Chartered Alternative Investment Analyst (CAIA) Professional Standards, Ethics, and the Alternative Investment Industry Flashcards

24 sample cards from the Professional Standards, Ethics, and the Alternative Investment Industry deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. What is the recommended record retention period under Standard V(C) absent other regulatory requirements?

   Members should retain records supporting investment analyses, recommendations, and actions for a minimum of seven years; records are the property of the firm.

2. List the sub-sections of Standard VI: Conflicts of Interest.

   VI(A) Disclosure of Conflicts; VI(B) Priority of Transactions; VI(C) Referral Fees.

3. What does Standard VI(A) Disclosure of Conflicts require?

   Members must make full and fair disclosure of all matters that could reasonably impair their independence and objectivity or interfere with duties to clients and employers; disclosures must be prominent, in plain language, and effectively communicated.

4. What priority order does Standard VI(B) Priority of Transactions establish?

   Client transactions take priority over transactions for the member's own account or the firm's account; clients must be served first, with adequate opportunity to act before the member trades personally.

5. What does Standard VI(C) Referral Fees require?

   Members must disclose to employer, clients, and prospective clients any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services.

6. List the sub-sections of Standard VII: Responsibilities as a CFA Institute Member or CFA Candidate.

   VII(A) Conduct as Participants in CFA Institute Programs; VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program.

7. What does Standard VII(A) prohibit regarding the CFA exam?

   It prohibits conduct that compromises the reputation or integrity of CFA Institute or the CFA designation or the validity/integrity of exams, including cheating and disclosing confidential exam content.

8. Under Standard VII(B), how must the CFA designation be referenced?

   Members must not misrepresent or exaggerate the meaning of membership, the designation, or candidacy; 'CFA' is an adjective, never a noun, and partial completion of the program may not be cited as a designation.

9. In an alternative investments context, why is Standard III(C) Suitability especially important for hedge funds?

   Hedge fund strategies often carry illiquidity, leverage, and complexity, so managers must ensure such investments fit each client's risk tolerance, liquidity needs, and constraints, and that complex products are not placed with unsuitable investors.

10. How does Standard V(A) Diligence apply to investing in a fund-of-funds or external manager?

    The member must perform reasonable due diligence on the underlying funds/managers (strategy, controls, valuation, track record) and cannot rely solely on third-party representations to establish a reasonable basis.

11. What are the primary sources of conflict of interest in private fund (GP/LP) structures?

    Misaligned fees and carried interest incentives, allocation of investments across funds, cross-fund transactions, GP self-dealing and related-party deals, fee/expense allocation, co-investment allocation, and valuation of illiquid holdings reported by the GP.

12. How can the '2 and 20' fee structure create a conflict of interest in hedge funds?

    The 2% management fee rewards asset gathering regardless of performance, while the 20% incentive fee creates an option-like payoff that can encourage excessive risk-taking, since the manager shares in gains but not symmetrically in losses.

13. What governance mechanisms mitigate GP–LP conflicts in private funds?

    Limited partner advisory committees (LPACs), independent valuation/audit, high-water marks, hurdle rates, clawback provisions, key-person and no-fault divorce clauses, side-letter disclosure, and independent fund administrators/directors.

14. What is a 'high-water mark' and how does it protect investors?

    A high-water mark is the highest peak NAV on which incentive fees have previously been paid; the manager earns performance fees only on new gains above that mark, preventing the investor from paying twice for recovering prior losses.

15. What is a 'hurdle rate' in a private fund waterfall?

    A minimum rate of return (preferred return) that LPs must receive before the GP is entitled to carried interest; it aligns GP incentives by requiring a baseline return before profit sharing.

16. What is a clawback provision and what conflict does it address?

    A clawback requires the GP to return previously distributed carried interest if, over the fund's life, the GP received more than its agreed share; it addresses the conflict of early profitable exits leading to overpayment of carry before later losses.

17. Why are self-reported marks a significant valuation conflict in alternative investments?

    Because illiquid assets lack observable market prices, managers estimate (mark) their own values; since fees and reported performance depend on these marks, managers have an incentive to overstate values, smooth returns, or delay markdowns.

18. What is 'return smoothing' and how does it bias hedge fund risk statistics?

    Return smoothing is the stale or deliberate dampening of reported returns from illiquid/self-marked positions; it understates volatility and correlations, artificially inflating Sharpe ratios and understating true risk.

19. What controls reduce valuation conflicts from self-reported marks?

    Use of independent third-party valuation agents and administrators, consistent documented valuation policies, fair-value hierarchy classification, independent audits, pricing committees, and disclosure of the percentage of assets that are manager-marked (Level 3).

20. How are assets classified under the fair-value hierarchy (Levels 1, 2, 3) used in alternatives?

    Level 1: quoted prices in active markets for identical assets; Level 2: observable inputs other than quoted prices (e.g., comparable transactions); Level 3: unobservable inputs requiring manager assumptions/models — the level most subject to valuation conflict in alternatives.

21. What characteristics commonly define alternative investments versus traditional investments?

    Relative to traditional stocks/bonds, alternatives typically feature illiquidity, limited regulation, low transparency, less efficient markets, unique legal/tax structures, performance-based fees, and lower correlation with traditional assets.

22. What are the major categories of alternative investments per the CAIA framework?

    Real assets (real estate, infrastructure, natural resources, commodities), hedge funds, private equity (and private debt), and structured products/credit derivatives.

23. What are the main investor motivations for allocating to alternative investments?

    Diversification (low correlation), enhanced absolute or risk-adjusted returns, access to illiquidity and complexity premia, inflation hedging (real assets), and downside protection or non-traditional return sources (alpha).

24. How do institutional investors differ from retail investors in alternatives, and what trend is 'institutionalization'?

    Institutional investors (pensions, endowments, sovereign wealth funds, insurers) have larger scale, longer horizons, and tolerance for illiquidity; 'institutionalization' is the trend toward greater institutional participation bringing more due diligence, transparency demands, operational rigor, lower fees, and regulatory scrutiny to the alternatives industry.

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Professional Standards, Ethics, and the Alternative Investment Industry flashcards FAQ