The area of alternative investments is gaining momentum among many investors, and as consequence, numerous options are available, and a greater variety of funds is currently offered, along with multiple ways of investing in them. Listed below are several types of investment funds in the alternative capital market:
Defining the field of Credit Funds:
Debt, as an asset category, includes a large number of investment funds with different investment strategies: Some invest in commercial debt, others in corporate debt and some focus on real estate. Funds can also be segmented by the following: debt with or without collateral, differences in the order of creditors (senior, junior or mezzanine)
Usually, each fund specializes in a specific kind of debt, so it can excel in it, providing excess return to investors, reducing default rates and maximizing the collaterals for each given debt. Debt funds mostly invest in non-tradable debt, thus allowing the investor large exposure to debt alternatives that investor cannot gain access to in the tradable market.
For the full list of Credit Funds analyzed by Objective >> Click here
In recent years, there is a rise in funding activities by non-bank credit institutions, as commercial banks are scaling back their real estate funding, mainly due to a rise in equity requirements. Often, the examination process, the underwriting and the loan placing are done in a similar manner to the procedures in the banking system, but the amounts are lower and the pace is faster, in order to allow entrepreneurs to execute attractive investments.
P2P loans (“peer-to-peer loans”) are a form of a direct loan between people or businesses, without a formal financial institution as mediator in the transaction. P2P loans are usually carried out in online platforms that match between borrower to potential lenders and are considered an alternative funding source. P2P loans offer loans with and without collateral. Loan collaterals can be residential real estate assets, other physical assets, deposits, other sources of revenue for the borrower and more.
P2P loans are carried out on a special online platform.
The following stages depict a generic P2P loan life cycle:
- A potential borrower is interested in receiving a loan and fills out an online request on the P2P platform.
- The platform assesses the request and determines the risks and the borrower’s credit risk, and the borrower can choose between several lenders. The borrower evaluates the options offered to him and chooses one.
- After the placement of the loan, the borrower is responsible for making the periodic interest payments (usually monthly payments), and the principal on the day of the loan repayment.
- The company that operates and maintains the online platform charges a fee both from the borrowers and the investors for the provided service.
Debt funds that invest through the platform choose a portfolio of loans or specific loans based on their analysis and choice of various parameters, such as: geographic location, profession, the purpose of the loan etc. The funds define their desired risk level, or the interest they wish to realize through their investment, and the platform offers the corresponding loans.
Advantages of P2P loans:
- Higher returns to investors.
- A more accessible funding source to borrowers.
- Lower interest rates, the result of the competition between lenders and the absence of bank fees.
Disadvantages of P2P loans:
- Credit risk – P2P loans are exposed to high credit risk. Many borrowers seeking P2P loans have a low credit rating that does not allow them to be eligible to a “conventional” bank loan. Thus, the lender should be aware of the probability that the borrower might default on his payments.
- Lack of governmental protection – The government does not provide any insurance or protection to the lenders in case the borrower defaults.
- Legislation – Some jurisdictions do not allow peer-to-peer loans or demand from the companies providing these services to comply with investment regulations. Therefore, P2P loans will not be available to some borrowers or lenders.
Real Estate Debt Funds:
Some investment funds specialize in providing debt to real estate. In recent years, we see a rise in commercial real estate activity that is funded by non-banks. Real estate is the highest-ranking asset category worldwide, and its size and relative stability has created the biggest debt market. Another key characteristic is the ability to subordinate the asset. The cost and pricing of the loan is dependent on the Loan-to-Value (“LTV”) ratio and the quality of the asset. The funds vary in the type of subordination, type of loan (senior, junior or mezzanine). There is also great variance from the lenders side as they require different kinds of debt, such as: all-purpose loans that are backed by real estate, bridging loans and loans to increase their equity.
Defining the field of Hedge Funds:
A hedge fund is a private investment fund that aims to yield investors profits regardless of market conditions and external circumstances. The name arises from the fact that, in essence, each transaction is hedged with an investment target. Hedge funds use different strategies in order to achieve an active return (or Alpha) for investors and there is a difference in the underlying risk based on the strategy and investment channel. The funds invest in tradable assets both in local and foreign markets, such as stocks, bonds, contracts, commodities etc. One aspect that is unique to hedge funds vs. mutual funds is the fact that hedge funds face less regulatory obligations, thus allowing hedge funds to execute more complex investments and responding quicker to the market.
