47: Alts Flashcards
In a 2-and-20 hedge fund fee structure, the “2” refers to a hedge fund’s
2= management fee
20= incentive fee
Profits are distributed as each fund investment is sold and subsequently shared according to the partnership agreement
Profits distributed as fund exits each investment
deal-by-deal (American) waterfall structure for incentive fees
Refers to the way in which payments are allocated to GP and LPs as profits and losses are realized on deals
Waterfall
The limited partners receive all distributions until they have received 100% of their initial investment plus the hurdle rate
The GP does not earn an incentive fee until the LP have received their initial investment back
Whole-of-fund waterfall (European waterfall)
For hedge funds, management fees are calculated as:
a percentage of assets under management (AUM); net asset value of fund
Typically structured as a partnership
The typical trade used by a merger arbitrage fund is:
Short position of the acquirer
Long position in the firm being acquired;
Short the stock of the acquirer and buy the stock of the firm being acquired
Merger arbitrage, a type of Event driven hedge funds strategy;
Long based hedge fund strategy that involves long or short positions in common equity, preferred equity, or debt of a specific corporation
Event-driven hedge fund strategy:
* merger arbitrage
* distressed/restructuring
* special situations strategies
strategy involves seeking to profit from long and short positions in publicly traded equities and derivatives with equities as their underlying assets
Equity hedge;
not based on events such as restructuring or acquisition
a hedge fund charges an incentive fee on all profits, but only if the fund’s rate of return exceeds a stated benchmark.
Soft hurdle
hedge fund charges an incentive fee only on the portion of returns that exceed a stated benchmark
hard hurdle
A fund’s value must exceed its highest previous value (net of fees) before the fund may charge an incentive fee:
high water mark
Prevents GP from collecting incentive fees twice on investment gains
Prevents a GP from receiving incentive fees on incresas in investment value that do not increase its value above its previous high value
Convertible arbitrage is a strategy that involves buying a security and selling short a related security with the goal of profiting when a perceived pricing discrepancy between the two is resolved
Relative value hedge fund strategy
Also includes: asset backed fixed income, general fixed income, volatility, multi-strategy
The goal of adding hedge funds to a traditional portfolio is:
- increase expected return
- decrease variance; because returns on these investments are less than perfectly correlated with returns on traditional investments
Attempt to profit from short positions in equities they believe to be overvalued
Equity hedge fund strategies, with a short bias
strategy attempts to identify undervalued equities
Fundamental value- Equity hedge fund strategy
Investing in companies that are experiencing high growth and rapid earnings; and for which the fund managers anticipate significant capital appreciation
Fundamental growth- Equity hedge fund strategy
time after initial investment over which limited partners either:
* cannot request redemptions
* or incur significant fees or redemptions (soft)
Lockup period
The period following a redemption request, within which the fund must fulfill the request;
amount of time a fund has to fulfill a redemption request made after the lockup period has passed
Notice period
This stage of venture capital financing provides capital during the period prior to an initial public offering
mezzanine stage
This formative stage of venture capital investing, the capital is furnished for product development, marketing, and market research:
Seed stage
This formative stage of venture capital investing is when investment funds are used for:
* business plans
* assessing market potential
* product development
* marketing effort
Seed stage
This formative stage of venture capital financing refers to investments made to fund initial commercial production and sales
Early stage
The capital supplied, in this formative stage, is used to fund initial production & sales
Early stage
With deal by deal strucutre, requires the manager to return any periodic incentive fees to investors that would result in investors receiving less than 80% of the profits generated by portfolio investments as a whole
LPS may recover incentive fees if subsequent losses result in prior incentive fees exceeding agreed percentage of overall profits
clawback provision
in the formative stage, this funding is for the formation of the business
angel investing
When the company issues debt to fund a dividend distribution to equity holders (the fund)
A private equity firm that wants to receive money from a portfolio company without giving up control of the portfolio company is most likely to engage in:
Recapitalization
Private equity firm sells the portfolio company to a competitor or another strategic buyer
Trade sale; private equity firm is exiting an investment
Value of having the physical commodity for use over the period of the futures contract
convenience yield
If there is little or no convenience yield, the futures market for that commodity is:
in contango
Futures price > spot price
Convenience yield < Storage costs
If the convenience yield is high, the futures market for that commodity is:
in backwardation
Futures price < spot price
Convenience yield > Storage costs
Returns are smoother than those based on actual sales and have the lowest standard deviation of returns
appraisal index
Returns are based on property values
Because estimating values tends to introduce smoothing into returns data, appraisal index returns are likely to have lower standard deviations than index returns based on repeat sales or trading prices of REIT shares.
