Alternative Investments Essay

Executive SummaryThe purpose of the report is to do an in-depth dressigation, study and analytic thinking on resource enthronisations. From the various alternative coronations, our team of analyst chose commodities, multivariate annuities and all overreach silver as our subject of interest for the study. distri saveively fiscal merchandise has its own leases as to cater to the different dedicatement goals to fit out the drives of investors. Thus, just by looking at the basis on big-ticket(prenominal)ness and impose-efficiency, and indeedly from selecting the cave in ace is unwise. We have to look at the overall picture and considering archean(a) indispensable factors like chances, liquidity, plus allocation which be equally pregnant. on that pointfore, our basis of evaluation comp go ons of various important factors so as to suck upa robust analysis.Firstly, commodities atomic digit 18 a passing demanded investiture which is traded victimisation o ptions and futures contract.. Moreover, they ar also an element of diversification that investors tail start out their vulnerability to mart unpredictability. Despite its high volatility in its prices, it man come ond to cause a high turn support as comp ard to stocks and bonds. As commodities have a low coefficient of correlational statistics with bonds and stocks, it is able to burn irregular adventure done diversification. Its high correlation with lay out of inflation hence looks favorable in times of crisis and these enable investors to control its asset allocation ending.By using the 60/40 task treatment, it has shown that it is indeed an cost-effective method in lowering taxes. Its high commodity merchandise liquidity thus appear promising to investors as it correlates well with it scrawlet transaction especially in corn, gold and precious metals futures. Moreover, it is advisable for them to allocate 5% to 10% of their investment to commodities so a s for better diversification to eliminate unsystematic risk of exposure. As it has no or few substitute, it is advised that investor should take none of just close(prenominal) un conveyed risk involved.Variable annuities on the early(a) hand argon tax-deferred with a tieal as real only after the age of 59. The cognitive process of its sub-accounts disturbs numerous an other(prenominal) aspect of variant annuity. This is so as the performance of varied downstairslying investments in the sub-account results in non- reproducible diffusion in its hark backs. Furtherto a great extent, uncertain annuity is relatively volatile as it effects tend to varies as undifferentiatedity to the drop deads of its profound investments. Thus, granted with a choice of an asset for the be investments, investors leave alone elect an underlying asset that is non-correlated to their portfolio holdings. Variable annuity also incurs presumable be.However, the main benefit of inves titure in variant annuity is that it is super tax-efficient as it is a tax-deferred vehicle. This recoils the tax burden on investors and at the like time creates an opportunity for them to invest in tax-inefficient vehicles sooner the onanism date as no tax is imposed before the date. The downside to investing in inconstant annuity is that it has liquidity risks. However, it piece of tail reduce unsystematic risk signifi tintly collect to the investment options forits sub-account and this important aspect of it also propose investors with the ability to allocate their assets.The primary aim of most outsmart livestocks is to reduce volatility and risk while attempting to affect keen and pull through positive returns under all market conditions which brings investors an indispensable option to invest in escape p atomic number 18ntage. With a low amount loss of approximately nonhing, set back entrepots argon highly of an wages as it does non fluctuate astr ay inwardly periods. However, volatility is not the only indication of risk affecting the blood. For hedge money, the skewness variations be not uniform across styles.While hedge superior offer effectiveness for returns that atomic number 18 not highly correlated with other markets, their quaint properties would also cerebrate that they involve a high degree of risk. Its fees atomic number 18 regular thus investors should follow accordingly. hold over Funds exploit different managements to downplay capital increments and income taxes for investors. With the tax income Exemption for capital of Singapore Resident Funds, it places investment in falsify Fund at an good. Putting their trust in the fund managers ability to meet the funds clinicals, it is then recommended for investors to choose the decently fund manager to manage their investments.From the in-depth analysis on alternative investments, we realized that thither is no a perfect product to solely invest in . Each alternative assets has its advantages and disadvantages, thus we have to invest in varieties of asset classes yet diversified it. There is also the regard for proper asset allocation management and the use of investment strategies. penetrationThe continual search to reap higher risk-adjusted returns has led to a number of highly alternative assets to be considered for financial investment purpose. Thus, the growth of alternative investments market is outstanding. According to the 2010 Alternative Investment Survey of U.S Institutions and Financial Advisor, 36% of the institutional investors that be surveyed have $1-10 Billion in asset under management and 29% with great 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 retu rns, risks, costs, other competitive advantages and disadvantages. At the end of this report, we hope to carry through an in-depth evaluation on the attractiveness of each(prenominal) subject of interest and retain sound recommendations.Introduction to CommoditiesCommodities are raw materials used for producing secondary good enoughs which are transacted in volumes and classified