Alternative Investments Flashcards
Real Estate Investments (Public/Private) & Advantages/Disadvantages/Risks
Real Estate Investments can be made via equity investment (your own cash) or via taking on debt.
Private Debt RE = Mortgages
Private Equity RE = Direct investment, partnerships, pooling of funds
Public Debt RE = Mortgage back securities
Public Equity RE = REITs and REOCs
Real estate investments provide current income, capital appreciation and inflation hedge
Risk of RE is a lot of lead time for the investment, lack of liquidity, cost of capital to take on debt, and environmental risks
Advantages of Public vs Private: Public provides superior liquidity, lower minimum investment, transparency, active professional management
REITs even provide tax exemptions, predictable earnings, and higher yield
Disadvantages: Lower tax efficiency vs private, lack of control, volatility tied to the market, limited growth potential
Real Estate Valuation (Cost, Income, Comparison)
Cost Approach: Estimated Land Cost + Estimated Building Replacement - Depr
Used when building is new, property is unusual, or there are few transactions to base off of
Income Approach: Direct Capitalization vs DCF
Direct Capitalization: Value = NOI/Cap Rate
NOI is NI before financing cost and taxes
Cap Rate can be calced two ways, Cap Rate = Discount - Growth Rate
Cap Rate = NOI/Comparable Sale
Value = Gross Income Multiplier * Gross Income, derive multiplier from comparable
DCF: Project NOI over period + Terminal value, discounted back
To get terminal value use Future NOI/Terminal Cap Rate, this may be different than the original terminal rate that you use.
Think of cap rate as r-g with r being Discount rate here
If a renter pays all expenses than calc value using rent instead of NOI since they pay for everything else, rent/cap rate. This will give you All Risk Yield (ARY)
Comparison Approach: Use similar transaction, adjust for age, size, location, etc.
REIT Valuation (NAV per share/comparable/FFO & AFFO)
NAV per share: Find the current market value of the asset using cap rate and use book value for all other assets and liabs. Then find the equity that the shareholders own and divide by the amount of shares to get the NAV per share
Relative Value: Apply your multiple to other funds FFO and AFFO
Funds from Operations (FFO) = Accounting Net Earnings + Depr - G/L on sale of property
Taking your earnings and adding back depr because it is not cash out the door but you subtract an gain/loss on sales of property because those G/L are no longer in operations and those G/L were from capital appreciation
Price to FFO: FFO/Share * Average Industry Price/FFO multiplier = NAV per Share
Adjusted Funds from Operations (AFFO) = FFO - Noncash rent - Recurring maintenance and capex
AFFO will give you a better idea of the funds that you actually have coming to you after the upkeep on the property and any discounts you give on rent, adjust better to show current income
AFFO Price, AFFO/Share * Price/AFFO Industry Multiplier = Price/Share
DCF: Usually 2 or 3 staged based on growth, use PV(divs) + PV(Terminal)
Financial Ratios (DSCR, LTV, Equity Div Rate)
Debt to Service Coverage (DSCR) = First year NOI/Debt Services, shows you how many times your NOI covers your debt service costs
Loan to Value (LTV) = Loan Amount/Appraised Value, do not want this over 100%
Equity Dividend Rate = First Year CF/Equity, gives you cash you got back vs cash invested ratio for first year
Private Equity Value Creation & Control Mechanisms
Sources of PE Value: Re-engineer firm for more value/efficiency, obtain debt at a better ate, and align interests of PE owners with management
PE Control Mechanism (how PE controls/protects from risks):
- Compensation: Comp is closely tied to firms performance
- Tag Along Drag Along: Clause that either gives minority shareholder the right to stay and tag along in a sale or drag along gives the majority shareholder the right to drag the minority shareholder along during a sale
- Board Representation: PE firm can guarantee control thru board even if IPO or takeover attempt
- Noncompete clauses: Company founds are not allowed to go out and start their our competing business
- Priority in claims: PE firm gets revs and asset claims first to protect themselves
- Required Approvals: Big business changes must be approved by PE firm
- Earn Outs: Used by VC, price paid to acquire a firm is tied to how well the firm performs
Venture Capital (VC) Characteristics/Risks & VC Method (ROI, Dilution) & Quantitative Methods (PIC, DPI, RVPI, TVPI)
VC have the following characteristics:
- Low predictability in CFs
- Product market is uncertain and products are based on new tech
- Asset base is weak
- Managers are new but entrepreneurs
- Burn a lot of cash with the hope of growing (1 or 2 successes for every 10 failures)
- Firms are usually sold to VC via an existing relationship
- VC is not in the active capital markets
