Chapter 9 - Alternative Investments Flashcards
What Constitutes an Asset Class?
- Homogeneity within
the asset class - Correlation of returns
- Availability of pricing
and composition data - Investability
What are Alternative Investments?
Alternative investments are asset classes that are different from the traditional three broad asset classes of equities, bonds, and cash.
Alternative investments allow the investor to move to a higher efficient frontier by increasing the number of investment opportunities available, increasing portfolio diversification and risk control, and adding superior risk/ return potential to the portfolio.
Explain Hedge Fund and their strategies.
Hedge Funds are pools if capital that are lightly regulated, allowing their fund managers greater flexibility in their choice of investments.
Large short positions, use leverage and derivatives for speculation, perform arbitrage transactions (which exploit perceived price differentials to make a profit), and invest in almost any situation in any market where they see an opportunity to achieve positive return.
What are Commodities?
Commodities are the basic homogenous materials produced and consumed by the world’s economies. Some commodities are used mainly for consumption (the commodity eventually becomes a product that is consumed), while others are used primarily for investment purposes.
Types include: Grain and Seed Oil, Livestock and Meat, Precious Metals, Energy Products.
During a PIMCO Study that commodities provided the highest return of any asset class in the study.
They have the lowest correlation to other asset classes.
They have a positive correlation with inflation, suggesting that they they can provide real inflation adjusted retruns.
What is Real Estate?
Real estate refers to land and/or any of the fixed assets (residences, buildings, and factories) built upon it.
It becomes liquid when it is securitized such as in a REIT.
Traits of Physical Real Estate
- For the average retail investor, residential property is one of the few investments that can be leveraged, or that the investor will feel comfortable leveraging (as opposed to shorting or margining investments).
- Real estate investment costs, similar to other investment fees, can be high.
- The various, and often complex tax issues need to be considered when holding real estate. Municipal taxes, water taxes, school taxes Etc…
- Real estate may represent a significant portion of an investor’s total net worth.
- Real estate competes with market investments, as it provides current consumption value that other
investments may not. - Real estate is sensitive to inflation.
- With potentially long holding periods, depending on the type and purpose of the investment, real estate can
stabilize overall portfolio returns. - Real estate can be considered a bond substitute with an added inflation protection feature.
What is Infrastructure Investment?
Over time, infrastructure deteriorates, and the need arises to repair or replace aging structures and build new projects. These infrastructure needs increase dramatically because of globalization and the growing middle-class in non-Western nations.
Infrastructure investments are characterized by large dollar amounts, long-term investment horizons, and stable,
long-term cash flows. They typically have some aspect of regulated pricing and returns that have low-to-no correlation with stocks, bonds, and cash.
What are Private Markets?
Private equity and credit investing are used for financing firms that are unwilling or unable to find capital using public means. Long-term returns on private investments (private equity in particular) exceed returns on most other asset classes. However, they can also subject investors to considerable downside risk.
Two Main Categories:
1. Private Equity Financing
2. Private Debt Financing
What are kinds of Private Equity Financing
Private equity financing includes buyouts, growth capital, turnaround, and venture capital.
Buyouts:
Leveraged Buyouts is the acquisition of a company primarily being financed through debt.
Growth Capital: Financing of established companies that are seeking liquidity to improve operations.
Turnaround: investing in underperforing or out-of-favour industries that need restructuring.
Venture Capital:
- Early Stage: Whn investment is made in acompany that is in the early states of developing their product.
- Late Stage: For firms that are better established but are still not profitable enough to be self-sufficient. Revenue growth is still very high in these companies.
What is Private Debt Financing?
Non-bank investors are increasingly extending loans directly to firms, with limited or no involvement on the part of banks. This lending, often referred to as private credit or debt financing.
The six prominent Strategies:
- Senior Debt/Credit: The most risk adverse. It has priority of repayment and is often secured by the companies assets.
- Subordinate (Mezzanine) Credit: Used to help companies in the transitionary stages. It fall below Senior credit in priority of repayment and claim on assets in the event of bankruptcy
- Unitrache Credit: A blend of both Senior and Subordinate credit into one blended rate.
- Distressed Credit: Distressed debt funds purchase the debt obligations of firms that are either in bankruptcy or are soon expected to enter bankruptcy. The fund manager anticipates that the current debt obligations of the target firm are mispriced
and that the value of the debt will increase after restructuring. - Credit opportunities: Unlike distressed debt funds, funds that employ an opportunistic strategy can invest in an array of industries and forms of credit investments. These investments can also have short time horizons, such as providing rescue financing to companies that lack short-term liquidity or have debt obligations maturing in the near future.
- Specialty Finance: Fund managers in specialty finance tend to target specific industries that require highly specialized expertise. Investments in this strategy have a wide range, and can include:
- Royalties
- Distressed Credit
- Trade Finance
Advantages Of Private Market Investing
- Superior returns - Long Term
- True security selection
- Absolute return goals
- Access to legitimate inside information
- Influence over management and flexibility of implementation
- Better matching of asset and liability flows for institutional investors
Advantages Of Private Market Investing
- Illiquid investments
- Dependence on key personnel
- Down-market performance
- High management and performance fees
- “Blind pool” investing - investors may not be able to see what they are investing in directly.
- The J-curve effect - funds typically incur losses before being to become profitable which resembles a J
What are Collectibles?
