After building a foundation of key terminology and mastering the differences between traditional and alternative investments, the next step is to dive deeper into the asset classes that form the building blocks of alternative investing.

The Importance of Alternative Asset Classes

Alternative asset classes provide diverse strategies and opportunities beyond traditional investments like stocks and bonds. These assets can enhance portfolio diversification, reduce risk, and potentially deliver higher returns. Let’s explore some of the primary alternative asset classes and their unique contributions to building strong, resilient portfolios.

Hedge Funds: A Diversification Tool

What are Hedge Funds?

Hedge funds are pooled investment funds that trade relatively liquid assets and can be used as a diversification tool. These funds employ various strategies to generate returns while mitigating downside risk, often investing in public markets and utilizing alternative trading techniques such as short-selling. By leveraging different financial instruments or market strategies, hedge funds can offset risks and provide downside protection.

Example Strategies:

• Long/Short Equity: This strategy involves buying and selling stocks based on fundamental valuations. For instance, a long position in a large bank and a short position in a small bank can lead to profits if the large bank outperforms the small bank.
• Event-driven: These strategies capitalize on corporate events, such as mergers. They can include special situations and opportunistic sub-strategies.
• Multi-Strategy Hedge Funds: These funds apply various strategies to smooth returns, reduce volatility, and decrease risks associated with single asset classes or strategies.

Key Insights:

Hedge funds primarily rely on market inefficiencies to generate returns, focusing on idiosyncratic risk, which is the inherent risk of investing in a specific asset.

Private Equity: Investing in Private Companies

What is Private Equity?

Private equity (PE) refers to investments in private, non-listed companies with the aim of bringing about significant changes. PE investments span different stages of a company’s life cycle, from early-stage venture capital to later-stage growth investing and corporate finance.

Advantages of Private Equity:

• Company-specific selection and intensive due diligence
• Active participation in driving business growth
• Alignment of interests with company management
• Extended holding periods

Ways to Gain Private Equity Exposure:

• Direct PE Fund: Managed by a private equity firm to invest in underlying companies, offering direct access to general friends (GPs) and diversification across strategies.
• PE Fund of Funds: Pools capital to invest in several direct private equity funds and co-investments, providing diversification with smaller investment requirements.
• Direct Co-Investment Fund: Executes minority investments directly in companies alongside lead sponsors, offering greater diversification and potential for higher returns and fee savings.

Private Credit: Non-Traditional Debt Investments

What is Private Credit?

Private credit, or direct or private lending, involves financing debt to private companies. These investments often rely on an illiquidity premium and complexity premium to drive excess returns.

Benefits of Private Credit:

• Diversification of an investor’s capital base
• Yield enhancement to a portfolio
• Opportunities to capitalize on cyclical market changes
• Attractive risk premia generated by illiquidity and complexity
• Decreased risk on enhanced yields due to negotiated structural protections

Example Strategies:

• Direct Lending: Provides debt financing to high-quality, private companies focusing on income.
• Opportunistic Debt: Allocates capital in various securities and markets based on perceived value, often benefiting from complexity or illiquidity.
• Special Situations/Distressed Debt Investing: Invests in the existing debt of financially distressed entities.

This content represents the views of Friends Wealth Management and is intended for informational purposes only.