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Wisdom & Fair Warning
Laurence Neville
04/01/2004
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Wheat and Chaff
Citigroup has developed a platform called Whole Net Worth
Asset Allocation that attempts to more accurately adjust for the problems of
misvaluation and stale pricing in private equity and to better reflect the
correlation between public equity and private equity. While its specific
workings remain proprietary, its conclusions are illuminating.
“After our
adjustments we have found a doubling of the risk in venture capital investments
compared to available indices,” says Rosenberg. “The likely outcome is that a
client, given a specified risk tolerance, would reduce private equity exposure.”
The firm still believes these assets to be solid investments over time, he
adds.
With traditional assets—and, therefore, in traditional asset allocation
models—there is an assumption that positive and negative investment returns
are equally likely (that is, that they have a normal distribution around the
mean, and form a bell curve when graphed). But the research by Citigroup has
shown that some investments are skewed negatively, according to Rui de
Figueiredo Jr., leader of research for Citigroup Alternative Investments and
associate professor at the Haas School of Business at the University of
California, Berkeley.
One explanation of this, relating to venture capital in
particular, is that when an investment goes awry, there is little to salvage,
since the companies involved are so young. With leveraged buyout funds, the
businesses already exist and throw off revenues; the private equity fund’s
intent is to improve efficiencies and leverage. Even if the latter effort fails,
the fund still owns a company with cash flow. “For investors, this does not make
these [venture capital] investments unattractive; it just means that they should
incorporate these risks into their thinking about how these investments might
perform,” argues de Figueiredo. Additional Information
 Picking Winners
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