Alternative Investments Essay

Executive SummaryThe purpose of the report is to do an in-depth endueigation, study and digest on alternative invests. From the various alternative enthronements, our team of analyst chose commodities, vari equal annuities and evade depots as our subject of interest for the study. Each financial product has its own aims as to cater to the different enthronisation monetary resource goals to twin the chooses of investors. Thus, just by looking at the basis on costlyness and measure-efficiency, and then from selecting the emend unity is unwise. We turn over to look at the boilers suit picture and considering opposite inherent factors kindred seeks, runniness, access tryst which be equally essential. on that pointfore, our basis of evaluation comprises of various of import factors so as to eluci naminga robust analysis. first, commodities be a in high spiritsly demanded enthronisation which is traded using options and futures occupy.. Moreover, they ar withal an fragment of diversification that investors house dismount their vulnerability to market irritability. Despite its high capriciousness in its prices, it managed to encourage a higher return as comp ared to stocks and bonds. As commodities consent a low correlation with bonds and stocks, it is adapted to reduce unsystematic luck through diversification. Its high correlation with rate of inflation hence looks approbatory in times of crisis and these enable investors to master its summation parcelling ending.By using the 60/40 tax treatment, it has shown that it is indeed an economic method in lowering taxes. Its high commodity market liquid state thus seem promising to investors as it correlates soundly with it market business especially in corn, aureate and precious metals futures. Moreover, it is advisable for them to allocate 5% to 10% of their investment to commodities so as for bankrupt diversification to eliminate unsystematic try. As it has no or few substitute, it is advised that investor should eat none of whatsoever unexpect run a risk involved. protean annuities on the some other hand are tax-deferred with a climb-down ensure that after the age of 59. The performance of its sub- depicts affects many a nonher(prenominal) aspect of variable annuity. This is so as the performance of varied on a lower floorlying investments in the sub-account results in non- logical distribution in its returns. Further more than, variable annuity is relatively volatile as it returns cristald to varies as accordance to the returns of its bloodlineamental investments. Thus, granted with a choice of an addition for the underlying investments, investors leave alone convey an underlying plus that is non-correlated to their portfolio holdings. Variable annuity also incurs reasonable costs.However, the of import benefit of investing in variable annuity is that it is highly tax-efficient as it is a tax-deferred vehicle. This reduces the tax angle on investors and at the uniform time creates an opportunity for them to invest in tax-inefficient vehicles in front the withdrawal date as no tax is imposed before the date. The downside to investing in variable annuity is that it has liquidity risks. However, it open fire reduce unsystematic risk significantly due to the investment options forits sub-account and this important aspect of it also provide investors with the ability to allocate their assets.The primary aim of most put over funds is to reduce volatility and risk while attempting to preserve capital and deliver positivistic returns under all market conditions which brings investors an indispensable option to invest in wangle fund. With a low monetary standard loss of almost zero, hedge funds are highly of an improvement as it does not fluctuate widely within periods. However, volatility is not the only indicator of risk affecting the fund. For hedge funds, the skewness variations are not u niform across styles.While hedge funds offer emf for returns that are not highly correlated with other markets, their unique properties would also mean that they involve a high degree of risk. Its fees are constant thus investors should follow accordingly. Hedge Funds exploit different ways to minimize capital gains and income taxes for investors. With the measure Exemption for Singapore Resident Funds, it places investment in Hedge Fund at an advantage. Putting their pull in the fund managers ability to meet the funds accusings, it is then recommended for investors to aim the refine fund manager to manage their investments.From the in-depth analysis on alternative investments, we realized that in that location is no a perfect product to solely invest in. Each alternative assets has its advantages and disadvantages, thus we ask to invest in varieties of asset classes but diversified it. There is also the need for proper asset allocation management and the use of investment strategies.IntroductionThe continual search to reap higher risk-adjusted returns has led to a tot up of highly alternative assets to be considered for financial investment purpose. Thus, the growth of alternative investments market is outstanding. fit to the 2010 Alternative Investment Survey of U.S Institutions and Financial Advisor, 36% of the institutional investors that are surveyed have $1-10 Billion in asset under management and 29% with greater than $11 Billion in asset under management. In this report, our team of financial analyst has chose to do an in depth analysis on commodities, variableannuities and hedge funds. Through this report, we are going analyze the aforementioned alternative assets through various important factors namely its returns, risks, costs, other competitive advantages and disadvantages. At the end of this report, we hope to acquire an in-depth evaluation on the attractiveness of each subject of interest and make sound recommendations.Introduction to CommoditiesCommodities are raw materials used for producing secondary goods which are transacted in volumes and classified into energy, metals, grains and