LM 1: Alternative Investment Features, Methods, & Structures Flashcards
What are 2 reasons investors consider alternative investments?
- diversification benefits
- excess returns
What are 8 characteristics of alternative investments? MLLLIIIP
- Manager specialization
- Low correlation with traditional asset classes
- Large capital outlays (capital expenditure)
- Long investment horizons
- Illiquidty concerns causing restrictions on redemptions
- Investment vehicles designed to overcome the challenges of direct investing
- Incentive compensation to overcome information asymmetry (when one party in a transaction has more information than the other)
- Performance appraisal challenges
What are 3 main types of private capital?
- private equity
- venture capital
- private debt
What is private equity?
gathers investors money and uses funds to invest in private companies or buy out public companies.
What is venture capital?
provide equity funding for new companies in the early stages of development
What is private debt?
debt financing to companies from investors, rather than banks, bank-led syndicates, or public markets.
What are 3 types of real assets?
- Real estate
- Infrastructure
- Natural resources
What is infrastructure?
assets that provide an essential public service. eventually, ownership is transferred to the government. (eg. airports, toll roads, etc.)
What are public-private partnerships used for?
used for creating long-lived fixed assets intended for public use like infrastructure
What are natural resources?
undeveloped lands with economic value and commodities that can be harvested, extracted, and/or refined. (eg. farmland, oil, etc.)
What are 3 types of natural resources?
- commodities (crude oil, metals)
- farmland (agriculture)
- timberland (trees)
What are 2 other types of real assets besides real estate, infrastructure, and natural resources?
- collectibles (wine, art, etc.)
- digital assets (cryptocurrencies and tokens)
What are digital assets and the 2 main categories of digital assets?
digital assets are assets that can be created, stored, and transmitted electronically.
- cryptocurrencies
- tokens
What are hedge funds?
managers who may pursue various strategies, assets, and positions to outperform a benchmark
What are hedge funds of funds (HFOFs)?
funds that invest in multiple hedge funds.
What are 3 methods of investing in alternative investments?
- fund investing
- co-investing
- direct investing
What is fund investing?
manager makes investments for investor
What is co-investing?
Investor indirectly invests through the fund but can also possess the right to invest directly in the same asset
What is direct investing?
investor makes direct investment into asset without using an intermediary
What is due diligence for fund investing?
doing due diligence in finding fund manager
What is due diligence for direct investing?
investor must look into target asset or business (requires expertise)
What kind of partner are fund managers?
general partner (gp)
What kind of partners are investors?
limited partners (lp’s)
How much liability do GP’s take on?
unlimited liability
How much liability do LP’s take?
limited liability, liability up to their investments
What is an LPA?
legal document that outlines the rules of the partnership of LPs and GPs
LPA (limited partnership agreement)
What are side letters?
side agreements between GP’s and LP’s
What are 2 types of fees for alternative investments?
- management fee
- performance fee
What is the difference between a hard hurdle rate and a soft hurdle rate?
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.
What is a 2 and 20 fee?
2% management fee
20% performance fee
What are 4 common investment clauses, provisions, and contingencies?
- catch up clause
- high water mark clause
- waterfall
- clawback
What is a catch-up clause?
a clause in which any return above hurdle rate would be split to make the GP whole and earn the full 20% performance fee.
What is high water mark?
used so investors do not pay twice for the same performance gains
What are clawback compensation arrangements?
allow LP right to get back incentive fee that have been paid to GP, if gains subsequently get reversed
What is a waterfall compensation arrangement?
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
What is an american waterfall?
GP collects fee on a per deal basis
What is a European waterfall?
performance fees paid after based on aggregate profits
What is management fee calculation based on for private equity vs hedge funds?
Private Equity: Based on percentage of committed capital
Hedge Funds: Based on percentage of assets under management (AUM)
