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CFA Level I — Alternative Investments Cheatsheet
2025 Curriculum · Volume 8 · 7 Learning Modules

LM1 Features & Structures
LM2 Performance
LM3 Private Capital
LM4 Real Estate
LM5–7 NR · HF · Digital

LM 1 — Features, Methods & Structures
CategoriesWhat Counts as Alternative
  • Private Capital: private equity (PE) + private debt
  • Real Assets: real estate, infrastructure, natural resources
  • Hedge Funds: distinguished by approach, not underlying assets
  • Low correlation with traditional assets; illiquid; long investment horizons
  • Require specialized knowledge to evaluate and oversee
  • Hedge fund investing in public equities is still an alternative
Higher expected return + illiquidity + lower market correlation = core alternative investment thesis

Methods3 Investment Approaches
Fund InvestingIndirect; highest fees; least control
Co-InvestingInvest alongside fund; lower fees; more control
Direct InvestingNo intermediary; lowest fees; maximum control
Control: Direct > Co-invest > Fund  |  Fee burden: Fund > Co-invest > Direct
  • Beginners → Fund; experienced → Co-invest; sophisticated → Direct
  • Manager offers co-invest when fund hits single-deal concentration limit
OwnershipGP / LP Structure
  • GP (General Partner): fund manager; unlimited liability; controls all decisions
  • LP (Limited Partner): investors; liability capped at invested amount; passive
  • LPA: Limited Partnership Agreement — governs all partners
  • Side Letter: supplemental LP-specific terms; overrides LPA for that LP
  • “Most favored nation” clause: favorable side-letter terms extend to all LPs
  • Excusal right: allows an LP to forgo a specific capital call
  • LPs are accredited investors (institutional or qualified HNW individuals)
FeesCompensation Structures
  • Management fee: 1%–2% of AUM (hedge funds) or committed capital (PE)
  • Performance fee / carried interest / carry: ~20% above hurdle rate
  • PE fee on committed capital (not AUM) → reduces incentive to deploy rapidly
  • Hard hurdle: performance fee only on returns exceeding hurdle
  • Soft hurdle: fee on entire return once hurdle exceeded; catch-up clause applies
rGP = max[0, p(r – rh)]   (no catch-up)
rGP = max[0, rcu + p(r – rh – rcu)]  (with catch-up)
  • High-water mark: performance fee only if fund value exceeds prior peak net of fees
  • Clawback: LPs reclaim GP fees earned on early wins when later losses occur
  • Deal-by-deal (American) waterfall: GP paid per deal → favors GP
  • Whole-of-fund (European) waterfall: GP paid only after LPs receive capital + hurdle → favors LP

LM 2 — Alternative Investment Performance & Returns
Life Cycle3 Phases & J-Curve
1Capital Commitment
→
2Capital Deployment
→
3Capital Distribution

  • Phase 1: fees & expenses incurred immediately; assets generate little income → returns negative
  • Phase 2: outflows exceed inflows; construction / turnaround underway
  • Phase 3: assets appreciate; capital gains realized on exits (IPO, sale); positive cash flows
  • J-curve: initial negative returns followed by acceleration → visually resembles letter J
MetricsPerformance Measurement
  • IRR: preferred — accounts for timing of cash flows; essential for PE & real estate
  • MOIC (Multiple of Invested Capital): quick shortcut; ignores cash flow timing
  • Returns often non-normal: fat tails, negative skew, illiquidity premium embedded
  • Staggered capital calls → net return varies by investor entry timing
  • Survivorship bias: failed funds removed from databases → industry performance overstated
  • Infrequent valuation (NAV updates) → volatility understated; correlation artificially low
Net investor return = Gross return − Management fee − Performance fee

LM 3 — Investments in Private Capital: Equity & Debt
PE TypesPrivate Equity Categories
Venture Capital (VC)Early-stage / startup; high growth; small stake
Growth EquityExpanding companies seeking capital; minority stake
LBOMature / declining firm; majority stake; heavy debt
Distressed PENear-bankrupt; restructuring play
SecondariesBuy existing LP interests before fund maturity
VC = startups & early stage | Broad PE = mature / declining firms. Both are non-publicly traded.