livestock. Manufacturers in the commodities market purchase commodities needed on a have it off market while speculators purchase and sell commodities using options and futures contracts. Commodity markets are real demand and bring markets. Thus with the increasing world population, there is now higher demand than supply for commodities, making commodities a viable investment for both the present and the future. anticipate ReturnsDuring inflation, commodities total returns provide soar. When making an investment in commodities one can expect returns that are capital return. Commodities have been providing its investors with relatively high returns, exhibiting disallow correlations with equities and bonds as well as hedge against risks. Based on the Commodity Price Index for the past family, expected returns were at 0.85% , volatility were at 0.0641 which is considered to be relatively low, while the return-risk was 0.1319.VolatilityVolatility in commodities prices fluctuated belatedly with their highs and lows due to the interference of the commodities market like political disputes and natural disasters. In 1973 to 2007, based on the S&P 500 Index, MSCI Index and Lehman Brothers Bond Index, it has an annualized return of 10.9% and 24.5% annual standard deviation, volatility. Although stocks performed better than commodity, commodities volatility was in the peak compares among stocks and bonds. Historical risk return on commodity had remained positive of or so 5% during the years. T-statistic, outlining the level of confidence that the risk return is different from 0 shows afigure of 2.84 which shows that it is higher than stocks and bonds.Distribution of returns Refer to AppendixFrom the convex curve, we can surmise that the distribution of returns on commodities is widely distributed and tends to be close to a normal distribution as investors are concern about their real returns as they want to outperform inflation. As compared to stocks and bonds, the returns in commodities are positively skewed. Since returns for commodities investment is right skewed, it means that the amount of returns will be higher than stocks and bonds which are negatively skewed. Returns distribution is very wide as the returns show a greater than 3 overmuch kurtosis. However, this also means higher risk for investors due to the wide distribution of returns.Correlation with other asset classes Refer to AppendixFrom the table, it shows that Standard & Poors 500 and the company are closely related in argument to the other asset classes. GSCI and 1 month T-bills with a correlation protect of -0.003, proves that they are in restricted of one other. It is revealed that commodities futures are negatively correlated to returns of stocks and bonds with coefficients of -0.42 and -0.25 respectively. The refore, by allocating funds to those assets of negative correlations, it provides the benefits of diversification when facing a complete risk asset class.Fees, Trading and other expensesThere are many fees and expenses that are implied in commodities employment. When trading commodities, investors incur management and brokerage fees, service tax and a possible loss of investments. When a futures contract is purchased, an initial down recompense on the total futures price (initial margin) is to be made. The margin requirement is fundamentally a small percentage of the total purchasing price for a commodity. This margin requirement unremarkably adds up to be little than 10%.LiquidityCommodity market liquidity often correlates well with commodity markettrading profits. Investors can benefit in high commodity market liquidity. It is easier to take down and exit trades. With the high trading volume and liquidity, the statistics of predictive ability of time honored tools like cand lestick patterns formulates tend to be more precise. Commodities that offer good commodity market liquidity include trading in Corn and Gold futures. Each of these trades at high volume and high liquidity. However, they are control by different factors. Gold and other precious metals perform well when investors are maladjusted about inflation or when there is the threat of economic or political disruption. Corn is determined by supply and demand. lieuThe location of where the commodity is produced is not an important factor that an investor should consider as there are similar products that will be sold regardless of where it has been produced. Hence investors retainer of location is not required when making an investment.Tax EfficiencyIn commodities, it is quite tax-efficient as they follow the 60/40 tax treatment whereby 60% of the gain is taxed as long-term gains and 40% are taxed as short gains. Long-term capital gains are capped at 15% which is favorable for high income inve stors, meaning that 60% of gains will be taxed at 15% while 40% of gains will be taxed at 35% which both equals to 23% for commodities. Thus, it will jockstrap investor to save money in tax.Ability to eliminate or significantly reduce unsystematic risk Investing in commodities does not reduce unsystematic risks. Firstly natural disaster and bad weather may affect a various types of commodities. Another risk is geopolitical risk. This risk occur as worlds natural resources are located in various continents and the jurisdiction over these commodities lies with sovereign governments, international companies, and many other entities. Thus, international disagreements over the control of natural resources are quite commonplace. Negotiations on the extractions are pretty tense as disagreements may slowly rise over licensing agreements, tax structures, environmental concerns, employment of indigenous workers, access to technology, and many other conglomerate issues.Ability to control th e asset allocation decisionInvestors are able to control asset allocation decision in commodities. This is so as commodities are not nonrecreationally managed unless you have the intentions to. Thus, investors who wish for professional money managers who specialize