CH20 Flashcards
What are traditional assets?
Stocks, bonds, bills
Traditional assets are the primary forms of investment that most investors are familiar with.
What are alternative assets?
Hedge funds, private equity, real assets, structured products
Alternative assets have gained popularity in recent years alongside traditional assets.
What is a hedge fund?
Investment pools with net asset value (NAV) representing the investor’s stake
Hedge funds often employ diverse strategies to achieve high returns.
What is private equity?
Investment pools aiming to generate value through direct impact
This includes angel investors, venture capital, and leveraged buyouts.
What are real assets?
Real estate, natural resources, commodities
Real assets are tangible assets that have intrinsic value.
Define structured products.
Combinations of securities and derivatives generating market-linked outcomes
Structured products are designed to provide customized risk exposures.
What is the transparency level of traditional assets?
Subject to the Securities Act of 1933 and the Investment Company Act of 1940
Traditional assets have predictable strategies and regular updates on portfolio composition.
What is the transparency level of alternative assets?
Limited information on strategy and portfolio composition
Hedge funds and private equity funds are less regulated than traditional assets.
Who are typical investors in traditional assets?
Individuals, institutions
Traditional assets are accessible to a wide range of investors.
Who are typical investors in alternative assets?
Accredited investors with net worth, income requirements, or professional certifications
Alternative assets often require more sophisticated knowledge and resources.
What is a key investment strategy for traditional assets?
Avoid style drift, limited leverage, restricted derivative use
Traditional investment strategies focus on stability and predictability.
What is a key investment strategy for alternative assets?
Opportunistic actions, flexibility in strategies
Hedge funds and private equity can adapt quickly to market changes.
What is liquidity in traditional assets?
Higher liquidity, meeting liquidity needs
Traditional assets can typically be bought or sold quickly.
What is liquidity in alternative assets?
Lock-up periods, redemption notices, structural illiquidity
Investors in alternative assets may face restrictions on when they can withdraw funds.
What is the fee structure for traditional assets?
Management fees are a fixed percentage of assets under management
Traditional investment vehicles generally have simpler fee structures.
What is the fee structure for alternative assets?
Management fees typically 1% to 2%, plus incentive fees around 20% of profits
Alternative assets often have more complex fee arrangements.
What defines a directional strategy in hedge funds?
Speculation that one market sector will outperform others
Directional strategies rely on market predictions.
What defines a nondirectional strategy in hedge funds?
Exploiting temporary misalignments in relative pricing
Nondirectional strategies aim to be market neutral.
What is statistical arbitrage?
Use of quantitative systems to uncover pricing misalignments
This strategy seeks to ensure profit through statistical analysis.
What is pairs trading?
Establishing long/short positions to exploit relative mispricing
Pairs trading involves analyzing correlated securities.
What is a portable alpha strategy?
Invest in positive-alpha positions, hedge systematic risk, establish market exposure
This strategy allows the transfer of alpha across asset classes.
What characterizes angel investors?
Wealthy individuals investing in early-stage business development
Angel investors often work through networks to fund startups.
What is venture capital?
Professionally managed money investing in startups
Venture capitalists typically seek high returns by funding innovative companies.
What are Angel Investors?
Wealthy individuals or families that invest in the earliest stages of business development
Often syndicated through angel networks
What is Venture Capital (VC)?
Professionally managed money that invests in startups
Two forms: Independent VC funds or corporate venture capital
How are VC funds typically structured?
As limited liability partnerships
General Partners control funds under management while Limited Partners provide capital
Define Vintage Year in the context of venture capital.
The first year of the venture fund when raised capital is first deployed
It influences expected fund performance
What is a Term Sheet?
The written agreement specifying the deal structure
Includes stock type, dividends, voting rights, capital invested, ownership, liquidation preferences, and anti-dilution measures
What determines required ownership per dollar invested in private equity valuation?
Value determined by a required capital multiplier
Terminal ownership share = Initial Investment × Capital Multiplier
How does an early-stage VC project terminal ownership share?
By using the formula: Terminal ownership share = Initial Investment × Capital Multiplier
Example: $2,000,000 investment with a target exit multiple of 10×
What is a Leveraged Buyout (LBO)?
LBO Funds take public companies private through invested equity and massive amounts of debt
Typically involves 10% to 40% equity and 60% to 90% debt
What is the typical exit strategy for LBOs?
Exit through IPO or acquisition, typically 10 years from initial purchase
What performance metrics are commonly used to evaluate hedge funds?
Excess Sharpe ratio, alpha, and information ratio
What is survivorship bias in hedge fund performance measurement?
Occurs when unsuccessful funds that cease operation stop reporting returns
Leaves only successful funds in the database
What are tail events?
Extreme but rare occurrences that fall into the far-left tail of the probability distribution
What is Jensen’s alpha?
The average return on the portfolio over and above that predicted by the CAPM
Given the portfolio’s beta and average market return
What does the Information Ratio measure?
Divides the alpha of the portfolio by the nonsystematic risk of the portfolio
What is the impact of industry specialization on VC performance?
Publicly traded companies backed by industry-specific VCs tend to perform better and survive longer
Compared to those backed by generalist VCs
What is grandstanding in venture capital?
The practice of bringing companies to public market too early
May damage VC reputation in the long run
What is the general trend in hedge fund performance since 2010?
General downward trend in excess Sharpe ratio and Information ratio, but alphas are still generally positive
What is the typical capital structure of an LBO?
Equity (10% to 40%) and debt (60% to 90%)
What is the performance comparison between VC-backed companies?
Companies backed by industry-specific VCs tend to perform better and survive longer than those backed by generalist VCs.
What is the typical annual management fee for hedge funds?
1% to 2% of assets.
What is the typical incentive fee for hedge funds?
20% of investment profits beyond a stipulated benchmark performance.
How are incentive fees structured in hedge funds?
Incentive fees are effectively call options, where the manager gets the fee if the portfolio value rises but loses nothing if it falls.
What does the strike price represent in hedge fund incentive fees?
Current portfolio value × (1 + benchmark return).
What is a high-water mark in hedge fund management?
The previous value of a portfolio that must be reattained before incentive fees can be charged.
What is the purpose of a high-water mark?
To give managers an incentive to shut down funds that have performed poorly.
What are funds of funds?
Investment funds that invest in other funds rather than directly in securities such as stocks or bonds.
What is the first distribution tier in private equity?
First distributions flow 100% to LP until invested capital is returned.
What is a hurdle rate in private equity?
A promised rate (often 8%) entirely to the LP before any incentive fee is distributed.
How do GPs collect carried interest in private equity?
Through use of a catch-up provision until 80%/20% parity.
What happens to distributions after the hurdle rate is met?
Remaining distributions go 80% to LPs and 20% to GPs (incentive fee).
What is a clawback provision in private equity?
Allows LPs to reclaim part of the GP’s paid carried interest in the event of severe losses.
What are the typical management and incentive fees in private equity?
2% management fee and 20% incentive fee.
Fill in the blank: A fund of funds has a hurdle rate for the incentive fee of a _______.
zero return.
If a fund of funds has $1 million invested and an aggregate portfolio return of -5%, what incentive fees does it still pay?
$0.12 for every $3 invested.
