Chapter 20 - Alternative Investments: Benefits, Risks, and Structure (Done) Flashcards
What are alternative investments?
Alternative investments are asset classes different from the traditional ones of equity, bonds, and cash. They include alternative strategy funds, alternative assets like real estate and commodities, and private equity.
What are the three types of alternative strategy funds?
The three types are relative value (exploiting discrepancies in pricing), event-driven (involving corporate transactions like mergers), and directional strategies (profiting from anticipated price movements).
What are some examples of alternative assets?
Examples include real estate, commodities, collectibles, infrastructure, and natural resources.
What is private equity?
Private equity involves common stock, preferred stock, and debt securities of private firms, differing from publicly traded stocks or debt.
What are the benefits of alternative investments?
Benefits include portfolio diversification and the potential for higher risk-adjusted returns, helping to reach the efficient frontier for optimal risk-return balance.
What are some risks associated with alternative investments?
Risks include market risk, liquidity risk, leverage risk, deal breakage risk, concentration risk, pricing model risk, trading model risk, and operational risk.
What are hedge funds?
Hedge funds are lightly regulated pools of capital with flexible management strategies. They are often limited to high-net-worth individuals or institutions.
What is a high water mark in hedge funds?
A high water mark ensures that hedge fund managers only earn incentive fees on returns that exceed the highest previous value of the fund.
What is a hurdle rate in hedge funds?
A hurdle rate is the minimum return a hedge fund must earn before its managers are paid an incentive fee, calculated only on returns above this rate.
How do hedge funds compare to mutual funds and liquid alternatives in terms of liquidity?
Hedge funds are less liquid, typically priced monthly, and may have initial lock-up periods, unlike mutual funds which are priced daily.
What are liquid alternatives (liquid alts)?
Liquid alts are similar to mutual funds but offer access to alternative strategies with daily liquidity, transparency, and lower minimum investment requirements compared to hedge funds.
What are the advantages and disadvantages of funds of hedge funds?
Advantages include due diligence, reduced volatility, professional management, access to hedge funds, and diversification with smaller investments. Disadvantages include additional costs, no guarantees of positive returns, and potential over-diversification.
How do mutual funds, hedge funds, and liquid alts differ in terms of transparency and reporting?
Mutual funds offer higher transparency with monthly and quarterly reporting of holdings, while hedge funds report semi-annually or annually. Liquid alts are similar to mutual funds in transparency.
What are the investment objectives of mutual funds, hedge funds, and liquid alts?
Mutual funds aim for maximum relative returns, hedge funds seek maximum absolute returns with downside protection, and liquid alts have similar objectives to hedge funds.
How do mutual funds, hedge funds, and liquid alts differ in terms of permitted borrowing and leverage?
Mutual funds have stricter borrowing limits (5% of NAV), hedge funds have flexibility as set by their memorandum, and liquid alts allow up to 50% leverage and 300% aggregate gross exposure.
