Is Fund Size Leading to Perverse Decision-Making?

The $7 billion TPG-led recapitalization of Washington Mutual. The $5-8 billion Corsair-led syndicate to support the ailing National City. The tens of billions invested by sovereign wealth funds (SWFs) in Citigroup, Merrill Lynch, Morgan Stanley and UBS. These are stunning numbers for firms that are in a lot of trouble. Now being a contrarian, I applaud the guts-of-steel necessary to invest in the face of financial panic. The problem is, I just don't see the panic reflected in the U.S. stock market, notwithstanding all the issues with the global credit markets. And I know that these private equity firms and the SWFs say that they are getting quality assets on the cheap. But I worry about the conflict between the ability and desire to write a big check and the best time to write such a check.

Because it seems to me that some funds are a little trigger-happy, pushing money out the door while they can in order to justify their existence and to spend time managing dollars instead of deploying them. And if I am right, this is a very worrisome trend, indeed.

Mega-funds, be they of the hedge, private equity or SWF variety, face pressures of scale. It is necessarily difficult to invest such massive sums, and it takes incomprehensible amounts of discipline to let ok deals (from a risk/return perspective) go by in order to wait for the truly great deals with solid margins of safety to present themselves.  Because it can get pretty embarrassing sitting on $10 billion (or in the case of SWFs, $100 billion or more) of commitments, getting paid management fees and not putting money to work. There is a natural pressure to pull the trigger, because it may be more painful waiting for the right deal to come along than doing a deal that ends up being mediocre but being busy in the process. And it certainly is impossible to raise a fund V, VIII or XII if one can't even get past 50% of committed capital for the current fund. This would bring the whole asset gathering operation to a screeching halt. And we can't have that, can we?

Why am I picking on these deals? Because the dollars are so large and the sector being mined so troubled. I get the argument about the value of WaMu and NatCity's core deposits and branch networks; I was once a Financial Institutions M&A specialist and spent lots of time looking at such things. But so much of the value of these deals turns on asset side of the balance sheet and the massive mortgage and commercial lending books. In my opinion we are early in the credit down-cycle, and even if one doesn't agree with my assessment, I think it is hard to argue that things will be rosy any time soon. And further, there is much uncertainty about the depth, breadth and timing of the credit downturn. With all of these unknowns, clearly the investors in these deals are looking at the price they're paying and saying "This is my margin of safety; I'm buying cheap." But does anyone really have enough information yet to make such an assessment? Is buying at a 30% discount to market the right number? Is fair value really 20%? Or is it 50%? I certainly don't know. Maybe they do, and they could be right. But the risk/reward calculus seems kind of skewed at the present time.

If the deal sizes weren't so large I'm not sure I'd raise my eyebrows quite as high. It's just that the pressures of size are so great that I can see it adversely impacting rational decision-making. I'll be keeping careful watch on these deals. And I'll be interested to see the next series of mega-ticket deals getting  done for exactly the same reasons.

Super-Angel Networks: Seed Capital 3.0

It seems as if everywhere I turn there is yet another article about a slowdown in venture capital investing. This from today's Wall Street Journal:

Facing an uncertain economic environment, venture capitalists showed restraint with their wallets in the first quarter.

These investors sank $6.8 billion into U.S. companies across 603 deals in the period, according to data from Ernst & Young and VentureSource, a division of Dow Jones & Co., publisher of The Wall Street Journal. The deal total is the lowest since the first quarter of 2005, while the investment level is down 8% from the $7.4 billion recorded in the year-ago quarter and 9% in the fourth quarter of 2007.

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Many venture investors say they aren't overly concerned by short-term economic factors, instead looking for the next big company that will emerge as a mainstream hit in two to four years.

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Still, investors are telling their portfolio companies to conserve cash and are looking especially closely at potential new companies to make sure they have clear and strong revenue channels.

The prism through which I view the venture capital environment is quite different. I am looking primarily at the seed stage, and the volume and quality of deal flow I've witnessed has never been higher. Further, I'm aware of more people like me funding these companies, people and small groups with previous start-up experience and sometimes large-company experience. Sometimes these people invest in the context of a small seed fund; other times they invest directly with their own money. But these new friends and business acquaintances of mine have eight common characteristics:

1. Love of new technologies and business models
2. Experience leveraging internet-enabled platforms
3. Groups of friends with expertise across an array of domains that can be tapped when needed
4. The desire to be part of a syndicate of like-minded investors
5. A healthy rolodex of entrepreneurs, corporate executives and venture capitalists
6. The willingness and interest in helping managements make their companies successful
7. A focus on building a portfolio of start-up investments
8. A wad of cash that can be deployed in building out this portfolio

I call these entities "Super Angels." As Kim Rachmeler said during CI Foo camp back in February, "The network knows what the nodes know not." Translation: by leveraging networks, you can learn stuff that you yourself cannot through an insular, go-it-alone approach. Now any VC will tell you "Oh yeah, I speak to firm X, Y, Z, and expert A, B and C." But the issue is that there are always conflicted motives. Are the VCs really going to get straight, honest answers from their peers? Come on. It's a big dance, they all know some pretty girls and they want to make sure they're dancing with as many as they possibly can. Super Angels, conversely, truly value  the expertise, complementary skills and expanded networks offered by other Super Angels. They are not so much in competition with one another as they are wanting to do good deals and to de-risk them through a combination of capital and top-notch, value-added investors. But the difference between this loose confederation of Super Angels and the common angel networks is that both the nodes and the networks among the Super Angels are often far stronger. At least this is way it seems to me.

Kind of like the Internet, I think the Super Angel phenomenon is only in the first inning of an extra-inning contest, and that their impact will increasingly be felt over the ensuing years. But let me be clear - I don't see Super Angels as the death-knell of VCs. Quite the contrary: I think they can become a more efficient farm team for the best VCs than the VCs themselves can ever think of building. Where the real impact will come is with VCs who have strayed from doing traditional seed by doing larger Series B and C rounds, and want to get back to their roots. Too late. And too much brain damage in dealing with such firms. I think Super Angels have the chance to own the seed stage business, and are the best-positioned parties to prosecute this class of investments because:

1. Many have been entrepreneurs
2. Many have been buyers of the types of companies they are funding
3. Many lack LPs and don't have to nit pick as much around terms
4. Many have the skills and contacts to make a success a self-fulfilling prophecy by getting involved
5. Many have the rolodex to get the right VCs involved in the right ventures at the right time
6. Many have the money along with their networks to do both seed stage and A round deals
7. Many entrepreneurs would much rather deal with a Super Angel than a VC any day of the week

I really do think this is a megatrend, one which will become increasingly important if both the broad market and the VC market continues to tighten. A smart, helpful, highly networked source of low brain-damage capital is a valuable thing. And this is where the Super Angels are going to rock it.

Buddy Media: $6.5MM and Off to the Races

It was just announced that one of my portfolio companies, Buddy Media, raised a $6.5 million Series B round led by my friends at Softbank Capital. Sometimes in the life of an investor things just feel right, and this company, its business model and its partners feel just right. From the time I got involved with Mike Lazerow and the Buddy Media team I've been impressed with their combination of vision, a bias towards action and cold-nosed pragmatism. And I've had the privilege of being in the midst of all this excitement from my seat on the Board. From the time we completed the Series A round it has been a whirlwind, closing strategic deals with applications developers, commercial deals with marquee advertisers and ad agencies and recruiting top people to accelerate growth. These were heady times.

Then it became clear the Buddy Media should pick one of two paths: do a strategic deal with a large media company or raise another round of capital, build out the ad network and blow things out. Over a six-week period the company received two offers and five term sheets from great firms. And after much deliberation, Mike and the Board all agreed that raising the additional capital, building the business and executing against the vision was the right way to go. We were fortunate enough to have gotten the interest and support of two great venture firms, Softbank and Greycroft Partners, in addition to myself and 13 of my fellow Series A investors who decided to re-up for the Series B. Quite frankly, it was a no-brainer. Further, two of my friends from Softbank, Eric Hippeau and Karin Klein, will be joining Mike and I on the Board. It should make for some exciting, productive Board meetings.

Buddy Media serves an important purpose: helping advertisers and their agencies best access, activate and monetize the communities on social networks. And with Acebucks as a rapidly-growing loyalty program, we look forward to driving value to our clients while building the ubiquity of Acebucks. The market has spoken loud and clear during Buddy Media's relatively short life: it is creating lots of value for its clients. And as long as we never lose sight of this goal, Mike's vision of Buddy Media's future will become reality.

A Few Thoughts on Incubation and Angel Investing

There has recently been a bunch of chatter about the role of angel investors, Y Combinator and its ilk, and the motivations of those running large pools of venture capital.  All I can do is speak from personal experience and observation, but it seems to me that folks are trying to make sweeping generalizations about classes of investors when so much of the early-stage investment business is both context and case-specific.

Y Combinator

Y Combinator is amazing. What else can you say? Paul Graham is, well, I don't know what to say about him except that he is something akin to a prophet in my book. The manner in which he has built Y Combinator is not simply a model of how to incubate great ideas, but how to build great teams, mentor young people, and probably to raise creative, intellectually curious children with critical thought. I don't have Paul's technology brain or cumulative experiences, so would not be confident in running such a platform on my own. What might turn out to be commercially viable? Who knows. I need a little more information to go on than Paul and his colleagues when making an investment decision. I kind of feel about Y Combinator the way I felt about Fred and Brad investing in de.licio.us. They saw the value. I had no clue. They were right. I don't invest in things like de.licio.us. I lack the prism through which to see the value people like Fred, Brad and Paul see in stuff like this. Can Brad Feld and TechStars do this? Maybe so. But, in general, I don't think mere mortals can successfully run platforms like these. I sure as hell know I can't.

Angels

Angel investors are all over the map. One-time angels investing in a friend or a family member's business. Angels who are part of investment groups. Angels who used to be entrepreneurs and are now helping seed new entrepreneurs. Angels who made a bunch of money in one line of business and like investing in early-stage deals and working with young companies. It is very hard to characterize "angels" with a single, catch-all phrase. Their resources differ. Their experiences differ. Their risk tolerances differ. And their staying power differs. One trend I've noticed since becoming an angel investor is that those with relevant business experience and contacts are increasingly sought-after, and that many entrepreneurs are starting to distinguish among different types of angel investors. Since so many VC funds are so large and are either unwilling or unable to make <$1 million investments, entrepreneurs are turning to angels whom they perceive to have many of the benefits of a VC (domain knowledge, contacts, advice, money) without the related brain damage. Therefore "professional" angel capital is playing an increasingly important role in the early-stage capital formation process, and has truly become a distinct asset class between the small-time angel investors and the venture capitalists. This is where I currently fit within the early-stage investment ecosystem.

Venture Capitalists

Venture capitalists, like angel investors, are not a single nameless, faceless mass. Each firm has its distinct set of competencies and areas of interest and expertise. But even more important are the specific partners within each firm. Some partners rock. Others suck. I'd be willing to bet that a small number of individuals - not firms - are responsible for the lion's share of VC home runs over the past 30 years, meaning that it is the partner more than the firm itself that can pick winners and losers and help take those with potential to the top. This makes it extremely important for the entrepreneur to pick wisely - partners, that is - and to find the best match for the long-run. A firm is a brand. Brands have value. But getting the right partner certainly outweighs brand value for early-stage companies, since you want to be around for the later-stage when the value of the brand can really help you. And if you can get both together, fantastic.

Still in Business

Finally, while economic troubles may staunch the flow of angel dollars from the marginal angel investor, the professional angels of which I speak will still be around for funding good, commercially viable ideas. And since most professional angels aren't looking to the IPO market for exists any time soon, they are less sensitive to the dependency on the exit as opposed to building long-term value that will be monetized at the appropriate time. And this is of huge benefit to the entrepreneur, who is seeking that value-added, stable capital that professional angels can provide. All is not lost in early-stage land. There are still a wide range of attractive sources from which to raise funds, depending on your stage, business model and type of investor you are seeking.

Congratulations, Covestor

I am happy to be an investor in Rikki Tahta's brain-child, Covestor, and am pleased to be joined by my friends Fred and Bijan in the deal. With an interesting and disruptive business plan together with strong and knowledgeable VC-backing, I am expecting great things from Rikki, Perry and the entire Covestor team over the ensuing months and years. I'm proud to be along for the ride.

BlogTalkRadio: Investment #10

I first met Alan Levy, Founder and CEO of BlogTalkRadio (BTR), through my friend Howard Lindzon. And once I spent some time with Alan hearing his vision and getting a grip on his platform, I knew he had a big, BIG idea. Here is Alan's description of the business on the BTR website:

BlogTalkRadio is the social radio network that allows users to connect quickly and directly with their audience. Using an ordinary telephone and computer hosts can create free, live, call-in talk shows with unlimited participants that are automatically archived and made available as podcasts. No software download is required. Listeners can subscribe to shows via RSS into iTunes and other feed readers. Our network has produced tens of thousands of episodes since it launched in August of 2006.

BTR gets to the crux of one of my key investment themes, the democratization of the Internet. With BTR, anyone can set up a real-time radio show. You need a phone and an internet connection. That's it. Whether eloquent or stumbling, stunning or somewhat harder on the eyes, famous or merely famous in one's own mind, BTR gives your the tools to easily and painlessly reach a live audience. BTR scores high on another one of my key investment themes, ease of use. The process of getting a show live is simple. Even Scoble can do it. Here is what Scoble said about BTR:

I love the new BlogTalkRadio. Why? I just call a phone number, +1-646-200-0000, (you can call it too). I record a conversation with my cell phone, and then it builds an RSS feed that points to MP3’s of my conversation. What’s the URL? It is my cell phone’s phone number. No need to sign up. No need to give personal details, or even agree to anything.

This way I can make a podcast whenever I want. Utterz does something similar, but you gotta setup Utterz before you make your phone call. I like frictionless publishing and no signup before you start makes a lot of sense to me.

These were Robert's reflections from using BTR during a discussion he was having with Dave Winer. Pretty cool. I've been working with Alan to help BTR achieve its goals as quickly as possible. Like all of the entrepreneurs I back, Alan is very commercial and focused on monetization without degradation of the user experience. And so far, I'd say he has done a masterful job balancing these two sometimes-competing interests. He is off to a great start (if you can call almost 3 million monthly listeners a start) building the company, and I am proud and excited to be involved with helping Alan fulfill BTR's promise. You should check it out.

Taking a Multi-strategy Approach to Alternative Investment

When it comes to corporate strategy, I have long been in favor of more focused, single-purpose enterprises than those which take a conglomerate approach. The reason: I find the benefits of centralized management largely illusory and only introduce friction to the operation of a portfolio of businesses. Sure, there might be cost savings both in financing and materials purchases through conglomeration, but in my book these benefits are generally outweighed by lack of focus and bureaucracy. For every GE, Danaher and Berkshire Hathaway there are literally hundreds of businesses whose diversification efforts failed and destroyed shareholder value. Give me a bunch of good, focused businesses with great management and I'll do my own diversification.

This contrasts with my view of investing.  Focusing on a single asset class, regardless of how expert the manager may be, exposes the investor to either poor returns with low uncertainty (e.g., investing in Treasuries) or unacceptably volatile and lumpy returns (e.g., investing in commodities or the emerging markets). This is clear. But what about when a particular manager seeks to invest across an array of strategies, much as a conglomerate invests in a group of different businesses? Does the same "friction" argument hold that renders the multi-strategy business structure so unappealing? Done well, I think not.

The difference between a conglomerate manager and a multi-strategy hedge fund manager is clear to me, but there are some caveats. Few conglomerate managers have an intimate understanding of all their business lines, and certainly not to the depth of those managing single-purpose businesses. Balancing the administrative benefits of conglomeration with the costs of bureaucracy and foregone entrepreneurship within the individual businesses is an extremely difficult and complex dance. Conversely, an investment manager who uses their expertise to employ a range of strategies (say, long/short equity, distressed and convertible arbitrage) gains the benefits of opportunism without the costs of straying from their core competency (in, say, deep fundamental analysis).

