ALTERNATIVE INVESTMENT STRATEGIES IN CONTEXT OF PORTFOLIO MANAGEMENT

ALTERNATIVE INVESTMENT STRATEGIES IN CONTEXT OF PORTFOLIO MANAGEMENT

Plainly speaking, Alternative Investments (AIs) are Investments other than traditional investments

(stock, bond and cash).

Features of Alternative Investments Though there may be many features of Alternative Investment but following are some common features.

(i) High Fees – Being a specific nature product the transaction fees are quite on the higher side.

(ii) Limited Historical Rate – The data for historic return and risk is very limited where data for the equity market for more than 100 years.

(iii) Illiquidity – The liquidity of AlternativeInvestment is not good as the next buyer may not be easily available due to limited markets.

(iv) Less Transparency – The level of transparency is not adequate due to limited public information available.

(v) Extensive Research Required – Due to limited availability of market information the extensive

analysis is required

(vi) Leveraged Buying – Generally investment in alternative investments is highly leveraged.

Over the time various types of AIs have been evolved but some of the important

AIs are asfollows:

ALTERNATIVE INVESTMENTS

(i) TRADITIONAL AlTERNATIVE INVESTMENTS

(ii) MODERN ALTERNATIVE INVESTMENTS

(i) TRADITIONAL AlTERNATIVE INVESTMENTS

(a)Real Estates

(b)Private Equity

(c) Commodities

(ii) MODERN ALTERNATIVE INVESTMENTS

(a) Distressed Securities

(b) Mutual Funds

(c)Exchange Traded Funds

(d)Hedge Funds

(e) Closely Held Companies

(f) Managed Futures

(g) Mezzanine Finance

(i) TRADITIONAL AlTERNATIVE INVESTMENTS:

(a) Real Estates:

As opposed to financial claims in the form of paper or a dematerialized mode, real estate is a tangible

form of assets which can be seen or touched.

Real Assets consist of land, buildings, offices,warehouses, shops etc.

Although real investment is like any other investment, it has some special features as every country has their own laws and paperwork which makes investment in foreign properties less attractive.

However, in recent times due to globalization investment in foreign real estate has increased:

1.1 Valuation Approaches:

Compared to financial instruments the valuation of Real Estate is quite complex as the number of transactions or dealings compared to financial instruments are very small.

Following are some characteristics that make valuation of Real Estate quite complex:

(i) Inefficient market:

Information may not be freely available as in case of finance instruments.

(ii) Illiquidity:

Real Estates are not as liquid as that of financial instruments.

(iii)Comparison:

Real estates are only approximately comparable to other properties.

(iv) High Transaction cost:

In comparison to financial instruments, the transaction and the management cost of Real Estate is quite high..

(v) No Organized market:

There is no such organized exchange or market as for equity shares

and bonds.

1.2 Valuation of Real Estates:

Generally, following four approaches are used in valuation of Real estates:

(1) Sales Comparison Approach –

It is like a Price Earning Multiplier as in case of equity shares.

Benchmark values of similar type of property can be used to value Real Estate.

(2) Income Approach –

This approach is like the value of Perpetual Debenture or Unredeemable Preference Shares. In this approach the perpetual cash flow of potential net income (after deducting expense) is discounted at market required rate of return.

(3) Cost Approach –

In this approach, the cost is estimated to replace the building in its present form plus estimated value of land. However, adjustment of other factors such as good location, the neighbourhood is also made in it.

(4) Discounted After Tax Cash Flow Approach –

In comparison to NPV technique, PV of expected

inflows at the required rate of return is reduced by the amount of investment.

(ii) MODERN ALTERNATIVE INVESTMENTS:

(a)Distressed financial instruments:

It is a kind of purchasing the financial Instruments of companies that are in or near bankruptcy.

Since these financial instruments are available at a very low price, the main purpose of buying such financial instruments is to make efforts to revive the sick company.

Further, these financial instruments are suitable for those investors who cannot participate in the market and those who want to avoid due diligence.

Now, a question arises how profit can be earned from distressed securities. We can see by taking a long position in debt and short position in equity, how investors can earn arbitrage profit.

(i) In case the company's condition improves because of priority, the investor will get his interest payment which shall be more than the dividend on his short position in equity shares.

(ii) If the company 's condition further deteriorates the value of both share and debenture goes down.

He will make good profit from his short position.

Risks Analysis of Investment in Distressed financial instruments:

On the face of it, investment in distressed financial instruments appears to be a good proposition but following types of risks need to be analyzed.

(i) Liquidity Risk –

These financial instruments may be saleable in the market.

(ii) Event Risk –

Any event that particularly affect the company not economy as a whole

(iii) Market Risk –

This is another type of risk though it is not important.

(iv) Human Risk –

The judge’s decision on the company in distress also plays a big role.