Alternative Assets – Part II

1. Alternative Assets – Part II “Strategies” Economics 489 University of Virginia September 24, 2007

2. Real Estate Private Equity Hedge Funds Alternative Asset “Strategies”

3. Commercial Real Estate Funds Domestic vs International “Core” versus ??? Multifamily RE Funds Typically 7 – 10 year life Blackstone/EOP Real Estate Funds

4. LBO Funds These are the largest: KKR, Blackstone, Carlysle Also, Lehman, GS, etc. They buy public companies Corporate restructuring High debt loads “Exit” strategies “Middle Market” Buyout Funds Mostly “private” companies, but some public company acquisitions Usually the funds has a “specialty” – technology, health care, infrastructure, etc. Private Equity Funds

5. Deal “sourcing” Auctions Common concepts: Closing “material changes” Break up fees Deal “cosmetics” Valuation issues Issues for RE, PE

6. Hedge Funds • Hedge Fund Strategies • Long only • Long / Short • Market Neutral • Event Drive • Risk Arbitrage • Distressed Securities • Convertible Arbitrage • Other • High Yield • Structured Producs • Emerging Market Debt • Prime Brokerage • Fund of Funds

7. Long Only Long / Short Market Neutral Event Driven Risk Arbitrage Distressed Securities Convertible Arbitrage Other High Yield Structured Products Emerging Markets Debt Hedge Fund Strategies Strategies

8. Long Only • Traditional Equity (Common Stock) Management • Higher Fee Structure than traditional money management • Sometimes little or no diversification Long Only Strategies

9. Short Stock (or bond or anything) • Selling something that you don’t own • Not unusual in the least • Delivery is the only issue • Borrow the security • By giving the lender the sale proceeds • Eventually do a “buy-in” or “Cover” Shorting Stock

10. Long / Short Strategies • Market Neutral is a special case • Equal dollars long/short • Beta adjusted neutrality • Often an “overlay” strategy • Free Wheeling • “Long Bias” • “Short Bias” • Tactical Asset Management Long / Short Strategies

11. Market Neutral • Beta equals zero (meaning return is unrelated to what happens in the stock market) • Sometimes this is called an “alpha” strategy • Implementation issues • Equal dollars • Beta adjusted Long / Short Strategies

12. Alpha Return =  +  (Market Return) CAPM says that  = 0 “” measures the talent of the asset manager Long / Short Strategies

13. Event Driven • Risk Arbitrage • Distressed Securities Event Driven

14. Risk Arbitrage • Corporate Event • Normally an acquisition or a merger • Could be a “spin off” or other “restructuring” • Simple acquisition • Buy the acquired • Sell the acquiror short Event Driven – Risk Arbitrage

15. Example GONO is trading at $ 30 per share ACME tenders for 100 % of GONO stock at $ 50 per share Where will GONO trade? Depends upon two things: Date of “closing” How sure the “closing” is So, maybe 60 days to closing, GONO trades at $ 48 2/48 is return for 60 days (nearly 5 percent) Event Driven – Risk Arbitrage

16. Distressed Securities • Usually a bankruptcy situation • Debt gets priced below the value of the assets • Buy the debt, go through the bankruptcy • Or sell the debt opportunitistically • World Com latest example Event Driven – Distressed

17. Convertible Arbitrage • Convertible Security is a hybrid • Part Bond • Part Warrant • If convertible is viewed as “cheap” • Buy convertible • Sell stock, warrants, options in some combination • Dynamically alter hedge as stock price moves around • In truth, it’s a spread trade, not an arbitrage transaction Convertible Arbitrage

18. 4 Percent XON covert Into 10 shares of XON at any date after Jan 1, 2006 Suppose XON is trading at $80 Then $1,000 bond (price = 100, par) pays $ 40 per year (say $ 20 per year, twice yearly) Parity of bond is $ 800, premium is $ 200, if price is 100 ($ 1,000) Buy bond, short stock – some ratio Example Convertible Arbitrage

19. Why not buy stock, short convert? Can’t borrow the convertible Convertible Arbitrage

20. High Yield Structured Products Emerging Market Debt Global Macro CTA Quantitative (?) Other (momentum ?) Other Other Hedge Fund Strategies

21. Hedge Fund uses strategies But, how do you execute these strategies Borrowing securities Borrowing money Executing in a wide variety of markets Simpler to do all in one spot – basically a “back office” operation Now, PB units help hedge funds raise money as well – “capital introduction” units Prime Brokerage Prime Brokerage

22. A fund That solicits money from individuals and institutions Invests the money in hedge funds as a limited hedge fund partner Fastest growing part of hedge fund industry Fund of Funds Fund of Funds

23. Hedge funds can be thought of as “like stocks” Mean-variance optimization procedures used to give an “efficient” portfolio of hedge funds Modern Portfolio Theory Argument

24. Individuals Don’t have time or expertise to pick their own Institutions Don’t have time or expertise to pick their own Believe that the FofF manager is better at it Believes the “diversification” or whatever else is employed is a good strategy for selecting and weighting the funds Who are the investors in F of F? Fund of Funds

25. Additional fee (typically 50 basis points) Additional carry (typically 500 basis points) Sometimes the funds invested in reduce their fees so that the net fees to the investor is not increased How are F of F’s Paid? Fund of Funds

26. Asset Allocation done synthetically (or indexed) Active strategies totally hedged by a benchmark (difference is then interpreted as alpha) Lot of proponents, not many implementations Portable Alpha

27. End