For the full list of Hedge Funds analyzed by Objective >> Click here
Main Strategies in Hedge Funds:
Long/Short – Hedge funds that take “Long” positions in stocks that are expected to rise in value, and “Short” positions in stocks that are expected to decrease in value. The Long/ Short strategy aims to minimize the exposure to market risks.
Opportunistic and Event Driven – Funds aim to make an opportunistic purchase of assets that are traded below their fair value, resulting from exogenous or endogenous events.
Macro Global – Funds that adjust their investments channels to maximize macroeconomic and geopolitical events throughout the world.
Statistical Arbitrage – Funds that make use of a group of trading strategies that focus on exploiting anomalies in the pricing of the underlying assets, all under the base assumption of “the mean reversion”.
Systemic Strategy – This strategy includes a wide range of activities that are supposed to happen automatically, based on algorithms that are programmed to exploit different market anomalies in a wide range of parameters.
Multi Strategy – A fund that uses a cluster of the above strategies, as seen fit by the investment managers of the funds in terms of timing and market conditions.
Defining the field of Infrastructure Funds:
Infrastructure funds invest in various investment channels through companies that invest in projects such as water desalination, sewage treatment, waste recycling; roads, mass transportation, seaports, electricity facilities, transport infrastructure, communication infrastructure etc.
For the full list of Infrastructure Funds analyzed by Objective >> Click here
In infrastructure investments, we differentiate between the construction stage and the operational stage. During the construction stage, the entrepreneur invests large amounts of capital in the project, while in the operational stage, the project yields a return that includes repayment of the investment and a payment for the ongoing maintenance of the project.
Construction Stage – The stage when the entrepreneur is self-financing the project. During this stage large funding is needed and risk levels are relatively high, as it is unknown whether the construction- which is usually complex- would be completed on time and within budget.
Operational stage – During this stage, the entrepreneur should see a return on his investment. This return is supposed to cover the construction expenses, financing costs, operational expenses and the profit margin. In many occasions, the cash flow during the operational stage is partially guaranteed by the state, therefore, making this stage less risky than the construction stage and with a revenue stream that is, at least, partially known.
Investing in Infrastructure Projects:
The government of Israel has recently been advocating for the public listing of infrastructure funds, so the general public is able to invest in the projects themselves. The funds will enjoy tax benefits as profits will be taxed directly at the shareholders’ level, as is the case with REIT funds, rather than taxing the fund itself. In addition, in order to encourage investment by pension funds and other institutional investors, that manage long term pension instruments- these investors will be tax exempt for all fund’s proceeds, not including irregular income (does not stem from the core activity of the fund).
Characteristics of Infrastructure Projects:
Infrastructure projects are highly complex, both from an engineering and operational aspect, and thus, their main source of funding is the banking system, large institutional investors and funds that operate in the same field. The collaboration between the public sector and the private sector in the development and construction of infrastructure projects is done through public-private partnership (or “PPP”), a renowned method worldwide that has seeped into Israel in the early 1990’s, with the first flagship project of “Road 6”.
PPP projects are characterized by long term agreement that allow each sector to exploit its relative advantages and to efficiently split the inherent risks. For example, while the public sector is usually responsible for supplying the necessary lands and bears the risk of “force majeure”, the private sector is responsible for the project’s financing, construction and operation over time. This way, the government can launch massive scale projects, even if it cannot budget their overall costs during initial stages and to spread that cost during a lengthy operational time period. On the other hand, the private entrepreneur recovers his investment in the project whether through a license or a franchise in which he won.
Defining the field of Private Equity Funds:
A private equity fund is a private investment fund that acquires companies or assets with growth potential or distressed companies/ assets, in order to improve their profitability and then realize the investment. The purpose of the fund is to maximize the value through growth and/or efficiency improvement, while relying on the expertise of the fund managers.
The term “Private Equity” includes various types of investment funds that differ in the size of the companies they invest in, the life cycle stage, type of assets and the nature of the investment.
The funds’ investment strategy is to identify investment opportunities, based on a pre-determined investment strategy, and then to realize them after a set period of time, usually 10 years, following which the fund will close. PE funds tend to invest in companies with clear potential to exit through an IPO, and aim to seize control in the mature company that already generates revenues from its product or service.
For the full list of Private Equity Funds analyzed by Objective >> Click here
Defining the field of Real Estate Funds:
Funds that invest in various real estate assets, with the targeted return depends on the perceived risk level. A distinction should be made between yielding real estate and entrepreneurial real estate. Funds allow investors to benefit from the knowledge of professionals in the field, create a portfolio diversification and to invest smaller sums than those needed to a direct investment in real estate. Funds invest in various types of assets, such as: office buildings, residential buildings, logistical centers, student dorms, hotels, assisted living etc.
