NISM Series XIX-E · Chapter 2: Types of Investments

L1 · Foundation

Traditional Investments and Where Alternatives Begin

Why alternatives are defined by what they are not, the liquidity test that separates the two worlds, the three-column traditional-alternative-dual classification, and the four traditional instrument families - equity shares, fixed income, derivatives and money market instruments.

25 min read · Worth 1% of the paper · Written from pages 31–49 of the official NISM workbook · Updated 17 September 2026

Traditional Investments and Where Alternatives Begin

2.1 Why alternatives have no tidy definition

Globally, the alternative investment industry EVOLVED OVER TIME, hence there is NO UNIFORM CLASSIFICATION or limitation to what constitutes such assets. They are therefore defined generally by several sources as INVESTMENTS OTHER THAN TRADITIONAL INVESTMENTS.

Investopedia's formulation, quoted in the workbook: "An alternative investment is a financial asset that does not fall into one of the CONVENTIONAL investment categories. Conventional categories include stocks, bonds, and cash."

That is a negative definition, and it is honest about the fact that the boundary moves.

What counts as traditional

Traditional investments - as distinguished from SAVINGS in bank deposits, government schemes, ornamental gold and residential property for living purposes - are confined to the domain of FINANCIAL SECURITIES:

stocks and bonds from the primary and secondary capital market
purchase of general categories of mutual fund units
Exchange Traded Funds (ETFs)

Who they are for: traditional investments cater to GENERAL INVESTORS who seek investment options which provide better returns than mere savings schemes.

Note the three-way distinction being drawn: savings (bank deposits, government schemes, ornamental gold, the house you live in), traditional investments (listed securities and funds), and alternative investments.

What alternatives are for, and for whom

Alternative investments evolved over time to cater to the requirements of SOPHISTICATED INVESTORS - institutional investors managing pools of funds, and High net-worth individual investors who have HIGHER RISK-TAKING CAPABILITY and need MORE SOPHISTICATED AVENUES than traditional investment options.

The bargain: unlike traditional investments, alternative investments are about investing in opportunities that can potentially generate HIGHER RETURNS but entail HIGHER RISK-TAKING as well.

The restriction that follows: given their nature, alternative investments are ONLY MEANT FOR risk-taking sophisticated investors who are either FUND MANAGERS WITH INSTITUTIONAL EXPERIENCE or PORTFOLIO MANAGERS FOR HNIs.

And the purpose, stated precisely: alternative investments are meant to COMPLEMENT traditional investments for such investors, by IMPROVING THEIR RISK-ADJUSTED RETURNS OVER THE LONG TERM.

Read that last sentence carefully. It does not say "generate higher returns" - it says complement and improve risk-adjusted returns. That framing runs through the whole chapter.

Table 2.1 - the three-column classification

Traditional	Alternative	Dual
Public equities - listed stock	Private equity - direct investments in unlisted stock (privately held companies)	Closed ended debt funds with illiquid assets such as real estate exposures
Listed debt securities issued by both listed and unlisted companies	Direct investment in unlisted (rated or unrated) debt securities or loan capital	Exchange traded stable and predictable cash flow instruments such as Security Receipts issued by securitisation companies, Special Purpose Vehicles (SPVs) and Asset Reconstruction Companies (ARCs)
Open ended mutual funds offering equity, debt or balanced exposures to listed debt, money market instruments and listed equity	Direct investments in real estate and infrastructure development Project SPVs	Units issued by Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) offering stable cash flow and rating
Exchange traded simple derivative instruments such as futures and options used to manage portfolio risk on equities	Direct investment in commodities	Mutual funds with alternative or contrarian strategies that entail higher risk taking
Exchange traded funds (ETFs)	Hedge Funds, complex structured products and derivatives such as Collateralised Debt Obligations (CDOs), Over-the-Counter derivatives
	Distressed Asset Funds that finance or acquire companies in financial distress, and Funds that invest in Special Situations such as Mergers and Acquisitions, hostile acquisitions and restructuring

On that last entry, the workbook explains what it means: these are COMPLEX CORPORATE TRANSACTIONS where one company takes OWNERSHIP CONTROL of another company, or goes through a REORGANISATION OF ITS ASSETS AND LIABILITIES due to financial difficulties.

