Reading 34: Alternative Investm....olio Management－LOS f investment, reference, invested, example, justify

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CFA Institute Area 8-11, 13: Asset Valuation
Session 11: Alternative Investments for Portfolio Management
Reading 34: Alternative Investments Portfolio Management
LOS f: Evaluate and justify the return enhancement and/or risk diversification effects of adding an alternative investment to a reference portfolio (for example, a portfolio invested solely in common equity and bonds).

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As an asset class, over the period 1990-2004, commodities would:

A) not have enhanced the return of a stock and bond portfolio and would have done worse except for the performance of the energy subgroup.

B) not have enhanced the return of a stock and bond portfolio largely from the underperformance of the energy subgroup.

C) have enhanced the return of a stock and bond portfolio largely from the performance of the energy subgroup.

D) have enhanced the return of a stock and bond portfolio and would have done better except for the underperformance of the energy subgroup.

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Answer and Explanation

The returns on commodities have generally been lower over the longer period of 1990-2004 than stocks and bonds both absolutely and on a risk-adjusted basis. The energy subgroup of commodities has had the highest returns, and without it, the broad GSCI index return would have been much lower.

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When compared to a portfolio of publicly traded stocks, private equity is:

A) correlated with stocks but adds moderate diversification because of its idiosyncratic risk component.

B) uncorrelated with stocks and adds a high degree of diversification.

C) uncorrelated with stocks and has no idiosyncratic risk component so it adds a low degree of diversification.

D) correlated with stocks and has a low idiosyncratic risk component so it adds virtually no diversification.

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Answer and Explanation

Private equity returns typically move with stock market returns. Computed correlations are often positive and low, but some attribute the low correlation to the infrequently-updated or stale prices of the private equity returns. Each investment has a large idiosyncratic risk component, however, which can provide moderate diversification.

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When added to a portfolio of stocks and bonds, based upon historical performance, we can expect distressed securities to contribute:

A) neither enhanced return nor diversification.

B) both enhanced return and diversification.

C) enhanced return but not diversification.

D) diversification but not enhanced return.

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Answer and Explanation

They can provide high returns because many investors cannot hold distressed debt securities, and few analysts cover the market. Based on comparisons of the average and Sharpe ratio, the HFR Distressed Securities Index outperformed both stocks and bonds both absolutely and on a risk-adjusted basis. The returns are often event-driven so the return is uncorrelated to the overall stock market and can provide diversification.