Alternative Investments Flashcards
alternative vs traditional investments
higher return, greater diversification, low correlation with stock, less liquid, longer time horizon, larger investment size, higher fee, more specialized knowledge;
managers have direct investments;
information asymmetry between managers and investors;
difficult to evalute performance;
no cash flows; fund managers use leverage; valuation may not have market prices; complex fees, tax
investment methods
fund investing, co investing, direct investing
fund investing
fund investing=investor contributes to a pool of investment funds with other investors;
adv: less direct involvement, rely on fund manager’s expertise, greater diversification (pool);
dis adv: large capital investment, long horizon, limited transparency, management fees (2-20%);
term sheet=includes investment policy, fee structure and requirements;
co-investing
investor contributes to a pool of investment funds (as with fund investing, indirect) but also has the right to invest (direct), directly alongside the fund manager, in some of the assets in which the manager invests.
adv to investor: reduce fees, investor has more control over investment choices still benefit from manager expertise;
adv to fund manager: increase scope and diversification
Direct investing
investor that purchases assets itself, rather than pooling its funds with others or using a specialized outside manager;
adv: no fees to mangers, full control;
dis-adv: less diversification, high min investment amount, requries expertise, have all the risk
compensation structures
limited partnerships:
general partner (GP)=fund manager;
limited partner (LP)=accredited investors but not involved in mangement, limited liability;
limited partnership agreement=rules and operations details;
side letters=state special terms (regulatory requirements) negotiated by LPs e.g. excusal rights, most-favored-nation clause;
master limited partnership (MLP)=specialize in natrual resources and real estate, publicaly traded like a stock;
1-2% AUM if hedge funds, commited capital if private capital funds (100m committed but 50m is invested, 50m dry power) ;
paid to GP regardless of performance;
performance fee: soft hurdle rate vs hard hurdle rate
Paid to GP depending on fund performance, no perf fee if below hurdle rate;
soft hurdle rate=performance fees are percentrage of the increase in LP’s investment value if over a stated minimum (GP get the 0-8% if exceed 8%); benefits GP;
hard hurdle rate=performance fees paid only to the increase on LP’s investment value exceed the stated minimum (GP get the 1% (total 9%) if exceed 8%); benefit LP;
catch-up clause=similar to soft hurdle rate; first 8% goes to LP, next 2% goes to GP, rest 20/80 split; total amount same as soft so benefit GP
performance fee: high-water mark vs clawback provision
high-water mark=paid only on gains above LP’s previous highest investment value (90m->100m investment value yes IC, 100m->95m->100m no IC), wont get paid twice for the same performance, no double dipping;
clawback provision=if GP receives incentive payments on gains that are later offset by losses, LP can clawback the fees paid
waterfall: deal-by-deal waterfall (American) vs whole-of-fund waterfall (or European waterfall)
waterfall refers to the way in which payments are allocated to the GP and the LPs as profits and losses are realized on deals;
deal-by-deal waterfall=profits are distributed as EACH fund exits each investment, and shared between GP and LP according to partnership agreement; benefit GP because performance fees are paid before LPs’ original investment+hurdle rate is returned to them; potential clawback; benefit GP
whole-of-fund waterfall=profits distributed until after LP received 100% of initial investment plus the hurdle rate, after ALL fund investments have been sold; delay performance fee and no clawback; benefit LP
private capital
provide finance to firms without issuing shares, PRIVATE; improve new and underperforming firms to have high evalutations;
modest correlation of private capital index returns with public market index returns (diversification); Infrequent valuation results in downward bias in both standard deviations and correlations;
vintage year=year made first investment
private equity=owner, invest in private or take public private
1. invest in private firms, maybe will IPO
2. public firms going private:
- leverage buyout (LBO)=finance by 90% debt 10% equity, use equity to payoff debt once go private;
-management buyout (MBO)=current managers involved in purchase and stayed;
-management buy-in (MBI)=replace managers;
- venture capital=start up, high risk high return;
-PIPE (Private investment in public equities)=providing equity financing to publicly traded companies;
1. Formative stage
pre-seed capital (angel investing)=idea
seed stage/seed capital=research, developement, marketing (PE vintage year)
early stage/start-up stage=begin production and sales
2. Later stage=expansion, improvements
3. mezzanine-stage financing=prepare for IPO
PE exit strategy (where money is made) [5-10 years]:
trade sale=sell firm to strategic buyer (competitor, pay more)
secondary sale=sell firm to any other PE investors
IPO or SPAC, best scenario
recapitalization=issue debt to fund div payment to PE owner (not an exit but provide returns)
write-off/liquidation=take loss
private debt=lender (bond, venture debt, distressed debt)
1. direct lending=leveraged loans using money borrowed from other sources
2. venture debt=lend to start ups for convertible bond or warrants
3. mezzanine debt=subordinated to firm’s exisiting debt
4. distressed debt=buy debt that are near in default, may be active in restructuring company
5. unitranche debt=combine different classes of debt into one loan with different interest rates
establishment spectrum:
VC (start-up) -> growth capital (more established, growing, primary capital) -> LBO (matured, high leverage, secondary capital)
risk spectrum lowest to highest:
infrastructure debt->senior real estate debt->senior direct lending->unitranche debt->mezzanine debt->PE
hedge fund
qualified private investors whose money is pooled and managed by fund managers using leverage and derivatives in traditional assets; limited partnership, LLCs, GP, private placement, indefinite life;
