CAIA Lvl 2 > Manager Selection > Flashcards

Manager Selection Flashcards

(62 cards)

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1
Q

Moral hazard

A

GPs being incentivised to take too much risk due to performance fee

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2
Q

Hold up problems

A

Breakdowns in negotiations between two parties due to neither party wanting to concede

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3
Q

Blue chip managers

A

All prior funds in top quartile over last two business cycles

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4
Q

Established managers

A

Majority of funds in top quartile over last two business cycles

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5
Q

Re-emerging managers

A

Managers who have underperformed in recent years but have had top quartile funds in the past

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6
Q

Reactive deal sourcing

A

Checking 100s of proposals

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7
Q

Superior deal sourcing

A

Use industry contacts (ideally prior to them raising funds)

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8
Q

5 Issues of using past performance

ARSGA

A
  1. Accuracy
  2. Representativeness
  3. Stationarity
  4. Gaming
  5. Appropriateness
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9
Q

Assumption when you scale up a σ by √N

A

Assumes zero autocorrelation.

Higher autocorrelation, higher long term vol

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10
Q

Six investment monitoring activities

A
  1. Strategy in line with stated objectives
  2. Review investment info
  3. Assess impact of market trends
  4. Assess risks
  5. Perf vs BM
  6. Verify legal and tax info
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11
Q

3 benefits of monitoring

A
  1. Greater options to liquidate the investment
  2. Greater control of management
  3. Larger implications for the portfolio
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12
Q

Two forms of active involvement inside fund’s governance

A
  • Re-negotiate management fees
  • Terminate without cause (‘good leaver clause’)
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13
Q

Three forms of active involvement outside the fund’s governance

A
  • Not committing to follow-on funds
  • Default on capital calls
  • Divest through secondary market
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14
Q

Three ways monitoring can add value to existing investments

A
  1. To better evaluate follow-on funds
  2. Greater awareness of peers
  3. Improved liquidity management
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15
Q

fund gatekeepers

A

intermediaries, such as investment consultants, researchers at banks, or family offices, who screen and select investment funds on behalf of institutional and high-net-worth clients

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16
Q

Bias blind spot

A

Tendency to underestimate your own biases

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17
Q

Failure and lessons from Amaranth collapse (HF) 2006

A

Over-concentration in natural gas futures calendar spread trade (long winter, short summer)

> Operated in OTC markets (low regulation) at huge volumes
Impact of prime brokers
Style drift (it began as a multi-strat)
Insufficient risk controls (e.g. leverage + limited oversight)

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18
Q

Failure and lessons from LTCM collapse (HF) 1998

A

RV credit fund. Employed significant leverage. Russian debt crises caused spreads to blow out, leading to big losses. Bailed out by 14 banks/HFs.

> Nobel prize economists can get it wrong
Large market positions through derivatives
Leverage and illiquidity can be lethal

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19
Q

Failure and lessons from Carlyle Capital Corp collapse (HF) 2008

A

Used short-dated loans to purchase long-term AAA agency mortgage bonds.

> MBS that are implicitly backed by the US govt, cannot be explicitly trusted

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20
Q

Failure and lessons from XIV collapse inverse vol ETN) 2018

A

Crowded short vol trade unwound (vol shot up). ETN fell by 95% in a day

> Importance of liquidity for structured products

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21
Q

ROE calculation with leverage

A

ROE = (ROAL) - (r(L-1))

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22
Q

Circuit breakers

A

Limiting trading activity if prices move too much too quickly

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23
Q

Failure and lessons from Bayou HF collapse 2005

A

Bayou was both an asset manager and broker. Allowed them to conceal losses for 8+ years.

> Some people are just fraudulent
Importance of independent auditors
Regulations are not a substitute for diligence

