Venture Capital : A Basket Case

Portfolio Construction

The main objective for portfolio construction is to build a suite of investments, from a range of asset classes, that balance the need for cash, protection from market downturns and consistency in returns with your long-term growth objectives.

Integral to the decision process accompanying portfolio composition is correlation.

How different investments are correlated to the performance of the rest of the market. The economic turbulence brought about by Covid-19 initially led to heightened market volatility across most asset classes. Exogenous events often catalyse investors’ search for uncorrelated return strategies. However it is not trivial to find assets whose value isn’t tied to larger fluctuations in the traditional markets. Indeed in times of panic what is often observed is the ‘correlation one’ nature of investments — as market participants liquidate across the spectrum leading to synchronous moves.

Less oft discussed but hugely pertinent in maximising returns and hence in portfolio construction is the concept of asymmetry.

An asymmetric return is the set of possible results of an investment strategy where the upside potential is greater than the downside risk. This is essentially what we are seeing playing out in the listed markets on Robinhood via call options. Asymmetric bets…

Recent world events have to a large degree exposed a dreadful truth. In that probably most of the time we are kidding ourselves about the control and the resilience we have in our daily lives. Be it over society, environment, geopolitics, mental, physical, romantic etc.

As such one should embrace randomness and unpredictability both in life and ones portfolio…

The central concept of Nassim Taleb’s Antifragile is the notion that there are two opposing ways in which something can respond to volatility: fragile things are harmed by volatility, while antifragile systems benefit positively.

If you graph a fragile system, there is limited upside and unlimited downside. If the traffic is very light, you might get to your destination five minutes faster. If it is very bad, it may take an hour. Negative asymmetry.

If you graph an antifragile system, there is limited downside and unlimited upside. Going to cocktail parties is antifragile — you can only lose a bit of time (limited downside) but you could meet someone who will change your life (unlimited upside).

Therefore one should concentrate on assets they perceive to be in the antifragile arena — tech thematic transformational, cleantech or agricultural macro investments have the potential to deliver outsized returns with limited downside via their multiplicative/scalable and asymmetric properties.

This approach to portfolio risk and construction bolsters the case and indeed goes some way to explain the huge asset allocation increase into venture capital and private equity.

Venture funds by their very construction are baskets of asymmetric bets.

Positive risk-reward: The basket case is far from lunacy…

guv@fuel.ventures

(*taylor pearson)