The single test that organises the table

Everything in Table 2.1 turns on one variable, and the workbook says so explicitly:

Column	The defining characteristic
Traditional	Primarily ON-MARKET opportunities whose common feature is LIQUIDITY - nearness to cash - because they can be exited through the market, or by anytime redemption offered by an open ended mutual fund
Alternative	The essential characteristic is ILLIQUIDITY - not readily convertible into cash, either because they are OFF-MARKET investments, or because they are COMPLEX STRUCTURES that do not have a ready market
Dual	Structures that have UNDERLYING ILLIQUID ASSETS but the instruments per se may be LIQUID, as they are either listed on the stock exchanges or redeemable through the mutual fund route with some restrictions

The dual category is the interesting one, and it is where most exam confusion lives. A REIT owns office buildings - about as illiquid an asset as exists - but the REIT unit trades on an exchange. The asset is alternative; the instrument is traditional. Hence "dual".

The footnote reinforces the traditional column's purpose: traditional investments are primarily meant to provide HIGH LIQUIDITY to investors through the capital market trading mechanism. Therefore, listed shares and bonds, units of mutual funds and exchange traded funds fit this requirement very well.

2.2 How traditional investments are classified

Broadly, investments can be classified into FINANCIAL or NON-FINANCIAL investments.

Non-financial investments include real estate, gold, commodities - and these are also called REAL INVESTMENTS.

Financial instruments are essentially CLAIMS ON FUTURE CASH FLOWS.

Two ways to cut financial instruments

First cut - by the nature of the claim on cash flows: there are TWO GENERIC TYPES of financial instruments - DEBT and EQUITY.

Second cut - by transferability of ownership in the secondary market:

	Security form	Non-security form
Examples	Shares, bonds, notes	Fixed deposits, insurance
Transferability	Easily transferable in the secondary markets	Cannot be transferred to any other investor; they do not have secondary markets

And where they trade: security form of financial investments are ACTIVELY TRADED ON BOTH CAPITAL AND MONEY MARKETS.

2.2.1 Equity shares

Equity shares represent OWNERSHIP in a company that entitles its holders a SHARE IN PROFITS and the RIGHT TO VOTE on the company's affairs.

The two defining positions of an equity holder:

Equity shareholders are RESIDUAL OWNERS of the firm's profit AFTER other contractual claims on the firm are satisfied
They have the ULTIMATE CONTROL over how the firm is operated

The two ways they are rewarded: DIVIDEND and CAPITAL APPRECIATION.

Time diversification

Investments in equities have proven TIME DIVERSIFICATION benefits and are considered to be a rewarding long-term investment.

What time diversification means: the notion that fluctuation in investment returns tend to CANCEL OUT THROUGH TIME, thus MORE RISK IS DIVERSIFIED AWAY OVER LONGER HOLDING PERIODS.

And the conclusion that follows: investment in equities offers BETTER RISK-ADJUSTED RETURN IF HELD FOR LONG TIME PERIODS.

Table 2.2 - listed against unlisted equity

Characteristic	Listed Equity	Unlisted Equity
Shareholding structure	Diversified, consisting usually of controlling shareholders (promoters) and their associates, institutional market investors, foreign investors and general public investors	Subscribed by the promoters of the company and their family, who in many cases remain controlling shareholders. Others may include promoter associates, alternative investment funds or high networth investors
Listing	Listed on a recognised stock exchange; available for ON-MARKET trading	Not listed. Available only for OTC trades. Usually, unlisted companies put RESTRICTIONS ON TRANSFERABILITY of their shares through their articles of association
Liquidity	Highly liquid - subject to not being an infrequently traded share	Illiquid, since it can only be traded bilaterally on an OTC basis
Counter-party risk in trading	NO - since the Clearing Corporation is the counterparty	YES
Regulation	Highly regulated	Less regulated
Management control	Depends on shareholding pattern	Usually with the family shareholders
Investment valuation	Derived through MARKET PRICE for retail investments, or LAST TRADED PRICE	Determined through a VALUATION PROCESS

The counter-party risk row explains a great deal. On an exchange the clearing corporation stands between buyer and seller, so neither needs to know or trust the other. In an OTC transfer of unlisted shares there is no such intermediary - which is why these deals carry escrow arrangements, conditions precedent and representations and warranties.