less regulated, flexible mandates, high fees, lack transparency, low liquidity (lock up period, notice period, liquidity gate=paritial redeemed); remove market beta, leverage for sector beta and manager alpha
return drivers: arbitrage and price volatility;
evaluted by total return or risk-adjusted return;
- equity hedge fund strategies= fundamental analysis, long and short positions (market neutral strategies=long undervalued and short overvalued, offset positions to minimize market risk, emphasize on growth and high earnings), growth stock, short bias (net short exposures);
- event-driven strategies:
merger arbitrage=long shares of acquired, short acquirer;
distressed/restructuring=long if restructuring;
activist shareholder=gain board seats to influence company decisions to increase value of shareholders, public company, long position;
special situations=spinoff (break out subsidary), asset sale, repurchase; - relatve value strategies=finding arbitrage from mispricings rather than predicting market:
convertible arbitrage fixed income=long convertible bond short stock to hedge;
specific fixed income=ABS, MBS, high yield;
general fixed income=arbitrgage between interest rate, spot rate and fwd rate;
multistrategy=across assets&markets; - opportunistic strategies:
macro strategies=trade on economic trends;
managed futures=trade commodity futures based on fundamental analysis;
forms of HF investment:
-commingled funds (master-feeder structure)=tax efficient, economies of scale, pool investments globally in feeder funds, which investment into master fund;
-seperately managed account=HF provide management service to investment held by investors (investor ownership), customized, for institutional investors;
fund of fund (additional layer of fees):
lower min investments, diversification, expertise but layers of fees;
HF returns (beta):
market beta=return from broad market index;
strategy beta=return specific to sectors;
alpha=return specific to manager expertise;
performance indicies have upward biased on returns, downward bias on risks on performed well and survived due to: survivorship bias, selection bias, backfill bias (inconsistent reporting inflate performance cuz mgmt choose when to report)
Real assets include real estate, infrastructure, natural resources, and other assets such as digital assets
Real estate Investments include residential or commercial properties, as well as real estate–backed debt.
Natural resources:commodities, investors can own physical commodities, commodity derivatives, or the equity of commodity-producing firms;
Farmland can produce income from leasing the land out for farming or from raising crop
Timberland investment involves purchasing forested land and harvesting trees to generate cash flows.
timing of cash flow
capital commitment phase (capital calls)=managers select properties to include;negative returns, fees, no cash flows, outflow>inflow
capital deployment phase=building out phase, outflow>inflow;
capital distribution phase=start generating revenue, inflow>outflow
J-curve
multiple of invested capital (money multiple)
multiple of invested capital (money multiple)=
(total capital returned+value of remaining assets)/total capital paid in
[similar to value+distribution/initial investment]
because this does not consider timing of cash flows, IRR is used aka ytm
performance appraisal
levered and unlevered return
unlevered portfolio return=rV0
levered portfolio return=r(V0+VB)-(rBVB) [VB is borrowed amount]
leveraged return=[r(V0+VB)-(rB*VB)]/V0=r+(Vb/V)(r-rb); breakeven when asset return=borrowing cost
leverage magnifies gain and loss
valution of investments
fair value hierarchy:
level 1=asset trade in active markets and quoted prices are readily available;
level 2=assets do not have readily available quoted prices but can be valued based on direct or indirectly observe inputs;
level 3=asset need unobserved inputs to establish fair value
redemptions
lockup period=LP cannot redeem or will pay redemption fees
notice period=amount of time fund has to fulfill redemption request
biases
survivorship bias (overstate return)
backfill bias=include the good ones to include in index (selection bias)
before-fee returns vs after-fee returns
after-fee returns=adjust cash flow for performance fee paid;
total fees=management feeend of period V1+max[0, performance fee(V1-V0)]
rate of return after fees=(V1-V0-total fees)/V0=HPR
calc performance fee after deducted management fee
fund of funds
Investors invest in the fund of funds, and the fund manager then allocates that capital to a variety of other funds (which could include mutual funds, hedge funds, private equity funds;
investing in funds of funds have additionally layer of fees, return less than direct invest in the fund
forms of real estate investments
debt
private: mortgage, loans, mezzanine debt;
public: MBS, CMBS, CMO, covered bonds, mortgage REITs, mortage ETFs
equity
public: publicaly traded shares, mutual funds, public REITs, ETFs
private: direct ownership (join venture, limited partnership), indirect ownership (real estate funds, private REITs)
direct real estate investment
adv: control, diversification from stock, tax benefits (depreciation expense)
dis adv: illiquidity and price opacity, need to manage property, specialized knowledge, high investment, concentration risk
indirect real estate investment
REITs (equity REIT generate rental income, mortgage REIT generate interests CMBS RMBS or hybrid REITs)
not tax exempt but exempt from double taxation (if 90% earnings paid out to avoid taxed at REIT level), exchange traded liquid, specialized knowledge, low investment
Core real estate strategies — Generally lowest risk and target returns=high quality comm or resi properties delivering stable returns; open end structure, indefinite lives; senior debt less risky than this
Core Plus — Generally low-to-moderate risk and target returns=closed end structure, definite lives; light renovation
Value-Add — Generally moderate-to-higher risk and target returns=closed end structure, definite lives; larger scale redevelopment renovation
opportunistic real estate strategies - major redevelopment renovation, speculation, riskiest
