6. PROPERTY + ALTS

Question 1

advantages and disadv of property investment

Answer 1

ADV
- historically attractive absolute returns
-diversification (low corr to trad investments)

DISADV
- liquidity
- lumpy returns
-transaction and maintenance costs
-effect of gearing
-correlation with economic prosperity
- risk of void periods

Question 2

Methods of getting property exposure in portfolio

Answer 2

• Direct - physically owning properties (stamp duty, insurance, estate agents etc)
• listed property companies

Funds (lock in periods)
- Unit trusts
-PAIFs
-ETFs
-REITS
-Limited partnerships

Question 3

DISADV of property funds

Answer 3

asset price bubbles

relative liquidity of listed vehicles vs funds

permitted levels of gearing

redemption charges and notice periods

Question 4

directly invested open ended property vs REITS

Answer 4

Open ended
- GFC caused significant losses in value for investors
- Post BREXIT vote 2016 - many open ended funds suspended
-mismatch between liquidity of open ended fund with illiquidity of underlying

REITS
- closed ended w/ fixed no. of shares traded between investors - so UL doesnt have to be sold to fund redemptions

Indirectly invested open ended funds invest in real estate secs on stock exchange

Question 5

4 main types of real estate fund

Answer 5

Core = low risk low return. Similar to benchmark. Usually open ended so may be hard to redeem when market is stressed

Core plus= low.moderate risk. High qual properties (like core). but with 40-60% leverage

Value add funds = growth, more gearing (60-75), and more active management. Higher returns

Opportunistic funds = exploit ops to buy from distressed sellers, redevs + EM. Similar in nature to PE. usually closed ended

Question 6

authorized property unit trusts vs unauth

Answer 6

Authorized (by FCA) designed mainly for retail, unauth only allowed to be offered to instit

AUTH
- exempt from CGT on gains
- income liable to corp tax (currently) 25%
-designed for UK domestic market, unfavourable tax treatment makes them unsuit for overseas investors

Offshore prop unit trusts
- more tax effective
-less heavily regulated
-not liable to income tax or CGT, end investor is taxed according to end position
-weaker level of investor protection in terms of gov/compensation

Question 7

IA property classifications

Answer 7

UK direct property
- 70% assets invested directly in UK prop (avg 5yr rolling)
- if <70% for >12m period, or below 60% or 1 month = can be removed from sector

Property other
- invest predominantly in prop but dont meet criteria of UK property direct. EITHER
- >70% in property over 5 year periods (either mostly overseas or dips below 60)
-invest 80% of assets in property securities
- invest 80% of assets in combo or direct and property secs

allows like for like comparison

Question 8

UK PAIF

Answer 8

UK property auth unit trusts
- since 2010, many open ended prop auth unit trusts converted to PAIF structure
= tax efficient, open ended, auth fund

-retail, sophis and instit clients UK and globally

• OEIC structure
  -Must carry out property rental bis that generates income from land/share ownership (UK or foreign equiv)
• UK tax purposer = must separate income into 3 stream (UK prop income, interest income, other income)
  -must take steps to avoid corp ownership >10% NAV

With PAIF status (given by HMRC) - property investment income is tax exempt, also CGT exempt

income distro subject to 20% witholding tax

tax charges for PAIFs with excessive debt, pay distros from exempt income to any comp holding >10% of shares

Question 9

Property ETFs

Answer 9

Track perf of range of real estate indices

FTSE EPRA Nareit UK/ Europe/Asia Pac/Global/Dev/Emerging

EPRA = European Public RE Association

Nareit = National association of real estate investment trusts

ETFs give prop exposure via REITs and shares of prop companies

Question 10

REIT

Answer 10

REAL ESTATE INV TRUST

closed ended

Company that owns and operates income producing real estate (can be commercial or resi)

differs from quoted comp that holds a portfolio of preoperty because it isnt liable to tax on income/gains made in portfolio
- distributed income with tax liability of SH

