Equities and asset allocation

Tracking an index:

Optimization strategy:
looks at factors to replicate, ensure correlations are minimized, quant heavy.
Uses LP or similar to construct target portfolio
Look for low cost way to ensure minimal tracking risk by targeting factors
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Active return = true active return + misfit return
(True active return = manager's return - manager's benchmark)
(Misfit return = manager's benchmark - investor's benchmark)

SD:
True active risk = the standard deviation of true active return
Misfit risk = the standard deviation of misfit active return

Mgr can use different stocks not inside a benchmark for his/her active portfolio benchmark as long as he keeps the misfit risk low (and tracks the benchmark well)

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Core - satellite portfolio: anchored mostly in index fund, use active mgmt for inefficiently priced assets:
can be thought of actively managed satellite portfolios surrounding the core


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Completeness fund: added to active portfolio to bring the risk back in line with the equity benchmark; brings misfit risk to almost zero.

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Managed futures:
Risk between bonds and equities; -ve or low correlation with equities; moderate correlation with bonds

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Venture capital:
Seed/early stage : before revenue
Later stage: after revenue starts coming in
Exit stage: selling the inv etc
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Preferred stock: typically later round preferreds are senior to earlier rounds
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Typical PE fund has life time of 7-10 yrs
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Commodity future return:
Spot return: Appreciation in spot price
Roll return: makes money in case of backwardation: the future price increases over time to match spot price
Collateral return: return on any asset held as collateral
[The collateral return or “collateral yield” is the result of the no-arbitrage assumption that if an investor is long a contract and invests an amount in T-bills that will be equal to the amount required to pay for the required purchase at the maturity of the futures contract. Such a fully-hedge position should earn the risk-free rate.
]
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commodity as hedges to inflation: commodities whose demand changes with economic climate (energy etc) are better hedges to inflation than otherwise as agricultural commodities.
Also storable commodity is a better hedge than non storable...

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hedge fund compensation:
AUM fee : 1 - 2%;
HWM (high water marks): to avoid double dipping; each high value of fund when incentive is paid is established as high water mark.

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FOF : suffers from less survivorship bias; but can have style drift
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hedge fund performance measurements:
Sharpe ratio not a good indicator because:
a) Upward bias for long time periods as extreme volatility is masked
b) Inappropriate for skewed, non normal distributions
c) illiquid market and infrequent trading the return observations could be wrong
d) Correlations not captured,

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Emerging market

Market liberalization vs market integration
are not same:
For example, a country might pass a law that seemingly drops all barriers to foreign participation in local capital markets. This is a liberalization, but it might not be an effective liberalization that results in market integration

Emerging market returns are *not* normally distributed

* Bid /as spreads could increase in the beginning of liberalization