LM 1: Alternative Investment Features, Methods, & Structures

Question 1

What are 2 reasons investors consider alternative investments?

Answer 1

1. diversification benefits
2. excess returns

Question 2

What are 8 characteristics of alternative investments? MLLLIIIP

Answer 2

1. Manager specialization
2. Low correlation with traditional asset classes
3. Large capital outlays (capital expenditure)
4. Long investment horizons
5. Illiquidty concerns causing restrictions on redemptions
6. Investment vehicles designed to overcome the challenges of direct investing
7. Incentive compensation to overcome information asymmetry (when one party in a transaction has more information than the other)
8. Performance appraisal challenges

Question 3

What are 3 main types of private capital?

Answer 3

1. private equity
2. venture capital
3. private debt

Question 4

What is private equity?

Answer 4

gathers investors money and uses funds to invest in private companies or buy out public companies.

Question 5

What is venture capital?

Answer 5

provide equity funding for new companies in the early stages of development

Question 6

What is private debt?

Answer 6

debt financing to companies from investors, rather than banks, bank-led syndicates, or public markets.

Question 7

What are 3 types of real assets?

Answer 7

1. Real estate
2. Infrastructure
3. Natural resources

Question 8

What is infrastructure?

Answer 8

assets that provide an essential public service. eventually, ownership is transferred to the government. (eg. airports, toll roads, etc.)

Question 9

What are public-private partnerships used for?

Answer 9

used for creating long-lived fixed assets intended for public use like infrastructure

Question 10

What are natural resources?

Answer 10

undeveloped lands with economic value and commodities that can be harvested, extracted, and/or refined. (eg. farmland, oil, etc.)

Question 11

What are 3 types of natural resources?

Answer 11

1. commodities (crude oil, metals)
2. farmland (agriculture)
3. timberland (trees)

Question 12

What are 2 other types of real assets besides real estate, infrastructure, and natural resources?

Answer 12

1. collectibles (wine, art, etc.)
2. digital assets (cryptocurrencies and tokens)

Question 13

What are digital assets and the 2 main categories of digital assets?

Answer 13

digital assets are assets that can be created, stored, and transmitted electronically.

1. cryptocurrencies
2. tokens

Question 14

What are hedge funds?

Answer 14

managers who may pursue various strategies, assets, and positions to outperform a benchmark

Question 15

What are hedge funds of funds (HFOFs)?

Answer 15

funds that invest in multiple hedge funds.

Question 16

What are 3 methods of investing in alternative investments?

Answer 16

1. fund investing
2. co-investing
3. direct investing

Question 17

What is fund investing?

Answer 17

manager makes investments for investor

Question 18

What is co-investing?

Answer 18

Investor indirectly invests through the fund but can also possess the right to invest directly in the same asset

Question 19

What is direct investing?

Answer 19

investor makes direct investment into asset without using an intermediary

Question 20

What is due diligence for fund investing?

Answer 20

doing due diligence in finding fund manager

Question 21

What is due diligence for direct investing?

Answer 21

investor must look into target asset or business (requires expertise)

Question 22

What kind of partner are fund managers?

Answer 22

general partner (gp)

Question 23

What kind of partners are investors?

Answer 23

limited partners (lp’s)

Question 24

How much liability do GP’s take on?

Answer 24

unlimited liability

Question 25

How much liability do LP’s take?

Answer 25

limited liability, liability up to their investments

Question 26

What is an LPA?

Answer 26

legal document that outlines the rules of the partnership of LPs and GPs

LPA (limited partnership agreement)

Question 27

What are side letters?

Answer 27

side agreements between GP’s and LP’s

Question 28

What are 2 types of fees for alternative investments?

Answer 28

1. management fee
2. performance fee

Question 29

What is the difference between a hard hurdle rate and a soft hurdle rate?

Answer 29

hard hurdle rate allow share profits above a set hurdle rate, whereas soft hurdle rate allows investor to share cumulative positive returns from 0 and above the hurdle rate.

Question 30

What is a 2 and 20 fee?

Answer 30

2% management fee
20% performance fee

Question 31

What are 4 common investment clauses, provisions, and contingencies?

Answer 31

1. catch up clause
2. high water mark clause
3. waterfall
4. clawback

Question 32

What is a catch-up clause?

Answer 32

a clause in which any return above hurdle rate would be split to make the GP whole and earn the full 20% performance fee.

Question 33

What is high water mark?

Answer 33

used so investors do not pay twice for the same performance gains

Question 34

What are clawback compensation arrangements?

Answer 34

allow LP right to get back incentive fee that have been paid to GP, if gains subsequently get reversed

Question 35

What is a waterfall compensation arrangement?

Answer 35

allow higher-tiered creditors to be paid principal and interest ahead of lower-tiered creditors.

method used in partnerships to allocate investments profits between GP’s & LP’s

Question 36

What is an american waterfall?

Answer 36

GP collects fee on a per deal basis

Question 37

What is a European waterfall?

Answer 37

performance fees paid after based on aggregate profits

Question 38

What is management fee calculation based on for private equity vs hedge funds?

Answer 38

Private Equity: Based on percentage of committed capital

Hedge Funds: Based on percentage of assets under management (AUM)