Concepts Description
Introduction to Alternative Investments
Alternative investments Investment in assets other than stocks, bonds and cash, including:
‐ Real estate
‐ Commodities
‐ Collectables
‐ Hedge fund (limited partnership)
‐ Private equity fund (limited partnership)
‐ Real estate investment trusts (REITs)
‐ Exchange Traded Funds (ETFs) that contain alternative investments
Differences between traditional Compared to traditional investments, alternative investments have:
investments and alternative ‐ Lower liquidity
investments ‐ Less regulations and disclosure
‐ Higher management fees
‐ More specialised management
‐ Potential diversification benefits
‐ More use of leverage and derivatives
‐ Potential higher return
‐ Limited and possible biased historical returns data
‐ Problematic historical risk measures
‐ Unique legal and tax consideration
Hedge funds ‐ Introduction Hedge funds are limited partnership of investors with adequate wealth, sufficient liquidity, and acceptable degree of investment sopistication
Return objectives can be statedd on an absolut basis (e.g.: 10%) or relative basis (e.g.: S&P 500 + 5%)
Hedge funds could employ different strategy, including:
‐ Take short equity positions
‐ Take long and short positions in derivatives
‐ Use leverage
Trade through prime brokers, who provide custodial services, administrative services, money lending, securities lending for short sales, and trading
Hedge funds are less liquid than traditional investments, with restrictions:
‐ Lockup period : period of withdrawal restriction after the initial investment
‐ Notice period : the amount of time a fund has after receiving a redemption request to fulfill that request
Management fee = % of committed capital
Incentive fee = % of profit
Fund of funds : an investment company that invests in multiple hedge funds → more diversifica on , allow smaller investors to access hedge funds. Fund of funds charge an addi onal
layer of fees beyond the fees charged by hedge funds
Hedge funds ‐ Strategies 1. Event driven strategies : based on corporate restructuring or acquisition that creates profit opportunities for long / short positions
‐ Merger arbitrage : Buy shares of firms being acquired , sell sort the firm making the acquisition
‐ Distress / Restructuring : Buy undervalued securities of firms in financial distress, when analysis indicates value will be increased by successful restructuring
‐ Activist shareholder : Buy sufficient equiy shares to influence a company's policy → increasing company value
‐ Special situations : Invest in firms that are issuing / repurchasing securities , spinning off divisions , selling assets , or distributing capital
2. Relative value strategies : Buying a security and selling short a related security → profit when perceived pricing discrepancy between 2 securi es is resolved
‐ Convertible arbitrage fixed income : Exploit pricing discrepancies between convertible bonds vs. common stock of the issuing companies
‐ Asset‐backed fixed income : Exploit pricing discrepancies between various mortgage‐backed securities / asset‐backed securities
‐ General fixed income ; Exploit pricing discrepancies between fixed income securities of various types
‐ Volatility : Exploit pricing discrepancies aring from differences between return volatility implied by options prices and manager expectations of future volatility
‐ Multi‐strategy : Exploit pricing discrepancies among securities in asset classes different from those listed above
3. Macro strategies : based on global economic trends and events → could involve long / short posi ons in equi es, fixed income, currencies or commodi es
4. Equity hedge fund strategies : profit from long/short positions in publicly traded equities and derivatives with equities as underlying assets
‐ Market neutral : Use techical / fundamental analysis to select undervalued equities for long / overvalued equities for short selling
‐ Fundamental growth : Use fundamntal analysis to find high‐growh companies
‐ Fundamntal value : Buy shares that are believed to be undervalued based on fundamental analysis
‐ Quantitative directional : Buy securities believed to be undervalued / Sell short securities believed to be overvalued based on technical analysis
‐ Short bias : Short position in overvalued equities
Hedge funds ‐ Benefits / Risks Benefits:
‐ Offer some diversification
Risks:
‐ In period of financial crisis, correlation of returns between global equities and hedge funds then to increase → limit hedge funds' effectiveness as a diversifying asset class
‐ Survivorship bias (excluded the performance of firms that no longer exist)
‐ Backfill bias (do not report performance at inception, but backfill performance later, when success track record is established)
