What a difference two years makes.

Since 2004, a slew of mega-funds of truly unprecedented size, abetted by credit-blind leveraged capital providers, have made headlines by preying on ever-larger public companies. Those constrained by their investment guidelines from taking down multibillion-dollar whales like, say, SunGard on their own have teamed up with their rivals to do so. Meanwhile, capital-raising among middle market specialists has burgeoned. While less frantic, perhaps because fewer opportunities to invest exist and multiples are rising faster than in the large-cap arena, the funds are finding themselves unwilling to turn investors away. Promises of capital-raising restraint have evanesced like a temperance resolution made in the midst of a four-alarm hangover.

Indeed, the investment landscape for private investors has reshaped itself remarkably in the past two years, a period in which the plain-vanilla markets themselves performed pretty unremarkably. The factor behind many of these transformations has been the enormous volume of global investment capital seeking a home. The Wall Street Journal reported in early November that global pension, insurance and mutual funds today have $46 trillion to invest; the paper notes that this is up almost a third since 2000 and that it has driven risk premia—the compensation we demand for holding risky assets—down across the board.

A look back, and forward
Think, for a moment, of the trends that are bearing on your own investment decision making; many will have a surfeit of capital lurking in the background. To give a few examples aside from private equity, in the past two years:

• The hedge fund sector has become less a vehicle for exploitation of brilliant traders’ intellectual brio and more a de facto source of liquidity in hitherto exotic markets like volatility (e.g., in a range of options-based strategies), credit (e.g., in high-yield, leveraged and synthetic credit strategies) and others. (As an aside, a recent observation made at an Institutional Investor conference by Mark Yusko of Morgan Creek Capital Management about this sector bears repeating: “There aren’t really 8,000 hedge funds,” he noted, “there are 32,000—there have to be, since every one I’ve met claims to be top quartile.”
  
  
• Pricing of soft commodity investments like timber has shot upward as institutional and private investor monies have scoured the globe for low volatility investments uncorrelated with the stock and fixed- income markets.
  
  
• Perhaps the most potentially pernicious effect of this ever-expanding blob of liquidity is the fact that, over the past several years, it has made the credit markets abandon their discretion, setting the stage for a difficult year or two when the credit cycle finally bottoms out.

One of our goals at Worth is to make our readers just well-informed enough to be dangerous—to those seeking to exploit holes in their understanding of specific financial esoterica, that is. Our monthly mechanism for doing so is our Risk & Reward column, in which we reverse-engineer a product or strategy being offered to private investors. This month, senior correspondent John Ferry takes a critical look back at 10 of those products whose fortunes rose or fell in the months since we first addressed them, often due to the transformation in the markets impelled by the ongoing flood of investment capital. The fact that so many of the products have either stalled or meandered should remind us of the need for caution when examining sophisticated transactions that often sound too good to be true.