CPM Alternative Investments in Portfolios 2 — Questions and Answers
Question 1: The J-curve effect in private equity describes:
- Rising returns in early years followed by a decline
- Initial negative returns in early years (due to fees and capital deployment) that turn positive as investments mature (Correct answer)
- A gradual flattening of returns over time
- Consistent positive returns from year one
Correct answer: Initial negative returns in early years (due to fees and capital deployment) that turn positive as investments mature
The J-curve reflects the typical private equity return pattern where early years show negative net returns (management fees, unrealized losses) that improve as portfolio companies mature and are exited.
Question 2: Which alternative investment strategy profits from pricing discrepancies between related securities?
- Long-only equity
- Global macro
- Relative value / arbitrage (Correct answer)
- Distressed debt
Correct answer: Relative value / arbitrage
Relative value strategies exploit pricing inefficiencies between related or linked securities (e.g., convertible arbitrage, statistical arbitrage), seeking to profit when prices converge.
Question 3: Infrastructure investments in a portfolio typically provide:
- High volatility and short investment horizons
- Stable, long-duration cash flows with inflation-linkage (e.g., toll roads, utilities) (Correct answer)
- High correlation with equity markets
- No income stream
Correct answer: Stable, long-duration cash flows with inflation-linkage (e.g., toll roads, utilities)
Infrastructure assets like toll roads, airports, and utilities generate predictable, long-duration, often inflation-linked cash flows, making them attractive for liability-matching and income-seeking investors.
Question 4: Which of the following best describes a fund of funds (FoF) in the alternative investment space?
- A single hedge fund with one strategy
- A fund that invests in multiple underlying hedge funds or private equity funds, providing diversification across managers and strategies (Correct answer)
- A publicly traded mutual fund
- A fixed income index fund
Correct answer: A fund that invests in multiple underlying hedge funds or private equity funds, providing diversification across managers and strategies
A fund of funds allocates capital across multiple underlying alternative investment funds, providing instant diversification across managers and strategies, but adds an additional layer of fees.
Question 5: The primary risk unique to direct real estate investment compared to REITs is:
- Market price fluctuation
- Illiquidity and high transaction costs associated with buying and selling physical property (Correct answer)
- Dividend cut risk
- Daily mark-to-market losses
Correct answer: Illiquidity and high transaction costs associated with buying and selling physical property
Direct real estate is highly illiquid, with significant transaction costs and long time horizons required to buy or sell properties, unlike publicly traded REITs which provide daily liquidity.
Question 6: Which of the following is a primary concern when conducting due diligence on a hedge fund manager?
- The fund's CUSIP number
- Operational risk, including verification of assets, trading systems, and conflicts of interest (Correct answer)
- The fund's country of domicile only
- Whether the fund invests in equities
Correct answer: Operational risk, including verification of assets, trading systems, and conflicts of interest
Hedge fund due diligence must thoroughly evaluate operational risk — including auditor quality, prime brokerage relationships, third-party administration, and potential conflicts of interest — to guard against fraud and operational failures.
CPM Alternative Investments in Portfolios 2
The J-curve effect in private equity describes: