Direct investment, Co-investments and Fund Investment Methods Comparison

AnalystPrep Summary

Investors can access alternative investments through fund investing, co-investing, or direct investing. Each method offers a different balance of control, diversification, fees, expertise requirements, and investment responsibility.

Fund investing provides professional management and diversification but involves management and performance fees. Co-investing allows investors to invest alongside fund managers with potentially lower fees and greater participation, but it requires more due diligence. Direct investing provides the highest level of control and flexibility, but it requires significant expertise, capital and active management.

For CFA Level I candidates, the key is to understand how investor control, diversification, costs, due diligence and required expertise differ across the three methods.

Comparing Alternative Investment Methods

Feature	Fund Investing	Co-investing	Direct Investing
Professional Management	Yes	Partial	No
Investor Control	Low	Moderate	High
Diversification	High	Moderate	Lower
Management Fees	Highest	Lower	None
Due Diligence	Moderate	High	Very high
Minimum Capital	Lowest	Moderate	Highest
Investor Involvement	Low	Moderate	High
Typical User	Most investors	Experienced investors	Institutional or sophisticated investors

Choosing the Right Alternative Investment Method

The best alternative investment method depends on the investor’s experience, available capital, desired control, diversification needs, risk tolerance, and time commitment.

An investor who wants professional management and broad diversification may prefer fund investing. An investor who has more experience and wants lower fees or greater exposure to selected deals may consider co-investing. A large institutional investor with significant expertise and capital may prefer direct investing.

Important factors include:

• Investment experience
• Available capital
• Desired control
• Diversification needs
• Due diligence capacity
• Risk tolerance
• Time commitment
• Fee sensitivity
• Access to investment opportunities

As investor control increases, the required expertise, due diligence, and responsibility also increase.

Key Takeaways

• Alternative investments can be accessed through fund investing, co-investing, or direct investing.
• Greater investor control generally requires greater expertise.
• Fund investing usually offers the highest diversification.
• Direct investing usually offers the greatest flexibility and control.
• Co-investing balances professional access with increased investor involvement.
• Fund investing typically involves higher management and performance fees.
• Direct investing requires substantial due diligence and capital.
• Investment method selection depends on objectives, capital, experience, time commitment, and risk tolerance.

Understanding Alternative Investment Methods

Investors can access alternative investments through three primary methods: fund investing, co-investing, and direct investing. Each method offers different levels of control, diversification, expertise requirements, fees, and potential returns.

Fund investing is often the most accessible method because investors rely on professional managers and pooled capital. Co-investing gives investors the opportunity to participate alongside a fund manager in specific deals. Direct investing gives investors maximum control, but it also requires the most capital, expertise, and active involvement.

This study note explains:

• Fund investing
• Co-investing
• Direct investing
• Advantages and disadvantages of each method
• Key differences between the methods
• How investors choose an appropriate access route
• CFA Level I applications

Alternative Investment Methods

Investors have three primary methods of accessing alternative investments. These methods are:

• Fund Investment: This is the first method where investors put their money into a fund, such as a Private Equity (PE) fund. For instance, an investor might choose to invest in the Blackstone Group, a well-known PE fund.
• Co-Investment: In this method, the investor invests in a fund’s portfolio company. For example, an investor might co-invest in a promising start-up with a venture capital fund like Sequoia Capital.
• Direct Investment: Here, the investor invests directly into a company or project, such as infrastructure or real estate. For instance, an investor might directly invest in a real estate project like a new residential complex in New York City.

Typically, investors start their journey in alternative investments via funds. As they gain more experience and knowledge, they may start to explore co-investing and direct investing.

Fund Investment

Investors, especially those with limited resources or experience, often choose fund investing as a means to participate in alternative investments. In fund investing, investors contribute capital to a fund, and the fund’s management takes care of the investments on their behalf.

The investor is then charged a management fee and, if the fund manager delivers superior results compared to a benchmark or hurdle rate, a performance fee. The investment decisions of fund investors are limited to either investing in the fund or not. Fund investing is available for all major alternative investment types, including hedge funds, private capital, real estate, infrastructure, and natural resources.

Investing in alternative assets requires specialized skills that many investors do not have. For instance, investing in real estate requires knowledge about property valuation, legal issues, and market trends, which a typical investor may not have. Such investors can gain exposure to these assets through fund investing. In this method, one or more investors contribute capital to an investment management company that identifies, selects, manages, and monitors investments on behalf of the investors.

Why Do Investors Choose Fund Investing?