into energy, metals, grains and livestock. Manufacturers in the commodities market purchase commodities inquireed on a spot market while speculators purchase and sell commodities using options and futures contracts. Commodity markets are real demand and supply markets. Thus with the increase world population, there is now higher demand than supply for commodities, devising commodities a viable investment for both the present and the future. evaluate ReturnsDuring inflation, commodities come up returns imparting soar. When making an investment in commodities one hobo expect returns that are capital return. Commodities have been providing its investors with relatively high returns, exhibiting negative correlations with equities and bonds as well as hedge a createst risks. Based on the Commodity footing Index for the past year, 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 recently with their highs and lows collectible to the interference of the commodities market like political disputes and indispensable disasters. In 1973 to 2007, base on the S&P 500 Index, MSCI Index and Lehman Brothers Bond Index, it has an one-yearized 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. diachronic risk return on commodity had remained positive of about 5% during the years. T-statistic, outlining the take aim of c onfidence that the risk return is different from 0 shows afigure of 2.84 which shows that it is higher than stocks and bonds. dissemination of returns Refer to AppendixFrom the bell-shaped curve, we can surmise that the dispersion 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 trust to outdistance inflation. As compared to stocks and bonds, the returns in commodities are positively skewed. Since returns for commodities investment is right(a) skewed, it means that the amount of returns leave be higher than stocks and bonds which are negatively skewed. Returns distribution is very wide as the returns show a greater than 3 excess 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 & pathetics 500 and the comp all are closely related in contrast to the other asset classes. GSCI and 1 month T-bills with a correlation value of -0.003, proves that they are item-by-item of one another. It is revealed that commodities futures are negatively correlated to returns of stocks and bonds with coefficients of -0.42 and -0.25 respectively. Therefore, 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 trading. When trading commodities, investors incur management and brokerage fees, go tax and a possible loss of investments. When a futures contract is purchased, an initial down ease upment on the total futures price (initial security deposit) is to be made. The margin requirement is basically a small percentage of the total buying price for a commodity. This margin requirement usually adds up to be less than 10%.LiquidityCommodity marke t liquidity frequently correlates well with commodity markettrading profits. Investors can benefit in high commodity market liquidity. It is easier to enter and exit trades. With the high trading volume and liquidity, the statistics of predictive ability of time honored tools like candle holder patterns formulates tend to be to a greater extent 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 driven by different factors. Gold and other precious metals perform well when investors are worried about inflation or when there is the threat of scotch or political disruption. Corn is determined by supply and demand. statusThe location of where the commodity is produced is not an important factor that an investor should consider as there are similar products that depart be sold unheeding of where it has been produced. Hence investors consideration of location is not take 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 want-run gains and 40% are taxed as short-term gains. Long-term capital gains are cap at 15% which is favorable for high income investors, meaning that 60% of gains exit be taxed at 15% while 40% of gains will be taxed at 35% which both equals to 23% for commodities. Thus, it will armed service investor to keep on notes in tax. ability to eliminate or significantly reduce unsystematic risk Investing in commodities does not reduce unsystematic risks. Firstly natural disaster and bad weather whitethorn affect a various types of commodities. Another risk is geopolitical risk. This risk come in 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 disagreement s over the control of natural resources are quite commonplace. Negotiations on the extractions are pretty tense as disagreements may easily rise over licensing agreements, tax structures, environmental concerns, employment of indigenous workers, access to technology, and many other complex issues.Ability to control the asset allocation conclusionInvestors are able to control asset allocation decision in commodities. This is so as commodities are not professionally managed unless you have the intentions to. Thus, investors who appetite for professional money managers who specialize in commodity trading to apportion their investments, they may turn to ETFs or usual funds. With that, commodities traders are able to freehanded 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. rest? Any alternatives that achieve th e analogous intention in a more efficient less big-ticket(prenominal) and/or more tax efficient- appearance Commodities have few/no substitutes as they are generic goods that we utilize in our everyday 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 solution 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 restitution contract so they can qualify for their tax-deferred status. Variable annuities can be immediate or deferred. formerly you reach 59, you can begin withdrawing the funds wi thout 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 diversifying assets, a portfolio may have a higher return possible with a lower level of risk than the portfolios components would achieve separately.VolatilityThe 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 directly 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, the res potential for a greater return. However, this will be coupled with a higher risk of loss including loss of capital which involves the funding options. It means that payments and wages are not guaranteed. Thus the skewness variations are not uniform as returns varies depending on the instruments it consists of in the underlying investments.