These funds allow for great diversification between many real estate assets vs. the high risk that an investment in a single asset entail.
For the full list of Real Estate Funds analyzed by Objective >> Click here
Yielding Real Estate Fund:
The purpose of these funds is to buy existing assets, improve them and then to sell them after a few years. Most of the assets generate an ongoing return and the funds aim to increase the return and the overall value of the assets. For example, in the sector of office and commercial centers, it is common to see transactions for properties with low occupancy rates. These rates are expected to rise, alongside the ongoing income from that property. In the residential sector, most of the transactions are the purchase of yielding properties that are ill-managed yet can be improved following a repair and an increase of the rent.
Entrepreneurial Real Estate Fund:
The purpose of these funds is to make an investment in non-existing assets. These investments require extensive knowledge regarding permits and construction. The asset generates an ongoing yield only after construction is complete and renters occupy the asset.
An investment in a yielding real estate is characterized by high yields, on the one hand, but it also involves a wide array of risks, including various construction risks. A construction project might be delayed, and/or the costs of which might increase during the lifetime of the project and impact the fund’s return. Expected returns are high as a result of the increase in the asset’s valuation once construction is complete.
Real Estate Investment Strategies:
Core – Acquiring stable and mature assets without making any changes in them. Assets generate ongoing return and the asset is then sold later on.
Core Plus – Similar to “Core”, but with mild changes to the properties, such as light improvements, furnishings etc.
Value-Added – Acquiring a property and then completing a major renovation that takes months or years to complete. After the renovation is complete, the property is sold.
Opportunistic – Developing a new property from the ground up, or acquire an existing one and “re-develop” it into a different type (e.g., shopping center to industrial complex), and sell it in the future.
Defining the field of Secondary Funds:
This sector includes the purchase of subscription units in any private funds, regardless of their investment. The secondary market exists to allow for liquidity in an illiquid asset, as it enables investors to sell their holdings in the fund, even though the investment period has yet to end.
The secondary market allows investors to pre-maturely exit their investment obligations. Secondary market transactions are usually performed at a significant discount from the fund’s pricing, given the investor’s need of liquidity.
In addition, as the funds began their investments, their portfolio can be analyzed to better grasp the feasibility of the investment. This is different than the early stages of a fund, in which we do not have complete information and there is more risk related to the expected portfolio.
For the full list of Secondary Funds analyzed by Objective >> Click here
Types of Secondary Transactions:
“Standard” secondary transactions (LP Led Transactions) – Occurs when a limited partner sells his holding in one or more funds. The investor wants to sell his position, usually for liquidity and portfolio exposure. The transaction takes place through a tender, and the selling price is usually discounted from the latest NAV that the fund published.
GP Led Transactions – These transactions are initiated by the investment manager (general partner) and are carried out for liquidity reasons or for a combination of liquidity and an additional equity investment in the portfolio. For example, when the investment manager sees future growth potential in his existing portfolio, but the fund has a time limitation, since the general partner is not yet interested in exiting the underlying companies, he sells part/ all of his portfolio to a different fund he manages.
Sometimes, the secondary investor is not just purchasing an existing holding, but also injects his equity investment into the new structure.
This investment – that involves both liquidity and equity- is referred to as “Complex Secondary Transaction”.
Defining the field of Venture Capital Funds:
A Venture Capital fund is a private investment fund that invests in start-up companies, usually tech start-ups, but not just from the technology sector. The investment could take place at different stages, from a very early stage (“Pre-Seed”), early stage of operations (“Seed”), companies with initial operations, mature and developed companies etc. Investment in these types of companies can potentially yield a high return if the company succeeds. With that, these companies pose a risk, as some of them will not reach their goals, and some might close during the development (and investment) stage.
As such, the investment strategy of the VC funds, which only invest in a small percentage of all projects presented to them, is based on examining the likelihood of exiting the investment within a few years after the investment, alongside the future value and the expected Return On Investment following this exit.
For the full list of Venture Capital Funds analyzed by Objective >> Click here
In conclusion, a diverse range of alternative investment funds are available in the market, and each entity is advised to make its own transactions based on the level of risk, current portfolio investments and the diversity of the portfolio, the need for liquidity and more.
Objective will be happy to provide objective advice on capital-raising funds.