The CAIA Association is an independent, not-for-profit, global organization committed to education and professionalism in the field of alternative investments. It offers two exams (Level I and Level II) to financial professionals in this growing field. Upon successful completion, individuals are designated Chartered Alternative Investment Analyst (CAIA) Charter Holders. The CAIA Association has members from over seventy-five countries on six continents.
Mark J. P. Anson, PhD, CAIA, is a Managing Partner at Oak Hill Investment Management, LP. Dr. Anson previously served as President and Executive Director of Investment Services at Nuveen Investments, Chief Executive Officer at Hermes Pension Management Limited, and Chief Investment Officer at California Public Employees' Retirement System. He has published over 100 research articles in professional journals, has won two Best Paper Awards, is the author of six financial textbooks, and sits on the editorial boards of several financial journals.
Donald R. Chambers, PhD, CAIA, is the Associate Director of the Level 1 Curriculum at the CAIA Association and is the Walter E. Hanson/KPMG Professor of Finance at Lafayette College in Easton, Pennsylvania. Dr. Chambers previously served as the Director of Alternative Investments at Karpus Investment Management.
Keith H. Black, PhD, CAIA, is the Associate Director of the Level II Curriculum at the CAIA Association. He was previously an Associate at Ennis Knupp and, before that, an Assistant Professor at Illinois Institute of Technology.
Hossein Kazemi, PhD, CAIA, is a Cofounder of and the Program Director for the CAIA Association. Dr. Kazemi is a Professor of Finance at the University of Massachusetts Amherst, an Associate Director of the Center for International Securities and Derivatives Markets, and an Associate Editor of the Journal of Alternative Investments.
Preface | p. xiii |
Introduction to Alternative Investments | p. 1 |
What Is an Alternative Investment? | p. 3 |
Alternative Investments by Exclusion | p. 3 |
Alternative Investments by Inclusion | p. 4 |
Structures among Alternative Investments | p. 8 |
Investments Are Distinguished by Return Characteristics | p. 12 |
Investments Are Distinguished by Methods of Analysis | p. 14 |
Goals of Alternative Investing | p. 17 |
Overview of This Book | p. 19 |
The Environment of Alternative Investments | p. 21 |
The Participants | p. 21 |
Financial Markets | p. 28 |
Regulations | p. 30 |
Taxation | p. 38 |
Statistical Foundations | p. 41 |
Frequency and Probability Distributions | p. 41 |
Compounding Multiple Time Period Returns | p. 44 |
Return Distributions and Autocorrelation | p. 48 |
Moments of the Distribution: Mean, Variance, Skewness, and Kurtosis | p. 50 |
Computing Sample Statistics | p. 54 |
More on Standard Deviation and Variance | p. 59 |
Testing for Normality | p. 64 |
Other Measures of Risk | p. 66 |
Estimating Value at Risk (VaR) | p. 70 |
Time Series Return Volatility Models | p. 75 |
Conclusion | p. 77 |
Risk, Return, and Benchmarking | p. 79 |
Benchmarking | p. 79 |
Asset Pricing Models | p. 82 |
Three Methods of Models | p. 82 |
Cross-Sectional versus Time-Series Models | p. 85 |
Single-Factor and Ex Ante Asset Pricing | p. 87 |
Empirical Analyses with the CAPM | p. 90 |
Multifactor Models | p. 96 |
Alternative Asset Benchmarking | p. 103 |
Conclusion | p. 107 |
Correlation, Alternative Returns, and Performance Measurement | p. 109 |
Correlation | p. 109 |
Internal Rate of Return | p. 118 |
Problems with IRR | p. 122 |
Returns Based on Notional Principal | p. 129 |
Distribution of Cash Waterfall | p. 132 |
Performance Measures | p. 139 |
Alpha and Beta | p. 147 |
