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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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Distressed debt arbitrage
- Buy bonds and short stocks
- assumes bonds will outperform if the firm improves or declines due to their priority over stocks
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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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