1.2 Distinction between Alternative Investments from Traditional Investments

The first method of distinguishing alternative investments from traditional ones is by exclusion. This method states that traditional investments are long-only, publicly traded investments, simply stocks, bonds, and cash. All others excluded from these three are considered Alternative investments.

Under the exclusion method alternative investments are without limit and can include any other form of investment.

The key features that distinguish alternative investments from traditional investments include the following:

The following features distinguish alternative investments (AIs) from the traditional investments (TIs).

1. Lower Liquidity – due to their lack of standard markets and limited activities on both sides of the deal, alternative investments are considered illiquid. Liquidity in alternative investments has to aspects: liquidity provisions of the fund and liquidity of the underlying fund’s investments. They are therefore associated with a liquidity premium and higher returns.
2. Low level of regulation but unique legal and tax considerations – AIs have less regulation framework compared to the traditional investments. They however face a unique legal and tax consideration.
3. Lower transparency – Certain Alternative Investments lacks an efficient market mechanism and may subject their valuation to speculations, creating uncertainties. Risks of AIs increase due to absence of ready valuation information. Limited and potentially problematic historical risk and return data.
4. High fees (Due diligence costs) – Costs associated with researching and monitoring alternatives can be high. Specialized expertise and specific business skills are often required. These markets frequently lack transparency, making information difficult to obtain.
5. Difficult performance evaluation – The lack of transparency and unique features of many strategies make it difficult to identify appropriate valuation benchmarks.
6. Diversification of revenues – Alternatives generally have low correlation with and offer significant diversification to traditional investments.
7. Lower diversification of managers and investments within alternative investments portfolio – Mainly because of large size of investments.
8. Use of Leverage – Alternatives are more likely to use more leverage than the traditional investments.
9. Management strategies – Alternatives almost always employ active management.
10. Restrictions on fund redemptions – withdrawal are prohibited mostly using lock time and other restrictions on exit for AIs.
11. Narrow manager specialization – Due to unique features and transparency issues, managers must take longer time evaluating and managing alternatives.