Everyone loves a Venn diagram. One of my industry friends insists the single best way to get a ton of views, likes and retweets on LinkedIn or Twitter is to build a pithy Venn. If it’s actually scribbled on cocktail napkin, so much the better.

As a case in point, last week there was an article in The New York Times that showed the “benefits” of hedge funds on one simple Venn diagram.  As my daddy always says, it was PFM - Pure Freaking Magic. 

Source: The New York Times

Source: The New York Times

Of course, me being me, I did have a slight problem with this drawing. Besides the obviously fake napkin motif, it was, in my opinion, a somewhat Venn-dictive Venn.  

For example, when I look at the intersection of the three characteristics diagrammed (expense, appeal to rich people, don’t work well), I see a lot of more likely suspects than hedge funds.

Jaguars, for example. In 2013, Consumer Reports had not one but two pricey Jaguar models on their “Least Reliable” list, leading one magazine to quip that dependability was “in the crapper.” I think that’s a technical term.

And then there’s the laundry list of other things that are expensive, don’t work very well and are loved by rich people. Pre-nups, trophy wives and pool boys all make appearances on this list. Oh, and draping cashmere sweaters over your shoulders. Who the hell came up with that?

But I digress.

The problem, as I see it, is that the characteristics (circles) on a Venn are selected by a person who may have biases. Their agenda then impacts everyone who sees the graph and assumes, like many people do when stuff looks scientific, that its conclusion is fact.

What if, for example, we instead graphed some of the benefits of alternative investments (Yes, contrary to a lot of reporting these days there are some) and determined how they intersected to create strong investment opportunities? How does this change the “story” about whether alternative investments are good for investors? Would that provide any Venn-dication?


@MJ Alts

@MJ Alts

Hedge funds, for example, as much as some people don’t want to admit it, do have positive traits. Sure, the average fund has underperformed the S&P 500 in recent periods, but between 2007-2009, the average hedge fund kicked the index’s keister (another technical term), providing valuable downside protection and smoothing volatility. More recently, in January 2015, the S&P 500 dropped about 3%, while the average hedge fund was essentially flat, and diversifying strategies like managed futures and global macro gained 3% and 1.7%, respectively. The markets don’t always rocket straight up. You don’t always have time to wait out a correction. You want to sleep at night. Therefore, hedge funds may actually create some value.

Or think about private equity. Sure you could focus on fees and liquidity. Or you could look at the liquidity premium investors potentially score. Over the past 25 years, US private equity has created a 3.4 percentage point differential over the S&P 500. In fact, it is only during the latest bull market that this asset class has been edged by the indices. In part, these returns are achieved due to streamlining balance sheets and the business, which can be a good thing in and of itself. One study showed that sectors with private equity activity grew 20% faster, while another showed that only 6% of PE backed firms end up in bankruptcy or reorganization, a default rate lower than corporate bond issuers. And because private equity invests in, well, private equity, it can be more insulated from market volatility, lowering an investor’s overall correlations.

And let’s not forget about venture capital. Over the past 15, 20 and 25 years US venture capital has more than doubled the returns of the S&P 500. Even in the leaner, dot.com bubble years, venture capital still performed relatively well. And while the average investor now has access to venture investing through crowd funding platforms, they generally can’t bring in significant follow on financing, they don’t get involved in recruiting, they can’t provide office space, search for acquisitions, etc.

So are alternative investments all rainbows and kittens and puppy dog tails? Of course not. My point is simply this: looking only at the pejorative characteristics of anything is counter-productive. It may cause well-suited investors to eschew what might otherwise be an outstanding investment strategy match. Looking only at the positive characteristics may mislead investors into thinking that fees, frauds, losses and other mishaps don’t happen.

Perhaps our dialog and diagrams about alternative investments just need a little balance. Maybe we could even institute a five circle minimum. Regardless of the approach, it's clear we need a more (pun-intended) well-rounded approach.

Sources: The New York Times, eVestment Alliance, Cambridge Associates, The Atlantic “Is Private Equity Bad for the Economy”

AuthorMeredith Jones