Accessing Alternative Investments Flashcards
Alternative betas
exposures to risk, risk premiums, and sources of returns not normally available through investments in traditional assets
Algorithmic replication approach
Bottom-up approach that tries to replicate trading approaches taken by most active managers within a particular strategy
Three theories/hypothesis for increased beta and decreased alpha in hedge fund returns
Fund bubble hypothesis, capacity constraint hypothesis, increased allocation to active funds hypothesis
Fund bubble hypothesis
bubbles caused by inferior managers entering a successful market diluting overall performance
Capacity constraint hypothesis
Most alpha is a zero-sum game and an increased supply of managers dilutes superior performance
Increased allocation to active hedge funds hypothesis
As hedge funds investments become more popular, the risk- adjusted performance of hedge funds will be adversely affected by the trading decisions of investors who have allocations to both hedge funds and traditional assets.
Eight potential benefits from hedge fund replication
- Liquidity
- Transparency
- Flexibility
- Lower fees
- Hedging
- Lower DD/Monitoring costs
- Diversification
- Benchmarking
Four primary issues in constructing a factor-based replication product
- Choice of benchmark
- Choice of factors
- Length of estimation period
- Number of factors
Three steps to factor-based replication
- Estimate weight of risky assets
- Estimate weight of cash
- Invest in different assets
Key concepts regarding factor-based replication
View commonality - Individual hedge funds in an index tend to cluster into common themes that drive overall performance of an index
Exposure inertia - Overall exposures change slowly over time
Three main observations regarding systematic and total risk for hedge funds
- Individual HF have 1/3rd the systematic risk of equities and 1/2nd total risk.
- Average HF returns exhibit 1/3rd the total risk of equity indices.
- Average HF returns exhibit 1/6th systematic risk of equity indices
Three approaches to access hedge funds
- Direct approach
- Delegated approach
- Indexed approached
Advantages of using the Direct Approach to access hedge funds
- Cost savings
- Cost effective
- Improved control & transparency in asset allocation and DD process
Bifurcated Fund Analysis Model
A model to help determine whether a manager is attractive from (1) a mean variance perspective and (2) rankings from flexible peer group scoring method
Four types of Fund of Hedge Funds
- Diversified (30-50 managers with low correlations)
- Concentrated (5-10 managers)
- Single-strategy (5-15 managers with same theme)
- Tactical (5-10 managers with exposure to same factors)
Types of open-ended real estate funds
Open-ended (allow investments and redemptions)
Property Unit Trusts (used in the UK, Authorized PUTs allow retail investors and are tax efficient)
Closed end real-estate fund
issue an initial number of shares before investments are made, and have a specific investment period (3). and fund termination period (4-6)
Market clientele
A certain type of customer that dominates a market
Major advantages of listed assets
- Liquidity
- Lower management fees
- Easier diversification
- Visible indication of market value
- Regulatory oversight
- Greater access to financing
- Tax simplification
Major advantages of privately organized assets
- Illiquidity premium
- More incentivized managers
- Greater asset targeting
- Appearance of stable values
- Greater investor oversight
- Greater management flexibility
- Tax benefits
Three ILPA guiding principles
- Transparency
- Alignment of Interest
- Governance
Three ILPA employees are playing TAG
Calculation of carried interest
(1) Calculated on a net after-tax profit basis
(2) Calculated from the capital contribution date to the distribution date
(3) Hard hurdle is preferred
Expenses covered under management fees
- Unforeseen expenses
- Consultant fees
- Operating partners/consultants
- Placement agent fees
- ESG related expenses
U COPE?
GP commitment requirements
- Should be substantial
- Not be transferable
- GP should not co-invest in selected deals
Difference between a top-up fund and annex fund
top-up fund is used to co-invest in one or more future investments of the main fund while an annex fund is used to invest in existing companies
Lock-step provision
co-investment agreement that states that the co-investor-GP relationship is equal to the LP-GP relationship
Potential advantages of co-investing
- Potential superior returns
- Targeted investment tool
- Better management of portfolio diversification
- Mitigating dilution
- Dual level of review
- Improved monitoring
- Establishing-relationships to invite-only funds
- Reduction of the J-curve effects
Potential disadvantages of co-investing
- Unbalanced portfolios
- Increased fiduciary risk
- Conflict of interest
- Disagreement among LPs
- Allocation of fees
Funding risk (PE)
Risk that an LP isn’t able to meet the capital requirement
Four benefits of a Private Equity Cash Flow Model
- Improve investment return for undrawn capital
- Increase profit generated by the private equity allocation through over commitment
- Calculate an economic value when a discount rate is available
- Monitor the cash flows and risk-return profiles of a portfolio of PE funds
Optimal over commitment ratio
The sum of two expected discounted costs: (1) opportunity cost of idle capital from excess liquidity, (2) costs of adverse events from inadequate liquidity
In what two ways can illiquidity be viewed?
(1) the amount of time to close a position at a price that is not affected by matters of urgency, or (2) the amount of lost value from closing a position with urgency rather than with patience.
Empirical evidence of an illiquidity premium in US Equities
Pastor-Stambaugh (2003): Liquidity risk is related to higher expected returns
Ben-Rephael: Stock liquidity has improved over the last four decades; trading activity has increased; liquidity premium has decreased
Time-zero pooling
Summing cashflows from different vintages as if they started on the same date
Three empirical findings regarding PE performance
(1) VC performance exceeds that of buyout funds
(2) PE outperformance and persistance have been lower than before 2000
(3) risk-adjusted net of fees tended to lower private equity performance to unattractive levels
