Alternative Investments

高顿教育CFA研究院
Brief Introduction
Introduction of the course
Quantitative Methods 8-12%
Economics 8-12%
Financial Statement Analysis 13-17%
Corporate Issuers 8-12%
Equity Investments 10-12%
Fixed Income 10-12%
Derivatives 5-8%
Alternative Investments 5-8%
Portfolio Management 5-8%
Ethics & Professional Standards 15-20%

2
Brief Introduction
Content
 Study Session 1: Alternative Investments
 Module 1: Categories, Characteristics, and Compensation
Structures of Alternative Investments
 Module 2: Performance Calculation and Appraisal of
Alternative Investments
 Module 3: Private Capital, Real Estate, Infrastructure,
Natural Resources, and Hedge Funds

3
 Alternative Investments
Hedge funds
Private equity
Private capital
Private debt
Basics

Commodity
Types
Natural resources
Farmland and
Real estate timberland
Alternative
investments Greenfield
Infrastructure
Brownfield
Challenges

Performance Ratios used

appraisal
Survivorship bias and
backfill bias
Alternative Investments

Definition Traditional vs alternative

Types and categories

Characteristics Fund investing

Basics
Investment methods Co-investing

Direct investing

GP and LP
Investment and
compensation structures
Compensation structure
Characteristics
Characteristics of alternative investments
 Higher expected returns
 Narrow manager specialization (专业化管理)
 Low correlation of returns with traditional investments
 Less regulation and less transparency
 Limited historical risk and return data
 High fees
 Restrictions on redemptions (i.e., “lockups” and “gates”)
 Concentrated portfolios
 Unique legal and tax considerations
 Investment Methods
Three methods for alternative investments

Fund manager Investor

(General partner) (Limited partner)

Direct
Co-investing investing
Fund investing Alternative
(Indirect) investment funds

Investment 1 Investment 2 Investment 3 Investment A

Investment Methods
Three methods for alternative investments
Advantages Disadvantages
 Professional services  Costly
Fund investing  Diversification benefits  Thorough due
(Indirect)  Lower capital diligence when
requirement selecting the fund
 Bring the expertise in-  Adverse selection
Co-investing
house bias
 Requires more
 Avoids paying ongoing
investment expertise
Direct management fees
 Requires greater
investing  Flexibility
levels of due
 Highest level of control
diligence
Compensation Structure
Management fee
 1% to 2% of assets under management for hedge funds or
committed capital for private equity funds
Performance fee (incentive fee or carried interest)
 applied based on excess returns
Hurdle rate
 Minimum rate of return that the GP must exceed in order to
earn the performance fee
 Hard vs soft hurdle
 Compensation Structure
Catch-up clause

1.6%
Remaining 8% is split 80/20,
6.4% 6.4% for LPs, 1.6% for GP
18%
IRR 2% Catch-up clause stipulates: 2% entirely for GP

8% 8% Hurdle: Entirely for LPs

GP earns 2%+1.6%=3.6% (18%×20%=3.6%）

Hedge Fund
Lockup period
Characteristics
Notice period

Benefit
Fund of hedge funds
Drawback
Hedge fund
Equity hedge

Event driven
Strategies
Relative value
Fee calculation
Macro
Hedge Fund Strategies
Hedge fund strategies
Sub-types Tips
Market A net position that is neutral with
neutral respect to market risk (zero beta)

Fundamental Uses fundamental analysis to

Equity hedge L/S growth identify high growth companies
strategies Fundamental Uses fundamental analysis to
value identify undervalued companies

