Free CAIA Level I Additional Strategies Practice Questions
Portfolio allocation to alternatives on CAIA Level I covers funds of funds (PE and hedge fund), liquid alternative vehicles, multialternative strategies, and the role of alternative investments in diversified institutional portfolios.
Sample Questions
Question 1
Easy
Fee layering in a fund of funds structure refers to:
Solution
B is correct.
Fee layering describes the situation where investors in a fund of funds pay two levels of fees: the management and incentive fees of the underlying funds, plus the additional management and incentive fees charged by the fund of funds manager itself.
Fee layering describes the situation where investors in a fund of funds pay two levels of fees: the management and incentive fees of the underlying funds, plus the additional management and incentive fees charged by the fund of funds manager itself.
Question 2
Medium
Netting risk in a fund of hedge funds arises when:
Solution
D is correct.
Netting risk occurs because incentive fees at the underlying fund level are calculated individually. If Fund A earns $10 million and Fund B loses $10 million, the FoF has a net zero return, but the FoF investor still pays an incentive fee to Fund A's manager. This asymmetry in fee calculation is a structural disadvantage of the fund of funds model.
Netting risk occurs because incentive fees at the underlying fund level are calculated individually. If Fund A earns $10 million and Fund B loses $10 million, the FoF has a net zero return, but the FoF investor still pays an incentive fee to Fund A's manager. This asymmetry in fee calculation is a structural disadvantage of the fund of funds model.
Question 3
Hard
A PE FoF invested in 8 underlying buyout funds across 3 vintage years. The FoF reports a pooled IRR of 14% and a commitment-weighted average IRR of 11%. What does the divergence between these two metrics most likely indicate?
Solution
B is correct.
A pooled IRR aggregates all cash flows across all underlying funds and computes a single IRR, naturally giving more weight to larger cash flows. A commitment-weighted average IRR weights each fund's individual IRR by its commitment size. When the pooled IRR exceeds the commitment-weighted average, it indicates that larger or earlier cash flows came from higher-returning funds. This divergence most likely reflects successful allocation timing, where the FoF made larger commitments to vintage years or funds that performed better.
A pooled IRR aggregates all cash flows across all underlying funds and computes a single IRR, naturally giving more weight to larger cash flows. A commitment-weighted average IRR weights each fund's individual IRR by its commitment size. When the pooled IRR exceeds the commitment-weighted average, it indicates that larger or earlier cash flows came from higher-returning funds. This divergence most likely reflects successful allocation timing, where the FoF made larger commitments to vintage years or funds that performed better.