1. Chapter 14 Alternative Assets
Portfolio Construction, Management, & Protection, 5e, Robert A. Strong
Copyright ©2009 by South-Western, a division of Thomson Business & Economics. All rights reserved.

2. JPMorgan Asst Management
“It is unusual that something as boring as infrastructure—pipelines, toll roads, electricity transmission lines, and airports—becomes the hot new thing but here it is."
Mark Weisdorf, CFA
Managing Director
JPMorgan Asst Management

3. Introduction Rapid recent growth in importance Five Category Groups
Pensions and endowments allocation growth:
5 percent in 2000
10 percent in 2008
Five Category Groups
Infrastructure
Private Equity
Hedge Funds
Commodities
Specialized Real Estate

4. Infrastructure Investments
Prominent alternative asset
$3.0 trillion in 2006
Typically started under government authority and later sold to private investors
Eliminates managerial burden
Raises cash for other societal needs
“brownfield projects”
Sometimes businesses provide originates services that are typically offered by government
“greenfield projects”
e.g., high-speed toll road to Washington D.C.’s airport
Considered to be more risky

5. Popular Types of Infrastructure
Approximately $3 trillion in 2006, including:
Toll roads & bridges
Airports and airport trolley systems
Railway and ferry systems
Sporting arenas
Shipping ports
Electricity transmission
Water distribution networks

6. International Aspect of Infrastructure Investment
Infrastructure investments:
Are also called public/private partnerships
Are necessary and facilitate economic development
Are found across the globe
Canada: $C66
India: $150 billion
Europe: €600 billion

7. Infrastructure Investment Characteristics
Long-life
Cash flows generally stable and inflation linked
Significant barriers to entry by competitors
Provides essential community service
Few substitutes for service
Typically are highly levered
Highly illiquid

8. Infrastructure Investment Options
Direct investment
Requires enormous capital reserves
Listed funds
Most popular investment method by individuals
Unlisted funds
Offered through investment banks
Most popular investment methods by pension funds and institutional investors

9. Advantages of Infrastructure Investment
Annual cash flow stream
Periodic increases to keep up with inflation
Private management may provide efficiencies unavailable to government
Low correlation with other assets
Too new for many long-term studies
Australian equities and infrastructure: 0.32
Zero correlation between non-Australian equities and Australian infrastructure

10. Hedge Funds No single definition Common characteristics
Low-correlation focused investment funds
Relatively few investors
Substantial minimal initial investment
Investors are limited partners
Hedge fund is general partner
The unlimited liability of general partner is used to justify management fees and large proportion of profits
Consistency of return is typical investment objective

11. Hedge Fund Demographics
Total number of funds is unknown
Only hedge funds with $30 million in assets or over 15 investors must register with SEC
Hedge funds publicize success, biasing perceptions in favor of hedge fund investment
Alfred Jones started first hedge fund in 1949
- used short positions to offset risk of equity positions
In 2008:
$2 trillion dollars invested
44% held by individuals

12. Hedge Fund Classifications
Nondirectional/Directional Strategy
Anticipated changes in the underlying market does not impact choices in nondirectional strategies
Arbitrage/Relative Value strategy
Assumes the “mispriced” securities will move towards their normal relationship
Merger arbitrage may result in selling shares of acquiring firm and buying those of acquired firm
Convertible arbitrage may result in selling shares and buy convertibles bonds to earn interest income
“may” because one has to consider current price and perceived value of both positions

13. 130/130 Strategy A long/short strategy
Buying undervalued stocks and selling overvalued stocks
Within a given portfolio, sell short the 30% considered to be overvalued and invest the proceeds in the 30% considered to be undervalued.
For every $1 originally invested, there now is another $0.60 worth of positions taken
The proportions could be any number greater than 100
110/110 or 120/120, but not 120/110

14. Hedge Fund-of-Funds Portfolio of hedge funds
Lower initial investment than individual funds
Higher management fees
Pay fees to fund managers and Fund-of-fund managers

15. Commodities Now a widely-used investment class
Primary advantage: Low correlation with equity investments
Over period, the correlation with the Wilshire 5000 Index has been between 0.02 and 0.10, depending on index
Primary disadvantage: Returns typically do not outpace inflation
May outpace inflation during short periods
In 2008: Oil and wheat hit record high prices

16. Commodities (cont’d) Some institutional investors use futures markets
Seek price gain, not the commodity itself
Others invest in farmland, almond groves, and vineyards where assets will be produced
“Price bubbles”
Farmland, ethanol, and all commodities

17. Private Equity
Acquisition of a significant portion of a company, develop the company’s value, and sell it to the investment community
There always is a clear exit strategy consisting of receiving cash
Unlike the entrepreneur, and private equity investor has a target selling date
Both are willing to put forth the time and effort needed to influence corporate decisions

18. Private Equity Investments in 2006
Private Equity Portfolio Allocation
Expect a Significant Increase in Allocation over period
Corporate Funds
4.4%
36%
Endowment Funds
8.4%
61%

19. Forms of Private Equity
Venture Capital
New companies or new ideas
High revenue growth, limited net income
Corporate Finance/Buyout
Established firm investment
Help them take advantage of competitive advantage
Mezzanine Financing
Provision of second-mortgage financing
May convert to equity
Distressed Firm Financing
Cash infusion when firm is unable to make debt payments

20. J Curve
Pattern of returns from private equity investment to cash event
Typically lose money in first four or five years
Eventually, return turns positive, resulting in annual returns in the 25 percent range
Over period, the U.S. venture capital market earned a percent annualized rate of return
The S&P 500 earned 11.19% over the same period
Given the risks, it is wise to own a “portfolio” of private equity investments!

21. Opportunistic Real Estate
High-risk, developed property investment
Generally have a specific purpose
Examples include golf courses, churches, bowling alley, hotels, student housing projects, single-family homes
Opportunistic real estate opportunities may arise from:
Severe regional economic conditions (bankruptcy of city’s primary employer)
Natural disasters (Hurricane Katrina)
Systematic problems (Subprime mortgage problems)
Opportunistic real estate investors focus more on price appreciation
Income streams are smaller, more volatile, and inconsistent
Traditional real estate investors are more concerned with current income
Less than 1 percent of public institutional investment assets