Alternative Investments Lecture 2 PDF

Alternative Investments LECTURE 2  What Is an Alternative Investment? An alternative investment is a financial asset that does not fall into one of the conventional equity/fixed income/cash categories. Private equity or venture capital, hedge funds, real property, comm...

Alternative Investments LECTURE 2  What Is an Alternative Investment? An alternative investment is a financial asset that does not fall into one of the conventional equity/fixed income/cash categories. Private equity or venture capital, hedge funds, real property, commodities, and tangible assets are all examples of alternative investments. Most alternative investments are unregulated by the SEC and tend to be somewhat illiquid. While traditionally for institutional investors and accredited investors, alternative investments have become feasible to retail investors via alt funds, ETFs and mutual funds, REITS.  Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, lack of regulation, and degree of risk. Many alternative investments have high minimum investments and fee structures, especially when compared to mutual funds and exchange-traded funds (ETFs). These investments also have less opportunity to publish verifiable performance data and advertise to potential investors. Although alternative assets may have high initial minimums and upfront investment fees, transaction costs are typically lower than those of conventional assets, due to lower levels of turnover.  Most alternative assets are fairly illiquid, especially compared to their conventional counterparts. Alternative investments are often subject to a less clear legal structure than conventional investments. So, it is essential that investors conduct extensive due diligence when considering alternative investments.  Strategy for Alternative Investments Alternative investments typically have a low correlation with those of standard asset classes This low correlation means they often move counter—or the opposite—to the stock and bond markets. This feature makes them a suitable tool for portfolio diversification. Investments in hard assets, such as gold, oil, and real property, also provide an effective hedge against inflation, which hurts the purchasing power of paper money.  The non-accredited retail investor also has access to alternative investments. Alternative mutual funds and exchange- traded funds—funds or liquid—are now available. These alt funds provide ample opportunity to invest in alt asset categories, previously difficult and costly for the average individual to access. Because they are publicly traded, alt funds are SEC-registered and -regulated  Pros Counterweight to conventional assets Portfolio diversification Inflation hedge High rewards Cons Difficult to value Illiquid Unregulated High-risk  Index Mutual Funds – Open End Funds – Close End Funds Exchange Traded Funds Real Estate Venture Capitals Hedge Funds Funds of Funds Closely Held Companies Distressed Securities Investments REITs Mutual Funds A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors. A professional fund manager uses this money to buy stocks, bonds, or money market instruments that make up the fund’s portfolio of investments. Offer advantage of not involved directly in the hectic and time consuming process of studying companies and then placing execution orders with brokers tracking price moment of stock.  Real Estate Investment Trust A Real Estate Investment Trust (REIT) is a company that owns or finances income-producing real estate. REITs are like mutual funds. REITs provide investors of all types with regular income streams, diversification, and long-term capital appreciation. REITs allow individuals to invest in real-estate properties in a similar way you purchase a stock of a company and own a share. A REIT combines a pool of money from individuals and institutions to buy real estate projects. The Unit holders of a REIT Scheme earn a share of the income produced through renting or selling of the real estate property without actually having to bear the hassle of buying or managing the property on their own. https://www.arifhabibdolmenreit.com/about-reit  Benefits to Investors Investment Diversification Diversification aims to reduce portfolio volatility for investors. Adding REITs to an investment portfolio reduces risk since REITs have little correlation with other assets, including stocks and bonds. Favorable Dividend Pay-out Policy REITs have to distribute at least 90% of its profits as dividends to the unit holders to avail tax exempt status. High payout reduces the risk of management for investors. Debt Free Investment REITs are wholly equity financed and only unsecured borrowing is permitted under the regulations. Hence, REIT has a debt free structure and free from related cash flow distress and default risks. Transparency REITs follow the same rules and regulations of disclosure as other public listed companies. Liquidity The REIT are required to be listed at the stock exchange which provides investors the option to exit anytime. Moreover, REIT units are priced by the stock market each day and readily respond to the changes in market sentiments.  