Introduction to Alternate Investments CHAPTER 1

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1 Introduction to Alternate Investments CHAPTER 1

2 Concept of Alternative Investments Alternative Investment Types Contrast Alternative and Traditional Investments Role of Alternative Investment in Strategic Asset Allocation Trends in Alternative Investments Due diligence Case Study

3 Alternative Investments Alternate Investments as the name suggests, refers to investments other than traditional asset classes (i.e. stocks, bonds and cash). It includes tangible assets as well as financial assets. Tangible assets include precious metals, artwork, coins, stamps, etc. Financial assets include real estate, private equity, commodities, hedge funds and cryptocurrencies.

4 Alternative Investments Alternate Investments are mostly held by high-net-worth individuals (HNIs). They generally lack liquidity. They require active and specialized management skills by the fund manager to manage, hence the management fees is higher. They are generally characterized by the high use of leverage and derivatives.

6 Concept of Alternative Investments Alternative Investment Types Contrast Alternative and Traditional Investments Role of Alternative Investment in Strategic Asset Allocation Trends in Alternative Investments Due diligence Case Study

7 Alternative Investment Types Types of Alternative Investments Hedge funds Private equity fund Real estate Commodities Cryptocurrency Others

8 Hedge Funds Hedge funds are funds for the wealthy and sophisticated investors. The managers of hedge funds have a lot more flexibility than the managers of mutual funds. Hedge funds proclaim to provide absolute performance i.e. performance which is not dependent upon the equity market s performance. Hedge funds escape certain regulations that apply to mutual funds. Hedge funds are illiquid, so there are certain restrictions on redemption of investments such as a lockup period (which is a time after initial investment during which withdrawals are not allowed).

9 Private Equity Private equity funds invest in equity of firms that are not publically traded or in the equity of publically traded firms that the firm intends to take private (leveraged buyout funds). Venture Capital funds are a subset of private equity specializing in the investment in early-stage to growth-stage companies. The capital from venture capital funds is extremely important for start-ups and early-stage companies that have no access to public financing as most of them lack revenue history. Venture capital is typically a risky asset class. Early venture capital investors in famous start-ups like Google, Facebook, and Twitter are making a significant return on their investments.

10 Real Estate Real estate investments include residential properties or commercial properties, as well as real estate backed debt. Real estate investments can be privately held or publically held. In private real estate investment, property is owned directly and the investor has complete control over property. Investment in public real estate is done by buying Real estate investment trusts i.e. (REITs) or Real estate operating companies i.e. (REOCs) (which is public equity), or by buying mortgage back securities (MBS)(which is public debt). The management controls the property.

11 Commodity A commodity refers to a useful or valuable thing. Commodities also include primary agricultural product or a raw material that is used as input in the manufacturing of other goods and services. Commodities are usually homogenous though there may be different grades of quality for the same commodity. The factors affecting price of commodities are demand and supply.

12 Cryptocurrency A cryptocurrency is a digital or virtual asset designed to work as a medium of exchange. Investors in crypto currencies believe that inflation is the tax they are paying due to the fraud of money printing. One individual can transfer funds to another individual without the intervention of a third party that takes commission(banks) is its greatest advantage. Bitcoin is the first decentralized digital currency, as the system works without a central bank or single administrator.

13 Others This category of investment includes investment in other tangible collectibles including wine, art, rare coins and stamps, valuable jewelry and watches. In such a type of asset class, there is no income generation but the owners however does get the enjoyment from its use, as is the case with a collectible automobile (vintage cars). In these types of investments storage costs are significant (especially with art and wine). Specialized knowledge is also required, the markets for many collectibles are generally illiquid and gains result from increases in price of these assets.

14 Concept of Alternative Investments Alternative Investment Types Contrast Alternative and Traditional Investments Role of Alternative Investment in Strategic Asset Allocation Trends in Alternative Investments Due diligence Case Study

16 Contrast Alternative and Traditional investment types A traditional portfolio will comprise of Equity, Debt and Cash. The primary logic of devoting some funds to alternate investments is the empirical evidence of its low correlation with traditional asset classes. Alternate investments provide an immense diversification benefit i.e. risk reduction. Compared to the traditional asset classes, alternative investments lack liquidity as it may take the owner substantial amount of time to sell off his investment at a fair price. Managers of alternative investments portfolios may use derivatives and leverage, invest in illiquid assets, and even short sell securities.

