CAIA Level II Glossary
28 essential terms and definitions for CAIA Level II. Each definition is written for exam preparation, covering the concepts as they are tested on the 2026 syllabus.
1
- 130/30 Strategy
- A 130/30 strategy holds 130% long positions and 30% short positions, maintaining 100% net market exposure while adding alpha-generating breadth through short positions. It bridges traditional long-only and market-neutral strategies.
A
- Activist Investing
- Activist investing is a hedge fund strategy that takes meaningful equity positions and pushes for operational, governance, or capital-structure changes to unlock value. It typically involves public letters, proxy contests, and engagement with boards.
- Alpha Decay
- Alpha decay is the tendency for an investment strategy's edge to erode over time as competitors adopt similar approaches and markets become more efficient. Persistent alpha typically requires continuous innovation in signal generation and execution.
C
- Carry Trade
- A carry trade borrows in a low-interest-rate currency and lends in a high-interest-rate currency. Profits depend on the funding currency not appreciating sufficiently to offset the interest-rate differential; carry trades historically perform poorly during risk-off episodes.
- Closed-End Fund (CEF)
- A closed-end fund issues a fixed number of shares that trade on an exchange. The market price can deviate (premium or discount) from net asset value because shares are not redeemable directly with the fund.
- Convertible Arbitrage
- Convertible arbitrage buys convertible bonds and short-sells the underlying equity to isolate volatility, credit, and rate exposures. Returns depend on the difference between implied volatility in the convertible and realized volatility of the underlying.
D
- Distressed Debt
- Distressed debt investing targets debt securities of companies in or near bankruptcy. Pricing reflects expected recovery in workout; success depends on credit analysis, restructuring expertise, and ability to influence the bankruptcy process.
- Drawdown
- Drawdown is the peak-to-trough decline in portfolio value during a specified period. It is both a risk and behavioral measure: large drawdowns often trigger investor redemptions even when realized returns subsequently recover.
E
- Endowment Model
- The endowment model is a long-horizon institutional portfolio construction approach that emphasizes diversification across alternative assets, capture of the illiquidity premium, and selection of top-quartile active managers in inefficient markets.
- Event-Driven Strategy
- Event-driven hedge fund strategies profit from corporate events such as mergers, restructurings, spin-offs, and bankruptcies. Sub-strategies include merger arbitrage, distressed, special situations, and activist.
F
- Factor Investing
- Factor investing systematically targets specific risk factors (value, momentum, quality, low volatility, size) believed to earn premiums over time. It is implemented via rules-based strategies that span beta and alpha in a fee structure between passive and active.
G
- Global Macro
- Global macro is a hedge fund strategy that takes directional positions in currencies, rates, equities, and commodities based on top-down macroeconomic views. It includes both discretionary and systematic implementations.
H
- Hedge Fund Replication
- Hedge fund replication aims to deliver returns resembling hedge fund indices using systematic factor exposures or liquid futures-based positions. The goal is broad strategy exposure at materially lower cost than direct fund investment.
I
- The illiquidity premium is the extra expected return investors demand for holding illiquid assets relative to comparable liquid alternatives. It is a primary justification for institutional allocations to private equity, real estate, and infrastructure.
- Internal Rate of Return (IRR)
- IRR is the discount rate at which net present value of cash flows equals zero. It is the canonical return measure in private-market funds but is sensitive to timing and can be manipulated by capital-call line usage that delays LP funding.
- Information Ratio
- The information ratio is a portfolio's active return divided by its active risk. It measures the consistency of alpha generation relative to a benchmark.
L
- Liquidity Risk
- Liquidity risk is the risk that an investor cannot sell or rebalance positions on the desired timeline at fair value. It is a central consideration in allocation decisions for alternative investments and in stress testing.
- Long/Short Equity
- Long/short equity is a hedge fund strategy holding both long and short equity positions. It aims to capture alpha independent of market direction; net exposure may range from market-neutral to fully directional.
M
- Managed Futures
- Managed futures take systematic positions in futures markets across asset classes. The dominant style is trend-following, which earns crisis-alpha when persistent trends in commodities, currencies, and rates emerge.
- Master-Feeder Structure
- A master-feeder structure has multiple feeder funds investing into a single master fund. It aggregates capital while permitting different investor tax treatments (US taxable, US tax-exempt, non-US) under the same investment strategy.
- Merger Arbitrage
- Merger arbitrage is an event-driven strategy that buys the target and shorts the acquirer in announced deals. It captures the spread between current price and deal terms, accepting deal-break risk in exchange for high probability of close.
- Multi-Strategy Fund
- A multi-strategy fund allocates capital across multiple hedge fund strategies under one umbrella. It provides diversification and tactical capital reallocation within a single vehicle, typically with a single fee schedule.
O
- Operational Due Diligence (ODD)
- Operational due diligence assesses a fund's operational infrastructure, internal controls, valuation policies, and counterparty risk. It complements investment due diligence and addresses risks unrelated to investment strategy that can still produce loss.
P
- Public Market Equivalent (PME)
- Public market equivalent is a private-market performance measure that compares fund IRR or multiple to the return on a chosen public benchmark over the same cash-flow timing. It provides apples-to-apples comparison versus an index alternative.
R
- Reg D Offering
- Regulation D is the SEC exemption from registration most commonly used for hedge fund and private fund capital raises. Rule 506(b) allows up to 35 non-accredited investors with no general solicitation; Rule 506(c) allows general solicitation but requires verification of accredited status.
- Risk Parity
- Risk parity is a portfolio construction approach that equalizes risk contributions across asset classes rather than dollar weights. It typically overweights bonds (often levered) relative to a 60/40 baseline to balance equity and rate risks.
S
- Side Pocket
- A side pocket is a separate sub-account within a hedge fund holding illiquid investments. It is isolated from redemption and performance-fee calculations until realized, protecting other investors from being forced sellers and stale-pricing distortions.
T
- Total Value to Paid-In (TVPI)
- TVPI is the private-market multiple equal to total value (distributions plus residual NAV) divided by capital paid in. It is the canonical multiple-on-capital measure and complements IRR by providing a time-insensitive return summary.