in commodity trading to handle their investments, they may turn to ETFs or reciprocal funds. With that, commodities traders are able to free decisions on the allocation of their assets. It is advisable for investor to allocate more of his investments to other types of investments and allocates 5 to 10% of his investments into commodities due to its volatility. tack? Any alternatives that achieve the same objective in a more efficient less expensive and/or more tax efficient- manner Commodities have few/no substitutes as they are generic goods that we utilize in our every mean solar sidereal day lives. Its suggested for any investor to take into consideration the unexpected risk such as natural disasters and bad weather . If they allocate most of their investment in commodities and when an adverse event strikes, they would be caught in a difficult position. Commodities have the best advantage against inflation. During inflation, prices of commodities have the tendency to rise. Therefore, as an investor in commodities, you would be able to gain much from the increment of value.Introduction to Variable AnnuitiesVariable annuities are tax-deferred investment vehicle that comes with a minimal insurance contract so they can qualify for their tax-deferred status. Variable annuities can be immediate or deferred. Once you reach 59, you can begin withdrawing the funds without any penalty.Expected ReturnsVariable annuity has no expected rate of returns as its return is based on the marketplace performance. Its fees will be subtracted from the returns. By exchangeing assets, a portfolio may have a higher return potential with a lower level of risk than the portfolios components would achieve separately.Vola tilityThe standard deviation indicates the tendency of the returns to rise or fall drastically in a short period of time. Since the return on investment in a variable annuity is nowadays tied to the performance of sub-accounts that make up investors annuity, the fund would exhibit a high standard deviation as each years return of the fund may differ from its mean return. This in turn makes variable annuity riskier as it is volatile.Distribution of returnsReturn on investment in a variable annuity is directly tied to the performance of sub-accounts that make up investors annuity. If the underlying investments are in stock and bonds for example, theres potential for a greater return. However, this will be match with a higher risk of loss including loss of capital which involves the funding options. It means that payments and earnings are not guaranteed. Thus the skewness variations are not uniform as returns varies depending on the instruments it consists of in the underlying invest ments.Correlation with other asset classesVariable annuity offers a range of investments options for the sub-accounts. Investors will have to choose a specific one of his interest. Thus, entitle with the benefit of deciding the underlying investments, it enable investors to pick an asset that is low correlated or non-correlated with other assets classes of his portfolio. Thus, variable annuity offers residue and diversification to investors.FeesFirstly, there is the turn in carriage. It is a type of barters charge that will be issued to the customer when they withdraw money from a variable annuity within a certain period (which may spay from six to ten years) after the purchase. It is to pay the financial professional as a commission for the sale of the variable annuity. It decreases gradually over the surrender period, usually 1% less each year. Next, it is the mortality and expense risk charge which is 1.25% per year. It compensates insurance company for insurance risks. Its profit is to pay the insurers initial cost of sale ofthe variable annuity. Next up is the administrative fees which are charges for record-keeping and other administrative expenses and is charged 0.15%.Trading and other expensesUnderlying Fund Expenses are fees that will be charged indirectly and they are imposed by mutual funds which are the underlying investment options in the variable annuity. Fees and Charges for other features are other miscellaneous fees charged in special features offered in some variable annuities. Such features include stepped-up expiration benefit and long-term care insurance.LiquidityVariable annuity has liquidity risk in it whereby the harvesting from the variable annuity may be unavailable at the time of withdrawal or it will be available but at a significantly lowered value. These are attributable to dickens factors. Firstly, because annuities are designed as retirement vehicles, getting out early can mean victorious a loss. Many variable annuitie s assess surrender charges for withdrawals within a specified period, which can be as long as 6 to 8 years. Furthermore, any withdrawals before an investor reaches the age of 59 /2 are subject to a 10% tax penalty by the IRS (Internal Revenue Service) in addition to any gain being taxed as ordinary income. Secondly, if the holder is in a need for currency and must liquidate his variable annuity, there is a possibility that on the date of liquidation, its account balance is lower than what it was previously simply due to market fluctuations.LocationAnnuities are a commonplace in the current world but actually it existed way back during the Roman times. It was then introduced in atomic number 63 and the United Kingdom. It made its mark in America in 18th century but was only fully aware of in the 1930s where the Great Depression caused Americans to save for a rainy day. Variable annuities were first created in America in 1952. Today, variable annuities is popular than ever with sales estimated to be USD40.2 billion and are offered in many countries due to its applicability for retirement purposes. Singapore is not excluded in the variable annuitiesmarket as well. Manulife Singapore launched the first variable annuity, Secure Retirement Plus (US$), in 2007 and later introduced Secure Retirement Plus(S$) in 2008.Tax EfficiencyVariable Annuities