“Alternative investments” is a term used to describe a broad category of investment assets that fall outside of traditional public securities, such as stocks, bonds, government securities, and public funds. Alternatives encompass private, less regulated investments that include asset categories such as private equity, private credit/debt, venture capital, real estate, infrastructure, and tangible assets.
Some private assets, such as private equity, private credit, and private real estate, may be similar in nature to their public market equivalents, while other asset classes, such as venture capital, infrastructure, and tangible assets are unique and are not available via public market instruments. In most cases, alternatives take on different characteristics than public offerings and are viewed in the context of their contributions to overall portfolios.
Many alternative investments are structured as closed-end funds or limited partnerships that are set up to accept a predetermined amount of money, invest that capital, and then self-liquidate after a predetermined time period, typically around 10-12 years or so.
Alternative investments are accessed through a global marketplace where transactions are made directly with the investment issuer or through private funds, such as hedge funds, venture capital funds, real estate funds, private equity funds, and private credit funds.
There are no formal secondary markets or exchanges for alternative investments. As such, they are much less liquid than traditional securities. In return for their relative illiquidity, many alternatives have historically offered investors superior long-term returns relative to public investments as well as attractive diversification opportunities that enhance overall portfolio returns with low-correlated assets.
The predominant investors in alternatives are institutions and high-net-worth (HNW) individuals, and the allocation of total assets to alternatives is substantial and growing. According to Blackrock, alternative investments have grown from representing 5 percent of global pension portfolios in 1996 to 26% by 2019.1
Alternative investments are structured differently than traditional investments and often contain assets that are not available in traditional investments. In addition, alternatives are generally designed around long-term investment horizons, engaging in strategies that are expected to take as long as 10 years or more to reach their objectives. As a result, they differ from traditional investments in many ways and exhibit different risk-reward characteristics. These include:
While alternative assets such as private company equities can be acquired individually, they are commonly packaged together with other similar-type assets into managed portfolios structured as funds or limited partnerships. Investors purchase shares in these funds, thereby obtaining a proportional interest in the entire portfolio.
Fund assets are usually grouped with others of a similar type and objective. That way, the funds reduce the risks of holding individual assets while maintaining an overall focus on a common investment objective. A private equity fund with a growth equity objective, for example, might hold equities in numerous private companies, perhaps even in a specific industry sector.
The fund structure offers several key advantages for alternatives investors:
Alternative investment funds are conceptually similar to closed-end funds in that a predetermined amount of capital is initially raised, assets are then acquired and managed, and the fund is designed to self-liquidate in a specified time period. An offering memorandum specific to the fund will spell out the terms, objectives, and fees of the investment for investors.
Alternative investments are more than simply private market versions of traditional public securities. They can consist of different types of assets, different investment structures, and different risk-return characteristics. The table below highlights the key characteristics that differentiate alternatives from traditional investments.
The overall appeal of alternatives is that they widen the available investment spectrum, offering investments of different types, different asset classes, and different characteristics. This provides more choices from which to address investor objectives as well as substantial diversification opportunities for investment portfolios.
The diversification advantages of alternatives stem from several features of alternative offerings:
For a comprehensive explanation, please refer to Why Invest in Private Equity.
The differences between alternative and traditional investments provide unique investment opportunities, asset types, and characteristics that accommodate investment strategies not necessarily available through traditional investments. Some of these strategies are explained below.
Venture capital investments provide funding to entrepreneurs with early-stage startup companies, funding novel ideas, new business models, or innovative technologies in the early stages of development. VC investments might include a new type of food source, a unique healthcare treatment, or a digital security service. Among the more notable venture successes of the past are companies such as Google, Twitter, Airbnb, and Zynga.
Growth equity strategies provide capital to later-stage ventures that are beyond the development stage and require capital for build-out, geographic expansion, or to be deployed on a more efficient or profitable scale. Growth equity opportunities might include a new type of restaurant chain, a cyber security provider, or an electric vehicle manufacturer.
As an example, fraud prevention company Kount, formed in 2007, established itself as a leader in applying patented AI and machine-learning technology to protect digital transactions. To fund its worldwide expansion, Kount received $80 million from private equity sources in 2015 to expand its footprint with major e-commerce companies. Over the ensuing three years, the company’s revenues tripled4.