I think the argument breaks down when managers go outside their skill sets, trying to operate like a multi-strategy when their team lacks the skills and experiences necessary to do so. So multi-strategy approaches that offer diversification and flexibility without the give-up in quality are particularly well-suited to the currently challenging and uncertain market environment. In fact, I'm not sure I can think of an environment where this approach is less appealing than a single-strategy model. Top alternative investment asset allocators (think pensions and endowments) may argue that they prefer single-strategy funds, and want the ability to allocate among the strategies employed by multi-strategy funds (as in the example above, they'd want to invest in best-of-breed long/short equity, distressed and convertible arbitrage managers separately). But this approach doesn't take into account a two important points: the ability of a top manager who is living the markets every day to make superior asset allocation decisions, and the benefits of learning that are available across a multi-strategy team. These are two powerful sources of value that are not available to the asset allocator with single-strategy funds.

But the perils of growth need to managed very carefully. As a multi-strategy fund grow, there may be times when it makes sense to run it as a portfolio of strategies (much like DB Advisors, Millennium and the like), giving the manager the ability to asset allocate based upon market conditions while providing the individual teams with more closely aligned motives than what existed in the massive single-team, multi-strategy approach. These are hard businesses to manage but with the right culture and incentive systems it can be done. But with the promise of attractive risk-adjusted returns across a wide range of investment environments, the trouble is worth it.

Responses to my "Interesting Conversations" Post

Thanks for all the amazing and timely responses to yesterday's post. Please, keep them coming. As I am in the middle of moving it will take me a little while to get back to you, but rest assured that I will. Thanks again.

Interesting Conversations Wanted

I am in the process of codifying thoughts around a potential fund. The fund will be equity long/short, with the ability to invest a portion of its assets in illiquids: early and mid-stage VC and private equity. It will have a TMT (technology, media and telecom) emphasis, but be able to deploy capital in other verticals on an opportunistic basis. As noted previously, we will work to develop a research edge through the use of advanced textual analytics and other data aggregation and filtering techniques. These insights will inform both public and private market investments. Further, a reflexive relationship will exist between insights gleaned from private investing (how public company products and markets may be disrupted) and public investing (how private companies and technologies can help address gaps in public company business lines and products).  It will also employ macro hedging techniques to mitigate market exposures in order to isolate the effects of security selection.

So my interest is in speaking with experienced buy-side analysts, especially those focused on TMT, who have an interest in this approach and are eager to brainstorm about it. Please shoot me a note at roger@iacapitalpartners.com should you wish to chat. Fun stuff.

Hostility Towards the Bear View

I have been blogging since late summer 2006. Since then, I've spoken my mind, shared my thoughts and beliefs, and tried to clearly discriminate between facts and opinions. And I've presented much of both. I have, as long-time readers know, pretty blunt views on Fed policy, investors' behaviors and the motives of market actors. I feel like I was pretty on top of the pending train wreck, having written about both complacent volatility markets and the likely severity of the subprime fallout. I even talked about what I perceived to be a false market rebound, a bounce in the face of inexorable eroding market conditions. Further, I've also stated quite clearly that I expect this downturn to last not months but a few years, placing me somewhere between Wall Street consensus and the sky-is-falling perma-bears. But even with my track record, transparency and complete lack of any self-interest whatsoever, I continue to take shots from whose who see me as way, way too bearish, and their barbs make it seems as if I am almost unpatriotic. Barry Ritholtz recently wrote about this phenomenon, where financial bloggers, in general, have been chided for being way too bearish. Yeah, right.

Consider this: earlier this week I wrote a post titled Just an FYI... 8 Mega Themes for the Future. There are the eight themes mentioned in the post:

1. The economy sucks now, and will continue to do so well into 2009 and perhaps beyond.

2. The real estate bust is a major reason for our despair.

3. Fears across the financial sector will make things worse, thereby fueling more fear and making things worse, and on and on.

4. Municipalities will be hurting, placing tremendous financial strains on states and the Federal government just as tax revenues are declining.

5. Computer security will continue to be a pressing issue.

6. Previously closed systems will become increasingly open.

7. Seemingly recession-proof sectors prove not to be recession-proof.

8. Emerging markets will continue to progress, driving convergence with the developed markets.

This post was subsequently republished on Seeking Alpha. The comment thread is here. One comment in particular highlights what I am talking about. From commenter "Tony Saprano":

I love your article because it makes me so VERY BULLISH! Here is why: even before your 8 market trends you list all of those negative links. HARDLY ONE WAS POSITIVE. The Russians are coming. The Russian are coming. The Russians are coming. Do you remember this phrase? I guess not. The fear was that they were going to invade America by crossing over Siberia and invade Alaska and come down through Canada. lol.

#1

You say the economy will suck well into 2009 - 2009 is only ten months out. You say we have deeply embedded problems - Americans loves a difficult challenge the more difficult the better. You say that these problems will affect the world over - this contradicts your 8th trend - you cannot have it both ways.

#2

You say that real estate is a mayor reason for our despair - I like to hear words like "despair" - to me it means the bottom is within sight. You say that there is a ripple effect on Wall and Main street - duh I wonder how many times have heard this but keep it up - its bullish.
Will buyers from foreign lands come in as an investment and currency play? See the Reuters story at the end.

#3

I love this one. Fear fueling more fear. Whoa!!! Will I be able to look up into the sky and see dark clouds of locusts eating everything in site? The Dow better drop 2,000 pts on Monday.

#4

Another great word - tremendous. Tremendous financial strain on our states. I guess Warren Buffet made a mistake by getting into the muni business. Poor Warren or should it be more poor teachers pay? Warren will get richer and the teachers will get poorer. I can't believe I said that. Anyway you should love your profession more than you love your salary. lol.

