Wall St. Cheat Sheet: Here’s a Look at the Rise of Alternative Investments

Earlier today the Wall St. Cheat Sheet published an article by Dave Milliken, CEO of Grofolio. Wall St. Cheat Sheet is one of the largest  financial media companies in the U.S. with over 13,500,000 monthly unique visitors, and was named the #1 Social Media Influencer on Wall Street according to Forbes. The article is posted below. 

The centerpiece of the widely adopted Modern Portfolio Theory is that having a diversity of investments can lead to greater returns without increased risk. But during the financial upheaval of 2008 and 2009, many investors learned the hard way that their assets were too highly correlated. The result: once bitten, twice shy investors have record cash sitting on the sidelines. Grofolio has created an innovative way for accredited investors to put their capital to work again.

Meanwhile, many institutional investor modified their investment approach to follow the Yale Endowment Model. Espoused by David F. Swenson, Yale’s Chief Investment Office since 1985, the endowment theory: 

• Have a strong bias towards equities
• Suggests less liquidity is good; that investors pay a premium for liquidity and there are rewards for investors who can hold assets for a long period of time

The popularity of the Yale Endowment Model has led to an explosion in alternative assets — generally private equities, including direct investment in individual companies and funds. A McKinsey and Company report titled “The Mainstreaming of Alternative Investments” showed that alternative assets, or alts, increased from 7.7 percent to 14.3 percent of total global assets under management between 2005 and 2011. The same report said institutional investors planned to increase allocations to almost all alternative classes in 2013.

Diversification underlies adoption of alternative assets. By placing capital across investment categories, investors can earn higher returns without greater risk – a free lunch. The chart below shows correlation across asset classes. A correlation of 1.00 means assets move in perfect tandem; when one increases by 10 percent, so does the other. A 0.00 correlation indicates no relationship between returns. The graph of one year (ending August 28) returns shows the real world result — major US and international indices move in tandem, virtually the equivalent of no diversification.

The results of adding private equities into a portfolio? Harvard’s endowment achieved 12.5 percent annualized returns over the last 20 years, including the financial meltdown, according to The New York Times.

Retail investors trail institutions in the shift to alts, which account for 9 percent of the global retail market, versus 16 percent for institutions. High net worth investors individual adoption is lower due to the time and complexity of investing in them. By their very nature, there is less public, third-party information. Further, the variety of alternative investment classes makes it hard for an individual to evaluate and build a portfolio.

The amount of dollars at stake is astounding. The World Bank measures total U.S. market cap at $18.7 trillion. If retail investors, who Columbia Business Law Review says own 26 percent of equities, catch up to institutions in terms of allocations in alternatives, that would mean $327 billion shifted away from traditional assets.

Innovative alternative investment marketplaces like Grofolio seem poised to spur widespread adoption of alternatives by HNWI, who can afford longer investment horizons. Grofolio makes it easier and more efficient for HNWIs to identify, evaluate, and invest in the right alternatives for their portfolios. This, in turn, should release the excess capital ‘sitting on the sidelines’ while providing the capital necessary to grow America’s small businesses.

Dave Milliken is the CEO of alternative investment marketplace Grofolio.com. Dave has extensive marketing leadership experience with MillerCoors, Louis Vuitton Moet Hennessey, The Scotts Miracle-Gro Company, and Smashburger, #99 in the 2011 Inc. 500. Dave holds an MBA, finance emphasis, from NYU and a BBA from Emory University.

Flashback: Grofolio presentation at [i4c] Campaign Finals

A year ago, Grofolio, then Funding Launchpad, presented to an audience of 1,000 as part of the [i4c] Campaign finals at Denver’s Ellie Caulkins Opera House. This presentation’s focus was the potential social impact of expanding access to capital to America’s startups and growth companies.

Alternative Assets: Complex, Risky, and Rewarding

Alternative investments tend to be more complex and less burdened by regulations than traditional assets – public stocks and bonds. As one might expect, investing in greater complexity and risk can lead to higher returns. Within a broader investment portfolio, alternative investments provide diversification; alternative assets generally have low correlation to traditional assets – public stocks and bonds. Hence, alternative investments are becoming more mainstream.

50% of the US GDP, and 65% of new jobs, are created by private companies. Given the large contribution to the economy, private firms represent a massive investment opportunity. Therefore, private equities, despite being labeled as alternative, represent a significant portion of the economic landscape.

Fees, risks and complexities notwithstanding, alternative investments are a great option for pursuing above market returns in an environment where interest rates  hover near zero percent and over a trillion dollars remain “sitting on the sidelines”.

Sign up for Grolio’s beta to learn more about alternative investment opportunities through the Grolio marketplace.

Is Modern Portfolio Theory Valid in Today’s Economy?

The ideal portfolio for any investor would be low risk with a high return. Unfortunately, investing isn’t that simple.

The best known solution to the risk/reward equation is modern portfolio theory (MPT). This theory suggests that a variety of investments, when combined, bring greater returns without increasing risk.  MTP was introduced in 1952, by Harry Markowitz, and made the assumption that investors did not want to take risks. While innate investor risk aversion remains, some question whether the MPT remains a valid theory in today’s market.

The basis for the MPT is portfolio diversification.  MPT has been questioned recently due to seemingly repetitive financial crises.  There are those who believe that due to the unknown factors in today’s uncertain economy, a new theory needs to be developed to handle the current investment environment.

However, there are many factors that make the MPT as valid today as it was in 1952, according to Paul Pfleiderer, in his article Is Modern Portfolio Theory Dead? Come On.  The basic fact of investing is that investors are rewarded for taking higher risks. However, not all risk is rewarded, such as risks that can be diversified away by holding bundles of investments. When an investor holds large quantities of high risk stock, they face diminished return given their risk. However, a portfolio that is diversified is based on several holdings with risk. The fluctuation of one stock does not have the same affect. MPT focuses on building a diversified portfolio, which works well in an uncertain environment, such as today’s economy.

Accredited investors and institutions are increasingly further diversifying into alternative assets, including private companies, hedge funds, venture capital, and real assets. Alternative assets generally demonstrate very low correlations with traditional assets. These assets are also generally less liquid. Investors who include alternative assets in their portfolio seek long-term wealth appreciation without the regular fluctuations of the public stock market.

Interested in adding alternative assets into your investment portfolio? Sign up for Grolio now to be notified when we launch later this summer.

Asset Correlation Matrix

The table below highlights the importance of portfolio diversification. By diversifying across traditional and alternative asset classes, investors earn a free lunch – higher returns without greater risk.

A correlation of 1.00 means assets move in perfect tandem. When one increases by 10%, so does the other. A 0.00 correlation indicates no return relationship between asset classes.

The correlation matrix below reflects Yale University Investments Office’s assumptions about future interrelationships.

	U.S. Equity	U.S. Bonds	Developed Equity	Emerging Equity	Absolute Return	Private Equity	Real Assets	Cash
U.S. Equity	1.00
U.S. Bonds	0.40	1.00
Developed Equity	0.70	0.25	1.00
Emerging Equity	0.60	0.20	0.75	1.00
Absolute Return	0.30	0.15	0.25	0.20	1.00
Private Equity	0.70	0.15	0.60	0.25	0.20	1.00
Real Assets	0.20	0.20	0.10	0.15	0.15	0.30	1.00
Cash	0.10	0.50	0.00	0.00	0.35	0.00	0.30	1.00

Source: Pioneering Portfolio Management, An Unconventional Approach To Institutional Investment, David F. Swensen, 2009