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Set out the main types of alternative investment

CFA® Level I · Alternative Investments · Alternative Investment Features, Methods, and Structures · AI.1.a

The idea

Alternative investments are usually grouped as private equity, hedge funds, real estate, commodities, private debt and infrastructure. They share features that distinguish them from public stocks and bonds: lower liquidity, longer horizons, less regulation and disclosure, and higher fee structures often combining a management fee with performance fees. Reported returns need care — valuations are frequently appraisal-based rather than market-based, which smooths returns and understates true volatility and correlation with public markets.

A practice question

From the question bank, with the reason each wrong option is wrong.

Which of the following is an alternative investment category?

  1. Private equity — correct
  2. Listed government bondsWhy not: The most traditional fixed-income asset there is, with daily pricing and deep liquidity.
  3. Large-cap public equityWhy not: Traditional equity, continuously priced on an exchange and heavily disclosed.

Alternatives are defined largely by sitting outside the traditional public stock and bond markets.

A harder one

An investor's capital in a private equity fund is typically:

  1. held in cash until the fund closesWhy not: Uncalled capital stays with the investor, not the fund, which is why the liquidity planning falls to them.
  2. committed and drawn down over time, with limited ability to exit — correct
  3. invested immediately and redeemable dailyWhy not: Describes an open-ended public fund and is the opposite of the commitment-and-drawdown structure.

Commitments are called as deals arise, and there is generally no redemption right — which is the practical meaning of illiquidity here.

The hardest tier

Why can reported private equity returns overstate the experience of the average investor in the asset class?

  1. Failed funds may stop reporting, leaving surviving funds in the data — correct
  2. Performance fees are added back to reported returnsWhy not: Reported returns are typically net of fees; the bias comes from which funds remain in the sample.
  3. Private equity returns are audited more strictlyWhy not: Audit quality does not create an upward bias, and public reporting standards are if anything tighter.

Survivorship bias in voluntary reporting lifts index averages. It is a data problem, not a claim about any individual fund.

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