ## Who are the most suitable investor groups for liquid alternative investments (liquid alts)? - [ ] Government entities and large institutions only - [ ] Conservative savers and fixed income investors - [ ] Only high net worth individuals - [x] A range of investors, including institutional investors, high net-worth individuals, and retail investors open to diverse investment opportunities > **Explanation:** Liquid alternative investments are designed to offer broader access to alternative strategies through mutual fund structures, making them suitable for a wide array of investor segments who seek diversification and potential non-correlated returns. ## Which of the following describes a convertible arbitrage strategy? - [ ] Buying only convertible securities based on market predictions - [ ] Focusing exclusively on high-yield bonds - [x] Simultaneously purchasing convertible securities and shorting associated stocks to exploit price inefficiencies - [ ] Engaging in interest rate speculation > **Explanation:** Convertible arbitrage involves exploiting pricing inefficiencies by buying convertible securities, such as bonds, and shorting the underlying stocks to profit from discrepancies in their price movements.

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In this section

  • 21.1 Introduction
    In this chapter of the Canadian Securities Course certification exam preparation guide, we delve into the various investment strategies employed by alternative strategy managers, performance measures, and the essential due diligence process.
  • 21.2 Alternative Investment Strategies
    Explore the various types of alternative investment strategies, including relative value, event-driven, and directional strategies, and understand the preferred strategies for alternative mutual funds.
    • 21.2.1 Relative Value Strategies
      Comprehensive guide to understanding relative value strategies including equity market-neutral strategies, convertible arbitrage, and fixed-income arbitrage. Key concepts, examples, FAQs, and detailed methodologies are explored for effective trading.
    • 21.2.2 Event-driven Strategies
      A comprehensive guide detailing event-driven strategies including merger (risk arbitrage) strategies, high-yield bond strategies, and distressed securities strategies. Learn how these unique corporate structures can generate profit through strategic investments.
    • 21.2.3 Directional Strategies
      In-depth exploration of directional investment strategies including long/short equity, global macro, emerging markets, dedicated short bias, and managed futures strategies. This chapter covers essential concepts, examples, mathematical calculations, and advantages and considerations.
    • 21.2.4 Multi-strategy Funds
      Understand the concept, benefits, and risks of multi-strategy funds in the context of Canadian securities. Explore the differences between multi-strategy funds and fund-of-funds, including diversification benefits and management fee considerations.
    • 21.2.5 Leveraged Etf Strategy
      Comprehensive guide on Leveraged ETF Strategy including investment strategies, risk measures, due diligence, and suitability for investors.
Saturday, July 13, 2024