Alternative Investment

Question 1

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Alternative Investments Uses and Features

Answer 1

Used for: diversification and potential for active management

1. Low liquidity
2. Due diligence = costs + harder to value + info inefficient (requires special skills)

Question 2

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Role of different types of AI in the Portfolio

Answer 2

Unique Risk Factors

Real estate and commodities

Unique Investment Strategies requiring manager skill

Hedge Funds and Mangaged Futures

Blend of Above

Private Equity and distressed equities

Question 3

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Real Estate Types

Answer 3

Types

Direct “equity”: residential, commerical, etc - direct management

Benchmark: NCREIF - quarterly, value-weighted (unlevered)

Indirect: REITS, CREFs (commingled), SMAs, other real estate companies

Benchmark: NAREIT - cap-weighted REITs, investable (levered)

Question 4

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Direct RE Pros/Cons

Answer 4

ProsCons

• tax-deductible expenses High commission/transaction costs
• allows high leverage Each propery is unique
• direct control High unit costs
• low return volatility Hands on management

Question 5

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Real Estate are affected by…

Answer 5

1. Interest rates ↑, RE ↓
2. • correlation with population
3. Inflation ↑, RE price ↑

CREFs, much better reflection of true RE performance

Question 6

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Private Equity Types

Answer 6

Types

• Venture capital - investing in private firms (J curve)
  
  • High failure rate
  • Less cash flows
  • Not leveraged
• Buyout funds - buy public firm and take private
  
  • Earlier and steady cash flows
  • Less error in measuring returns
  • Less upside potential

Question 7

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Private Equity - Direct vs Indirect Investing

Answer 7

• Direct: Convertible Preferred Stock (first claim on cash flow and assets
• Indirect: Through LPs or LLCs
  
  • GP - selects and manages, plans exit
  • Provides tax advantages (avoids double tax)

Question 8

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Commodities

Direct vs Indirect Investment

Storable vs Nonstorable

Answer 8

Direct Indirect

Cash purchase Buy companies (mining company)
Long derivatives Mutual Fund/ETFs

Storable Nonstorable

Metal, gold, energy Agriculture
Inflation hedge No inflation hedge

Question 9

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Backfill bias

Answer 9

applying returns that would have been earned if strategy was followed

Question 10

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Hedge Funds - Issues and Concerns

Answer 10

• investment characteristics change over time
• survivorship and backfill bias (applying returns that would have been earned if strategy was followed)
• due diligence issues (many are unregulated)
• Understated std (risk) and correlation
• Overstated Sharpe ratio
• Infrequency pricing leads to smoothing