Alternative Investments

Contago

futures prices > spot prices

Backwardation

futures prices < spot prices

Basis

Spot Price - Futures Price

Calendar Spread

difference between futures prices for contracts w/ different expiration dates (eg. March-June calendar spread)

negative in contango, postive in backwardation

Crude Oil

shipped/ stored in natural form, later refined

Seasonality in demand is lower

Natural Gas

must be liquified to ship overseas

Seasonality in demand is higher (needed for heating water)

Industrial and Precious Metals

storable; demand varies w/ business cycle

Grains and Softs

productions sensitive to weather, disease

Livestock

supply sensitive to price of feed grains, weather, and disease

Softs

Cotton, sugar, coffee, cocoa; supply sensitive to weather and disease

Insurance Theory

longs rewarded for providing protection to producers

implies backwardation is a normal condition

Hedging Pressure Hypothesis

expands on insurance theory by including long hedgers

implies backwardation when producer’s hedging behavior dominates; contango when user’s hedging behavior dominates

Theory of Storage

futures prices relate to spot prices through storage costs and convenience yield

futures price = spot price + storage costs - convenience yield

Total Return Swap

variable payments are based on change in price of a commodity

Excess Return Swap

payments are based on difference betwen commodity price and benchmark value

Basis Swap

variable payments are based on the difference in prices of 2 commodities

Volatility Swap

based on volatility on price; volatility buyer receive a payment when volatility of the commodity’s price is higher than expected

Step up clauses

scheduled rent increases

Variable Rents

linked to inflation / CPI

Overage Clauses

higher rent if tenant sale rises

Cost Approach

estimated MV of land + replacement cost of buildings - depreciation

used for unusual properties, new properties that comps are not available

Sales Comparison Approach

estimate of value based on transaction prices of comparable properties; adjustments are made to account for differences between subject and comparable properties

Income Approach

PV of future cash flows, either through direct capitalization or discounted cash flow

NCREIF Property Index (NPI)

fund manager data quarterly; value weighted using appraisal data

Global Real Estate Index

a cap-weighted index published quarterly

included local currency return

combines data from NCREIF (US), INREV (EUR), and ANREV (Asia)

Appraisal Lag

changes in appraisal-based indexes tend to lag changes in actual prices; mitigate by unsmoothing data

Transaction-Based Indexes

measure price changes based on actual sales of real estate

Repeat-Sales Index

multiple sales of the same property; at least 2 needed

regression allocates change in value per quarter

Hedonic Index

regression based on value based on constituent characteristics (location, size, use, age, etc).

Real Estate Investment Trusts (REITs)

tax-advantaged companies, exempt from corporate income tax

limited income gorwht (no rental growth or capital appreciation); more price volatility

Real Estate Operating Companies (REOCs)

ordinary companies that own real estate, not tax advantaged, less restrictions

Net Asset Value

value of REIT assets to private market buyer

better measure of fundamental value than BV

Price-to-Funds from operations (P/FFO)

most common multiple used for REITs

Price-to-adjusted FFO (P/AFFO)

better measure of economic income

Equity Related Hedge Fund Strategies

Focused on Stock market

long/short equity, dedicated short bias, equity market neutral

Event Driven Hedge Fund Strategies

Profit from predicting outcome of corporate events; can invest in equities or related derivatives; subject to event risk

merger arbitrage and distressed securities

Relative Value Hedge Fund Strategies

Exploits valuation differences between hybrid securites

fixed income arbitrage, convertible bond arbitrage

Opportunistic Hedge Fund Strategies

top down; uses both technical and fundamental analysis; can use systematic implementation or discretionary process

Global Macro and Managed futures

Specialist Hedge Fund Strategies

uses manager knowledge of market to pursue specialized opportunities

volatility strategies, reinsurance strategies

Multi-manager Hedge Fund Strategies

Portfolio of various hedge fund strategies

Fund of Funds, Multi - Strategy

Long / Short Equity

Similar to long only, with only ½ the std dev

generate alpha from long and short exposures to single stocks, but benefit from overall long exposure

Dedicated Short Selling & Short Biased

Flexibility shifting between factors

Modest net long exposure between 40-60%

Dedicated Short sellers establish 60-120% pure short position but may use cash to offset exposure

