INVESTMENT BANKING

LESSON 16 ALTERNATIVE INVESTMENTS & ASSET

MANAGEMENTInvestment Banking (2nd edition) Beijing Language and Culture

University Press, 2013

Investment Banking for Dummies, Matthew Krantz, Robert R. Johnson,Wiley & Sons, 2014

WHAT’S IN THE NEWS OR WHAT’S THERE TO LEARN?

LESSON 16 TOPICS

A. INTRODUCTION

B. TYPES OF ALTERNATIVE INVESTMENTS

1. Hedge Funds

2. Venture Capital

3. Commodities

4. Real Estate

C. ASSET MANAGEMENT & TOOLS

D. MANAGING CONFLICTS WITH CLIENTS.

LESSON 16 A. INTRODUCTION

INTRODUCTION – What do you think of when you hear the word, investments?

Apart from the usual there is a large class of assets called alternative (other) investments that are becoming more popular.

LESSON 16 A. INTRODUCTION

Alternative investments allow investors to diversify their portfolio and minimize risk. When stock and bonds are down, metals like gold may perform better. And the returns, can be much better than stocks and bonds – but not without risk!!

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS

Alternate investments include the following:1. HEDGE FUNDS2. VENTURE CAPITAL3. COMMODITIES4. REAL ESTATELet’s look at these!

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Hedge Funds

1. HEDGE FUNDS – “Hedge” means to protect. For example: an airline wants to hedge against rising fuel prices so they will enter a futures contract to guarantee the price of fuel today, instead of 6 months from now. The idea is to limit risk but more often investors using hedge funds want to make huge profits. Thus more risk.

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Hedge Funds

Just for example, the most common are:a. Long-only hedge funds – like a mutual fund, stocks are bought that are only going to go UP in valueb. Equity long-short – managers buy funds they expect to go up (long) and short-sell stocks going down (short).

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Hedge Funds

What is short selling? The sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is motivated by the idea that a security's price will decline, enabling it to be bought back at a lower price to make a profit.

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Hedge Funds

Laws in America limit hedge fund investing to people who have over $1 million in net worth (not including a house) and have made over $200,000 a year for the past two years. These are people who can “afford” the risks.

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Hedge Funds

1. Hedge fundsc. Event-driven funds:

Funds invested in special activities like mergers and acquisitions (M & A).

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Venture Capital

2. Venture Capital - Money provided by investors to startup firms & small businesses with long-term growth potential. This is a very important source of funding for startups that are not able to get bank loans or access to capital markets. It typically involves high risk for the investor, but has the potential for above-average returns.

Examples: Microsoft was started with venture capital

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Venture Capital

Venture capital involves a commitment of funds for 5-10 years. Venture capitalists have a large ownership position in a company. These deals are risky and most fail. Only 1 in 10 firms is profitable but the money made in 1 huge deal can make it worth it all! IPO’s can be a result.

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Commodities

3. COMMODITIES – Includes goods from agriculture products (corn, soybeans, cattle, pigs) to metals (gold, silver). Not known for a flow of income but for their consumption and speculation values.

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Commodities

Companies buy and sell commodities to “hedge” (protect) their positions such as airlines for fuel, farmers, wheat prices – all in futures contracts.Commodities are not tied to the stock market – prices do not move together. Makes for attractive investment.

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Real Estate

4. REAL ESTATE – Not thought of as an alternative investment since most all investors own a home. But this kind of investing is owning homes as pure investment.Not a liquid investment and requires maintenance

LESSON 16 B. TYPES OF ALTERNATIVE INVESTMENTS – Real Estate

It is the failure of mortgage backed securities (MBS) that fueled the crisis of 2008. Real estate provides the collateral for the securities that are sold.

LESSON 16 C. ASSET MANAGEMENT

C. ASSET MANAGEMENT – This division of an IB firm helps clients:

1. Manage their money2. Provide financial advice3. Manage accounts4. Provide financial counseling

Clients can be large companies or very large investors.

