No Volatility, No Risk?
Private assets, sometimes called “alternative investments,” are investments that do not trade on a public exchange and do not neatly fall into any traditional asset class. A short list would include real estate, hedge funds, private equity and credit, venture capital, and collectibles (art, autos, etc.). Basically, investments that are only available to accredited investors or institutions but not the general public. Promising low volatility and diversification, there has been a push to make them more widely available by listing them publicly. This has led to some nasty surprises, some of which are applicable to options trading and can be indicative of some very real risks that most investors ignore.
Since private assets are usually contained within a fund, the fund’s value is stated as its Net Asset Value (NAV), or (Total Assets – Total Liabilities) ÷ Total Outstanding Shares. Total Assets are the market value of the fund’s investments, and here’s where the private to public transformation gets tricky. Since many private assets are illiquid with extremely wide bid/offer spreads, and are only valued monthly, quarterly, or annually, the fund’s assessment of their value may vary significantly from that of the market’s. Combined with long lock-up periods (i.e., investors can only sell at specific times, and then only specified percentages), and investors can be in for quite a shock.
Several real estate and private credit funds have gone public over the last few months and have been routed their first day of trading. Take Bluerock Private Real Estate Fund (BPRE). The fund closed at $14.70 on its first day of trading on the NYSE, a 39.7% loss from the $24.36 NAV published just the previous Friday. Although the fund had warned investors that it may trade below its NAV, and partially reflected pent-up selling pressure from investors previously constrained from doing so, I don’t think they were expecting almost 40% lower. A similar story enfolded for the FS Specialty Lending Fund (FSSL), which published a NAV of $18.60 per share and then began trading 10 days later at $14 per share, 24.7% lower. The fund warned about “substantial discounts,” but almost 25% lower?
Private funds advertise that they are immune to the daily price fluctuations characteristic of public markets and only produce valuation on a periodic basis. There are at least three problems here. First, not seeing volatility doesn’t mean it doesn’t exist and can lead one to think that the investment is less volatile than it actually is. Monthly, quarterly, or annual valuations conceals the funds’ true risk and can leave investors in the dark. Second, private valuations are not susceptible to the discipline of daily mark-to-market. No matter how dysfunctional the markets can be at a particular time, assets are only worth what the market is willing to pay for them. Hopes and dreams or one’s opinion on what they are really worth have nothing to do with it. And third, bid/offer spreads on illiquid instruments can be extremely wide. The more illiquid or esoteric, the wider the spread. Hence, the shock that most experience when they try to sell their art, classic cars, coins, or small gold bars. The values published are usually not the price at which you can liquidate the asset.
The last point is applicable to options, particularly relatively illiquid deep out-of-the-money strikes. Bid/offer spreads can be very wide, and the settlement price might not represent the value at which you could liquidate your position. In other words, the value of your portfolio might be overstated. Institutional trading desks deal with this by subtracting a liquidity premium (usually a few percentage points, but it varies widely) from their mark-to-market. You should too.
Who’s the GOAT?
People love lists, and the end of every year brings a fresh batch. In the world of investing, this year brings a unique twist. As you may know, Warren Buffett is finally retiring at age 95. Naturally, many are now asking if he was the greatest investor of all time. As with most “who’s the greatest” arguments, the issue isn’t coming up with candidates, but putting them in order. You can come up with seemingly objective criteria, and try to apply them consistently, but it’s more difficult than it seems. Subjectivity inevitably seeps into the process.
Regardless, the question “Who is the Greatest Investor of All Time?” seems to have been settled. Return seems to have been the main criteria, but others such as longevity, strategy innovation, and consistency all played into the results. Here’s the top three:
- Warren Buffett. Berkshire Hathaway’s returns are indisputable: 20% CAGR since 1965, about 140X more than the S&P returned during the same period. If you gave Buffett $10,000 to invest in 1965 when he started, it would be worth $550 million today (what were my parents thinking?!) Add common sense, the simplicity of value investing, folksy Midwestern charm, and an unparalleled reputation, and Buffett wins every time.
- James Simons. Much less well known outside of investment circles, he was the original mysterious quant and changed the investment game forever. His firm, Renaissance Technologies, had more PhDs than traders, and was constantly searching for hidden patterns. Evidently, they found them: Simons’ main fund, Medallion, is arguably the most successful hedge fund in history, averaging 66% gross annually from 1988 – 2021; $100 invested in 1988 would have grown to $2.1 million by 2021. In addition, Simons knew how to make money personally: he didn’t charge the usual 2 and 20 but received an astronomically high 5% management fee and 44% of profits after 2000. No wonder he was worth about $31 billion at the time of his death last year.
- Peter Lynch. Not as well-known now as in the 80s, he was the PM of the Fidelity Magellan mutual fund and grew it from a paltry $18 million in 1977 to $14 billion in 1990. During that time, he averaged 29.2% CAGR without leverage or the ability to go short. Combining common sense (know what you buy, ignore what you don’t) and a best-selling book (“One Up on Wall Street), he dominated the Street and the financial press in the 80s. He retired at age 46 in 1990 after only 13 years. Part of his talent was knowing when to get out.
Others are mentioned, such as Jesse Livermore, George Soros, John Templeton, Paul Tudor Jones, Hetty Green, Cornelius Vanderbilt, Jay Gould, etc. Everyone seems to have a favorite.
I would point out that most candidates put forth were from recent times. That’s natural, but I could make the case that comparing investors across different time periods isn’t necessarily valid. Investing before the Securities Acts of 1933 and 1934, when stock manipulation, bribery, and inside information were common, or before 1913, when federal income taxes were instituted, was entirely different from today’s highly regulated environment. Stock ownership, which is now over 60% of the US population, was less than 1%, and overwhelmingly a rich man’s game.
The argument is interminable, and ultimately, it’s inconsequential. What is important are the characteristics that all the top investors have in common and what you can learn from them.
And finally, never underestimate the role of probability. Each one of these investors had innovative strategies, investing discipline, and staggering returns. However, I suspect that other investors had a similar combination and for whatever reason did not perform as well. Did random chance enter into their success?
**********
I wish you all Happy Holidays and will be back in 2026!