Alternative Investments

DONALD R. CHAMBERS, PhD, CAIA, is Associate Director of Programs at the CAIA Association, Chief Investment Officer of Biltmore Capital Advisors, and Emeritus Professor at Lafayette College in Easton, Pennsylvania. Dr. Chambers previously served as Director of Alternative Investments at Karpus Investment Management. He is a member of the editorial board of the Journal of Alternative Investments. MARK J. P. ANSON, PhD, CAIA, CFA, CPA, JD, is Chief Investment Officer for Commonfund. Prior to joining Commonfund, he was the President and Chief Investment Officer of the Bass Family Office–winner of the Family Office of the Year award for 2014-2015. Dr. Anson previously served as President and Executive Director of Investment Services at Nuveen Investments Inc., Chief Executive Officer of both the British Telecom Pension Scheme and its wholly owned asset management company in London, 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. KEITH H. BLACK, PhD, CFA, CAIA, FDP is a managing director at the CAIA Association overseeing content strategy. He was previously an associate at Ennis Knupp and prior, an assistant professor at Illinois Institute of Technology. He is a member of the editorial board of the Journal of Alternative Investments. HOSSEIN B. KAZEMI, PhD, CFA, is co-founder of and the Senior Advisor for the CAIA Association. Dr. Kazemi is the Michael and Cheryl Philipp Distinguished Professor of Finance at Isenberg School of Management, the University of Massachusetts Amherst, the Director of the Center for International Securities and Derivatives Markets, and editor of the Journal of Alternative Investments and Alternative Investment Analyst Review.

• Preface xxxiiiAcknowledgments xxxviiAbout the Authors xliPart 1 Introduction to Alternative InvestmentsChapter 1 What is an Alternative Investment? 31.1 Alternative Investments by Exclusion 31.2 Alternative Investments by Inclusion 41.3 The Blurred Lines between Traditional and Alternative Investments 81.4 A History of Alternative Investing: The U.S. Case 101.5 Investments are Distinguished by Return Characteristics 111.6 Investments are Distinguished by Methods of Analysis 141.7 Eight Other Characteristics that Distinguish Alternative and Traditional Investments 161.8 Five Goals of Alternative Investing 181.9 Two Pillars of Alternative Investment Management 201.10 Overview of This Book 22Review Questions 23Chapter 2 The Environment of Alternative Investments 252.1 The Participants 252.2 Alternative Investment Structures 332.3 Key Features of Fund Structures 362.4 Financial Markets 402.5 Regulatory Environment 422.6 Liquid Alternative Investments 432.7 Taxation 472.8 Short Selling 49Review Questions 52Notes 53Chapter 3 Quantitative Foundations 553.1 Return and Rate Mathematics 553.2 Returns Based on Notional Principal 573.3 Internal Rate of Return 603.4 Problems with Internal Rate of Return 643.5 Other Performance Measures 733.6 Illiquidity, Accounting Conservatism, IRR, and the J-Curve 753.7 Distribution of Cash Waterfall 77Review Questions 85Note 86Chapter 4 Statistical Foundations 874.1 Return Distributions 874.2 Moments of the Distribution: Mean, Variance, Skewness, and Kurtosis 904.3 Covariance, Correlation, Beta, and Autocorrelation 944.4 Interpreting Standard Deviation and Variance 1044.5 Testing for Normality 1114.6 Time-Series Return Volatility Models 114Review Questions 116Chapter 5 Foundations of Financial Economics 1175.1 Informational Market Efficiency 1175.2 The Time Value of Money, Prices, and Rates 1225.3 The Three Primary Theories of the Term Structure of Interest Rates 1275.4 Forward Interest Rates 1295.5 Arbitrage-Free Models 1315.6 Binomial Tree Models 1345.7 Single-Factor Default–Free Bond Models 1375.8 Single-Factor Equity Pricing Models 143Review Questions 148Note 149Chapter 6 Derivatives and Risk-Neutral Valuation 1516.1 Foundations of Forward Contracts 1516.2 Forward Contracts on Rates 1556.3 Forward Contracts on Equities 1576.4 Forward Contracts on Assets with Benefits and Costs of Carry 1656.5 Forward Contracts Versus Futures Contracts 1716.6 Managing