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35 Cards in this Set
- Front
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Categories of alternative investments |
*Hedge Funds *Private Equity Funds *Real estate *Commodities *Infrastructure *Other |
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Potential benefits of alternative investments in the context of portfolio management |
historically low correlation of returns with those of traditional investments. Historical returns have been higher on average than for traditional investments. |
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Hedge Funds |
can use leverage, take short equity positions, and take long or short positions in derivatives. The complex nature of hedge fund transactions leads managers to trade through prime brokers, who provide many services. Hedge fund investments are less liquid than traditional, publicly traded investments. |
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Hedge Funds Fund of Funds |
is an investment company that invests in hedge funds, giving investors diversification among hedge fund strategies and allowing smaller investors to access hedge funds in which they may not be able to invest directly. |
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Hedge Fund Strategies Event-driven Strategies |
are typically based on a corporate restructuring or acquisition that creates profit opportunities for long or short positions in common equity, preferred equity, or debt of a specific corporation. *Merger arbitrage: buy shares of a firm being acquired and sell short the firm making the acquisition. *Distressed/ restructuring: buy undervalued securities of firms in financial distress *Activist shareholders: buy sufficient equity share to influence a company's policies with the goal of increasing company value. *Special situations: invest in the securities of firms that are issuing or repurchasing securities, spinning off divisions, selling assets, etc. |
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Hedge Fund Strategies Relative value strategies |
involve buying a security and selling short a related security with the goal of profiting when a perceived pricing discrepancy between the two is resolved. |
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Hedge Fund Strategies Macro strategies |
are based on global economic trends and events and may involve long or short positions in equities, fixed income, currencies, or commodities. |
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Hedge Fund Strategies Equity hedge fund strategies |
seek to profit from long or short positions in publicly traded equities and derivatives with equities as their underlying assets. |
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Hedge Fund potential benefits and risks |
returns have tended to be better than those of global equities in down equity markets and to lag the returns of global equities in up markets. |
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Hedge Fund Due Diligence |
Partial list of factors to consider: *Investment strategy *Investment process *Source of competitive advantages *Historical returns *Valuation and returns calculation methods *Management style *... |
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Private Equity |
invest either in private companies or public companies they intend to take private (leveraged buyout funds), or in early stage companies (venture capital funds). Two additional, but smaller, categories of private equity funds are distressed investment funds and developmental capital funds. |
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Private Equity Strategies |
LBOs are the most common type of private equity fund investment. The debt may be bank debt, high-yield bonds or mezzanine financing (debt or preferred shares that are subordinate to the high-yield bonds issued; carries warrants or conversion features that give investors participation in equity value increases). |
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Private Equity Strategies MBOs |
existing management team is involved in the purchase |
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Private Equity Strategies MBIs |
external management team will replace existing management team. |
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Other Private Equity Strategies |
Developmental capital or minority equity investing refers to the provision of capital for business growth or restructuring. In the case of public companies, such financing is referred to as private investment in public equities (PIPEs). Distressed investing involves buying debt or mature companies that experiencing financial difficulties. |
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Private Equity Structure and Fees |
Committed capital is the amount of capital provided to the fund by investors. The capital is usually drawn down over three to five years, but the drawdown period is at the discretion of the fund manager. Incentive fees or private equity funds are typically 20% of profits, but these fees are not earned until after the fund has returned investor's initial capital. A clawback provision requires the manager to return any periodic incentive fees to investors that would result in investors receiving less than 80% of profits generated by portfolio investments as a whole. |
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Private Equity Exit Strategies |
*Trade Sale: sell a company to a competitor or another strategic buyer *IPO: sell some or all shares to the public *Recapitalization: company issues debt to fund a dividend distribution to equity holders *Secondary sale: sell a portfolio company to another private equity firm or a group of investors. *Write-off/ liquidation: reassess and adjust to take losses from an unsuccessful outcome |
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Real Estate |
investment in real estate can provide income in the form of rents as well as the potential for capital gains. Underlying assets include: - residential property - commercial property - loans with residential or commercial property as collateral |
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Forms of Real Estate Investments |
Residential property is considered a direct investment in real estate. Commercial real estate properties generate income from rents. Can also be held by a limited partnership in which the partners have limited liability and the general partner manages the investment and the properties, or by a real estate investment trust (REIT). |
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REITs |
