Over the years, a number of alternative investments have become increasingly available to RIAs and their high-net-worth clientele. Hedge fund of funds burst into the scene about 15 years ago, followed by mutual funds that utilize a plethora of market neutral strategies. Private equity may well be the next piece of the alternative puzzle to approach mainstream status.

Most of the large private equity firms specialize in taking public companies private. This transition is highly attractive to executives, as it frees them of the strains of Sarbanes Oxley and allows them to spend all of their time concentrating on a “good to great” transition. Once the company is on better financial footing, they are typically sold via IPO into the capital markets once again, with the hope of enriching private equity investors in the process.

In return for tying up their limited partner’s cash for ten years, the return of the asset class includes an “illiquidity premium” that typically vaults returns 8%-10% over the stock market; as a result, investors should expect to earn this premium, plus the return of the equity markets, for the life of their commitment.

Fortunately, this premium is uncorrelated to the returns of either stocks or bonds; as a result, adding private equity can potentially both reduce the risk (as measured by standard deviation) and increase the return of a traditional portfolio composed of equity and fixed income.

The private equity market is maturing in a number of ways. Funds that specialize in esoteric parts of the market, like Indian education or Chinese infrastructure, are flourishing. The ability to sell private equity interest via secondary markets is also developing, which should increase the liquidity of the asset class. Savvy advisors should consider investigating the opportunities afforded in these funds.

The Monthly Index Report for June 2007

Index

May-07

QTD

YTD

Description
S&P 500 Index*

3.25%

7.72%

7.92%

Large-cap stocks
DJIA*

4.32%

10.31%

9.34%

Large-cap stocks
Nasdaq Comp.*

3.15%

7.55%

7.83%

Large-cap tech stocks
Russell 1000 Growth

3.60%

8.48%

9.76%

Large-cap growth stocks
Russell 1000 Value

3.61%

7.44%

8.77%

Large-cap value stocks
Russell 2000 Growth

4.56%

7.30%

9.96%

Small-cap growth stocks
Russell 2000 Value

3.67%

4.75%

6.27%

Small-cap value stocks
EAFE

1.89%

6.51%

10.92%

Europe, Australasia & Far East Index
Lehman Aggregate -0.76%

-0.22%

1.28%

U.S. Government Bonds
Lehman High Yield

0.75%

2.06%

4.75%

High Yield Corporate Bonds
Calyon Financial Barclay Index**

2.02%

5.96% 3.52% Managed Futures
3-mo. Treasury Bill*** 0.42% 0.85%

2.20%

All returns are estimates as of May 31, 2007. *Return numbers do not include dividends.

** Returns are estimates as of May 30, 2007. ***Returns are estmiates as of May 29, 2007.

Ben Warwick is CIO of Memphis-based Sovereign Wealth Management. He can be reached at ben@searchingforalpha.com.