Alternative Investments Portfolio Management Flashcards
Decision risk
The risk of changing strategies at the point of maximum loss
Types of real estate investments
- Real estate investment trusts (REITs)
- Commingled real estate funds (CREFs)
- Separately managed accounts
- Infrastructure funds
Appraised value versus market value for real estate
- Appraised values tend to be less volatile than market values because of an effect known as smoothing
- As a result of smoothing, volatility and correlations with other assets will tend to be understated, leading to an overstatement of the benefits of real estate in the portfolio
Venture capital timeline
- FF&F = founder’s friends and family
Angel investor
An accredited individual investing chiefly in seed and early stage companies
Buyout funds
- Mega-cap buyout funds take public companies private
- Middle-market buyout funds purchase private companies whose revenues and profits are too small to allow them to access capital from the public equity markets
Dividend recapitalization
Involves issuing debt to finance a special dividend to owners
Carried interest
The share of the private equity fund’s profits that the fund manager is due once the fund has returned the outside investors’ capital
Private equity management fees
- Are typically based on the percentage of the value of limited partners’ committed funds
- Management fees often scale down in the later years of a partnership to reflect a lower workload as the fund becomes fully invested
Hurdle rate (also called preferred return)
The profits that represent a return in excess of a specified rate above which profits are subject to the carried interest
Vintage year
The year in which the first influx of investment capital is delivered to a project or company
Vintage year effects
Investors often make comparisons with funds closed in the same year to ensure that funds are compared with other funds at a similar stage in their life cycle and under similar economic conditions, incorporating the effect of market opportunities on various funds’ probabilities of success
Non-marketable minority interest discount
- Is calculated successively on the prior discounted amount
- Example:
- Marketable controlling interest value: (10% × 500) = 50
- Minority-interest discount: (20% × 50) = –10
- Marketable minority interest: (50 – 10) = 40
- Marketability discount: (25% × 40) = –10
- Non-marketable minority interest: (40 – 10) = 30
VC funds versus buyout funds return characteristics
- Buyout funds are usually highly leveraged
- The cash flows to buyout fund investors come earlier and are often steadier than those to VC fund investors
- The returns to VC fund investors are subject to greater measurement error
Samuelson effect
The term structure of forward price volatility generally declines with the time to expiration of the futures contract
Components of the difference between the futures price and the spot price according to the theory of supply
- Forgone interest from purchasing and storing the commodity
- Storage costs
- Convenience yield
Backwardation and contango relation to roll yield
Types of hedge funds
- Equity market neutral
- Convertible arbitrage
- Fixed-income arbitrage
- Distressed securities
- Merger arbitrage
- Hedge equity
- Global macro
- Emerging markets
- Fund of funds (FOF)
Stale price bias
Bias created by low security trading
Backfill bias
Bias that arises when when missing past return data for a component of an index are filled in at the discretion of the component
Rolling return
- The rolling return is the arithmetic average of returns
- The average rolling return is the average of the rolling returns (i.e. there are 7 6 months period holding in a year. Average RR = (RR6,1 + … + RR6,7 )/ 7)
Downside deviation
- r* is the minimum hurdle or acceptable rate
Maximum drawdown
The largest difference between a high-water point and a subsequent low
Sortino ratio
= (Annualized rate of return – Annualized minimum acceptable return) / Downside deviation
Gain-to-loss ratio
= (Number of months with positive returns / Number of months with negative returns) × (Average up-month return / Average down-month return)
Distressed debt arbitrage
Involves purchasing the traded bonds of bankrupt companies and selling the common equity short
Prepackaged bankruptcy
Working with the company and other creditors, the buyout firm(s) seeks to arrange a prepackaged bankruptcy in which the firm(s) becomes the majority owner of a private company on favorable terms
J factor risk
Referred to the judge’s track record in adjudicating bankruptcies and restructurings
Absolute priority rule
A reorganization or liquidation plan must follow the rule of priority with respect to the order of claims by the debtor’s security holders
Smoothed (traditionnal) versus unsmoothed NCREIF
- The traditionnal NCREIF index is based on property appraisals rather than market values
- Appraised values tend to be less volatile than market values because of an effect known as smoothing
- As a result of smoothing, volatility and correlations with other assets will tend to be understated, leading to an overstatement of the benefits of real estate in the portfolio
- Using the unsmoothed NCREIF index gives a more accurate picture of the benefits of real estate investment
Sharpe ratio validity for commodities
The Sharpe ratio is compromised when returns are skewed and/or have high kurtosis
Techniques to game the Sharpe ratio
- Lengthening the measurement interval resulting in a lower estimate of volatility
- Compounding the monthly returns but calculating the standard deviation from the uncompounded monthly returns
- Writing out-of-the-money puts and calls on a portfolio
- Smoothing returns using certain derivative structures, infrequent marking to market of illiquid assets, and pricing models that understate monthly gains or losses can reduce reported volatility
- Getting rid of extreme returns (best and worst monthly returns each year) that increase the standard deviation
Fallen angels
Refers to debt securities that were originally deemed investment grade when issued by financially healthy companies but have subsequently been downgraded to below investment grade
Fund-of-funds (FOF) fees and lock-up periods
FOF usually do not impose lock-up periods and charge higher fees
Fund-of-funds benefits
- The skill at selecting fund managers provided by the fund-of-funds manager
- Diversification provided from investing in multiple funds
- Access to closed funds that fund-of-funds already has a stake in
Distressed securities investing key points
- Uncertainty regarding the economy, interest rates, and the state of equity markets are not as important as liquidity risks
- Their Sharpe ratio is often overstated
- Due diligence costs are likely to be costly - investing in distressed securities is complex and requires legal, operational, and financial analysis and each distress situation requires a unique approach and solution.
Advantages/disadvantages of direct equity investments in real estate
- Advantages:
- Financial leverage
- Low relative volatility
- Disadvantages:
- High transaction costs
Tax issues complexity - private versus intstitutional clients
Tax issues are more complex for private client than for institutional investors because alternative investments often involve the creation of partnerships and other structures that have distinct tax issues
Passively managed unlevered position in futures long-term returns
Is the risk-free rate less costs
Hedging properties of commodities
Commodity classes such as livestock and agriculture exhibit negative correlation with unexpected inflation as measured by monthly changes in the inflation rate. Thus they are poor inflation hedges. Storable commodities directly linked to economic activity exhibit positive correlation with changes in inflation and have superior inflation-hedging properties
