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Alternative Investments
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Table of Contents

Preface xxxiii Acknowledgments xxxvii About the Authors xli Part 1 Introduction to Alternative Investments Chapter 1 What is an Alternative Investment? 3 1.1 Alternative Investments by Exclusion 3 1.2 Alternative Investments by Inclusion 4 1.3 The Blurred Lines between Traditional and Alternative Investments 8 1.4 A History of Alternative Investing: The U.S. Case 10 1.5 Investments are Distinguished by Return Characteristics 11 1.6 Investments are Distinguished by Methods of Analysis 14 1.7 Eight Other Characteristics that Distinguish Alternative and Traditional Investments 16 1.8 Five Goals of Alternative Investing 18 1.9 Two Pillars of Alternative Investment Management 20 1.10 Overview of This Book 22 Review Questions 23 Chapter 2 The Environment of Alternative Investments 25 2.1 The Participants 25 2.2 Alternative Investment Structures 33 2.3 Key Features of Fund Structures 36 2.4 Financial Markets 40 2.5 Regulatory Environment 42 2.6 Liquid Alternative Investments 43 2.7 Taxation 47 2.8 Short Selling 49 Review Questions 52 Notes 53 Chapter 3 Quantitative Foundations 55 3.1 Return and Rate Mathematics 55 3.2 Returns Based on Notional Principal 57 3.3 Internal Rate of Return 60 3.4 Problems with Internal Rate of Return 64 3.5 Other Performance Measures 73 3.6 Illiquidity, Accounting Conservatism, IRR, and the J-Curve 75 3.7 Distribution of Cash Waterfall 77 Review Questions 85 Note 86 Chapter 4 Statistical Foundations 87 4.1 Return Distributions 87 4.2 Moments of the Distribution: Mean, Variance, Skewness, and Kurtosis 90 4.3 Covariance, Correlation, Beta, and Autocorrelation 94 4.4 Interpreting Standard Deviation and Variance 104 4.5 Testing for Normality 111 4.6 Time-Series Return Volatility Models 114 Review Questions 116 Chapter 5 Foundations of Financial Economics 117 5.1 Informational Market Efficiency 117 5.2 The Time Value of Money, Prices, and Rates 122 5.3 The Three Primary Theories of the Term Structure of Interest Rates 127 5.4 Forward Interest Rates 129 5.5 Arbitrage-Free Models 131 5.6 Binomial Tree Models 134 5.7 Single-Factor Default-Free Bond Models 137 5.8 Single-Factor Equity Pricing Models 143 Review Questions 148 Note 149 Chapter 6 Derivatives and Risk-Neutral Valuation 151 6.1 Foundations of Forward Contracts 151 6.2 Forward Contracts on Rates 155 6.3 Forward Contracts on Equities 157 6.4 Forward Contracts on Assets with Benefits and Costs of Carry 165 6.5 Forward Contracts Versus Futures Contracts 171 6.6 Managing Long-Term Futures Exposures 178 6.7 Option Exposures 180 6.8 Option Pricing Models 186 6.9 Option Sensitivities 188 Review Questions 190 Notes 191 Chapter 7 Measures of Risk and Performance 193 7.1 Measures of Risk 193 7.2 Estimating Value at Risk (VaR) 198 7.3 Benchmarking and Performance Attribution 203 7.4 Ratio-Based Performance Measures 204 7.5 Risk-Adjusted Return Measures 210 Review Questions 214 Notes 214 Chapter 8 Alpha, Beta, and Hypothesis Testing 215 8.1 Overview of Beta and Alpha 215 8.2 Ex Ante Versus Ex Post Alpha 217 8.3 Single-Factor Models and Regression 220 8.4 Inferring Ex Ante Alpha From Ex Post Alpha 225 8.5 Return Attribution, Alpha, and Beta 226 8.6 Ex Ante Alpha Estimation and Return Persistence 230 8.7 Return Drivers 231 8.8 Using Statistical Methods to Locate Alpha 234 8.9 Sampling and Testing Problems 239 8.10 Statistical Issues in Analyzing Alpha and Beta 242 Review Questions 246 Notes 247 Part 2 Real Assets Chapter 9 Natural Resources and Land 251 9.1 Natural Resources Other Than Land 251 9.2 Land 256 9.3 Timber and Timberland 261 9.4 Farmland 263 9.5 Valuation and Volatility of Real Assets 268 9.6 Pricing and Historic Data Analysis 272 9.7 Contagion, Price Indices, and Biases 275 9.8 Key Observations Regarding Historical Returns of Timberland 278 9.9 Key Observations Regarding Historical Returns of Farmland 278 Review Questions 279 Notes 279 Chapter 10 Commodities 281 10.1 Investing in Commodities Without Futures 281 10.2 The Term Structure of Forward Prices on Commodities 288 10.3 Rolling of Forward and Futures Contracts 296 10.4 Normal Backwardation and Normal Contango 302 10.5 Commodity Exposure and Diversification 307 10.6 Expected Returns on Commodities 310 10.7 Commodity Futures