#5

This is just plain lame. I'm more concerned about terrorist than this one. But I guess we'll  have to hire more FBI agents.

#6

From the macro to the micro. The internet is the internet and that's it. Let's not make too much out of it. Just sit back and watch Google, Apple, News Corp and Microsoft battle it out while your home is foreclosing. lol.

#7

They overbuilt. Its that simple. But aren't there other recession proof sectors that are still hiring. Even with the last unemployment report? I wonder which one it was?

#8

I'm bearish here and this is why. Inflation will eat (no pun intended) these countries alive. They now have a appetite for meat the pundits say. They want cars. They want homes. They have water and pollution issues. Gee what else can I say? 2 or 3 billion people will be eating T-bone steaks. It ain't going to happen. However, health care is an issue in the emerging markets and you have to address this issue before the t-bones. I guess this is why Warren has been loading up on JNJ, GSK and SNY.

Do you detect just a hint of sarcasm and hostility here? This kind of comment is not unique, and symbolizes to me the difference between being locked in a short-term historical mind-set and seeing what is really happening through a clear set of glasses. This is what Taleb writes about all the time. It is hard, even painful and highly dissonant, to consider possibilities outside of one's own experience. For the past 25 years, with some burps here and there, this generation has seen the market go up. Yes, NASDAQ got hurt, but the Dow and S&P 500 hit new highs, credit was abundant, deal activity was robust and real estate prices skyrocketed. It has generally been party time for smart investors.

But what we are seeing ripple through the system now is different than what we've experienced in the past 25 years. Financial markets are far more intertwined. The credit bubble has caused homeowners to over-leverage and overextend, setting themselves up for a brutal fall. And this is what we're seeing today. It isn't unpatriotic or merely negative to state these things. They are what they are. But for the collective mind-set to begin approximating economic reality, people will need to push themselves to imagine a future that is very, very different than the recent past. If not, it will all come as a big surprise when the depths of the problems persist well beyond most people's expectations. And the pain and suffering will hurt all the more.

Clear Asset Management: Investment #2

August 2004. I was in the process of negotiating my departure from Deutsche/DB Advisors. I had been approached several months earlier by a good friend, Andrew Corn, who had a vision for starting a quantitative asset management firm that took the human element out of investing. He had spent over 20 years working with investment banks and asset managers on IPO roadshows, how to present their numbers and systems for scaling reporting, and sold his successful business to a publicly-traded PR and marketing firm in 2002. After selling his business he had been SVP of TheStreet.com, helping to start Independent Research Group and running marketing.  It was this experience that codified his thinking around the value of quant models, in stark contrast to Cramer's approach of booyah and all that stuff. It was at this time that Andrew approached me to seed him and help with his business plan. And what emerged was the plan for the business Clear Asset Management.

Having run a large quant platform, Andrew's vision for a fundamentally-driven series of quant algorithms resonated with me. I also knew personally that Andrew was a very persistent, very frugal person of high integrity, three key attributes I have to see in any entrepreneur. I also knew that he was flexible and that if things weren't working he'd try other things, pushing on through until he found the right formula for success. For instance, his original view was that Clear Asset would offer institutional-quality asset management products to retail, using the Internet as the vehicle for asset accumulation. This helped build brand and a measure of awareness, but this did not attract the assets we had hoped. But as time went on and the firm's portfolio performance was top-tier, Andy re-jiggered his plan to focus on institutions. He went to emerging manager conferences. He sat on panels. He networked like crazy. And all the while the company was winning performance awards like PSN's Top Gun again and again. Further, he has hired and built an unconventional, process-driven product creation engine that has resulted in five top-performing long-only portfolios, a successful ETF business through Clear Indexes and a recently-launched Large Cap Value Long/Short hedge fund (which is currently being run as a 150/150 portable alpha strategy and is rocking it - hard). In short, it is amazing what Andrew and the Clear Asset team has accomplished in 3.5 years. Now the time has come to blow it out.

As I do with all my companies, I have worked with Andrew and Clear Asset's Chairman, Fred Fraenkel, to identify strategic partners whose distribution networks we can leverage in order to scale up the portfolios. We are currently in advanced discussions with a few awesome partners. The foundation has been laid. The team has successfully executed the plan. 2008 will be an exciting year for Clear Asset, a year when alpha-generators will rule and beta-trackers will suffer. And the company has been consistently excellent at generating alpha. This is why it is exciting working with small, rapidly-growing companies. Times like these. When so much work has gone into getting the company, the business, the model to this point and all that remains is to scale. TheLadders.com did it. And I am confident that Clear Asset will do it as well.

TheLadders.com: Investment #1

February 2004. I was CEO of DB Advisors at the time, and was introduced to Marc Cenedella, Founder and CEO of TheLadders.com, though a mutual friend (one of my guys from derivatives). It took me about 5 minutes to "get it," after which I asked for all the requisite follow-up information (business plan, financial model, etc.). If Marc were to present to me today, having now been an active angel investor for almost four years, I'd probably have written him a check on the spot. But having never invested in a start-up, I really wasn't sure how I'd "know" that it was a smart investment. But my instincts were good. Then, like now, I need to be able to get the business in minute, have deep faith and confidence in the entrepreneur, and know that I can help due to my connections, business experience, etc.