Long-Term Futures Exposures 1786.7 Option Exposures 1806.8 Option Pricing Models 1866.9 Option Sensitivities 188Review Questions 190Notes 191Chapter 7 Measures of Risk and Performance 1937.1 Measures of Risk 1937.2 Estimating Value at Risk (VaR) 1987.3 Benchmarking and Performance Attribution 2037.4 Ratio-Based Performance Measures 2047.5 Risk-Adjusted Return Measures 210Review Questions 214Notes 214Chapter 8 Alpha, Beta, and Hypothesis Testing 2158.1 Overview of Beta and Alpha 2158.2 Ex Ante Versus Ex Post Alpha 2178.3 Single-Factor Models and Regression 2208.4 Inferring Ex Ante Alpha From Ex Post Alpha 2258.5 Return Attribution, Alpha, and Beta 2268.6 Ex Ante Alpha Estimation and Return Persistence 2308.7 Return Drivers 2318.8 Using Statistical Methods to Locate Alpha 2348.9 Sampling and Testing Problems 2398.10 Statistical Issues in Analyzing Alpha and Beta 242Review Questions 246Notes 247Part 2 Real AssetsChapter 9 Natural Resources and Land 2519.1 Natural Resources Other Than Land 2519.2 Land 2569.3 Timber and Timberland 2619.4 Farmland 2639.5 Valuation and Volatility of Real Assets 2689.6 Pricing and Historic Data Analysis 2729.7 Contagion, Price Indices, and Biases 2759.8 Key Observations Regarding Historical Returns of Timberland 2789.9 Key Observations Regarding Historical Returns of Farmland 278Review Questions 279Notes 279Chapter 10 Commodities 28110.1 Investing in Commodities Without Futures 28110.2 The Term Structure of Forward Prices on Commodities 28810.3 Rolling of Forward and Futures Contracts 29610.4 Normal Backwardation and Normal Contango 30210.5 Commodity Exposure and Diversification 30710.6 Expected Returns on Commodities 31010.7 Commodity Futures Indices 31210.8 Commodity Risk Attributes 31410.9 Observations Based on Historical Returns 318Review Questions 318Notes 318Chapter 11 Other Real Assets 31911.1 Commodity Producers 31911.2 Liquid Alternative Real Assets 32211.3 Infrastructure 32511.4 Intellectual Property Overview 33611.5 Cash Flows of Intellectual Property 34111.6 Visual Works of Art and Historical Performance Data 34411.7 R&D and Patents as Unbundled Intellectual Property 34611.8 Intellectual Property Conclusions 349Review Questions 350Notes 350References 350Chapter 12 Real Estate Assets and Debt 35312.1 Categories of Real Estate 35312.2 Advantages, Disadvantages, and Styles of Real Estate Investments 35512.3 Real Estate Style Boxes 36112.4 Residential Mortgages 36312.5 Commercial Mortgages 37212.6 Mortgage-Backed Securities Market 37512.7 Liquid Alternatives: Real Estate Investment Trusts 38012.8 Key Observations Regarding Historical Returns of Mortgage REITs 382Review Questions 384Notes 384Chapter 13 Real Estate Equity 38513.1 Real Estate Development 38513.2 Commercial Real Estate Valuation 38913.3 Details of the Income Approach to Real Estate Valuation 39713.4 Illustration of the Income Method of Real Estate Valuation 40213.5 Alternative Real Estate Investment Vehicles 40313.6 Equity REIT Returns 40913.7 Key Observations Regarding Historical Risks and Returns of Equity REITs 410Review Questions 412Part 3 Hedge FundsChapter 14 Structure of the Hedge Fund Industry 41514.1 Distinguishing Hedge Funds 41514.2 Hedge Fund Fees 41914.3 Hedge Fund Classification 43114.4 Hedge Fund Returns and Asset Allocation 43314.5 Evaluating a Hedge Fund Investment Program 43814.6 Three Research Studies on Whether Hedge Funds Adversely Affect the Financial Markets 44114.7 Hedge Fund Indices 44214.8 Conclusion 451Review Questions 451Notes 451Chapter 15 Macro and Managed Futures Funds 45315.1 Macro and Managed Futures Strategies 45315.2 Global Macro 45515.3 Managed Futures 45915.4 Systematic Trading 46415.5 Four Core Dimensions of Managed Futures Investment Strategies 47615.6 Systematic Futures Portfolio Construction 47915.7 Eight Core Benefits of Managed Futures for Investors 48315.8 Evidence on Managed Futures Returns 48515.9 Benefits of Managed Futures Funds 49315.10 Key Observations Regarding Historical Returns of Macro and Systematic Diversified Funds 499Review Questions 499Notes 499Chapter 16 Event-Driven Hedge Funds 50116.1 The Sources