Alternative Investments

CFA® Level I, published weight 7–10%. Private capital, real estate, natural resources, hedge funds, digital assets.

What the outline covers

Alternative Investment Features, Methods, and Structures
Alternative Investment Performance and Returns
Investments in Private Capital: Equity and Debt
Real Estate and Infrastructure
Natural Resources
Hedge Funds
Introduction to Digital Assets

Sample questions

These 5 questions are free in the app too. Try each one before opening the answer.

Question 1

A hedge fund charges a 2% management fee on beginning assets and a 20% incentive fee on returns net of the management fee. Beginning assets are $100m and the gross return is 15%. The total fee is closest to:

AUM $100m · gross return 15% · 2% mgmt · 20% incentive, net of mgmt

A. $4.60m
B. $4.80m
C. $5.00m
D. $5.60m

Show the answer

A. Management fee = $2m. Gross gain = $15m; net of management fee = $13m. Incentive = 20% × 13 = $2.6m. Total = $4.6m.

Reading: Alternative Investments — Performance and Returns, LOS 2.c

Question 2

A property generates net operating income of $450,000 and comparable properties transact at a capitalisation rate of 6%. The estimated value is:

NOI $450,000 · cap rate 6%

A. $2,700,000
B. $7,500,000
C. $4,500,000
D. $27,000

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B. Value = NOI / cap rate = 450,000 / 0.06 = $7,500,000. Direct capitalisation assumes NOI is constant in perpetuity.

Reading: Alternative Investments — Real Estate and Infrastructure, LOS 4.c

Question 3

The J-curve effect in private equity refers to:

A. Rising fees over a fund’s life
B. Early negative returns followed by later positive returns
C. The shape of the capital call schedule
D. Persistent underperformance versus public markets

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B. Fees and early write-downs are recognised before exits generate gains, so reported returns are negative early and recover later.

Reading: Alternative Investments — Investments in Private Capital, LOS 3.b

Question 4

An illiquid strategy reports a Sharpe ratio far above comparable liquid strategies. The most likely explanation is:

A. Genuinely superior risk-adjusted skill
B. Return smoothing from appraisal-based valuation
C. A higher risk-free rate assumption
D. Survivorship bias in the risk-free rate

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B. Stale and appraisal-based marks smooth reported returns, understating volatility and inflating the Sharpe ratio. It is a measurement artefact.

Reading: Alternative Investments — Performance and Returns, LOS 2.d

Question 5

Compared with a direct investment in a hedge fund, a fund-of-funds most likely offers:

A. Lower total fees and higher manager concentration
B. Higher total fees and greater diversification
C. Identical fees and identical diversification
D. Lower fees and greater diversification

Show the answer

B. A fund-of-funds adds a second layer of fees but provides diversification across managers and access to closed funds.

Reading: Alternative Investments — Hedge Funds, LOS 6.b

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