Contrary to conventional cliché, there is very little that is binary about venture investing outcomes. It is not just feast or famine. Rather, outcomes are diverse and asymmetric. You can lose your entire investment, just lose a portion, break even, receive periodic distributions producing double-digit IRRs or achieve exits at 5X, 10X, 20X multiples or greater on your initial investment.

What does appear to be binary is the manner in which prospective investors in private ventures perceive the asymmetric return profile of venture investment outcomes….most either adore it or abhor it.

On one hand, an investor like Jim Rogers is attracted to what he no doubt views as a positive asymmetric profile of venture investment outcomes. His venture acumen began developing at the age of five by selling peanuts and by picking up empty bottles that fans left behind at baseball games. In 1970, he co-founded the Quantum Fund. During the following 10 years the portfolio gained 4200% while the S&P advanced about 47%. Nice.

In a recent rant Rogers opined not only that “diversification was garbage”, but also went on to say that “you only need four or five good ideas in your life to get really rich”.

(Note that Rogers says “really” rich…which seems a bit elitist seeing as how only one or two good ideas can make one simply rich.)

Nevertheless, 90X returns over the S&P implies that he had very little fear of placing losing bets.

But what about those less adventurous souls that eschew positive asymmetric return scenarios in favor of more traditional investments with binary and symmetrical outcomes? Why are there so few angel and venture investors despite the compelling data of the asset class’ returns and the proven history of private enterprise as the single greatest creator of family wealth?

Economics psychologist Daniel Kahneman explained this behavior with his 1979 nobel-winning, Prospect Theory which describes decisions between alternatives with uncertain outcomes where the probabilities are known. In prospect theory, Kahneman identified Loss Aversion–people’s tendency to strongly prefer avoiding losses to acquiring gains. In fact, studies suggest that losses are twice as powerful, psychologically, as gains.

In their perpetual pursuit to mirror the risk-free rate of return, some investment advisors are factoring prospect theory and loss aversion into their asset-allocation schemes. But loss aversion studies opposing symmetrical outcomes…such as either winning $100 or losing $100. It provides little insight with respect to investor’s fear of positive asymmetric return profiles.

I prefer the wisdom in David Gal’s 2006 study, A Psychological Law of Inertia and the Illusion of Loss Aversion, which discounted loss aversion as “superfluous” and found instead that risk/return tradeoff decisions were decidedly “influenced by a tradeoff between the status-quo and change”. Gal calls it inertia, noting that that people will tend to remain at the status-quo when they have no clear preference between the status quo and an alternative option.

The rigid portfolio allocation to the same traditional asset classes within the same stale strategic asset allocation model is the status quo that Gal is referring to. The results have been far from compelling yet most investors, and their advisors, keep doing the same thing while expecting different results.

In a recent WSJ article, Jason Zwieg accounts for this “mental lazziness” that prevents  investors and advisors from challenging their status quo approach to investing (and consequently, not embracing alternative asset classes and strategies). “In short, your own mind acts like a compulsive yes-man who echoes whatever you want to believe. Psychologists call this mental gremlin the confirmation bias…people are twice as likely to seek information that confirms what they already believe as they are to consider evidence that would challenge those beliefs.”

Try Harder. Properly allocated, private equity and venture investments can materiality improve a portfolio’s risk/return tradeoffs and benefit from the proven superior performance of the asset class. But, expanding your repertoire by opening your portfolio to private investment opportunities requires commitment and effort to educate yourself on the rules of the engagement and evaluation.

Achieving superior returns by embracing private investment requires initiative…not inertia.

Album: Underachievers Please Try Harder, Camera Obscura, 2004

As my career has been largely devoted to the intersection of money management and venture finance, I am no stranger to the independent RIA universe.

I have worked with dozens of wealth managers and family offices that regularly evaluate and allocate to private venture investments. Although they represent a fraction of the RIA universe, they are invariably among the most successful of their peers. These progressive wealth managers represent the primary audience of this blog.