Funds that invest in specific commodity sectors such as oil and gas or precious metals are best described as
specialized commodity funds
Can provide a hedge against inflation:
Commodities & Natural Resources
Including a previous year’s performance when adding a new fund, in an index
Backfill bias
Survivorship bias and backfill bias cause an upward bias on:
Index Returns
Infrequent valuation of portfolio companies cause a downward bias on:
correlations & standard deviation (risk)
The Sharpe ratio is a less-than-ideal performance measure for alternative investments because:
Returns on alternatives are not normally distributed
(Sharpe ratio assumes normal distribution)
The IRR calculation involves the assumption of two rates:
Rate for outgoing cash flows: WACC: required rate of return on investment
Rate for incoming cash flows: reinvestment rate
The need to use a model for valuation arises when there is not reliable market values available on an asset because:
asset is so illiquid
Focus on the left side of the return distribution curve, where losses occur
Downside risk measures
models used to measure: Sortino & VaR
Macro stategy fund
Mostly involves leveraged buyouts of established, profitable, and cash generating companies
Private equity
Typically structured as a partnership
Returns are described in terms of the J-curve effect
The management fee is typically based on committed capital, not invested capital:
private equity funds
vs hedge funds who’s feed are based on AUM
Invests in other hedge funds, and incurs an additional layer of management & incentive fees:
Fund of Funds
Provides lower returns compared to directing investing in a hedge fund
Institutional investors typically begin investing in alternative investments via:
Pool assets with other investors
Fund investing
Limited partnership agreement
lower minimuim investment amounts
less investor involvement
pay management & incentive fees
benefit from the expertise of the fund manager (general partner)
A private equity firm that provides equity capital to a publicly traded company to finance the company’s restructuring, but does not take the company private:
Private Investment in Public Equity
Examples of:
Social infrastructure:
Utility infrastructure:
Communications infrastructure:
Health care
Waste treatment plants
Broadcasting towers
A hedge fund strategy that takes positions in shares of firms undergoing restructuring or acquisition is said to be pursuing:
Event driven strategy
Private equity funds use which water fall structure?
Whole of fund (European)
The GP does not earn an incentive fee until the LP have received their initial investment back
Making a direct investment in an asset that an investor also owns an interest in indirectly through a fund (invests through a fund):
Pool assets with other investors, but also invest directly alongside fund manager:
Co-investing
Reduced fees
Greater investor control
Requires greater involvement and expertise
Investing through a limited partnership:
Investing in a group of assets (real estate or private companies)
Provides greater diversification compared to direct investing
Gives investors more control over the selection of assets
Lower management fees
Investor purchases and manages the asset itself
Direct Investing
Control over decisions
Requires expertise
Less diversification
Avoids management fees charged in a limited partnership structure
Rate of return that must be exceeded before incentive fees are paid to the general partner:
Hurdle rate
Catch-up provisions favor:
General Partner
The limited partners get the first % hurdle rate gross return and the general partners get all returns above that rate to a maximum specified
The use of derivatives is typically a feature of:
hedge funds
Provides an investor with indirect equity exposure to real estate:
Real estate investment trusts (REITs)
Infrastructure asset with growth opportunities and returns that are expected to be lower:
Brownfield Assets
Lower risk compared to Greenfield assets
The Fund structure for fund investing includes:
General partners: fund managers
Limited partners: investors
Portfolio managers invest in one of two ways to achieve returns:
Alts are generally actively managed; however a portfolio manager may use passive management to provide exposure to certain alts asset classes
Passively: focus on index or asset coverage (real estate, commodities, infrasture)
Private equity strategy that includes:
* management buyouts
* management buy ins
Leveraged buyouts
* Management buyouts; Existing managers buyout the company
* Management buy-ins; replace exisiting managers with new managers
Real estate investment that is characterized by illiquidity:
Commerical property
Returns are only generated from price changes:
Commodities
(different from all other alternative investments)
Due to biases, hedge fund returns & risk are:
Returns: overstated
Risk: understated
