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Intra - Alternative Investments > Chap 2 - The Environment of Alternative Investments > Flashcards

Chap 2 - The Environment of Alternative Investments Flashcards

1
Q

In the financial markets, who constitute the buy side ?

A

Definition: Institution purchasing assets for their portfolios

Examples
* Pension funds (plan sponsors)
* Sovereign wealth funds
* Foundations and endowments
* Family Offices
* Private Limited Partnerships
(PLP)
* Investment Pools
* Managed Accounts

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2
Q

In the financial markets, the buy side what are the Separately Managed Accounts ?

A
  • An SMA investor owns the assets as a registered owner
  • An SMA may have objectives specific to a particular investor, e.g. taxation.
  • SMA offers transparency to investors
  • An SMA offers its investor real portfolio liquidity
  • An SMA format exposes investors to losses in excess of their investment when
    leverage or derivatives are used.
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3
Q

In the financial markets, who constitute the sell side ?

A

Definition: The Sell Side acts as an agent or intermediary for investors when they trade.

Types of company :
* Dealers within money center banks
* Investment Banks
* Retail or executing brokers
* Proprietary Trading Firms
* Full-service brokers, including Prime
Brokers

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4
Q

From the sell side, what is Prime Brokerage ?

A

Prime Brokerage
* Due to the complexity of hedge fund investments, Investment Banks, Dealers and other
financial institutions offer Prime Brokerage
Services :
* Borrowing/Lending shares or cash
* Helping to find new investors
* Organizing financing
* Offering research
* Serve as custodian
* Offer financial and tax advice

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5
Q

Who are the service providers ?

A

Service providers :

  • Prime Brokers
  • Accountants
  • Auditors
  • Directors
  • Law firms
  • Infrastructure and technology firms
  • Consultants
  • Custodians and banks
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6
Q

What is a limited liability ?

A

Definition:
* Potential loss limited to a fixed amount, such as the amount invested in an asset.

Passive investment;
To benefit from this protection, most jurisdictions require that the investor or manager is not actively engaged in controlling the company’s operations.

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7
Q

What are Limited Liability Companies ?

A

Definition :
* Separate entity designed to protect investors against losses in excess of their investments

  • Does not require that distributions and other ownership benefits be made in proportion to each member’s capital contribution to the business
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8
Q

How does a Master-Feeder Funds works ?

A

How it works :

  • Designed to provide efficient access for investors who are subject to different tax regimes but wish to invest in the same portfolio.
  • The master trust is the legal structure
    (usually offshore) used to invest in the assets of onshore and offshore investors.
  • A feeder fund is a legal structure through which investors with a common tax preference can gain efficient access to the tax system.
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9
Q

What are the Documents needed for setting up a hedge fund ?

A

Documents :

1) Private-placement memoranda
2) Limited Partnership agreement
* Investor protection clauses
* Economic clauses
3) Subscription agreement
4) Management Company Operating Agreement

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10
Q

What is a liquid alternative investments ?

A

Definition :

  • An investment vehicle that provides access to alternative investment strategies
    while offering the liquidity of financial markets.
  • Aim to be more accessible to retail investors.
  • Can be bought/sold on a daily basis
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11
Q

What is a REITs ?

A

REITs (Real Estate Investment Trust) :

  • A real estate investment trust is a corporation that owns, operates or finances
    income-producing real estate.
  • Enables individual investors to earn dividends on their real estate investments, without
    having to buy, manage or finance properties themselves.
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12
Q

What are some benefits of liquid alternative Investments ?

A

Benefits :

  • Retail access
  • Access to real estate, private equity, real assets global macro, long and short
    equity and multi-strategy investments
  • Fees
  • Liquidity
  • Diversification
  • 401K eligibility (like an RRSP)
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13
Q

What are some drawbacks of liquid alternative Investments ?

A

Drawbacks :

  • Leverage and concentration limits
  • Returns different from those of private funds or direct investments
  • Not all alternative strategies are eligible
  • Lower returns for less liquid strategies when compared to private funds or direct
    investments
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14
Q

What are the major four categories of participants ?

A

The buy side, sell side, outside service providers and regulators.

