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How’s it going, everyone? Today, I want to teach you how to underwrite investments for your fund!
Click here to watch the full video!
We, as fund managers, are trying to find alpha: the area between relatively low risk and relatively high reward! How do we achieve that?
The Goal: Finding Alpha
As fund managers, our primary objective is to identify alpha—those investment opportunities where the potential reward outweighs the associated risks. But how do we effectively achieve this balance?
Example: Bringing in the Right Partners
Let’s consider a practical example. Imagine my friend Joe and I start a company. For potential investors, the risk and reward are both moderate—nothing too exciting.
Now, suppose we bring in a new business partner, someone like Elon Musk. From an investor’s perspective, this changes everything. The perceived risk decreases, and the potential reward skyrockets. This is a classic case of creating asymmetrical risk through strategic partnerships—a key way to find alpha in your investments.
Assessing and Managing Risk
Another critical aspect of underwriting investments is understanding the risks you face and how to manage them effectively. Let’s break it down:
Controllable factors:
- Rent levels
- Purchase price
- Debt structure
Uncontrollable factors:
- Interest rates
- Economic conditions
- Market fluctuations
The next step is to evaluate how sensitive your investment is to these risks. For instance, if interest rates were to increase by 0.5%, how would that impact your returns? Conversely, what if rates dropped by 0.25%? By considering various scenarios—worst-case, base-case, and best-case—you can better understand the potential outcomes.
Once you’ve identified the risks and their impact, focus on controlling the elements you can manage. By optimizing these factors, you position your fund to achieve the best possible returns.
A Quick Recap…
- Identify Risks: Distinguish between what you can and cannot control.
- Manage Sensitivity: Assess how each risk affects your potential outcomes.
- Optimize Returns: Focus on creating best-case scenarios by managing controllable risks.
As Ray Dalio wisely pointed out, you can diversify away 80% of the risk in any investment without sacrificing the upside potential.
Conclusion
Underwriting investments for your fund is all about balancing risk and reward. By bringing in the right partners and focusing on what you can control, you can find alpha and set your fund up for success.
Click here to watch the full video!
Or, read more free content on the Fund Launch Blog! And as always, visit Fund Launch if you’re ready to start your own investment fund!
Thanks for stopping by,
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DISCLAIMER: This content is for educational and informational purposes only. It is not to be taken as tax, financial, or legal advice. You should always consult a legal professional before taking action. Furthermore, this is not a recommendation to buy or sell any security. The content is solely just the opinion of the authors.
