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

Broker Model Needs Repair (Financial Post)

“By charging you 1% annually to manage your money, a large portion of your wealth ends up in his or her pocket.”

Financial Advisers Face a Crisis of Confidence (Investment News)

“About 80% of affluent investors — that is, those with more than $500,000 in investible assets — are disgusted with their adviser because their adviser is spooked”

Album:   Read All About It, The Newsboys, 1988

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

 Venture Populist is the online resource for investors and investment professional to explore portfolio allocations to investments characterized by their probability of positve asymmetrical outcomes; positively-skewed risk/reward ratios that can be achieved via investments such as venture capital, private equity, direct (angel) private investment in start-ups and emerging private and operating cash-flow businesses, private real estate, private debt, franchises, as well as, publicly-traded emerging growth companies, (long volatility) option strategies and other highly-specialized investment strategies perhaps employed by some hedge funds, managed futures and market-timers. 

Venture Populist was created for investors and their advisors that seek to enhance their portfolio’s investment returns through allocations to private investments.

The Venture Populist Manifesto maintains that;

• Modern Portfolio Theory, traditional asset-allocation models and buy-and-hold investing have been materially discredited over the past 80 years.
• Black swans do exist and most portfolios are unprepared for them.
• Asset class correlations are not static.
• Stocks have not delivered their anticipated risk premium.
• Liquidity, safety of principal, income and positive asymmetric outcomes are the most important criteria in building better investment portfolios

Moreover, private investment is the single largest creator of private wealth. With proper dedication, individual investors and their advisors can educate themselves to become more familiar with best practices in evaluating and allocating to private investment opportunities.

Venture Populist advocates investor education and the legislation of regulatory and tax policies that maintain a marketplace which enables individual investors to pursue the creation of private wealth through private investment.

Album:   Welcome, Santana, 1973