I regularly advocate that RIAs that possess the requisite mandate, the means and the mindset should embrace private venture investments–for the benefit of their client’s portfolios, as well as, their practices. Yet, the majority of independent wealth managers should best leave this sandbox to VCs and angel investors.

Does your advisory practice possess the rationale and the resources to advise clients in start-up, early-stage and other private venture investments?

Your advisory practice may be uniquely qualified, if you consider:

• (To begin by stating the obvious…) You are in the business of wealth preservation and wealth creation.  Without question, the primary source of family wealth in America is the result of private enterprise and private venture investments characterized by their potential for positive asymmetric outcomes.

• You embrace Modern Portfolio Theory.  Despite its flaws, MPT advocates diversification into non-correlated asset classes. One-off investments in private ventures are distinctly non-correlated to broader asset classes and major market indices and have exhibited less correlation during negative black swan events.

• You possess the proper due diligence skills.  In addition to those skills you also posess the doubting disposition that is critical in evaluating private investments. The skills that advisors have developed in the course of investment manager evaluation are relevant and applicable to the private equity universe. Moreover, your experiences have taught you to be cynical and skeptical of assumptions regarding future performance.

• You are an entrepreneur.  As an independent wealth manager have chosen to compete in a highly-competitive, low margin industry. Your personal experiences should render you more prone to recognize the prerequisite personality traits of a successful entrepreneur…de rigueur in the executive team due dilly process. You also recognize the mission-critical elements beyond the strengths of the management team that determine the probability of successful enterprise.

• You understand finance.  As a stock, sector and industry analyst you know your way around balance sheets, cash flow, valuation issues and income statements. I am frequently surprised at the number of professional private venture investors that have little understanding of business and finance.

• You possess both an awareness of regulatory issues and a fiduciary responsibility that is consistent with the best practices of seasoned angel investors and VCs.

• You are networked. Beyond your practice, you have access to an expansive network of tools, resources and expertise that are essential to evaluating new technologies, industry sectors, new business models, intellectual property and other elements of private investment. Your industry colleagues offer incomparable access to the analysts, research, legal and domain expertise that is required in the course of successful private investing.

• You have access to the critical resources.  As an independent wealth manager you have enviable access to the two most important resources of private investment….investor capital and deal flow. Your HNW clients most likely became HNW clients as a result of their own ventures in private investment. Serial entrepreneurs and HNW investors are an excellent ongoing source of deal flow.

Advisors that affirmatively identify which each of these traits may have the mandate and the means to expose their client’s portfolios to the asset class that has historically created the vast majority of our nation’s private wealth and can dramatically differentiate your practice from its peers.

More advisors should explore asset allocation beyond the lame limitations of highly-correlated asset classes, stale style boxes and pointless pie charts.

Album:    Playing the Angel, Depeche Mode, 2005

 In my last post I introduced an alternative asset-allocation approach for investors that no longer subscribe to the discredited models of traditional (strategic) asset allocation, Modern Portfolio Theory (MPT), Efficient Market Hypothesis and what pedestrians refer to as “buy-and-hold”  investing.

This new portfolio construction approach, Hybrid Portfolio Theory, is a unique and timely portfolio construction methodology that is distinctly disparate from MPT in that it employs two distinct capital pools: Portfolio A, the larger portfolio has the primary objectives of safety of principal, liquidity and income, and, Portfolio B that only allocates to private or public investments that exhibit the potential for positive asymmetrical outcomes (PAO) via exposure to positive black swans.

Last week Investment Advisor Magazine and Ameritrade co-sponsored a webinar that allowed me to introduce Hybrid Portfolio Theory to investment professionals. The call was well attended with nearly 500 registrations.

[You are welcome to listen to the archived call and view the presentation which is hosted at this link, or, you can simply view the Powerpoint, without the audio, here.]

We cut the call at the hour mark which means that many questions from participants that were in the queue for the Q&A portion were unable to be addressed. I welcome the opportunity to address your questions, comments and critiques and would encourage you to post them on the comment boards of the Hybrid Portfolio Theory post and I will reply in that forum.

If you would like to have a direct dialogue, please reach out to me via LinkedIN and we can schedule a private conversation.

After the call, I received dozens comments on HPT via LinkedIN. I was not at all surprised to hear from a number of advisors who had previously embraced a number of HPT core principles in their portfolios. I plan to introduce these advisors (and the manner in which they have adopted or adapted HPT to their portfolios) to VP readers in the months ahead.

Many of the comments received revealed that investment advisors were compelled by the concepts of HPT, but also had many questions about implementation and execution of the strategy at the client, portfolio and practice level.

For good reason…HPT is not as pie-chart ready as Modern Portfolio Fallacy.

Going forward, VenturePopulist posts will address issues associated with the implementation of HPT and defining the broad PAO opportunity set…with particular focus on private equity (angel investing and venture capital) investments.

Thank you for your all of your responses to HPT…the curious, the complimentary and the critical. I welcome and look forward to your comments on our boards.

Album:   What’s Next? Foster Edwards Orchestra, 1964

There is a better way to build investment portfolios than the methods presently employed by most investors and advisors.

Perhaps that is hard to imagine seeing as how well we have been served by Modern Portfolio Fallacies and the Efficient Market Hypocrisies, but if you have an open mind, there is a strong chance that these portfolio construction principles will resonate with you…particularly on the heels of what we have learned from the half dozen market meltdowns experienced since ‘87.

I know that the idea of a new asset-allocation model is intuitively tiresome…but if there was ever a time to revisit the prevailing conventional wisdom, it is now. This smarter portfolio approach places heavy emphasis on safety of principal, liquidity and income, yet simultaneously provides investors with compelling potential for capital appreciation.

I refer to it  as Hybrid Portfolio Theory (HPT) and could safely say that less than one percent of advisors have contemplated, let alone implemented such a methodology in their practice…despite its proven efficacy and how well it resonates with high-net-worth investors.

In HPT the investor allocates 100% of the assets into two distinct (hybrid) portfolios. The larger portfolio (A) represents 75-90% of the assets and is invested with the primary objective of liquidity, safety of principal and income. This portfolio is benchmarked against a blend of risk-free and short-term yield rates and invests predominantly in money markets, CDs, short-term muni’s and Treasuries.

The challenge of portfolio A is to maximize yield in bps and increase yield to the point that does not threaten the overall liquidity and safety of principal. With liquidity and safely of principal as primary objectives, that effectively eliminates allocations to high-yield corporate and junk bonds, REITs, MLPs, closed-end and utility stocks by the literal-minded HPT practitioner.

Why Bother with Stocks?

So, what is the source of return for capital appreciation in HPT? Not traditional equities. Stocks go up and stocks go down. That’s a symmetrical outcome that we now know empirically to be a bad bet unless you have a multi-decade investment horizon. Rob Arnott’s recent article “Bonds: Why Bother?” in the Journal of Indices emphatically settled the score.

Arnott proved that the 5% risk premium promoted by the financial services industry is at best unreliable and is probably little more than an urban legend. Starting at any time from 1980 up to 2008, an investor in 20-year treasuries, rolling them over every year, beats the S&P 500 through January 2009. Going back 40 years to 1969, the 20-year bond investor still outperforms by a marginal amount, even with the Carter-era inflation and traumatic bond market in the seventies.

It is not debatable. Equities have not delivered their risk premium and are simply not worthy of their risk. Rather than pursing the laughably unreliable risk premium of equities, Portfolio B is exclusively seeking higher risk–higher return positive asymmetric outcomes (PAO). The Portfolio B benchmark is in the 10-20% range.