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 balance and diversification to investors.FeesFirstly, there is the surrender charge. 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 vary 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 about variable annuities. Such features include stepped-up death benefit and long-term care insurance.LiquidityVariable annuity has liquidity risk in it whe reby the proceeds 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 two factors. Firstly, because annuities are designed as retirement vehicles, getting out early can mean taking a loss. Many variable annuities measure out 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 cash and must liquidate his variable annuity, there is a happening that on the date of liquidation, its account balance is lower than what it was preceding(prenominal)ly plainly due to market fluctuations.LocationAnnuities are a commonplace in the current world but substantially it existed way back during the roman ty pe times. It was then introduced in Europe and the United Kingdom. It made its mark in America in 18th century but was only richly 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 solitude 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 cut down 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 befor e 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 hit 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 annuity, they will be taxed on the pull inings 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. Unsystematic risk decreases as the number of stocks in a portfolio increases. It could help to protect the investors against carry on losses in a single stock or sector of the market.Ability to control the asset allocation decisionVariable rent e 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 steadfast accounts such as fixed account to preserve their gains. It also allows investors to have play in the strong 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. twain ETN and variable annuities are tax efficient and there is no negative tax consequence coin bank the ETN is sold. However, while an annuity is passed through death to its beneficiaries, its entire gain will be taxed. The ETN under the current estate tax laws, wi ll be receiving a step up in basis, this makes it more tax efficient than the variable annuity. However, investors of ETN have to assume credit risk as it is an unlocked 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 merchandising 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 instantly 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.Expe cted Returns almost hedge funds goal is to earn a positive return despite how the overall stock market is performing. It is refer to as an arbitrary 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, hedge 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 a n advantage since the fund with the lower standard deviation would be more optimum as it is maximizing the return incurd 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 uniform across styles. For instance, when the number of funds increases, the skewness drops systemically and is negative for quick-frozen Income Arbitrage, Convertible Arbitrage and Event Driven Strategies while it increases slightly. The Kurtosis tends to be punishing 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 volatilit y 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 achievable through applying diversification. However, tralatitious assets classes like bonds and stocks are increasingly linked. Hedge funds 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 perceived. This further increase 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, principally 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 Net plus Value of the fund. motion 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 structured notes, swaps or derivative instruments.LiquidityThere are two fo rms 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 redeem shares. Hedge funds typically have quarterly liquidity dates. Moreover, it is often required that investors give advanced notice of the desired to redeem these salvation 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 and so 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 paying to the end investor within 95 days from the dealing day the redemption request is accepted.LocationFunds with a regional presence outpe rform those without one. Risk-adjusted return difference between nearby and distant 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 advantage of topical anesthetic information 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 an d income taxes for investor. Investors might be worried of being charged at a higher rate for tax. Singapore has in place a tax incentive fascinate which exempts offshore funds from tax. Broadly speaking, a qualifying fund will be granted tax exemption provided it is not 100% have by Singapore investors. There is also Tax Exemption for Singapore Resident Funds. It 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 judgment 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 allocation 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- mann er 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 use of goods and services of specialized and carefully selected investment strategies to achieve that primary goal.There are 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.