CFA® Level I Alternative Investments

The 7 learning modules

1. 01 Alternative Investment Features, Methods, and Structures

   What makes an investment alternative and how the main categories (private capital, real assets and hedge funds) differ. You compare three ways of investing: through a fund, by co-investing alongside a fund, and directly, trading off fees and control against the expertise and scale needed. The second half covers the limited partnership structure, the roles of the general and limited partners, and how managers are paid: management fees, performance fees, hard and soft hurdles, catch-up clauses, deal-by-deal and whole-of-fund waterfalls, clawbacks and high-water marks.

   6 lessons · 2 videos in the Academy →

2. 02 Alternative Investment Performance and Returns

   Why comparing alternatives with traditional assets is difficult: long investment life cycles, illiquid holdings valued by appraisal or models, leverage and non-normal returns. You calculate the multiple of invested capital, compare it with IRR, and work out the effect of borrowing on the return to investors' own capital. Much of the module is fee calculations under different terms, including custom share classes and funds of funds, and it ends with the biases that affect published indexes, such as survivorship and backfill bias.

   10 lessons · 4 videos in the Academy →

3. 03 Investments in Private Capital: Equity and Debt

   The categories of private equity (leveraged buyouts, venture capital by stage, and minority or growth equity) and the ways a fund exits an investment, from trade sales and public listings to recapitalisations, secondary sales and write-offs. On the debt side you meet direct lending, venture debt, mezzanine debt, distressed debt and unitranche loans, and where each sits on the risk–return spectrum. Questions also cover the diversification that private equity and private debt can add to a portfolio of listed assets.

   6 lessons · 2 videos in the Academy →

4. 04 Real Estate and Infrastructure

   Residential and commercial real estate, and the ways to invest in it: directly or indirectly, through equity or debt, in public or private form, including REITs and mortgage-backed securities. You look at sources of return (income and capital appreciation), the pros and cons of direct ownership, and diversification benefits. Infrastructure is covered as a related real asset: economic versus social assets, greenfield versus brownfield projects, how private investors take part through concessions and long-term contracts, and why its cash flows tend to be stable.

   8 lessons · 2 videos in the Academy →

5. 05 Natural Resources

   How land investments differ from real estate, and the features of farmland and timberland, including the owner's ability to delay a timber harvest while the trees keep growing. For commodities, you cover the main ways to invest (physical holdings, futures, exchange-traded products, commodity trading advisers and specialised sector funds) and how forward prices relate to spot through the cost of carry and the convenience yield. The module ends with risk, return, inflation hedging and diversification.

   6 lessons · 2 videos in the Academy →

6. 06 Hedge Funds

   Hedge funds are defined by how they invest (leverage, short selling and derivatives) rather than what they hold. You learn the four groups of strategies: equity hedge, event driven, relative value and opportunistic, with examples such as merger arbitrage, convertible bond arbitrage and global macro. The module compares ways of investing, from direct fund investment and separately managed accounts to funds of funds and ETFs, and covers liquidity terms such as lockups and gates, the split of returns into market beta, strategy beta and alpha, and diversification.

   9 lessons · 2 videos in the Academy →

7. 07 Introduction to Digital Assets

   How distributed ledgers and blockchains record transactions, the difference between proof of work and proof of stake, and between permissioned and permissionless networks. You classify digital assets (cryptocurrencies, stablecoins, central bank digital currencies and different kinds of tokens, including NFTs) and see how they differ from financial assets. Questions also cover direct and indirect ways to invest, such as exchanges, futures and ETFs, and the risk, return and diversification profile of the asset class.

   7 lessons · 1 video in the Academy →

What the questions cover

• Categories of alternatives, and investing through funds, co-investment or direct investment
• Fund structures and fee terms: management and performance fees, hurdles, catch-up, waterfalls, clawbacks and high-water marks
• Performance measurement: MOIC, IRR, the effect of leverage, and biases in reported returns
• Private equity categories and exit routes, and the main types of private debt
• Real estate and infrastructure: investment structures, sources of return and diversification
• Farmland, timberland and commodities, including forward pricing, contango and backwardation
• Hedge fund strategies and investment forms, and the basics of digital assets

