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Introduction To Alternative Investment
Introduction To Alternative Investment
1) Investments
4 Type of Strategies:
- Event driven [Take position based on corporate events - Merger arbitrage, distressed situations, Activist shareholders (control), special situation (buy back,spin off)]
- Relative value strategy (buying a security and selling short a related security)
- Marco strategies (based on global economic trends, currencies and commodities) - Top down analysis
- Equity hedge fund strategies (Use of technical or fundamental strategy, short selling over valued securities) - Bottom up analysis
HF valuation:
- For traded securities - mkt price and non-traded security - estimates
HF due diligence:
- Lack of complete information
- Examination can include strategy used, histrical performance; benchmark used; valn and return calculation method used
- Other qualitative factors to consider are key person risk, reputation, growth plans,etc
5) Private Equity
- Invests in Pvt companies or public companies they intend to make it pvt, Leverage buy out (LBO), venture capital (VC)
Bank debt, high-yield bonds and mezzaine fianancing (conversion options,warrannts to equity)
MBOs MBIs
Existing mngt team is involved in buy outs External management team will replace exisiting management team
Venture capital
Formative stage Later stage Mezzanine stage
a) Angel investing - Production and sales - Capital provided to prepare the firm for an IPO
- Idea stage - Expansion thru increased sales and marketing - Time between pvt co becomes public company
- funding by individual
b) Seed stage
- Product development, Mkt R&D
- Venture capitalist invests
c) Early stage
- Investment made to initial comm production
6) Real Estate
- Income in the form of rent
- Helps in diversification since its an hedge against inflation
b) Commercial properties
- Direct investment (generates rental income)
- CMBS
d) Timberland
- Sale of agricultural products or timber
- Price of timberland depends on expectation of lumber prices in future and how much has been harvested
e) Farmland
- Price depends on land, farm commodity products, quality of crops produced
a) Appraisal index - Period estimate of property values - National council of Real estate inv fiduciaries (NCREIF)
Index return is smoother den actual sales and have lowest std deviation
b) Repeat sales index - Based on price of properties that have sold multiple times
Sample sold may not be representative of board properties available
Correlation of REIT and equity shares is 0.6 have same business cycle
Correlation of REIT and bond has been very low
Methods used for perfomance valn can be one reason for lower reported correlation
a) Comparable sales approach - Valuation based on sale of similar property adjusted for location, condition, age and size
b) Income approach
i) PV of C.F
ii) Net operating income/Capitalization rate
d) REIT valuation
i) Income approach - Adjusted FFO/Capitalization rate
Adjusted FFO = Net income + Dep + Loss on sale of property - Gain on sale of property (since non recurring to be excluded)
ii) q
7) Commodities
- Physical goods will have storage and transportation cost and hence derivatives are used to gain exposure
Types of commodities
a) Exchange traded funds (ETFs) - invests in commodities future and index
b) Equities that are directly linked to commodity - Purchase share of a company producing it ; Drawback commodity price and share price are not perfectly correlated
c) Managed funds - Actively managed; specific sectors with min investment and better liquidity
d) Individual manaed accounts - For high net worth; tailored made accounts
e) Specialized funds in specific sectors - Oil and gas, metals, etc
- Return on commodities have low correlation as compared to equity and bonds (0.20)
- Sharpe ratio have been low due to lower returns and high volatility of commodity prices
- Acts as hedging against inflation (commodity real return will be zero; futures can have +ve real returns)
Commodity pricing
- Spot price is based on demand and supply for the product
- If supply is inelastic in the short term and demand rises; price will be volatile
- Future price = spot price (1+risk free int rate) + storage cost - convenience yield
- where Convenience yield = value of having physical commodity used over time
- If there is little or no convenience yield den future price will be higher den spot price called as "contango" and vice versa is called as "backwardation"
a) Roll yield - Difference between 2 future contracts (+ve in backwardation and -ve in contango)
b) Collateral yield - Interest earned on collateral reqd into a futures contract
c) Change in spot price - Convergence of future price into spot price
a) Profits can be
- Any gain in value
- Any gain in value in excess of management fees
- Any gain in excess of hurdle rate
c) Highwater mark - Incentive is not paid on gains that just offset prior losses
Investor will not be charged twice on the same gains
Management fees can be charged on beginning asset value or ending asset value
Incentive can be based on net of management fee or independent of management fee (if nothing provided in qs - net of management fees)
Incentive fees = [Ending value - beg value - Management fee - hurdle rate] * Incentive %
b) REITs and ETFs - Mkt returns and std deviation can be used as they are traded on exchange
c) Lack of liquidity in alt.inv and hence premium should be added while valuation