Free CAIA Level I Funds of Funds 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
Portable alpha strategies are characterized by:
Solution
B is correct. Portable alpha strategies separate the beta and alpha components of return. The investor obtains the desired market beta through a derivative overlay (such as equity index futures) that requires minimal capital, and deploys the remaining cash with an alpha-generating manager whose returns are uncorrelated with the targeted beta. The freed capital allows the alpha source to be 'ported' onto a beta benchmark.
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.