Overview of Alternative Investments

1What alternative investments are

Traditional investments are listed shares, bonds and cash, bought directly or through mutual funds. Alternative investments are everything outside that core, usually held through specialised funds:

• Private equity (PE): investing in unlisted companies, or taking listed companies private, to grow and later sell them.
• Venture capital (VC): a form of PE that funds early-stage, high-growth start-ups.
• Private credit (debt funds): lending directly to companies outside the banking system.
• Real estate and infrastructure: property, roads, power, ports, often through funds.
• Hedge funds: pooled funds using flexible strategies such as long-short equity, arbitrage, leverage and derivatives.
• Others: commodities, art and collectibles, structured products, distressed assets.

Remember

• Alternatives = outside listed shares, bonds and cash.
• PE, VC, private credit, real assets and hedge funds are the main types.

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2Typical features of alternatives

• Illiquidity: money is often locked in for 5–10 years or more. Investors expect an illiquidity premium, an extra return for giving up liquidity.
• Long horizon and uncertain cash flows: money is drawn and returned over years, not invested in one go.
• Hard to value: unlisted assets have no daily market price, so valuations depend on models and judgement.
• Complex, higher fees: usually a management fee plus a share of profits (carried interest or performance fee).
• High minimum investment and access limited to wealthy or institutional investors.
• Less transparency and greater dependence on the skill of the manager. The gap between the best and worst managers is much wider than in listed markets.
• Low correlation with listed markets (at least in reported values), which can improve diversification.

Exam trap The low reported volatility of private assets partly reflects infrequent valuation ("smoothing"), not only lower risk.

Remember

• Illiquid, long-term, hard to value, higher fees, high minimum, manager-dependent.
• Illiquidity premium = reward for locking money away.

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3How alternatives developed

• Modern venture capital is usually traced to American Research and Development Corporation (ARD), founded in 1946.
• The first hedge fund is credited to Alfred Winslow Jones in 1949. He combined long and short positions to reduce market risk.
• Leveraged buyouts grew from the 1970s and 1980s and gave rise to large private equity firms.
• University endowments and pension funds later became big investors, using alternatives to raise long-term returns.

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4Who invests and why

Typical investors are high-net-worth individuals (HNIs), family offices, pension and provident funds, insurers, endowments, sovereign wealth funds, banks and corporates.

They use alternatives to:

• diversify away from listed markets;
• enhance returns, by earning illiquidity and complexity premiums and backing skilled managers;
• gain access to opportunities not available in listed markets, such as start-ups and private credit;
• in some strategies, reduce volatility or earn returns that do not depend on market direction.

Alternatives suit investors who can lock money away for long periods, tolerate the risk of loss and the lack of liquidity, and understand complex products. They are not suitable for money needed in the short term.

Remember

• Use: diversification, return enhancement, access.
• Suits only investors with long horizons, high risk tolerance and enough liquidity elsewhere.

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