No CGT on disposals so long as they distribute 90% of taxable income to SH as divi

SH is liable to CGT on REIT

Investment trust (liquid, easy to trade, prem/discount)

Question 11

Limited partnerships

Answer 11

Unlisted property vehicle
Complex structure = general partner who is lead investor with unlimited liability
Any number of limited partners with limited liability

Key features
- income/gains taxed on partners (investors)
-usually established for limited no. of years then assets disposed of and procedds distributed (unless partners vote to expand life)
- general partner appoints operators to oversee admin
-limited partners not involved in decision making or lose limited liability
-Jersey and Guernsey are home for many limited partnership property funds

Question 12

Characteristics of infra funds

Answer 12

• large physical assets (often essential services/facilities)
• long duration
• diversification = uncorrelated returns
  -stable and predictable cash flows
• high barriers to entry
  -regulated assets (water, electricity) = essential services, lower risk
  -unregulated (schools, hospitals) = social infra, prices based on negatations

Question 13

lumpiness/indivisibility of returns in infra

Answer 13

Lumpy inputs = large financial outlay (e..g building a runway) and lumpy returns on asset sales

Smooths with portfolio of operational assets with income streams

diversification by geog, asset class, etc

Question 14

return characteristics of infra funds

Answer 14

Typically less cyclical/have inverse correlation with other asset classes
- useful diversification
-many have highly contracted inflation linked revenue so useful to diversify against inflation shock
-stable CF through cycle
- derated recently as many increased yields make them relatively less attractive vs government bonds

-early stage projects offer higher return profiles but are riskier as they are exposed to more vol (economic cycle, wage inflation, inflation in supply chain)

Question 15

What is a commodity

Answer 15

a raw material or primary agricultural product that can be bought and sold = relatively homogenous allowing standardized contracts

Question 16

Direct Commodity Investment

Answer 16

Cash market (physical purchase)
- expensive to store and insure
-large min quantities
-risk of deterioration (especially for softs)
-standard contract size with gradings to specify quality
-gives fungibility to wholesale market
-more for whole/industry than investors

FUTURES MARKET
- contract to buy/sell set quant of asset on fixed future date @ price agreed today
- delivery is deferred
- no need to take delivery
-standardised parcels (contracts) e.g. 25 tonnes of copper
- must trade in whole numbers of contract (limitation that favours OTC swaps)
-homogenous specified asset

FORWARDS/SWAPS
- forward = private customisable, OTC
-commodity swap (floating commodity price vs fixed) = used to hedge against swings in market and lock in price

Question 17

Indirect commodity investment

Answer 17

Shares of commodity comps
- e.g. miners/oil producers, revenues and therefore share price linked to commodity price
-correlation not perfect as there are many other factors + hedging costs

Commodity funds
- hedge against inflation, more cap growth focused>income
-retail UCITS cant invest in commodities, but nonretail and QIS can (UCITS can use derivs to invest in commodity index)
- commodity ETF = provide exposure to commodities/basket by buying UL commodities/futures/shares in comps
-ETCs typically track a single commodity, share price moves with spot/futures price of UL

Question 18

Commodity categories

Answer 18

HARD
- metals and energy =most common
- natural resource that must be mined/extracted

SOFT
-agricultural prods or livestock

Question 19

Hard commodities -metals

Answer 19

• include natural resources that must be mined or extracted

BASE
- AKA industrial (Copper, lead, tin,nickel, steel etc)
- big expense to extract from ground + then to refine
- Demand is taken as indicator for global economic demand
- energy transition goals likely to see demand increase

PRECIOUS
- gold, silver, platinum, palladium
-gold is a traditional hedge against inflation acting as a store of value + benefitting from flight to safety

Prices are influenced by supply and demand
-avail of raw mats, costs of extraction and processing
-demand (Rapidly industrializing economies, hedge funds buying futures)

Question 20

Energy

Answer 20

Principally traded through crude oil and derivs (gasoline + other fractions - butanes, kerosene)