Short bias Shorts overvalued equity securities

Hedge Fund Strategies
Hedge fund strategies (Cont.)
Sub-types Tips
Merger Long acquired company, and short
arbitrage acquirer
Distressed Focus on securities of companies in
Event-driven
securities or near bankruptcy
strategies
Purchase sufficient equity to
Activist
influence a company‘s policies or
shareholder
direction
Seek to profit from expected movements in
Macro
economic variables influenced by major economic
strategies
trends and events
Hedge Fund Strategies
Hedge fund strategies (Cont.)
Sub-types Tips
Fixed income Exploit a perceived mispricing
convertible between a convertible bond and its
arbitrage component parts
Take advantage of mispricing
Fixed income
Relative value across different asset backed
asset backed
strategies securities
Fixed income Focus on the relative value within
general the fixed income markets
Use options to go long or short
Volatility
market volatility
Compensation Structure
Management fee and incentive fee
Basics Considerations
Calculated on Beginning-of-period AUM
Management
assets under
fees
management (AUM) End-of period AUM

Incentive Calculated on Net of management fees

fees profits Independent of management fees
High water The incentive fees are paid when assets under
mark management are above the previous net highest value
Private Capital
LBO

Venture capital
Private equity
Exit strategies

Compensation
structure
Private capital
Direct debt

Mezzanine debt
Private debt
Venture debt

Distressed debt
Private Equity
Investment strategies
Company maturity Strategies
Formative stage (成型阶段)
 Angel investing
 Seed stage (first stage VC invests)
Venture
Start up business  Early stage
capital
Later stage financing (后期)
Mezzanine stage financing
(成熟期/夹层融资)
Growth More established
/
capital business
Leveraged Management buyouts (管理层收购)
Mature business
buyouts Management buy-ins (管理层换购)
Private Equity
Compensation structure
Basics
Management fees Calculated on committed capital
Incentive fees Calculated on profits
Deal-by-deal (or American) waterfalls:
 More advantageous to the GP
Waterfall
Whole-of-fund (or European) waterfalls:
 More advantageous to the LPs
Claw back Right of LPs to reclaim part of the GP’s
provision performance
 Natural Resources

Characteristics
Commodities
Commodity futures
Natural resources price

Timberland and
Characteristics
farmland
Commodities
Commodity futures price
 Futures price ≈ Spot price(1 + r) + Storage costs - Convenience
yield
 Futures prices may be higher or lower than spot prices
depending upon the convenience yield.
 Futures price > Spot price
• Contango (期货溢价): little or no convenience yield.
 Futures price < Spot price
• Backwardation (现货溢价): high convenience yield.
Timberland and Farmland
Characteristics
Timberland Farmland

Trading size Larger units Smaller sizes

Flexibility More flexibility Little flexibility

 Biological growth  Harvest quantities
Return  Changes in prices of cut  Changes in prices of
driver wood commodity
 Underlying land  Changes in prices of land
 Low liquidity
 Costs are relatively high
Risk
 Weather
 Competition
Real Estate

Residential
Categories
Commercial
Forms of investment
Real estate
Benefit and risk

Real estate index

Forms of Real Estate Investment
Forms of real estate investment
Debt Equity
 Direct ownership of real estate
(sole ownership, joint ventures,
 Mortgages
real estate limited partnerships)
Private  Construction lending
 Indirect ownership via real estate
 Mezzanine debt funds
 Private REITs
 Shares in real estate corporations
 MBS
 Shares of real estate investment
 CMO trusts (REITs)
Public  Mortgage REITs
 Mutual funds
 ETFs that own securitized  Index funds
mortgage debt
 ETFs
Real Estate Index
Real estate index

Construction Characteristics

Appraisal Use estimates of value as Subjective

index inputs to the index Understated volatility

Repeat sales Use repeat sales of properties  Sample selection

index to construct the index bias

Use the prices of publicly  More frequently

REIT index traded shares of REITs to traded, more
construct the index reliable is the index
 Alternative Investments
Hedge funds
Private equity
Private capital
Private debt
Basics

Commodity
Types
Natural resources
Farmland and
Real estate timberland
Alternative
investments Greenfield
Infrastructure
Brownfield
Challenges

Performance Ratios used

appraisal
Survivorship bias and
backfill bias
Alternative Investments

Good luck on the exam！