Alt Inv. Flashcards
(66 cards)
Q: What distinguishes alternative investments from traditional investments?
A: Alternative investments include hedge funds, private equity, and real estate, differing from traditional long-only investments in publicly traded stocks and bonds. They are typically actively managed, may include illiquid securities, and often have low correlations with traditional assets.
Q: What are the key characteristics of alternative investments?
A: Alternative investments typically require specialized knowledge, exhibit low correlations with traditional assets, have less liquidity, longer investment horizons, and require larger capital commitments.
Q: What are the two main types of private capital investments?
A: Private capital consists of private equity and private debt. Private equity includes leveraged buyouts (LBOs) and venture capital, while private debt involves direct lending, venture debt, or distressed debt investments.
Q: What are some examples of real assets in alternative investments?
A: Real assets include real estate, infrastructure (e.g., roads, airports), natural resources (e.g., commodities, farmland, timberland), and other assets such as collectibles, patents, and digital assets.
Q: How do fund investment, co-investment, and direct investment differ?
A:
Fund Investment: Investors pool money into a fund managed by a professional.
Co-Investment: Investors contribute to a fund but also invest directly alongside the fund manager in select assets.
Direct Investment: Investors purchase assets themselves without a fund manager.
Q: How are fund managers typically compensated in alternative investments?
A: Fund managers earn a management fee (1-2% of assets) and a performance fee (typically 20% of profits, often with a hurdle rate). Some structures include high-water marks, catch-up clauses, and clawback provisions to align interests between investors and managers.
Compared with alternative investments, traditional investments tend to:
A)
be less liquid.
B)
have lower fees.
C)
require more specialized knowledge.
Explanation
Traditional investments typically have lower fees, require less specialized knowledge by investment managers, and are more liquid than alternative investments. (Module 76.1, LOS 76.a)
An investor who wants to gain exposure to alternative investments but does not have the in-house expertise to perform due diligence on individual deals is most likely to engage in:
A)
co-investing.
B)
fund investing.
C)
direct investing.
Explanation
With fund investing, due diligence on the fund’s portfolio investments is a responsibility of the fund manager rather than the fund investors. Direct investing and co-investing require greater due diligence of individual deals on the part of the investor. (Module 76.1, LOS 76.b)
For an investor in a private equity fund, the least advantageous of the following limited partnership terms is a(n):
A)
clawback provision.
B)
European-style waterfall provision.
C)
American-style waterfall provision.
Explanation
An American-style waterfall structure has a deal-by-deal calculation of incentive fees to the GP. In this case, a successful deal where incentive fees are paid, followed by the sale of a holding that has losses in the same year, can result in incentive fees greater than those calculated using a European-style (whole-of-fund) waterfall. A clawback provision benefits the limited partners by allowing them to recover performance fees paid earlier if the fund realizes losses later. A clawback provision, coupled with an American-style waterfall, will result in the same overall performance fees as a European-style waterfall if the transactions occur in subsequent years. (Module 76.1, LOS 76.c)
Q: What are the key risks associated with alternative investments?
A: Timing of cash flows, use of leverage, valuation challenges, and complex fee structures.
Q: What are the three phases of the alternative investment life cycle?
A: 1) Capital commitment phase (negative returns due to capital outflows), 2) Capital deployment phase (continued negative returns as investments develop), 3) Capital distribution phase (positive returns as investments generate cash flows).
Q: What is the J-curve effect in alternative investments?
A: A pattern where returns are negative in early phases (capital commitment and deployment) and increase in the later capital distribution phase.
Q: Why is IRR the most appropriate measure of after-tax investment performance for alternative
investments?
A: Because IRR (a money-weighted rate of return) accounts for the timing and magnitude of cash flows, which managers control.
Q: How does leverage impact alternative investment returns?
A: It magnifies gains and losses, can lead to margin calls, and may result in forced liquidations at unfavorable prices.
Q: What are the three levels of fair value hierarchy for alternative investments?
A: Level 1: Quoted market prices, Level 2: Valuations based on observable inputs, Level 3: Valuations based on unobservable inputs (e.g., private equity).
Q: How can fee structures affect alternative investment returns?
A: Fees vary by investor and can include management fees, performance fees (with hurdles or high-water marks), and redemption restrictions like lockups and gates.
Q: What biases can affect reported alternative investment returns?
A: Survivorship bias (excluding failed funds) and backfill bias (including only successful historical returns), leading to overstated performance.
Q: What is private capital?
A: Private capital is funding provided to companies that is not raised from public markets. It includes private equity and private debt.
Q: What is a leveraged buyout (LBO) in private equity?
A: An LBO is when a private equity firm acquires a public company using a large percentage of debt, taking it private to improve operations and increase value
Q: What are the stages of venture capital (VC) investment?
A: VC investment stages include pre-seed (angel investing), seed-stage, early-stage, later-stage (expansion), and mezzanine-stage (pre-IPO financing).
Q: What are the main private equity exit strategies?
A: Exit strategies include trade sale, public listing (IPO, direct listing, SPAC), recapitalization, secondary sale, and write-off/liquidation.
Q: What are the main types of private debt?
A: Private debt includes direct lending, venture debt, mezzanine debt, distressed debt, and unitranche debt, each with different risk and return profiles.
Q: How does private capital provide diversification benefits?
A: Private capital has lower correlation with public markets (0.63-0.83), reducing portfolio risk. Diversifying across vintage years and business cycles improves returns.
Q: What are the two primary ways to invest in real estate?
A: Real estate investment can be made directly by purchasing properties or indirectly through limited partnerships and publicly traded securities like REITs.
