Management buyout & buyin

Leveraged buyouts
Assets are used as collateral for debt, and future cash flows will finance debt.

Formative financing
Pre-​seed capital/Angel investing: idea formation
Seed-​stage: product development
Early stage: between operation and production+sales

Venture capital
Later-​stage financing
Between production+sales and IPO
Initial or major expansion

Mezzanine stage financing: preparation for going public

Growth capital: minority investment in mature companies looking for capital to expand or
restructure.
Other investing strategies
Private equity
Private investment in public companies (PIPEs)

Trade sale (to a strategic buyer)

IPO

Private capital
Recapitalization: allow PE investors to pull out money from the company, releverages when
Exit strategies
interests are low, and PE fund still maintains control over portfolio company.

Secondary sale: sell to another PE fund

Fund investment

Writeoff/liquidation
Direct investment
Investment methods
Diversification benefits
Co-​investment
Risk & return
Standard deviations and correlations with equity returns are biased downward.
Due Diligence for Fund Investing, Direct Investing, and Co-​Investing

Direct lending
General partner (GP)
Partnership structures
Mezzanine debt: private debt subordinated to senior debt, unsecured, and may require
special features. Limited partner (LP)

Venture debt: lending to venture firms, often convertible into common stock. Management fee
Private debt

Distressed debt: buying debt of mature firms with financial difficulties Compensation structure Hurdle rate
Hard (only applies performance incentives on the excess between actual return and
Performance/Incentive fee
hurdle rate)
Other private debt strategies Soft (applies performance incentives on total return as long as hurdle rate is passed)

Risk & return Catch-​up clause

Investment and compensation structures

Residential property High-​water mark Prevents GP from gaining the same incentive fee twice for the same gain.

Commercial real estate European style (whole-​of-​fund): LPs receive all distributions until they have received 100% of
initial investment plus the hurdle rate (typically after all investments have been sold).
Mortgage REIT: risk & return similar to fixed income
Investment clauses, provisions, and contingencies Waterfall American style (deal-​by-​deal): profits are distributed as each fund investment is sold and
Equity REIT: uses leverage, return = rental income - debt servicing shared according to partnership agreement
Favors GP because incentive fees are paid before 100% of LPs' original investment plus
Real estate investment trust (REIT) hurdle rate is returned to them.
Indexes: Real estate
Appraisal index: understates volatility due to infrequent appraisals
Repeat sales (transaction-​based) index: sample selection bias Clawback provisions (mostly for American style waterfall): if GP accrues or receives incentive
Types of alternative investments Alternative Investments payments on gains that are subsequently reversed as the partnership exits deals, LPs can
REIT index: may not represent actual properties
recover previous excess incentive payments.

Mortgage-​backed securities (MBS)

Sharpe ratio

Long-​term returns from sale and leases, diversification benefits, and inflation hedge.
Common approaches Sortino ratio
Risk & return
Expenses may increase unexpectedly and leverage magnifies risks.
Calmar ratio and MAR ratio

Ways of categorizing infrastructure investment

Economic (transport, utility) and social (education, healthcare) Multiple of invested capital (money multiple) = total value of all distributions + residual asset
Stage of development (brownfield, greenfield) values / initial total investment
Real assets Does NOT consider timing of cash flows => Must use IRR
Geographic location Private Equity and Real Estate Performance Evaluation

Forms of investment J-​curve for returns

Direct
Indirect Leverage Generally trade through prime brokers who lend or execute transactions for the fund.
Infrastructure

Revenue different from expectation, leverage creating Issues in performance appraisal Redemptions may require liquidating positions and incur transaction costs.
financial risk, operational risk, construction risk

Risk & return Drawdowns (decline in NAV) may trigger redemptions.

Regulatory risks
Illiquidity and redemption terms
Redemption fees, lockup periods, and notice periods minimize impact of drawdowns.
Currency, political, and profit repatriation risks

Hedge funds Fund of funds may offer more redemption flexibility than direct investment in hedge funds.
Futures price > Spot price => Commodity forward curve is upward sloping
=> Prices in Contango
Market prices liquid => (Bid + Ask)/2

Futures price < Spot price => Commodity forward curve is downward sloping Natural resources
=> Prices in Backwardation Market prices illiquid => consider liquidity discount or haircut
Commodities
Valuation issues Reported NAV is based on quoted price
Agricultural and Timber land
Trading NAV includes haircut
Diversification benefits and inflation hedge, but high volatility.

Market prices NOT available => Estimate with statistical models

Invest through ETFs, Managed futures funds, and funds specializing in specific commodity sectors.

Fee structure

Equity hedge

M&A

Distress/Restructuring
Event-​driven
Activist Strategies

Special situations

Relative value Hedge funds

Macro

Diversification benefits (but may still have high correlation with traditional investments
during times of crisis)

Survivorship bias
Risk & return
Backfill bias

Appraisal values less volatile than market values => Standard deviation and correlation of
fund returns with traditional investments may be biased downward.