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发表于 2012-4-2 10:58
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Hollis, Ignitowski, Jacobs, and Kelso are four analysts working in a windowless basement office at Madison Partners, a money manager specializing in alternative investments. They have an ongoing debate over which alternative-investment vehicle is best. As is often the case in long-running feuds, each frequently refers back to a favorite argument.
Hollis: “I like receiving convertible preferred stock for my venture-capital investments because my claim is usually senior to those of investors who get in later.”
Ignitowski: “Agricultural commodity investments are better, because they provide an inflation hedge and have traditionally delivered better returns than bonds.”
Jacobs: “Private-equity limited partnerships not only limit the potential losses of initial investors, but also avoid double taxation.“
Kelso: “A fund of funds has less survivorship bias than an index, and it rarely falls prey to style drift.”
Opinions about investment classes aside, the four Madison analysts are tasked with performing due diligence on hedge funds. Hedge funds are notoriously difficult to analyze, and the analysts divide up the task, with each focusing on a certain aspect of the due diligence.
Hollis considers the hedge fund's strategy, looking at the investment style as well as the individual investments to assess whether the fund is likely to outperform not only the market, but other hedge funds. In this analysis, he also considers the fund's financial policies and market risk profile, using downside deviation rather than standard deviation. Hollis also considers the age of the fund. He prefers funds that have been around for awhile because experienced management gives the funds an edge. Lastly, Hollis' duties also include reviewing the funds' structure, examining who manages, audits, or regulates the fund.
Ignitowski focuses on performance data. Because hedge funds are not well regulated, they have a lot of freedom regarding how they present performance data. Ignitowski drills down into the performance of individual holdings to assess whether the stated returns are accurate. He then recalculates cumulative performance data using weekly returns, adjusting when possible for inflows and outflows. Ignitowski prefers larger funds since they have historically outperformed smaller funds.
Jacobs tackles the administrative details, starting with an analysis of the fund's fee structure. He researches legal issues, including pending lawsuits, regulatory actions, and lock-up provisions. Jacobs' review also addresses personnel issues, including the amount of staff, turnover rates, and, when possible, rates of compensation.
Kelso calls investors in the hedge fund for references. He asks about investors' knowledge of the managers' investment styles and whether they deviate from the stated style.
After the four analysts compile their analysis of hedge funds, their due diligence is forwarded upstairs to the investment director, Francine Finster. She does not see the analysts' e-mail on this particular day because she is in conference with Dan Braden, a dot-com millionaire who retired at 35 with just one goal: becoming a billionaire. Braden considers his portfolio of traditional investments – 60 percent large-cap stocks, 20 percent small-cap stocks, and 20 percent bonds -- well-diversified for his age and level of wealth, but his knowledge of alternative investments is not extensive, and he is consulting Madison Partners for help with that portion of his portfolio.
Braden has high hopes for his portfolio. He wants Finster to find him an asset class that will provide better returns than stocks and a higher Sharpe ratio than bonds, while at the same time bringing an additional diversification benefit to the portfolio. Finster promises to look at some indexes and do some research into historical returns of various asset classes in an attempt to find this investment, but doubts she can find anything that will meet Braden's criteria.
Finster convinces Braden to allow Madison to manage his alternative investments. She immediately purchases a security for him, expecting it to lower his annual returns but increase his Sharpe ratio.
Looking ahead, Finster expects Braden to be a fairly difficult customer, demanding very high returns and creative strategies. She decides that he might like the idea of a swap. Finster prefers interest-rate and commodity swaps but has not been involved in either type of transaction for a number of months. To refresh her memory, she wrote down some bullet points comparing the two types of swaps:- The value of an interest-rate swap will change over time if market rates change, but will not change over time if market rates stay the same, even if prices change.
- The value of a commodity swap will change over time regardless of whether market rates or prices change.
- Both interest-rate and commodity swaps have a value of zero initially.
- In the event of a change in market rates, the value of both an interest-rate swap and a commodity swap will change.
The alternative investment Finster added to the Braden portfolio is least likely to be: | B)
| a venture-capital fund. |
| C)
| a direct real estate investment. |
|
Venture capital funds generally behave like private equity, and are designed to boost returns, not diversify. Futures and real estate are traditionally used as diversification tools and are likely to lower overall returns for a stock-heavy portfolio. As such, venture-capital is the least likely to reduce returns while raising the Sharpe ratio. (Study session 13, LOS 31.d)
Which of the Madison analysts does NOT ignore hedge-fund conventions? A)
| Ignitowski, with his opinions about fund size. |
| B)
| Hollis, with his opinions about fund age. |
| C)
| Hollis, with his measure of fund risk. |
|
Common hedge-fund conventions include, "large funds underperform small funds," "young funds outperform old funds," and the use of simple monthly returns compounded over 12 periods. The analysts do not follow these conventions. While standard deviation is a common convention for calculating the risk of equity and debt investments, downside deviation is commonly used for hedge funds. As such, Hollis' measure of fund risk is in keeping with hedge-fund convention. (Study session 13, LOS 31.s)
Based on historical data, Finster can most likely meet Braden's lofty goals by investing in: | B)
| nothing, because no asset class meets those requirements. |
| C)
| distressed securities. |
|
The HFR Distressed Securities index outperforms both stocks and bonds absolutely, with higher Sharpe ratios than either. It is also poorly correlated with the stock market, so it would diversify a stock portfolio. Private equity has historically delivered better returns than stocks, but it is highly correlated with the stock market, and Sharpe ratios can be quite high. Direct investments in real estate generally provide returns lower than those of stocks, though they do provide substantial diversification benefits. (Study session 13, LOS 31.f)
Which of Finster's notes about swaps is least accurate? A)
| The value of a commodity swap will change over time regardless of whether market rates or prices change. |
| B)
| The value of an interest-rate swap will change over time if market rates change, but will not change over time if market rates stay the same, even if prices change. |
| C)
| Both interest-rate and commodity swaps have a value of zero initially. |
|
The values of both interest-rate swaps and commodity swaps will change over time regardless of movement (or lack thereof) in market rates or prices. Both types of swaps do indeed have a value of zero at inception, and a change in market rates will affect the value of both types of swaps. (Study session 13, LOS 32)
The Madison due diligence for hedge funds is detailed, but not comprehensive. Which traditional aspect of due diligence is neglected? A)
| Consideration of the fund's use of leverage. |
| B)
| Analysis of the fund's research expenditures. |
| C)
| Assessment of the fund's suitability for particular investors. |
|
A review of the fund's competitors is a good idea, but it is not part of due diligence. Neither is an assessment of the fund's suitability for particular investors. Both of those reviews should be part of the investment decision, but due diligence normally means an analysis of how the fund operates, rather than its investment merits relative to outside criteria. The fund's use of leverage would fall under Hollis' expertise as he considers the investment style, financial policies, and risk profile. Madison Partners appears to have this issue well in hand. However, the fund's research strategy and expenditures are key to understanding how the fund operates, and none of Madison's analysts appears to address this topic. (Study session 13, LOS 31.b)
Which of the Madison Partners made the most accurate statement about alternative investments?
Hollis is wrong because the claims of later investors are generally senior to those of investors holding convertible preferred stock. Ignitowski is wrong because agricultural commodities have historically provided lower returns than bonds. Jacobs' assessment of private-equity limited partnerships is accurate. (Study session 13, LOS 31.k) |
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