Alternative Investments

Alternative investments include assets beyond traditional stocks, bonds, and cash. They can provide diversification and potentially higher returns, but often come with higher risks, lower liquidity, and greater complexity. Investment advisers must understand these characteristics to make suitable recommendations.

Characteristics of Alternative Investments

All alternative investments share certain traits that distinguish them from traditional assets:

Characteristic	Implication
Lower liquidity	Harder to sell quickly; may have lock-up periods
Less transparency	Limited disclosure; harder to value
Higher fees	Often 2% management + 20% performance fees
Less regulation	Many exempt from SEC registration
Low correlation	May move differently than stocks/bonds
Accredited investors	Many limited to wealthy, sophisticated investors

Commodities

Commodities are physical goods that serve as the building blocks of the economy.

Types of Commodities

Category	Examples
Precious Metals	Gold, silver, platinum, palladium
Energy	Crude oil, natural gas, heating oil
Agriculture	Corn, wheat, soybeans, coffee, cotton
Industrial Metals	Copper, aluminum, zinc, nickel
Livestock	Cattle, hogs

Investment Methods

Method	Characteristics
Physical ownership	Own actual commodity (bullion, coins); storage costs
Futures contracts	Leverage; require rolling contracts; complex
Commodity ETFs	Liquid; may use futures (contango risk)
Mining/producer stocks	Company risk; may not track commodity directly
Commodity mutual funds	Diversified; professional management

Key Features

Inflation hedge: Gold and other commodities may rise with inflation
No income: Commodities don't pay dividends or interest
High volatility: Prices can swing dramatically
Storage costs: Physical commodities require safekeeping
Diversification: Low correlation to stocks and bonds

In Practice

An investment adviser recommends a small gold allocation (5-10%) to a client concerned about inflation. The adviser explains that gold has historically served as a store of value during inflationary periods, though it generates no income and can be volatile in the short term.

Hedge Funds

Hedge funds are privately offered pooled investment vehicles that use sophisticated strategies to seek absolute returns.

Structure and Fees

Feature	Typical Structure
Legal Structure	Limited partnership
Minimum Investment	$100,000 - $1 million+
Fee Structure	"2 and 20" (2% management + 20% of profits)
Lock-up Period	1-3 years typically
Redemption	Quarterly or annually; notice required
Regulation	Limited; exempt from Investment Company Act

Common Hedge Fund Strategies

Strategy	Description	Risk Level
Long/Short Equity	Buy undervalued, short overvalued stocks	Moderate
Global Macro	Trade based on macroeconomic trends	High
Event-Driven	Profit from corporate events (M&A, bankruptcy)	Moderate-High
Market Neutral	Equal long and short; minimize market exposure	Lower
Distressed Securities	Invest in bankrupt or troubled companies	High
Managed Futures	Trade commodity and financial futures	High

On the Exam

Key hedge fund points:

"2 and 20" fee structure (management + performance)
Accredited or qualified investors only
Lock-up periods restrict liquidity
Limited regulation compared to mutual funds
High-water mark: Manager must recover losses before earning performance fees

Private Equity

Private equity involves investing in private companies or taking public companies private.

Types of Private Equity

Type	Focus	Time Horizon
Venture Capital	Early-stage startups	7-10 years
Growth Equity	Expanding companies	5-7 years
Buyout (LBO)	Acquiring mature companies	4-7 years
Distressed	Restructuring troubled companies	3-5 years

Characteristics

Illiquid: Capital locked for 5-10+ years
J-curve: Initial negative returns; profits come later
Capital calls: Investors commit capital; fund calls as needed
High minimum: Often $250,000 - $1 million+
Limited partners: Investors are passive
General partner: Manager makes investment decisions

Real Assets

Real Estate

Investment Method	Characteristics
Direct ownership	Control; management burden; illiquid
REITs	Liquid; traded on exchanges; 90% distribution requirement
Real estate funds	Diversified; professional management
Crowdfunding platforms	Lower minimums; less liquid

Other Real Assets

Timberland: Long-term appreciation; income from harvesting
Farmland: Income from crops; land appreciation
Infrastructure: Toll roads, airports, utilities; stable cash flows

Collectibles

Collectibles include tangible items valued for their rarity and desirability.

Types

Art and antiques
Rare coins and stamps
Fine wine
Classic cars
Sports memorabilia
Jewelry and watches

Characteristics

Feature	Implication
Highly illiquid	Difficult to sell quickly
No income	No dividends or interest
Subjective valuation	Value based on opinion
Storage/insurance costs	Ongoing expenses
Special tax treatment	Maximum 28% capital gains rate

On the Exam

Collectibles are taxed at a maximum 28% long-term capital gains rate—higher than the 20% maximum for most other capital assets.

Digital Assets (Cryptocurrencies)

Digital assets have emerged as a new alternative investment category.

Characteristics

Feature	Detail
High volatility	Extreme price swings common
24/7 trading	Markets never close
Decentralized	No central authority
Regulatory uncertainty	Rules still evolving
Security risks	Hacking, lost keys
No FDIC insurance	Not protected like bank deposits

Suitability Considerations

Digital assets are speculative and suitable only for investors who:

Understand the technology and risks
Can afford to lose their entire investment
Have a high risk tolerance
Don't need liquidity

Suitability Considerations