Alternative Investments. Hossein Kazemi

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      James T. Gillies, CAIA

      Special credit goes to CAIA staff for their valuable contributions in painstakingly bringing the third edition to completion.

      CAIA Staff

      Outside Editor

      About the Authors

      The CAIA Association is an independent, not-for-profit global organization committed to education and professionalism in the field of alternative investments. The Association was established in 2002 by industry leaders under the guidance of the Alternative Investment Management Association (AIMA) and the Center for International Securities and Derivatives Markets (CISDM) with the belief that a strong foundation of knowledge is essential for all professionals. The curriculum includes two exams (Level I and Level II) administered to professional analysts in this growing field so that, upon successful completion, the individuals are designated Chartered Alternative Investment Analysts (CAIA). The CAIA designation has a great deal of prestige in the global community. Members come from over 80 countries on six continents.

      Dr. Donald R. Chambers, CAIA, is Associate Director of Programs at the CAIA Association; the Walter E. Hanson/KPMG Professor of Finance at Lafayette College in Easton, Pennsylvania; and Chief Investment Officer of Biltmore Capital Advisors. 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.

      Dr. Mark J. P. Anson, CAIA, CFA, CPA, Ph.D., J.D, is a board member of CAIA and 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.

      Dr. Keith H. Black, CAIA, is Managing Director of Curriculum and Exams at the CAIA Association. He was previously an Associate at Ennis Knupp and, before that, an Assistant Professor at Illinois Institute of Technology. He is a member of the editorial board of the Journal of Alternative Investments.

      Dr. Hossein Kazemi is a senior adviser to the CAIA Association. He is the Michael and Cheryl Philipp Professor of Finance at the University of Massachusetts, Amherst; Director of the Center for International Securities and Derivatives Markets; a cofounder of the CAIA Association; and Editor-in-Chief of the Journal of Alternative Investments– the official publication of the CAIA Association.

      PART One

      Introduction to Alternative Investments

      Part 1 begins with an introduction to alternative investments and a description of the environment of alternative investing. Chapters 3 to 6 include primers on quantitative methods, statistics, and financial economics as they relate to alternative investments, as well as a chapter on measures of risk and return. The last three chapters of Part 1 discuss performance attribution, hypothesis testing of risk and return, and multivariate and nonlinear methods. The material is designed to provide a foundation for Parts 2 to 5, which detail each of the four main categories of alternative investments.

      CHAPTER 1

      What Is an Alternative Investment?

      Definitions of what constitutes an alternative investment vary considerably. One reason for these differences lies in the purposes for which the definitions are being used. But definitions also vary because alternative investing is largely a new field for which consensus has not emerged, as well as a rapidly changing field for which consensus will probably always remain elusive.

      Analyzing these various definitions provides a useful starting point to understanding alternative investments. So we begin this introductory chapter by examining commonly used methods of defining alternative investments.

      1.1 Alternative Investments by Exclusion

      Alternative investments are sometimes viewed as including any investment that is not simply a long position in traditional investments. Typically, traditional investments include publicly traded equities, fixed-income securities, and cash. For example, if a particular investment (such as private equity) is not commonly covered as equity in books on investing, then many people would view it as an alternative investment.

      The alternative-investments-by-exclusion definition is overly broad for the purposes of the CAIA curriculum. First, the term investment covers a very broad spectrum. A good definition of an investment is that it is deferred consumption. Any net outlay of cash made with the prospect of receiving future benefits might be considered an investment. So investments can range from planting a tree to buying stocks to acquiring a college education. As such, a more accurate definition of alternative investments requires more specificity than simply that of being nontraditional.

      This book and the overall CAIA curriculum are focused on institutional-quality alternative investments. An institutional-quality investment is the type of investment that financial institutions such as pension funds or endowments might include in their holdings because they are expected to deliver reasonable returns at an acceptable level of risk. For example, a pension fund would consider holding the publicly traded equities of a major corporation but may be reluctant to hold collectibles such as baseball cards or stamps. Also, investments in very small and very speculative projects are typically viewed as being inappropriate for such an institution due to its responsibility to select investments that offer suitable risk levels and financial return prospects for its clients.

      Not every financial institution, or even every type of financial institution, invests in alternative investments. Some financial institutions, such as some brokerage firms, are not focused on making long-term investments; rather, they hold securities to provide services to their clients. Other financial institutions, such as deposit-taking institutions like banks (especially smaller banks) might invest in only traditional investments because of government regulations or because of lack of expertise.

      Of course, institutional-quality alternative investments are also held by entities other than financial institutions. Chapter 2 of this book discusses the alternative investment environment, including the various entities that commonly hold them (e.g., endowment funds and wealthy individuals).

      1.2 Alternative Investments by Inclusion

      Another method of identifying alternative investments is to define explicitly which investments are considered to be alternative. In this book, we classify four types of alternative investments: