Transcript 0324665105_140447.ppt

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.
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“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
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Introduction

Rapid recent growth in importance
• Pensions and endowments allocation growth:
– 5 percent in 2000
– 10 percent in 2008

Five Category Groups
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Infrastructure
Private Equity
Hedge Funds
Commodities
Specialized Real Estate
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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
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Popular Types of Infrastructure

Approximately $3 trillion in 2006, including:
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Toll roads & bridges
Airports and airport trolley systems
Railway and ferry systems
Sporting arenas
Shipping ports
Electricity transmission
Water distribution networks
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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
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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
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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
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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
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Hedge Funds
No single definition
 Common characteristics
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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
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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
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Hedge Fund Classifications
 Nondirectional/Directional
Strategy
• Anticipated changes in the underlying market does not
impact choices in nondirectional strategies
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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
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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
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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
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Commodities
Now a widely-used investment class
 Primary advantage: Low correlation with equity
investments
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• Over 1994-2008 period, the correlation with the
Wilshire 5000 Index has been between 0.02 and 0.10,
depending on index
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Primary disadvantage: Returns typically do not
outpace inflation
• May outpace inflation during short periods
• In 2008: Oil and wheat hit record high prices
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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
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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
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Private Equity Investments in 2006
Private Equity
Portfolio Allocation
Expect a Significant
Increase in Allocation
over 2007-2009 period
Corporate Funds
4.4%
36%
Endowment Funds
8.4%
61%
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Forms of Private Equity

Venture Capital
• New companies or new ideas
– High revenue growth, limited net income
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Corporate Finance/Buyout
• Established firm investment
– Help them take advantage of competitive advantage
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Mezzanine Financing
• Provision of second-mortgage financing
– May convert to equity
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Distressed Firm Financing
• Cash infusion when firm is unable to make debt payments
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J Curve
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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
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Given the risks, it is wise to own a “portfolio” of private
equity investments!
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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
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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)
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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
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Less than 1 percent of public institutional investment assets
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