are tax-deferred. It can help investors save more while reducing their overall tax burden. This provides investors with good opportunity to invest in tax-inefficient vehicles such as bonds and types of equities. However, there will be a taxable amount of 10% IRS penalty with withdrawal before reaching the age of 59 years. This means that investors pay no taxes on the income and investment gains from their annuity until the withdrawal date. They may also transfer their money from one investment option to another within a variable annuity without paying tax at the time of the transfer. At their withdrawal of variable annuit y, they will be taxed on the earnings at ordinary income tax rates rather than lower capital gains rates.Ability to eliminate or significantly reduce unsystematic risk By diversifying, investing in variable annuity does reduce unsystematic risk. Investors are able to make payment purchase and allocate it to various asset classes such as small-company stocks, international government bonds and fixed annuities. irregular risk decreases as the number of stocks in a portfolio increases. It could help to protect the investors against sustained losses in a single stock or sector of the market.Ability to control the asset allocation decisionVariable Annuity has an accumulation phase whereby the investor makes purchase payments in which they can allocate it to a number of investment options. Moreover, it is a flexible investment that allows investors to move their money into more stable accounts such as fixed account to preserve their gains. It also allows investors to have play in the st rong stock market.Substitute? Any alternatives that achieve the same objective in a more efficient less expensive and/or more tax efficient- manner ExchangeTraded Note (ETN) is an alternative that can achieve the same objective of a variable annuity in a less expensive and more tax efficient way. A variable annuity can cost up to 4% a year in its fees, while ETN only charge 1% fees. Both ETN and variable annuities are tax efficient and there is no negative tax consequence till the ETN is sold. However, while an annuity is passed through finale to its beneficiaries, its entire gain will be taxed. The ETN under the current estate tax laws, will be receiving a step up in basis, this makes it more tax efficient than the variable annuity. However, investors of ETN have to run into credit risk as it is an unsecured debt. Thus, we have to look at other equally important factors before deciding the better alternative as just using cost-effectiveness and tax-efficiency does not equate to a robust evaluation.Introduction to Hedge FundHedge fund is a fund that can take both long and short positions through the use of arbitrage, buying and selling undervalued securities, trading options or bonds, and investing in any opportunity in any market where it foresees impressive gains at reduced risk. Its strategies vary enormously especially today with volatility and anticipation of corrections in overheated stock markets whereby many hedge against downturns in the markets. Main aim of most hedge funds is to reduce volatility and risk while trying to preserve capital and deliver positive returns under all market conditions.Expected ReturnsMost hedge funds goal is to earn a positive return despite how the overall stock market is performing. It is refer to as an absolute return. Absolute return gains and losses of a hedge fund can be measured relative only to the assets in the fund itself and investors do not compare returns to market benchmarks. With the absolute return goal, h edge fund managers often use aggressive investment techniques like short selling and leveraging.VolatilityStandard deviation reports a funds volatility which indicates the tendency of the returns to rise or fall drastically in a short period of time. It measures this risk by measuring the degree to which the fund fluctuates inrelation to its mean return, the average return of a fund over a period of time. Since hedge fund seeks absolute returns independent of market movements the standard deviation for this fund would then be zero as the funds return does not differ within periods. Hence it shows that hedge funds are highly at an advantage since the fund with the lower standard deviation would be more optimal as it is maximizing the return authoritative for the amount of risk acquired.Distribution of ReturnsBy knowing which way data is skewed, one can better estimate whether a data future point will be more or less than the mean. For hedge funds, the skewness variations are not uni form across styles. For instance, when the number of funds increases, the skewness drops systemically and is negative for Fixed Income Arbitrage, Convertible Arbitrage and Event Driven Strategies while it increases slightly. The Kurtosis tends to be concentrated in the -0.5 to +0.5 range. Changes in kurtosis tend to less predictable and differ widely over time and across investment styles. However, diversification within some hedge fund strategies may appear highly attractive in mean or variance terms, but this is much less so when skewness and kurtosis are taken into account as assessing hedge funds based on return and volatility criteria maybe misleading because of the potential underestimation of return volatilities.Correlation with other asset classesCorrelation is interlinked with diversification. Investors aim for a sound portfolio which is manageable through applying diversification. However, traditional assets classes like bonds and stocks are increasingly linked. Hedge fun ds which performances often highly dependent on the qualities of individual investment decisions or strategies, as opposed to being highly correlated to an overall market, diversify risk thus bringing about high returns. Instead of achieving returns from market activities, hedge funds use unique investing strategies to exploit market inefficiencies that the markets have not perceive. This further intensified diversification which put them at a