TheLadders.com business model immediately struck me as being so smart, yet so blindingly obvious: create a self-selection mechanism on the part of the job seekers by making them pay for access to the best jobs, but only jobs that had comp packages $100,000 and above. I knew the problems that firms using Monster and HotJobs had, getting 10,000 resumes for a job for which maybe 100 were remotely qualified, and ultimately hiring one person. This creates a very inefficient candidate sourcing mechanism. Yet when Marc shared with me his experiences in pitching his innovative model to HotJobs (his employer at the time) and Monster (who wanted to hire him), he was turned down flat. This fueled his passion and desire to do it his way, alone, and to create a large and sustainable business over time.

Fast-forward to today. TheLadders.com is a runaway success. Huge revenues, huge traction, substantial brand awareness, and thousands of people helped throughout its life. Marc has executed his business plan and more, one of the few companies in which invested where the plan on day one is not materially different than the plan four years later. It is a tribute to Marc, his vision and his leadership. Kevin Ryan (Doubleclick) and myself were the two largest angels, and several months after the closing of the angel round Matrix Ventures (Nick Beim) lead a $7.5 million round at a substantial valuation uptick. And it has largely been downhill from there. I wish all of my companies were like TheLadders.com  and every CEO like Marc. It was just dumb luck that my first deal may well be the best angel deal I've ever done.

Reviewing My Portfolio Companies: It's About Time

I am going to begin a series of posts looking at my portfolio companies, sharing my thoughts as to why I invested, the things I've learned, and how the companies have grown since my initial involvement. I figured it was high time now that my portfolio looks more like a VC portfolio than an angel portfolio, and that I am now starting to see the maturing of a number of my earlier investments. It is very exciting and has been cause for me to do some reflecting on my investment process, my deal instincts and my success (or the lack thereof) as an early-stage investor.

My "blink" is that I've done a pretty good job, especially considering that I am fairly young in the business. That said, I've certainly learned some important lessons along the way that I will share as best I can. One thing is for sure: my experience as an entrepreneur has informed my investing. I am far more savvy and value-added now having built a company than I was as a passive angel investor while a Wall Street executive. I know I bring far more to my companies now as an investor, a Board member or an adviser than I did earlier in my investing tenure. But I am always learning and always growing, and in these next few weeks I will share with you whatever my introspection and perspective will allow. I'm sure I'll learn a lot through the process of sharing my experiences and hopefully you will, as well.

Yahoo vs. Its Investors: Let the Litigation Begin

It is really hard being right, but someone has to do it. Now we see that some Yahoo shareholders are getting really pissed off with the Board and simply aren't going to take it any more. This from the AP via Yahoo News:

                        DOVER, Del. - Two Detroit pension funds have sued Yahoo Inc. and its board of directors, saying they breached their duties to shareholders in trying to thwart a takeover by Microsoft Corp.

The lawsuit was filed in Delaware Chancery Court on Thursday by lawyers representing Detroit's police and fire retirement system and general retirement system, as well as "all other similarly situated public shareholders."

According to the lawsuit, Yahoo's board is pursuing "value-destructive" third-party deals in an effort to fight off Redmond, Wash.-based Microsoft, which on Feb. 1 announced a takeover bid of $31 per share in cash and stock, a 62 percent premium over Yahoo's previous day's closing price.

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"Yahoo's directors cannot 'just say no' indefinitely to legitimate acquisition offers," the lawsuit reads. "Likewise, Yahoo's directors cannot pursue transactions that do not require shareholder approval for the primary purpose of making Yahoo unattractive to Microsoft."

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"An imminent proxy fight necessitates judicial intervention since it poses a deadline for Yahoo's board to place shares in friendly hands," according to the plaintiffs, who allege that Yahoo board members have placed "personal distaste for Microsoft" ahead of shareholder welfare.

"Regardless of their emotional ties to Yahoo and their desire to retain their positions as directors at the company, the Yahoo directors owe fiduciary duties to Yahoo and its shareholders," the lawsuit states.

If this isn't a wake-up call to Yahoo's Board and its advisers I don't know what is. The writing is on the wall, guys. You'd better have some serious cards up your sleeve, arrows in your quiver of whatever other hackneyed phrase you'd like to roll out, because time is running short. Being labeled as un-shareholder friendly and obstructionist isn't the best thing for your company or your careers, so get off the stick and take some decisive steps. Because maybe, just maybe, if you embrace Microsoft you might be able to squeeze a little more value out of the deal. But each day that goes by without this insight will cost both you. Big time.

Keep Investing Simple: A Reminder from One of the Greatest

Keeping it simple. Building a diversified portfolio of low-cost investment vehicles like index funds and ETFs. Staying cool in the face of market turmoil by sticking to long-term asset allocation and re-balancing as necessary. Avoiding the urge to try and out-smart increasingly complex and competitive markets. These are the mantras about which I've written since first becoming a blogger, particularly with respect to retail investors that lack the resources, time and know-how to prudently invest in individual securities. Some have other mantras, like chasing the hot stock of the day (read: Jim Cramer), which to me have always created a sense of false confidence in the hearts and minds of many retail investors. So I was quite happy to see one of the greatest long-term investors chime in at a time of awful market conditions to remind us all what really matters: keeping it simple, keeping costs low, staying diversified, staying focused. The investor: David Swensen.

From today's New York Times:

Don’t try anything fancy. Stick to a simple diversified portfolio, keep your costs down and rebalance periodically to keep your asset allocations in line with your long-term goals. That is the advice of David F. Swensen, who has run the Yale endowment since 1988, relying on a complex strategy that includes investments in hedge funds and other esoteric vehicles. The endowment earned 28 percent in its last fiscal year, which ended June 30, beating all other endowments. It finished the year with $22.5 billion.

For most people, he recommends a very basic approach: use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult.

