Chapter 14
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Chapter 14






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    Chapter 14 Chapter 14 Presentation Transcript

    • 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.
      • “ 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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!
    • 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