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24
Q

Affinity fraud

A

Targeting certain ethnic groups

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25
Failure and lessons from Lancer Group collapse early 2000s
Valuing their own assets in the fund to generate better fees. Investors lost trust and redeemed, causing the fund to collapse
26
Painting the tape
fraudelent placing of transactions to record highs or lows in reported prices
27
Three levels of assets used to define fair value (as defined by the Financial Accounting Standards Board)
1. Level 1 assets: no adjustments needed (e.g. publicly traded securities) 2. Level 2 assets: values are based on inactive market prices (e.g. distressed debt securities) 3. Level 3 assets: require subjectivity in form of model valuations (e.g. non-listed assets)
28
Internal asset valuations should include the following parameters: US GAAP fair value asset hierarchy
- Qualified and objective third parties - Well-documents valuation methodology (including all inputs and assumptions) - Review/approval be a second independent valuer
29
Portfolio risk aggregators
Third parties that gather and present info on private investments. Main benefit is that GPs may be more inclined to share info with these people vs investment advisers.
30
Risk alert observations on assets and DD (since 2008)
1. Increased reliance on third parties 2. Increased reliance on transparency reports produced by external administrators 3. Increased focus on detecting performance manipulation 4. Increased quant analysis of decision making 5. Valuations based on independent quotes 6. Avoid ambiguity in valuation process
31
The three risks of special concern
1. Being short volatility 2. Counter party risk in OTC markets 3. Shorting
32
4 warning signs with respect to fund investments
1. Lack of transparency 2. Returns not in line with strategy 3. An unclear process 4. Inadequate controls
33
4 warning signs with regards to risk management
1. Over-concentration 2. Unsophisticated people on investment team 3. Style drift 4. Lack of transparency
34
3 areas an ODD seeks to examine
1. Operational errors 2. Agency conflicts 3. Operational fraud
35
Rogue trader
When an opportunistic employee ignores the investment mandate to generate additional gains
36
Operational fraud
deliberate behaviour to deceive investors
37
Operational risk
non-financial / non-investment risks
38
4 main functions of non-investment operational activities
1. Trade allocation 2. Execution (including the maintenance of a trade blotter) 3. Posting (i.e. internally recording all trading activity) 4. Reconciliation (i.e. reviewing all trades)
39
Internal settlement
Matching third-party trade confirmations for completed trades to the firm's trade blotters and transferring the cash to settle trades.
40
4 main categories for cash
1. Fund expenses 2. Trading 3. Inflows/outflows 4. Unencumbered cash (spare)
41
'Cutting / striking the NAV'
The agreement between the fund and administrator as to when the final NAV is struck
42
Investigative due diligence
The background investigation of key fund personnel by third parties. > Equity ownership model (focusing on the equity holders) > Decision-makers > Risk makers
43
9 warning signals of operational risk
1. No qualified external administrator 2. Unknown auditors 3. Changing third-party providers 4. Red flags in financial statements 5. Red flags in employee background checks 6. Undisclosed conflicts of interest 7. Weak operating infrastructure 8. Poor valuation processes 9. Lack of transparency
44
Operational scalability
Scope to improve IT systems without disrupting operations
45
Meta risk
A qualitative risk not captured by specific, measurable financial risks
46
4 approaches to conducting ODD reports
1. Hiring a dedicated ODD person 2. Several staff members sharing ODD responsibilities 3. A modular approach, splitting the review between teams 4. A hybrid approach
47
Process documentation
Creation of a document that details the results of a ODD report
48
Operational benchmarking
Reconciling operational best practices with existing procedures
49
3 guiding principles of Institutional Limited Partners Association (ILPA)
1. Alignment of interests 2. Governance 3. Transparency
50
Six common duties for Board of Directors in private funds
1. Oversight of redemption gates 2. Review financial statements 3. Amendments to legal documentation 4. Approve use of mechanisms (e.g. audit holdback) 5. Review valuations 6. Review service providers
51
LP Agreement (LPA)
Defines the rights of the LP
52
LP Advisory Committee (LPAC)
Deals all consents (e.g. conflicts, valuations etc) > Simple majority (>50%) (e.g. extend fund duration) > Qualified majority (>75%) (e.g. remove GP without cause)
53
5 common operational fund committees
1. Operations 2. Valuation 3. Business continuity 4. Best execution 5. Compliance
54
Limited liability shield
Permits LPs to keep the committed capital amount from creditors
55
Side letters
Agreements between the GP and LPs detailing special arrangements (e.g. co-investment arrangements, 'most favoured nation' clauses, economic terms, reporting, excuse rights/exclusions etc)
56
Most favoured nation clause in a side letter
No LP can be treated less favourably than another.
57
Risk Assignment in the PPM
Covers the ways in which the blame for different risks are attributed to different parties. Exculpation: excusing someone from the blame Indemnification: specific parties held liable for actions and must provide compensation
58
Hurt money
GP Committment (typically 1%+)
59
Investment warning indicators:
(1) a lack of transparency (2) returns not consistent with strategy (3) unclear investment process (4) inadequate controls and inadequate segregation of duties.
60
Risk management warning indicators:
(1) significant concentration in investments (2) lack of adequate knowledge (3) investment strategy drift (4) overly complicated investment descriptions / lack of transparency.
61
The four common types of fund insurance coverage:
(1) GP liability coverage (2) Errors and omissions insurance (E&O) (3) Employment practices liability coverage (4) Directors' and officers' liability coverage (D&O).
62
The bias ratio
Used to detect return manipulation by fund managers that results in a return distribution that is different from the return distribution in competitive markets. The ratio is especially useful for funds that have significant illiquid holdings and are therefore more subject to price manipulation.
CAIA Lvl 2
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