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CFA1: Alternatives

  • Open-end fund: continuous offering, sales or redemption fees, ongoing management fees, possible ongoing distribution fees
    • Net Asset Value = value of fund asserts - fund liabilities / #shares outstanding
  • Closed-end fund: fixed number of shares, IPO; trade like stocks, bid-ask spread(share price at premium or discount)
    • fixed supply of shares, trade at large discounts/premiums as demand changes
  • Exchange-Traded Funds(ETF): fixed portfolio, usually mimics an index
    • advantages: diversification, trade like equity, efficient operating expense ratios
    • disadvantages: few indexes to track, inefficient markets(low trading volume), tracking error
    • in-kind redemption
  • Real Estate Investment
    • close-end investment; trade on the stock market
    • Comingled funds: pools of capital created by institutions to invest in real estate projects
    • Net Operating Income: property's gross potential income * %vacancy or collection losses - operating expenses(maintenance, insurance and property taxes)
    • investment and financing decisions are made seperately; market value analysis does not consider how the asset will be financed
    • Sales comparison approach - recent trasactions
    • Income approach estimation: value = NOI/required return (property valuation)
    • Cost approach
    • Hedonic price estimation - more formalized/structured sales comparison approach
  • Venture Capital
    • NPV = (probability of survival x estimated payoff) / (1+required return) - initial investment
  • Hedge Funds
    • seek absolute return
    • pursue various investment strategies
    • flat percent fee + performance-based fee(incentive)
  • Risk factors
    • illiquidity risk: decreased trading flexibility when trading in thin markets
    • counterparty risk: exposure to creditworthiness of the broker-dealers
    • settlement risk: counter-party default
    • pricing risk: broker-dealers adopt extremely conservative pricing policies, which requires hedge funds to post a greater margin
  • Investment strategy
    • sector~ : particular industry
    • index~ : portfolio to mimic the benchmark index (e.g. S&P500)
    • style~ : investments with common underlying characteristics
  • Funds
    • Market-neutral funds: long and short positions; offset to hedge against market movements
    • Long/short funds: take both long/short positions; no offset attempt
    • Global macro funds: bet on direction of a market, currency, interest rate; no offset
    • Event-driven funds: focus on unique market opportunities; no offset attempt
  • Performance biases
  1. Cherry picking: reporting selected results
  2. Non-market valuation: smoothes results, reduces reported risk
  3. Survivorship bias: poor performers bail out&disappear; returns biased upwards, risk biased downward
  4. Asymmetrical returns: standard deviation becomes a misleading risk measure

  • Fund of Funds
    • diversification
    • additional management fees, dependance to manager's selection
  • Closel Held Company Valuation
    • legal definitions of intrinsic value, fundamental value, and fair value can differ among jurisdictions
    • discount for lack of liquidity/marketability compared to comparable publicly traded firm, lack of control
    • premium for control/controlling interest
  • Distressed Securities: companies on the brink of bankruptcy, have filed for bankruptcy protection, or attempting to avoid bankruptcy with out-of-court debt restructuring
    • similar to venture capital investing - illiquid asset, long expected investment horizon, requires heavy involvement by investors, extensive analytic work
  • Commodities investment
    • gives exposure to an economy's production and consumption growth
    • directly related overall economy growth/recession
    • savings in commodities prices are likely to be larger than changes in finished goods prices
    • primary motivations: inflation hedge, speculation on the near-term direction of commodity prices
    • commodity-linked equity: shares of commodity producing companies (eg. oil companies such as Shell)
    • commodity-linked bonds: provide income as well as exposure to commodity price changes
  • Collateralized Commodity Futures
    • enter into a futures contract, buy T-bill equal to contract value
    • Holding period return = T-bill %returns + futures %return(change in contract value)