17 Contrast Alternative and Traditional investment types Alternative investment managers have more specialized knowledge than traditional investment managers. Alternative investments are taxed differently and often have more regulatory restrictions than traditional investments. There is lack of historical return and volatility data for alternative investments. Alternative investment lack transparency leading to suspicion in the minds of investors.

19 Concept of Alternative Investments Alternative Investment Types Contrast Alternative and Traditional Investments Role of Alternative Investment in Strategic Asset Allocation Trends in Alternative Investments Due diligence Case Study

20 Strategic Asset Allocation Strategic asset allocation is a strategy that is used in portfolio management. It involves fixing target allocations for various asset classes, rebalancing the portfolio on a long term basis (more than a year) to maintain the original allocations. Weights of the assets in the portfolio can deviate due to different returns from various assets; hence they are rebalanced to the originally allocated weights in the long term. Strategic asset allocation is an investment strategy focused on the needs of the investor rather than the constant tracking of the markets.

Strategic Asset Allocation Alternate investments provide immense diversification benefit due to its low correlation with the traditional asset classes and are also illiquid.

21 Strategic Asset Allocation Alternate investments provide immense diversification benefit due to its low correlation with the traditional asset classes and are also illiquid. To remove the influence of emotion from investment strategies, strategic asset allocation can be used so that the investors do not have to constantly track the market and rebalance their portfolio.

22 Concept of Alternative Investments Alternative Investment Types Contrast Alternative and Traditional Investments Role of Alternative Investment in Strategic Asset Allocation Trends in Alternative Investments Due diligence Case Study

23 Trends in Alternative Investments Trends in alternate investments influence how the financial managers and advisors leverage their investor s money to maximize profits. The alternative investment class represents a total of $7.7 trillion invested in hedge funds and private capital, according to the Preqin s Investor Outlook: Alternative Assets, H In the year 2016, alternative investments have experienced a growth of $300 billion, which shows that there are new investors jumping on board to diversify their investments.

24 Increasing rush towards diversification within the alternate investments

25 Investors allocation among different Alternative investment classes

26 Concept of Alternative Investments Alternative Investment Types Contrast Alternative and Traditional Investments Role of Alternative Investment in Strategic Asset Allocation Trends in Alternative Investments Due diligence Case Study

27 Due Diligence Since alternative investments is an asset class which is illiquid, less regulated and uses leverage as well as complex derivatives, investors should conduct proper due diligence before investing in it.

28 Due Diligence Management of Risk Control and Operation Portfolio Management Terms of the Fund Legal Review

29 Concept of Alternative Investments Alternative Investment Types Contrast Alternative and Traditional Investments Role of Alternative Investment in Strategic Asset Allocation Trends in Alternative Investments Due diligence Case Study

30 Case Study On the 23 rd of June 2016, the citizens of the United Kingdom voted to leave the European Union. On this day the global stock markets steeply dipped, the British pound plunged, while the prices of precious metals (gold and silver) spiked. Due to the weakening of the pound sharply, the purchasing power of the pound holders also decreased. The traditional investors, the general public who used to underestimate the correlation of the traditional asset classes they were holding, realized that during a crisis, correlation of returns between such asset classes spikes.

Case Study In such a situation, there is always a flight to safety Gold. Gold does not have industrial use cases like other metals such as Iron and Copper.

31 Case Study In such a situation, there is always a flight to safety Gold. Gold does not have industrial use cases like other metals such as Iron and Copper. Gold does not yield dividends or cash flows like bonds and stocks but, it is scarce and highly demanded, that is what determines it value. Today gold holds a market capitalization of approximately $7 trillion.

32 Case Study On 28 April 2017, BBC reported that property investment firm JLL (company) data shows that 28% of the transactions in UK property market in 2016 was from Asian investors, which are up from the 17% the year before that. This indicates that Brexit is not dissuading Asian property investors from investing in the United Kingdom. This shows how alternate investments are rising and people are choosing to diversify their wealth across different investments to save themselves from the risk of high correlation of returns between assets during a crisis.

33 Real Estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world. - Franklin D. Roosevelt

34 THANK YOU

Financial Institutions Topical Research Series. Alternative Investments: The Broad Set of Investments Beyond Public Securities. (Table of Contents)

Financial Institutions Topical Research Series Alternative Investments: The Broad Set of Investments Beyond Public Securities (Table of Contents) April 26, 2017 TABLE OF CONTENTS Evolution of the Alternative