Asset Allocation for Private Investments

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manlymatt83
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Joined: Tue Jan 30, 2018 8:23 am

Asset Allocation for Private Investments

Post by manlymatt83 »

This forum makes it trivial to understand asset allocation in a three fund portfolio - TSM + Fixed Income, rebalance between both.

It also seems clear to me how people handle "tilts". For example, if you have a 20% SCV tilt, that just becomes a percentage of your equity holdings as compared to bonds.

But when it comes to holding assets such as private investments, especially those you hold from the past, can't exit, but no longer plan to add to, how would you factor those into your total allocation?

For example ... assume a hypothetical 1MM portfolio, with $50,000 of private investments that have a theoretical value, but won't see actual returns for years or maybe even decades. Would you take a certain % of your total allocation (say 5%?) and allocate that to these "alternative investments", and split the remaining 95% between TSM/Bonds? Or would you factor the value of these private investments directly into your TSM calculations, even though they don't represent TSM?
123
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Re: Asset Allocation for Private Investments

Post by 123 »

Private Investments could be a lot of things but it could be handled similiarly to real estate holdings which some people like. Since private investments, like real estate generally, cannot easily and economically be reallocated elsewhere it is probably best to just leave it out of the asset allocation. So a formula like "Investable Assets = Net Worth - Private Investments - Home Equity - Real Estate - Emergency Fund" allows you to allocate what you can easily invest at market prices.

There are other things that are generally excluded from investable assets for most people like precious metals, crypto-currencies, commodities, oil and mineral rights, timber, farm land etc. They are still part of your net worth but lack the flexibility to be easily exchanged to stocks or fixed income at (usually) a fair value due to more limited markets and need for trading expertise.
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dbr
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Re: Asset Allocation for Private Investments

Post by dbr »

From the other thread:

It is both a good question and would be an interesting thread. The question also applies to how to treat a large position in an individual stock among mutual funds and may also apply to the frequently asked question of how to account for real estate in a portfolio. Note that university endowments comprise all sorts of odd assets and are yet managed as a portfolio. To anticipate, the issue hinges on how to ascertain the expected return, the expected volatility (perhaps standard deviation of periodic returns), and the correlation of periodic returns between this asset and the other assets. At least that is the traditional model expected in portfolio theory. From this information one can derive the expected return and the expected volatility of the portfolio in order to (hopefully, very hopefully)* make decisions about what proportions to hold.

*I wonder what the grammarians say about using a parenthetical expression to split an infinitive.

Other options are to finesse the question by just calling it a stock and that is close enough. If you aren't going to actually do some kind of portfolio theory analysis then that is going to be good enough. I agree with Taylor on that.

The suggestion to leave it out of the portfolio altogether would also make sense is if is just too different to meaningfully compare to other investments, especially if it is too small to care. Most ordinary investors don't include the house as part of an investment portfolio. That is not because a house is not an investment but because it is too hard to make sense of it in the same terms as stock and bond mutual funds. A person would have the same problem with owning timberland, an art collection, and so on. The special case of unexercised incentive stock options, for example, might be finessed by counting them as income when then are exercised and as potential future income before they are exercised, but not as a portfolio asset at all. Note such options are actually leveraged holdings in the underlying stock but with a floor and optionality.

Etc.
Topic Author
manlymatt83
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Re: Asset Allocation for Private Investments

Post by manlymatt83 »

Interesting. I never really thought about not counting these types of investments as part of your overall asset allocation. But you’re right, they are static and can’t really easily be liquidated. I may just take a step back and think about making these part of my net worth, but for asset allocation purposes not really considering them. Whatever happens to them happens to them, but I can consider that in isolation.

But I guess that doesn’t make sense for something like crypto, precious metals, even more liquid private investments where they can double in value (or loss half their value) overnight and you have some control. In that case, even if not rebalancing INTO them, maybe you decide to take profits.

I definitely know that if my private investments lost half of their value overnight, I wouldn’t seek out new ones just to rebalance back into “5%” or whatever.
000
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Re: Asset Allocation for Private Investments

Post by 000 »

manlymatt83 wrote: Fri Sep 25, 2020 2:33 pm Interesting. I never really thought about not counting these types of investments as part of your overall asset allocation. But you’re right, they are static and can’t really easily be liquidated. I may just take a step back and think about making these part of my net worth, but for asset allocation purposes not really considering them. Whatever happens to them happens to them, but I can consider that in isolation.
I would consider any significant asset part of my asset allocation, including alternatives and unlisted/private assets.