Fund investing allows investors to access alternative investments through a professionally managed vehicle. This is often the most practical method for investors who want exposure to private equity, hedge funds, real estate, infrastructure, or private debt without managing individual investments directly.

Investors may choose funds because they provide professional selection, portfolio construction, monitoring, and diversification. Fund managers are responsible for sourcing opportunities, conducting due diligence, managing investments, and exiting positions.

However, fund investing usually involves management fees and performance fees. Investors also have less control over individual investment decisions and may face lock-up periods or limited liquidity.

For many investors, fund investing offers the best balance between access, expertise, and diversification.

Comparing Fund Investment with Traditional Public Equity and Fixed Income

Fund investment structures for alternative investments differ significantly from traditional public equity and fixed-income fund or ETF investments:

• Alternative funds usually involve the pre-commitment of funds before investment selection and an extended lock-up period during which the fund cannot be liquidated.
• Investment structures for alternative funds typically come with higher management fees and intricate fee arrangements. Unlike equity or fixed-income funds, these structures often provide less frequent transparency regarding periodic returns and fund positions.
• Investors in alternative funds usually compensate managers using a performance-based fee structure to better align manager and investor incentives over extended periods. 

Advantages of Fund Investment

• Fund investing requires less investor involvement compared to direct and co-investing.
• The alternative investment option is accessible to anyone, regardless of their expertise.
• Diversification benefits come from the multiple investments found in a single fund.
• It requires a low minimum capital compared to the other investments.

Disadvantages of Fund Investment

• It is costly since an investor must pay management and performance fees.
• An investor is expected to conduct due diligence when selecting the appropriate fund.
• There are exit restrictions due to lockups and similar limitations.

Co-investment

Co-investing is a strategic method of investment where an investor diversifies their investment approach by investing in assets both indirectly through a fund and directly in the same assets. This is achieved by obtaining co-investment rights. For instance, if a private equity fund is investing in a startup, an investor with co-investment rights could also directly invest in that startup alongside the fund.

Co-investing allows an investor to participate in a deal identified by a fund, not just by investing in the fund itself. This method of investment provides an opportunity for investors to expand their investment knowledge, skills, and experience beyond what they would gain from a fund-only investment approach.

How Does Co-investing Work?

Co-investing allows investors to invest directly alongside a fund manager in a specific transaction. This gives investors more targeted exposure than a traditional fund investment while still benefiting from the manager’s sourcing and expertise.

Co-investment opportunities are often offered to existing limited partners. They may allow investors to increase exposure to attractive deals and reduce overall fees compared with a standard fund structure.

However, co-investing requires more due diligence than fund investing. Investors must evaluate the specific transaction, manager alignment, concentration risk, exit strategy, and potential conflicts of interest.

Co-investing can be attractive for experienced investors, but it requires stronger internal resources and a higher ability to assess individual opportunities.

Advantages of Co-investing 

• An investor can learn from the fund’s expertise and improve at direct investing.
• Investors co-invest an additional amount into an investment, often without paying management fees on the capital they used for direct investments.
• Co-investing allows investors to be more actively involved in managing their portfolios than fund investing.

Disadvantages of Co-investing 

• Co-investors have limited control over the investment selection process compared to direct investing.
• It may be subject to adverse selection.  A fund may offer less attractive investment opportunities to the co-investor while allocating capital to more appealing deals.
• Co-investing requires an investor to be more actively involved since they must evaluate both investment opportunities and the fund manager.

Benefits of Co-Investment for Managers

Managers also benefit from choosing one or more co-investors. The benefits include:

• Accelerating Investment Timing: When available funds and expected inflows are insufficient for a specific deal, co-investors can provide the additional capital needed to expedite the investment. For instance, if a hedge fund manager identifies a lucrative investment opportunity but lacks sufficient funds, they can bring in co-investors to quickly secure the deal.
• Expanding Investment Opportunities: Co-investing can expand the scope of available new investments. By pooling resources with co-investors, managers can access larger, more diverse investment opportunities that they might not be able to afford on their own.
• Increasing Diversification: Co-investing can help increase the diversification of an existing pool of fund investments. By bringing in co-investors, managers can spread the risk across a wider range of assets, reducing the potential impact of any single investment’s poor performance.

Direct Investment

Direct investing is a method employed by large, sophisticated investors who possess the necessary skills and knowledge to manage individual alternative investments. This approach eliminates the need for an intermediary, providing the investor with maximum flexibility and control over their investment choices, financing methods, and timing. For instance, a billionaire investor like Warren Buffet might directly invest in a company like Apple, buying shares directly from the market instead of going through a mutual fund or an ETF.