A PAO is defined by its ability to generate high double-digit or multiples of return on investment, as can be achieved by successful investments in venture capital, private equity, direct (angel) private investment in start-ups, small business, private manufacturing business, private real-estate, private debt, franchises, operating cash-flow businesses, as well as, publicly-traded emerging growth companies and leveraged option strategies or highly-specialized investment strategies such as managed futures.

The PAO mandate is broad but should ultimately be defined by a positively skewed risk-reward ratio, as well as, the practitioner’s sector expertise and due diligence resources.

The investor’s overall hybrid portfolio benefits by assuring that the vast majority of assets are not exposed to a downright bad wager relative to risk-free or short-term assets, as well as, unpredictable (yet, frequent) black swan events that decimate investor portfolios.

HPT should be engaged and implemented as a theory, not as an absolute rigid asset-allocation model. If the portfolio manager, advisor or investor accepts that; 1) current asset-allocation frameworks cannot successfully mitigate significant market exposure and do little to protect investors from unpredictable negative black swans, 2) investors are generally over-exposed to equities in light of the proven absence of any sustainable risk premium, and, 3) investors benefit from limited but diversified exposure to investments and strategies characterized by the possibility of positive asymmetric outcomes…this is a portfolio theory that you can adapt into your other core asset-allocation principles and values.

When adapting HRT to your own biases, the allocator can exercise discretion with respect to;

1. The A:B Portfolio ratio
2. The constituent opportunity set for Portfolio A–from short-term high liquidity, lower-yielding, shorter-term instruments to Treasurys, TIPS and munis
3. The consitutent opportunity set for Portfolio B–from private venture investments to publicly-traded emerging growth companies to specialized trading and option strategies
4. The benchmarks applied to the A and B Portfolios

Today, investors more than ever appreciate and welcome the notions of safety and liquidity. They no longer believe in the buy-and-hope asset-allocation models and “stocks for the long run” mantras peddled by talking heads. Moreover, the coveted HNW-investor demographic that you either aspire to, or presently serve understands and accepts the risk and liquidity realities of private investment in venture and enterprise. In fact, in most cases, such investment or employment is how they generated their private wealth.

Assuming the proper resources, advisors that embrace Hybrid Portfolio Theory (for appropriate investor portfolios) your advisory practice would benefit by;

• Delivering the services, results and sensibility that desirable HNW investment clients are actually seeking from advisors,
• Protecting your client’s assets and portfolios from incurring significant losses from exposure to unpredictable black swan events,
• Strengthening advisory-client relationships by developing a unique and connected client community within your practice, and,
• Competitively distancing your practice from the vast majority of investment advisory firms that can provide no evidence of a discernible value proposition.

I understand that this sounds provocative considering what investors and advisors have come to believe in after years of over-attentive care and feeding by the financial services industry. Yet, if you acknowledge the historical data,  the frequent and unpredictable impact of negative black swans and the notion of investing for positive asymmetric outcomes ,you should not be questioning the virtues of HPT as much as the critical issues of; access to the opportunity sets, due diligence, implementation and execution of the strategy.

Stick with us as we intend to tackle those issues in coming posts.

A more detailed Powerpoint presentation and audio webinar on HPT is available here.

Album:    Hybrid Theory, Linkin Park, 2001

The Black Swan by Nicholas Nassim Taleb holds its own among the most important investment books ever written. In it, Taleb argues persuasively that any sensible long-term strategy in a world dominated by extreme and unpredictable (black swan) events has to accept, and even embrace, that very unpredictability. It is poignant and timely advice for any investor and a must-read for investment professionals.

I met Taleb for lunch at Bice in NYC one afternoon about three years ago while I was heading Alternative Strategies for an investment management firm. I was interested in exploring the idea to engage Taleb as a sub-advisor for an investment fund that we were contemplating. I found him to be personable, enthusiastic, engaging and surprisingly modest.

