Chapter 14
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Chapter 14






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Chapter 14 Presentation Transcript

  • 1. Chapter 14 Alternative Assets Portfolio Construction, Management, & Protection , 5e, Robert A. Strong Copyright ©2009 by South-Western, a division of Thomson Business & Economics. All rights reserved.
  • 2.
    • “ It is unusual that something as boring as infrastructure—pipelines, toll roads, electricity transmission lines, and airports—becomes the hot new thing but here it is."
    • Mark Weisdorf, CFA
    • Managing Director
    • JPMorgan Asst Management
  • 3. Introduction
    • Rapid recent growth in importance
      • Pensions and endowments allocation growth:
        • 5 percent in 2000
        • 10 percent in 2008
    • Five Category Groups
      • Infrastructure
      • Private Equity
      • Hedge Funds
      • Commodities
      • Specialized Real Estate
  • 4. Infrastructure Investments
    • Prominent alternative asset
      • $3.0 trillion in 2006
    • Typically started under government authority and later sold to private investors
      • Eliminates managerial burden
      • Raises cash for other societal needs
      • “ brownfield projects”
    • Sometimes businesses provide originates services that are typically offered by government
      • “ greenfield projects”
      • e.g., high-speed toll road to Washington D.C.’s airport
      • Considered to be more risky
  • 5. Popular Types of Infrastructure
    • Approximately $3 trillion in 2006, including:
      • Toll roads & bridges
      • Airports and airport trolley systems
      • Railway and ferry systems
      • Sporting arenas
      • Shipping ports
      • Electricity transmission
      • Water distribution networks
  • 6. International Aspect of Infrastructure Investment
    • Infrastructure investments:
      • Are also called public/private partnerships
      • Are necessary and facilitate economic development
      • Are found across the globe
        • Canada: $C66
        • India: $150 billion
        • Europe: €600 billion
  • 7. Infrastructure Investment Characteristics
    • Long-life
    • Cash flows generally stable and inflation linked
    • Significant barriers to entry by competitors
    • Provides essential community service
    • Few substitutes for service
    • Typically are highly levered
    • Highly illiquid
  • 8. Infrastructure Investment Options
    • Direct investment
      • Requires enormous capital reserves
    • Listed funds
      • Most popular investment method by individuals
    • Unlisted funds
      • Offered through investment banks
      • Most popular investment methods by pension funds and institutional investors
  • 9. Advantages of Infrastructure Investment
    • Annual cash flow stream
      • Periodic increases to keep up with inflation
    • Private management may provide efficiencies unavailable to government
    • Low correlation with other assets
      • Too new for many long-term studies
      • Australian equities and infrastructure: 0.32
        • Zero correlation between non-Australian equities and Australian infrastructure
  • 10. Hedge Funds
    • No single definition
    • Common characteristics
      • Low-correlation focused investment funds
      • Relatively few investors
      • Substantial minimal initial investment
      • Investors are limited partners
        • Hedge fund is general partner
        • The unlimited liability of general partner is used to justify management fees and large proportion of profits
        • Consistency of return is typical investment objective
  • 11. Hedge Fund Demographics
    • Total number of funds is unknown
    • Only hedge funds with $30 million in assets or over 15 investors must register with SEC
    • Hedge funds publicize success, biasing perceptions in favor of hedge fund investment
    • Alfred Jones started first hedge fund in 1949
      • - used short positions to offset risk of equity positions
    • In 2008:
      • $2 trillion dollars invested
      • 44% held by individuals
  • 12. Hedge Fund Classifications
    • Nondirectional/Directional Strategy
      • Anticipated changes in the underlying market does not impact choices in nondirectional strategies
    • Arbitrage/Relative Value strategy
      • Assumes the “mispriced” securities will move towards their normal relationship
      • Merger arbitrage may result in selling shares of acquiring firm and buying those of acquired firm
      • Convertible arbitrage may result in selling shares and buy convertibles bonds to earn interest income
        • “ may” because one has to consider current price and perceived value of both positions
  • 13. 130/130 Strategy
    • A long/short strategy
      • Buying undervalued stocks and selling overvalued stocks
    • Within a given portfolio, sell short the 30% considered to be overvalued and invest the proceeds in the 30% considered to be undervalued.
    • For every $1 originally invested, there now is another $0.60 worth of positions taken
      • The proportions could be any number greater than 100
        • 110/110 or 120/120, but not 120/110
  • 14. Hedge Fund-of-Funds
    • Portfolio of hedge funds
    • Lower initial investment than individual funds
    • Higher management fees
      • Pay fees to fund managers and Fund-of-fund managers
  • 15. Commodities
    • Now a widely-used investment class
    • Primary advantage: Low correlation with equity investments
      • Over 1994-2008 period, the correlation with the Wilshire 5000 Index has been between 0.02 and 0.10, depending on index
    • Primary disadvantage: Returns typically do not outpace inflation
      • May outpace inflation during short periods
      • In 2008: Oil and wheat hit record high prices
  • 16. Commodities (cont’d)
    • Some institutional investors use futures markets
    • Seek price gain, not the commodity itself
    • Others invest in farmland, almond groves, and vineyards where assets will be produced
    • “Price bubbles”
      • Farmland, ethanol, and all commodities
  • 17. Private Equity
    • Acquisition of a significant portion of a company, develop the company’s value, and sell it to the investment community
      • There always is a clear exit strategy consisting of receiving cash
    • Unlike the entrepreneur, and private equity investor has a target selling date
      • Both are willing to put forth the time and effort needed to influence corporate decisions
  • 18. Private Equity Investments in 2006 61% 8.4% Endowment Funds 36% 4.4% Corporate Funds Expect a Significant Increase in Allocation over 2007-2009 period Private Equity Portfolio Allocation
  • 19. Forms of Private Equity
    • Venture Capital
      • New companies or new ideas
        • High revenue growth, limited net income
    • Corporate Finance/Buyout
      • Established firm investment
        • Help them take advantage of competitive advantage
    • Mezzanine Financing
      • Provision of second-mortgage financing
        • May convert to equity
    • Distressed Firm Financing
      • Cash infusion when firm is unable to make debt payments
  • 20. J Curve
    • Pattern of returns from private equity investment to cash event
    • Typically lose money in first four or five years
    • Eventually, return turns positive, resulting in annual returns in the 25 percent range
    • Over 1992-2007 period, the U.S. venture capital market earned a 19.65 percent annualized rate of return
      • The S&P 500 earned 11.19% over the same period
    • Given the risks, it is wise to own a “portfolio” of private equity investments!
  • 21. Opportunistic Real Estate
    • High-risk, developed property investment
      • Generally have a specific purpose
      • Examples include golf courses, churches, bowling alley, hotels, student housing projects, single-family homes
    • Opportunistic real estate opportunities may arise from:
      • Severe regional economic conditions (bankruptcy of city’s primary employer)
      • Natural disasters (Hurricane Katrina)
      • Systematic problems (Subprime mortgage problems)
    • Opportunistic real estate investors focus more on price appreciation
      • Income streams are smaller, more volatile, and inconsistent
      • Traditional real estate investors are more concerned with current income
    • Less than 1 percent of public institutional investment assets