Collectibles are rare and unique manufactured or handcrafted objects that are desirable to individuals. They include
fine art, classic automobiles, rare stamps, and coins.
Typically Reserved for High-Net worth individuals
Risks:
- Illiquid Market
- Pure Capital gains, no income
- High appraisal, Maintenance, Other costs
- High Transaction Cost
- Risk of Fraud
Benefits
- High opportunity revenue
- Potential Price Appreciation
- Lower Correlation to other asset classes
- Illiquid market inefficiencies
What are the different Hedge Fund Strategies and their Market Exposure ? Equites
- Relative value equity strategies (low market exposure hedge fund strategy): Equity market-neutral strategies.
- Event-driven equity strategies (medium market exposure hedge fund strategy): Merger arbitrage.
- Directional equity strategies (high market exposure hedge fund strategy): Long/short equity, global macro, emerging markets, managed futures, and dedicated long or short bias.
What are the different Hedge Fund Strategies and their Market Exposure ? Fixed-Income
- Relative value fixed income strategies (low market exposure hedge fund strategy): Convertible arbitrage and fixed-income arbitrage.
- Event-driven fixed income strategies (medium market exposure hedge fund strategy): Distressed securities and high-yield bonds.
- Directional fixed income strategies (high market exposure hedge fund strategy): Global macro, emerging markets, and managed futures.
What are the two ways investors can invest in futures and futures options.
- Standard managed futures account
- This account is managed on a discretionary basis for the investor by an appropriately trained professional who is currently licensed, called a Commodity Trading Manager (CTM)
- These accounts are generally only distributed to individual investors who qualify as exempt or accredited.
- Commodity Trading Account
- This permits individual investors to trade and manage their commodity futures portfolio themselves/
What are the Benefits and risks of using futures and futures options.
Benefits:
- Direct Exposure to Commodities
- Diversification
- Liquidity
- Low Transactions costs
Risks:
- Excessive Leverage
- Lack of Diversification
List the three Commodity ETFs
- index ETFs
- Commodity ETFs
- Leveraged ETFs
What is a Pure Play in reference to when discussing Commodities
A pure play refers to a commodity-producing company’s operation whose revenues are 100% dependent on the production of the raw commodity itself. Theoretically, the stock return on a pure play would have a high correlation with the return on the commodity price.
What are Real Estate & Mortgage Syndications?
Real estate and mortgage syndications are funds that offer opportunities to invest in specific projects, real estate portfolios, or mortgage portfolios that are not readily available to individual investors. Depending on the specific offering, the appeal of these investments is the potential for above average returns and tax deferrals.
The majority of real estate and mortgage syndications sold as prospectus-exempt issues are speculative and illiquid.
What is Land Banking?
Land banking usually involves the purchase of a tract of raw land outside of an urban area with the expectation that the urban area will expand because of economic growth in the region.
What is a Brownfield Development?
A brownfield development is the redevelopment of an abandoned or underused commercial or industrial property, generally in an urban community.
An example of this would be the purchase of an abandoned manufacturing facility and its conversion into, or replacement with, residential housing.
What is a Blind Pool?
Blind pool investors are presented with information about the general type of real estate or real estate securities that the pool management intends to invest in.
However, the exact specifications of the investments are unknown and unavailable at the time when the investor commits to the blind pool.
What are the two types of Mortgage-backed Securities?
- Collateralized mortgage obligations
- mortgage-backed bond that separates mortgage pools into staggered maturity groups (tranches) that reallocate the interest and principal payments. Each tranche is sold as a separate security and has a different claim on the underlying cash flow
- Stripped MBS
- This divides the cash flows from the underlying mortgage security into two or more new securities. Stripped securities can be partially stripped, so that each investor receives a combination of principal and interest payments, or they can be completely stripped.
What is a REIT and what are its risks and benefits?
Real estate investment trusts (REITs) consolidate the capital of a large number of investors to invest in and manage a diversified real estate portfolio. Investors participate by buying “units” in the trust. Investors receive net returns generated by the pool, pro rata to their unit proportion.
Benefits
- Professional Management
- Liquidity
- Limitation of Personal Risk
- Portfolio Diversification & Diversification within the Real Estate segment.
- Reduced Leverage
- Tax efficiency
- Stable yield - Bond Like
Risks
- Real Estate Market Volatility
- Poor quality of management
Ways to invest in Private Markets
- Direct Investing
- Provides the most control, but requires a high degree of skill and know-how as well as capital. - Direct Funds
- Join a direct fund as a limited partner. The fund will invest its pool of cash into 10 - 20 transactions offering better diversification.
- Allows other professionals to manage the investment. - Fund of Funds
- This invests your funds into up to 20 different Direct funds each with their own 10 - 30 direct investments. - Publicly Traded Equities
- There are a few publicly traded companies which focus investment of their capital in private markets. - Exchange Traded Funds (ETFs)
- A low cost alternative that allow for a higher amount of diversification through a wide range of strategies. - Evergreen Funds
- First, the management fee structure tends to be lower than that of traditional private market funds, which means fewer expenses are charged to the investor over the life of the investment. Second, evergreen funds can use a reinvestment cycle, usually every four-to-five years, and upon valuation of the fund, investors can exit without penalties. This reinvestment cycle also allows the fund manager to raise new capital.
- No termination date, but it can be hard to value every four years