I had read and re-read Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life before our meeting and I was looking forward to discussing his contempt for investment managers that sell themselves on their track record…a cynicism that I shared. But Taleb had just finished his final draft manuscript of The Black Swan and directed our discussion towards his treatise on asymmetric outcomes-the central theme of the unpublished tome that he brought along with him and referenced throughout our visit.

The notion of asymmetric outcomes, “I will never know the unknown since by definition it is unknown. However, I can always guess how it may affect me, and I should base my decisions around that”, causes Taleb to advise to seek out (investment) situations “where favorable consequences are much larger than unfavorable ones.”

That is a central tenet of Venture Populism and my advocacy of committing a portion of an investor’s portfolio to private venture-oriented investments. Like Taleb, I believe that effective investment portfolios should contain meaningful (and appropriate) exposure to positive Black Swans-such as private equity investments in emerging ventures and distressed companies.

In posts to come I will expand on this premise and propose a provocative new model for portfolio construction that balances the investor’s need to mitigate the asset-depleting impact of negative black swan events with simultaneous allocations that benefit from the potential of positive Black Swans and asymmetrical outcomes.

Many advisors now concede that Modern Portfolio Theory, traditional asset-allocation and buy-and-hold investing models have failed and investors are looking for improved approaches that preserve capital and manage unexpected risks more effectively without giving up on the prospects for capital appreciation.

The Black Swan is indeed a brilliant and provocative work. As the New York Times review summed, “It concerns the occurrence of the improbable, the power of rare events and the author’s lament that in spite of the empirical record we continue to project into the future as if we were good at it.”

We expect all swans to be white and are shocked when a black swan swims by…the same way that we were lulled into complacency with flawed risk management models and were then shocked when the market fell 50% and erased away trillions of wealth.

Investors and their advisors can build better portfolios that are for the most part insulated from the impact of negative black swan events, yet have simultaneous exposure to asymmetrical risk/return opportunities.

Album:   The Black Swan, Story of The Year, 2008

In prior posts I have taken swipes at traditional asset allocation, buy-and-hold investing, the Efficient Frontier, the Efficient Market Hypothesis and Modern Portfolio Theory (MPT).

Sure, I am trying to be provocative, poke a little at advisor complacency and provoke polemic on the comment boards…but I am also sincere. MPT relies entirely on investment history for investment analysis and conclusions. These tired and discredited methods are rubbish…and have cost investors trillions.

It is encouraging to see evidence of advisor post-mortems in progress as some advisors are seeking not to repeat the mistakes of the past. I was also entertained by John C. who cracked on the comment board, “What’s over 50 years old and still considered modern?   MPT”

But pretty pie charts and Powerpoints are not so easily disposed of. As an anonymous critic incites, “The appeal of Modern Portfolio Theory in the investment advising community is its simplicity, graphic presentation value, and most of all, little or no investing judgment or skill is required; just pick, print, present, and hope; chasing efficient frontiers, hoping that investment history will somehow repeat itself, and just waiting for historical updates to generate new efficient frontiers to justify investment change.”

Nevertheless, some advisors are stubbornly standing by their man(tra).

Modern Lovers

Consider these edited comments that I received from Matthew K. in response to the Crisis = Opportunity post;

“MPT works. With the right allocation and systematic rebalancing to maintain percentages as well as in line with client’s goals, there is no lost decade. Markowitz knew what he was doing, and as an academic, he did not stand to profit…When MPT is juxtaposed with Daniel Kahneman’s Nobel Prize winning ideas on heuristics, you see how MPT does add value when used in line with client’s goals…Any classic definition of “Venture” includes the idea of risk taking. Where does that fit in CAPM or the efficient frontier?”

I cannot rebut a hopeless romantic, so let’s engage Matthew K. in a virtual volley with interlaced quotes excerpted from a FT article and a McKinsey interview with the especial epistemologist, Nassim Nicholas Taleb. Taleb is the author of two true investor instant classics and must-reads, Fooled By Randomnes and The Black Swan.

