In Part One of this four-part series titled “The Importance of Affiliates,” we looked at the need to know new investments and find good ones. Part Two will focus on the ability of affiliates to tell the difference between a good deal and a bad one. For our purposes, the key issue here is whether to deal with an affiliate or a principal in a transaction. We’ll go over why principals always come with performance fees and look at how to know when you’re getting a deal that’s worth your time.
As we’ve discussed in previous articles, you don’t have to deal directly with principals when you’re investing on your own. For instance, you can invest your money in a range of futures markets where many companies with significant futures businesses are set up. Or, you can invest funds in emerging markets, where the growth potential is relatively high but the risk/reward profile is much more uncertain. You can also use multiple asset classes to diversify your portfolio (trending sectors, metals, precious metals, energy, and bond funds) so that you’ll have enough of a mix of high-risk/low-reward investments to meet any financial crisis. The bottom line is that you don’t have to deal with anyone except yourself if you want to be very hands off investor.
But what about future growth opportunities? What should you do when you run out of cash and your liquidity exceeds your current holdings, leaving you with nothing but cash and stocks to work with? The answer is that you should reposition your portfolio so that you’re loaded down with assets that create a cushion for future profits, regardless of how you come about those profits.
Repositioning helps you realize the maximum possible return on your capital while minimizing the risk of capital loss. By creating a safety net, you improve your likelihood of realizing good capital gains while limiting your losses. It’s all about being able to identify growth opportunities using a combination of your existing and new investment holdings. Let’s look at how you can turn those growth opportunities around for your bottom line:
First, when you reposition, you should do it with a view toward expanding your holding in the areas where you have the greatest growth potential. You don’t want to pull all of your equity out of one area and put it into another. Instead, you want to increase your holding in areas where you have a strong underlying driver of value such as the health of the stock market or the outlook for oil and gas prices. By stepping back from the most illiquid investments, you’ll have a much better chance of being able to realize good capital gains.
Second, you need to make sure that you are not allocating capital to new areas where there isn’t enough growth potential to support your own expansion efforts. So, it’s important to understand how your current and new investments fit together. What makes up an area? How do you extract value out of it? How should you group your current and new investments? Allocating capital without answering these questions is like driving down a long stretch of highway without paying any attention to how your car is doing or whether it’s getting stolen.