Don’t be distracted by market forecasts, he said. “You have to diversify against the collective ignorance,” he said. “I think nobody is in a position to react to these big macro-issues. Where is the dollar going to be or what is G.D.P. growth going to be in China? For every smart person on one side of the question, there is another smart person on the other side.”

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“The only people who should get involved are sophisticated individuals who have significant resources and a highly qualified investment staff,” Mr. Swensen said.

“Most people do not have the resources and time to pick market-beating managers” of hedge funds, private equity funds or funds of funds, he said. And he said that the techniques used by hedge funds often result in higher taxes than those of index funds.

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He says it is fruitless for individual investors to pick stocks. “There is no way that an individual can go out there and compete with all these highly qualified and compensated professionals,” Mr. Swensen said.

HE criticized the approach of Jim Cramer, the CNBC host, who encourages investors to trade stocks in strategies that Mr. Swensen says cost heavily in commissions and taxes.

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Mr. Swensen says investors should forget market timing entirely. Once an individual sets up a program, it should be rebalanced quarterly or semiannually, he said, “but it should be disciplined.”

When the markets decline, try not to pay attention, he said. “Let yourself off the hook,” he said. “If you pursue the sensible long-term policy, look at it over a 5- to 10-year period. Don’t look at five months.”

 

“There is nothing that Cramer says that can help people make intelligent decisions,” Mr. Swensen said. “He takes something that is very serious and turns it into a game. If you want to have fun, go to Disney World.”

This is the way I invest. A 20-year markets professional. It is startling to see the language I've used to describe my thoughts on the topic and Mr. Swensen's: they are almost identical. And needless to say, our thoughts on Mr. Cramer are also completely in sync. The hardest thing about doing what both he and I suggest is plain to understand: humility and ego. Why can't people be more humble about their investing abilities? Why can't they internalize the empirical research that clearly shows why mere mortals are doomed to fail as investors? Why must so many people have to find fun within investing, something which is, I'm sorry, at any time and always a serious business? In any event, if even one person reads this and changes their investment behaviors I'll be happy. Please, please, PLEASE - be careful out there.

Opportunity Knocks: The De-Commoditization of Capital

Much has been written about the negative impacts of the subprime mess and the knock-on credit crisis. But what about the flip-side; who stands to gain from general economic and capital markets uncertainty? I'll tell you - those who have balance sheet capacity and abundant liquidity to pick up bargains while others are suffering. Where capital was once incomprehensibly cheap and available it is now both dear and scarce. And this about-face took less than six months to unfold. Quite simply, capital is no longer a commodity.

I was speaking to a friend who is a senior member of an advisory team within a finance company that goes head-to-head against the Wall Street investment banks every day of the week. And they generally do pretty well, leveraging the capacity and appetite to book risk on deals where they are adviser. But things have gotten much better for them as of late, since so many of the investment banks are dealing with their own credit crises and have become far more reluctant to underwrite deals and incur syndication risk. This is but one small example of a firm that is capitalizing upon the adverse conditions in the credit (and now equity) markets.

When it comes to the credit crisis almost all roads run through the largest banks and investment banks. They packaged up, retained and sold (and some actually got into the origination end of) mortgage risk; were underwriters of massive amounts of leveraged loans; and provided incremental leverage and liquidity to hedge funds. And if they had only been middlemen in the process, that would have been ok. But they weren't, and it is these held mortgage securities, retained loans and existing financing commitments that are burning holes in their balance sheets, causing them to both pull in their lending horns while aggressively bringing in new sources of capital. The traffic cop of transactional credit creation is currently on holiday. So given this, who is out there to capitalize on the increasing cheapness of both the debt and equity markets?

Consider the possibilities for these types of firms:

• Private equity firms: The leaders are generally awash in liquidity and have patient investors, indicating a vast opportunity set. And while their ability to lever acquisitions has dropped precipitously, the decline in purchase prices will help to dampen the effect of more equity-heavy capital structures on returns. Will returns reach the heights of the mid-2000s? Likely not in the near term. But these firms have the resources and experience to create value in both U.S. and overseas markets, and will have plenty of opportunities to deploy massive amounts of capital to capture the bargains that will inevitably emerge from today's market crisis.

• Hedge funds: While jittery and highly correlated markets are generally not good for stat arbs and other quantitatively-oriented investors, value-driven long/short equity and even-driven managers should do pretty well. In the global market sell-off value should once again rear its head, giving excellent stock-pickers with intermediate time horizons fertile ground to build an attractive portfolio and to watch it pay off over time. Event managers should also see some pretty interesting opportunities as corporations look to increase focus and efficiency and build liquidity by jettisoning non-core assets. Further, a number of larger companies which have underperformed will come under pressure to restructure either by selling or spinning off operations. In each of these circumstances, both value and event managers should see a range of attractive opportunities in a depressed and uncertain market.

• Corporations: Some will have the chance to be opportunistic while others will not. Companies like Berkshire Hathaway and Microsoft, with rock-solid balance sheets and tens of billions in liquidity can pretty much pick and choose their spots. Perhaps start new businesses to take advantage of others' problems (like BRK entering the municipal bond insurance business), or maybe pick up some valuable assets that have gotten much cheaper as of late (like MSFT's bid for YHOO). The point is, those with liquidity will have lots of options while those who are heavily levered and capital constrained will be focused more on staying afloat than on picking up the valuable entrails of some other firm's rotted carcass.

