Subject 1. Alternative investments

Stocks, bonds and cash are the most commonly known traditional investments. Alternative investments may encompass any non-traditional investments of financial assets such as hedge funds, private equity, venture capital, real estate, commodities, and other assets.

Some of the distinctive characteristics of alternative investments compared with traditional investments:

  • Lower liquidity due to their lack of standard markets and limited activities on both sides of the deal.
  • Less regulation but rather unique legal and tax considerations.
  • Lower transparency - certain alternative investments lack an efficient market mechanism and may subject their valuation to speculations, creating uncertainties. Risks of alternative investments increase due to absent of ready valuation information.
  • Higher fees - costs of purchase and sale may be relatively high.
  • Limited and potentially problematic historical risk and return data.Investors must be careful in evaluating the historical record of alternative investments as the higher than normal returns may be subject to a variety of biases, and the volatility of returns tend to be underestimated.

There are two basic investment strategies.

Passive managers "buy-and-hold." There are very limited ongoing buying and selling actions. Their portfolios are expected to generate Beta return.

Most alternative investment managers use active, alpha-seeking strategies. The assumption is inefficiencies exist that can be exploited to earn positive return after adjusting for beta risk. These active strategies include absolute return, market segmentation and concentrated portfolios.

Sharpe ratios and many downside risk measures are commonly used to measure risk and return of alternative investments.

Despite unique risks and considerations, alternative investments can be useful tools to improve the risk-return characteristics of an investment portfolio. They can increase diversification and reduce volatility given low correlations to more traditional investments.

Many alternative investments use a partnership structure.

  • The general partner (the fund) manages the business, assumes unlimited liability, and receives a management fee and an incentive fee.
  • Limited partners own fractional interest in the partnership.

User Contributed Comments 6

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ankurwa10: Tip to remember. A for Alpha so Active seeks Alpha, and Passive seeks Beta.
nikmouwen: ankurwa10 Thank you, good tip!
zackrivers: great tip
sals1230: thanks for that tip!
dbedford: Alpha males are active and Beta males are passive.
nmech1984: dbedford, any strategy on bi males?