2 main benchmarks
- Brent Crude (North sea extraction, most important for europe, trades on ICE)
- WTI (lighter crude oil, primarily sourced in US, traded on NYMEX)

Oil = usually largest component of commodity indies due to volume required globally

priced in USD (moves inversely to USD over medium term)

Demand for oil driven by consumption generally (WTI price went neg for 1st time during COVID, fears storage capacity would run out)

OPEC = coordinates and unifies petroleum policies of member states. Recently have prolonged supply cuts to support price

Question 21

SOFT commodities

Answer 21

Agricultural prods with varied uses

textiles (e.g. wool.cotton)
foodstuffs (sugar, wheat, rice, coffee)
Livestock (pigs, cattle)

Softs have the characteristic of being renewable, usually on an annual cycle. Crops can be grown season after season

Many are perishable (both before and after harvest) which can make prices v volatile

supply factors
- good/poor harvests
-livestock diseases
-weather
-political unrest
-climate events

Question 22

Hedge funds

Answer 22

HF = broad with no specific definition
wide range of strats
most aim to deliver positive abs returns - often with cash + benchmarks
traditionally earn high fees often with a performance fee
often managers take high risk high return view
diversifier from traditional markets
often domiciled in juris with favourable tax + low disclosure reqs

Regulators are increasingly introducing short selling regs after the 2021 game stop led market vol
- in UK funds must report net shorts in shares or sovereign debt once limits have been breached

Naked shorting is banned in the UK (and most other places)

Question 23

Hedge fund strats

Answer 23

Non directional and Event driven)

Non direction
-relative value
- FI arb
-market neutral
-convertible arb
-stat arb
- vol arb

Event driven
-special sits
-merger arb
-distressed comps

Directional
- long/short
-short only
-EM
-Global macro
-systematic

Many HF employ multi strat, multi manager approaches with various sleeves for different strategies

Question 24

Non directional HF strats

Answer 24

Non directional = stable, positive absolute returns regardless of market
- must remove market risk to isolate funds from market

RV
- exploits temp differences in prices of related secs, often with pairs trading (long/short)
-mean reversion on spread on between 2 assets

FI arb
- exploit inefficiencies in rates, yield curves, pricing of bonds, corp spreads, swaps
-relies on stats and mathematical models
- exploit expected changes in yield curves

Equity market neutral
- provides returns uncorrelated to market with combo of L/S positions and management of B to be zero or negligible - also uses arb
-often has more directional risk than they are supposed to as correlations of pairs trading can be unstable

Convertible arb
- aims to capitalise on mispricing between convertible bond an underlying stock
-typically long bond and short stock

Statistical arbitrage
-any strat that uses stat/econometrics tech to provide signals for trade execution
-predicated on mean reversion
-algo trading

Volatility Arbitrage
- profit from difference between forecast volatility of asset and implied vol of options on that asset
- if u think implied vol of UL (based on option) is too low, long call + short UL
- v complex, investor must be correct on assessment of vol, and timescale

Question 25

Event driven hedge fund strategies

Answer 25

Aim to take adv of temp stock mispricings before/after corporate events

Special sits
- target profit from change in val as result of corp action/takeover/spin off/bankprupty, generally not LT

Merger Arb
- profit from spreads in announced or suspected M&A/takeovers
- typically buy target and sell acquirer
- risk if deals fall through

Distressed securities
-e.g. corp bonds, bank debt, stock of distressed comps (heading to bankruptcy)
- debt secs are substantially reduced in value when company is in distress -HF assessing that comp not in as difficult position as market thinks

Question 26

Directional HF strats

Answer 26

Aim to profit from directional moves in the market - speculating on absolute value of secs

Long/Short Equities
- identify mispricings vs internal val models (fundamental and technical analysis)
- differ from non-directional as typically take net market direction risk
-tends to outperform in bear markets and underperform rising markets

Short only
-rare as many switched to L/S, focused on finding overvalued stocks
-can be a portfolio hedge in bear markets

