CFA Alternative Investments Syllabus

Alternative Investments syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Alternative Investments in CFA, not a summary of it.

1. 1

   Types of Alternative Investments

   3 topics

   • Hedge Funds
   • Private Equity
   • Real Estate
2. 2

   Real Assets

   2 topics

   • Commodities
   • Infrastructure
3. 3

   Alternative Investment Valuation

   2 topics

   • Valuation of Hedge Funds
   • Valuation of Private Equity

Alternative Investments flashcards for CFA

25 of 49 cards from the Alternative Investments deck — real questions with worked answers.

1. What are the four main categories of alternative investments beyond hedge funds?

   Private capital (private equity and private debt), real estate, natural resources (commodities, timberland, farmland), and infrastructure. Hedge funds are also a major category alongside these.

2. Define a hedge fund.

   A private investment vehicle that pools capital from accredited/institutional investors and uses a wide range of strategies (leverage, short selling, derivatives) to earn active, often absolute, returns largely uncorrelated with traditional markets.

3. What are the four broad hedge fund strategy classifications?

   Equity hedge, event-driven, relative value, and macro/CTA (managed futures) strategies.

4. Name the three main equity hedge strategies.

   Long/short equity, dedicated short bias, and equity market neutral.

5. What distinguishes an equity market-neutral strategy?

   It holds offsetting long and short equity positions to keep the portfolio's net market (beta) exposure near zero, seeking returns from stock selection rather than market direction.

6. List the common event-driven hedge fund sub-strategies.

   Merger arbitrage, distressed/restructuring, activist, and special situations.

7. How does a classic merger arbitrage trade work in a cash deal?

   The manager buys the target company's shares (trading below the offer price) to capture the deal spread, profiting if the acquisition closes; the risk is deal failure.

8. List the main relative value hedge fund strategies.

   Fixed-income convertible arbitrage, fixed-income asset backed, fixed-income general, volatility, and multi-strategy relative value.

9. What do global macro and managed futures (CTA) strategies trade on?

   Macro strategies take directional views on economic trends across asset classes; managed futures (CTAs) use systematic, often trend-following, models trading exchange-listed futures and forwards.

10. What is the typical hedge fund fee structure ('2 and 20')?

    A management fee of about 2% of assets under management plus an incentive/performance fee of about 20% of profits.

11. What is a high-water mark in hedge fund fees?

    The highest cumulative NAV previously reached; incentive fees are only charged on new profits above this level, so investors are not charged twice for recovering prior losses.

12. What is a hurdle rate in hedge fund incentive fees?

    A minimum return the fund must exceed before an incentive fee is earned. It can be hard (fee only on returns above the hurdle) or soft (fee on the entire return once the hurdle is met).

13. Compare a lockup period and a notice period.

    A lockup period is the minimum time initial capital must remain invested before redemption is allowed; a notice period is the advance notice (e.g., 30-90 days) required before redeeming.

14. What is a fund of hedge funds and its main drawback?

    A fund that invests in multiple hedge funds to gain diversification and access; its main drawback is an additional layer of fees ('fee-on-fee') on top of the underlying funds' fees.

15. For an investor in a hedge fund, write the general formula for net return after '2 and 20' fees with no hurdle.

    If gross return produces value change, net-of-fee return to investor $= r_{gross} - m - p\cdot\max(0,\; r_{gross}-m)$, where $m$ is the management fee rate and $p$ the incentive fee rate applied to profits net of the management fee.

16. A fund charges 2% management (on beginning assets) and 20% incentive on returns net of management fee. Beginning value is 100, ending gross value 120. Compute total fees.

    Management fee $=0.02\times100=2$. Gross profit net of mgmt fee $=120-100-2=18$. Incentive fee $=0.20\times18=3.6$. Total fees $=2+3.6=5.6$; investor ending value $=120-5.6=114.4$.

17. Distinguish the two approaches to valuing hedge fund positions and their price conventions.

    Trading (mark-to-market) positions are marked at bid for longs and ask for shorts (conservative), or sometimes at mid-market; illiquid positions require estimates or matrix/model pricing.

18. Why can survivorship bias overstate hedge fund index returns?

    Poorly performing funds close and drop out of databases, so the surviving reported funds show higher average returns and lower volatility than the true universe.

19. What is backfill (instant history) bias in hedge fund databases?

    When a fund joins a database, its prior (usually favorable) track record is added retroactively, inflating historical index returns.

20. Why are reported hedge fund returns often smoothed, and what statistical effect does this create?

    Illiquid holdings are valued using stale or estimated prices, smoothing returns. This understates volatility and correlations and overstates risk-adjusted performance (e.g., Sharpe ratio) and can create positive serial correlation.

21. Define private equity.

    Investment in the equity of companies that are not publicly traded, either by taking private companies through buyouts or funding private firms, aiming to add value and exit at a profit.

22. What are the two dominant private equity strategies?

    Leveraged buyouts (LBOs) and venture capital.

23. What is a leveraged buyout (LBO)?

    The acquisition of a company financed largely with debt, where the target's assets and cash flows service the debt; the sponsor seeks to improve operations and exit at a higher valuation.

24. Distinguish an MBO from an MBI.

    In a management buyout (MBO) the existing management team acquires the company; in a management buy-in (MBI) an external management team buys and takes over the company.

25. List the stages of venture capital financing.

    Formative stage (angel/seed and early stage/startup), later/expansion stage, and mezzanine-stage (pre-IPO) financing.

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