Although a private equity investment may involve a higher risk, it also offers the potential for substantially higher returns. This article explores the relationship between the risk/reward ratio and private equities.

An independent financial advisor sitting at his desk, going over private equity investment options for his clients.

In investing, risk and reward are two sides of the same coin. Investors willing to take more risks are generally rewarded with the potential for higher returns. The opposite also rings true, and private equity investments are no exception to this rule.

In fact, private equity investments often involve a higher risk level than traditional investments. It differs from stocks and bonds in that it operates independently from major market fluctuations.

Despite unique challenges, private equity helps diversify investment portfolios by reducing public market and cyclical risks. Unlike index funds, private equity has more control over the invested companies and can actively react to market cycles. It makes them incredibly resilient to downturns. That’s why, in a nutshell, this investment type shouldn’t be off-putting to you.

Your capital is in good hands when working with a recognised investment management firm such as IFSA. After all, our central team has more than sixty years of combined industry experience. This ranges from portfolio development for independent financial advisors (IFAs) to private investors and family-owned enterprises.

Let’s look at the risk/reward ratio in private equity investments. We also offer insights into how investors can assess their own risk tolerance and navigate this complex investment space to achieve their financial goals.

Consider the risk/reward ratio

The risk/reward ratio applies to all investment types, not just private equity. Investors and IFAs use this ratio to weigh the potential return on investment (ROI) against the risk assumed to earn the return.

To use the formula, calculate the risk-to-reward ratio by dividing the potential loss by the expected profit (i.e. risk ÷ reward). Simply put, an investment with a 1:6 ratio implies the investor will risk R1 to earn a potential profit of R6.

Although the ideal risk/reward ratio varies depending on the trading strategy, the rule of thumb says anything greater than 1:3 indicates an opportunity worth pursuing. Online investment calculators can help you determine whether a venture is worthwhile.

Understanding the relationship between investment risk and potential return

Ultimately, the risk/reward ratio helps you temper your ROI expectations regarding loss and gain. Remember, even when profiting from select trades, the overall win rate counts. Should it fall below 50%, you lose money in the long run.

The risk/reward ratio helps to estimate the difference between the price you set to stop your trade (once it moves against you) and the price you select to sell for a profit. When comparing these values, you can identify your prospective profit-to-loss ratio for the specific trade.

What is volatility – and what can you do about it?

Volatility in investing refers to unpredictable and sudden changes in market or security prices. It can occur in both price drops and sudden increases. Mainstream markets are affected by economic indicators, political events, and company news.

In contrast, volatility in private equity markets is driven by factors specific to the companies in which investments are made, including management changes, operational performance and exit opportunities. Additionally, private equity investments are typically illiquid and subject to longer holding periods, impacting volatility.

However, when you invest with IFSA, there are three major advantages: high returns, low market volatility, and monthly dividends to add to your passive income. Additionally, you have always-on guidance to the latest insights, with the peace of mind that your investment is not left to prosper on its own. It’s actively managed by our team, who sits on the board of directors for the various businesses we invest in.

The latest IFSA Fund Fact Sheet provides an overview of how we manage the Cornerstone Capital Private Equity Fund for the best possible outcomes – while keeping volatility in mind.

Private equity investment risks: Are they right for you?

Although there is no reward without taking risks, people have different tolerances. You must consider your tolerance to ensure you invest in a way that best suits your wants and needs. At IFSA, risk mitigation is a top priority. We do everything we can to ensure each investor enjoys a profitable outcome.

We know what difference a capable fund manager’s experience, skill and resources can make, which is why we play an active role in the companies we acquire equity in. Doing so balances the key private equity risks most commonly experienced by investors: operational, funding, liquidity, market and capital risks.

Private equity: Diversifying your portfolio

“You should have a mix of traditional investments – equities, bonds, some cash. You should also have offshore exposure in that sphere, and you need alternatives in your portfolio as well to the likes of private equities and hedge funds.” – IFSA CEO Frikkie van Loggerenberg

Diversifying your portfolio is always a good idea, regardless of your preferences. Putting all your funds into a single investment type is risky.

Private equities are a good option because they generally have lower volatility rates than traditional investments, which are influenced by the stock market’s ups and downs. Those investing in private equities can also impact crucial decisions regarding the strategic direction and financial targets of the companies.

Learn how IFSA helps to secure financial success

Whether you’re a private investor or IFA, when the time comes to rebalance your or your clients’ portfolios, come and speak to us. At IFSA, we are familiar with both groups’ situations.

Reach out today for a complimentary consultation, as we’re here to assist you long-term. Together, we identify private equity investment opportunities with the best risk/reward ratio for your needs. Allow us to help maximise your investment potential.

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