Alternative Investments Indexes: A Quick Overview | CFA Level I Equity Investments

Alternative investments are interesting for investors due to their potential diversification benefits. They include hedge funds, private equity funds, real estate, commodities, infrastructure, and rare items like fine wine and antiques. In this lesson, we’ll discuss the unique features of indexes for the more widely held alternative assets: commodities, real estate, and hedge funds.

1. Commodity Indexes

Commodity indexes represent futures contracts on commodities such as agriculture, metals, and energy. Remember, we’re talking about futures contracts here, which means returns are not solely from changes in spot prices. Commodity futures returns include roll yield and collateral yield. The contracts also mature and must be replaced over time. As a result, commodity futures returns can differ significantly from spot price changes.

Weighting methods used in commodity indexes vary:

• Equal weighting: e.g., Commodity Research Bureau Index
• Global production values: e.g., S&P GSCI
• Fixed weights determined by the index provider

Different weighting methods lead to different commodity exposures, as well as risk and return characteristics.

2. Real Estate Indexes

Real estate investments can be direct (physical commercial and residential properties) or indirect (securities like Real Estate Investment Trusts, or REITs). REITs invest in properties or mortgages and issue ownership interests in the asset pool to investors. REIT shares are traded on the stock market, offering liquidity to investors.

Real estate indexes can be constructed using:

• Returns based on property appraisals
• Repeat property sales
• REIT indexes representing publicly traded REIT shares (e.g., FTSE International’s family of REIT indexes)

3. Hedge Fund Indexes

Hedge fund indexes reflect returns on hedge funds, which are private investment vehicles that manage portfolios of securities and derivative positions using strategies like leverage and long/short positions. Most hedge fund indexes equally weight the returns of the hedge funds included in the index.

However, hedge funds are largely unregulated and not required to report their performance to index providers. This results in:

• Varying performance across different indexes
• An upward bias in index returns, with hedge funds appearing as better investments than they actually are