Alternative Investments covers private equity, real estate, hedge funds, commodities, infrastructure, and digital assets. These investments offer diversification benefits but come with unique risks including illiquidity, complex fee structures, and limited transparency.
Private equity involves investing in companies that are not publicly traded. Key strategies include leveraged buyouts (LBOs) — acquiring companies using significant debt; venture capital — investing in early-stage companies; and growth equity — investing in mature private companies. PE funds typically use a limited partnership structure with a 10-year fund life. Performance is measured using IRR and multiples (MOIC — Multiple on Invested Capital). The J-curve effect describes the pattern of negative returns in early years followed by positive returns as investments mature.
Real estate investments can be direct (owning physical property) or indirect (REITs, real estate funds). Valuation approaches include the income approach (capitalization rate = NOI/Value), sales comparison approach, and cost approach. REITs (Real Estate Investment Trusts) are publicly traded entities that must distribute at least 90% of taxable income. Key metrics include cap rate, funds from operations (FFO), and net asset value (NAV). Real estate provides inflation hedging and portfolio diversification.
Hedge funds are private investment vehicles that use diverse strategies to generate returns. Common strategies include: Long/short equity — buying undervalued stocks and shorting overvalued ones; Global macro — trading based on macroeconomic views; Event-driven — profiting from corporate events (mergers, restructurings); Relative value — exploiting pricing differences between related securities. Fee structure is typically '2 and 20' (2% management fee + 20% performance fee). High-water marks ensure managers only earn performance fees on new profits.
Commodity investments provide exposure to physical goods like energy, metals, and agriculture. Returns come from three sources: spot price changes, roll yield (from futures contract rolling), and collateral yield (interest on margin). Contango (futures price > spot price) creates negative roll yield; backwardation (futures price < spot price) creates positive roll yield. Commodities offer inflation hedging and low correlation with traditional assets.
Digital assets include cryptocurrencies (Bitcoin, Ethereum), tokens, and other blockchain-based assets. Key concepts include distributed ledger technology (blockchain), consensus mechanisms (proof of work, proof of stake), smart contracts, and decentralized finance (DeFi). Digital assets are characterized by high volatility, regulatory uncertainty, and evolving market infrastructure. Valuation remains challenging due to the lack of traditional cash flows.
Rate of return on real estate based on net operating income.
Multiple on Invested Capital — measures total return in private equity.
Return to investors after deducting the typical '2 and 20' fee structure.
Return from rolling expiring futures into new contracts. Positive in backwardation.
Key considerations when evaluating alternative investments.