Key formulas

Multiple of invested capital

$\displaystyle \text{MOIC} = \frac{\text{Realised value} + \text{Unrealised value}}{\text{Invested capital}}$Invested capital is paid-in capital less management fees and fund expenses. MOIC ignores the timing of cash flows; IRR does not.Learn it: Measuring returns: IRR versus MOIC →

GP return with a hard hurdle

$\displaystyle r_{GP} = \max[0,\ p(r - r_h)]$p is the performance fee, r the fund's return for the period and r_h the hurdle rate. Management fees are ignored.Learn it: Compensation: fees, hurdles, catch-ups, clawbacks and waterfalls →

GP return with a catch-up

$\displaystyle r_{GP} = \max[0,\ r_{cu} + p(r - r_h - r_{cu})]$With a full catch-up, r_cu = r_h × p/(1 − p). If the return clears the hurdle plus the catch-up, the GP ends up with p of the whole return.Learn it: Compensation: fees, hurdles, catch-ups, clawbacks and waterfalls →

Hedge fund fees with a high-water mark

$\displaystyle \text{MF} = m \times V_1, \quad \text{IF} = p \times \max[0,\ (V_1 - \text{MF}) - \text{HWM}]$V_1 is year-end value before fees; HWM is the highest earlier value after all fees, or the entry value for a new investor. If the fees are calculated independently, apply p to the gain before the management fee.

Leveraged return

$\displaystyle r_L = \frac{r(V_c + V_b) - V_b r_b}{V_c} = r + \frac{V_b}{V_c}(r - r_b)$V_c is investors' own capital and V_b the amount borrowed at rate r_b. Leverage helps only when the portfolio return exceeds the borrowing rate.Learn it: Leverage: magnifying gains and losses →

Commodity forward price

$\displaystyle F_0(T) = S_0 e^{(r + c - i)T}$r is the risk-free rate, c the cost of carry and i the convenience yield. When i exceeds r + c, forward prices sit below spot (backwardation); otherwise the curve is in contango.Learn it: Commodity pricing: carry, convenience yield and curve shape →

The Alternative Investments formula sheet: the key formulas explained

Common mistakes

• Treating a soft hurdle like a hard one. With a hard hurdle the performance fee applies only to the return above the hurdle; with a soft hurdle, once the hurdle is cleared the fee applies to the whole return, often through a catch-up.
• Using the wrong base for the management fee, or charging the incentive fee on the gross gain when the question says it is calculated net of the management fee (or the reverse).
• Measuring the high-water mark from the fund's peak value before fees. It is the highest value after all fees, and an investor who joins later has their own high-water mark at their entry value.
• Forgetting the interest on borrowed money in a leverage question. Leverage magnifies losses as well as gains, and it lowers the return whenever the portfolio earns less than the borrowing rate.
• Getting contango and backwardation the wrong way round. In contango forward prices are above spot and rolling a long futures position tends to lower returns; backwardation tends to add to them.
• Mixing up survivorship and backfill bias. Survivorship bias comes from failed funds dropping out of a database; backfill bias comes from a successful fund's earlier history being added when it starts reporting. Both overstate index returns.
• Using paid-in capital as the MOIC denominator without first deducting management fees and expenses, or assuming a higher MOIC always means a higher IRR when the holding periods differ.

How to study it

• Fee questions turn on the exact wording. Before calculating, note what the management fee is based on (beginning or year-end assets, committed capital) and whether the incentive fee is net of the management fee or independent of it.
• Write the fee calculation as a short sequence of lines: gross value, management fee, value net of that fee, hurdle or high-water mark, incentive fee, net return. Most wrong answers come from skipping one line.
• Know which way each bias and complication pushes the numbers: survivorship and backfill bias overstate returns, while appraisal-based valuations understate volatility and correlation.
• For the descriptive modules, learn the classifications as lists: private equity categories and exits, private debt types, the four groups of hedge fund strategies, and the types of digital asset. Many questions ask you to name what a scenario describes.
• Link contango and backwardation to the balance between carrying costs and convenience yield, and to what they do to a long investor who rolls futures.

Try 3 Alternative Investments questions

Practise and prove Alternative Investments

The question bank and the mock exams are the practice half of CheapMocks Academy. Try the free sample questions, see the topic weights for the whole exam and the latest Level I pass rates.

Alternative Investments FAQ