Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

What risk is associated with managed futures investing?

1. Capacity risk relates to a managed futures fund not having enough cash to invest.

2. Transparency risk occurs because obtaining prices for managed futures is difficult.

3. Liquidity risk exists when a large fund has an influence on a thinly traded market.

4. Lack of trends risk is a bigger concern in less volatile markets.

The correct answer is: Liquidity risk exists when a large fund has an influence on a thinly traded market.

Liquidity risk is a significant concern when it comes to managed futures investing, particularly in an environment where the underlying markets are thinly traded. Managed futures strategies often involve taking positions in various futures contracts, and if a large fund or trader needs to execute substantial transactions, it can significantly impact market prices. In less liquid markets, even modest orders can cause large price swings, leading to unfavorable execution prices for the trade. This can be problematic for managers trying to execute strategies efficiently, especially during times of market stress when liquidity may dry up further. Investors need to be cognizant of how large inflows or outflows from managed futures funds can exacerbate liquidity issues in the underlying assets. As a result, liquidity risk is not only a concern for individual trades but can also affect overall fund performance and strategy execution. The other possible risks mentioned, while valid in other contexts, do not capture the essence of the operational challenges that can arise from market conditions specific to managed futures.