13-25 Alternative Investments Flashcards
8 due diligence checkpoints
- assess market opportunity
- assess investment process
- asses organization
- assess the people
- assess terms and structure of investment (fee structure, lock out period, exit strategy, etc)
- assess service providers (lawyers, brokers, etc)
- review documents
- write-up
4 common features of alternative investments
- high due diligence costs due to lack of transparency and difficulty of getting information
- difficult performance evaluation - lack of transparency and proper benchmarks
- low liquidity - associated with liquidity premium and higher returns - need to consider suitability for investor
- diversification - low correlation with stocks and bonds
- access to special investment strategies (HF and VCs) and unique asset classes (distressed securities) with high return potential
5 common issues for private wealth clients
- taxes
- suitability
- communication
- decision risk
- concentrated positions
advantage and disadvantage to direct equity real estate investing
advantage
- many expenses are tax deductible
- ability to use more leverage than most other investments
- direct control of properties
- ability to diversify geographically
- lower volatility of returns than stocks even after correcting for smoothing
disadvantages
- lack of divisibility so each investment is huge part of portfolio
- high information costs
- high commissions
- high operating and maintenance cost (hands-on management)
- special geographical risks like neighborhood deterioration
- political risks like changing tax codes
6 differences between NAREIT and NCREIF
NCREIF is benchmark for direct investments while NAREIT is benchmark for exchange traded REITs
NCRIEF
- source of valuation is individual real estate properties
- smoothing of risk data - understatements of actual volatility
- value-weighted index
- index returns are not deducted for investment advisory fees bc passthrough
- low to negative correlation with broad equity market
- no leverage of underlying assets (doesn’t matter how money was created to invest)
NAREIT
- source of valuation is share prices of REITs traded on exchange
- prices are more current due to frequent trading
- cap-weighted index
- index returns are after deducting investment advisory fees (layer of fees go to REITs)
- returns of REITs are more correlated with equity (less of a diversification)
- yes leverage of underlying assets (REITs are using borrowed money from SHs to invest and manage real estate companies)
5 hedge fund benchmark selection issues
- relevance of past data is questionable (frequent change in composition)
- popularity bias (value-weighted index impacted by huge asset inflow)
- survivorship bias
- stale price bias (illiquid assets lead to understated standard dev and overstated risk-adj returns)
- backfill or inclusion bias
9 hedge fund strategies
Explain
- convertible arbitrage
- equity market neutral
- fund of funds
- distressed securities
- merger arbitrage or deal arbitrage
- global macro
- fixed-income arbitrage
- hedge equity strategies
- emerging markets
5 hedge funds strategies
- relative value (exploit relative mispricings)
- event-driven (S-T like merger arb or distressed securities)
- equity-hedge
- global asset allocators
- short selling
limitation of sharpe ratio in hedge fund performance evaluation
- time dependency: annualized sharpe ratios are biased upwards by a factor of square of time
- assumes normality
- assumes liquidity
- assumes uncorrelated returns
- stand-alone measure: doesn’t consider diversification effects
4 risks associated with distressed securities
- event risk
- market liquidity risk
- market risk
- J-factor risk
3 types of distressed securities investing strategies
1 long-only value investing - high yield (publicly traded below-inv grade debt), orphan equities (emerging from reorganization) - qualified investors willing to do due diligence and bet on rising value will invest
2 distressed debt arbitrage - buy distressed debt while shorting company’s equity (earns return whether company value rises or falls due to seniority of bonds over equity)
3 private equity - buy enough ownership in undervalued distressed company to exert some control and improve value
