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.

Private Equities: How Lower Liquidity Leads to Lower Risk

Despite an abundance of evidence about the benefits of adding alternative investments to their portfolio, most investors continue to hold just traditional assets. Given the economic turmoil of the past few years, it’s no wonder investors remain risk averse. Many investors do not realize that what they consider “safer” actually adds more risk – and lower returns – versus a truly diversified portfolio.

Adding investments in illiquid private equities – companies that are not publicly traded – are a great option for achieving long-term wealth appreciation. While it may seem counterintuitive, if you have a long-term time horizon, illiquidity creates the benefit of lower volatility. Traders cannot move in and out of private equity investments in seconds, which has become a trademark of today’s stock market investor, whether an individual or financial institution. Valuations, in turn, are closer tied to company performance and fundamentals and suffer fewer shifts and shocks.

David F. Swenson, in Pioneering Portfolio Management, recognizes that liquidity should be avoided, not pursued, because in a properly diversified portfolio it results in lower overall returns. Swenson further suggests liquidity disappears when you need it most, and becomes available for private companies as they grow.*

Looking for a faster, more efficient way to find alternative investments for your portfolio? Grolio is your alternative assets marketplace. Join Grolio now and search investments in minutes.

Sources: https://en.wikipedia.org/wiki/David_F._Swensen and http://seekingalpha.com/

Overview of the Endowment Model

The endowment model, often referred to as the “Yale model,” refers to an investing strategy developed by David F. Swensen and Dean Takahashi. Swensen has been the Chief Investment Officer at Yale University for almost 30 years.

Consider three key theories behind this widely accepted strategy.

1.     Diversification. The endowment model teaches that by choosing a variety of uncorrelated asset classes you’ll yield higher returns. Investors are encouraged to divide their portfolio into five or six asset classes. The model also highlights a bias towards equity.

2.     Risk increases with similar or opposite funds. Swensen’s theory is that funds should be different, but not opposite, to decrease risk. Similar funds are too volatile because losses would be felt too greatly if that market takes a hit. Conversely, selecting funds that are opposite will not yield as much return because when one investment is doing well, the opposite one is most likely doing poorly. Gains and losses would ultimately cancel each other out.

3.     Less liquidity is good. This idea was quite revolutionary when Swensen revealed his model. The endowment model teaches that investors pay a premium for liquidity, thus lowering return. Swensen also suggests liquidity disappears when it is needed most. Thus, this strategy focuses more on alternative investments, such as private equities, hedge funds and venture capital.

The endowment model’s name comes from the long, successful track record on behalf of university and other endowments and family offices. These organizations are generally focused on long-term appreciation over immediate cash needs. The Yale and Harvard endowments have reported returns of between 15 and 16 percent over the last 25 years.

Interested in achieving true portfolio diversification and long-term wealth appreciation?  Join today to be notified when Grolio launches.

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

Regulation D Rule 506 – A Primer

In the United States, selling securities generally requires registering with the United States Securities and Exchange Commission (SEC), in accordance with the Securities Act of 1933. There are qualifications that exempt a fundraiser from having to register with the SEC, which are outlined in Regulation D of that Act.

Regulation D Rule 506 provides a “safe harbor” under Section 4(2) of the Securities Act. An issuer using the Rule 506 exemption can raise an unlimited amount of funds. The purpose of this exemption is to aid small businesses and entities that may not be able to afford the registration fees of the SEC. In order to be in compliance with Section 4(2) exemption, the following standards must be upheld:

• The offering must be “private“; the fundraiser cannot use general solicitation, or advertising, to attract potential investors.
• The fundraiser may sell securities to an unlimited number of accredited investors.
• Issuers may also sell securities to up to 35 non-accredited, “sophisticated” investors. These investors must have credentials that enable them to properly evaluate the merits and risks of the potential investment. Due to the incremental effort of ensuring sophistication, many issuers forego the opportunity to sell to non-accredited investors.
• The company or fundraising entity must make itself available to answer questions from prospective buyers.
• The issuer chooses what information they provide to prospective investors, provided it does not violate the antifraud prohibitions of federal securities laws.
• The financial statement requirements for financial documents are the same as for Rule 505 of Regulation D.
• Investors receive “restricted securities” which cannot be resold for at least a year without registering them.

Using a Rule 506 exemption does not completely eliminate documentation to the SEC; a “Form D” – a brief summary of the names and addresses of the company’s owners and stock promoters – must be filed after their first sale closes.  Unlike registered securities, the Form D is a simple document with minimal disclosures.

For accredited investors, Grofolio is your digital market for finding private placements to diversify your portfolio. Please contact us to learn more about Reg D Rule 506 offerings or alternative assets.