issue shares that trade publicly like shares of stock. REITs are often identified by the type of real estate assets they hold: mortgages, hotel properties, malls, office buildings, or other commercial property. |
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Other Real Estate Assets |
timberland and farmland, for which one component of returns from from sales of timber or agricultural products. |
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Potential Benefits and Risks of Real Estate |
performance is measured by three different types of indices: *appraisal index is based on periodic estimates of property values. *repeat sales index is based on price changes for properties that have sold multiple times. *REIT indices are based on the actual trading prices of REIT shares, similar to equity indices |
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Real Estate Investment Due Diligence |
Property values fluctuate because of global and national economic factors, local market conditions, and interest rate levels. Decisions regarding selecting, financing and managing real estate projects directly affect performance. Distressed property investing has additional risk factors compared to investing in properties with sound financials and stable operating histories. |
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Commodities |
while it is possible to directly invest in commodities, the most commonly used instruments to gain exposure to commodity prices are derivatives. Other methods of exposure to commodities include: *ETFs *Equities that are directly linked to a commodity *Managed futures funds *Individual managed accounts *Specialized funds in specific commodity sectors |
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Potential Benefits and Risks of Commodities |
returns on commodities have been lower than returns on global stocks or bonds. Correlations of commodity returns with those of global equities and global bonds have been low, typically less than 0.2. |
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Commodity Prices and Investments |
Spot prices for commodities are a function of supply and demand. For many commodities, supply is inelastic in the short run because of long lead times to alter production levels. |
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Infrastructure |
investments include transportation assets such as roads, airports, ports, and railways, as well as utility assets, such as gas distribution facilities, electric generation and distribution facilities, and waste disposal and treatment facilities. Other categories are communications and social. Investments in infrastructure can be made by constructing the assets and either selling or leading them to the government or by directly operating the assets. Alternatively, investment in infrastructure can be made by purchasing existing assets from the government to lease back to the government or operate directly. |
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Hedge fund fees |
Total fee paid by investors in a hedge fund consists of a management fee and an incentive fee. The management fee is earned regardless or investment performance and incentive fees are a portion of profits. Profits can be 1) any gains in value, 2) any gains in value in excess of the management fee, or 3) gains in excess of a hurdle rate. High water mark means that the incentive fee is not paid on gains that just offset prior losses. |
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Hedge Fund Valuation |
are based on market values for traded securities in their portfolios but use model values for non-traded securities. Most conservative to use prices at which a position could be closed (bid prices for long positions and ask prices for short positions). Some funds use the average instead. |
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Private Equity Company Valuation |
is essentially the same as valuing a publicly traded company, although the discount rate or multiples used may be different for private companies. Market/comparables approach: market or private transaction values of similar companies may be used to estimate multiples of EBITDA, net income, or revenue. DCF approach Asset-based approach: either liquidation values or fair market values of assets can be used. |
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Real Estate Valuation |
*Comparable sales approach bases valuation on recent sales of similar properties. *Income approach estimates property values by calculating the present value of expected future cash flows from property ownership or by dividing the net operating income (NOI) for a property by a capitalization rate. *Cost approach estimates the replacement cost of a property. |
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Commodity Valuation |
futures price = spot price (1 + Rf) + storage costs - convenience yield Convenience yield is the value of having the physical commodity for use over the period of the futures contract. If there is little or no convenience yield, futures prices will be higher than spot prices, a situation termed contango. When the convenience yield is high, futures prices will be less than spot prices, a situation referred to as backwardation. |
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Sources of commodities futures returns |
1) Roll yield: the yield due to a difference between the spot price and futures price, or a difference between two futures prices with different expiration dates. Futures prices converge toward spot prices as contracts get closer to expiration. Roll yield is positive for a market in backwardation and negative for a market in contango. 2) Collateral yield: interest earned on collateral required to enter into a futures contract 3) Change in spot prices: total price return is a combination of the change in spot prices and convergence of futures prices to spot prices over the term of the futures contract. |
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Risk management of alternative investments |
Standard deviation may be a misleading measure because returns distributions are not approximately normal and because appraisal or models are used which are smoothed. VaR is an estimate of the size of a potential decline over a period that will occur, for example, less than 5% of the time. Sortino ratio measures risk as downside deviation rather than standard deviation. |
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Due Diligence |
*Organization: Experience, quality and compensation of management *Portfolio management: management of the investment process *Operations and controls: reporting and accounting methods *Risk management: fund policies and limits *Legal review: fund legal structure *Fund terms: fees and expenses |