2.2.2 Fixed income securities

Debt instruments, also called fixed income instruments, are CONTRACTS containing a PROMISE TO PAY A STREAM OF CASHFLOWS during the term of the contract to the investors.

They may be TRANSFERABLE - a feature specified in the contract that permits its sale to another investor - or NON-TRANSFERABLE, which prohibits sale to another party.

On the cash flows: generally the promised cashflow of a debt instrument is a PERIODIC PAYMENT, but the parties involved can negotiate ALMOST ANY SORT of cashflow arrangement.

And what else the contract does: a debt contract also establishes the FINANCIAL REQUIREMENTS AND RESTRICTIONS that the borrower must meet, and the RIGHTS OF THE HOLDER of the debt instruments IF THE BORROWER DEFAULTS.

Who issues, and how debt is classified

Debt securities are issued by COMPANIES, MUNICIPALITIES, STATES and SOVEREIGN GOVERNMENTS, to raise money to finance a variety of projects and activities.

Classification by issuer: GOVERNMENT debt securities and CORPORATE debt securities, where the issuer is a non-government entity. Government securities form the LARGEST COMPONENT of the debt market in India as well as the world.

Classification by maturity:

	Maturity
Money market securities	One year or less than one year
Capital market	A place for LONG TERM fund mobilisation

And the premium that arises from the longer horizon: since the investment horizon in the capital market is longer, the UNCERTAINTY ABOUT THE FUTURE CASH FLOWS GOES UP. Investors require extra compensation for the same. It is referred to as "TERM PREMIUM".

2.2.3 Derivatives

Derivatives are financial instruments whose value DEPENDS UPON, or is DERIVED FROM, the value of other, more basic UNDERLYING VARIABLES. These are traded both in the OTC market and on exchanges.

The exchange-traded derivatives in India are FUTURES and OPTIONS.

Instrument	Definition
Futures	Agreements between a buyer and seller to buy or sell the underlying asset at a PREDETERMINED PRICE and QUANTITY on a PREDETERMINED DATE
Options	Contracts that give the HOLDER the RIGHT (BUT NOT THE OBLIGATION) to buy or sell the underlying asset at a predetermined price and in a specified quantity, at or before a predetermined date

The two kinds of option: options that allow the holder the right to BUY the underlying asset are known as "CALL" options; options that allow the holder the right to SELL are known as "PUT" options.

Two terms to fix: the predetermined price at which the asset can be bought or sold by the option holder is the "EXERCISE" or "STRIKE" price, and both futures and option contracts are settled on a predetermined date known as the "EXPIRY" date.

The investment consequence: derivatives have a SHORT SHELF LIFE, and as investments they are primarily meant for investors with a SHORT INVESTMENT HORIZON.

And their reach: exchange-traded derivatives are now available for trading on the ENTIRE SPECTRUM of assets, encompassing EQUITY, DEBT, CURRENCIES and COMMODITIES.

2.2.4 Money market instruments

Money market instruments are used for RAISING AND INVESTING FUNDS for periods ranging from ONE DAY UP TO ONE YEAR.

The purpose of the money market is to enable INSTITUTIONS AND COMPANIES to meet SHORT-TERM FUNDING NEEDS by borrowing and lending FROM EACH OTHER.

The four instruments named: repos and reverse repos, certificates of deposits, treasury bills, and commercial papers.

Their common structure, which is examined: ALL these securities are ISSUED AT A DISCOUNT and REDEEMED AT PAR, and are ZERO COUPON in structure.

And the regulator: the RESERVE BANK OF INDIA regulates the money market segment - not SEBI.

Think of it like this

Alternatives are defined the way "non-vegetarian" is

Nobody can list every non-vegetarian dish in the world, so the category is defined by what it excludes. The workbook does the same: alternative investments are defined generally as investments other than traditional investments, because the industry evolved over time and there is no uniform classification or limitation to what constitutes such assets. The boundary shifts as new instruments appear.

