THROUGH 18 RELATE TO ALTERNATIVE INVESTMENTS VICTOR MOREN...

Questions 13 through 18 relate to Alternative Investments Victor Moreno Case Scenario Victor Moreno, CFA, is an alternative investment analyst recently hired by Northbay Asset Management (NAM), a U.S. based firm. NAM primarily deals with equity and fixed income. Its equity securities are benchmarked to the S&P 500 index while fixed income securities use the Lehman Aggregate Bond Index as benchmark. Moreno is exploring commodities, private equity and real estate as potential asset classes for client portfolios. Dmitri Anderson, portfolio manager at NAM, asks Moreno to justify each of the three proposed asset classes. Moreno shares the following knowledge with Anderson: Real estate: Although both types of real estate investments, direct and indirect, offer diversification benefits, direct real estate is a suitable asset class for both the informational advantaged and disadvantaged investor. Commodities: When the inflation outlook is poor, cyclical commodities provide an effective inflation hedge. Private equity: They are similar to seasoned public equity as they exhibit similar return dispersion and help enhance long-term return. Anderson has heard that private equity investments can be direct or indirect. He asks Moreno to describe the indirect venture capital form to him. Moreno responds by describing the structure, process and drawbacks of the asset class to Anderson. Structure: Indirect venture capital investments can be structured as limited liability companies or limited partnerships with life extension options. Process: Investors deposit their funds in a centralized pool which are subsequently deployed by a managing director for investments. Drawbacks: Partners suffer from limited liability and double taxation. Anderson has also heard of dividend recapitalization often being associated with buyout funds. He asks Moreno what is meant by the term. After concluding his discussion with Anderson, Moreno analyzes an investment in Decorum Limited (DL), a furniture manufacturer. DL is a recently established private venture which has managed to receive financing from two external parties. It intends to use the funds to develop its products. DL will commence commercial manufacturing in two days time. It has sold product samples to a selected number of customers, who are extremely pleased with their design and quality. Moreno estimates that if DL were publically traded, its value would have been $320 million. On behalf of NAM, Moreno intends to acquire a 15% non-marketable minority stake in DL. A minority interest and a marketability discount of 28% and 36%, respectively, are deemed appropriate for the manufacturer. Larry Armstrong is a junior portfolio manager with some knowledge on alternative investments. He is exploring an exchange traded fund (ETF) which utilizes a futures trading strategy to manage exposure to the petroleum industry. Armstrong believes that NAM client portfolios should benefit from participation in the commodity ETF. 13. Based on the justifications provided for the three asset classes, Moreno is most likely accurate with respect to: A. commodities only. B. real estate and commodities only. C. neither of the three asset classes. 14. When describing indirect venture capital funds, Moreno is correct with respect to their: A. structure. B. process. C. drawbacks. 15. With respect to Anderson’s query, the most appropriate response is that dividend recapitalizations: A. enable buyout funds to recoup their acquisition costs in a few years time. B. allow for the restructuring of operations and improvement of management. C. are used as an exit route for private equity funds, buyout and venture capital. 16. Based on the information provided on DL, the private equity firm is most likely in its: A. seed stage. B. early stage. C. second stage. 17. The value of the marketability discount applied to NAM’s minority stake in DL is closest to (in $ millions): A. 12.44. B. 13.44. C. 17.28. 18. Which of the following does not reflect an advantage of Armstrong’s proposed ETF investment? A. Effective exposure to global energy prices. B. Investors need not bear physical storage costs. C. Small investors can gain exposure to commodities.