Private Equity PE is a source of patient capital for companies. Unlike mutual funds that have infinite lives, a PE fund has finite but longer lives generally spanning 7-12 years. The firms are continually involved in identifying deal flow or potential companies that could be invested in to create value. A number of investment philosophies guide a PE firm in choosing its target. It may buyout companies, provide expansion capital, undertake PIPE (Private Investment in Public Companies) or de- list and privatize them. These firms may invest at any stage of a company i.e. start-ups, expanding or mature. After a target is identified, PE firms may provide financial resources, strategic guidance, technical expertise through its professional team, technological support, cost cutting, or other operational improvements to create value and help companies actualize their potential.  Private Equity Such support is especially valuable for public sector companies that typically have outdated business philosophies and are in dire need of operational and strategic revamping. These firms may invest at any stage of a company i.e. start-ups, expanding or mature. After enabling a company to reach its potential, harvesting this value through deciding on the most productive exit option is a crucial decision.  Private Equity Private Equity (PE) Fund-Structure and Lifecycle PE is a buy-to-sell business model that allows high-net-worth individuals and institutional investors to directly acquire ownership interest in companies. These funds are commonly structured as limited partnerships; PE Firms (General Partner) obtain capital commitments from limited partners (LPs/ investors) and manages a portfolio of companies generally charging management fees which is typically 2 percent of AUMs and 20% performance fees (on profits after accounting for hurdle rate). Besides equity investments, PE funds may also engage in Leveraged Buy-Outs (LBOs) wherein they supplement equity investments through bank debt, senior credit facility or mezzanine (hybrid) debt. Hedge Funds To "hedge", according to Webster's dictionary, is "a means of protection or defense (as against financial loss), or to minimize the risk of a bet." The term "hedge fund" includes a multitude of skill-based investment strategies with a broad range of risk and return objectives. A common element is the use of investment and risk management skills to seek positive returns regardless of market direction. A hedge fund is a private "pool" of capital for accredited investors only and organized using the limited partnership legal structure. The general partner is usually the money manager and is likely to have a very high percentage of his/her own net worth invested in the fund.  Hedge Funds Strategies # 1 Long/Short Equity Strategy. # 2 Market Neutral Strategy. # 3 Merger Arbitrage Strategy. # 4 Convertible Arbitrage Strategy. # 5 Capital Structure Arbitrage Strategy. # 6 Fixed-Income Arbitrage Strategy. # 7 Event-Driven Strategy. # 8 Global Macro Strategy. For details visit: https://www.wallstreetmojo.com/hedge-fund- strategies/  12b-1 fees “12b-1 fees” are fees paid out of mutual fund or ETF assets to cover the costs of distribution – marketing and selling mutual fund shares – and sometimes to cover the costs of providing shareholder services. 12b-1 fees get their name from the SEC rule that authorizes a fund to charge them.  2 by 20 Rule Two and twenty describes the fees charged by managers of private hedge funds—specifically, the 2% annual fee and 20% performance fee (also called carried interest). Two and twenty has long been the standard in the financial industry for hedge funds, venture capital funds, and other private investment funds.  High water mark provision It is the highest peak in value that an investment fund or account has reached. This term is often used in the context of fund manager compensation, which is performance-based. The high-water mark ensures the manager does not get paid large sums for poor performance. For example, assume an investor is invested in a hedge fund that charges a 20% performance fee, which is quite typical in the industry. Assume the investor places $500,000 into the fund, and, during its first month, the fund earns a 15% return. Thus, the investor's original investment is worth $575,000. The investor owes a 20% fee on this $75,000 gain, which equates to $15,000. At this point, the high-water mark for this particular investor is $575,000, and the investor is obligated to pay $15,000 to the portfolio manager.  Hurdle Rate Provision A hurdle rate is the minimum amount of profit or returns a hedge fund must earn before it can charge an incentive fee. A hurdle rate has a similar function. If a hedge fund sets a 5% hurdle rate, for example, it will only collect incentive fees during periods when returns are higher than this amount. If the same fund also has a high-water mark, it cannot collect an incentive fee unless the fund's value is above the high-water mark, and returns are above the hurdle rate.  Claws Back Provision A clawback is a contractual provision whereby money already paid to an employee must be returned to an employer or benefactor, sometimes with a penalty. Many companies use clawback policies in employee contracts for incentive-based pay like bonuses. Most clawback provisions are non-negotiable. For example, companies can claw back pensions if there is any evidence of fraud or misuse of information by the pensioner.