Alternative Investments

Question 1

How would an investor buy/sell commodities directly?

Answer 1

Through a commodity broker, or by investing in a commodities fund. Direct exposure to commodities is possible on the Cash/Spot Markets.

Question 2

What are the advantages of direct exposure in commodity markets, over indirect exposure?

Answer 2

• Acquiring the commodity in advance or needing it, if the prices are favourable.
• Lower counterparty/political risks.

Question 3

What are commodity funds (e.g. Exchange-Traded Contracts)?

Answer 3

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.

Question 4

What are the two main exchanges for energy derivatives?

Answer 4

The New York Mercantile Exchange (NYMEX)

ICE Futures Europe (London)

Question 5

What is the main exchanges for agricultural derivatives?

Answer 5

The Chicago Mercantile Exchange (CME) - also trades non-conventional derivatives in weather.

Question 6

What is the main exchanges for metal derivatives?

Answer 6

London Metal Exchange

Question 7

What are the advantages of gaining indirect exposure in commodities (e.g. via indices)?

Answer 7

• Shares pay dividends.
• No storage costs.
• Minimal dealing size.

Question 8

S&P GSCI Index:

Answer 8

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.

Question 9

Bloomberg Commodity Index (BCOM):

Answer 9

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%.

Question 10

Rogers International Commodity Index (RICI):

Answer 10

An index of 35 commodities from 11 exchanges, playing a significant role in worldwide consumption.

Question 11

Thomson Reuters/Jeffries CRB Index:

Answer 11

Unweighted arithmetic index of 19 categories of commodities from 19 futures markets.

Question 12

Why are commodities a good hedge against inflation and ‘event risk’?

Answer 12

• Commodity prices tend to rise with inflation.
• Inverse relationship to equity/bond prices.
• Tend to be in short-supply.

Question 13

What is a collectible?

Answer 13

A physical asset that appreciates in value over time as a result of its rarity, desirability or inflation.

Question 14

Why may collectibles be a good hedge against inflation?

Answer 14

• Low correlation with other asset classes, and therefore a significant diversification benefit to any fund seeking long-term real returns.

Question 15

What does direct property investment entail?

Answer 15

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.

Question 16

Why may property be considered an attractive asset class?

Answer 16

• 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.

Question 17

What is autocorrelation (as seen with property markets)?

Answer 17

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.

Question 18

What are property bonds?

Answer 18

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.

Question 19

What characteristic must a company have to register as a REIT?

Answer 19

• 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.

Question 20

Property derivatives:

Answer 20

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.

Question 21

What are Property Income Certificates (PICs)?

Answer 21

Structured as listed Eurobonds with an embedded swap. They deliver IPD returns on a quarterly basis over a specified period (usually 3 years).

Question 22

What are IPD Index Swaps?

Answer 22

Occurs when the buyer receives the total return on the IPD index in exchange for LIBOR plus a margin.

Question 23

What are IPD Futures Contracts?

Answer 23

Based on quarterly and annual total return indices (Eurex traded).

Question 24

What are UK IPD trades?

Answer 24

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).

Question 25

What are the three methods of evaluating property?

Answer 25

Costs Approach: The replacement cost of the land and buildings.
Sales-Comparison: Comparing prices of similar properties.
Income Approach: Net Operating Income / Market Cap Rate.

Question 26

Why do are spot price returns and returns from investors in commodity futures primarily differ?

Answer 26

Roll yield - commodity futures expire periodically and investors have to ‘roll’ into new contracts to maintain their exposure. This is the ‘roll yield’. If the futures curve is upward sloping the roll yield will be negative and if it is downward sloping it will be positive.

Question 27

The MSCI IPD indices of commercial property returns are constructed using which of the following types of data?

Answer 27

Portfolio valuations.

Question 28

Reference rates for oil and oil-related products are published by whom?

Answer 28

Platts

Question 29

Coffee would be classified as a:

Answer 29

Soft commodity

Question 30

How often do commercial properties have rent reviews?

Answer 30

Every 5 years.

Question 31

Who are the main class of property investors?

Answer 31

Pension and life companies

Question 32

Is the supply of property elastic or inelastic?

Answer 32

Inelastic

Question 33

Who are estate agent fees payable by?

Answer 33

The sellers of the property

Question 34

Commodities and inflation have what kind of relationship?

Answer 34

They are positively correlated.

Question 35

Commodities have what kind of relationship with equities and bonds?

Answer 35

Commodities are negatively correlated with equities and bonds.