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15
Q

Who are the buy side ?

A

Buy side refers to the institutions and entities that buy large quantities of securities for
the portfolios they manage. Buy side entities include asset owners and asset managers.

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16
Q

What is a Plan sponsor ?

A

A plan sponsor is a designated party, such as a company or
an employer, that establishes a health care or retirement plan (pension) for
employees that has special legal or taxation status, such as a 401(k) retirement plan in the United States or a superannuation fund in Australia. Plan sponsors are companies or other collectives that establish the health care
and retirement plans for the benefit of the organization’s employees or members.

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17
Q

What is a foundation ?

A

A foundation is a not-for-profit organization that donates funds and support to other organizations for its own charitable purposes.

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18
Q

What is a endowment ?

A

An endowment is a fund bestowed on an individual or institution (e.g., a museum, university, or hospital) to be used by that entity for specific
purposes and with principal preservation in mind.

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19
Q

What is a Family office and private wealth ?

A

Family office and private wealth: Family office and private wealth institutions are private management advisory firms that serve ultra-high-net-worth
investors. A family office is a group of investors joined by familial or other
ties who manage their personal investments as a single entity, usually hiring professionals to manage money for members of the office.

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20
Q

What is a Sovereign wealth funds ?

A

Sovereign wealth funds: Sovereign wealth funds are state-owned investment funds held for the purpose of future generations and/or to stabilize the state currency. These funds may emanate from budgetary and trade surpluses, perhaps through exportation of natural resources and raw materials such as oil, copper, or diamonds.

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21
Q

What is a Private limited partnerships ?

A

Private limited partnerships: Private limited partnerships are a form of business organization that potentially offers the benefit of limited liability to the organization’s limited partners (similar to that enjoyed by shareholders of corporations) but not to its general partner. For tax purposes, limited partnerships tend to flow taxable revenue and expenses directly through to their partners rather than being taxed at the partnership level.

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22
Q

What is a Private investment pools ?

A

Private investment pools: Hedge funds, funds of funds, private equity funds,
managed futures funds, commodity trading advisers (CTAs), and the like
are private investment pools that focus on serving as intermediaries between
investors and alternative investments.

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23
Q

What is a Separately managed accounts ?

A

Separately managed accounts: Separately managed accounts (SMAs) are
individual investment accounts offered by a brokerage firm and managed
by independent investment management firms. The relationship between
an investment adviser and a client to whom advice is provided is typically
documented by a written investment management agreement.

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24
Q

What are the five main differences between SMA’s and pooled investment arrangements (funds) ?

A
  1. A fund investor owns shares of a company (the fund) that in turn owns
    other investments, whereas an SMA investor actually owns the invested
    assets as the owner on record.
  2. A fund invests for the common purposes of multiple investors, whereas an SMA may have objectives tailored to suit the specific needs of its only investor, such as tax efficiency.
  3. A fund is often opaque to its investors to promote confidentiality; an SMA offers transparency to its investor.
  4. Fund investors may suffer adverse consequences from other investors’
    redemptions (withdrawals) and subscriptions (deposits), but an SMA
    provides protection from these liquidity issues for its only investor.
  5. Whereas the fund structure may allow investors to have limited liability, the SMA format may allow losses to be greater than the capital
    contribution when leverage or derivatives are used.
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25
Q

What is a Mutual funds (’40 Act funds) ?

A

Mutual funds (’40 Act funds): Mutual funds, or ’40 Act funds, are registered
investment pools offering their shareholders pro rata claims on the fund’s portfolio of assets. In the United States, mutual funds that offer their shares for sale to the public are known as ’40 Act funds.

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26
Q

What is a UCITS (Undertakings for Collective Investment in Transferable Securities) ?

A

UCITS (Undertakings for Collective Investment in Transferable Securities): Regulation of public funds in Europe centers on the concept of
UCITS. UCITS allow retail access and marketing of hedge-fund-like investment pools, somewhat akin to the retail access and marketing of ’40 Act funds in the United States. UCITS conform to European regulations such
that the product can be sold throughout the various members of the EU. They are subject to strict regulations (diversification,minimum size, annual audit, etc.)

