Alternative Investments Flashcards
How would an investor buy/sell commodities directly?
Through a commodity broker, or by investing in a commodities fund. Direct exposure to commodities is possible on the Cash/Spot Markets.
What are the advantages of direct exposure in commodity markets, over indirect exposure?
- Acquiring the commodity in advance or needing it, if the prices are favourable.
- Lower counterparty/political risks.
What are commodity funds (e.g. Exchange-Traded Contracts)?
Mostly future contracts that are run by Commodity Trading Advisors (CTAs). These funds use both cash and futures markets, hence the fund performance may not exactly correspond the underlying commodities due to changes in basis.
Exposure may also be gained through Hedge Funds or Exchange-Traded Contracts (ETCs). Similar to ETFs, ETCs are asset-backed open-ended investments that track the performance of a commodity index.
What are the two main exchanges for energy derivatives?
The New York Mercantile Exchange (NYMEX)
ICE Futures Europe (London)
What is the main exchanges for agricultural derivatives?
The Chicago Mercantile Exchange (CME) - also trades non-conventional derivatives in weather.
What is the main exchanges for metal derivatives?
London Metal Exchange
What are the advantages of gaining indirect exposure in commodities (e.g. via indices)?
- Shares pay dividends.
- No storage costs.
- Minimal dealing size.
S&P GSCI Index:
An arithmetic weighted index representing long-only investments in commodity futures.
Weightings are reassessed annually on the 5 year moving average of world production values.
Bloomberg Commodity Index (BCOM):
A diversified index that allows investors to track commodity futures contracts on physical commodities.
Weightings are reassessed based on dollar-adjusted production values averaged over a 5 year period with weightings between 2-3%.
Rogers International Commodity Index (RICI):
An index of 35 commodities from 11 exchanges, playing a significant role in worldwide consumption.
Thomson Reuters/Jeffries CRB Index:
Unweighted arithmetic index of 19 categories of commodities from 19 futures markets.
Why are commodities a good hedge against inflation and ‘event risk’?
- Commodity prices tend to rise with inflation.
- Inverse relationship to equity/bond prices.
- Tend to be in short-supply.
What is a collectible?
A physical asset that appreciates in value over time as a result of its rarity, desirability or inflation.
Why may collectibles be a good hedge against inflation?
- Low correlation with other asset classes, and therefore a significant diversification benefit to any fund seeking long-term real returns.
What does direct property investment entail?
Buying the long leasehold/freehold of, primarily commercial property. It normally takes place in retail, office and industrial property sectors.
The returns of direct property investment are made up from capital growth and income.
Why may property be considered an attractive asset class?
- Property is a less volatile investment than other asset classes.
- It is a risk diversifier - the long-term correlation between real estate and equities/bonds is very low.
- High income returns.
- Represents a hybrid investment return that combines features of both equities and bonds.
- Property has a residual value.
- Transparent and illiquid market conditions.
- Hedge against inflation.
What is autocorrelation (as seen with property markets)?
Occurs when future returns are related to current returns.
This is due to infrequent property valuations and a lack of liquidity. The effect of this is that levels of risk and volatility can be underestimated.
What are property bonds?
A property bond is a bond backed by real estate holdings or real property.
In the event of a default situation, property bondholders could sell off the underlying property backing a bond to compensate for the default.
What characteristic must a company have to register as a REIT?
- Pay-out at least 90% of its property net profits to investors.
- No single investor can hold more than 10% of its shares.
- The company must own at least 3 properties, with each property having less than 40% share.
- Obtain a listing on any RIE.
- Closed-ended UK funds.
Property derivatives:
Available based on certain property indices published by the Investment Property Databank (IPD) e.g. UK IPD Index and IPD Index Swaps.
Typically targeted at institutions and HNWIs.
What are Property Income Certificates (PICs)?
Structured as listed Eurobonds with an embedded swap. They deliver IPD returns on a quarterly basis over a specified period (usually 3 years).
What are IPD Index Swaps?
Occurs when the buyer receives the total return on the IPD index in exchange for LIBOR plus a margin.
What are IPD Futures Contracts?
Based on quarterly and annual total return indices (Eurex traded).
What are UK IPD trades?
Pay a total return earned by UK commercial property based on the IPD annual index minus 2.8% (These are warrants traded on the LSE).