Liquidity is the difference between the vegetable market and the land deal

You can sell tomatoes in an hour at roughly the going rate. Selling a plot of land takes months, needs a specific buyer, and the price you get depends on how badly you need to sell. Traditional investments are on-market opportunities whose common feature is liquidity; the essential characteristic of alternative investments is illiquidity, being off-market or complex structures without a ready market.

The dual category is the flat in a building you cannot sell

Imagine shares in a company whose only asset is an office tower. The tower would take two years to sell; the shares trade in seconds on the exchange. That is exactly what a REIT unit is - underlying illiquid assets, but the instrument per se is liquid because it is listed. That mismatch is the whole reason the workbook needs a third column.

Equity shareholders eat last and decide everything

In a joint family business, the suppliers, the staff and the bank are paid before anyone in the family takes anything home - but it is the family that decides what business to be in. Equity shareholders are residual owners of the firm's profit after other contractual claims are satisfied, and they have the ultimate control over how the firm is operated. Last in the queue, first in the decision.

Time diversification is the monsoon averaged over twenty years

One year's rainfall tells you nothing; the twenty-year average tells you where to farm. Time diversification is exactly this - fluctuation in investment returns tend to cancel out through time, so more risk is diversified away over longer holding periods. That is why equities offer better risk-adjusted return if held for long time periods, and why judging them over one year is meaningless.

The clearing corporation is the escrow agent you never meet

When you buy a listed share you never ask who sold it or whether he will deliver - the clearing corporation is the counterparty, so there is no counter-party risk. Buy unlisted shares and there is nobody in the middle: you must check the seller's title, hold money in escrow and take warranties. That single row in Table 2.2 explains why unlisted deals need lawyers and listed trades do not.

Term premium is the extra rent for the longer lease

A tenant who wants a ten-year lease at a fixed rent pays more than one who signs for eleven months, because the landlord is taking a view on a decade of uncertainty. The workbook says the same of debt: since the investment horizon in the capital market is longer, the uncertainty about future cash flows goes up, and investors require extra compensation - the term premium.

Money market instruments are the discount on the advance cheque

A trader who needs money today accepts Rs 97 for a cheque of Rs 100 payable in three months. He has issued at a discount and will redeem at par, with no interest paid in between - which is precisely the structure of repos, certificates of deposit, treasury bills and commercial papers. All zero coupon, all short, and all regulated by the RBI rather than SEBI.

