Study Notes for CFA® Level III – As ...
Reading 5: Overview of Asset Allocation -a. Describe elements of effective investment governance... Read More
Investors enter alternative investment programs with specific goals: risk reduction, return enhancement, income, or a mix of these. These programs are long-term commitments, so it’s crucial to continuously monitor their progress.
Investors must ensure that their original program goals remain achievable over the investment horizon. Changing market conditions, like historically low cap rates, can impact the program’s relevance to those goals.
Monitoring is challenging and time-consuming. Data isn’t readily available, and analyzing it requires expertise to draw meaningful comparisons and insights, a task not easily managed by those unfamiliar with the field.
Monitoring alternative investment fund performance comes with challenges, such as benchmarking and forming relevant peer groups. Unlike traditional assets, alternatives are unique and don’t fit neatly into standardized criteria for comparisons.
Some investors use pre-compiled benchmarks and adjust them based on similarities to the underlying investments. Others employ absolute return criteria or use spreads on equity indices. There’s also the complexity of choosing between time-weighted returns, money-weighted returns, or internal rate of return (IRR).
Given these complexities, hiring experienced staff dedicated to monitoring and evaluation becomes important, especially for larger investments or when dealing with numerous underlying funds.
Ongoing monitoring of an alternative investment program is essential, and whether it’s done in-house or through a specialized firm, certain critical considerations should be taken into account:
Success in alternative investments often relies on key investment professionals. If these individuals leave the fund, it can impact performance. Investors should track who is making investment decisions.
Achieving perfect alignment between General and Limited Partners is challenging. However, open communication helps. Key questions include whether the manager has invested alongside limited partners and if there are plans for a new fund.
Fund managers should stay within their areas of expertise to generate alpha. Investing in unfamiliar areas poses risks.
Understanding the fund’s risk management philosophy and ensuring adherence is crucial, especially if leverage is involved.
Large drops in clients or assets may indicate problems.
Knowing about the manager’s other clients is important. Do they redeem quickly when trouble arises?
Confirming third-party service providers like administrators and auditors are engaged by the fund manager is essential. Changes in service providers can signal issues.
Monitoring these aspects helps ensure the ongoing success of an alternative investment program.
Question
The outcome of an investment in alternative assets can be affected by the fund’s clients, the Limited Partners:
- False.
- True.
Solution
The correct answer is B.
Clients, as Limited Partners, have the potential to impact the investment strategy. During events like the 2008 financial crisis, clients withdrawing capital from alternative investments contributed to the funds’ financial challenges. While lock-up periods may impose penalties on early withdrawals, they don’t entirely prevent them. Therefore, it’s crucial to consider the behavior of other clients in a fund before making an investment decision.
Reading 28: Asset Allocation to Alternative Investments
Los 28 (h) Discuss considerations in monitoring alternative investment programs