Short-Biased Managers establish net short positions of 30-60%

Historical evidence is predictable low returns

Equity Market Neutral

Generate alpha from mispricings without taking market beta risk

70-90% long, 20-50% short

Pair Trading

sub type of Equity Market Neutral Strategy

invests in two related, but relatively mispriced securities, one overvalued, one undervalued

may represent different classes of shares, or firm & holding parent

Stub Trading

sub type of Equity Market Neutral Strategy

take long & short positions in a subsidiary and its parent company

positions equal % owned in subsidiary

Merger Arbitrage

earn a return from uncertainty due to time between announcement and completion of an acquisition

Significant left tail risk; high sharpe ratios given steady returns

Hard Catalyst

merger arbitrage; after announcement trade

Soft Catalyst

merger arbitrage, enter trade before announcement

Distressed Securities

invested in securities of firms that are in financial distress; firms can either reorganize or liquidate

long lock-up periods, given extended time to exit

Fixed Income Arbitrage

earn return from temporary mispricings of fixed income

overall low expected return, so much use of leverage (400-1500%) to magnify returns

Yield Curve Trades

long and short positions that profit from yield changes

Different firms: liquidity, credit, and interest rate risks

Same firm: mainly interest rate risk

Carry Trades

short low yield, long high yield

return = yield differential + price changes

Convertible Bond Arbitrage

profit from buying implied volatility of undervalued convertible bonds; often tries to hedge the delta and gamma risks

Subject to liquidity issues; performs best during normal market conditions w/ good liquidity

If option is OTM, conversion price is above current stock price, and the delta is close to zero, the bond is not converted

Credit-Oriented Arbitrage Strategy

buys a convertible bond to exploit mispriced issuer credit risk and default profiles

Volatility Oriented Arbitrage Strategy

captures value specifically from the embedded equity call option of a convertible bond.

Global Macro Strategies

profit from identifying variables like inflation, exchange rates, central bank policies

lumpier and uneven returns & higher volatility compared to other strategies

High alpha and strong diversification

Directional Strategy

global macro strategy

buy companies that will benefit from rising interest rates; short companies that will be disadvantaged

Thematic Strategy

global macro strategy

buy companies that will benefit from expected free-trade deals

Managed Futures

long /short in derivatives; nature of derivatives involve a lot of leverage

extremely liquid, but may be subject to crowding

low correlation w/ traditional assets; useful in market stress, right tail skew

Time-series momentum

buy securities w/ rising price, sell securities w/ falling price

Cross-sectional Momentum

buy asset classes w/ rising price, sell asset classes w/ falling price

Volatility Trading

Strong diversification bc of negative correlation; buy underprice volatility, sell overpriced volatility

long position in volatility has a postive convexity

Reinsurance / Life Settlements

insured person sells insurance policy to hedge fund that then pays premiums

Adds alpha while providing diversification; typically illiquid

Fund-of-Funds

typically 2 & 20 structure: 2% management fees and 20% performance incentive fees

Potential netting risk: investors may need to make larger incentive payments even if fund performance is poor

Diversification, lower volatility, less downside risk

Multi-Strategy Hedge Funds

Run by one firm; steady returns & low volatility

More favorable fees, could have poorer liquidity due to lock ups & redemption

Diversification, low-volatility returns, but left-tail risk

Conditional Linear Factor Model

used to quantify risk exposures of hedge fund strategies

conditional bc funds behave differently during normal & turbulent market conditions

Stepwise Regression

avoids highly correlated risk factors and therefore avoids multicollinearity

uses only 4 of the 6 factors: equity, currency, credit, volatility

Sharpe Ratio

uses std dev (total risk), so both downside & upside std. dev impact the ratio

Higher in: Systematic futures hedge funds, distressed securities, fixed income arbitrage, global macro, equity market neutral

Sortino Ratio

Better reflects hedge risk bc only uses downside deviation

Higher in: Equity market neutral, Systematic futures, L/S equity, Event Driven

Drawdown

represents peak-to-trough portfolio decline (expressed as %)

Smaller → the more ideal

Intertemporal Rate of Substitution

how much extra interest is needed to convince someone to delay spending today

Term Spread

= Yield on longer-term bond - Yield on Shorter-term bond

normally positive and attributable to risk premium

Growth Stocks

characterized by high price multiples, low dividend yield, and immature markets

Value Stocks

characterized by low price multiples, high dividend yields, and mature markets