Investment methods: fund, co-investment, direct

Learning Outcome Statement

Compare direct investment, co-investment, and fund investment methods for alternative investments.

On the exam: The stem gives the ownership route, capital basis, fees, liquidity, and market or appraisal value, then asks for a method comparison or net multiple in an MCQ, matrix, fill-in-the-blank, or ordered-response question.

You are choosing how an alternative asset reaches your portfolio. The route changes how close you are to the asset, how much the manager decides, and how easily you can exit.

The route determines how close decision-making sits to you. It also determines whether your exposure follows the asset, a sponsor-led deal, or a manager-selected fund. Direct ownership leaves selection and management with you; a co-investor relies on the lead sponsor; a fund investor relies on its manager. Keep those roles separate when identifying who bears asset-level exposure.

At exit, gross proceeds, $G$, are sale cash before listed fees. Transaction costs, $C$, are paid at exit. Management fees, $M$, and performance fees, $P$, reduce investor cash. Net proceeds, $N$, are what remains.

$$ N=G-C-M-P $$

For a multiple-based return, invested capital, $I$, is the amount called and deployed, and committed capital, $K$, is the amount promised. Use $I$ for an invested-capital comparison and $K$ only when the question requests a committed-capital comparison.

$$ \text{Net multiple}=\frac{N}{I}\quad\text{or}\quad\frac{N}{K} $$

Every listed fee lowers $N$. Switching from $I$ to $K$ changes the multiple without changing cash received. This is a multiple-based return.

The ownership routes can be pictured as follows.

🔒Ownership routes from investor to alternative asset

Liquidity asks what event returns cash to you. A quoted or estimated value does not automatically create an immediate exit. For direct ownership, cash generally arrives when you sell the asset. A co-investment depends on a deal exit or transfer, while a fund investor follows the fund terms or transfers the interest. Treat the value signal and the exit route as distinct clues.

Market value reflects a current transaction value. Appraisal value is an estimate that may be stale. A reported fund value can lag a changing market when appraisals update slowly.

Read the map left to right for control and bottom to top for liquidity. Its positions are qualitative, not fee or return measurements.

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Fee drag follows the capital base and the fee type. The method with the most control is not automatically the method with the highest net cash. First identify the capital amount used to calculate each fee, then subtract only the stated charges. A transaction cost at exit differs from recurring management fees and profit-linked performance fees, so the same gross proceeds can produce different investor cash.

The co-investment management fee uses invested capital. The fund management fee uses committed capital, and its performance fee uses positive profit before that fee. If a fee is not stated for a method, do not add it. Then align the comparison itself: use the same gross or net treatment, borrowing treatment, and capital denominator for every method. A mismatch in any one basis can make a numerical ranking misleading even when each calculation is arithmetically correct.

The worked case is net and unlevered, then shows both fund denominators. Read the inputs before calculating: each method has a one-year holding period, market value at exit, and no borrowing. The fund reports both promised and deployed capital, so its final return can be shown on either denominator without changing the proceeds received.

Worked example

You are handed a direct investment, a co-investment, and a fund investment with the same one-year holding period. Exit values are market values. All methods are unlevered, and the fund reports both committed and invested capital. You need net proceeds and a comparable invested-capital multiple.

Transaction costs are paid at exit. The performance fee applies to positive profit before that fee. Only stated fees are subtracted. The fund starts with USD 96 million of gross proceeds; its management charge is based on committed capital, and its performance charge is based on profit before that charge. These deductions explain the waterfall and leave the net amount used in the fund multiples.

The bar series shows gross fund proceeds, the management-fee deduction, the performance-fee deduction, and net proceeds.

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1. For direct investment, subtract the stated exit cost from gross proceeds. This gives $N=120-2=118.00$ and the invested-basis multiple $\frac{N}{I}=\frac{118.00}{100}=1.180$.

2. For co-investment, charge the management fee on invested capital. The fee is $M=100\times0.005=0.50$, profit before the performance fee is $120-100-1-0.50=18.50$, and the performance fee is $P=18.50\times0.2=3.70$. Net proceeds are $N=120-1-0.50-3.70=114.80$, giving $\frac{N}{I}=\frac{114.80}{100}=1.148$.

3. For fund investment, charge the management fee on committed capital, then use invested capital for profit. The fee is $M=100\times0.02=2.00$, profit before the performance fee is $96-80=16.00$, and the performance fee is $P=16\times0.2=3.20$. Net proceeds are $N=96-2.00-3.20=90.80$. The invested-basis multiple is $\frac{N}{I}=\frac{90.80}{80}=1.135$, while the committed-basis multiple is $\frac{N}{K}=\frac{90.80}{100}=0.908$.

Compare these results only after confirming the basis in the final column. The invested-capital multiples use capital actually deployed, while the committed-capital figure uses the full promised amount. Net proceeds remain the same under either denominator; only the reported multiple changes. This distinction is especially useful when a fund leaves part of its commitment uncalled.

Direct has the highest invested-basis multiple in this case. The fund’s committed-basis result is lower because its denominator includes capital not deployed.

Changed condition

Keep every input except the fund’s gross proceeds unchanged. The lower exit changes the fund comparison as follows.

Net proceeds and the invested-basis multiple should both fall. The performance fee also falls because lower gross proceeds create less profit before performance, cushioning the decline. Before reading on, calculate the lower-exit invested-basis multiple.

Common error

You may treat the fund’s committed capital as if the fund had invested all of it, then compare the fund’s net proceeds with the direct investment’s USD 100 million. That feels right because the commitment is the headline amount and appears beside the direct amount. The separate USD 80 million invested amount shows what the fund actually put to work. Match the denominator to the stated basis.

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Revision snapshot

Direct investment gives the investor direct ownership and control of the asset. Co-investment gives the investor a stake in a specific deal alongside a lead sponsor. Fund investment gives the investor a fund interest while the manager selects and manages the assets.

Committed capital is the promised amount. Invested capital is the amount called and deployed.

$$ N=G-C-M-P $$

Net proceeds equal gross proceeds less transaction costs, management fees, and performance fees. Compare returns on the same basis: gross or net, levered or unlevered, and committed or invested capital. Market value reflects a current transaction value. Appraisal value is an estimate that may be stale. The trap is treating committed capital as if it were all invested.