Alternative Assets: Complex, Risky, and Rewarding

June 18, 2013 Dave Milliken

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”.

Overview of the Endowment Model

June 10, 2013 Dave Milliken

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 Grofolio launches.

Can You Hold Alternative Investments in Your IRA?

June 6, 2013 Dave Milliken

The Individual Retirement Account (IRA) has become one of the most popular tax-advantaged investment vehicles used by Americans today. It was recently estimated that four out of 10 U.S. households owned assets in IRAs[1], accounting for over a quarter over all U.S. retirement wealth[1]. Moreover, eight out of 10 households have retirement savings that may eventually rollover into an IRA[1]. Because IRA ownership is generally associated with higher net worth investors[1], properly diversifying IRA assets has become an integral part of any shrewd investors’ overall retirement savings strategy.

However, IRA assets must be held with a qualified custodian, and because most custodians lack expertise in alternative investments, IRA savings are commonly limited to traditional investment options like stocks, bonds, or mutual funds. For this reason, most investors are surprised to learn that the Internal Revenue Code has always allowed IRA owners to invest their tax-advantaged assets in a broad range of alternative investments. That’s right— diversifying your retirement plan to include hedge fund assets, private equity or other investments in private companies is within reach. As U.S. investors continue to seek out alternative investments to complement their retirement savings, more custodians are expanding the scope of investments they allow their customers to hold in their retirement accounts.[2]

Why consider alternative investments in your IRA? One must only look back a few years to the recent financial crisis for a startling answer. Retirement assets suffered some of the steepest losses during the financial crisis, in part because of the non-diversified traditional investments held therein. Allocating retirement savings to alternative investments—like hedge funds, private company investments or venture capital—is no longer simply fodder for cocktail-hour bluster, but rather a sensible way to broaden asset diversification, a proven strategy to reduce volatility in a portfolio’s performance, and even increase the potential for higher returns over time.

The mission of Grofolio is to provide greater access to alternative investments. Grofolio makes it easier and more efficient for all accredited investors to find, search, sort, and filter alternative investments to identify the best fits for their portfolio—whether the investable assets are qualified under an IRA or not. Grofolio also offers the chance to interact with other potential investors.

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

(Grofolio recommends talking to a qualified tax consultant before investing retirement assets in alternative investments).

[1] http://www.ici.org/pdf/per18-08.pdf

[2] E.g. Equity Institutional (http://equityinstitutional.com), or Millennium Trust Company (http://www.mtrustcompany.com)

Is Modern Portfolio Theory Valid In Today's Economy?

May 31, 2013 Dave Milliken

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 Grofolio now to be notified when we launch later this summer.

Why Invest in Alternative Assets?

May 23, 2013 Dave Milliken

When thinking about their investment portfolios, most investors think of traditional assets – stocks, bonds, and mutual funds. The last decade has proven that traditional assets are not as safe or sure as once thought. Although seemingly separate and independent, returns for these asset classes are too highly correlated; as one experienced difficulties, so too did the others. Investors found that their portfolios were not as diversified as they had thought.

This is where alternative investing comes in. Alternative investments cover a wide range of instruments with two things in common; they are not traditional and their performance is not linked to the returns of traditional assets. As Investopedia notes, “Alternative assets come in many varieties, but a common thread is their low correlation coefficients with both equities and fixed income.” A low correlation means that when the traditional investments are experiencing difficulties it will not affect or have very little effect on your alternative investments.

Hence the increase in interest in, and dollars flowing into, alternative assets. They provide a “measurable degree of independence from systematic market risk factors.” Instead of having the appearance of diversity, your portfolio will in fact offer a free lunch - both higher returns and lower risk.

Historically, investing in alternative assets was generally limited to endowments, pension funds, and family offices managing investments for a wealthy family. Only these groups had the manpower and experience to identify appropriate investments for their portfolios. Minimum investments were also out of reach for all but institutions and the highest net worth investors.

Grofolio’s mission is to provide greater access access to alternative investments. Grofolio makes it easier and more efficient for all accredited investors to find, search, sort, and filter alternative investments to identify the best fits for their portfolio. Grofolio also offers the chance to interact with other potential investors.