Alternative Investments

Question 1

Absolute Return objective

Answer 1

Traditional investments, such as stocks and bonds, in most cases, have a relative return objective, which seeks to achieve a return above a certain benchmark, depending on asset class. Conversely, the goal of an alternative investment is to have positive returns regardless of market environment and cycle. This type of return objective is called an absolute return objective.

Question 2

Alternative Investment restriction

Answer 2

Alternative investments introduce, at times, several restrictions into a client’s portfolio. Not only are fees often higher with alternative investments, but they sometimes include lockup periods that could affect the liquidity in a portfolio.

Question 3

Alternative strategy

Answer 3

The concept of an “alternative asset class” should be differentiated from that of an “alternative strategy”. An alternative strategy generally utilizes traditional asset classes in their execution. The strategist will choose traditional investment instruments in a non-traditional portfolio strategy because doing so allows him or her to reduce the number of risk factors affecting the outcome of the strategy. This allows for more simplicity and the ability to focus on those areas that he or she has particular skill in. Arbitrage is an alternative investment strategy that illustrates this concept. In pure arbitrage, for example, an asset that is deemed mispriced is simultaneously purchased and sold in different markets to take advantage of pricing disparities. However, this strategy is employed with traditional assets such as stocks and bonds as opposed to alternative assets.

Question 4

Promissory Notes

Answer 4

Promissory notes are debt instruments where the investor is lending money to a corporation in return for a fixed amount of income (interest).

Investors should beware of promissory notes that boast things such as:

1. risk free (risk free should come with low yield)
2. above market returns (should be associated with higher risk)
3. insured (check to see if the insurer is non-existent or off-shore insurer)
4. short-term (9 months, typically means that the note did not have to go through the due-diligence process of registering with the SEC or state)

Question 5

Private Equity

Answer 5

Private Equity refers to securities that are sold to a small number of investors (typically institutional investors, such as a bank or corporations, or to funds that invest exclusively in PE investments). These securities do not need to be registered but issuers must be assured that the investor is either sophisticated or accredited and do not intend to sell the security prior to the date specified in the investment letter.

Question 6

New risks in Alternative Investment

Answer 6

With the creation of new investments, there come new risks that we must be aware of. While these risks are not necessarily new as a standalone investment risk, they are heightened with cryptocurrencies.

1. Hacking risk – this has shown to create some concern as exchanges were hacked and coins were stolen.
2. Regulatory risk – due to the decentralized nature of cryptocurrency and the fact it avoids many governments’ tracking mechanism that is in place for traditional currency, cryptocurrency poses a high risk that regulators will intervene and limit some of the technology’s benefits (such as anonymity).
   For example, cryptocurrency poses a sizable money laundering risk which is shown in recent ransom cases through the US.
3. Liquidity – despite the growing market cap, coins are still not a heavily traded asset class with deep pools of participants. This can lead to lack of liquidity as prices fall, making movements rather extreme.
4. ESG Concerns – More recently, the carbon footprint and electricity impact of mining has been under intense scrutiny. Each mining transaction can create a high amount of carbon release due to the significant computing energy needed to complete the transactions.