The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

Solutions

CHAPTER 2

1. The correlation between asset classes is a key statistical measure for successful diversification. Adding asset classes that have low or even negative correlations improves the risk–return space for investors (i.e., they improve the efficient frontier).

2. The view is that alternative asset classes are nothing more than different investment strategies within an existing traditional asset class and derive their value from traditional asset classes. Hedge funds offer a good example because managers merely apply aggressive investment strategies to stocks and bonds. Private equity is common stock (a traditional asset class) of a nonpublicly traded company.

3. Alternative assets represent an alternative source of beta that differs from traditional assets by providing new systematic risk premiums that differ from those obtained from say stocks and bonds. A good example is commodities since they provide a different risk exposure than stocks or bonds and for this reason the risk premium associated with commodities is less than perfectly correlated with the markets for traditional asset classes. Alternative assets are alpha drivers since they offer opportunities to earn excess return, as well as seeking sources of return less correlated with traditional asset classes, which reduces risk in the entire portfolio via diversification.

4. Market directional hedge funds are those that retain some amount of systematic risk exposure. Corporate restructuring hedge funds ...