PE ExitsExit Strategies
IPOList company on public exchange
Strategic Sale (M&A)Sell to corporate buyer
Secondary SaleSell to another PE or financial buyer
Management Buyout (MBO)Management team buys the company
RecapitalizationAdd debt; return capital to LP/GP early
Liquidation / Write-offWind down; last resort for failed investment

Private DebtDebt Categories
Direct LendingSenior secured loans to mid-size firms
Mezzanine DebtSubordinated; equity upside via warrants
Venture DebtLoans to early-stage firms with low cash flow
Distressed DebtNear-bankrupt issuer; restructuring opportunity
CLOsSecuritized pools of leveraged loans
  • Higher yield than public debt via illiquidity premium
  • Low public-market correlation → diversification benefit
Risk / ReturnPrivate Capital Characteristics
  • Typical fund life ~10 years (3–5 yr investment period + harvest period)
  • Capital calls drawn down over 3–5 years from committed capital
  • Higher expected return vs. public equity (illiquidity & complexity premium)
  • Return dispersion is wide — manager selection is critical
  • Low correlation with public markets → diversification benefit
  • NAV updated infrequently → understates true volatility; smoothing effect

LM 4 — Real Estate & Infrastructure
Real EstateForms, Risk Spectrum & Returns
Investment Forms
Direct ownershipPhysical property; illiquid; control
REITs (public)Liquid; daily trading; income-focused
MBS (debt)Mortgage-backed securities; fixed income
Private RE funds / JVsPooled; equity or debt; illiquid
Risk Spectrum: low to high
  • Core → Core-Plus → Value-Add → Opportunistic (highest risk; development)
  • Sources of return: income (leases) + capital appreciation (~50/50 split)
  • Inflation hedge via rent step-ups; hedging quality varies by region
  • Low correlation with stocks; good diversifier; bond-like income
  • REITs: liquid but may correlate with equities during severe market stress
InfrastructureCategories & Development Stages
Economic Infrastructure
  • Transportation: roads, bridges, tunnels, airports, seaports, rail
  • ICT: telecom towers, data centers
  • Utility & Energy: power generation, water, gas, solid waste treatment
Social Infrastructure
  • Education, healthcare, social housing, correctional & government buildings
Development Stages
GreenfieldNew construction; highest risk; BOT lifecycle
BrownfieldExpand existing; shorter hold; stable returns
Secondary-stageFully operational; immediate cash flows; lowest risk
PPP = Public-Private Partnership. Concession agreement governs private operator’s rights, obligations & fees.

LM 5 — Natural Resources
LandFarmland & Timberland
Farmland returnsCrops + leases + price appreciation
Timberland returnsTimber harvest + carbon offsets + appreciation
  • Farmland: family-owned; smaller tracts; harder to access via futures
  • Timberland: institutional ownership; thousands of acres
  • Timberland harvest is flexible — can store value by delaying harvest
  • Both provide inflation hedge & portfolio diversification
CommoditiesPricing & Investment Features
  • No cash flows of their own; return from price changes
  • Strong inflation hedge: commodity prices are a component of CPI
  • Low correlation with stocks & bonds → diversification benefit
  • Access: futures, ETFs, physical ownership, equity in producers
ContangoFutures > spot; ample inventory
BackwardationFutures < spot; low inventory; convenience yield > cost of carry

PricingKey Commodity Concepts
  • Spot price: current market price for immediate delivery
  • Convenience yield: non-cash benefit of physically holding commodity
  • Cost of carry: storage + insurance + financing costs
  • Backwardation = convenience yield > cost of carry
  • Low inventory → backwardation; High inventory → contango
  • Physical ownership: more product types; less liquid; less transparent
  • Derivatives: more liquid; price transparent; leveraged exposure

LM 6 — Hedge Funds
FeaturesHedge Fund Characteristics
  • Private vehicles for institutional & high-net-worth (HNW) investors only
  • Distinguished by investment approach — not underlying assets
  • Use leverage, derivatives, short selling to enhance or hedge returns
  • Lightly regulated compared to mutual funds / ETFs
  • Structured as limited partnerships (GP = manager, LPs = investors)
  • Evaluated on absolute return basis, not vs. benchmark index
  • Lock-up periods restrict redemptions; gate provisions limit large outflows
  • Typical fee: “2 and 20” = 2% management fee + 20% performance fee
Hedge funds are NOT an asset class — they are investment vehicles. HFs investing in public equities are still alternatives.