Overview of Beta and Alpha | p. 147 |
Ex Ante versus Ex Post Alpha | p. 149 |
Inferring Ex Ante Alpha from Ex Post Alpha | p. 155 |
Return Attribution | p. 158 |
Ex Ante Alpha Estimation and Persistence | p. 163 |
Return Drivers | p. 164 |
Summary of Alpha and Beta Analysis | p. 168 |
Hypothesis Testing in Alternative Investments | p. 169 |
Four Steps of Hypothesis Testing | p. 170 |
A Test Assuming Normality | p. 173 |
Tests with Inferential Statistics | p. 176 |
Sampling and Testing Problems | p. 181 |
Cumulative Returns and Performance | p. 185 |
Statistical Issues in Analyzing Alpha and Beta | p. 189 |
Summary of Alpha and Beta Estimation | p. 196 |
Conclusion | p. 198 |
Real Assets | p. 201 |
Land, Infrastructure, and Intangible Real Assets | p. 203 |
Land | p. 203 |
Timber and Timberland | p. 208 |
Farmland | p. 210 |
Infrastructure | p. 214 |
Intellectual Property | p. 220 |
Valuation and Volatility | p. 224 |
Historical Risks and Returns | p. 228 |
Real Estate Fixed-Income Investments | p. 233 |
Residential Mortgages | p. 233 |
Commercial Mortgages | p. 241 |
Mortgage-Backed Securities Market | p. 244 |
Collateralized Mortgage Obligations | p. 249 |
Real Estate Investment Trusts | p. 255 |
Risks and Returns of Mortgage REITs | p. 256 |
Real Estate Equity Investments | p. 261 |
Real Estate Development | p. 261 |
Valuation and Risks of Real Estate Equity | p. 264 |
Alternative Real Estate Investment Vehicles | p. 272 |
Real Estate and Depreciation | p. 278 |
Real Estate Equity Risks and Returns | p. 283 |
Risks and Returns of Equity REITs | p. 288 |
Hedge Funds | p. 293 |
Introduction to Hedge Funds | p. 295 |
Distinguishing Hedge Funds | p. 295 |
Hedge Fund Types | p. 302 |
Hedge Fund Fees | p. 304 |
Conclusion | p. 315 |
Hedge Fund Returns and Asset Allocation | p. 317 |
Describing the Hedge Fund Universe | p. 317 |
Mean, Variance, Skewness, and Kurtosis of Strategies | p. 319 |
Categorizing Hedge Fund Strategies | p. 321 |
Should Hedge Funds Be Part of an Investment Program? | p. 328 |
Do Hedge Funds Undermine the Financial Markets? | p. 333 |
Hedge Fund Indices | p. 335 |
Conclusion | p. 344 |
Macro and Managed Futures Funds | p. 345 |
Major Distinctions between Strategies | p. 345 |
Global Macro | p. 347 |
Returns of Macro Investing | p. 351 |
Managed Futures | p. 354 |
Systematic Trading | p. 357 |
Systematic Trading Styles | p. 359 |
Prior Empirical Research | p. 369 |
Conclusion | p. 376 |
Analysis of Historical Returns Conclusion | p. 376 |
Event-Driven Hedge Funds | p. 381 |
The Sources of Most Event Strategy Returns | p. 381 |
Activist Investing | p. 384 |
Merger Arbitrage | p. 397 |
Distressed Securities Funds | p. 405 |
Event-Driven Multistrategy Funds | p. 412 |
Relative Value Hedge Funds | p. 417 |
Convertible Bond Arbitrage | p. 418 |
Volatility Arbitrage | p. 433 |
Fixed-Income Arbitrage | p. 447 |
Relative Value Multistrategy Funds | p. 459 |
Equity Hedge Funds | p. 461 |
Sources of Return | p. 462 |
Market Anomalies | p. 466 |
The Fundamental Law of Active Management | p. 47 |
Implementing Anomaly Strategies | p. 475 |
The Three Equity Strategies | p. 480 |
Conclusion | p. 493 |
Funds of Hedge Funds | p. 495 |
Benefits and Costs of Diversification | p. 495 |
Investing in Multistrategy Funds | p. 502 |
Investing in Funds of Hedge Funds | p. 505 |
Fund of Funds Historical Returns | p. 508 |
Conclusion | p. 520 |
Commodities | p. 523 |
Commodity Futures Pricing | p. 525 |
Forward and Futures Contracts | p. 525 |
Rolling Contracts | p. 530 |
The Term Structure of Forward Prices | p. 531 |
Backwardation and Contango | p. 542 |
Returns on Futures Contracts | p. 545 |
