Regular readers of this column frequently inquire as to which alternative asset classes or investment strategies may have risk-return characteristics that are similar to direct investments in startups and early-stage private ventures.
These pings often come from wealth managers who recognize direct private venture investments (PVI) not only as a compelling asset class, but also as a business practice differentiator and game-changing value proposition for their advisory firm. However, despite their interest in PVI, they lack the access to deal flow, due diligence skills, regulatory latitude, HNW client base, or, simply the compulsory cojones to actually allocate their client capital to private ventures.
Other advisors have embraced the progressive precepts of Hybrid Portfolio Theory yet require more accessible investment products than direct investments in private ventures to populate Portfolio B—the 15% to 30% of the alpha-producing portion of the portfolio that seeks positive asymmetric investment outcomes.
I have always maintained that specialized managed futures, distressed, deep-value securities and out-of-the-money option strategies have the asymmetric return profiles that are required to fulfill Portfolio B's mandate. But for many investors and advisors, these aforementioned strategies are as arcane, elusive and illiquid as investing in PVI. Many investors simply do not have the investment horizon required to successfully harvest venture investments. They require liquidity—not lockups.
The Illiquidity Premium
Fortunately, there remains a compelling asset class for the more pedestrian advisor seeking leptokurtosis in exchange-traded investments—specifically, among less liquid publicly-traded stocks.
Relevant research and return data indicate that there is a seemingly-significant semblance between the returns of venture capital and less liquid, publicly-traded small company stocks.
In 2004, John Cochrane, finance professor at the University of Chicago's Booth School of Business, published "The Risk and Return of Venture Capital" which examined whether individual investments in venture capital projects "behave the same way as publicly-traded securities" and which kind of securities they resemble.