Introduction to Alternative Investments
Alternative investments Investment in assets other than stocks, bonds and cash, including:
‐ Real estate
‐ Commodities
‐ Collectables
‐ Hedge fund (limited partnership)
‐ Private equity fund (limited partnership)
‐ Real estate investment trusts (REITs)
‐ Exchange Traded Funds (ETFs) that contain alternative investments
Differences between traditional Compared to traditional investments, alternative investments have:
investments and alternative ‐ Lower liquidity
investments ‐ Less regulations and disclosure
‐ Higher management fees
‐ More specialised management
‐ Potential diversification benefits
‐ More use of leverage and derivatives
‐ Potential higher return
‐ Limited and possible biased historical returns data
‐ Problematic historical risk measures
‐ Unique legal and tax consideration
Hedge funds ‐ Introduction Hedge funds are limited partnership of investors with adequate wealth, sufficient liquidity, and acceptable degree of investment sopistication
Return objectives can be statedd on an absolut basis (e.g.: 10%) or relative basis (e.g.: S&P 500 + 5%)
Hedge funds could employ different strategy, including:
‐ Take short equity positions
‐ Take long and short positions in derivatives
‐ Use leverage
Trade through prime brokers, who provide custodial services, administrative services, money lending, securities lending for short sales, and trading
Hedge funds are less liquid than traditional investments, with restrictions:
‐ Lockup period : period of withdrawal restriction after the initial investment
‐ Notice period : the amount of time a fund has after receiving a redemption request to fulfill that request
Management fee = % of committed capital
Incentive fee = % of profit
Fund of funds : an investment company that invests in multiple hedge funds → more diversifica on , allow smaller investors to access hedge funds. Fund of funds charge an addi onal
layer of fees beyond the fees charged by hedge funds
Hedge funds ‐ Strategies 1. Event driven strategies : based on corporate restructuring or acquisition that creates profit opportunities for long / short positions
‐ Merger arbitrage : Buy shares of firms being acquired , sell sort the firm making the acquisition
‐ Distress / Restructuring : Buy undervalued securities of firms in financial distress, when analysis indicates value will be increased by successful restructuring
‐ Activist shareholder : Buy sufficient equiy shares to influence a company's policy → increasing company value
‐ Special situations : Invest in firms that are issuing / repurchasing securities , spinning off divisions , selling assets , or distributing capital
2. Relative value strategies : Buying a security and selling short a related security → profit when perceived pricing discrepancy between 2 securi es is resolved
‐ Convertible arbitrage fixed income : Exploit pricing discrepancies between convertible bonds vs. common stock of the issuing companies
‐ Asset‐backed fixed income : Exploit pricing discrepancies between various mortgage‐backed securities / asset‐backed securities
‐ General fixed income ; Exploit pricing discrepancies between fixed income securities of various types
‐ Volatility : Exploit pricing discrepancies aring from differences between return volatility implied by options prices and manager expectations of future volatility
‐ Multi‐strategy : Exploit pricing discrepancies among securities in asset classes different from those listed above
3. Macro strategies : based on global economic trends and events → could involve long / short posi ons in equi es, fixed income, currencies or commodi es
4. Equity hedge fund strategies : profit from long/short positions in publicly traded equities and derivatives with equities as underlying assets
‐ Market neutral : Use techical / fundamental analysis to select undervalued equities for long / overvalued equities for short selling
‐ Fundamental growth : Use fundamntal analysis to find high‐growh companies
‐ Fundamntal value : Buy shares that are believed to be undervalued based on fundamental analysis
‐ Quantitative directional : Buy securities believed to be undervalued / Sell short securities believed to be overvalued based on technical analysis
‐ Short bias : Short position in overvalued equities
Hedge funds ‐ Benefits / Risks Benefits:
‐ Offer some diversification
Risks:
‐ In period of financial crisis, correlation of returns between global equities and hedge funds then to increase → limit hedge funds' effectiveness as a diversifying asset class
‐ Survivorship bias (excluded the performance of firms that no longer exist)
‐ Backfill bias (do not report performance at inception, but backfill performance later, when success track record is established)