Taleb has a strong opinion on the matter of MPT and modern finance…and he is no modern lover:

MK- MPT works. With the right allocation and systematic rebalancing to maintain percentages as well as in line with client’s goals, there is no lost decade.

NNT-We learn from crisis to crisis that MPT has the empirical and scientific validity of astrology, without the aesthetics…In 1990 William Sharpe and Harry Markowitz won the prize three years after the stock market crash of1987, an event that, if anything, completely demolished the laureates’ ideas on portfolio construction….I would ban portfolio theory immediately. It’s what caused the problems…Portfolio theory simply doesn’t work. It uses metrics like variance to describe risk, while most real risk comes from a single observation, so variance is a volatility that doesn’t really describe the risk. It’s very foolish to use variance.

MK-Markowitz knew what he was doing, and as an academic, he did not stand to profit…When MPT is juxtaposed with Daniel Kahneman’s Nobel Prize winning ideas on heuristics, you see how MPT does add value when used in line with client’s goals.

NNT-Academic economists are no more self-serving than other professions. You should blame those in the real world who give them the means to be taken seriously: those awarding that “Nobel” prize… Every time I have questioned these methods I have been abruptly countered with: “they have the Nobel”, which I have found impossible to argue with. There are even practitioner associations such as the International Association of Financial Engineers partaking of the cover-up and promoting this pseudoscience among financial institutions. The knowledge and risk awareness we are accumulating from the current subprime crisis and its aftermath will most certainly not make it to business schools.

Thanks, (virtual) Nassim. I will take the next one.

MK-Any classic definition of “Venture” includes the idea of risk taking. Where does that fit in CAPM or the efficient frontier?

VP-Of course, venture implies risk-taking… they are nearly synonymous. A venture investor is knowingly acknowledging and accepting an implicit and quantifiable serving of risk that is decidedly less than a range of positive (asymmetric return) outcomes. Perhaps investors would have been better served if their notion of the risk that they were assuming in their efficient frontiers was not muted (and implied to be mitigated) by the marketing machinations of MPT. CAPM is a future-oriented model yet it essentially relies on historic data to predict future returns. The Efficient Frontier? I have seen the inputs, I have seen the outputs…and I have seen the results…the efficient devastation of unsuspecting portfolios.

Album:   The Modern Lovers, The Modern Lovers, 1976

In a video interview about the column, Jeff Goldberg, the article’s author, describes garden-variety vendors of investment advice as, “…these Jiffy Lube kind of places. They’ll take your money. They’ll invest it in the same things that everybody else is being invested in.”

Is that a cruel but fair commentary? It is if advisors keep doing what they have been doing yet (insanely) hope for different results…and good luck securing new clients amidst the new prevailing wisdom. Face it, with the exception of advisors that embraced alternative asset classes and/or market timing, the vast majority of advisors portfolios were marked to market in the selloff and their clients have likely lost a generation of investment opportunity that may never be made up.

In prior posts we have posited and proofed the problem;

• Stocks are not worth their risk premia and bonds look downright scary.
• MPT, B&H and traditional asset allocation models have been completely discredited
• Diversification is not easily achieved because in crisis all correlations go to one.

But we also spoke to the solution;

• The vast majority of private wealth in America is the result of participation or investment in private venture….such as business start-ups, venture capital and private equity.
• The HNW investor understands and appreciates the wealth-creating potential of private venture investing (PVI)…in many cases that is how they became wealthy.

Advisors could materially improve their value proposition, their competitiveness and their client’s portfolios by developing PVI competency and integrating the asset class into their practices.

Why I Hired My Advisor

I know too well that this message will be lost on 80% of advisors who view private investments (in start-up or existing businesses, private equity or venture capital) as a new problem, rather than a solution. That’s probably the way it should be as it is likely that only 20% of IAs possess the capacity and the client-base that could support and embrace the asset class.

