We can beat the market instead of being it

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Weaknesses of Traditional Diversification

Charlie Munger pointed out that many think that owning 100 stocks makes them more professional than owning just four or five.

\ "I think this is absolute madness," Munger said.

\ "I think it's easier to find five than 100," said the 97-year-old investor. "Those who push for diversification, I call it 'diworsification.' I'm more comfortable owning two or three stocks I understand and have an advantage in.”

\ The objective is not to follow the market but to have a concentrated portfolio of assets with low correlation.

Traditional Alternatives (Private Equity & Credit)

Private equity and private credit are two of the most critical alternative investments that promise good opportunities for capital growth and income. Their benefits come with considerable risks, which must be managed carefully. Investors must take a strategic approach that will minimize risks and maximize returns.

Private Equity Risk (i.e. Traditional Buyouts)

1. Liquidity risksome text

• PE investments are long-term, usually requiring 7–10+ years for returns.

• Limited exit opportunities before a liquidity event (e.g., IPO or sale).

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1. Valuation Risksome text

• Valuations are based on internal models, not market prices hence errors.

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1. Execution Risksome text

• Portfolio companies may fail to grow or implement operational improvements.

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1. Exit Risksome text

• Market conditions could delay profitable exits and returns (i.e. Covid pandemic)

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1. Concentration Risksome text

• Overexposure to certain industries, areas, or development stages can increase losses.

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Managing Risks in Private Equity Strategies

1. Detailed Analysissome text

• Evaluate the company's financials (ideally in a downside scenario), market position, and growth prospects.

• Review the experience and track record of the PE fund manager.

• Know leverage in deals to keep it manageable.

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1. Diversificationsome text

• Diversify investments by industry, geography, and stage (growth equity, buyouts, etc.).

• Avoid overconcentration in high-risk sectors like technology or startups.

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1. Active Portfolio Managementsome text

• Collaborate with portfolio companies on value-creation strategies including operational efficiencies and market expansion.

• Ensure board representation or rights to oversee key business decisions.

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1. Exit Strategy Planningsome text

• Identify exit strategies, such as IPOs, strategic sales, or recapitalization.

• Monitor market conditions to time liquidity events optimally.

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1. Valuation Focussome text

• Never overpay for an asset by using conservative valuation metrics.
• Stress-test downside scenarios to estimate investment resilience.

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Private Credit Risks

1. Default Risksome text

• There are also possible losses resulting from the default of debtors.

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1. Liquidity Risksome text

• Private credit loans are normally illiquid and thus very difficult to sell (going to a secondary market will take time and require a potential haircut)

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1. Interest rate risksome text

• Higher rates affect fixed loans, and lower rates could reduce floating returns.

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1. Economic Vulnerabilitysome text

• Macroeconomic downturns can raise default rates, especially for riskier borrowers.

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1. Covenant Risksome text

• Covenant-lite loans can weaken lender protections.

Strategies for Risk Management in Private Credit

1. Borrower Analysissome text

• Know the borrower's industry and economic sensitivity.

• Assess the borrower's credit, including cash flow, debt, and collateral.

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1. Portfolio Diversificationsome text

• Diversify concentration risk by lending to a mix of borrowers across sectors and geographies.

• Balance exposure between senior secured loans (lower risk) and mezzanine debt (higher risk, higher return).

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1. Loan Structuringsome text

• Focus on secured loans with solid collateral and enforceable covenants.

• Include defensive measures, such as minimum debt-service coverage ratios.

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1. Continuous Monitoringsome text

• Borrowers must provide regular financial reports to monitor performance and compliance.

• Be proactive in restructuring or renegotiating terms during financial difficulties.

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1. Interest Rate Controlsome text

• Hedge interest rate exposure using derivatives, mainly for floating-rate loans.
• Analyze how interest rate changes affect fixed and floating-rate debt portfolios.

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Methods of Diversification in Cryptocurrencies ("Non-Traditional Alternatives")

1. Known Asset Classessome text

• Cryptocurrencies: Native coins like Bitcoin (BTC) or Ethereum (ETH).

• DeFi Tokens: Tokens of decentralized finance platforms (e.g., Uniswap, Aave).

• Stablecoins: Pegged to fiat for reduced volatility (e.g., USDT, USDC).

• NFT and Metaverse Tokens: Related to digital art, collectibles, and virtual worlds (e.g., Decentraland, Axie Infinity).

