SS13 - Alternative Investments Flashcards
What are the six basic groups of alternatives?
- real estate
- private equity
- commodities
- hedge funds
- managed futures
- distressed securities
What are the four common features of alternatives?
- low liquidity
- diversification
- due diligence costs
- difficult performance evaluation
What issues arise for private wealth clients in relation to alternative investments?
- taxes
- suitability
- usually refers to lock-up periods or emotional feelings
- communication
- discussing complex strategies with the client is not easy
- decision risk
- risk emotionally abandoning strategy at the point of maximum loss
- concentrated positions
What are the two main classifications of real estate?
- Direct
- ownership of residences, commerical real estate, agricultural land
- Indirect
- there is a well-defined middle group that manages properties
What are the main types of indirect real estate investments?
- companies that develop and manage RE
- REITs
- publically traded equity shares in a portfolio
- equity REITs own property
- mortgage REITs hold mortgages
- CREFs
- pooled investments in real estate
- more flexibility than REITs
- Infrastructure funds
What are the advantages and disadvantages of real estate?
Advantages
- low corr. with stocks and bonds
- low return volatility
- usually inflation hedge
- may provide tax advantages
- source of potential to leverage return
Disadvantages
- high info and t-costs
- political risk re: tax law changes
- high op expenses
- inability to subdivide direct investments
- large idiosyncratic risk
What is private equity and what are its major subcategories?
PE is an ownership interest in a non-publically-traded private company.
Subcategories:
- venture capital
- buyout funds
- middle-market buyout funds
- mega-cap buyout funds
How do buyout funds add value?
- restructuring company operations and management
- buying companies for less than intrinsic value
- creating value by adding leverage or restructuring existing debt of the company
What are the major private equity exit strategies?
- selling companies through private placements
- IPOs
- dividend recapitalizations
- company issues substantial debt and pays a large special dividend to the buyout fund and other equity investors
- recapitalization
- increases company leverage buy does not change owner
What are the advantages and disadvantages of commodity investments?
Advantages
- liquid
- low correlation with stocks and bonds
- business-cycle sensitivity
- positive correlation with inflation
Disadvantages
- none listed. margin?
What are the major hedge fund classifications?
- equity market neutral
- convertible arbitrage
- fixed-income arbitrage
- distressed securities
- merger arbitrage
- hedged equity
- global macro
- emerging markets
- fund of funds (FOFs)
What are the similarities and differences between managed futures and hedge funds?
Similiarities
- use same LP structure
- 2 and 20
- considered skill based and not an asset class
Differences
- type of assets traded
- MF trades only in derivates markets
- HF trades in spot and futures markets
- usually take positions based on indices where HFs usually are more focues on individual assets
What are the major vehicles for investments in managed futures?
- private commodity pools
- managed futures programs as SMAs (CTA managed accounts)
- publicly traded commodity fugures funds
What are the trading strategies adn classifications for managed futures?
- systematic trading strategies
- follow rules
- may be short, med, or long-term
- discretionary trading strategies
- depend on judgement of manager
- could be based on economic or other criteria
What are the major real-estate benchmarks?
- NCREIF for direct investments
- value-weighted of commercially owned properties
- valuation obtained periodically so vol is downward biased.
- NAREIT for indirect investments
- cap-weighted of all REITs traded on AMEX or NYSE
- is a “live” index
What problem does the infrequent trading of real estate cause for real estate indices?
Infrequent trading results in an understatement of volatility.
Unsmoothing:
- std dev increases
- Sharpe ratio decreases
What problems does the leverage of alternative investments cause of real-estate indices?
When leverage effect is removed:
- returns lower
- Sharpe ratios lower
But still has low correlation with other assets.
What are two methods of weighting commodity indices?
Note that because of zero-sum nature of futures, you cannot use a market-cap weighting method.
- basing weights on world production of underlying commodities
- basing weights on perceived relative importance of underlying commodity
What are the myriad of ways a hedge fund index can be constructed?
- selection criteria can vary
- methods: AUM, length of track record, restrictions on new investments
- style classification
- weighting schemes
- equal or AUM weighted?
- rebalancing rules
- must be defined for equal-weight. can be monthly or annually
- investability
What are the major issues associated with hedge fund indices?
- relevance of past data
- popularity bias
- funds that attract capital will have disproportionate effect on index
- survivorship bias
- indices may drop hedge funds with poor track records or that fail. bias is estimated to be 1.5-3%/year
- stale price bias
- backfill/inclusion bias
- arises from filling in missing past data
What are the risk/return characteristics of each alternative?
- Private equity
- less a diversifier and more a long-term return enhancer
- Commodities
- diversification to stocks and bonds
- inflation hedge (except for ags)
- Hedge Funds
- generated higher absolute and risk-adjusted return than stocks and bonds
- Managed Futures
- similar to hedge funds
- Distressed Securities
- high average return
- large negative skew (so sharpe can be misleading)
What are the major differences between venture capital funds and buyout funds?
buyout funds usually have:
- higher level of leverage
- earlier, steadier cash flows
- less error in measurement of returns (because more are from actual cash flows)
- less frequent losses
- less upside potential
What is a good use of convertible preferred stock?
Convertible preferred stock is a good vehicle for a direct venture capital investment.
What issues must be addressed in formulating a private equity investment strategy?
- low liquidity
- diversification through a number of positions
- five to ten investments needed for diversification
- diversification strategy
- knowing the unique aspects of proposed PE investment and how it relates to the larger portfolio
- plans for meeting capital calls
- committed funds are called as needed. investor needs to be prepared to meet calls
