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2.6.8. Alternative investments

As noted, there are two so-called alternative investment vehicles:

• Hedge funds.

• Private equity funds.

Hedge funds (HFs) accept funds from certain high net worth individuals, foreign sector investors, and contractual intermediaries in the shape mainly of retirement funds (although they would only allocate a small portion of their assets to hedge funds). Hedge funds also make use of leverage, i.e. borrow, and derivative instruments and some "go short". They are investors in the corporate and government sectors and have derivatives margin balances.

There are many varieties of private equity funds (PEFs). In a nutshell they are large funds that issue PIs and invest in private equity, i.e. non-listed companies that they often "nurse" back to health (and listed companies that they delist, restructure, and list again).

2.6.9. Quasi-financial intermediaries

It will be recalled that there are a number of institutions and funds that border on being classified as financial intermediaries. A reminder:

• Development finance institutions (DFIs).

• Special purpose vehicles (SPVs) (securitizations, CDOs, etc.).

• Investment trusts.

• Finance companies.

• Credit unions.

• Micro-lenders.

These institutions do not borrow and/or lend to the same extent as the mainstream intermediaries, or are not ongoing lenders and borrowers, i.e. they tend to have liability and asset financial portfolios that tend to be static.

The DFIs generally intermediate between ultimate lenders and financial institutions (in the form of them taking up the securities of the DFIs or the provision of loans to them) on the one hand and mainly domestic ultimate borrowers on the other. The domestic ultimate borrowers are comprised of the household sector (mainly housing loans and small business loans to them), the corporate sector (in the form of loans and shares)and the government sector (in the form of loans to local authorities).

example of bank securitization of mortgages

Figure 6: example of bank securitization of mortgages

Special Purpose Vehicles or SPVs (also termed securitization vehicles) are specialist intermediaries. They may be closed or open. In the case of a closed securitization vehicle, it may hold a portfolio of, say, mortgages, which are financed by the issue of mortgage-backed securities (MBS) (usually mainly to the CIs and CISs). While it is intermediating, this is usually done on a once-off basis (a closed SPV). Generally, SPVs intermediate between CIs (e.g. retirement funds) and CISs on the one hand and the borrowers (as represented by the securities / assets placed in the SPV) on the other. An example of the securitization of mortgages funded by the issue of MBS is presented in Figure 6.

Investment trusts / companies tend to be financed by capital and loans and have a portfolio of shares / equities and/or other securities which is largely static.

Finance companies finance themselves by share capital and loans in various forms (from banks or other companies). Their assets are loans in various forms to the household and corporate sectors.

The business of a credit union, known also as a savings and credit cooperative (SACCO) is similar to that of a bank, but with the difference that it is a co-operative institution. The essence of its business is that of buying and selling money within a group of people who work in the same place or who are members of the same community (i.e. have a common bond).

Micro-lenders lend exclusively to the household sector. On the liability side of their balance sheets they are funded from own capital (i.e. from the household sector) and loans (from the household sector and from the corporate sector).

2.7. Summary

Financial intermediaries exist because of the conflict between the financial requirements of surplus and deficit economic units. There is a wide array of financial intermediaries, and they can be identified by the financial liabilities and assets on their balance sheets. They are usually distinguishable by their liability portfolios, and this is the reference point for categorization. The categories of financial intermediaries are mainstream and quasi-financial intermediaries, and the former is divided into deposit and non-deposit institutions. There are three categories of the latter: contractual intermediaries, collective investment schemes and alternative investments.

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