• Utility Tokens: Provide dedicated blockchain services (e.g., Chainlink, Filecoin).

• Layer-2 Solutions: Increasing blockchain scalability (e.g., Polygon, Arbitrum).

• Web3 Tokens: Powering decentralized internet and storage (e.g., Helium, The Graph).

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1. Select platforms using various blockchains.some textsome text

• Diversify across blockchains like Ethereum, Binance Smart Chain, Solana, Cardano, and Avalanche.

• Reduces reliance on one ecosystem and mitigates risks of protocol-specific failures.

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1. Allocate by Risk Appetitesome text

• Conservative: Focus on established cryptocurrencies and stablecoins.

• Balanced: Add mid-cap altcoins and DeFi.

• Aggressive: Add small-cap and emerging projects with high growth

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1. Geographic and Industry Diversificationsome text

• Invest in projects with global appeal or regional focus.

• Cover sectors like finance (Ripple, Stellar), gaming (Enjin, Gala), or supply chain (VeChain).

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1. Diversify Revenue Streamssome text

• Stake, yield farm, liquidity pool, or operate a node to earn passive income.

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Diversifying Based on Your Risk and Investment Timeline

1. Conservative Portfolio (Low Risk, Stable Long-Term)some textsome text

• BTC 40%

• Ethereum (ETH): 30%

• Stablecoins (USDT, USDC): 20%

• Layer-2 Token (Polygon): 10%

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1. Moderate Risk Balanced Portfolio for Growthsome text

• Bitcoin (BTC): 30%

• Ethereum (ETH): 25%

• Layer-1 Altcoins (Solana, Cardano): 20%

• DeFi Tokens (Uniswap, Aave): 15%

• Stablecoins (USDT, USDC): 10%

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1. Aggressive Portfolio (High Risk, High Reward)some textsome text

• Ethereum (ETH): 20%
• Layer-1 Altcoins (Avalanche, Fantom): 20%
• NFT/Metaverse Tokens: 20%
• Small-Cap Altcoins: 20% (Projects like Render, Arbitrum)
• DeFi Tokens (Curve, PancakeSwap): 10%
• Stablecoins (USDT): 10%

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Risk Hedging

Hedging risk in cryptocurrency and altcoins involves strategies to curtail losses while still holding onto gain potential. Here are the effective hedging approaches:

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1. Diversify Your Investmentssome text

   • Core Cryptocurrencies: Invest heavily in stable coins like Bitcoin (BTC) and Ethereum (ETH), as they are less volatile than smaller altcoins.

   • Invest in various altcoin categories (e.g., DeFi, gaming, infrastructure) to minimize dependence on a single sector.

   • Hold stablecoins (e.g., USDT, USDC) to decrease portfolio volatility and ensure liquidity.

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2. Hedge with Stablecoinssome text

   • Volatility Buffer: Stablecoins help maintain stability during downturns since they are pegged to fiat.

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3. Yield Opportunitiessome text

   • Stake or lend stablecoins to generate passive income during market lulls (watch out for potential counterparty risk)

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4. Use Dollar-Cost Averaging (DCA)some textsome text

   • Invest in fixed amounts at regular intervals, rather than in a lump sum, to temper price volatility.

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5. Use Stop-Loss Orderssome text

   • Automatically liquidate assets if prices drop below a predefined threshold to prevent major losses.

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6. Hedge with inverse products or derivatives.some textsome text

   • Short Selling: Profit from price drops via futures or margin trading.

   • Use cryptocurrency options to hedge against losses while keeping upside potential.

   • Inverse ETFs: If tokens have available ETFs (e.g., Bitcoin), they can serve as a hedge.

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7. Invest in Low-Correlation Assetssome text

   • Diversify into stocks, gold, or real estate to lower crypto-specific risks.

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8. Assign to Infrastructure Projectssome text

   • Invest in tokens such as Chainlink and Polygon, which have stable growth potential due to their broad utility.

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9. Build a Cash Cushionssome text

   • Keep a portion of your portfolio liquid, in cash or other liquid assets, for market downturns or emergencies.

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10. Accounting for Market Cyclessome text

    • Don't overdo it with assets highly correlated to each other. Couple volatile coins with stable projects. Understand Market Cycles Rebalance your portfolio whenever the market changes (e.g., in bear markets, reduce exposure to high-risk altcoins).

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