1. INVESTMENT BANKING LESSON 16 ALTERNATIVE INVESTMENTS & ASSET MANAGEMENT Investment Banking (2 nd edition) Beijing Language and Culture University Press, 2013 Investment Banking for Dummies, Matthew Krantz, Robert R. Johnson,Wiley & Sons, 2014

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

3. 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.

4. 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.

5. 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!!

6. Alternate investments include the following: 1. HEDGE FUNDS 2. VENTURE CAPITAL 3. COMMODITIES 4. REAL ESTATE Let’s look at these!

7. 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.

8. 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 value b. Equity long-short – managers buy funds they expect to go up (long) and short-sell stocks going down (short).

9.  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.

10. 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.

11. 1. Hedge funds c. Event-driven funds: Funds invested in special activities like mergers and acquisitions (M & A).

12. 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

13. 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.

14. 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.

15. 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.

16. 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

17. 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.

18. C. ASSET MANAGEMENT – This division of an IB firm helps clients: 1. Manage their money 2. Provide financial advice 3. Manage accounts 4. Provide financial counseling Clients can be large companies or very large investors.

19. 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.

20. 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

21. 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.

22. 2. Bond Mutual Funds: a. Investment-grade funds – highly- rated companies b. 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

23. 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.

24. 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.

25. 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.

26. 1. Build a wall 2. Place restrictions 3. Compliance 4. Disclose conflicts of interest 5. Make code of ethics Let’s look at these!

27. 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

28. 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.

29. 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?

30. 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.

31. 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.