Alternative Investments
Alternative investments encompass assets outside of traditional public equities, fixed income, and cash. They are targeted by institutions to harvest the illiquidity premium, access differentiated return streams, and provide non-correlated diversification.
1. Private Equity & Venture Capital
Direct investment in private companies. Strategy involves capital structure optimization (LBOs), operational restructuring, and multiple arbitrage.
The PE Waterfall (Distribution of Capital)
- Return of Capital: LPs receive their initial investment back.
- Preferred Return (Hurdle Rate): Usually ~8% annualized return to LPs.
- Catch-up: GPs receive 100% of distributions until the profit split matches the agreed-upon carry (e.g., 20%).
- Carried Interest: Remaining profits split 80/20 between LPs and GPs.
2. Real Estate (Commercial)
Physical assets providing yield (rents) and capital appreciation. Valued primarily via capitalization rates (Cap Rates).
Value = Net Operating Income (NOI) / Capitalization Rate
3. Hedge Funds
Unregulated investment pools employing complex trading strategies (long/short, global macro, event-driven, relative value) with significant leverage and derivatives to generate absolute returns regardless of market direction.
Key Metrics
- IRR (Internal Rate of Return): The discount rate making NPV zero. Time-weighted.
- MOIC (Multiple on Invested Capital): Total Value / Paid-In Capital. Ignores time.
- J-Curve: The tendency of PE funds to post negative returns in early years due to management fees drawing down capital before investments mature.