CAIA Level II cheat sheet

Adding alternatives shifts the efficient frontier outward mainly through diversification and an illiquidity premium; the measured benefit shrinks when illiquid assets are marked to model and reported volatility is understated.

Smoothed (appraisal-based) returns understate volatility and overstate the Sharpe ratio; serial correlation also understates correlation with liquid assets, so de-smooth returns (Geltner-style autoregressive adjustment) before running mean-variance optimization.

Policy constraints are captured by RRTTLLU: Return requirement, Risk tolerance, Time horizon, Liquidity, Legal/regulatory, Tax, Unique circumstances.

Liability-driven investing: a 100 bp fall in rates raises the present value of liabilities by roughly duration x 1%, so the hedge ratio must be measured on a surplus (assets minus liabilities) basis, not on total assets.

Funding ratio = assets / present value of liabilities; funded status = assets minus liability PV. De-risking glidepaths shift allocation toward duration-matching bonds as the funding ratio improves.

Commitment (pacing) models must treat unfunded commitments as an off-balance-sheet liability; over-commitment risk rises when distributions slow while capital calls continue.

Illiquid sleeves are rebalanced through cash-flow direction (distributions to underweights, new commitments to overweights) rather than calendar-based trading, because secondary sales incur discounts to NAV.

Monte Carlo simulation is used instead of single-path projection when the question involves shortfall probability, path dependency, fat tails, or sequencing of calls and distributions.

Institutional archetypes: DB pension (liability driven, funded status focus), endowment/foundation (perpetual horizon, spending rule near 5%), insurer (duration and capital matching), sovereign wealth fund (intergenerational, high alternatives tolerance).

Fee model: management fee typically 1.5-2.0% of committed capital (sometimes stepping down after the investment period) plus 20% carried interest above an 8% hurdle, with GP catch-up and LP clawback.

IRR overstates return when capital is called early and distributed late; pair IRR with TVPI = (NAV + cumulative distributions) / paid-in capital and DPI = cumulative distributions / paid-in capital.

J-curve: net cash flow to LPs is negative in early years from fees and write-downs, then positive after exits; early NAV-based IRRs are unreliable and understate eventual performance.

Vintage-year diversification reduces entry-valuation timing risk because fund returns are driven largely by the pricing environment at deployment.

LBO return decomposition: equity return is approximately EBITDA growth + multiple expansion + debt paydown + leverage effect.

Buyouts use leverage on mature cash-flow businesses; venture capital follows a power law where a small number of deals drive fund returns, and top-quartile persistence is strongest in venture.

Fund structure: blind pool, 10-year term plus extensions, roughly 5-year investment period, GP calls committed capital with about 10 business days' notice, uninvested commitments are dry powder.

Secondaries provide liquidity at a discount to NAV; GP-led continuation funds create conflicts of interest requiring LP advisory committee review and independent fairness opinions.

Strategy risk/return ladder: mezzanine and distressed credit carry shorter duration and contractual income; growth equity sits between venture capital and buyout in risk.

Cap rate = net operating income / value; property total return is approximately income return (cap rate net of capex) plus capital appreciation, and cap rates move inversely to values.

Leverage metrics: equity dividend rate = (NOI - debt service) / equity; DSCR = NOI / debt service, with lenders commonly requiring 1.25x or higher.

Appraisal-based indices such as NCREIF ODCE smooth returns and lag transaction prices; de-smooth with an autoregressive adjustment before using volatility or correlations in optimization.

Commodity futures return decomposition: spot return + roll yield + collateral yield; roll yield is positive in backwardation and negative in contango, where long-only indices lose as contracts roll down the curve.

Infrastructure risk buckets: regulated asset base (lowest demand risk), availability-based or concession structures (medium), and merchant/demand-based assets (highest); contracted cash flows justify lower discount rates.

Timberland return = biological growth + land appreciation, with harvest timing as an option; farmland return is driven by crop income plus land value change.

Inflation linkage varies: short-lease real estate and CPI-indexed regulated utilities reset quickly, while long-lease assets and unindexed contracts lag inflation.

REITs add equity market beta and daily liquidity; direct real estate adds illiquidity, appraisal lag, and control rights.

'2 and 20' means a 2% management fee on NAV plus a 20% incentive fee subject to a high-water mark (sometimes also a hurdle); the HWM prevents charging performance fees twice on recovered losses.

Liquidity terms: notice periods, lockups (often one year), redemption gates (commonly 20% of NAV per quarter), and side pockets for hard-to-value positions.

Database biases inflate reported index returns: survivorship bias (failed funds removed), backfill bias (funds added after strong early performance), and self-selection bias.

