CAIA Level I common mistakes
CAIA Level I · Understand the traps and how to avoid them.
Clears a questionable practice by noting it is legal in the local market - e.g., accepting a lavish gift from a broker, or trading ahead of a client order where local rules are silent - and moves on without further analysis.
The candidate reads the Code and Standards as a legal-compliance checklist. In practice the Standards require the stricter of applicable law and the Code, plus fiduciary duties of loyalty, prudence and care, so 'legal' is only the floor.
What to do instead
Run a two-step test before acting: (1) Is it legal AND consistent with the stricter of local law and the Standards? (2) Would full written disclosure to clients and my employer make me uncomfortable? If either answer is unfavourable, don't do it - and document the reasoning contemporaneously.
Presents a backtested, simulated or model track record in a pitch as though it were actual client results, or shows a 'since inception' composite that quietly excludes terminated or poorly performing accounts.
Marketing pressure combined with the belief that a footnote somewhere in the deck cures the problem. Candidates also underweight how much of an alternatives track record can be reconstructed rather than lived.
What to do instead
Label hypothetical/simulated results explicitly, disclose that no actual trading occurred and that results have inherent limitations, and never splice simulated returns onto actual ones without a clear break. When presenting live performance, include all fee-paying discretionary accounts in the composite, disclose the composite definition and the treatment of terminated accounts.
Computes Sharpe ratios and correlations straight off appraisal-based, backfilled or survivorship-filtered indices for real estate, private equity and hedge funds, then concludes that a small allocation dramatically improves portfolio efficiency.
Appraisal smoothing induces serial correlation, which mechanically understates volatility and correlation; backfill and survivorship bias inflate reported returns. The math looks clean, so the candidate never questions the input data.
What to do instead
Unsmooth the return series (first-order autoregressive / Geltner-style adjustment) before computing risk statistics, use lag-adjusted or longer-horizon correlations, and haircut the resulting Sharpe ratio for illiquidity and stale pricing. State explicitly that reported alts volatility is a lower bound.
Annualises a sub-year return by scaling it - multiplying a quarterly return by four or a three-month return by 12/n - and reports a money-weighted return for a manager who does not control client cash flows.
Spreadsheet habit and the fact that many fund marketing documents quote simple-annualised or IRR figures. The candidate matches the number to the format rather than to the question being asked.
What to do instead
Compound: annualised return = (1 + r)^(periods per year) − 1. Choose time-weighted return when the manager lacks control of external cash flows, and money-weighted (IRR) only when the investor controls the timing of contributions and withdrawals; say which you used and why.
Reads 'one-day 95% VaR of $10 million' as 'the most we can lose is $10 million' or as a 95% probability of loss, and stops there.
The name 'value at risk' invites a worst-case reading, and exam stems are written to reward that ambiguity if you let them.
What to do instead
Restate the number in words: on roughly 5% of days, losses are expected to exceed $10 million. Pair it with expected shortfall/CVaR to describe the tail, note that VaR is not sub-additive and so can appear to 'diversify' when it does not, and always state the confidence level and horizon.
Calculates a hedge fund's incentive fee as 20% of the gross return after deducting only the management fee, ignoring the high-water mark and any hurdle, and ignores whether the hurdle is hard or soft.
The candidate recites '2 and 20' from memory without reading the fee waterfall in the offering document, where the order of deduction, crystallisation frequency and hurdle definition actually live.
What to do instead
Follow the fund terms in order: management fee on net assets, then incentive fee on profits above the high-water mark and above any hurdle, crystallised at the stated frequency. Work through whether a soft hurdle (fee on all profits once the hurdle is cleared) or hard hurdle (fee only on profits above the hurdle) applies, and remember a high-water mark protects the investor after a down year.
Compares a private equity fund's IRR directly with a public equity index return and treats the difference as manager outperformance.
IRR is money-weighted and is boosted by early distributions and by the J-curve's back-loaded cash flows, while the index is time-weighted and continuously priced. The two numbers are not the same measure of anything.
What to do instead
Compare on a public market equivalent basis (e.g., a PME that invests index cash flows on the same schedule) or against a levered, size- and sector-matched benchmark. Report DPI, TVPI and RVPI alongside IRR, and explicitly account for the J-curve, leverage and the illiquidity premium before attributing the spread to skill.
Assumes a floating-rate senior loan or unitranche carries little or no interest-rate risk because the coupon resets with the reference rate.
The candidate conflates duration of the reference rate with spread duration. Floors, credit spread widening and prepayment/extension optionality all move the price even when the base rate resets.
What to do instead
Separate base-rate duration from spread duration and shock them independently; model the reference-rate floor (which truncates the benefit of rate cuts); and stress a spread-widening scenario in which the loan's price falls despite a floating coupon. Add prepayment and extension risk to the analysis.
Treats the capitalisation rate as the property's total return - valuing an asset as NOI divided by cap rate and concluding that a 4% cap rate means a 4% annual return.
Cap rate is a going-in income yield, not total return, and the shortcut survives because it produces a plausible-looking number. Cap-rate compression is then misread as income rather than as a change in the discount rate or growth expectation.
What to do instead
Decompose: total return ≈ income return (cap rate) + NOI growth ± change in cap rate. Relate cap rate to the discount rate and growth (cap rate ≈ discount rate − growth), distinguish going-in from stabilised cap rates, and show separately what happens to value if the exit cap rate moves 50 bp.
Treats a 'principal-protected' structured note as a risk-free investment and analyses only the equity-linked payoff, ignoring that the protection is a promise from the issuer.
Attention goes to the appealing upside formula and the headline guarantee; issuer credit risk is invisible unless the note is decomposed into its building blocks.
What to do instead
Decompose the note into a zero-coupon bond plus an embedded option position. Discount the bond at the issuer's credit spread to see what the protection is really worth, value the option with an appropriate implied volatility, and check whether the stated participation rate is consistent with the residual cash after funding the bond and paying the distributor.