Alternative Investments: CAIA Level I, 3rd Edition

CHAPTER 30 Investment Process, Operations, and Risk

The descriptions of fund failures in Chapter 29 highlight the need for a thorough understanding of both a fund manager's risks and a fund manager's risk management process. Quantitative risk analysis is usually focused on historical analysis of past risk and return. However, very few fund collapses can be predicted based on analysis of past returns alone. Recent research is providing evidence that a careful study of fund failures and state-of-the-art due diligence processes can reduce the risk of allocating money to funds that experience catastrophic losses.

This chapter provides a framework for an asset allocator to assess the investment process risk, operational risk, and overall risk management processes of a fund manager as a prelude to Chapter 31 on due diligence.

30.1 Investment Strategy and Process

The analysis of the potential returns and risks of a fund or another investment vehicle are inextricably linked with its investment strategy. A fund's investment strategy refers to the sets of objectives, principles, techniques, and procedures used to construct and modify the fund's portfolio.

30.1.1 Stated and Permitted Investment Strategies

A critical aspect of a fund's risk is the potential divergence between the stated investment strategy of the fund and the actual investment strategy. The stated investment strategy of a fund is the investment strategy that a diligent investor would expect the fund to pursue, based ...