- Firms are less scalable after initial investment is made
- Main compensation for VC is carried interest (incentive fee)
VC usually don’t have DCF or comparable sales so valuation is usually based on pre/post VC investment which makes it difficult to truly value
VC Method: Uses ROI = Exit Value / Post money valuation or Post = Exit Value / ROI
Dilution will occur at every investing stage as price goes up and shares get more spread out
PIC (Paid in capital) = Amount you paid into fund
DPI (Distributions to PIC) = Ratio of distributions paid back to you vs what you paid in, this is a good measure because it is cash to cash and net of all fees involved
RVPI (Unrealized) = Unrealized/PIC
TVPI (Total) = (Distributions + Unrealized) / PIC
Buyout Characteristics & PE Exits/Terms/Risks/Cost
Buyout Characteristics:
- Buyouts have stable and predictable CFs
- Buyouts have established products and markets and their asset base is substantial
- Buyouts have more debt than equity and their management is experienced and strong
- Risk is usually associated with the industry level, exit is predictable and usually go in with the goal of reducing inefficiencies
- Low working cap requirements, easy to due diligence
- Goal is to make most of CFS and revitalize the firm which can lead to reinvestment
- Usually successful, rare to fail, active in capital markets
- Sale usually occurs via auction and comp for PE firm is all fees (transaction, monitoring/management, carried interest)
Buyout usually has access to DCFs and relative valuation, use earnings growth as metric
PE Exit Routes: IPOS, secondary sales, management buyouts, liquidation
PE Risks: Liquidity, overvalued purchase, agency risk, tax, valuation, regulatory, capital
Ratchet: Anti-dilution term that is used by PE firm to ensure that they keep control of the firm in a case of an IPO or takeover
Corporate Governance: Legal arrangements, performance clauses, clawbacks, waterfall, no fault divorce (investors remove GP), removal with cause
Commodity Types (Oil, Gas, Metals, Livestock, Grain, & Softs) & Spreads & Cotango vs Backwardation
Commodity Types:
Crude Oil: Drilled out of ground, needs to be refined to be used, can be transported easily once it is refined though, usually short life span
Natural Gas: Does not need to be refined, can be transported via pipeline, however to be transported overseas it must be liquified
Livestock: Sensitive to price of grain, cycle depends on size of animal, meat can be frozen for storage
Grain/Softs(Cash crops): Dependent on weather, seasonal but can be stored after harvest
Commodities do not have CFs so future/spot price relationship is dependent on cost of carry and benefits of carry
Basis Spread = Spot - Future
Calendar Spread = Near Term Contract - Long Term Contract
Cotango: Future > Spot Price, Basis and Calendar spreads are negative because its more expensive to buy for future, Cost of Carry > Benefit of Carry
Backwardation: Future < Spot Price, Basis and Calendar spreads are positive because its more expensive today to buy, Cost of Carry < Benefit of Carry
Theories of Future Returns (Insurance, Hedging Pressure, Theory of Storage) & Commodity Contract Breakdown (Price and Roll Return)
Insurance Theory: Commodity producers buy insurance to lock price in, causes future prices to go down so spot > futures, market is normally in backwardation
Hedging Pressure: Insurance theory holds if alot of people are purchasing insurance, however if alot of people are not purchasing insurance (longing the commodity, believing the price will go up) than futures > spot and the market will be in cotango
Theory of Storage: Spot and Future Prices depend on storage cost and convenience yield that the commodity provides, if cost of carry (storage cost) > convenience yield (benefit) than the Futures > Spot
Total return can be broken into Price Return and Roll Return
Price Return = Current Spot - Previous Spot / Previous Spot
Roll Return = Expiring Future - New Future / Expiring Future
Roll Return will be positive if market is in backwardation because Spot > Future so the expiring future > new future, but will be negative if the market is in cotango because Spot < Future so the expiring future < new future
Types of Swaps & Commodity Index
Swap types are different by what the variable payment is tied too:
Total Return Swap: △Commodity Price
Excess Return Swap: △Commodity Price - △Benchmark Price, how much more did the commodity change against the benchmark
Basis Swap: △Commodity 1 - △Commodity 2 gives you return
Volatility: △Volatility of commodity price
Commodity index will be affected by methodology and weighting
Methodology: Can either use passive or active rolling, passive you just do the same thing at minimal cost, active you try to get the best deal but at a cost, if you are good active is best
Weighting: Rebalancing a lot is bad in a trendy market and good in a choppy one, never rebalancing is good in a trendy market (ride the wave) and bad in a choppy one