If an asset is liquid (crypto, precious metals ETFs), rebalancing is easy.

If an asset is illiquid, the sector exposure of the liquid portfolio could be managed to help maintain some target allocation. The example presumably most relevant to the most people is real estate. For an investor desiring a fixed total portfolio exposure to real estate, publicly traded REITs could be used to maintain a consistent allocation. The same can be done by owning a combination of physical precious metals and precious metals ETF.

For an investor in an illiquid and highly differentiated business (e.g. tech startup), it will be more difficult to do this until the business does well enough to have a liquidity event. It is still worth considering the exposures one has in such a business though. A startup employee/investor might wisely decide to increase exposure to tech giants because of the possibility they outcompete the startup and decrease exposure to small caps.

Even if you cannot rebalance with an asset to maintain a constant percentage allocation, that does not mean you shouldn't consider the role of the asset in the broader liquid portfolio allocation.
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manlymatt83
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Re: Asset Allocation for Private Investments

Post by manlymatt83 »

000 wrote: Mon Sep 28, 2020 8:33 pm
manlymatt83 wrote: Fri Sep 25, 2020 2:33 pm Interesting. I never really thought about not counting these types of investments as part of your overall asset allocation. But you’re right, they are static and can’t really easily be liquidated. I may just take a step back and think about making these part of my net worth, but for asset allocation purposes not really considering them. Whatever happens to them happens to them, but I can consider that in isolation.
I would consider any significant asset part of my asset allocation, including alternatives and unlisted/private assets.

If an asset is liquid (crypto, precious metals ETFs), rebalancing is easy.

If an asset is illiquid, the sector exposure of the liquid portfolio could be managed to help maintain some target allocation. The example presumably most relevant to the most people is real estate. For an investor desiring a fixed total portfolio exposure to real estate, publicly traded REITs could be used to maintain a consistent allocation. The same can be done by owning a combination of physical precious metals and precious metals ETF.

For an investor in an illiquid and highly differentiated business (e.g. tech startup), it will be more difficult to do this until the business does well enough to have a liquidity event. It is still worth considering the exposures one has in such a business though. A startup employee/investor might wisely decide to increase exposure to tech giants because of the possibility they outcompete the startup and decrease exposure to small caps.

Even if you cannot rebalance with an asset to maintain a constant percentage allocation, that does not mean you shouldn't consider the role of the asset in the broader liquid portfolio allocation.
Helpful... I'm not sure I understand the increase of exposure to tech giants if you're at a startup. Can you explain that again? And why would you want to decrease exposure to small caps - if you're in tech, say working for Amazon, wouldn't you want to decrease your exposure to big tech and increase small cap exposure for diversification?
000
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Re: Asset Allocation for Private Investments

Post by 000 »

manlymatt83 wrote: Mon Sep 28, 2020 8:38 pm Helpful... I'm not sure I understand the increase of exposure to tech giants if you're at a startup. Can you explain that again? And why would you want to decrease exposure to small caps - if you're in tech, say working for Amazon, wouldn't you want to decrease your exposure to big tech and increase small cap exposure for diversification?
My example was for a tech startup, not Amazon.

If I work and/or invest in a tech startup, I might increase exposure to large cap tech and decrease exposure to small cap tech because the tech startup is most similar (among liquid stocks) to small cap tech stocks and there would seem to be a decent chance that one of the tech giants eats the tech startup's lunch.

If I work and/or invest in Amazon, I might do the opposite or reduce overall tech allocation.
Topic Author
manlymatt83
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Re: Asset Allocation for Private Investments

Post by manlymatt83 »

000 wrote: Mon Sep 28, 2020 8:46 pm
manlymatt83 wrote: Mon Sep 28, 2020 8:38 pm Helpful... I'm not sure I understand the increase of exposure to tech giants if you're at a startup. Can you explain that again? And why would you want to decrease exposure to small caps - if you're in tech, say working for Amazon, wouldn't you want to decrease your exposure to big tech and increase small cap exposure for diversification?
My example was for a tech startup, not Amazon.

If I work and/or invest in a tech startup, I might increase exposure to large cap tech and decrease exposure to small cap tech because the tech startup is most similar (among liquid stocks) to small cap tech stocks and there would seem to be a decent chance that one of the tech giants eats the tech startup's lunch.

If I work and/or invest in Amazon, I might do the opposite or reduce overall tech allocation.
Got it! Thanks!
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