Question

1. Discuss the trade-off of liquidity, diversification, and returns potential offered by private equity, hedge funds, etc. as alternatives to the traditional asset classes of public equity, bonds, and money market instruments.

Answer 1

Trade-off liquidity.

Liquidity involves the trade-off between the price at which an asset can be sold, and how quickly it can be sold. In a liquid market, the trade-off is mild: one can sell quickly without having to accept a significantly lower price. In a relatively illiquid market, an asset must be discounted in order to sell quickly.

Diversification.

Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio. ... The rationale behind this technique is that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns and lower the risk of any individual holding or security.

Returns potential offered by private equity

For high-net-worth individuals and institutional investors, private equity is an attractive investment option because of its potential for high returns. ... However, the venture capital index returned an annualized 26.1% over the last 15 years, while private equity returned an annualized 12%

Hedge funds

Hedging against investment risk means strategically using financial instruments or market strategies to offset the risk of any adverse price movements. Put another way, investors hedge one investment by making a trade in another.