LESSON 16 C. ASSET MANAGEMENT

C. ASSET MANAGEMENT TOOLS:

1. Stock mutual funds – A managed “pool” of different

companies as part of 1 fund. This diversification minimizes the risk within the portfolio of stocks.

LESSON 16 C. ASSET MANAGEMENT – Stock Mutual Funds

1. Stock Mutual Funds:a. Industry funds – firms within

an industry such as technology, healthcare.

b. International funds – stocks from around the world.c. Emerging market funds –

Stocks from developing countries

LESSON 16 C. ASSET MANAGEMENT – Stock Mutual Funds

1. Stock Mutual Funds:d. Growth funds – Stocks in above-average growth

companies.e. Index funds – Stocks that

are part of the S&P 500, well known, established companies.

LESSON 16 C. ASSET MANAGEMENT – Bond Mutual Funds

2. Bond Mutual Funds:a. Investment-grade funds –

highly- rated companiesb. High-yield funds (like junk

bonds) – below grade companies with higher risk, thus higher yield.

c. Municipal funds – state, county or city bonds for schools, infrastructure

LESSON 16 C. ASSET MANAGEMENT – Exchange-traded funds (ETF)

3. Exchange-Traded Funds – Like mutual funds but with immediate liquidity. Bought and sold on the market on a daily, almost minute by minute basis.

LESSON 16 D. MANAGING CONFLICTS WITH CLIENTS

With all the different functions of IB & all the clients they serve there are many conflicts that are not easily resolved. IB have been accused of manipulating (controlling) markets and making lots of money. There are no easy answers.

LESSON 16 D. MANAGING CONFLICTS WITH CLIENTS

Regulations are always needed but the money regulators make is nothing with whom they are charged to regulate.

So, how to eliminate and manage the conflicts? 5 things to consider.

LESSON 16 D. MANAGING CONFLICTS WITH CLIENTS

1. Build a wall2. Place restrictions3. Compliance4. Disclose conflicts of interest5. Make code of ethicsLet’s look at these!

LESSON 16 D. MANAGING CONFLICTS WITH CLIENTS – Build a Wall

1. Build a wall – The “Chinese Wall” – The ethical & information barrier between divisions of a financial institution to avoid conflict of interest. For example, a Chinese wall is made to separate people who make investments from those who have “inside” confidential information that could influence the investment decisions.

The term comes from the Great Wall of China

LESSON 16 D. MANAGING CONFLICTS WITH CLIENTS – Place Restrictions, Ensure Compliance

2. Place Restrictions – Restrict personal trading by employees and monitoring the proprietary trading (trading for the company) and personal trading by the employees of IB.

3. Ensure compliance – making sure that an IB is not breaking any laws in doing business. Working within the boundaries of a code of ethics.

LESSON 16 D. MANAGING CONFLICTS WITH CLIENTS – Disclose Conflicts of Interest

4. Disclose (make known) conflicts of interest – USA laws require disclosure in documents like the prospectus for an IPO, that show certain facts and relationships that could be potential conflicts of interest.

What should be disclosed or made known ti investors?

LESSON 16 D. MANAGING CONFLICTS WITH CLIENTS – Disclose Conflicts of Interest

4. Disclosures:

a. Conflicts - Is the IB firm acting as a manager that is underwriting for the company.

b. Ownership – Does an IB own more than 1% of common stock in the company.

c. Payments – Has the IB received payments for IB services from the company in the past 12 months.

d. Market Making – Does the IB make a market in the securities or derivatives of the company.

LESSON 16 D. MANAGING CONFLICTS WITH CLIENTS – Establish a Code of Ethics

5. Establish a Code of Ethics – Enron (remember the scandal) had a 64 page code of ethics. This does not guarantee anything but by putting it in writing and made a requirement for people within the IB to follow and be reminded to read often will only help.