Private equity strategies center on equity investments in private companies, which can include objectives such as working capital for companies that prefer to remain privately owned, leveraged buyouts, restructurings, or sector-specific private endeavours.
A prominent example of a private equity buyout was Dell Computer, which was taken private in 2013 by its CEO Michael Dell and private equity firm Silver Lake Partners. The private equity investment enabled an ailing computer manufacturer to engage in a number of subsequent divestitures and acquisitions that significantly transformed the company and enhanced investor returns5.
Private debt/credit instruments provide credit financing to companies that are privately sourced and therefore do not trade in public markets. In return for the illiquidity of such investments, private credit may offer potentially higher yields across a range of risk-return scenarios and are generally either collateralized by specific assets or given seniority among other debts the company may hold. Private credit investments can provide financing for a new facility or equipment, an acquisition, or to refinance other debts.
In 2021, Blackstone executed a number of substantial private credit deals including a $2.85 billion loan to consulting services company Guidehouse in support of its acquisition of The Dovel Group and a $1.1 billion loan to support the acquisition of consumer data company NPD Group by Hellman & Friedman6.
Infrastructure investments provide financing for large community-based projects, such as a water treatment plant or a new stadium.
Private equity funds make efforts to liquidate their assets and return capital to investors in a prescribed time period, usually around 10-12 years. When assets in the fund cannot easily be liquidated in that time frame, they can often be sold to a separate investment fund that specialises in acquiring these ‘secondary’ assets. These transactions usually happen in private equity secondary markets.
Impact investment funds focus on private investments that are expected to provide social as well as economic benefits. An impact investing fund might fund an offshore wind farm or a waste treatment facility for a specified community.
Private real estate funds offer investments in real estate categories such as retail shopping malls, luxury resort development, warehouse space, and residential or office buildings. See more on Private Equity vs Real Estate.
Co-investments offer investors who are already participating in alternative investment funds the opportunity to invest additional capital in specific assets their fund is already investing in. Co-investments have terms that are generally separate from the terms of the investor’s commitment to the main fund.
An investor might, for example, be a limited partner in a private equity fund making investments in growth equity assets. An opportunity may exist for the investor to increase their investment in a specific asset (among many held by the fund) that holds particular appeal to them.
Investing in alternatives requires investors to understand the different types of structures and strategies available, identify open offerings, and perform due diligence on specific opportunities. In some cases, the minimum investment may be more than the investor is able to commit.
To help investors with these issues, Moonfare creates investment offerings that address various private market strategies, align with prominent global alternatives specialists who offer and manage such investments, and make these investments available to individuals through intermediary funds that allow for lower minimum commitments. Moonfare’s offerings may be in the form of direct private investments, portfolio funds, co-investments, or secondary investments.
In addition to lowering minimum capital requirements, Moonfare conducts due diligence on investment issuers and GPs, and provides liquidity opportunities for investors in Moonfare funds.
Accredited investors, such as high-net-worth individuals, and institutions, such as pensions, endowments, and insurance companies, can invest in alternatives. The criteria for accredited investors may vary in different countries. In the U.S., an accredited investor is defined by the Securities and Exchange Commission to be someone (or an entity) with at least a $200,000 annual income or liquid net worth of more than $1,000,000. See more at Types of PE Investors.
The minimum commitment for Moonfare fund investments is €50k in Europe and $75k in the U.S.
A typical time horizon for an alternative investment fund would be 10-12 years.
High-net-worth individuals (with portfolios greater than $1 million) and institutional investors (pensions, endowments, insurance companies).
Important notice: This content is for informational purposes only. Moonfare does not provide investment advice. You should not construe any information or other material provided as legal, tax, investment, financial, or other advice. If you are unsure about anything, you should seek financial advice from an authorised advisor. Past performance is not a reliable guide to future returns. Don’t invest unless you’re prepared to lose all the money you invest. Private equity is a high-risk investment and you are unlikely to be protected if something goes wrong. Subject to eligibility. Please see https://www.moonfare.com/disclaimers.
2 Liquidity on the secondary market is not guaranteed.
3 As of June 30, 2020. U.S. Private Equity Benchmarks (Legacy Definition) Q2 2020 Final Report, Page 8.