EM
- come into fray due to massive growth of EM markets

Private placements
- strategies that focus on secs issued without public offering or propsectus publication

Question 27

Tactical trading

Answer 27

Global macro
- trategy that bases its holdings primarily on the overall economic and political views of various countries or their macroeconomic principles
- cross asset class, can be long and short

Systematic
- use mathematic models and algos to evaluate markets, detect trading ops and generate signals and investment decisions
- trend following
- often ‘black box’ proprietary methods

Question 28

Adv and disadv of HF fund of dunds

Answer 28

FOF - fund that invests in selection of HF

ADV
- diversification
-easy access to HF for retail investors
- may be able to access closed funds
-PM does more HF DD

DISADV
- double layer of fees
- less visbility of UL investments
- low possibility of manager interaction
- diversification of strategies can be counterproductive

Antidote to FOF funds is multi manager discretionary sleeve strategy

Question 29

VCTs

Answer 29

Publicly listed comps in UK similar to IT - invests in new and young businesses with potential for rapid growth
- closed ended
-trades on LSE

Tax relief (must apply to HMRC to be a VCT

INCOME TAX
-30% up to max subscription of 200k
-must be held for 5 years
-must be newly issued shares
-cant be carried back

INCOME TAX RELIEF ON DIVI
-VCT itself is exempt from corp tax
-divis are exempt from

CGT RELIEF
-exempt with no min holding period
-losses cant be used to offset gains

Higher returns and highe risk
UL often illiquid as unlisted
SMID risk (failure, write down, IR sensitivity)
prem/discount to NAV

Question 30

EIS

Answer 30

Direct investment into small/med unquoted comps in UK
<250 employees
<15mn gross assets
<£5mn annual amount raised per comp

INCOME TAX
- 30% up to max contribution of 1mn (further 1mn for knowledge intensive companies)
- can be carried back to previous tax year unliek VCTs

CGT GAIN RELIEF- no CGT if held for 3 years (pre 2000, 5 yrs)

CGT LOSS RELIEF
-losses are allowable where IT or CGT relief has been given

CGT DEFERRAL
- CGT can be deferred by reinvesting gain into EIS company (1yr before to 3yrs after disposal)
-deferred gain is charged when EIS shares are disposed of

IHT Business Relief
- qualify for bis relief if owned for 2 years

tax breaks only avail for UK residents

Question 31

SEIS

Answer 31

Similar to EIS - designed to stimulate entrepreneurship (smaller, riskier, earlier stage)

Must be <2 yrs old, <25 employees, assets <200k, not controlled by other comps
Cannot raise >150k total in SEIS

INCOME TAX RELIEF
- 50% up to 100k contribution pre year
- can be carried back
- must hold for 3 years+

CGT DEFERRAL
- same as EIS, CGT deferred by investing -1yr to 3 years post disposal

CGT LOSS RELIEF
-Losses allowable when either IT or CGT relief provided

IHT BR
- same as EIS - 2yr holding 100% BR

tax breaks for UK resi only, must have <30% stake in company

Can follow share issue with SEIS with EIS/VCT but must have spent >70% of money

Question 32

2017 budgets risk to capital condition

Answer 32

Some argue VCTs/EIS etc are more about tax relief than addressing LT barriers to finance for high growth/innovative firms

Risk 2 capital condition = principles based test to ensure VCT,EIS,SEIS only invest in businesses that arent simply low risk tax shelters but focus on growth ops

Question 33

Patient capital

Answer 33

2018Long term investments often into early stage enterprises

focus on LT gains over ST

provide support to entrepreneurs

Intitally 2.5bn fund with British business bank
then additional 30bn announced during covid to ensure firms could continue to access capital

Question 34

Woodlands relief

Answer 34

Relates to forestry and woodlands devoted to growing timber - IHT can be deferred until timber is cut and sold

Value of timber (not land) can be excluded from estate when someone dies

BR may be available on woodland that qualifies as a business asset