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12.2 Alternative Strategies, Performance Measurement & Due Diligence
Canadian Securities Course CSC
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1 Introduction & Exam Overview
About the CSC Exams
2 Chapter 1: The Canadian Investment Marketplace
1.1 The Canadian Securities Industry & the Investment Dealer's Role 1.2 Financial Intermediaries: Banks, Trusts, Credit Unions, Insurers & Pension Funds 1.3 Financial Market Trends 1.4 Investment Capital, Financial Instruments & Financial Markets 1.5 Canadian Exchanges, ATSs, Dark Pools & the Order Protection Rule 1.6 Canadian Securities Regulators, the CSA & CIRO 1.7 Investor Protection: OSFI, CIPF and CDIC 1.8 Ethics, Standards of Conduct & the Client Focused Reforms 1.9 Conflicts of Interest, Complaint Handling & Remediation
3 Chapter 2: The Economy
2.1 Economics Foundations & Measuring Economic Growth 2.2 The Business Cycle & Economic Indicators 2.3 Inflation & Interest Rates 2.4 The Labour Market & Unemployment 2.5 The Bank of Canada & the Inflation-Control Target 2.6 Implementing Monetary Policy: The Operating Band, Market Operations & Transmission 2.7 Fiscal Policy, Deficits & the Challenges of Government Policy 2.8 International Finance & Trade: The Balance of Payments and the Canadian Dollar
4 Chapter 3: Features and Types of Fixed-Income Securities
3.1 The Fixed-Income Marketplace, Bond Terminology & Security 3.2 Protective Covenants, Retirement Provisions & Extendible/Retractable Features 3.3 Government of Canada Securities: T-Bills, Marketable Bonds & RRBs 3.4 Provincial & Municipal Debt and Strip Bonds 3.5 Corporate Bonds, Credit Spreads & Bond Ratings 3.6 Money Market Instruments, Floating-Rate Notes & International Bonds 3.7 Other Fixed-Income Securities & Reading Bond Quotes
5 Chapter 4: Pricing and Trading of Fixed-Income Securities
4.1 Bond Pricing, Price–Yield Relationships & Accrued Interest 4.2 Yield Calculations & Return Measures 4.3 The Term Structure of Interest Rates & Yield Curve Theories 4.4 Fundamental Bond Pricing Properties: Volatility Rules, Duration & Convexity 4.5 Bond Market Trading & Bond Indexes
6 Chapter 5: Common and Preferred Shares
5.1 Common Shares: Ownership Rights, Voting & Restricted Shares 5.2 Dividends, DRIPs, Stock Splits & Consolidations 5.3 Preferred Shares: Features, Cumulative Dividends & Taxation 5.4 Preferred Share Variations: Convertible, Callable, Retractable, Floating & Rate-Reset 5.5 Fundamental Equity Metrics & Ratios 5.6 Stock Indexes & Averages
7 Chapter 6: Equity Transactions
6.1 Order Types, Execution & Market Mechanics 6.2 Margin Trading: Long Accounts & Borrowing 6.3 Short Selling & Short-Margin Requirements 6.4 Trading & Settlement Procedures: T+1, CDS & Confirmations
8 Chapter 7: Derivatives
7.1 Derivatives: Role, Underlying Assets & Users 7.2 Options Fundamentals: Calls, Puts & Moneyness 7.3 Option Strategies & Risk Management 7.4 Forward & Futures Contracts 7.5 Rights & Warrants
9 Chapter 8: Corporations and their Financial Statements
8.1 Corporate Structures & Corporate Governance 8.2 The Annual Report, Accounting Standards & the Auditor's Report 8.3 The Balance Sheet & Income Statement 8.4 The Cash Flow Statement & Earnings Quality 8.5 Public Company Disclosure, Investor Rights, Take-Over Bids & Insider Trading
10 Chapter 9: Financing and Listing Securities
9.1 Government & Corporate Financing: Underwriting and Syndicates 9.2 The Prospectus Process, Stabilization & Purchaser Rights 9.3 The Exempt Market & Private Placements 9.4 The Listing Process: TSX, TSXV & Capital Pool Companies 9.5 Continuous Disclosure, Material Changes & Insider Reporting
11 Chapter 10: Investment Analysis
10.1 Methods of Equity Analysis & Macroeconomic Analysis 10.2 Fundamental Industry Analysis 10.3 Company Analysis: Competitive Advantages, Governance & the Dividend Discount Model 10.4 Discounted Cash Flow & Relative Valuation Multiples 10.5 Financial Statement Ratio Analysis 10.6 Assessing Preferred Share Investment Quality 10.7 Technical Analysis: Charts, Trends & Patterns 10.8 Technical Indicators, Volume, Breadth & Sentiment
12 Chapter 11: Portfolio Analysis
11.1 Measuring Investment Return 11.2 Measuring Risk: Types of Risk, Standard Deviation & Downside Measures 11.3 Portfolio Risk & Return: Correlation and Diversification 11.4 Beta, the Capital Asset Pricing Model & the Security Market Line 11.5 Portfolio Manager Styles: Equity & Fixed Income 11.6 The Portfolio Management Process: Objectives, Constraints & the IPS 11.7 Asset Mix, Monitoring, Performance Evaluation & Rebalancing
