CFA Level I Exam · Alternative Investment Features, Methods, and Structures

Investment Methods and Structures in Alternative Investments

Updated 7 October 2026 · Fact-checked

Investors reach alternatives by direct investment, co-investment, fund investment or fund of funds. Most funds are limited partnerships: the general partner manages and the limited partners supply capital with limited liability. Fees are a management fee plus carried interest, often subject to a hurdle rate, with a waterfall setting distribution order.

Understand Investment Methods and Structures

Alternative investments are usually bought in one of four ways. The method decides how much control you get, how much you pay in fees and how much work you must do yourself.

Direct investment means you buy the asset yourself, such as a building, a private company stake or a wind farm. You control the choice and avoid a manager's fees. But you need expertise, large capital and you carry concentrated risk. Few investors can diversify this way.

Fund investment means you commit capital to a pooled vehicle run by a manager. You get diversification, professional skill and a smaller minimum ticket, but you pay fees and give up control over each deal. Co-investment means you invest alongside a fund in a specific deal, usually with little or no fee or carry. It needs more skill and speed, and the fund manager decides whether to offer it. A fund of funds invests in several funds for you. It gives access, diversification and manager selection, but adds a second layer of fees.

Many private funds use a limited partnership. The general partner (GP) runs the fund, makes the investment decisions and has unlimited liability. The limited partners (LPs) supply most of the capital, have no role in management and are liable only up to what they committed. The rules sit in the fund's limited partnership agreement. LPs commit capital, and the GP draws it down when needed.

The GP is paid in two main ways. The management fee is a percentage of committed or invested capital, or of net asset value, charged whatever the performance. Carried interest (the incentive fee or performance fee) is a share of profits, often 20%. A hurdle rate is a minimum return that must be reached before the GP earns carry. A hard hurdle pays carry only on profits above the hurdle. A soft hurdle pays carry on all profits once the hurdle is cleared. A clawback makes the GP return excess carry paid early if later losses mean it was overpaid.

Key formulas to remember

Management fee: Management fee = fee rate × fee base; The base may be committed capital, invested capital or NAV. Read which one the question gives. It is charged regardless of performance.
Carried interest without a hurdle: Carry = carry rate × profit; Profit is usually measured after the management fee if the question says so.
Hard hurdle carry: Carry = carry rate × (profit − hurdle amount); Carry applies only to the excess over the hurdle. Hurdle amount = hurdle rate × capital.
Soft hurdle carry: If profit > hurdle amount: Carry = carry rate × total profit; otherwise 0; Once the hurdle is cleared, the GP earns carry on all profit.
Net return to LPs: LP profit = profit − management fee − carry; Compute fees in the order the question states.

How to solve Investment Methods and Structures questions

Most questions are either conceptual (which method or party fits) or a short fee calculation. Use this order.

1Identify what is asked: a method (direct, co-investment, fund, fund of funds), a party's role, or a fee amount.
2For method questions, list the clue: control, cost, diversification, expertise or access. Match it to the method.
3For role questions, ask who manages and who funds. GP manages with unlimited liability. LPs fund with liability limited to their commitment.
4For fee questions, write down the fee base, the rates and the hurdle type.
5Compute the management fee first, then profit after fee if the question says so.
6Test the hurdle. Hard hurdle: carry only on the excess. Soft hurdle: carry on all profit if cleared.
7Subtract fees and carry to get the LP result, then check which of the three options matches.

Quickest way: Clue-and-fee shortcut

When to use it: Use it when you have about 90 seconds and the options are close.

Scan for keywords: 'alongside' means co-investment, 'invests in other funds' means fund of funds, 'unlimited liability' means GP.
For numbers, compute only the amounts you need: fee, hurdle amount, carry.
Decide hard or soft before calculating. Soft hurdle with profit above the hurdle means carry on everything.
Eliminate options that ignore the hurdle or use the wrong base.
Options are listed smallest to largest, so check whether your answer sits at the extreme.