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27
Q

What is a Master limited partnerships (MLP’s) ?

A

Master limited partnerships: Master limited partnerships (MLPs) are publicly traded investment pools that are structured as limited partnerships and that offer their owners pro rata claims. Like equities, MLP units are traded on major stock exchanges, but they have legal and tax structures similar to those of private limited partnerships.

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28
Q

Who constitutes the sell side and what is their purpose ?

A

Sell-side institutions, such as large dealer banks, act as agents for investors when they trade securities. Sell-side institutions make their
research available to their clients and are more focused on facilitating transactions than on managing money.

29
Q

What is a Large dealer banks ?

A

Large dealer banks: Large dealer banks are major financial institutions that deal in securities and derivaties. Generally, most large dealer banks act as intermediaries in the markets for securities, repurchase agreements, securities lending, and over-the-counter (OTC) derivatives. In addition, large dealer banks are often engaged in proprietary trading. Large dealer banks also have large asset management divisions that cater
to the investment management needs of institutional and wealthy individual clients.

30
Q

What is a Broker ?

A

Brokers that receive commissions for
executing transactions and that have research departments that make investment recommendations. Brokers play the role of middlemen in the trading process, traders can use broker services when they want to remain anonymous to other traders.

31
Q

What is Proprietary trading ?

A

Proprietary trading: occurs when a firm trades securities with its own money in order to make
a profit. Large dealer banks serve as counterparties to OTC derivatives such
as options, forwards, and swaps that require the participation of a counterparty dealer who meets customer demand by taking the opposite side of a
desired position.

32
Q

What are the sources of revenue for a broker ?

A

Other sources of broker revenue include soft commissions, payments for order flow, interest on margin loans, short interest rebates (on short sales), underwriting fees when the firm helps clients sell securities, and mergers and acquisitions (M&A) fees.

33
Q

What are front/back office operations ?

A

Brokerage firms and other firms with major investment activities organize their activities into three major operations: (1) front office, (2) back
office, and (3) middle office. Front office operations involve investment
decision-making and, in the case of brokerage firms, contact with clients.
Back office operations play a supportive role in the maintenance of accounts and information systems used to transmit important market and trader information in all trading transactions, as well as in the clearance and settlement of the trades. Middle office operations form the interface between the front office and the back office, with a focus on risk management.

34
Q

Who constitutes the Outside service providers ?

A

Other major participants in the world of alternative investments are outside service providers, such as prime brokers, accountants, attorneys, and fund administrators.

35
Q

What is a Prime brokers ?

A

Prime brokers: Prime brokers allow an investment manager to carry out trades in multiple financial instruments at multiple broker-dealers while keeping all cash and securities at a single firm, and have the following primary functions: clearing and financing trades for clients, providing research, arranging financing, borrowing and lending securities, and producing portfolio accounting. Prime brokers offer a range of services.
Prime brokers have a powerful tool in their ability to make margin calls. The ultimate threat is that the prime
broker can seize collateral from the hedge fund manager and liquidate the collateral to raise cash.

36
Q

What is a Accountants and auditors ?

A

Accountants and auditors: The accounting firm providing services to a hedge
fund or to another alternative investment fund should include an experienced auditor and tax adviser. During the creation of the fund or investment vehicle, the accounting firm provides services largely parallel to those of an attorney: reviewing legal documents to ensure that accounting methods and allocations are appropriate and feasible, and that relevant tax issues
have been addressed.

Accountants usually cooperate with the prime broker and
fund administrator to gather the necessary information for audits and tax
returns.

37
Q

What is an Attorney ?

A

Attorneys: An attorney helps determine the best legal structure for a fund’s unique investment strategies, objectives, and desired investors. The attorney takes care of filing any documents required by the government (federal or other levels) and creates the legal documents necessary for establishing
and managing a hedge fund or another alternative investment.

38
Q

What is a Fund administrators ?