Strategy taxonomy: equity long/short, event driven, relative value/arbitrage, global macro, managed futures; each differs in net equity beta, correlation regime, and liquidity.

Managed futures/trend following behaves like long volatility: it profits from sustained directional moves and typically provides crisis risk offset during equity selloffs.

Look-through factor attribution: hedge fund returns are partly explained by equity beta, size, value, momentum, and carry; alpha must be judged net of these exposures.

Operational due diligence covers valuation policy, administrator independence, custody, and key-person risk; operational failures account for a large share of hedge fund blowups.

Alpha decay and capacity: assets grow faster than exploitable opportunities, compressing returns; smaller funds frequently outperform larger peers in less liquid strategies.

Fee layering: fund-of-funds structures add a second management and incentive fee, which materially reduces net alpha available to the end investor.

Credit spread = bond yield minus the benchmark risk-free yield; components are expected default loss (PD x LGD), liquidity premium, tax effects, and risk premia.

Expected loss = probability of default x loss given default, where LGD = 1 - recovery rate; senior secured loans typically recover 60-80%, unsecured bonds 30-40%.

Merton structural model: equity is a call option on firm assets with strike equal to face value of debt; risky debt equals riskless debt minus a put; default occurs when asset value falls below debt at maturity.

Securitization waterfall: collections pay senior expenses, then tranche interest and principal in order of seniority; the equity/first-loss tranche absorbs initial losses and receives residual cash flow.

Attachment and detachment points define subordination: a tranche covering losses from 3% to 7% attaches at 3% and detaches at 7%, and its thickness is the detachment minus attachment.

Prepayment risk (contraction when rates fall) and extension risk (when rates rise) create negative convexity: MBS prices appreciate less as rates fall and depreciate more as rates rise.

Option-adjusted spread removes the cost of embedded options from the Z-spread, enabling comparison of bonds with different prepayment or call features.

Private credit: floating-rate senior direct loans with covenant protections, origination premium, and illiquidity premium; key risks are covenant erosion and mark-to-model valuation opacity.

CLO arbitrage: weighted average asset spread minus weighted average tranche cost minus fees; the equity tranche is leveraged, first-loss, and most sensitive to asset defaults.

CFA Institute Code and Standards require integrity, competence, diligence, and respect, placing client interests ahead of the firm's and one's own, and disclosing conflicts.

Standard II: trading on material nonpublic information is prohibited; the mosaic theory permits combining public information with non-material nonpublic information to reach a conclusion.

Standard III(A) Loyalty, Prudence, and Care establishes fiduciary duty; soft dollars must benefit the client and satisfy the research safe harbor of Section 28(e) of the Securities Exchange Act of 1934.

Standard III(B) Fair Dealing: recommendations must reach all clients simultaneously, and oversubscribed issues or filled orders allocated per a written, disclosed pro rata policy.

Priority of transactions: client and employer trades take precedence over personal trades; typical controls are pre-clearance, blackout periods, and restricted lists.

GIPS requires firm-wide composites of all actual, fee-paying, discretionary portfolios, prescribed disclosures, at least five years of performance building to ten, and treats verification as voluntary.

Standard III(D) Performance Presentation prohibits misrepresentation; performance must be fair, accurate, timely, and complete, with no cherry-picking of accounts.

Standard I(C) Misrepresentation extends to plagiarism and to omitting facts that would make a statement misleading; sources must be cited.

Tokenization of alternative assets can lower minimums and improve transferability, but introduces custody, settlement-finality, smart-contract, and securities-law classification risks.

Many digital tokens lack cash flows, so valuation rests on network effects and store-of-value narratives; private-key management and custodian failure are primary operational risks.

Climate risk is split into physical risk (acute and chronic hazards) and transition risk (policy, technology, and sentiment shifts); TCFD recommends governance, strategy, risk management, and metrics/targets disclosure.

Emissions scopes: Scope 1 is direct, Scope 2 is purchased energy, Scope 3 is the value chain; Scope 3 usually dominates an issuer's footprint and is the least reliable data category.

Greenwashing risk arises when ESG labels exceed measurable practice; regimes such as the EU SFDR taxonomy impose fund-level classification and disclosure obligations.

Retail access vehicles include interval funds, tender-offer funds, BDCs, and non-traded REITs; liquidity is periodic and typically capped near 5% of NAV per quarter.

Insurance-linked securities and catastrophe bonds transfer peak peril risk to investors who earn a spread but face principal loss on an indemnity, industry-loss, or parametric trigger.

Emerging sleeves such as private credit and litigation finance offer diversifying, often floating-rate or outcome-linked cash flows, with risks from valuation opacity, rate sensitivity, and judicial outcomes.