better stead than traditional asset classes.FeesHedge fund consists of 3 kinds of fees. Sales Charge. It is a one-time charge, generally 5% and its the front-end load or commission that is charged on the investment amount. Management fee. It varies around 2% and it is charged on an annual basis and imputed into the dismiss summation Value of the fund. Performance fee. It varies around 10-20% above the benchmark and it is charged on an annual basis and imputed into the Net Asset Value of the fund. The benchmark can be simply the zero return line or a benchmark like the London Interbank Offered Rate. Performance fees are charged on a high water mark which means investors are only charged for excess returns with reference to the previous high. If investment drop in value, the manager must bring it back above the previous greatest value before they can receive performance fees.Trading and other expensesApart from the above fees, investors also need to pay expenses such as the accounting and tax preparation expenses, auditing expenses, costs and expenses of entering into and utilizing credit facilities and merged notes, swaps or derivative instruments.LiquidityThere are two forms of liquidity constraints that are impose on investors which are liquidity dates and lock-up. Liquidity dates refer to pre-specified times of the year when an investor is allowed to return shares. Hedge funds typically have quarterly liquidity dates. Moreover, it is often required that investors give advanced notice of the desired to redeem these redemption notices are often required 30 days in advance of actual redemption. lockup refers to the initial amount of time an investor is required to keep his or her money in the fund before redeem shares. Lockup therefore represents a commitment to keep initial investment in a fund for a period of time. For Singapore registered hedge fund, MAS guidelines stipulate one regular dealing day per quarter. Redemption of funds usually requires a notice period and it states that redemption proceeds must be paid to the end investor within 95 days from the dealing day the redemption request is accepted.LocationFunds with a regional presence outperform those without one. Risk-adjusted return difference between nearby and long-distance hedge fund portfolio is about 4% and is significant. A funds geographical proximity to the companies in which it invests the closer it is to its investments the greater the chances that the hedge fund will earn high returns. They are better able to take advan tage of local study via short selling and the use of derivatives. Direct way for hedge fund to take advantage of local knowledge is to invest in stocks and bonds in their region. Moreover, Singapore is perceived as having a high level of transparency and reliability in business, economic and regulatory affairs. It boasts a stable political structure, well-established judicial system and forward-looking financial authority thus bringing an advantage to investors locally.Tax efficiencyTax consideration can be a benefit of alternative investments, particularly hedge funds which exploit different ways to minimize capital gains and income taxes for investor. Investors might be worried of being charged at a higher rate for tax. Singapore has in place a tax incentive scheme which exempts offshore funds from tax. Broadly speaking, a qualifying fund will be granted tax freedom provided it is not 100% owned by Singapore investors. There is also Tax Exemption for Singapore Resident Funds. I t requires pre-approval from the authorities and although it is aligned to the offshore fund exemption scheme, some additional conditions have been imposed.Ability to eliminate or significantly reduce unsystematic risk To diversify from stock-specific risk known as non-systematic risk one can invest in a range of stocks with different characteristic. Most investors of such practice regard it as unwise not to diversify into non-systematic risk. However, killing two birds with one stone is a more attractive opportunity to be seized. Thus, we turn to hedge fund. The main idea behind diversifying your non-systematic risk into assets like hedge funds is that any investment with a positive expected return, low volatility and low correlation to the rest of portfolio, will have a great chance of reducing the overallportfolio volatility which is an additional advantage as compared to diversifying through stocks and bonds. Thus, hedge fund is an indispensable option.Ability to control asset a llocation decisionHedge fund manager has total trading authority over the fund. They are not required to provide investors with information about the underlying holdings of the hedge funds. Thus, theres a lack of transparency when investing in hedge funds. Investors are putting their complete trust in the managers ability to meet the funds objectives. As such, investors lose control over their asset allocation. Thus, it is essential to choose the right fund manager to manage their investments.Substitute? Any alternatives that achieve the same objective in a more efficient less expensive and/or more tax efficient- manner The primary objective of hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions. The emphasis here is positive returns under all market conditions and thus this explains fully utilization of specialized and carefully selected investment strategies to achieve that primary goal.There ar e alternatives which are less expensive and more tax-efficient such as ETFs and ETNs. Both offer similar advantages which are lower fees, lower investment minimums and greater tax efficiency. However, both products have different investments goals. ETFs mirror the indexes they track by holding diversified collection of securities, such as stocks or bonds but traded like stock on an exchange while ETN is an unsecured debt typically issued by an investment bank that mirror index like ETF. Thus, from the way they operate, we are able to conclude that their investment aims just show differences with that of hedge funds.