W E A L T H C A R E C A P I T A L M A N A G E M E N T : w h i t e p a p e r
The Alternative To Alternative Classes
DAv I D B . L o E P E R , C I M A , C I M C ChairMan/CeO
600 east Main Street, richmond, Va 23219 p 804.644.4711 f 804.644.4759 www.wealthcarecapital.com
W E A L T H C A R E
C A P I T A L
M A N A G E M E N T
I've written many controversial papers before, but this one will certainly have me looking under my car before I get in and turn the ignition. The topic is "alternative investments," an asset class that is growing more in popularity with each negative year we add on to the bear market in stocks. Calling "alternative investments" an asset class is a bit of a misnomer when compared to other classes like cash equivalents, equities, or fixed income. Most asset classes have some fundamental characteristics that logically permit them to be assembled into an asset class. For example, any investment of high credit quality and ultra-short duration is considered a member of the cash equivalent class. Any stock, be it foreign or domestic, large or small, high yield or no yield, still represents ownership of a for-profit (or attempted profit) enterprise. Even all the variations of fixed income be it short or perpetual, junk (sorry, did I mean to say the more politically correct "high yield" ) or government backed, zero coupon or inflation indexed, still represents investments that are a loan to an entity, which is why they are also known as debt. But what makes "alternative" investments interesting is there are no fundamental characteristics that tie them together, other than they do not belong in traditional asset classes. Here we have the world of hedge funds and managed futures, private equity, leveraged buy-out funds, mezzanine financing funds, and venture capital, to name just a few. It is an asset class made up of "misfits" where membership is determined by having no other club where one would be welcome. There are some things that I wish to be clear about. First, I am not against these investments, and in various fiduciary roles I have had in my career, I supported and was on record as voting in favor of placing well over $1 billion of assets in such investments. I have therefore willingly put other peoples' money where my mouth is. When I served on the investment advisory committee for the virginia Retirement System, I voted against terminating their revolutionary managed futures program (my vote was not enough to prevent the demise of the program). Finally, the funding for my company came from venture capital funds (in addition to many individual "angels"). There are many reasons and rationale for these investments. Capitalism works. As both benefactor and beneficiary of such vehicles, one might think I would have nothing but praise for such investments. Those that would think I would have such an opinion…praise without objective consideration...do not know me. While there are some potential positives to these investments for certain purposes, that does not mean that they are free from their share of potential problems. This is not to say they are uniformly "bad," it is merely a statement that says there are some things we need to think about with these investments and it is our job to objectively consider them. Unfortunately, many professionals evade the effort of this thoughtful consideration once they cross the line of "not all bad, and potentially good." This approach leads them into a trap by moving from what we do know about these investments into a realm of making assumptions about them that we simply do not have the evidence to support. Even worse, by accepting some of these erroneous assumptions, these professionals may take previously better assumptions that are more material, and makes those material assumptions erroneous and contradictory. The result is materially misleading information. I've often wondered how we ended up in this position as an industry. There are two fundamental causes. First, we cannot escape the fact that many in our industry are not sufficiently knowledgeable about what they are doing. Second, we have many in the software industry that add features to their software based on this wider universe of potential users that are not sufficiently knowledgeable. This combination does nothing other than perpetuate and broaden the misuse and has the effect of encouraging previously or potentially competent users down the road of misinformation. For example, if you examine the software market for mean variance optimizers, observe that there are none of any significant market penetration that do not enable the user to set allocation "constraints." So

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