ActiveAllocator Insights

Transcription

1 ActiveAllocator Insights DISCLAIMER: ActiveAllocator.com provides simple and useful analytical tools as well as education to help investors make better financial decisions. We rely on financial data, provided by external parties. The data is believed to be accurate, but is not guaranteed or warranted by us. This presentation is intended only as an informational tool, and should not in any way be construed as investment advice. If you make investment decisions based on information you receive in connection with the site, you do so at your own risk. ActiveAllocator and its employees will not be liable for any losses that you may sustain. Site users should conduct their own independent research and due diligence and obtain professional advice, if necessary, before making any investment decisions.

2 Insight What Are Some Issues in Illiquid Investing?

3 Illustrative ActiveAllocator Considers Illiquidity Effects Shocks to market depth too account for increased risk Price Bid Price Stronger preference for liquidity Supply of liquidity Market liquidity premium Weaker preference for liquidity Offer Demand for liquidity Negative Initial Liquidity Market Shock Depth Lot Size Q Quantity

4 ActiveAllocator Unlocks Multiple Sources of Returns Fundamental Beta Basis Growth Credit Public Debt Potential Excess Returns Skill Alpha Liquidity Security Selection Market Timing Control Value-Added Access and Structure Ceding Options To: Rebalance Reinvest Respond to cash flow requirements Downside Risk Event Risk Optionality Insurance Source: Adapted from CAI Research

5 ActiveAllocator Separates Investments Into Each Source of Return S&P 500 ETF Large Cap Manager Real Estate Fund Private Equity Fund Fundamentals Hedge Fund Skill Liquidity Downside Source: Adapted from CAI Research Major Concerns about Illiquid Asset Classes Risk Shallower markets Restricted exit options How to measure this risk? How ActiveAllocator Addresses These Issues Proxy for Mark-to-market returns Incorporate liquidity risk Three-dimensional portfolios Explicit tradeoff based on individual requirements for liquidity Non-Tradability Rebalancing limited Unforeseen cashflow needs New investment opportunities?

6 ActiveAllocator Addresses Basic Issues Within Illiquid Investments (Cont) Concerns Generally perceived as high risk shallow markets and restricted exit options highest risk when liquidity is needed most problem compounded by the historical failure to appropriately measure this risk How Does ActiveAllocator Resolve? Mark-to-market illiquid asset classes to make them comparable to liquid asset classes, including: market risk liquidity risk Limit the ability to rebalance the portfolio Entail opportunity costs for expenditure and investment needs for liquidity are investor-specific Incorporate the cost of limitations on rebalancing Arrive at personalized allocations according to liquidity requirements to allow investors to reflect individual requirements for liquidity Source: Adapted from CAI Research

7 ActiveAllocator Arrives at Better Correlations and Volatilities Marking-to-Market Model Illiquid Investments Valuation Issues Inconsistent valuation methods Returns are a mix of cash-on-cash and current valuations Not marked-to-market, implying 'stale' prices Lack of historical returns Sensitive to leverage VC -6.6 Reported Returns (% Annual) NASDAQ The basic problem is that the data is measured with error LBO TRUE = LBO OBS + error systematic random ISSUE Incorporate information in existing return data Incorporate information in existing return data Eliminate serial correlation Eliminate serial For Illustrative Purposes Only correlation Filter out remaining systematic error Filter out remaining systematic error Account for for liquidity liquidity risk Incorporate in private markets risk in private markets which we model through a rigorous method The basic problem is that the data is measured with error method Issue APPROACH Use the good parts of the bad data Unsmooth the data Incorporate information in public market (eg S&P, Russell 2000) effects In our view, this process leads to more reasonable (and accurate) estimates of risk and correlations which we model through a rigorous Approach Use the "good" parts of the "bad" data Unsmooth the data Incorporate information in public market (e.g., S&P, Russell 2000,) Incorporate private market effects In our view, this process leads to more reasonable (and accurate) estimates of risk and correlations

8 Marking-to-Market Model ActiveAllocator Arrives at Better Correlations and Volatilities (Cont) Volatility (%) Correlation to S&P LBO Venture Average LBO Venture Average Manager or Benchmark Reported Corrected Data Manager or Benchmark Reported Corrected Data For Illustrative Purposes Only

9 ActiveAllocator Calculates Tradability Premium Average Annual Return (%) Risk vs Return: Traded vs Non-Traded Assets The Tradability Premium and its Drivers 25.0% 20.0% VC Implied Premium Correlation Volatility Typical Lock-up 15.0% LBO Expected Effect 10.0% 5.0% Real Estate Bonds Cash Public Equities Real Estate Leveraged Buyouts Venture Capital 3.1% 5.9% 4.3% % 5.5% 13.8% 7+ years 7+ years 7+ years 0.0% 0.0% 5.0% 10.0% 15.0% Volatility For Illustrative Purposes Only

10 Marking-to-Market ActiveAllocator Recognizes Rebalance Cost on a Dynamic Portfolio Return Optimal Portfolio for particular investor Efficient Frontier Portfolio Drift Rebalancing cost depends on initial allocation to illiquid, risk tolerance, relative returns and risks Risk For Illustrative Purposes Only

11 ActiveAllocator Algorithms Driven by Liquidity Frontiers Historical Expected Return Efficient Frontiers for different levels of liquidity 14.00% 12.00% Minimum % in Liquid Assets 50% 70% 90% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% Source: Adapted from CAI Research Historical Expected Risk For Illustrative Purposes Only

12 ActiveAllocator From Theory to Practice Issues 1. Need a reasonable and consistent framework to associate expected risks and returns with illiquids, both as stand-alone investments and as part of multi-asset class portfolios 2. A process to convert a wide range of client needs to specific and quantifiable risk, return, and liquidity objectives 3. A method to classify all potential illiquid investments, i.e. defining asset classes or sub-asset classes as part of the total portfolio 4. Need to bring this thinking to financial advisors in an easy implementable form usable with clients ActiveAllocator Provides 1. A model built upon robust risk and return forecasting for all asset classes- liquid and illiquid 2. A simple tool to quickly simulate a variety of outcomes to be used collaboratively with clients 3. Standard set of illiquid asset classes to classify client holdings. Flexible and customizable 4. A set of user-friendly tools to construct optimal liquidilliquid portfolios, that are most likely to meet client needs over time

13 In Summary: