Alternative Investments

Most common “Alternative Investments”

1. Alternative Equity Markets: Investing in equities that are not traded on

traditional stock exchanges, such as private equity placements, venture capital,
or investments in companies listed on secondary markets.
2. Real Estate: Investment in properties or real estate-related assets with the
goal of generating rental income, capital appreciation, or both.
3. Private Equity: Investment in privately held companies or ownership stakes in
public companies that are not traded on public stock exchanges. Private equity
firms typically acquire control of companies, restructure them, and aim to sell
them at a profit.
4. Hedge Funds: Investment funds that pool capital from accredited investors
and employ various strategies to generate returns, often using leverage,
derivatives, and alternative investment techniques.
5. Currencies: Trading or investing in foreign currencies with the aim of profiting
from fluctuations in exchange rates.
6. Commodities: Investing in physical goods such as gold, silver, oil, agricultural
products, or other raw materials with the expectation of profit from price
movements.
7. Infrastructure: Investment in physical assets that provide essential services to
society, such as roads, bridges, airports, utilities, and telecommunications
systems.
8. Energy / Renewables / Environmental: Investment in energy-related assets,
including traditional energy sources such as oil and gas, as well as renewable
energy projects such as solar, wind, and hydroelectric power.
9. Collectibles: Investing in items with inherent value or rarity, such as art,
antiques, fine wine, classic cars, or rare coins, with the expectation of
appreciation over time.
10. Tax-driven Investments: Investment strategies structured to take advantage
of tax incentives or loopholes, such as investing in certain types of real estate
projects, opportunity zones, or tax-advantaged retirement accounts

Rationale for Alternative Investments

 Diversification

 Returns over time are not highly correlated to traditional asset classes

 Broaden fund’s investment “opportunity set”

 Alternative asset classes are less “efficient”

 Greater ability for managers to add value

When combined with traditional assets, can enhance total fund returns over time
with less risk (“volatility”)
Alternative Equity Markets
Developing markets (BRIC, Brazil, Russia, India, China)

Emerging markets (Argentina, Bangladesh, Egypt, Indonesia, Nigeria)

Property

Equity investments in real properties

Major property types include:

Office
Industrial
Retail
Multi-Family

Forms of Real Estate Investment

Free and Clear Equity
Leveraged Equity
Mortgages/ABS (Eurobond)
Aggregation Vehicles (REITs)

Property Characteristics

 Immovable vs fungible and divisible

 Not directly comparable
 Illiquid
 Market value is difficult to assess
 Transaction costs and fees are high
 Inefficiencies due to lack of information

Valuations
 Cost approach
 Sales comparison
 Income approach (perp)
 Discounted after-tax Cash Flows

Private Equity

Investments in companies through private markets (rather than through publicly

traded securities) – both debt & equity

Major forms include:

Venture Capital (early, mid and late-stage) – private capital used to finance a
start-up business or grow an existing one
Buyouts – acquisition of a company or an operating division, often by existing
management
Distressed Investing – aka special situations, vulture funds
Mezzanine – final round of financing intended to help carry a company to an initial
public offering
Hedge Funds

 Term can be ambiguous and refers to a wide range of investment strategies

 Investment objectives are to earn large absolute returns over time (rather than
relative returns)

 Typically, only available to accredited investors – high net worth individuals,

foundations …

 May use short selling or other hedging strategies; often as plays against the
market

 Use extensive leverage and derivatives to enhance returns

 Rather than ‘hedge’ to eliminate risk they try to isolate specific bets for
purpose of generating alpha

 Differing legal and fee structures – “2 and 20”

Hedge Fund - Classifications

 Long / Short Funds

 net positive or negative
 Market Neutral Funds
 Pairs Trading
 Fixed Income Arb
 Global Macro Funds
 Managed Futures Funds
 Emerging Markets Funds
 Event-Driven Funds
 Distressed Securities Funds
 Risk Arb M&A
 Fund of Funds

Hedge Fund – Unique Risks

 Liquidity Risk
 Pricing Risk
 Counterparty Credit Risk
 Settlement Risk
 Short Squeeze Risk
 Financing Squeeze

Commodities
Energy
Oil, gas, coal, uranium
Soft commodities
Softs: coffee, coco, tea, sugar, OJ
Livestock: cattle, pork bellies
Grains: wheat, soy beans, corn, maize, rapeseed
Industrial: timber, rubber, cotton
Metals
Copper, aluminium, steel, iron, lead, tin, palladium

Precious metals
Gold, silver, platinum

Commodities
Typically low correlation with
stocks and bonds, and positive
correlation with inflation
Passively managed with long
futures position and t-bills

Commodity returns can be linked to economic growth

Currencies

G3: US$, Euro, Yen

High and low int rate currencies

The “Carry Trade”: A carry trade is a trading strategy that involves borrowing at a
low-interest rate and investing in an asset that provides a higher rate of return
Borrow in low currency and invest in high currency
High risk because of leverage and currency fluctuations
Remember Iceland
Trade weighted opportunities
Deficits: US and developed world
Surpluses: BRICS and commodity countries
Infrastructure
Roads
Rail
Airports
Bridges
Tolls
Electricity and Communications networks
Energy / Renewables / Environmental
Windfarms
Carbon credits
Forestry
Biodiesel
Waste systems
Collectibles
Art & Antiques
Wine
Cars
Diamonds
Books
Race Horses

Note: Gains from the disposal of wasting assets, i.e. assets with a predictable life of
less than 50 years, for example, a private motorcar, livestock, wine etc. are exempt
from Capital Gains Tax
 Tax Incentives for Art Investments
In Ireland, Sale of Works of Art Loaned for Display (Section 606, Taxes
Consolidation Act, 1997) provides an exemption from Capital Gains Tax on the
sale of Works of Art by a taxpayer which have been on public display for 10 years.
The disposal can be to any purchaser, that is not just to a gallery or museum. It can
apply to non-Irish items as well as Irish items of Art.

If the taxpayer disposes of a work of art which meets the criteria below, no capital
gains tax (currently 25%) arises
This applies to Works of Art including pictures, sculptures and prints which,
In the opinion of the Revenue Commissioners have a market value of not less than
€31,740 (the Revenue may consult experts)
Are included in / the subject of a display to which the public has reasonable access
Must be on loan for 10 years in a gallery / museum approved by the Revenue
Commissioners (The Irish Museum of Modern Art is approved)

Tax Incentives for Art Investments

Tax Driven Investments
Business Expansion Scheme (BES -> EIS)
Section 23 type rental income shelters
Section 486B investments in renewable projects
Nursing homes, hotels, private hospitals

Alternative Investments are grouped together not because they have similar features
but instead because they have characteristics distinct from traditional investments.
Investing in alternatives can be done through fund investing, co-investing, or direct
investing. Alternative investments typically offer investors greater diversification
and
higher expected returns than traditional investments but often involve longer-term,
illiquid investments in less efficient markets. Investing in alternatives requires
specialized knowledge. Alternative investments typically rely on more complex and
richer
compensation structures than traditional investments in order to better align manager
and investor incentives over longer periods.
LEARNING MODULE OVERVIEW
■ Alternative investments are investments other than ownership
of traditional asset classes (public equity and fixed-income
instruments and cash) and include private capital, real assets, and
hedge funds.
■ Private capital includes private equity and private debt. Real assets
include real estate, infrastructure, and natural resources. Hedge funds
may invest across both traditional and alternative asset classes and
are distinguished by their investment approach, which often includes
leverage, derivatives, or other strategies.
1
LEARNING MODULE
1
■ Investors often consider alternative investments in pursuit of greater portfolio
diversification and/or increased expected returns. In doing so, they usually face longer
investment periods, reduced liquidity, and less efficient markets than for more
traditional assets.
■ Alternative investment fund investors fully outsource the control and management of
investments in exchange for relatively high fees, while co-investment and direct
investment methods involve greater investor effort and control over the selection and
management of assets in exchange for relatively lower fees.
■ Another common type of alternative investment structure is a limited partnership in
which responsibilities are flexibly allocated between investors and managers—with
managers as general partners and investors as limited partners. Limited partnerships
usually have more complex compensation structures, which include both management
and performance fees.
■ Additional alternative investment structures include trusts and limited liability
companies.
LEARNING MODULE SELF-ASSESSMENT

1. Identify which of the following choices is most likely an alternative investment:

A. An investment in a hedge fund focused on traditional assets
B. Shares in a manufacturing firm traded on the Bursa Malaysia exchange
C. A euro foreign exchange future purchased on the Chicago Mercantile
Exchange(Purchased in a traditional exchange)

2. An advantage of investing in alternative investments most likely is:

A. high liquidity.
B. low investment fees.
C. higher expected returns.
Solution:
3. Investors with limited experience most likely enter into alternative
investments through:
A. co-investing.
B. fund investing. (A carry trade is a trading strategy that involves borrowing at a low-
interest rate and investing in an asset that provides a higher rate of return)
C. direct investing.
4. When an investor invests in an asset without the use of an intermediary, it
is
called:
A. co-investing.
B. fund investing.
C. direct investing.
5. Which statement regarding alternative investment partnership structures is
most accurate?
A. The fund manager has limited liability for anything that goes wrong.
B. The fund manager is a limited partner, and investors are general
partners.
C. Investors’ upfront cash outflow can be a small portion of their total
commitment to the partnership.
6. After failing to meet the hurdle rate(Discount rate), which of the following would a
general
partner still most likely receive as compensation?
A. Carried interest
B. Management fee
C. Committed capital

ALTERNATIVE INVESTMENT FEATURES

Alternative investments are investments other than ownership of public equity
securities, fixed-income instruments, or cash that represent the more traditional asset
classes. These investments are referred to as alternatives to traditional asset classes
because of their characteristics and the way they are structured. Investors are often
attracted to alternative investments when seeking greater diversification and/or higher
expected returns in exchange for what are often longer-term, illiquid investments in
less efficient markets. The features of these investments necessitate specific skills and
information to evaluate their performance and include unique factors investors must
consider if adding them to a portfolio.
Alternative Investments: Features and Categories
Some alternative investment features are shared with traditional public debt and
equity securities, while others are significantly different.

Features that may distinguish alternative investments include the following:

■ The need for specialized knowledge to value cash flows and risks
■ Typically low correlation of returns with more traditional asset classes
■ Illiquidity, long investment time horizons, and large capital outlays
These features lead to the following alternative investment characteristics:
■ Different investment structures due to the challenges of direct investment
■ Incentive-based fees to address/minimize information asymmetry between managers
and investors
■ Performance appraisal challenges
For example, while many alternative investments have equity or debt characteristics,
they often require a larger or longer financial commitment due to an underlying
investment’s extended life cycle or different investment methods and vehicles used to
align the capabilities and incentives of managers and investors over time. Unlike
individual securities, the size and type of some alternative investments may also be
prohibitively large for certain investors. For these reasons, most investors limit
alternative investments to that portion of their portfolio designated to fund obligations
several years in the future. Sophisticated investors with the longest investment time
horizons, such as large pension funds, sovereign wealth funds, and not-for-profit
endowments, tend to allocate a larger share of their portfolio to these assets.
Alternative investment categories include private capital, real assets, and hedge funds.

Private Capital
Private Capital is a broad term for funding provided to companies that is sourced from
neither the public equity nor the public debt markets. Capital that is provided in the
form of equity investments is called private equity, whereas capital that is provided
as a loan or other form of debt is called private debt.
Private equity and private debt are alternative investments with features similar to
public equity and public debt. For example, both private and public equity investors
are company owners with residual claims to future cash flows and dividends. However,
while investors in private equity may have full access to company information
and
latitude to influence day-to-day management and strategy decisions, investors in
publicly traded equity receive only publicly available information, such as
annual reports
and periodic financial statements, with voting rights limited to decisions requiring
shareholder approval.
Private equity refers to investment in privately owned companies or in public
companies with the intent to take them private. In general, private equity is used in
the mature life cycle stage or for firms in decline,with leveraged buyouts being a key
approach.

EXAMPLE 1
Venture Capital vs. Private Equity
Heartfield Digital is an early-stage digital media venture established 18 months ago.
Heartfield plans to convert conventional music and art collection rights to digital form
for sale and distribution. Its founders are seeking early-stage investors in order to
conduct market research, build partnerships, and initiate operations.
In contrast, Arguston Inc. is a mid-sized manufacturing firm in a mature industry that is
experiencing a decline in profitability. Arguston’s share price has stagnated, and given
its high-cost structure and dwindling operating cash flow, Arguston lacks the scale to
make necessary technological upgrades to maintain competitiveness. A prospective
private equity investor might consider an investment plan to restructure Arguston’s
operations, acquire a smaller competitor, and/or create efficiencies, perhaps by
updating the plant and equipment. In several years, Arguston may emerge as a more
profitable independent company
or as an attractive acquisition target for a competitor. Technically, venture capital (VC)
is a form of private equity. The main difference is that while private equity investors
prefer stable companies, VC investors usually come in during the startup phase.
Venture capital is usually given to small companies with huge growth potential, such as
Heartfield Digital, while broader types of private equity financing would be more
appropriate for a mature firm, such as Arguston.
For private debt, in addition to private loans or bonds, venture debt is extended to
early-stage firms with little or no cash flow, while distressed debt (introduced in a
separate fixed-income lesson) involves public or private debt of corporate issuers
believed to be close to or in bankruptcy that could benefit from investors with capital
restructuring skills.
Real Assets
In contrast to financial assets, real assets generally are tangible physical assets, such
as real estate (for example, land or buildings) and natural resources, but also include
such intangibles as patents, intellectual property, and goodwill. Real assets either
generate current or expected future cash flows and/or are considered a store
of value. Real estate includes borrowed or ownership capital in buildings or land.
Developed land includes commercial and industrial real estate, residential real estate,
and infrastructure. Commercial real estate includes land and buildings where private
business activity is the primary cash flow source, whereas residential real estate’s cash
flows stem from rents or mortgage payments by households. Publicly traded forms of
real estate include real estate investment trusts (REITS), which are issuers of
equity
securities, and mortgage-backed debt securities, which are introduced and
discussed in a fixed-income lesson.
Infrastructure is a special type of real asset that typically involves land, buildings and
other long-lived fixed assets that are intended for public use and provide essential
services. Bridges and toll roads are common examples of tangible infrastructure assets.
Infrastructure may be developed either solely by governments or through a
public–private partnership (PPP)in which private investors also have a stake. For
example, a public–private partnership might be used in order to attract long-term
private investment for a broadband internet investment. Infrastructure assets create
cash flows either directly in the form of fees, leases, or other compensation for access
rights or indirectly by promoting economic growth and supporting a government’s
ability to generate increased tax revenue on future economic activity. When private
investors are involved, a contract known as a concession agreement usually governs
the investor’s obligations to construct and maintain infrastructure as well as the
exclusive right to operate and earn fees for a pre-determined period..
Hedge Funds
Hedge funds are private investment vehicles that may invest in public equities or
publicly traded fixed-income assets, private capital, and/or real assets, but they are
distinguished by their investment approach rather than by the investments
themselves. Hedge funds make frequent use of leverage, derivatives, short
selling, and
other investment strategies, which often results in a substantially different
risk and return profile from that of merely buying and holding the underlying assets
in an investment portfolio. Investors may also invest in a portfolio of hedge funds, often
referred to as a fund of funds.

1. Tangible physical assets that generate current or expected future

cash flows and/or are considered a store of value are best labeled as:
A. real assets.
B. private equity.
C. venture capital.

2. Contrast private equity and venture capital.

Private capital is used at different times in a company’s life cycle and in
different forms. Most private equity is used in the mature life cycle stage or
for firms in decline. Private equity managers often use the greater control
and flexibility of private versus public ownership to make management and
strategy changes including closing, selling, or reorganizing lines of business
to increase profitability over a several-year period. In contrast, venture
capital is used for non-public companies with high growth potential in their
early life cycle or startup phase.

