Learning Objectives:

  • Understand alternative investment classes and their characteristics 

  • Analyse private equity, real estate, and commodity investments 

  • Evaluate the role of alternatives in portfolio construction 

7.1 The Role of Alternative Investments in Portfolio Construction

Alternative investments are asset classes beyond traditional stocks and bonds, playing an increasingly important role in portfolio construction. The University of Warsaw syllabus includes “Alternative investments” as a topic . The Western Sydney University Financial Products and Markets subject covers “Other Asset Classes and Managed Funds,” indicating the importance of understanding alternatives .

Key Reasons for Considering Alternatives:

  • Diversification: Alternative investments often have low correlation with traditional asset classes, potentially reducing portfolio volatility.

  • Potential for Higher Returns: Some alternative investments offer the potential for returns that are less dependent on market conditions.

  • Inflation Hedging: Certain alternative assets, such as commodities and real estate, can serve as a hedge against inflation.

7.2 Private Equity

Private equity involves investing in private companies. The University of Warsaw syllabus includes “Venture capital” as a topic under alternative investments . The University of York module includes “private equity” in its coverage of alternative asset classes .

Key Forms of Private Equity:

  • Venture Capital: Investment in early-stage companies with high growth potential, typically at the seed, start-up, or early-growth stage .

  • Growth Equity: Investment in more mature private companies seeking capital for expansion.

  • Leveraged Buyouts (LBOs): Acquiring companies using significant debt financing, with the target company’s assets often serving as collateral.

  • Mezzanine Financing: Subordinated debt with equity features, often used in buyouts and expansions.

7.3 Real Estate

Real estate investments involve ownership or financing of property. The University of Warsaw syllabus includes “Real estate” as a topic under alternative investments .

Key Forms of Real Estate Investment:

  • Direct Ownership: Investing directly in physical properties (residential, commercial, industrial).

  • Real Estate Investment Trusts (REITs): Companies that own and operate income-producing real estate, offering publicly traded exposure to real estate markets.

  • Mortgage-Backed Securities: Securities backed by pools of mortgage loans.

  • Real Estate Private Equity: Funds that invest in real estate projects or property portfolios.

7.4 Commodities

Commodities are physical assets such as gold, oil, grains, and metals. The University of Warsaw syllabus includes “Commodities” as an alternative investment topic .

Key Features of Commodity Investment:

  • Physical Assets vs. Derivatives: Commodity exposure can be gained through physical ownership or through derivatives such as futures contracts.

  • Inflation Hedge: Commodities have historically provided a hedge against inflation and currency debasement.

  • Diversification: Commodities have exhibited low correlation with traditional stock and bond returns in some historical periods.

  • Supply and Demand Fundamentals: Commodity prices are driven by physical supply and demand factors.

7.5 Private Debt and Other Alternatives

Private Debt: Non-bank lending to companies, including direct lending, mezzanine debt, and distressed debt.

Infrastructure: Investments in public utilities and infrastructure projects, often providing stable, long-term cash flows.

PreviousNext