Strategies5 Broad Strategy Categories
Equity HedgeLong/short equity; market-neutral; sector-focused
Event-DrivenMerger arb; activist; distressed; special situations
Relative ValueFixed income arb; convertible arb; statistical arb
Opportunistic / Global MacroMacro themes; managed futures (CTAs)
Multi-ManagerFund of funds (FoF); multi-strategy pods
Investment Forms
DirectSingle-manager fund; separate managed account (SMA)
IndirectFund of funds; HF indices; liquid alternatives
FoF: added diversification but carries double layer of fees (fund + FoF layer)

LM 7 — Introduction to Digital Assets
DLTDistributed Ledger Technology
  • Decentralized, immutable record-keeping distributed across all nodes
  • Once added to blockchain, transactions cannot be altered
  • Proof of Work (PoW): miners solve computational puzzles; energy-intensive (Bitcoin)
  • Proof of Stake (PoS): validators pledge (stake) digital assets; energy-efficient
Network Types
PermissionlessOpen to all; decentralized; slower; less cost-effective
PermissionedRestricted members; faster; more cost-effective
Bitcoin = permissionless. Most enterprise/corporate blockchains = permissioned.

Asset TypesDigital Asset Categories
CryptocurrencyNative blockchain currency (Bitcoin, Ether)
StablecoinPegged to fiat; low volatility by design
CBDCCentral bank digital currency; government-backed
NFTNon-fungible token; unique; digital art/collectibles
Security TokenTokenized ownership rights in a security
Utility TokenAccess to services within a network; no dividends
Governance TokenVoting rights in permissionless network decisions
ICOInitial coin offering; unregulated alternative to IPO
Tokenization = representing physical asset ownership on a blockchain → streamlines title verification & transfer

Key DistinctionCrypto vs. Tokens
  • Cryptocurrencies: have their OWN blockchain (Bitcoin, Ethereum)
  • Tokens: built ON top of an existing blockchain (ERC-20 tokens on Ethereum)
  • Fungible = identical, interchangeable units (crypto coins)
  • Non-fungible (NFT) = unique; cannot be replicated or substituted
  • DeFi = decentralized finance apps built on blockchain (NFT marketplaces, lending)
  • Smart contracts = self-executing code; remove need for intermediaries
Risk / ReturnDigital Asset Characteristics
  • No inherent cash flows → no fundamental value anchor; price is speculative
  • High price volatility; supply caps (e.g., Bitcoin max 21M) don’t eliminate this
  • Not government-backed or regulated (most cryptocurrencies)
  • Low historical correlation with traditional assets → potential portfolio diversifier
  • Access: direct exchange ownership, crypto ETFs, hedge funds, futures contracts
  • Key risks: regulatory, cybersecurity, custody failure, ICO fraud, concentration

High-Frequency Exam Traps & Quick Reference
Key Distinctions (frequently tested)
Hedge fund vs. PE fundHF = liquid, short horizon; PE = illiquid, long horizon
VC vs. PEVC = early stage; PE = mature or declining
Hard vs. soft hurdleHard = fee on excess only; Soft = fee on all (with catch-up)
American vs. European waterfallAmerican (deal-by-deal) → GP-friendly; European (whole-fund) → LP-friendly
Clawback vs. high-water markClawback = reclaim prior fees; HWM = block new fees until new peak
Contango vs. backwardationContango = futures > spot; Backwardation = futures < spot
Greenfield vs. brownfieldGreenfield = new build (most risk); Brownfield = expand existing
Crypto vs. tokenCrypto = own blockchain; Token = on another’s blockchain
NFT vs. fungible tokenNFT = unique/non-interchangeable; Fungible = identical
PE management fee basisCommitted capital, NOT AUM (unlike hedge funds)

Quick Reference Numbers & Rules
Typical management fee1%–2% of AUM or committed capital
Typical performance fee20% of returns above hurdle rate
Typical PE fund life10 years from initial closing
Capital call period (PE)3–5 years from initial closing
LP liabilityCapped at amount invested (limited)
GP liabilityTheoretically unlimited
J-curve returnsNegative early → positive later (Phase 3)
Real estate income split>50% from income; remainder from appreciation
Survivorship bias effectOverstates industry average performance
MOIC limitationIgnores timing of cash flows → use IRR instead

Remember: Alternatives offer higher expected returns and diversification in exchange for illiquidity, complexity, and long time horizons. Control hierarchy: Direct > Co-invest > Fund investing. Fee burden: Fund > Co-invest > Direct. LP liability is always capped at investment; GP has unlimited liability. IRR is preferred over MOIC because it accounts for the timing of cash flows.