Investment Methods in Alternative Investments

Investment Methods in Alternative Investments

Methods of investing in alternative investments include:

  • Fund investing.
  • Co-investing.
  • Direct investing.

Fund Investing

In fund investing, investors contribute capital to a fund, and then the fund identifies, chooses, and makes investments on behalf of the investors. Investors pay a fee based on the value of the fund managers’ assets. In addition, they pay a performance fee if the fund manager delivers a return above the benchmark.

Fund investing can be termed as indirect investing in alternative assets. This is because fund investors’ investment decisions are based on whether to invest in a fund or not. Furthermore, investors do not influence a fund’s investments.

Fund investing applies to all types of alternative investments.

Advantages of Fund Investing

  • 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 Investing

  • 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.


In co-investing, an investor indirectly invests in assets through a fund. Nevertheless, the investor owns the rights (co-investment rights) to invest in the same assets directly. Intuitively, co-investing allows the investor to make parallel investments when the fund identifies a lucrative deal.

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.

Direct Investing

In direct investment, an investor directly invests in an asset without using any intermediary. Direct investing, therefore, gives investors higher control and flexibility when selecting investments, financing methods, and approaches. However, investing directly in alternative investments is most popular among established private equity and real estate investors. Pension funds and sovereign wealth funds may also invest in infrastructure and natural resources.

Advantages of Direct Investing 

  • 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 Investing 

  • 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.

Due Diligence for Fund Investing, Direct Investing, and Co-investing

In direct investment, an investor chooses the company to invest in. However, there is a need for high and competence-based due diligence before they invest in a private company.

Fund investing provides the benefits of a diversified portfolio, but this advantage comes at an additional cost. Even though the fund performs due diligence on the ventures to invest in, the investor, too, must perform due diligence on the fund manager, before investing in a fund.

In co-investing, the general partner assists the investor in performing direct due diligence on a portfolio company.


 Which of the following is most likely a disadvantage of co-investing?

A. It may be subject to adverse selection bias.

B. The investor won’t enjoy fund diversification benefits.

C. Selecting the right fund is not easy because of the information asymmetry.


The correct answer is A.

Co-investing may be subject to adverse selection bias. This is because the fund avails less attractive investment opportunities to the co-investor while allocating its own capital to more appealing deals.

B is incorrect. Being unable to enjoy the diversification benefits is a disadvantage of direct investing, not co-investing.

C is incorrect. Selecting the right fund is difficult because information asymmetry is a disadvantage of fund investing.

Shop CFA® Exam Prep

Offered by AnalystPrep

Featured Shop FRM® Exam Prep Learn with Us

    Subscribe to our newsletter and keep up with the latest and greatest tips for success
    Shop Actuarial Exams Prep Shop Graduate Admission Exam Prep

    Sergio Torrico
    Sergio Torrico
    Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
    So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
    Kriti Dhawan
    Kriti Dhawan
    A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
    nikhil kumar
    nikhil kumar
    Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
    Great support throughout the course by the team, did not feel neglected
    Benjamin anonymous
    Benjamin anonymous
    I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
    Daniel Glyn
    Daniel Glyn
    I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
    michael walshe
    michael walshe
    Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.