A

Fund administrators: Many hedge funds and other alternative investment
funds now engage a fund administrator to be responsible for bookkeeping, third-party information gathering, and securities valuation functions for all of their funds, both onshore and offshore. The fund administrator has ten roles: (1) maintains a general ledger account, (2) marks the fund’s books, (3) maintains its records, (4) carries out monthly accounting, (5) supplies its monthly profit and loss (P&L) statements and calculates its returns, (6) verifies asset existence, (7) independently calculates fees, (8) provides an unbiased, third-party resource for price confirmation on security positions, (9) produces a monthly capital account statement for investors, and (10) apportions fund income or loss among them.

The administrator takes over the duties of day-to-day accounting and bookkeeping so that managers can focus on maximizing the portfolio’s returns.

39
Q

What is a Hedge fund infrastructure ?

A

Hedge fund infrastructure: Hedge funds can require a complicated infrastructure and extensive technological systems. The hedge fund infrastructure
may have three main financial components: (1) platforms, (2) software, and
(3) data providers.

Financial platforms are systems that provide access to
financial markets, portfolio management systems, accounting and reporting
systems, and risk management systems.

Financial software may consist of
prepackaged software programs and computer languages tailored to the
needs of financial organizations.

Financial data providers
supply funds primarily with raw financial market data, including security
prices, trading information, indices, and company-specific information
such as income statements and balance sheets.

40
Q

What is a Consultants ?

A

Consultants: Consultants may be hired by pensions, endowments, or highnet-worth individuals to provide a number of roles and services that center
on advice, analysis, and investment recommendations.

Consultants are increasingly being used to serve the role of chief investment officer in small organizations. The role of an outsourced chief investment officer (OCIO) ranges from performing all of the decision-making
duties of an in-house chief investment officer to a reduced role of assisting
staff with a subset of decisions.

41
Q

What is a Depositories and custodians ?

A

Depositories and custodians: Depositories and custodians are very similar
entities that are responsible for holding their clients’ cash and securities and
settling clients’ trades, both of which maintain the integrity of clients’ assets
while ensuring that trades are settled quickly. The Depository Trust Company (DTC) is the principal holding body of securities for traders all over the
world and is part of the Depository Trust and Clearing Corporation (DTCC),
which provides clearing, settlement, and information services.

42
Q

What is a Bank (Commercial and Investement) ?

A

Banks: A commercial bank focuses on the business of accepting deposits and
making loans, with modest investment-related services. An investment bank
focuses on providing sophisticated investment services, including underwriting and raising capital, as well as other activities such as brokerage services,
mergers, and acquisitions.

43
Q

What can cause a conflict of interest for a consultant ?

A

Consulting conflicts of interest
can emerge when consultants are compensated by money managers because
this form of payment can detract from the ability to offer independent advice
to clients and encourage the consultant to favor the money managers offering compensation. Further, the compensation that consultants receive from
money managers is undisclosed and can be quite substantial.

44
Q

What is a limited liability ?

A

Limited liability is the restriction of potential loss to a fixed sum, such as the amount invested in an asset. For example, a fund manager who incorporates might be protected from losses beyond the assets of the corporation. Receiving this protection in most jurisdictions requires that the investor or manager not be actively engaged in control of the firm’s operations.

45
Q

What is a passive investment ?

A

In the context of investment strategies, passive investments can refer to buy-and-hold strategiesoften designed to match the risk and return of an index.

Passive investments are positions in entities (such as operating firms
or investment firms) over which the owner of the position does not exert substantial control and therefore may receive reduced liability exposures and/or passive investment tax treatments.

46
Q

What is a corporation ?

A

A corporation is a legal entity in which its shareholders receive distributions on a pro rata or pari passu basis and which generally provides limited liability for passive investors.

47
Q

What is a limited liability company (LLC) ?

A

A limited liability company (LLC) is a distinct entity: (1) designed to offer
its investors (“members”) protection from losses exceeding their investments absent fraud or other activities that could “pierce the veil” between the member’s ownership interest in the LLC and the member’s other holdings, and (2) that does not require that distributions and any other advantages of ownership be made in proportion to each member’s capital contribution to the firm. Thus, unlike a corporation in which dividends are paid to owners (shareholders) based on the number of shares held, an LLC may be structured to make distributions to members with or without consideration of ownership percentages.

