Alternative Investments can also be separated from their traditional counterparts using inclusion method. Under the inclusion approach, Alternative Investments are exclusively stated in specific categories. This method is used by most managers in classifying their investments during asset allocation (a topic covered under Advanced Portfolio Management).
The following 5 categories of alternative investments are discussed in details under chapters 3 to 8 of this course. Thus we will only give an overview in this segment.
Real assets refer to buildable lands, and buildings (real estate), including residential homes; raw land and income-producing properties (such as warehouses, office and apartment buildings).
Real assets is a category that is dominated in size by real estate. Most real estate has the institutional structure of being privately held and traded. Real estate is a type of tangible assets which are investment assets that can be seen and touched. In contrast, financial assets are only recorded as pieces of paper.
Included in this category is infrastructure investments, which are claims on the income of toll roads, regulated utilities, ports, airports and other real assets that are traditionally held and controlled by the public sector (i.e. various levels of government). Investable infrastructure opportunities include securities generated by the privatization of existing infrastructure or by private creation of new infrastructure via private financing.
Characteristics of Real Assets
To ‘hedge’ is a means of protection or defense (against financial loss) or to minimize the risk of a bet. The term ‘Hedge fund’ includes a multitude of skill-based investment strategies with a broad range of risk and return objectives. They are thus driven by the trading structure: the use of active, complex, and/or proprietary trading strategies. A common element is the use of investment and risk management skills to seek positive returns regardless of market direction. Hedge funds are also distinguished by regulatory structures (e.g. use of offshore structures due to tax regulations) and compensation structures, including the use of performance-based investment management fees.
A hedge fund is a private pool of capital for accredited investors only and organized using the limited partnership legal structure. The general partner is usually the money manager and is likely to have a very high percentage of his own net-worth invested in the fund. The fund has an offering memorandum which is intended to provide much of the necessary information to support an investor’s due diligence.
Commodities include agricultural products, energy products and metals. Investment in commodities may be in form of direct purchase of physical products or investment in businesses in production of physical commodities. Returns are based on change in price and do not include an income stream such as dividends, interest or rent.
Commodities are primarily driven by their securities structure, since they are usually traded using futures contracts, but tend not to be heavily influenced by other structures. Most investors do not want to get involved in storing commodities such as cattle or crude oil. A common investment objective is to purchase indirectly those real assets that should provide a good hedge against inflation risk. Another investment objective is for portfolio diversification.
Commodity derivatives are financial instruments that derive their value from the value of the underlying commodities. They include futures, forwards, options and Swaps.
Commodity spot prices are determined by market demand and supply. The price of a commodity futures contract is determined by the spot price, risk-free rate, storage costs and convenience yield.
Other commodity investments include collectables such as antiques and fine arts, fine wines, stamps and coins, jewelry and watches, etc. Collectables don’t usually provide current income, are illiquid and not easy to value fairly; and incur storage costs. There are very a few price indices for different collectables.
Private equity firms generally buy companies, repair them, enhance them, and sell them on. By definition, these private equity acquisitions and investments are illiquid and longer term in nature.
Consequently, the capital is raised through private partnerships which are managed by entities known as private equity firms. Private equity consists of four components, namely: Venture capital, mezzanine capital, buyouts, and distressed debt.
Private equity is clearly distinguished by the institutional structure that it is not publicly traded. Compensation, securities, and trading structures also play a non-trivial roles in shaping the nature of private equity.
Structured products are instruments created to exhibit particular return, risk, taxation, or other attributes. They derive their value from other instruments through a process known as securitization. The investment vehicles offer the opportunity to earn the potential appreciation of each segment of the financial markets, so that investors can select various commodities without entering directly into the commodities markets.
Structured assets consist of all securities that are backed by real assets. Â Â Â Â Â Â Â Â Â Â Â Â Â Â Asset-backed securities include mortgages, credit card receivables, auto loans, home equity loans and manufactured housing loans, student loans, small business administration loans and collateralized bond obligations.
Other asset-backed securities include those backed by home improvement loans, healthcare receivables, agricultural equipment loans, equipment leases, commercial mortgage loans, music royalty receivables, movie royalty receivables and municipal parking ticket receivables.
Structured products are distinguished by the securities structure. However, institutional, regulatory and compensation structures typically moderately influence them.
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