Alternative Investments Flashcards
Categories of alternative investments:
- Hedge funds
- Private capital (private equity, private debt)
- Real estate
- Natural resources (commodities, farmland, timberland)
- Infrastructure
Differences between alternative and traditional investments
- Different types of assets held, structure of investment vehicles
- Higher fees (management incentives)
- Less liquid
- Less regulated, less transparent
- Different tax treatments
- More concentrated portfolios
- Redemption restrictions
Direct investing:
investor purchases assets:
* Advantages: no fees to outside managers, and full control over investment choices
* Disadvantages: possible lack of diversification, high minimum investment amounts, and requires expertise
Fund investing:
invest in a pool of assets alongside other investors
* Advantages: uses fund manager’s expertise, requires less direct involvement in investment choices, greater diversification, and lower minimum investment amounts compared to direct investing
* Disadvantages: management and incentive fees, and possibility of poor manager performance
Co-investing:
fund investing with the right to invest directly in fund assets alongside the manager
* Advantages: may reduce fees and gives investor more control over investment choices while still benefiting from fund manager’s expertise
* Disadvantages: requires greater expertise, involvement, and due diligence than fund investing
Compensation structures
- General partner (GP) is the fund manager
- Investors are limited partners (LPs)
- Limited partnership agreement states fund rules and operational details
- Side letters may state special terms negotiated by individual LPs
Management fees
- Typically, 1%-2%
- Paid to GP regardless of fund performance
- Based on assets under management for hedge funds
- Based on committed capital for private capital funds (dry powder = not invested yet)
Catch-up clause
similar to soft hurdle rate (first x% goes to LP, then x% to GP, and then a 80/20 split)
Clawback provision
if the GP receives incentive payments on gains that are later offset by losses, LPs can recover excess incentive payments
Deal-by-deal (or American) Waterfall
distributed as fund exists each investment, shared between GP and LPs according to partnership agreement, better for GP
Whole-of-fund (or European) waterfall
LPs receive all distributions until they recover initial investment plus hurdle rate, then GP participates in distributions = better for LP (delay incentive payments)
Sharpe ratio:
(return – Rf)/ std. deve of returns (normal dist risk) (high is better)
Sortino ratio
(return – Rf)/downside deviation (better risk adj) (high is better)
Treynor ratio
(return – Rf)/beta (systematic risk of a diversified portfolio) (high is better)
Calmar ratio
average annual compound return/maximum drawdown (high is better)
