TO 30 RELATE TO ALTERNATIVE INVESTMENTS AA WEALTH MANAGEM...
Questions 25 to 30 relate to Alternative Investments
AA Wealth Management Case Scenario
AA Wealth Management oversees the accounts of private wealth clients. Lester Doyle,
CFA, is AA’s alternatives investment specialist and has recently joined the firm after
serving ten years at a leading investment bank.
Doyle has been tasked with revising the portfolios of AA’s high net-worth clients which
are traditionally invested in fixed income and equity securities. Doyle is expanding client
portfolios and is particularly interested in the inclusion of fund of funds (FOFs)
investment offered by Celta. He assigns his subordinate, Lisa Mathews, to prepare a
presentation discussing the four strategies offered by the fund.
Hedge Fund Strategies Comprising Ceta’s FOF
Hedged Equity:
•
Are market-neutral
•
Suitable for investors desiring long equity exposures
•
Take long and short positions in equity stocks belonging to the
same industry
Equity Market-Neutral:
•
Have an overall beta of zero
•
Earn alpha by exploiting mispricing of equity stocks
•
Regarded as less of a return enhancing strategy
Short Selling:
Take short positions in emerging market securities as the
probability of market decline and thus profit potential is highest
Fixed-income Arbitrage:
•
Exposed to directional market movements
•
Exploit changes in the term structure of interest rates
•
Identify undervalued and overvalued fixed income securities
Rita Singh is one of AA’s clients. Her investment portfolio is allocated to equities and
bonds in the proportion 30/70. Doyle is exploring the potential for allocating a further $3
million to the FOFs offered by Ceta. Prior to the allocation, Doyle arranges a meeting
with Singh where he makes the following observations:
Observation 1: She relies heavily on her investment portfolio to fund her son’s college
education and medical expenses. Her annual income is just sufficient to
support her living expenses.
Observation 2: She would like to be able to access performance track records with respect
to existing and non-existing fund holdings at all times.
Observation 3: She is looking for a low cost solution.
Doyle decides to pursue the FOF investment. He collects monthly return on the hedge
fund and its benchmark, the Hedge Fund Composite Index, for the previous year, 2014
(Exhibit 1). He will use the data to forecast future fund performance. Doyle’s investment
in the fund will be for a period of eight months. Doyle computes the roll returns on
Singh’s investment for that period.
Next Doyle evaluates whether the investment will improve the portfolio’s annualized
risk-adjusted performance. He compiles expected performance on the portfolio and the
hedge fund for the current year, 2015, in an exhibit (Exhibit 2).
Exhibit 1:
Monthly Returns For
Ceta’s Fund of Funds (2014)
Month
Hedge Fund
January
15.7%
February
18.8%
March
- 5.7%
April
12.7%
May
2.7%
June
9.8%
July
15.0%
August
- 14.0%
Exhibit 2:
Current Performance of Singh’s Portfolio
And Hedge Fund Investment (2015)
Existing
FOFs
Portfolio*
Investment
Annualized Return (%)
9.7
14.8
2.2
Annualized risk-free rate
(%)
Annualized standard
15.0
28.9
deviation (%)
Correlation between
portfolio’s return and hedge
- 0.5
fund investment return
*Performance before the inclusion of the FOFs investment.
25. Is Mathews accurate with respect to her description of the:
equity market-
hedged equity
neutral strategy?
short selling
strategy?
A.
No
No
Yes
B.
Yes
No
Yes
C.
No
Yes
No
26.
Mathews’ description of the fixed-income arbitrage fund strategy is inaccurate because:
A.
yield curve shifts are not incorporated.
B.
only undervalued securities are sought.
C.
portfolios are generally neutralized against directional market movements.
27. Based on Doyle’s meeting with Singh, a FOFs investment is least favorable based
on Observation:
A.
1.
B.
2.
C.
3.
28. Using the data in Exhibit 1, the value of Singh’s investment at the end of her
investment horizon using the eight month average rolling return is closest to:
A.
$3.1709 million.
B.
$3.1867 million.
C.
$3.2063 million.
29. Using Exhibit 2, should Doyle allocate $3 million to the FOF?
A.
No.
B.
Yes, her portfolio’s risk-adjusted performance will improve.
C.
Yes, her portfolio’s risk-adjusted performance will deteriorate.
30. A limitation of Doyle using the data in Exhibits 1 and 2 to analyze and forecast
risk-adjusted performance is:
A.
future performance is difficult to predict.
B.
consistency analysis is less relevant given fund composition.
C.
hedge funds allow entry/exit into funds on a quarterly or less frequent
basis and so monthly returns are inappropriate.