CFA III SS 13 Alt Investments

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  1. Due Diligence Concerns:
    • 1. Real Estate (direct, not REIT)
    • 2. Private Equity
    • 3. Hedge Funds
    • 4. Managed futures
    • 5. Distressed Securities
    • 1. valuation methods, zoning and legal issues
    • 2. performance evaluation/attribution; internal operational processes; financial/legal audit
    • 3. structure; strategy; performance data
    • 4. use derivatives and leverage; risk management
    • 5. business valuation; credit analysis
  2. Types of private equity
    • start-up or formative stage: new firm
    • middle-market: established firm, may be preparing for IPO
    • private investment in public companies (PIPE): privatize public firm or a division of the firm
  3. Commodities:
    • 1. type of inv
    • 2. benefits
    • 1. direct inv through buying physical asset or derivatives; indirect through inv in firm whose principal business is the commodity
    • 2. fairly liquid; low correlation with stocks and bonds; positive correlation with inflation
  4. Managed futures:
    • 1. primary structure
    • 2. return strategy
    • 3. compare to hedge funds
    • 1. limited partnership
    • 2. absolute return strategies
    • 3. similar structures and mgmt compensation; managed futures generally have macro focus, hedge funds have micro focus
  5. Buy out funds: middle market vs mega-cap
    • leveraged buy out purchases the equity and issues debt, which is tax advantaged
    • middle market: buy division spun off from larger public firm or private firms that cannot efficiently obtain capital
    • mega-cap: buy whole public firm
  6. infrastructure funds
    • purchase public infrastructure assets (ex. toll roads)
    • quick, stable, long-term cash flows
    • good for pension funds
    • don't trade, so low correlation with stock
  7. Benchmarks for:
    • 1. real estate - direct
    • 2. real estate - indirect
    • 3. private equity
    • 4. commodities
    • 5. managed futures
    • 6. distressed securities
    • 7. hedge funds
    • 1. NCREIF property index: non-investable index, value weighted index of commercially owned property; annual appraisal, so prefer "unsmoothed" index
    • 2. NAREIT index: cap weighted; "live" - traded on market; hedged NAREIT removes impact of market
    • 3. Cambridge Associates and Thomson Venture Economics: depends on events, such as IPOs, mergers, new financing; value may be dated
    • 4. DJ-AIG Commodity index: many others, are investable; world wide production weighting or perceived world wide importance using importance
    • 5. mount lucas management index (MLMI): replicates return to trend-following strategy; commodity trading advisors (CTA) also produces indices based on peer groups - called invalid in later SS
    • 6. same as hedge funds
    • 7. some equal or value weighted, but difficult; exhibit survivorship, popularity, and backfill bias
  8. Risk associated with alternative investments
    • Low correlation with stocks and bonds (negative in the case of commodities)
    • Usually illiquid
    • Large idiosyncratic component
    • Managed futures is the exception to the above
  9. Venture Capital:
    • 1. Stages
    • 2. Investor types
    • 3. Convertible preferred stock
    • 1. Early - seed, start-up, then first stage; Later - expand sales, steady revenue; Exit - merger or IPO; also formative and expansion stages
    • 2. Angel - first investor outside family and friends; venture capitalists - find projects and offer support; firms - looking for strategic corporate venturing
    • 3. Steady income, paid before common, and conversion will be valuable if firm is bought out
  10. Direct vs indirect commodity investing
    • Direct is purchasing actual commodities or gaining exposure via derivatives
    • Indirect is purchasing stocking in firms who deal primarily in the commodity - firms usually hedge the commodity price, however, so may not provide full exposure
  11. Returns on Futures
    • Spot return: aka price return; the change in spot price
    • Collateral return: aka collateral yield; approximate risk-free rate
    • Roll return: aka roll yield; movement by futures price that is not explained by movement in spot price
    • Roll return = change in futures price - change in spot price
  12. Hedge fund classifications:
    • 1. convertible arbitrage
    • 2. distressed securities
    • 3. emerging markets
    • 4. equity market neutral
    • 5. fixed-income arbitrage
    • 6. fund of funds
    • 7. global macro
    • 8. hedged equity
    • 9. merger arbitrage
    • 1. buy convertible bonds and short stocks
    • 2. speculation on low-grade bonds
    • 3. invest in emerging markets (long)
    • 4. exploit mispricing and remove systematic risk
    • 5. long and short positions based on expected yield curve
    • 6. invest in multiple hedge funds - provide some diversification, but higher fees
    • 7. take positions in major financial and non-financial markets
    • 8. same as above without focus on removing systematic risk
    • 9. buy target, short acquirer
  13. Distressed debt arbitrage
    • Buy bonds and short stocks
    • assumes bonds will outperform if the firm improves or declines due to their priority over stocks
  14. Distressed securities special risks
    • event: return often depends on a particular company event
    • market liquidity: low liquidity and cyclical supply and demand
    • j factor: human factor introduced by judge - may decide to favor stockholders over bond holders
    • market: impact of macro changes
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CFA III SS 13 Alt Investments
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