13 Chapter 12: Alternative Investments, Other Managed, and Structured Products
12.1 Alternative Investments: Structures, Fees & Liquid Alternatives 12.2 Alternative Strategies, Performance Measurement & Due Diligence 12.3 Segregated Funds, Labour-Sponsored Funds & Listed Private Equity 12.4 Income Trusts, REITs & Closed-End Funds 12.5 Structured Products: PPNs & Market-Linked GICs 12.6 Split Shares & Asset-Backed Securities
14 Chapter 13: Mutual Funds
13.1 Managed Products & Mutual Fund Structure 13.2 Pricing Mutual Fund Units: NAVPS & Forward Pricing 13.3 Mutual Fund Fees, Sales Charges & Unit Series 13.4 Mutual Fund Regulation, Fund Facts & Account Opening 13.5 Types of Mutual Funds & Fund Management Styles 13.6 Redemptions, Withdrawal Plans & Measuring Fund Performance
15 Chapter 14: Exchange-Traded Funds (ETFs)
14.1 ETF Origins, Structure, Tax Efficiency & ETF Facts 14.2 ETF Creation, Redemption & Arbitrage 14.3 Types of ETFs & Advanced Strategies 14.4 Comparing ETFs, Mutual Funds & Individual Securities
16 Chapter 15: Working with the Institutional Client
15.1 The Institutional Marketplace & Institutional Clients 15.2 Institutional Investment Guidelines, Styles & Restrictions 15.3 Buy Side & Sell Side: Trading Desks, Revenue, Clearing & Best Execution 15.4 Block Trading, Dark Pools & Algorithmic Trading
17 Chapter 16: Fee-Based Accounts and Working with the Retail Client
16.1 Fee-Based Accounts: Managed & Non-Managed Models 16.2 Fee Transparency, CRM2 & Total Cost Reporting, and MWRR vs. TWRR 16.3 The Financial Planning Approach & the Life Cycle 16.4 Behavioral Finance, Sequence-of-Returns Risk & Client Coaching 16.5 Estate Planning Basics
18 Chapter 17: Canadian Taxation
17.1 The Canadian Taxation System 17.2 Taxation of Investment Income 17.3 Capital Gains, Losses & The Superficial Loss Rule 17.4 Registered vs Non-Registered Tax-Advantaged Accounts 17.5 Tax Planning Strategies, Pension Plans & the RDSP
12.2 Alternative Strategies, Performance Measurement & Due Diligence
Key Takeaways Explain This Topic AI
Equity long/short funds vary their net exposure; market-neutral funds aim for near-zero beta.
Merger arbitrage buys the target and, in share deals, shorts the acquirer; its main risk is deal failure.
Hedge fund indexes overstate typical results because of survivorship and backfill bias.
Due diligence covers the strategy, manager, operations, terms and client fit; suitability rules apply even to liquid alternatives.
Last updated: October 2026
Alternative investments are defined less by what they own than by the strategies they use. This section explains the main hedge fund strategy families, how alternative strategy performance is measured, and the due diligence and suitability work an advisor must do before recommending these products.
1. Core Alternative Investment Strategies
Hedge funds deploy diverse strategic playbooks designed to harvest idiosyncratic alpha or exploit specific structural anomalies. The five dominant classifications are detailed below:
Strategy Classification Primary Objective Long/Short Characteristics Primary Risk Factors
Equity Long/Short Outperform equity markets with lower volatility and drawdowns Maintains variable net long exposure (e.g., 30%–70% net long) Stock selection risk, factor crowding, directional market risk
Market Neutral Generate steady absolute returns independent of market direction Zero net beta ( β ≈ 0 \beta \approx 0 β ≈ 0 ) and near-zero net dollar exposure Model risk, short squeeze, breakdown in historical correlations
Event-Driven Capitalize on corporate transactions (mergers, restructurings, spinoffs) Long target companies; short acquirers (in merger arbitrage) Deal termination (antitrust, regulatory, financing failure)
Relative Value Arbitrage Exploit temporary mispricings between mathematically related securities Pairs long undervalued security against short overvalued security Liquidity crunch, extreme spread divergence, high leverage risk
Global Macro Profit from macroeconomic shifts across currencies, rates, commodities Directional long/short bets across sovereign debt, FX, equity indexes Geopolitical shocks, macroeconomic forecasting error, timing risk
1. Equity Long/Short
The most widely deployed hedge fund strategy. The manager conducts rigorous fundamental research to identify undervalued equities to purchase (long positions) while simultaneously shorting overvalued or structurally impaired companies.