Indices 312 10.8 Commodity Risk Attributes 314 10.9 Observations Based on Historical Returns 318 Review Questions 318 Notes 318 Chapter 11 Other Real Assets 319 11.1 Commodity Producers 319 11.2 Liquid Alternative Real Assets 322 11.3 Infrastructure 325 11.4 Intellectual Property Overview 336 11.5 Cash Flows of Intellectual Property 341 11.6 Visual Works of Art and Historical Performance Data 344 11.7 R&D and Patents as Unbundled Intellectual Property 346 11.8 Intellectual Property Conclusions 349 Review Questions 350 Notes 350 References 350 Chapter 12 Real Estate Assets and Debt 353 12.1 Categories of Real Estate 353 12.2 Advantages, Disadvantages, and Styles of Real Estate Investments 355 12.3 Real Estate Style Boxes 361 12.4 Residential Mortgages 363 12.5 Commercial Mortgages 372 12.6 Mortgage-Backed Securities Market 375 12.7 Liquid Alternatives: Real Estate Investment Trusts 380 12.8 Key Observations Regarding Historical Returns of Mortgage REITs 382 Review Questions 384 Notes 384 Chapter 13 Real Estate Equity 385 13.1 Real Estate Development 385 13.2 Commercial Real Estate Valuation 389 13.3 Details of the Income Approach to Real Estate Valuation 397 13.4 Illustration of the Income Method of Real Estate Valuation 402 13.5 Alternative Real Estate Investment Vehicles 403 13.6 Equity REIT Returns 409 13.7 Key Observations Regarding Historical Risks and Returns of Equity REITs 410 Review Questions 412 Part 3 Hedge Funds Chapter 14 Structure of the Hedge Fund Industry 415 14.1 Distinguishing Hedge Funds 415 14.2 Hedge Fund Fees 419 14.3 Hedge Fund Classification 431 14.4 Hedge Fund Returns and Asset Allocation 433 14.5 Evaluating a Hedge Fund Investment Program 438 14.6 Three Research Studies on Whether Hedge Funds Adversely Affect the Financial Markets 441 14.7 Hedge Fund Indices 442 14.8 Conclusion 451 Review Questions 451 Notes 451 Chapter 15 Macro and Managed Futures Funds 453 15.1 Macro and Managed Futures Strategies 453 15.2 Global Macro 455 15.3 Managed Futures 459 15.4 Systematic Trading 464 15.5 Four Core Dimensions of Managed Futures Investment Strategies 476 15.6 Systematic Futures Portfolio Construction 479 15.7 Eight Core Benefits of Managed Futures for Investors 483 15.8 Evidence on Managed Futures Returns 485 15.9 Benefits of Managed Futures Funds 493 15.10 Key Observations Regarding Historical Returns of Macro and Systematic Diversified Funds 499 Review Questions 499 Notes 499 Chapter 16 Event-Driven Hedge Funds 501 16.1 The Sources of Most Event Strategy Returns 501 16.2 Activist Investing 505 16.3 Merger Arbitrage 517 16.4 Distressed Securities Funds 524 16.5 Event-Driven Multistrategy Funds 532 Review Questions 534 Notes 534 Chapter 17 Relative Value Hedge Funds 535 17.1 Overview of Relative Value Strategies 535 17.2 Convertible Bond Arbitrage 536 17.3 Volatility Arbitrage 551 17.4 Fixed-Income Arbitrage 565 17.5 Relative Value Multistrategy Funds 575 Review Questions 578 Notes 578 Chapter 18 Equity Hedge Funds 579 18.1 Commonalities of Equity Hedge Funds 579 18.2 Sources of Return 580 18.3 Market Anomalies 584 18.4 Implementing Anomaly Strategies 590 18.5 The Three Equity Strategies 594 18.6 Equity Hedge Fund Risks 605 Review Questions 605 Notes 606 Chapter 19 Funds of Hedge Funds 607 19.1 Overview of Funds of Hedge Funds 607 19.2 Investing in Multistrategy Funds 616 19.3 Investing in Funds of Hedge Funds 619 19.4 Investing in Portfolios of Single Hedge Funds 622 19.5 Multialternatives and Other Hedge Fund Liquid Alternatives 624 19.6 Key Observations Regarding Historical Returns of Funds of Funds 628 Review Questions 631 Notes 631 Part 4 Private Securities Chapter 20 Private Equity Assets 635 20.1 Introduction to Private Equity Terms and Background 635 20.2 Overview of Three Forms of Pre-IPO Private Equity Investing 637 20.3 Venture Capital 639 20.4 Venture Capital as a Compound Option 647 20.5 Growth Equity 648 20.6 Buyouts and Leveraged Buyouts 651 20.7 Buyouts of Private Companies 653 20.8 Leveraged Buyouts (LBOs) 655 20.9 Merchant Banking 663 20.10 Dynamics of Private Equity Opportunities 663 Review Questions 665 Notes 666 Chapter 21 Private Equity Funds 667 21.1 Overview of Private Equity Funds 667 21.2 Private Equity Funds as Intermediaries 671 21.3 The LP and GP Relationship Life Cycle 677 21.4 Private Equity Fund Fees and Terms 680 21.5 Key Determinants of Venture Capital