Private Equity and Direct Investing

In the context of private equity, direct investing involves the acquisition of a direct stake in a private company. This is done without the use of a fund managed by an external asset manager or general partner.

The direct investor must have the resources to provide the specialized knowledge, skills, and oversight capabilities that direct investment requires. For example, a venture capitalist might directly invest in a startup, taking a significant stake in the company and actively participating in its management and decision-making process.

Direct Investing in Other Sectors

While the direct investment approach is commonly applied to private capital and real estate, it is also used by some very large investors, such as pensions and sovereign wealth funds, for direct investment in infrastructure and natural resources.

Why Is Direct Investing More Complex?

Direct investing gives investors the highest level of control because they invest directly in an asset, company, project, or security rather than through a pooled fund.

This method may be used by pension funds, sovereign wealth funds, family offices, endowments, and other sophisticated investors with significant internal expertise. Common direct investments may include infrastructure assets, real estate properties, private companies, private debt, and natural resource projects.

Direct investing can reduce external management fees and give investors more control over timing, strategy, governance, and asset selection. However, it also requires substantial capital, specialized expertise, active management, legal review, due diligence, and risk monitoring.

For CFA candidates, the key trade-off is control versus complexity.

Advantages of Direct Investment 

• An investor avoids paying ongoing management fees to an external manager.
• Direct investing allows an investor to create a portfolio of investments that suits their needs.
• Direct investing provides an investor with the utmost flexibility and control over their investment.

Disadvantages of Direct Investment

• Direct investing requires a greater level of investment expertise.
• A direct investor won’t enjoy the diversification benefits of fund investing.
• Direct investing requires more significant levels of due diligence because of the absence of a fund manager.
• Compared to fund investing, it requires a higher minimum capital.

Which Investment Method Fits Different Investors?

Investor Profile	Most Suitable Method
Beginner	Fund Investing
Investor seeking diversification	Fund Investing
Experienced individual	Co-investing
Investor seeking lower fees with manager access	Co-investing
Institutional investor	Direct Investing
Investor seeking maximum control	Direct Investing
Investor with limited due diligence resources	Fund Investing
Investor with strong internal investment team	Direct Investing

Example: Choosing Between Alternative Investment Methods

Consider three investors seeking alternative investment exposure.

A retail investor wants diversified exposure to private markets but does not have the expertise to analyze individual private companies. This investor may choose a private equity fund or alternative investment fund.

An experienced investor already invested with a private equity manager is offered the chance to co-invest in one of the manager’s portfolio companies. This investor may accept the opportunity to gain targeted exposure and potentially lower fees.

A pension fund with a large internal investment team may directly acquire an infrastructure asset, such as a toll road or renewable energy project. This gives the pension fund more control but also requires significant expertise and ongoing management.

This example shows how capital, experience, control, and due diligence capacity influence method selection.

Comparing Benefits and Challenges

Method	Main Advantages	Main Challenges
Fund Investing	Diversification and professional management	Higher fees and less control
Co-investing	Lower fees and greater participation	More due diligence and concentration risk
Direct Investing	Full control and flexibility	High expertise, capital, and active management requirements

When Is Each Method Most Appropriate?

Fund investing is often appropriate when investors want diversified exposure, professional management, and access to alternative investments without directly managing individual assets.

Co-investing may be appropriate for experienced investors who already have relationships with fund managers and want to increase exposure to selected opportunities while potentially reducing fees.

Direct investing may be appropriate for large institutional investors, sovereign wealth funds, pension funds, family offices, or sophisticated private investors with the capital and expertise needed to manage investments directly.

The appropriate method depends on the investor’s objectives, resources, governance structure, liquidity needs, and ability to perform due diligence.

Question #1

Which of the following is least likely a potential benefit for the manager in choosing to co-invest?

1. Reducing the need for active management of the investment.
2. Expanding the scope of available new investments by pooling resources.
3. Accelerating the timing of the investment when available funds are insufficient.

The correct answer is A.

Reducing the need for active management of the investment is not a potential benefit for the hedge fund manager in choosing to co-invest. Co-investment does not necessarily reduce the need for active management. In fact, it may increase the need for active management due to the complexity of managing multiple investors and their expectations.

Co-investment can bring additional resources and capital, but it also brings additional responsibilities and potential conflicts of interest. The manager will still need to actively manage the investment to ensure that it is performing as expected and to manage the relationships with the co-investors. Therefore, reducing the need for active management is not a benefit of co-investment for the hedge fund manager.

