Alternative Investments Flashcards
Hedge Funds
Legal Structure
Main document
Hedge funds use the limited parternship structure, with the general partner being the fund manager (often heavily invested in the fund).
The offering memoradum includes the info for investor due diligence, such as purpose of the fund, trading style, hedging strategies, instruments to be used.
Hedge Funds
4 classes of hedge fund
Event-driven: Merger arbitrage, distressed debt, activist, special situations (eg corporate spin offs)
Relative value arbitrage
Macro funds
Equity hedge strategies: take long and short positions in equities and equity derivatives
Hedge Funds
Fees
Common fee structure
Hurdle Rate
High water mark
Common fee structure is “2 and 20”, meaning 2% fixed and 20% incentive fee.
Hurdle rate means incentive fees not paid until the rate is reached (eg libor, government benchmark yield).
High water mark means if the fund falls from NAV at the time you entered, you don’t pay incentive fees until the fund is greater than your entering NAV. Limits risk taking as normally fund managers make a fortune from big losses and big wins that net to zero.
Hedge Funds
Which prices for equities are used to determine the trading NAV of a hedge fund?
Trading NAV uses bid prices with a downwards adjustment to reflect illiquidity.
Private Equity
Legal Structure
Fee Structure
Clawback provision
PE firm has limited partners and one general partner. Limited partners are the investors, with liability limited to the capital they invest. GPs are the managers.
GP charges a management fee based on the committed capital (even uninvested part!). After LPs investment is fully recouped, remaining gains are split 80:20.
A clawback provision allows the LPs to recover a portion of the GPs carried interest, if the investment goes badly in the future.
Private Equity
4 strategies
LBO (including MBO).
Venture capital: split into formative-stage, later-stage (after commercial production has begun) and mezzanine (preparing for IPO).
Development capital: Minority equity investments
Distressed investing: Chapter 11 or 7 companies
Real Estate
Aggregation Vehicles
2 examples
Aggregation vehicles bring together many investors to allow investment in real estate assets.
RELPs (Real Estate Partnerships) are profesionally managed RE investments based on the GP/LP structure.
REITs are closed ended funds that provide a tax shelter and allow investors to participate in RE investments. There are restrictions on the use and distribution of capital.
Real Estate
Which asset class is RE most correlated with?
Real Estate is more closely correlated to global equity markets than bond markets.
Real Estate
3 valuation methods
Comparison sales approach: Look for similar properties that have been sold recently, and adjust based on comparisons with them.
Income approach: Divide the annual net operating income by the market capitalisation rate, which is effectively the market rate of return on similar assets based on property sales in the market.
Cost approach: Value property at the value of the land plus the cost to build the property from scratch.
Commodities
Contango
Backwardation
Contango means futures prices are higher than the spot price.
Backardation means spot prices are higher than futures prices.
Private Equity
What risk measure is used for PE investments?
PE investments don’t use standard deviation or beta, but VAR.
Asset values may be based on models or estimates, therefore returns will be smoothed and variance or covariance measures (such as standard deviation or beta) won’t be useful.
