Investing Methods in Alternative Investments | CFA Level I Alternative Investments

In this lesson, we’re going to explore the different methods of investing in alternative investments and touch on investment structures.

Fund Investing, Direct Investing, and Co-Investing

There are three main methods to invest in alternative investments:

• Fund investing
• Direct investing
• Co-investing

Fund investing involves investors pooling their capital into a fund, and a fund manager makes investments on their behalf. This indirect approach comes with fees, but the fund manager’s expertise can be a valuable asset. It also allows for lower minimum investments and greater diversification.

With direct investing, investors invest directly in assets without using an intermediary. This approach is more common among large, sophisticated investors like pension funds and sovereign wealth funds. It offers more control and flexibility, and there are no management fees. However, it requires greater expertise and may result in less diversification.

Co-investing is a hybrid approach where investors contribute to a fund and also have the right to invest directly alongside the fund manager. This method can reduce fees, provide more control over asset selection, and benefit from the manager’s expertise.

Due Diligence and Investment Structures

When it comes to due diligence:

• Fund managers are responsible for due diligence on underlying investments in fund investing.
• Investors are responsible for due diligence when selecting a fund or conducting direct investments.
• Co-investors conduct due diligence on underlying assets with the support of the fund manager.

In fund investing, alternative investments commonly use partnership structures. Limited partnerships have a general partner (fund manager) and limited partners (investors). The partnership is governed by a limited partnership agreement.

Funds typically charge a management fee (1%-2% of assets under management) and an incentive or performance fee based on excess returns. We’ll dive deeper into fee structures and calculations later in this series.

And that’s a wrap on this lesson about investing methods in alternative investments. Up next, we’ll delve into the different classes of alternative investments, starting with hedge funds.