But every advisor benefits from a discussion that introspectively considers the true value proposition that they provide to their investment client. Invariably, portfolio performance (relative to client objectives) will always be a factor that advisory clients consider when they evaluate their advisors. Advisors should be open to asset classes that have a proven history of being non-correlated to equity markets and providing exceptional relative and absolute returns over intermediate-term market cycles.

The performance of the private investment category is indisputably compelling and speaks for itself. The most recent Thomson Reuters US Private Equity Performance Index data released through 2008 show the “All Venture” category (which includes data from early/seed, and later-stage VC funds) returned 17% over the last 20 years against the 6.1% return of the S&P. Over return periods less than 20 years the performance relative to equity indices has been even more compelling.

Venture Populist seeks to assist advisors (and investors) by advocating the integration of private venture investing into more investor relationships and portfolios and providing a forum and resource for like-minded professionals and investors.

Advisors that allocate to private venture investments claim that they differentiate their practice (from their advisor peers that are pursuing the same HNW clients) and strengthen their advisor-client relationships by increasing the quantity and quality of the advisor-client dialogue.

Private wealth and family office portfolio managers consistently maintain that the majority of their client dialogue (at the portfolio level) is spent discussing private investments. Have you ever noticed your reflection in the glazed pupils of investor’s faces when you discuss Modern Portfolio Theory or the Efficient Market Hypothesis? That’s a monologue. Discussing the prospects of a private investment in a start-up, emerging or established business…with a HNW investor who made his money in business…and you have dialogue. Business people enjoy talking about business. That provides the advisor with an excellent opportunity to engage clients on a different level than advisor-client, vendor-customer, or salesmen-prospect. Rather, as two professionals contemplating a joint business transaction.

In subsequent posts I will speak to additional ways that an advisor’s practice is positively impacted through PVI including;

• Better client retention rates,
• The development of a collaborative client “community” within the practice,
• Incentivizes for clients to refer new clients to the practice, and most importantly,
• The increased potential for improved portfolio performance,

…while radically differentiating his practice from his peers and invigorating the value proposition to the client.

Album:   Private Practice, Dr. Feelgood, 1978

An opinion poll that is currently posted on Investment News asks advisors, “Do you think the market downturn has created a lost generation of investors?”

It is a thought-provoking question as investors of all ages (and ironically, of all risk tolerances) have seen portfolios reduced by as much as one half of their peak value. Have these investors lost a generation of opportunity that they can never recover?

The answers tallied thus far are as provocative as the question and may suggest a lost consciousness among many advisors. Surprisingly, approximately half of the respondents thus far disagreed with the notion of a lost generation of investors despite the fact that some of their own clients have incurred substantial losses that are not likely to be made up prior to retirement.

These advisors are naively optimistic, in denial or merely oblivious. Either way they are doing a disservice to their clients and their practice. By ignoring the mistakes of their recent past they are destined to repeat them. In the past dozen years they have seen several black swans with their own eyes yet they still manage assets as if all swans were white.

A slight majority of advisors are indeed aware of the irrevocable nature of some investor’s losses. As one advisor posted on the opinion poll’s comment boards with respect to a hypothetical 68 year-old investor losing half of their portfolio’s value;

“Based on the annualized returns of a 60/40 portfolio over the past 15 years (5.44%) it will take your client ~13 years to recover what he/she had 18 months ago, IF the annual average return was to resume at 5.44% tomorrow. IMHO it’s quite likely that John or Jane will NOT return. And if you use the 0.19% annualized that a 60/40 has returned over the past 10 years, try explaining to your former client that it will take more than 365 YEARS to get back to where he/she was.”

Advisors whose practices will prosper going forward are those (50%) that are revisiting the buy-and-hold, asset allocation and diversification models that have failed so miserably. Same old, same old will simply produce the same results.

