Alternatives

Some Asset Managers Focus on “Alternative Investments”

• What are “Alternative Investments”? And why are they called “Alternatives”?
  • “Alternative Investments are “alternatives” to “traditional, long-only investments”
  • Traditional Long-only examples:
    • Stock, fixed income and cash investments
    • Mutual Funds & Exchange Traded Funds (ETF)
  • Also “Alternatives” to traditional “60% – 40%” stock/bond asset allocation
  • Typically “Alternative Investments include:
• Types of “Alternative Investments” 
  • Hedge Funds
  • Funds of Hedge Funds
  • Private Equity
  • Real Estate
  • Commodities

Basic Definitions of different types of “Alternative Investments”: 

“A pooled investment vehicle that generally meets the following criteria: (1) it is not marketed to the general public (i.e., it is privately-offered); (2) it is limited to high net worth individuals and institutions; (3) it is not registered as an investment company under relevant laws (e.g., U.S. Investment Company Act of 1940); (4) its assets are managed by a professional investment management firm that shares in the gains of the investment vehicle based on investment performance of the vehicle; and (5) it has periodic but restricted or limited investor redemption rights.”[1] Note recent changes in hedge fund marketing rules due to the “JOBS Act” approved by the SEC on July 10, 2013.

“A fund of hedge funds is an investment vehicle whose portfolio consists of shares in a number of hedge funds. The fund of funds strategy can be applied to any type of investment fund, from a mutual fund to a private equity fund. The fund of funds – which may also be called a collective investment or a multi-manager investment – simply holds a portfolio of other investment funds instead of investing directly in securities, such as stocks, bonds, commodities or derivatives.

“In its broadest sense, private equity is an ownership interest in a company or portion of a company that is not publicly owned, quoted or traded on a stock exchange. However, from an investment perspective, private equity generally refers to equity-related finance that is designed to bring about some sort of change in a private business, such as:

• Helping to grow a new business
• Bringing about operational change
• Taking a public company private
• Financing an acquisition

A fund investing in the real estate market – can include investment in several types of real estate including housing, hotels and commercial property. Real estate investments may be made using equity or debt

…products (futures contracts, physical commodities, ETFs, etc.) traded on an authorized commodity exchange. The types of commodities include agricultural products, metals, petroleum, foreign currencies and financial instruments and indexes…

• Why Invest in “Alternatives”?
  • To Obtain investments with low correlation to traditional equity and fixed income investments
  • To Gain further portfolio diversification
  • To “Hedge” various risks and achieve lower volatility
  • To Provide “Left- Tail” downside protection
  • To Seek differentiated sources of “alpha” (outperformance compared to a risk adjusted index)
  • To Provide higher risk –adjusted return

• Alternative Investments
  • Offer many choices of investment strategies
  • As illustrated in the flowing table:

• Suitability of Alternative Investments Depends on Multiple Investor Factors
  • Investment Policy Statement (IPS)
  • Asset Allocation Policy
  • Asset/Liability Matching
  • Risk tolerance
  • Cash flow needs
  • Duration of investment period
  • Management and performance fees
  • Other factors.

• Similarities Between Hedge Fund and Private Equity Investments
  • Hedge Funds and Private Equity Funds are typically private investments for “accredited investors” and “qualified purchasers”
  • Both are subject to private placement memoranda and subscription agreement spellingl-out all relevant terms and obligations of various parties
  • Due to the long-term and illiquid characteristics of certain hedge fund strategies, some hedge funds can have structures and terms that are quite similar to typical private equity funds
• Differences in Hedge Fund and Private Equity Terms and Structures
  • Typical key structure differences and differences in terms are highlighted in the following table

• “Liquid Hedge Funds”
  • Recent developments include some forms of “Liquid Hedge Funds”
    • With daily calculation of Net Asset Value (NAV) and daily liquidity in Mutual Fund Format
    • See the June 2013 SEI study entitled: “The Retail Alternatives Phenomenon”.
  • Note: Nature of these products limits the number and types of hedge fund strategies that can be pursued due to liquidity requirements
  • Due to liquidity requirements, typical hedge fund strategies in mutual fund type product structures include: equity/long short strategies and global macro strategies.

• Comments on Real Estate and Commodities Funds
  • Most Real Estate private investment funds are most similar to the characteristics noted above for Private Equity investments
  • Most private investment Commodities Funds are most similar to the characteristics noted above for hedge funds with
    • Initial lock-up periods and periodic redemption terms subject to lead time notices.
  • Depends on:
    • Type of Investment Strategy
    • Term of Investment
  • More highly liquid Real Estate funds can be structured as Real Estate Investment Trusts (REITS) and/or Mortgage Backed Securities  (MBS) which trade similarly to mutual funds
  • Conversely some Commodities Funds are structured very similarly to typical Private Equity Funds

[1] Managed Funds Association (MFA), Hedge Fund Glossary: www.managedfunds.org/industry-resources/hedg-fundglossary/

[2] Bloomberg: July 10, 2013: http://www.bloomberg.com/news/2013-07-09/sec-set-to-lift-80-year-old-ban-on-advertising-by-hedge-funds.html

[3] BarclayHedge.com: Glossary : http://www.barclayhedge.com/research/educational-articles/hedge-fund-strategy-definition/hedge-fund-strategy-fund-of-funds.html

[4] Blackrock Q&A: http://www2.blackrock.com/us/individual-investors/products-performance/alternative-investments/private-equity?cmp=alternatives&chn=PPC_Mobile&c=bing&kw=private%20equity

[5] Preqin Glossary: https://www.preqin.com/itemGlossary.aspx?pnl=QtoT

[6] National Futures Association Glossary: http://www.usafutures.com/commodityglossary.htm

[7] “Accredited Investor”:  based on US Securities Act of 1933 as amended; generally, a natural person with net worth exceeding $1million or a charitable organization with total assets in excess of $5 million. See SEC full definition at: http://www.sec.gov/answers/accred.htm; “Qualified Purchaser”: based on Investment Company Act of 1940, as amended; Typically individual/family owning not less than $5 million in investments and company owning not less than $25million in investments., See SEC full definition (page 16): www.sec.gov/about /laws/ica40.pdf