Key terms in this chapter

Alternative Investment Fund: A privately pooled investment vehicle collecting funds from sophisticated investors for investment in accordance with a defined investment policy for their benefit. "Privately pooled" means pooled from select investors - institutions and HNIs - and not from the general public at large.
Alternative investments: Defined generally as investments other than traditional investments, since the industry evolved over time and there is no uniform classification. Per Investopedia, a financial asset that does not fall into one of the conventional categories of stocks, bonds and cash.
Art and collectibles as an investment: Generate moderate long-term returns with low correlation to equities and bonds, hence good diversification - but are big ticket, non-standard since each work is unique, traded in an unregulated market, provide no income, are relatively illiquid, and require specialised knowledge because of high information asymmetry and adverse selection.
Benefits of alternative investments: Risk diversification beyond traditional avenues; better risk-return trade-off through active investment and monitoring of high-growth opportunities; alpha generation from off-market strategies; growth capital to businesses that cannot attract conventional finance; experienced fund managers generating customised opportunities; and limited scope for customisation of investment terms.
Buyout and leveraged buyout: Control acquisitions, and buyouts done with significant leverage, in which investors typically look to acquire controlling interests of 51 per cent or more of the share capital or voting rights of a target company.
Category III AIF commodity and tax position: Category III AIFs may invest in all commodity derivatives products traded on commodity derivatives exchanges, up to 10 per cent of investable funds in one underlying commodity. Their income is taxed at fund level, requiring the fund to withhold 42.7 per cent of all income on derivatives trading before passing returns to investors.
Commodity Trading Advisors: Managers registered with the National Futures Association in the USA who follow the "managed futures" strategy, deploying systematic or discretionary strategies in commodity, equity and currency futures to benefit from short-term mispricing among asset classes and derivative contracts.
Derivatives: Financial instruments whose value depends upon or is derived from the value of other, more basic underlying variables, traded both OTC and on exchanges. In India the exchange-traded derivatives are futures and options.
Discretionary and non-discretionary portfolio managers: A discretionary portfolio manager individually and independently manages the funds of each investor; a non-discretionary portfolio manager manages funds in accordance with the directions of the investors. Both operate under a written agreement setting out mutual rights, liabilities and obligations.
Distressed securities: Securities of companies in financial distress or near bankruptcy, available at huge discounts but requiring higher skills and greater experience in business valuation. Known as "fallen angels", many funds and institutional investors are prohibited from holding them, and they are popular among hedge fund managers.
DPIIT start-up definition: A business not more than 10 years old that has not recorded turnover of more than Rs 100 crore in any financial year, engaged in innovation, development or improvement of products, or a scalable business model with high potential of employment or wealth generation.
Dual category: Structures with underlying illiquid assets whose instruments are themselves liquid, being either listed on stock exchanges or redeemable through the mutual fund route with some restrictions - such as REIT and InvIT units.
Equity shares: Represent ownership in a company entitling holders to a share in profits and the right to vote on the company's affairs. Equity shareholders are residual owners of profit after other contractual claims are satisfied, and have ultimate control over how the firm is operated. They are rewarded by dividend and capital appreciation.
First-mover returns: High returns resulting from investing early into new asset classes - one of the opportunities asset allocators in institutional investment classes are urged not to miss, alongside improved diversification.
Fixed income securities: Contracts containing a promise to pay a stream of cashflows during the term of the contract. They may be transferable or non-transferable, and also establish the financial requirements and restrictions the borrower must meet and the holder's rights on default.
Fund of funds: AIFs that do not invest directly in investee companies but invest in other AIFs - a practice more common with hedge funds. They may have no specialised theme, relying instead on risk diversification across several thematic funds, and suit offshore AIFs without a permanent establishment in India.
Futures and options: A future is an agreement to buy or sell the underlying at a predetermined price and quantity on a predetermined date. An option gives the holder the right but not the obligation to buy (a call) or sell (a put) at the exercise or strike price, at or before the expiry date.
Hedge funds: Pooled investment vehicles investing in financial assets, complex derivative contracts and currencies, distinguished by investing across asset classes, using complex strategies such as arbitrage and carry trade, and taking both long and short positions with significant leverage at fund level.
Infrastructure fund (AIF definition): An Alternative Investment Fund which invests primarily in unlisted securities or partnership interest or listed debt or securitised debt instruments of investee companies or special purpose vehicles engaged in or formed for operating, developing or holding infrastructure projects.
InvITs: Units issued by entities managing large infrastructure assets with long term contracts ensuring steady and periodic returns with predictable and lower risk. Preferred by low risk taking long-term investors such as pension funds and insurance companies, and listed and tradable, making them akin to traditional assets.
Leveraging at fund level: The fund entity borrowing from market sources to make investments, seeking arbitrage return by using cheaper debt to make higher investment gains. It increases overall investment risk because the fund must repay the debt irrespective of investment gains or losses.
Limitations of alternative investments: Complex fund structuring hard for investors to comprehend; complex contractual terms and tedious documentation requiring constant professional support; less transparency and difficulty assessing underlying risks; complex return determination methodologies; illiquidity from long investment cycles; and failure to satisfy the requirement for regular income.
