Free CAIA Level I Allocations to Alternative Investments Practice Questions

A 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.
Choice D is incorrect because fee layering refers to the stacking of fees, not fee negotiation. While FoF managers may negotiate fee discounts, fee layering itself is the additional cost layer.
Choice B is incorrect because fee layering is unrelated to fee waivers during drawdowns; it describes the structural double-fee arrangement.
Choice C is incorrect because fee layering is a structural characteristic of the FoF model, not a regulatory disclosure requirement.

C 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.
Choice B is incorrect because when all underlying managers are profitable, netting risk is not the concern; netting risk specifically involves the offset of gains and losses across funds while still paying performance fees on the winners.
Choice A is incorrect because netting risk relates to the asymmetric payment of incentive fees across underlying funds, not the FoF manager's own fee collection.
Choice D is incorrect because netting risk requires multiple underlying funds with divergent performance; a single-fund allocation cannot produce netting risk.

A 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.
Choice B is incorrect because fee drag would reduce both metrics relatively uniformly. A 3 percentage point difference between two return metrics is not explained by fees, which are embedded in both calculations.
Choice C is incorrect because while valuation differences can affect reported returns, both the pooled and commitment-weighted IRRs are calculated from the same underlying fund valuations and cash flows. Measurement methodology differences would not systematically create this divergence pattern.
Choice D is incorrect because currency hedging costs would affect both return metrics. They would reduce returns across the board rather than creating a specific divergence between pooled and commitment-weighted IRRs.