of Most Event Strategy Returns 50116.2 Activist Investing 50516.3 Merger Arbitrage 51716.4 Distressed Securities Funds 52416.5 Event-Driven Multistrategy Funds 532Review Questions 534Notes 534Chapter 17 Relative Value Hedge Funds 53517.1 Overview of Relative Value Strategies 53517.2 Convertible Bond Arbitrage 53617.3 Volatility Arbitrage 55117.4 Fixed-Income Arbitrage 56517.5 Relative Value Multistrategy Funds 575Review Questions 578Notes 578Chapter 18 Equity Hedge Funds 57918.1 Commonalities of Equity Hedge Funds 57918.2 Sources of Return 58018.3 Market Anomalies 58418.4 Implementing Anomaly Strategies 59018.5 The Three Equity Strategies 59418.6 Equity Hedge Fund Risks 605Review Questions 605Notes 606Chapter 19 Funds of Hedge Funds 60719.1 Overview of Funds of Hedge Funds 60719.2 Investing in Multistrategy Funds 61619.3 Investing in Funds of Hedge Funds 61919.4 Investing in Portfolios of Single Hedge Funds 62219.5 Multialternatives and Other Hedge Fund Liquid Alternatives 62419.6 Key Observations Regarding Historical Returns of Funds of Funds 628Review Questions 631Notes 631Part 4 Private SecuritiesChapter 20 Private Equity Assets 63520.1 Introduction to Private Equity Terms and Background 63520.2 Overview of Three Forms of Pre-IPO Private Equity Investing 63720.3 Venture Capital 63920.4 Venture Capital as a Compound Option 64720.5 Growth Equity 64820.6 Buyouts and Leveraged Buyouts 65120.7 Buyouts of Private Companies 65320.8 Leveraged Buyouts (LBOs) 65520.9 Merchant Banking 66320.10 Dynamics of Private Equity Opportunities 663Review Questions 665Notes 666Chapter 21 Private Equity Funds 66721.1 Overview of Private Equity Funds 66721.2 Private Equity Funds as Intermediaries 67121.3 The LP and GP Relationship Life Cycle 67721.4 Private Equity Fund Fees and Terms 68021.5 Key Determinants of Venture Capital Fund Risks and Returns 68721.6 Roles and Three Key Distinctions of Venture Capital and Buyout Managers 68921.7 Leveraged Buyout Funds 68921.8 Private Equity Liquid Alternatives 69321.9 Private Equity Funds of Funds 69821.10 Private Investments in Public Equity 69921.11 Private Equity Secondary Markets and Structures 703Review Questions 706Notes 707Chapter 22 Private Credit and Distressed Debt 70922.1 Types of Fund Private Credit Vehicles 70922.2 Fixed-Income Analysis 71122.3 Credit Risk Analysis and the Bankruptcy Process 71522.4 Leveraged Loans 72522.5 Direct Lending 72722.6 Mezzanine Debt 72822.7 Distressed Debt 73722.8 Private Credit Performance and Diversification 743Review Questions 744Note 744References 745Part 5 Structured ProductsChapter 23 Introduction to Structuring 74923.1 Overview of Financial Structuring 74923.2 Major Types of Structuring 75023.3 The Primary Economic Role of Structuring 75123.4 Collateralized Mortgage Obligations 75323.5 Structural Model Approach to Credit Risk 76123.6 Interest Rate Options 76623.7 Introduction to Collateralized Debt Obligations 768Review Questions 773Note 773Chapter 24 Credit Risk and Credit Derivatives 77524.1 An Overview of Credit Risk 77524.2 Reduced-Form Modeling of Credit Risk 77624.3 Credit Derivatives Markets 78324.4 Interest Rate Swaps 78624.5 Credit Default Swaps 79324.6 Other Credit Derivatives 80124.7 CDS Index Products 80424.8 Five Key Risks of Credit Derivatives 805Review Questions 807Notes 807Chapter 25 CDO Structuring of Credit Risk 80925.1 Overview of CDO Variations 80925.2 Balance Sheet CDOs and Arbitrage CDOs 81225.3 Mechanics of and Motivations for An Arbitrage CDO 81425.4 Cash-Funded CDOs Versus Synthetic CDOs 81625.5 Cash Flow CDOs Versus Market Value CDOs 82025.6 Credit Enhancements 82125.7 Other Types of CDOs 82325.8 Risks of CDOs 824Review Questions 829Chapter 26 Equity-Linked Structured Products 83126.1 Structured Products and Six Types of Wrappers 83126.2 Four Potential Tax Effects of Wrappers 83226.3 Structured Products with Exotic Option Features 83526.4 Popular Structured Product Types 84326.5 The EUSIPA Classification 84426.6 Global Structured Product Cases 84826.7 Structured Product Valuation 85026.8 Motivations of Structured Products 854Review Questions 855Notes 856Index 857