48
Q

A bankruptcy-remote entity is often structured as a special purpose vehicle or entity. A special purpose vehicle (SPV) or special purpose entity (SPE) is a legal entity such as an LLC that serves a specific function (such as holding assets), often with the goal of being bankruptcy remote. A bankruptcy-remote entity is designed
to provide protection from involvement in potential bankruptcy proceedings of the entities placing assets in the vehicle.

A

True

49
Q

What is the structure of a master-feeder trust ?

A

A feeder fund is a legal structure through which investors with common preferences with regard to taxation can have efficient access to the investment performance of the master trust. In the simplified
case of two types of investors (onshore and offshore), the investors use separate feeder funds to access the master trust. Investors in both of these feeder funds benefit from the separation of funds because tax consequences flow appropriately to each
investor. Together, the master trust and feeder funds are referred to as a master-feeder
structure.

50
Q

What is the purpose of the master trust and the tax consequences ?

A

The purpose of the master trust is tax neutrality, not evasion. In Bermuda, for
example, master trust funds pay only a corporate licensing fee, not corporate income tax. This ensures that there are no tax consequences to the fund investors at the master trust level. Instead, the tax consequences for the investors occur at their country of domicile based on the relevant feeder fund. Investors in the onshore,
or U.S.-based, feeder fund are subject to the U.S. Internal Revenue Code, whereas investors in the offshore feeder fund are subject to the tax codes of their respective domiciles.

51
Q

What are the four key documents used in establishing and managing a hedge fund, private equity fund, or other private partnership ?

A

There are four key documents used in establishing and managing a hedge fund, private equity fund, or other private partnership: (1) private-placement memoranda
(a.k.a. the offering memorandum), which include the formal description of an investment opportunity that complies with securities regulations; (2) a partnership agreement (a.k.a. a limited partnership agreement), which is a formal written contract
creating a partnership; (3) a subscription agreement, which is an application submitted by an investor who desires to join a limited partnership; and (4) a management
company operating agreement, which is an agreement between members related to a
limited liability company and the conduct of its business as it pertains to the law.

52
Q

What are the two main categories of clauses of an limited partnership agreement (LPA) ?

A

The LPA has two main categories of clauses: (1) investor protection clauses and (2) economic terms clauses. Investor protection clauses cover investment strategy, including possible investment restrictions, key-person provisions, termination and
divorce, the investment committee, the LP advisory committee, exclusivity, and conflicts. Economic terms clauses include management fees and expenses, the GP’s contribution, and the distribution of cash (i.e., the waterfall). The distribution waterfall
defines how returns are split between the LP and GP and how fees are calculated.

53
Q

What is Adverse selection ?

A

Adverse selection takes place before
a transaction is completed, when the decisions made by one party cause less desirable parties to be attracted to the transaction.
Example, an LP wants a GP with low fees and could potentially attract unskilled candidates that claim to be skilled.

54
Q

What is Moral Hazard ?

A

Moral hazard, in contrast, takes place after a transaction is completed and can be
defined as the changes in behavior of one or more parties as a result of incentives that come into play once a contract is in effect.
Example, without proper monitoring,
a GP may take excessive risk in order to increase the potential performance fee, or
an unskilled manager may decide not to take substantive risk and just collect the
management fee.

55
Q

What is a qualified majority ?

A

A qualified majority is generally more than 75%
of LPs in contrast to the over 50% required for a simple majority.

56
Q

What are Primary and Secondary markets ?

A

A primary market refers to the methods, institutions, and mechanisms
involved in the placement of new securities to investors.

A secondary market facilitates trading among investors of previously existing securities.

57
Q

New issues are sold in primary capital markets and distributed by an underwriter, who is responsible for the organization, risk bearing (during placement), and distribution (or sale) of newly issued securities. Investment banks serve as underwriters for the placement of traditional investments. For example, investment banks place
new equity issues that originate either as new and additional shares in existing securities (secondary issues) or as first-time issues of shares not previously traded (initial public offerings, or IPOs).

A

True

58
Q

What is Securitization ?

A

Securitization involves bundling assets, especially unlisted assets, and issuing claims on the bundled assets. The securities are registered and sold in the public market. Securitization can allow banks to divest loans and operating firms to divest illiquid assets such as accounts receivable to lay off risk and obtain cash.