Common mistakes in Investment Methods and Structures

Treating co-investment as the same as fund investment.
Both involve a manager and other investors.
Fix: Co-investment is a separate, deal-specific stake alongside the fund, usually with lower or no fees. Fund investment is a commitment to the whole pool.
Saying LPs manage the fund or have unlimited liability.
The words 'partner' and 'general' are confused.
Fix: The GP manages and has unlimited liability. LPs are passive and liable only up to their commitment.
Applying carry to all profit under a hard hurdle.
Students forget the difference between hard and soft.
Fix: Hard hurdle: carry only on profit above the hurdle. Soft hurdle: carry on all profit once the hurdle is beaten.
Using the wrong base for the management fee.
Committed capital, invested capital and NAV look alike.
Fix: Underline the base in the stem and multiply the fee rate by exactly that figure.
Forgetting the extra fee layer in a fund of funds.
Students focus on diversification benefits.
Fix: Remember the investor pays the fund of funds manager and also the fees of the underlying funds.
Thinking the management fee depends on performance.
It is mixed up with carry.
Fix: Management fee is charged regardless of results. Carry rewards performance.

Worked examples

Example 1

A fund has €200 million of committed capital. It charges a 2% management fee on committed capital and 20% carried interest with a hard hurdle of 8% on committed capital. The fund earns a profit of €50 million before fees. For this question only, carry is calculated on profit before the management fee. This overrides the usual convention of measuring profit after the fee, so follow the stem. What is the carried interest? (A) €6.8 million (B) €9.2 million (C) €10.0 million

Show the solution

Hurdle amount = 8% × €200 million = €16 million.
Hard hurdle: carry applies only to the excess, so excess = €50 million − €16 million = €34 million.
Carry = 20% × €34 million = €6.8 million.
The management fee (2% × €200 million = €4 million) is not needed, because the stem says carry is calculated on profit before the management fee.
Option B (€9.2 million) is a trap: 20% × (€50 million − €4 million). It deducts the fee, which the stem says not to do, and it ignores the hurdle.
Option C (€10.0 million) is a trap: 20% × the full €50 million, which ignores the hurdle.

Answer: (A) €6.8 million

Example 2

A fund has €100 million of committed capital, a 2% management fee on committed capital, 20% carry and a soft hurdle of 6% on committed capital. Profit before fees is €10 million. For this question only, carry is calculated on profit before the management fee, which overrides the usual after-fee convention. What is the carried interest? (A) €0.8 million (B) €1.6 million (C) €2.0 million

Show the solution

Hurdle amount = 6% × €100 million = €6 million.
Profit of €10 million is above €6 million, so the soft hurdle is cleared.
Soft hurdle: carry applies to all profit.
Carry = 20% × €10 million = €2.0 million.
Option A (€0.8 million) is a trap: it treats the hurdle as hard. 20% × (€10 million − €6 million) = €0.8 million.
Option B (€1.6 million) is a trap: it deducts the €2 million management fee first. 20% × (€10 million − €2 million) = €1.6 million, which goes against the stem.

Answer: (C) €2.0 million

Exam tips

Know the four methods by one-line clues: control (direct), alongside (co-invest), pooled (fund), layered (fund of funds).
Always decide hard or soft hurdle before any arithmetic. It is the most common trap.
Check the fee base in the stem: committed capital, invested capital or NAV.
Remember who has unlimited liability: the GP only.
Fee questions are short. Compute only what the options require and move on.

Practice questions from Alternative Investment Features, Methods, and Structures

Investment Methods and Structures: frequently asked questions

What is the difference between co-investment and fund investment?

Fund investment is a commitment to a pooled vehicle that invests in many deals. Co-investment is a direct stake in one deal alongside the fund. Co-investment usually carries lower or no fees but needs more skill and speed.

What are the roles of the general partner and limited partners?

The GP manages the fund, makes investment decisions and has unlimited liability. LPs provide most of the capital, take no part in management and are liable only up to their commitment.

How does a fund of funds work?

It pools investor money and invests it in several underlying funds. You gain access, diversification and manager selection. You also pay two layers of fees: the fund of funds manager and the underlying fund managers.

What is the difference between a hard and a soft hurdle rate?

A hurdle rate is the minimum return before the GP earns carry. With a hard hurdle, carry is paid only on profit above the hurdle. With a soft hurdle, once the hurdle is cleared, carry is paid on all profit.