B is incorrect. Expanding the scope of available new investments by pooling resources is also a potential benefit of co-investment. By pooling resources with co-investors, a hedge fund manager can potentially access larger or more diverse investment opportunities that would be out of reach if the manager were investing alone. This can help to diversify the investment portfolio and potentially increase returns.

C is incorrect. Accelerating the timing of the investment when available funds are insufficient is indeed a potential benefit of co-investment. If a hedge fund manager has identified a lucrative investment opportunity but does not have sufficient funds to take full advantage of it, bringing in co-investors can provide the additional capital needed to make the investment sooner rather than later.

Question #2

An investor with co-investment rights is considering directly investing in a startup alongside a private equity fund. Which of the following is most likely a potential drawback that the investor should consider?

1. Co-investing does not provide any learning opportunities.
2. Co-investing requires more active management, which can increase costs.
3. Co-investing does not allow the investor to participate in a deal identified by a fund.

The correct answer is B.

Co-investing requires more active management, which can increase costs. When an investor co-invests alongside a private equity fund, they are taking on a more active role in the investment. This means that they will need to dedicate more time and resources to managing the investment, which can increase costs. This is in contrast to investing in a private equity fund, where the fund manager takes on the responsibility of managing the investments.

The investor will need to conduct their own due diligence, negotiate terms, monitor the investment, and potentially take on a role in the management of the startup. All of these activities require time and expertise, which can increase the cost of the investment. Therefore, while co-investing can provide potential benefits such as increased control and potentially higher returns, it also comes with increased costs and responsibilities.

A is incorrect. Co-investing can provide significant learning opportunities. By taking on a more active role in the investment, the investor can gain a deeper understanding of the business and the industry. This can be a valuable experience that can be applied to future investments. Therefore, the statement that co-investing does not provide any learning opportunities is incorrect.

C is incorrect. Co-investing does allow the investor to participate in a deal identified by a fund. In fact, this is one of the main benefits of co-investing. The investor can leverage the expertise and deal-sourcing capabilities of the private equity fund while also having the opportunity to invest directly in the startup. Therefore, the statement that co-investing does not allow the investor to participate in a deal identified by a fund is incorrect.

Glossary

Fund Investing — Investing through a pooled investment vehicle managed by a professional investment manager.

Co-investing — Investing alongside a fund manager in a specific transaction or asset.

Direct Investing — Investing directly in an asset, company, or project without using a pooled fund.

Alternative Investment — An investment outside traditional publicly traded stocks, bonds, and cash.

Due Diligence — The process of evaluating an investment before committing capital.

Management Fee — A fee paid to an investment manager for managing assets.

Performance Fee — A fee based on investment performance, often paid when returns exceed a hurdle rate.

Diversification — Spreading investments across assets to reduce concentration risk.

General Partner — The fund manager responsible for managing a limited partnership.

Limited Partner — An investor in a limited partnership who contributes capital but does not manage the fund.

Lock-up Period — A period during which investors cannot redeem or withdraw capital.

Private Equity Fund — A pooled investment vehicle that invests in privately held companies.

Frequently Asked Questions

What is fund investing?

Fund investing means accessing alternative investments through a professionally managed pooled investment vehicle.

What is co-investing?

Co-investing means investing alongside a fund manager in a specific asset, company, or transaction.

What is direct investing?

Direct investing means investing directly in an asset, company, or project without using a pooled fund.

What is the difference between direct investing and fund investing?

Fund investing relies on a professional manager and pooled capital, while direct investing gives the investor direct ownership and control over the investment.

Which investment method offers the most control?

Direct investing usually offers the most control because the investor selects and manages the investment directly.

Which investment method provides the greatest diversification?

Fund investing usually provides the greatest diversification because a fund typically invests across multiple assets or transactions.

Why is direct investing more complex?

Direct investing requires significant capital, due diligence, specialized expertise, legal review, active monitoring, and risk management.

What are co-investment rights?

Co-investment rights give certain investors the opportunity to invest alongside a fund manager in specific transactions.

Which investment method is best for beginners?

Fund investing is usually most suitable for beginners because it provides professional management and diversification.

Why do institutional investors use direct investment?

Institutional investors may use direct investment to gain more control, reduce external fees, customize exposure, and manage long-term assets directly.

Alternative Investment Methods at a Glance

Method	Best For	Main Benefit	Main Limitation
Fund Investing	Most investors	Diversification	Higher fees
Co-investing	Experienced investors	Lower fees and greater participation	Higher due diligence
Direct Investing	Institutional and sophisticated investors	Maximum control	Expertise and capital requirements