There are several major types of investments, including traditional investments such as stocks and bonds, and alternative investments such as private equity, hedge funds, real estate, commodities, and infrastructure. This article summarizes and compares the key characteristics, risks, and benefits of traditional vs alternative investments, with a focus on private equity and hedge funds.
Higher fees, leverage, restrictions for alternative investments
Alternative investments generally have higher fees, use more leverage, have more investor restrictions, and are more actively managed compared to traditional investments. Typical fees include a management fee based on assets under management or committed capital, plus a performance fee above a hurdle rate. Investor restrictions often include lock-up periods and redemption notice periods.
Lower liquidity, regulation, transparency for alternative investments
Alternative investments also tend to be less liquid, less regulated, less transparent, and have less return history compared to publicly traded stocks and bonds. Valuations rely more on estimates versus observable prices. The combination of higher leverage and lower liquidity can increase downside risk.
Lower correlations provide diversification for alternative investments
A key potential benefit of alternatives is having returns that are less correlated with traditional assets. This diversification can reduce portfolio risk and increase risk-adjusted returns. For example, private equity returns have historically had low-to-moderate correlations with public equity.
Private equity takes ownership stakes with little public disclosure
Private equity funds take direct ownership stakes in private companies or take public companies private. Capital is committed to be invested over time as deals are identified. Investors have little visibility into the portfolio due to limited disclosure requirements.
Hedge funds actively trade, face risks like margin calls
Hedge funds actively manage long, short, and derivative positions across asset classes. Trading is opaque to investors but can be subject to risks like margin calls. Hedge fund strategies include long-short equity, macro, relative value, event driven, and more.
In summary, alternative investments differ from traditional investments on dimensions including liquidity, regulation, fees, leverage, transparency, diversification benefits, and risks. Major types like private equity and hedge funds have distinct return drivers, disclosure rules, and risk factors for investors to weigh.