Gross Exposure: Sum of long positions plus absolute value of short positions divided by capital: Gross Exposure = Long Value + ∣ Short Value ∣ Fund NAV \text{Gross Exposure} = \frac{\text{Long Value} + |\text{Short Value}|}{\text{Fund NAV}} Gross Exposure = Fund NAV Long Value + ∣ Short Value ∣
Net Exposure: Difference between long positions and short positions divided by capital: Net Exposure = Long Value − ∣ Short Value ∣ Fund NAV \text{Net Exposure} = \frac{\text{Long Value} - |\text{Short Value}|}{\text{Fund NAV}} Net Exposure = Fund NAV Long Value − ∣ Short Value ∣
Example: A fund holding 90% long equity and 40% short equity possesses 130% gross exposure and a 50% net long exposure, reducing overall market sensitivity by half relative to a benchmark index.
2. Market Neutral
Market-neutral funds seek complete insulation from broader market direction. By matching long and short positions within the same industry sector, market capitalization tier, and beta profile, the manager targets a portfolio beta of zero ( β ≈ 0 \beta \approx 0 β ≈ 0 ). Returns depend exclusively on stock-picking acumen (alpha), exhibiting near-zero correlation to the S&P/TSX Composite or S&P 500.
3. Event-Driven Strategies
Event-driven strategies exploit pricing discrepancies caused by major corporate catalysts:
Merger Arbitrage (Risk Arbitrage): When Company A announces an agreement to acquire Company B for $50.00 cash per share, Company B's stock typically rises from its pre-announcement price of $40.00 to $48.00. The $2.00 gap reflects the risk that the deal may fail to close. The arbitrageur buys Company B at $48.00, capturing the $2.00 spread when the acquisition completes. In share-for-share mergers, the manager buys the target stock and shorts the acquiring company's stock according to the negotiated exchange ratio. The primary risk is deal failure (e.g., rejection by the Competition Bureau, regulatory intervention, or shareholder veto), which causes the target stock to collapse back toward its pre-announcement level.
Distressed Securities: Investing in senior secured debt or subordinated bonds of corporations undergoing formal bankruptcy restructuring or reorganization under the Companies' Creditors Arrangement Act (CCAA) in Canada. Managers buy debt at deep discounts (e.g., 25 to 40 cents on the dollar), aiming to convert debt into controlling equity upon restructuring.
4. Relative Value Arbitrage
Exploiting temporary pricing discrepancies between closely related financial instruments that have a known mathematical relationship:
Convertible Arbitrage: Purchasing an undervalued convertible bond while simultaneously shorting the underlying common stock to hedge equity risk. The manager monetizes the embedded option's cheap implied volatility and collects coupon income.
Fixed-Income Arbitrage: Exploiting transient pricing dislocations along the Government of Canada yield curve, such as anomalies between on-the-run (newly issued) and off-the-run (seasoned) sovereign bonds.
5. Global Macro
Global macro managers adopt a top-down perspective, analyzing macroeconomic data, central bank interest rate policies, currency valuations, inflation trajectories, and geopolitical developments. They take large directional positions—often heavily leveraged via futures, forwards, and swaps—in sovereign bond markets, foreign exchange crosses, commodity futures, and national equity indexes.
Measuring Alternative Strategy Performance
Standard measures need care when applied to alternatives:
Absolute-return targets. Many strategies aim for positive returns in all markets, so comparing them with a stock index can mislead. Managers often state a cash-plus or inflation-plus target.
Risk-adjusted measures. The Sharpe ratio is common, but it can flatter strategies with infrequent, severe losses. The Sortino ratio (excess return ÷ downside deviation) and maximum drawdown show downside risk more directly.
Index biases. Hedge fund indexes depend on voluntary reporting, so they suffer from survivorship bias (failed funds drop out) and backfill bias (funds add good past results when they start reporting).
Smoothed prices. Illiquid holdings priced by models make returns look less volatile than they really are.
Due Diligence and Suitability
Before recommending an alternative strategy, an advisor should examine:
Area Questions to ask
Strategy What drives returns? How does it behave in crises? How much leverage, shorting and concentration does it use?
Manager What is the team's experience, track record and alignment (do they invest their own money)?
Operations Who are the custodian, administrator and auditor? How are illiquid assets valued?
Terms Fees, high-water mark, hurdle, lock-ups, redemption notice, gates
Fit Does the product meet the client's objectives, risk profile, liquidity needs and investment knowledge?
Under the Client Focused Reforms, the firm must understand the product (KYP) and the representative must judge it suitable and in the client's interest. Liquid alternatives are available to retail investors, but their leverage and complexity still require careful suitability analysis.