Alternative Investment Features, Methods, and Structures

Question 1

Alternative Investments

Answer 1

Investments that do not fall under
traditional investments - long-only investments in cash or publicly traded stocks and bonds

Question 2

Benefits of alternative investments

Answer 2

1) Portfolio diversification
2) Higher returns from illiquid securities
3) Markets may be less efficient than traditional investments

Question 3

Key characteristics of alternative investments

Answer 3

1) Specialized knowledge
2) Less correlated with traditional investments
3) Illiquid
4) Longer time horizon
5) Larger investment commitment

Question 4

Private capital

Answer 4

Private equity / Private debt

Question 5

Private euity

Answer 5

Invests equity of companies that are not publicly traded
- LBO funds
- Venture capital

Question 6

Private debt

Answer 6

Direct loans to young companies (venture debt) / Invest in companies struggling to pay back (distressed debt)

Question 7

Real assets

Answer 7

Real estate / infrastructure / natural resources

Question 8

Real estate

Answer 8

Residential or commercial properties & real estate-backed debt

Question 9

Natural resources

Answer 9

Commodities, farmland and timberland
- Physical commodities
- Commodity derivates
- Equity of commodity producing firms

Question 10

Infrastructure

Answer 10

Long-lived assets that provide public services
- Public-private partnerships where both take stake in infra

Question 11

Hedge funds

Answer 11

Investments only open to qualified investors
1) Use leverage
2) Hold long or shorts
3) Use derivates
4) Invest in illiquid assets

Question 12

Fund investing

Answer 12

Investing in pool of assets alongside other investors using fund manager
- Larger capital committment
- Higher fees
- Less information of portfolio

Question 13

Co-investing

Answer 13

Investor contributes to pool of funds but has right to invest alongside fund manager
- Allows investor to gain skills
- Less fees to fund manager

Question 14

Direct investing

Answer 14

Investor purchasing assets themselves without pooling or fund manager

Question 15

Limited partnerships

Answer 15

Ownership structure of alternative investment
1) General partner = fund manager
2) Limited partner = investors (no say and no liabilities)

Limited partners usually committ less money than they originally promised

LP shares only available to accredited investors

Question 16

Limited partnership agreement

Answer 16

Contains rules and details of partnership

Question 17

Side letters

Answer 17

Special terms that apply to one LP but not others

Question 18

Most-favored nation clause

Answer 18

When LPs require side letters that were offered to other LPs

Question 19

Master Limited Partnership (MLP)

Answer 19

Allows public trading of LPs - common in natural resources or real estate

Question 20

Fess paid by investors

Answer 20

Management fee + Performance fee (Carried interest)

Question 21

Management fee

Answer 21

% of committed capital (not invested) / paid no matter what the investment performance

Question 22

Dry powder

Answer 22

Committed capital that has not yet been drawn down

Question 23

Hurdle rate

Answer 23

Rate that must be met before any performance fees are paid
- Soft: % of total increase in value of each investment
- Hard: Only gains above hurdle

Question 24

Catch-up clause

Answer 24

Returns: 14%
Hurdle rate: 8%
Performance fee: 20%

First 8% goes to LPs
Next 2% goes to GP
Further gains split 80/20

Question 25

High-water mark

Answer 25

No fees paid on gains that only offset prior losses

Question 26

Deal-by-deal waterfall

Answer 26

Profits are distributed as each investment is sold (Least beneficial to investors)

Question 27

Whole-of-fund waterfall

Answer 27

LPs receive all distributions until they have reached initial investment + hurdle rate

Question 28

Clawback provision

Answer 28

LPs can recover excess incentive payments if they incur losses upon exit