Chapter 5: Special asset classes (2) Flashcards
Asset-backed securities
Resulting securities issued from a securitisation. Pay coupons based on the cashflows generated by the securitised assets.
Securitisation
The issue of securities, usually bonds, where the bonds are serviced and repaid exclusively out of a defined element of future cashflow owned by the issuer. A way for a company to raise finance
Classes of asset backed securities (ABSs)
- residential and commercial mortgage-backed securities (MBS)
- credit card receivables (CCABS)
- collateralised loan, bond and debt obligations (CLO, CBO and CDOs)
- insurance securitisations
SPV
A subsidiary created by a company to isolate financial risk. Bankrupty remote with regard to the orignal company.
Structure of asset-backed securities
Cashflows from the portfolio are normally made in multi-tranche format involving several differently ranking levels of debt, e.e. senior, mezzanine and equity. This is done to appeal to the various risk/return preferences of different investors, thereby reducing the overall cost of capital.
Private equity
Private equity is the provision of equity capital where there is no immediate exit route via the secondary market, i.e. investment in unquoted securities
Forms of private equity
- Venture capital
- Leveraged buy-outs (Management buy-outs and buy-ins)
- Development capital
- Restructuring capital
Venture capital
Capital for businesses in the conceptual stage or where products aren’t developed and revenues and/or profits may not have been achieved.
Leveraged buy-outs
Equity capital for acquisition or refinancing of a larger company.
- Management buy-outs - existing management buy-out the owners of the company
- Management buy-ins - when the buyer is an external management team
Development capital
Growth or expansion working capital for mature businesses in need of product extension and/or market expansion
Restructuring capital
New equity for financially or operationally distressed companies
Private equity funds
Providers of private equity brought together
Advantages of private equity
- Out-performs over the long term
- Loosely correlated asset = enhance portfolio performance without materially increasing risk - diversification
Disadvantages of private equity to institutional investors
- lack of liquidity and marketability
- variable past performance record and impacted by survisorship bias
- difficulty in valuation
- need for specialist investment advice
- high costs
- lack of reliable information
- regulatory constraints
- high risk
When are private equity funds appropriate owners of businesses?
May be appropriate owners of business where:
- the risk profile is unsuitable for public ownership
- the cost of capital may be reduced under private ownership (e.g. by using very high levels of financial gearing
- where valuation is difficult in the public arena for any other reason
Hedge fund
Investment fund that aims to meet high or absolute returns by investing across a number of asset classes or financial instruments.
Typically have less restriction on:
- borrowing
- short-selling
- use of derivatives
Classes of hedge funds
- Global macro funds
- Event-driven funds
- Market-neutral funds
- Multi-strategy funds
Global macro funds
These concentrate on economic change around the world and sometimes make extensive use of leverage and derivatives.
Combination of long and short positions that reflect the hedge fund manager’s view on how macroeconomic factors like levels of international asset markets, interest rates and currencies will move.
Event-driven funds
Trade securities of companies in reorganisation and/or bankruptcy (‘distressed’ securities) or companies involved in a merger or aquisition (‘risk arbitrage’)
Market-neutral funds
Simultaneously enter into long as well as short positions at a market or sector level, while trying to exploit individual security price movements
Designed to be market-neutral (beta or currency)
- long portfolio beta is equal to short portfolio beta
- thus performance of fund is not affected by general market movements
- just focus on stock selection profits by exploiting market inefficiencies.
Multi-strategy funds
Invest in a range of investment strategies to provide a level of diversification (of strategy) and helps smooth profits.
- combination of strategies on the same set of assets.
Past performance of hedge funds can be affected by 3 types of bias
- Survivorship bias
- Selection bias
- Marking to market bias
Survivorship bias
When data doesn’t realistically reflect survivors and failures. When emphasis is on survivors, average returns will be over-estimated.
Selection bias
Funds with good history are more likely to apply for inclusion. Backfilling will then cause a significant upward bias.