Album:   The Sly, Slick and Wicked, The Lost Generation, 1970

Do you wish you had a yuan for every time you heard the inaccurate reference that the Chinese symbol for “crisis” is the same as for “opportunity”?

How often will we have to hear this nonsense from pontificating pundits, investment advisors and portfolio managers out ballyhooing the pending stock buying opportunity of a lifetime?

The equation above is only applicable when something is actually learned from the chaos and behavior is changed. The common definition of insanity–the behavior of people who keep doing the same thing, yet expect different results–is likely more relevant.

So far, I see little evidence that investment advisors have learned anything from their vanishing assets-under-management, despite irrefutable evidence that:

• Stocks have plummeted more than 60% in real terms since the market peak in 2000. They have performed no better than 20-year Treasuries for the past 40 years and certainly have not delivered their risk premium.
• Bonds may be the next bubble (according to Warren Buffett) as unprecedented spending, ballooning deficits, risk of a devalued dollar, and inflation could prompt foreign investors to dump Treasuries.
• Modern Portfolio Theory, traditional asset-allocation and diversification models, and buy-and-hold investing have been materially discredited over the past 80 years.

Will investment advisors revisit their mantras or continue to tout the same traditional asset-allocation models that have so dutifully devastated their investment portfolios?

Empirically, investor returns on private investments constitute the single largest source of private wealth in America. All stages of private venture investment (early/seed through mezzanine and later) have dramatically outperformed traditional equity indexes over the past five, 10 and 20 years.

Investment advisors should educate themselves to become more familiar with best practices in evaluating and ultimately embracing private investment opportunities for investors. Prudently implemented, private investments can materially benefit your client’s portfolios, and, in turn, your investment advisory practice.

By “private investments” we are referring primarily to investments in private enterprise. (But Venture Populist will address the wider range of private investment strategies, including angel investing, private equity, venture capital, venture debt financing, private placement offerings, and private investment in public equity (PIPEs).

Walk the Walk

True, sustainable wealth is rarely generated through traditional investment or employment. It is the consequence of inheritance, windfall (lottery), illegal activity, or private enterprise. Contrary to the widespread, pedestrian misconception, inheritance is not the major source of private wealth in America. Rather, it is entrepreneurial success or investment in private enterprise.

According to Drs. Thomas Stanley and William Danko’s research published in their book The Millionaire Next Door: The Surprising Secrets of America’s Wealthy–80% of today’s American millionaires are first-generation rich. More than half never received as much as $1 in inheritance, and 91% never received as much as $1 from their previous generation’s ownership of a family business.

The same was true a century ago per Stanley and Dankos’s citation of a 1892 study of the 4,047 American millionaires…”84% were nouveau rich, having reached the top without the benefit of inherited wealth.”

The highly-coveted high-net-worth and ultra-HNW investor knows this better than anyone, because, as probability has it, they very likely accumulated their own private wealth through entrepreneurial activity or investment in private venture. When investment advisors are speaking with HNW investors about private investment opportunities in start-up ventures or emerging companies they have their attention, and do not show that glazed look of disinterest that a lecture on the Efficient Frontier evokes. The HNW may not be familiar with the specific product, service, or technology that the venture you may be discussing is engaged in, but they do understand business, private enterprise, and their potential for wealth creation.

Advisors should become more receptive to learning to speak the language of their desired target market, rather than continuing to subscribe to the defiled dogmas and outmoded portfolio fallacies (like Modern Portfolio Theory) that have so wantonly wasted wealth and invalidated their perceived value proposition.

Album:   Crisis, Mike Oldfield, 1978

A March 6th Bloomberg story, “Bonds Beat Stocks in ‘Earth-Shattering’ Reversal“, danced on the freshly dug grave of my prior post that rhetorically questioned the Death of Equities. In fact, as the chart illustrates, the patient passed away back in October of 2007 which was the peak for global stocks.

Album:   The Best of Gary U.S. Bonds, Gary U.S. Bonds, 1990