Alternative Investments (Ch11) Flashcards
why are alternative investments attractive? (4)
- high returns
- Low correlation with traditional asset classes
- better risk and reward characteristics
- allows investor to diversify
Why are alternatives considered more risky? (3)
- lack of transparency
- they are illiquid
- not regulated by the government
how can the agency problem/cost be minimised?
through incentives and controls
what are some examples of incentives? (3)
compensation
reputation
mgmt ownership
what are some examples of alternative assets? (5)
- real estate
- hedge funds
- commodities
- private equity
- gold
what super category do FIS, equity and real estate come under?
capital
what is alpha a measure of?
return generated above the compensation for taking on risk.
what are the two different ways to invest in real estate?
directly (buying commercial property) and through REITs (indirectly)
what are the benefits of investing in real estate directly? (2)
- tax benefits
- personal preferences
what are the disadvantages of investing in real estate directly? (4)
- illiquid
- concentrated risk
- hard to value due to personal preferences
- maintenance and admin
what are the benefits of investing in real estate indirectly (REITs)? (5)
- liquidity (90% of income distributed as dividends)
- diversification
- no admin or maintenance
- professional management
- high returns on a consisted basis through dividends
what are the disadvantages of investing in real estate indirectly (REITs)? (2)
- lack of transparency
- possible agency problem
what are four return factors of REITs?
- supply and demand (development)
- replacement costs (inflation)
- economic factors
- interest rates
how are traditional assets correlated with REITs?
over long and short term compared to equities and real estate?
low correlation over all
over short term: more highly correlated with equities
how are REITs correlated over long and short term with equities and real estate?
equity: short term a higher positive correlation, over long term low positive to negative correlation
real estate: short term low positive correlation, long term high positive correlation
What is private equity?
buying a company and selling parts of it
what are key aspects of venture capital? (3)
- invest in intellectual capital
- high risk high returns
- information asymmetries
venture capital invests in start ups that go all the way to IPO
Why are hedge funds so risky?
- because they are not regulated
- they can invest in any type of asset they want
- they can use derivates, sell short and use leverage.
what are the implications of not being regulated?
- retail investors can not invest in these funds
- hedge funds can not market themselves
how are interests for hedge fund managers and investors aligned? how does this differ from mutual funds? which aligns interests directly
Compensation structure
- management fees (% x AUM)
- hedge funds also have incentive fees
incentive fees align interests directly
what are two things that incentive fees can be dependant on?
- the hurdle rate (the minimum required rate of return)
- the high watermark (highest value the fund has ever reached must be reached again before managers receive incentive fee)
- either one or both of these can apply
how do management fees align interests in the short and long term?
it can be said that they don’ align interests in the short term because managers get these fees regardless of how the fund performs, however they do align interests in the long terms as the larger the amount of AUM the larger the fee based on percentage. if a fund isn’t performing well there will be no increase in AUM.
why can a retail investor not invest in hedge funds?
- hedge funds are risky
- require large initial investment
- Low liquidity
if a retail investor could afford the initial investment why would a hedge fund still be considered a bad investment?
even if retail investor could afford to invest their wealth would be concentrated, and they wouldn’t be able to bare the risk of a market downturn
why is a hedge fund considered to have low liquidity? (4)
they have features that restrict liquidity
- redemption frequency is less (i.e. quarterly)
- notification period
- lock up period (initial period during which no withdrawal can be made)
- gate (eg only 20% of assets are allowed to be with drawn at any one point)
why is there often bias when hedge funds report?
- end of life bias (funds no longer alive/seeking capital don’t report)
- back-fill bias (only report fund when it has good performance, includes stressful prior years = stronger upward trend)
- survivor bias (funds that no longer exist are removed from database)
would hedge funds be considered an asset class?
no, they are not an asset class they are a structure through which investors can access various asset classes
what is the best way to invest in a hedge fund overall?
as a part of a diversified portfolio, as they offer improved risk and return characteristics
Why is it unlikely that hedge funds will achieve the same level of risk adjusted returns as in the past?
- large inflows of capital lead to strategy saturation/fund saturation
- Skill shortage
- investors prefer performance and risk reduction
how are hedge funds structured?
- as limited partnerships, or
- as limited liability companies
what are four hedge fund styles and strategies?
- relative value
- event driven
- hedged equities
- trading
what does the relative value strategy do?
exploit mis-pricing between equivalent securitiesPosti
what does the event driven strategy do?
exploit mis-pricing due to market events
what does the hedged equities strategy do?
exploit mis-pricing between equity securities
what does the trading strategy do?
exploit expected price movements using fundamental and technical analysis
if hedge fund reporting is optional why do they report? give two reasons
- preforming well
- seeking capital
out of private equity, venture capital and hedge funds which are the most liquid?
hedge funds
what is the correlation between hedge funds and FIS and Equities? what are the return characteristics?
Low correlation with FIS and LCaps
Positive correlation with SCaps
High probability of small positive return
Low probability of large negative returns
hedge against market downturns
what is the correlation between Venture Cap and Priv Equity and FIS and Equities? what are the return characteristics?
Low negative correlation with FIS
High positive correlation with Equities
High probability of small positive return
Low probability of large negative returns
hedge against market downturns
what is the correlation between REITs and FIS and Equities? what are the return characteristics?
low correlation with both FIS and equity
High liquidity characteristics- reduce price risk
what is the correlation between Commodities and Equities? what are the return characteristics?
negative correlation with equity, perform best at the end of a business cycle