Fund Risks and Returns 687 21.6 Roles and Three Key Distinctions of Venture Capital and Buyout Managers 689 21.7 Leveraged Buyout Funds 689 21.8 Private Equity Liquid Alternatives 693 21.9 Private Equity Funds of Funds 698 21.10 Private Investments in Public Equity 699 21.11 Private Equity Secondary Markets and Structures 703 Review Questions 706 Notes 707 Chapter 22 Private Credit and Distressed Debt 709 22.1 Types of Fund Private Credit Vehicles 709 22.2 Fixed-Income Analysis 711 22.3 Credit Risk Analysis and the Bankruptcy Process 715 22.4 Leveraged Loans 725 22.5 Direct Lending 727 22.6 Mezzanine Debt 728 22.7 Distressed Debt 737 22.8 Private Credit Performance and Diversification 743 Review Questions 744 Note 744 References 745 Part 5 Structured Products Chapter 23 Introduction to Structuring 749 23.1 Overview of Financial Structuring 749 23.2 Major Types of Structuring 750 23.3 The Primary Economic Role of Structuring 751 23.4 Collateralized Mortgage Obligations 753 23.5 Structural Model Approach to Credit Risk 761 23.6 Interest Rate Options 766 23.7 Introduction to Collateralized Debt Obligations 768 Review Questions 773 Note 773 Chapter 24 Credit Risk and Credit Derivatives 775 24.1 An Overview of Credit Risk 775 24.2 Reduced-Form Modeling of Credit Risk 776 24.3 Credit Derivatives Markets 783 24.4 Interest Rate Swaps 786 24.5 Credit Default Swaps 793 24.6 Other Credit Derivatives 801 24.7 CDS Index Products 804 24.8 Five Key Risks of Credit Derivatives 805 Review Questions 807 Notes 807 Chapter 25 CDO Structuring of Credit Risk 809 25.1 Overview of CDO Variations 809 25.2 Balance Sheet CDOs and Arbitrage CDOs 812 25.3 Mechanics of and Motivations for An Arbitrage CDO 814 25.4 Cash-Funded CDOs Versus Synthetic CDOs 816 25.5 Cash Flow CDOs Versus Market Value CDOs 820 25.6 Credit Enhancements 821 25.7 Other Types of CDOs 823 25.8 Risks of CDOs 824 Review Questions 829 Chapter 26 Equity-Linked Structured Products 831 26.1 Structured Products and Six Types of Wrappers 831 26.2 Four Potential Tax Effects of Wrappers 832 26.3 Structured Products with Exotic Option Features 835 26.4 Popular Structured Product Types 843 26.5 The EUSIPA Classification 844 26.6 Global Structured Product Cases 848 26.7 Structured Product Valuation 850 26.8 Motivations of Structured Products 854 Review Questions 855 Notes 856 Index 857

About the Author

DONALD R. CHAMBERS, PhD, CAIA, is Associate Director of Programs at the CAIA Association, Chief Investment Officer of Biltmore Capital Advisors, and Emeritus Professor at Lafayette College in Easton, Pennsylvania. Dr. Chambers previously served as Director of Alternative Investments at Karpus Investment Management. He is a member of the editorial board of the Journal of Alternative Investments. MARK J. P. ANSON, PhD, CAIA, CFA, CPA, JD, is Chief Investment Officer for Commonfund. Prior to joining Commonfund, he was the President and Chief Investment Officer of the Bass Family Office winner of the Family Office of the Year award for 2014-2015. Dr. Anson previously served as President and Executive Director of Investment Services at Nuveen Investments Inc., Chief Executive Officer of both the British Telecom Pension Scheme and its wholly owned asset management company in London, Hermes Pension Management Limited, and Chief Investment Officer at California Public Employees' Retirement System. He has published over 100 research articles in professional journals, has won two Best Paper Awards, is the author of six financial textbooks, and sits on the editorial boards of several financial journals. KEITH H. BLACK, PhD, CFA, CAIA, FDP is a managing director at the CAIA Association overseeing content strategy. He was previously an associate at Ennis Knupp and prior, an assistant professor at Illinois Institute of Technology. He is a member of the editorial board of the Journal of Alternative Investments. HOSSEIN B. KAZEMI, PhD, CFA, is co-founder of and the Senior Advisor for the CAIA Association. Dr. Kazemi is the Michael and Cheryl Philipp Distinguished Professor of Finance at Isenberg School of Management, the University of Massachusetts Amherst, the Director of the Center for International Securities and Derivatives Markets, and editor of the Journal of Alternative Investments and Alternative Investment Analyst Review.

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