Risk Management and Due Diligence for Alternative Investments

Risk Management and Due Diligence for Alternative Investments

Due diligence for hedge fund selection includes looking at the track record (if any), investment strategies, redemption rules, and many other qualitative and quantitative factors.

Private equity funds require investors to look at the track record. The investment horizon is equally an important consideration. In addition, a careful review of the investment redemption and payback rules is crucial. Due diligence in real estate means good property management (often through dedicated firms) and a careful assessment of the market forces relevant to the property.

In any case, alternative investments often rely heavily on managers to execute a good strategy. Bad management practices can often go unnoticed in the volatile and translucent markets of alternative investments.  Independent valuation and proper guidelines for investments can provide a buffer against losses. Proper due diligence includes a look at operations, executives, organization, portfolio management, accounting controls, risk management, legal review, contract terms, and a host of other factors.

Alternative investments form a part of a portfolio for a savvy investor. They, however, ought to always fit within a broader portfolio. These investments offer an invester a chance to get more performance and lower risk. Even then, a degree of caution is warranted.

Asymmetric risk and return profiles, along with limited liquidity, low information, and regulatory/governance complexity, are hurdles for investors. In addition, these securities often have counterparty risk, liquidity risk, compliance issues, and difficult forecasting potential.  However, they offer a savvy investor a chance to balance their portfolio and seek higher returns with lower risk if used correctly.

Question

Which of the following are least likely risk management issues for alternative investments?

  1. Asymmetric risk and returns
  2. Reliance on expert management skills
  3. Lack of diversification benefits

Solution

The correct answer is C.

Diversification benefits are a key selling point of the alternative investment market.  These investment are marked by volatile returns and the need for savvy management.  Reasonable fund terms are crucial to an investor’s individual financial needs (redemption, fee structure, holding period, etc.)

Reading 50 LOS 50f:

describe risk management of alternative investments

Shop CFA® Exam Prep

Offered by AnalystPrep

Featured Shop FRM® Exam Prep Learn with Us

    Subscribe to our newsletter and keep up with the latest and greatest tips for success
    Shop Actuarial Exams Prep Shop Graduate Admission Exam Prep


    Sergio Torrico
    Sergio Torrico
    2021-07-23
    Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
    diana
    diana
    2021-07-17
    So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
    Kriti Dhawan
    Kriti Dhawan
    2021-07-16
    A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
    nikhil kumar
    nikhil kumar
    2021-06-28
    Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
    Marwan
    Marwan
    2021-06-22
    Great support throughout the course by the team, did not feel neglected
    Benjamin anonymous
    Benjamin anonymous
    2021-05-10
    I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
    Daniel Glyn
    Daniel Glyn
    2021-03-24
    I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
    michael walshe
    michael walshe
    2021-03-18
    Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.