59
Q

What is a Third market ?

A

Third markets are regional exchanges where stocks listed in primary secondary markets can also be traded. Third markets represent a segment of the OTC market where nonmember
investment firms can make markets in and trade securities without going through the
exchange.

60
Q

What is a Fourth market ?

A

Fourth markets are electronic exchanges that allow traders to quickly buy and
sell exchange-listed stocks via the electronic communications systems offered by these
markets. Because of the anonymity of traders within these electronic networks, registered broker-dealers provide sponsorship for these systems so that traders have
an alternative system to physical exchanges to buy and sell stocks.

61
Q

What is systemic risk ?

A

Systemic risk is the potential
for economy-wide losses attributable to failures or concerns over potential failures
in financial markets, financial institutions, or major participants. For example, the
collapse of a very large hedge fund may lead to a sequence of collapses and failures that disrupt the financial system and cause widespread economic losses, not so
much from the direct asset losses of the collapse as from the inability of the other
market participants to trade and manage risks due to the uncertainty that is generated.

62
Q

What are the five primary forms of hedge fund regulation ?

A
  1. Requirements regarding establishing a hedge fund, including registration, licensing, minimum capital, and waiting periods
  2. Registrations or restrictions on investment advisers and hedge fund managers
  3. Restrictions on distribution and marketing of hedge funds, including which marketing channels may be used (e.g., banks), whether advertising is permitted, and
    to whom funds may be sold
  4. Restrictions on operation of a hedge fund, including leverage, liquidity, risk,
    reporting, and location of outside service providers
  5. Requirements regarding ongoing reporting
63
Q

The nature of the liquidity offered by liquid alternatives might better be
described as “offering retail access” rather than “being able to be converted into
cash quickly,” the reason being that many alternatives, such as managed futures funds
and structured products, have offered daily liquidity for years but are not commonly
viewed as liquid because the products have been predominantly accessible only to
institutional and high-net-worth investors.

A

True

64
Q

What are the five distinct types of liquid alternative funds ?

A
  1. Unconstrained clones: These liquid funds follow virtually the same strategy
    as private placement products with underlying liquid assets, such as some hedge
    funds or managed futures funds.
  2. Constrained clones: These liquid funds implement a similar strategy as private placement products but are limited in risk exposure by leverage, concentration, or liquidity constraints.
  3. Liquidity-based replication products: These liquid funds are designed to
    mimic illiquid private placement investments, using liquid securities as proxies.
  4. Skill-based replication products: These liquid funds are designed to mimic a
    highly skilled private placement strategy using a simplified and more mechanical
    strategy.
  5. Absolute return or diversified products: These liquid funds are designed
    to offer absolute returns and/or diversifying returns not directly related to opportunities historically available in private placements and potentially inconsistent
    with alternative strategies as typically deployed.

They tend to be
offered by institutions with expertise in traditional investments that are responding
to investor preferences for investment products that offer diversification relative to traditional equity and bond markets.

65
Q

What is a Closed-end mutual fund
structure ?

A

Closed-end mutual fund
structures provide investors with relatively liquid access to the returns of underlying
assets even when the underlying assets are illiquid.

66
Q

What is a rebate ?

A

A rebate is a payment of interest to the securities’ borrower on the collateral posted. A typical rebate is a little less than current short-term market interest rates

67
Q

A special stock is a stock for which higher net fees are demanded when it
is borrowed. To the short seller, this means receiving a smaller rebate. For example,
general collateral stocks, which are stocks not facing heavy borrowing demand, may
earn a 2% rebate when risk-free rates are at 2%, whereas stocks on special may earn
zero rebates or even negative rebates, wherein borrowers must pay the lenders money
in addition to the interest that the lender is earning on the collateral.

A

True

68
Q

What is a short squeeze ?

A

A short squeeze occurs when holders of short positions
are compelled to purchase shares at increasing prices to cover their positions due
to limited liquidity. As the ratio of shares being sold short increases relative to the
total number of freely floating shares, it becomes increasingly difficult to borrow
additional shares, and the potential for a short squeeze increases.

Intra - Alternative Investments (14 decks)

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