3. Identify which statement about a digital asset is most accurate. A digital

asset:
A. includes digital art but not cryptocurrencies.
B. is anything that can be stored and transmitted electronically and has
associated ownership or use rights.
C. must adhere to very specific designs or requirements in order to work
within the limited types of technology that support it.
Solution:
4. Determine the correct answers to fill in the blanks: Alternative investment categories
include _______________, _________________, and
______________.
Solution:
Alternative investment categories include private capital, real assets, and
hedge funds.
Investments Fund

ALTERNATIVE INVESTMENT STRUCTURES

Describe investment ownership and compensation structures commonly used in
alternative investments
Beyond the direct or indirect method of investing in alternatives, the illiquidity,
complexity, and long-term nature of these investments require more complex
structures to
bridge potential gaps between manager and investor interests. Alternative investment
structures may explicitly address both the roles and responsibilities of investors and
managers to address these gaps. In addition, alternative investment structures tailor
the distribution of returns between these two parties to better align the incentives
(or interests) between manager and investor.

Investment Traditional Investment Alternative Investment

A. Publicly traded equity shares are a traditional, not an alternative, investment.
B. Real estate is a real, tangible physical asset that will generate current and/or future
cash flows.
C. Hedge funds are private investment vehicles, not traditional ones, even though they
may invest in public equities or fixed income, private capital, and/or real assets. They
are distinguished by their investment
approach rather than the types of investments they make via the fund.
D. Infrastructure is a special type of real asset typically involving land, buildings, and
other long-lived
fixed assets that are intended for public use and provide essential services. When
private investors get involved in such projects, they participate through a public–
private partnership.
E. The most junior tranche in an asset-backed security is still a fixed-income
instrument. Fixed-income
instruments are traditional investments.

Market Neutral strategy reading:

Market neutral investing is an investment strategy designed to generate returns that

are independent of overall market movements. This is achieved by simultaneously
holding both long (buy) and short (sell) positions in various securities or assets

1. Macroeconomic Uncertainty: The text emphasizes the persistence of

macroeconomic uncertainty, characterized by inflation above central bank
targets and signs of economic weakness due to rapid monetary tightening.
2. Portfolio Diversification: Traditional asset classes may no longer suffice in
providing stable returns. Hence, investors should consider diversifying their
portfolios with additional sources of returns to mitigate risks.
3. Market Neutral Strategies: These strategies aim to generate returns
independent of market direction by making both long and short investments.
They exploit security selection and leverage differences in performance across
securities.
4. Systematic Investing: Systematic processes are recommended for market
neutral investing, enabling granular and nimble approaches to investment
analysis and implementation. This approach maximizes the effectiveness of
market neutral strategies.
5. Alpha Opportunity: The spread in performance between long and short
positions presents an alpha opportunity for market neutral strategies. Higher
variation in performance across securities enriches the opportunity set for
return generation.
6. Security Dispersion: Market volatility leads to increased security dispersion,
providing opportunities for market neutral strategies to capitalize on relative
return differences across securities.
7. Diversification Benefits: Market neutral strategies offer low correlations to
traditional asset classes and can provide an additional source of diversification
in portfolios, especially in the current regime of macroeconomic uncertainty.
8. Systematic Approach: Implementing a systematic approach to market neutral
investing involves granular, data-driven analysis, rapid portfolio recalibration,
and explicit balancing of return considerations with risk and cost tradeof

1. The commodity sector that is least affected by weather risk is:

A. grains.

B. precious metals.
C. refined energy products.

2. For which of the following commodities is the production and consumption cycle

least affected by seasonality?

A. Hogs.

B. Coffee.

C. Natural gas.

3. Which of the following factors is most likely to distinguish the valuation of a

commodity from the valuation of an equity that pays no dividends?

A. Holding costs. Commodities can be valued by tjeir PVof its future sales price

B. Discount rate.

C. Timing of the future sale.

4. A commodity is most likely to be physically stored by a(n):

A. exchange.

B. speculator.

C. arbitrageur. To spot differences between spot and futures

5. A futures market in backwardation will exhibit:

A. positive basis and positive calendar spreads.

B. negative basis and positive calendar spreads.

C. negative basis and negative calendar spreads.

6. Which theory of commodity futures returns is least likely to explain why futures

markets can be in contango?

A. Insurance Theory.

B. Theory of Storage.

C. Hedging Pressure Hypothesis