Alternatives

Question 1

Alternative Investments Uses and Features

Answer 1

Used for: diversification and potential for active management

Features

1. Low liquidity
2. good diversification
3. high due diligence costs
4. difficult to value
5. Informationally inefficient (requires special skills)

Question 2

Role of different AI in the Portfolio

Answer 2

Unique Risk Factors

Real estate and commodities

Unique Investment Strategies requiring manager skill

Hedge Funds and Mangaged Futures

Blend of Above

Private Equity and distressed equities

Question 3

Due Diligence Checkpoints

Answer 3

Assess the following;

1. Market opportunity
2. Investment process
3. Service providers (brokers, lawyers, etc.)
4. Terms/structure of investment
5. Organization and People
6. Review & document

Question 4

Special Issues for Private Clients

Answer 4

1. Tax considerations
2. Suitability
3. Communication (client’s level of knowledge)
4. Do they understand the risk?

Question 5

Real Estate Types

Answer 5

Types

Direct “equity”: residential, commerical, etc - direct management

Benchmark: NCREIF - quarterly, value-weighted (unlevered)

Indirect: REITS, CREFs (commingled), SMAs, other real estate companies

Benchmark: NAREIT - cap-weighted REITs, investable (levered)

Question 6

Direct RE Pros/Cons

Answer 6

ProsCons

• tax-deductible expenses High commission/transaction costs
• allows high leverage Each propery is unique
• direct control High unit costs
• low return volatility Hands on management

Question 7

Real Estate Characteristics

Answer 7

1. Interest rates ^, RE down
2. • correlation with population
3. Inflation hedge

CREFs, much better reflection of true RE performance

Question 8

Smoothing

Answer 8

• Appraisals rely on past data and understate swings in value
• Appearance of stability: periodic appraisals instead of continuous pricing

Question 9

RE Benchmarks

Answer 9

NCREIF IndexNAREIT Index (REIT)

• Quarterly reported All REITS on NYSE
• Value-weighted Cap-weighted
• Annual appraisals Blend of RE and equity
• Smoothing (understates volatility) “Hedged” strips out equity charact.
• Not investable Investable

Question 10

Private Equity Types

Answer 10

Types

• Venture capital - investing in private firms (J curve)
  
  • High failure rate
  • Less cash flows
  • Not leveraged
• Buyout funds - buy public firm and take private
  
  • Earlier and steady cash flows
  • Less error in measuring returns
  • Less upside potential

Question 11

PE Traits

Answer 11

• High failure rate
• Structure/price negotiated
• Internal (nonpublic) information may be used
• Involves active role is managing business

Question 12

PE Vocabulary

Answer 12

• Seed: for market research/ R&D
• Start-up: pre-revenue to bring idea to life
• Mezzanine: funding to IPO
• Angel Investor: first investors
• VC: specialist providing financing and expertise

Question 13

Private Equity

Direct vs Indirect Investing

Answer 13

• Direct
  
  • Convertible Preferred Stock
    
    • First claim on cash flow and assets
• Indirect
  
  • Through LPs or LLCs
    
    • Provides tax advantages (avoids double tax)
    • GP - selects and manages, plans exit

Question 14

Private Equity

Fee Structures

Answer 14

• Annual base fee: 1.5-2.5%
• Carried interest fee: incentive fee after investors capital returned
• Performance fee: % of profits above hurdle rate or preferred return
• Claw-black: reclaim fees if fund doesn’t meet minimum return

Question 15

Private Equity

Issues

Answer 15

• High risk and return
• Illiquid
• Long time horizon, 7+ years
• Limited information
• Lack of marketability and control may lower valuations

Question 16

Commodities

Direct vs Indirect Investment

Storable vs Nonstorable

Answer 16

Direct Indirect

Cash purchase Buy companies (mining company)
Long derivatives Mutual Fund/ETFs

Storable Nonstorable

Metal, gold, energy Agriculture
Inflation hedge No inflation hedge

Question 17

Commodities

Benchmarks

Weighting Typpes

Answer 17

1. Based on long only futures contract prices (Dow Jones)
2. Replicable and Investable

Two weighting types:

Worldwide production
Perceived worldwide importance

Question 18

Commodities

Return Sources

Answer 18

Formula: Total return = collateral return + spot return + roll return

• ​Collateral Yield: known in advance
• Spot Return: ▲ in futures price (F_t - F₀)
• Roll Yield
  
  • (F_t - F₀) - (S_t - S₀)
  • Backwardation: F₀ < S₀ positive roll
  • Contango: F₀ > S₀ negative roll

Example: Futures price changed by $6, the spot return is $2, collateral return is $1.

Roll return = 6 - 2 = 4, Total return = 1 + 2 + 4 = 7

Question 19

Managed Futures Traits

Answer 19

Skilled based investment

Uses derivatives markets (futures/options) going long/short

Question 20

Hedge Funds

Issues and Concerns

Answer 20

• investment characteristics change over time
• survivorship and backfill bias
• due diligence issues (many are unregulated)
• Understated std (risk) and correlation
• Overstated Sharpe ratio
• Infrequency pricing leads to smoothing

Question 21

Fund of Funds Pros and Cons

Answer 21

ProsCons

• Shortened due diligence process Double management fees
• Can replicate a HF index Higher change of style drift
• Diversification