Listed versus unlisted equity: Listed equity is highly liquid, highly regulated, valued at market or last traded price, and carries no counter-party risk because the clearing corporation is the counterparty. Unlisted equity is illiquid and traded only bilaterally OTC, is less regulated, is valued through a valuation process, and does carry counter-party risk.
Managed portfolios: Investment vehicles pooling money from investors and investing on their behalf - indirect investment. The five solutions available in India are mutual funds, collective investment schemes, portfolio management services, alternative investment funds and specialized investment funds.
Mezzanine capital: Funds provided in a hybrid structure involving the features of both debt and equity capital - one of the forms the wider term "private equity" covers, alongside equity, preference and debt.
Modern portfolio theory turning point: In the 1950s and 1960s modern portfolio theory established the mechanics and advantages of diversification, advocating that risk from alternative investments can be diversified - after which institutional investment strategy began to be evaluated on a portfolio basis.
Money market instruments: Used for raising and investing funds for one day up to one year, enabling institutions and companies to meet short-term funding needs. They comprise repos and reverse repos, certificates of deposit, treasury bills and commercial papers - all issued at a discount, redeemed at par and zero coupon, regulated by the RBI.
Multi-strategy funds: Hedge funds deploying multiple investment strategies within the same fund scheme, giving the benefit of diversification while controlling the pay-out of management fees - in contrast to a fund of funds, where fees are substantially higher because of the additional layer charged by the FoF manager.
Mutual fund: A trust pooling the savings of investors sharing a common financial goal, whose income and capital appreciation are shared by unit holders in proportion to units owned. It is a pass-through intermediary in the true sense, and is not a get-rich-quick or risk-free investment.
Private equity: A generic term for direct investments in companies not listed on a stock exchange - equity capital raised without accessing public equity markets. Venture capital is a type of private equity for early-stage businesses, while private equity predominantly denotes investment in later stage companies with an established business model and track record.
Purpose of alternative investments: To complement traditional investments for sophisticated investors by improving their risk-adjusted returns over the long term - not simply to generate higher returns.
Real investments: Non-financial investments including real estate, gold and commodities.
Registered Investment Adviser: Under the SEBI regulation of 2013, only qualified professionals licensed by SEBI may act as advisers and be paid fees by investors. They must follow a strict code of conduct, advise in investors' best interests and disclose conflicts of interest. Distributors such as mutual fund distributors, share brokers and insurance agents can no longer claim the title.
REITs: Securities entitling holders to the underlying cash flow generated from rent yielding properties, offering exposure to real estate without physically holding the assets. Being liquid due to their listed status, they are sometimes considered traditional or dual assets.
SEBI definition of a hedge fund: An Alternative Investment Fund which employs diverse or complex trading strategies and invests and trades in securities having diverse risks or complex products including listed and unlisted derivatives.
Security and non-security form: Security form investments such as shares, bonds and notes are easily transferable in secondary markets; non-security form investments such as fixed deposits and insurance cannot be transferred and have no secondary markets.
Specialized Investment Fund: A new product line under the SEBI (Mutual Funds) Regulations - sophisticated mutual funds with a minimum required investment of Rs 10 lakh from investors across all investment strategies.
Sunrise sectors: Emerging investment themes around which AIF strategies are being built - artificial intelligence as a subset of machine learning, virtual and artificial reality, green energy and renewables, sustainability and ecological conservation, and social justice and empowerment.
Systematic and discretionary strategies: Systematic strategies use complex algorithms to track price movement across asset classes and geographies and take futures exposures against pre-defined objectives; discretionary strategies rely on the judgement and expertise of the investment manager.
Term premium: The extra compensation investors require because the longer investment horizon of the capital market means greater uncertainty about future cash flows, compared with money market securities of one year or less.
The liquidity test: Traditional investments are primarily on-market opportunities whose common feature is liquidity; the essential characteristic of alternative investments is illiquidity, being off-market or complex structures without a ready market.
The portfolio argument for alternatives: Evaluated standalone, many alternative assets have insufficiently reliable income and even risk of capital loss; but held in a portfolio, these relatively high-risk investments can lower the total risk of the portfolio because of their ability to provide improved diversification.
Time diversification: The notion that fluctuation in investment returns tend to cancel out through time, so more risk is diversified away over longer holding periods - which is why equities offer better risk-adjusted return if held for long time periods.
Traditional investments: Confined to financial securities - stocks and bonds from the primary and secondary capital market, general categories of mutual fund units, and Exchange Traded Funds. They cater to general investors seeking better returns than mere savings schemes.
Venture capital investing: Direct investment in infant companies - start-ups or early stage businesses - concerned with new products, new services, technology or intellectual property based activities or a new business model. Considered highly risky because such businesses are susceptible to high mortality and their potential is difficult to assess.
Venture debt: Specialised lending to start-ups that have successfully raised institutional venture capital equity. It carries a higher rate of interest than normal commercial loans, is typically unsecured, and is usually repaid in 2 to 3 years from subsequent equity rounds. The AIF Regulations classify venture debt funds as part of venture capital funds, not separately.

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Original explanatory writing based on the official NISM workbook for Series XIX-E, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

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