Commodities: Applications and Evidence | p. 551 |
Commodity Investing for Diversification | p. 551 |
Commodity Investing for Return Enhancement | p. 555 |
Investing in Commodities without Futures | p. 557 |
Commodity Exposure through Futures Contracts | p. 562 |
Three Fallacies of Roll Return | p. 568 |
Commodity Futures Indices | p. 570 |
Commodity Risks and Returns | p. 572 |
Historical Risks and Returns | p. 574 |
Private Equity | p. 579 |
Introduction to Private Equity | p. 581 |
Private Equity Terminology and Background | p. 581 |
Private Equity as Equity Securities | p. 584 |
Private Equity as Debt Securities | p. 587 |
Trends and Innovations in Private Equity | p. 592 |
Equity Types of Private Equity | p. 599 |
Venture Capital versus LBOs | p. 599 |
The Underlying Businesses of Venture Capital | p. 600 |
Venture Capital Funds | p. 601 |
Venture Capital Risks and Returns | p. 609 |
Leveraged Buyouts (LBOs) | p. 613 |
Leveraged Buyout Risks and Returns | p. 623 |
Debt Types of Private Equity | p. 625 |
Mezzanine Debt | p. 625 |
Distressed Debt | p. 632 |
Risks of Distressed Debt Investing | p. 637 |
Structured Products | p. 639 |
Credit Risk and the Structuring of Cash Flows | p. 641 |
An Overview of Credit Risk | p. 641 |
Modeling Credit Risk | p. 644 |
Structural Model Approach to Credit Risk | p. 646 |
Reduced-Form Model Approach to Credit Risk | p. 655 |
Structuring Using Collateralized Debt Obligations | p. 663 |
Conclusion | p. 666 |
Credit Derivatives | p. 667 |
Credit Derivative Markets | p. 667 |
Credit Default Swaps | p. 669 |
Other Credit Derivatives | p. 678 |
Risks of Credit Derivatives | p. 680 |
Conclusion | p. 683 |
Collateralized Debt Obligations | p. 685 |
Introduction to Collateralized Debt Obligations | p. 685 |
Balance Sheet CDOs versus Arbitrage CDOs | p. 688 |
Cash-Funded CDOs versus Synthetic CDOs | p. 692 |
Cash Flow CDOs versus Market Value CDOs | p. 695 |
Credit Risk and Enhancements | p. 696 |
New Developments in CDOs | p. 699 |
Risks of CDOs | p. 703 |
Risk Management and Portfolio Management | p. 709 |
Lessons from Hedge Fund Failures | p. 711 |
Problems Driven by Market Losses | p. 711 |
Failures Driven by Fraud | p. 721 |
Conclusion | p. 727 |
Risk Analysis | p. 729 |
Investment Strategy Risks | p. 729 |
Market Risk | p. 730 |
Operational Risk | p. 732 |
Investment Process Risk | p. 734 |
Controlling Operational Risk | p. 736 |
Aggregating the Risks of a Fund | p. 740 |
Portfolios with Options | p. 742 |
Conclusion | p. 745 |
Due Diligence of Fund Managers | p. 747 |
Screening with Three Fundamental Questions | p. 748 |
Structural Review | p. 752 |
Strategic Review | p. 756 |
Administrative Review | p. 760 |
Performance Review | p. 761 |
Portfolio Risk Review | p. 767 |
Legal Review | p. 770 |
Reference Checks | p. 773 |
Measuring Operational Risk | p. 774 |
Regression, Multivariate, and Nonlinear Methods | p. 777 |
Single-Factor Models and Regression | p. 777 |
Multiple-Factor Models and Regression | p. 781 |
Nonlinear Returns | p. 783 |
Changing Correlation | p. 785 |
Applications of Multifactor Models | p. 787 |
Hedge Fund Performance Persistence | p. 791 |
Portfolio Optimization and Risk Parity | p. 795 |
Mean-Variance Portfolio Optimization | p. 795 |
Complications to Mean-Variance Optimization | p. 803 |
Risk Budgeting | p. 807 |
Risk Parity | p. 810 |
Portfolio Management, Alpha, and Beta | p. 819 |
The Estimation of Alpha and Beta | p. 819 |
The Separation of Alpha and Beta | p. 821 |
Portable Alpha | p. 822 |
Alpha, Beta, and Portfolio Allocation | p. 827 |
Conclusion | p. 831 |
Appendix: Data Sources | p. 833 |
Index | p. 849 |
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