• Banks and Investment Banks: Like corporations, there will be a massive skew between those who can pro-actively take advantage of market bargains and those who will be focused on rebuilding and repairing damaged businesses. For example, Citigroup, Merrill Lynch and UBS: geared up to raise capital, skinny down the organization and re-focus on core businesses. Breadth hurt as management complexity and greed masked building problems in risky businesses. Consider Goldman and JP Morgan Chase: capital is sufficient, need to optimize headcount given current market conditions and to remain nimble and aware as bargains arise from both trading and investment perspectives. Further, they continue to have the ability to use balance sheet to support deals, though not as freely as in the past as existing LBO commitments weigh on capital availability.

• Venture Capital: This should be a golden opportunity for the highly liquid venture capital industry. Early-stage opportunities remain abundant, while later-stage venture capital will become increasingly attractive as alternative financing sources dry up. They, like the private equity firms, raised money when times were good. That was smart. But difficult times should bring possibly even more opportunities to the best firms.

Notwithstanding the challenging markets, it is important to remember that not everyone will suffer. Capital formation will continue apace, but capital allocation will be far more disciplined than it has been over the past three years.

It's a Matter of Culture

Yahoo! vs. Microsoft. Developers vs. Businesspeople. Baseball players vs. Football players. It's just a matter of culture. With the exception of baseball players and football players, the others have to get along in order for their teams to be successful. Michael Lewis penned an article in today's New York Times Magazine section that provides what I believe to be a useful metaphor for thinking about the some of the most important cultural disparities facing today's technology arena. Yahoo! and Microsoft coming together, the Web 2.0-savvy, Internet-fueled 10-year old vs. the desktop-heavy, software-based 20-year old? A rapid, web-based development culture vs. the slow, millions-of-lines-of-code software development culture?  But even if the metaphor holds, it is the ways of facing into and dealing with these differences that separates the great from the merely good or, more often, the abject failures. It is a hard thing to do, and only the companies that create a unifying culture beyond those of its distinct groups will convert its talent and intellectual property into shareholder value. And this is what building and running a successful business is all about.

The Metaphor

Michael Lewis compares and contrasts the private sanctums of baseball and football players, conveying what I believe to be a pretty instructive framework for analyzing the cultural issues facing both established and start-up technology companies:

In their private sanctums, baseball players behave as if someone might walk in at any moment and ask them to leave; they’re a bit like starving dogs who have just stumbled upon a slab of raw meat. Not all of them, of course — the effect is atmospheric, produced by the sum of the personalities. Give 25 professional baseball players a place to call their own and they give it a forbidding name: clubhouse. If you aren’t a member, you don’t belong.

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Professional football players aren’t like that, as a rule. They don’t have clubhouses; they have locker rooms. If you happen to wander into one, no one tries to make you feel bad for being there. The football player doesn’t resent you for being in his private place any more than the elephant resents the fly for setting up camp on his tail.

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There’s a reason for this: In a football locker room, there is no question who really belongs. In a baseball clubhouse, the reporters, at least the younger ones, can be the physical match of the players; in a football locker room, there is no debate to be had about which bodies belong and which do not. There’s no doubt who could beat up whom, if it came to that. This clarity has the effect of putting everyone at ease.

In short, baseball players are clique-ish and insular, while football players are more open and inviting. And in Mr. Lewis's conception, it is pretty much due to the self-confidence and security of football players vs. baseball players. Football players are self-confident, knowing that they are a distinctly different species than the rest of human-kind, and comport themselves with a degree of security and esteem not found in the baseball locker room. Baseball players have the skills, but their gifts aren't as readily apparent upon first glance than the distinctive physical superiority of football players. And this makes them edgy, defensive and more apt to keep to themselves.

The Bold Statement

Now I am certainly not a technology-lifer and haven't spent my entire career observing the developer/business person dichotomy, but I've seen quite a lot of it over the past three years as both the leader of a technology company and as one who has invested in 20 such companies. And I have been a keen observer and analyst of corporate culture since I joined the work force over 20 years ago. From my own observations, it strikes me that within technology companies, developers share many of the characteristics of baseball players while business people are more akin to football players. Why?

The Developer culture: A baseball locker room

The developer is producing something that is very concrete, almost like a work of art. Give the code x input and it generates y output. The code's efficacy is pretty clear. Coding against a time line is a lot of pressure. It is intense, and requires both creativity and attention to detail. And only certain types of people have the psychological and spiritual make-up for this kind of work. And at the highest levels they are, in fact, a rare and valuable breed. Further, developers also know that their efforts are often at the center of what the company is trying do, and this is where much of their job-related esteem comes from (along with elegant, economical, tightly-written code). That said, they are often not interacting with customers and are seldom part of the revenue generation process. And it is this distance that can often make developers insecure and feel under-appreciated. So they support themselves as a unit and a kind of "we-they" dynamic can emerge relative to non-developers, sometimes fueled by a perceived intellectual superiority that goes along with their own distinct developer culture. [NB: for those from Wall Street, this is very similar to the Sales vs. Trading dynamic, where traders feel themselves to be the principal creators of value and look down at salespeople, while salespeople see traders as tempermental, spoiled egotists that couldn't close a deal with a human being if their lives depended on it]. Developers. Baseball players. The metaphor pretty much holds for me.

The Business culture: A football clubhouse

The business person, conversely, isn't writing code. They are trying to monetize the code. This is done by working closely with customers, hearing what they want, bringing the feedback to the developers via product management, and leaning on the developers to make sure they deliver against a customer-driven time line. Once the product is ready to ship (be released, publish an API, etc.) given customer requirements, it is the business person's responsibility to get payment and to keep existing customers happy and new ones coming in abundance. Business people can only be successful with the help of others - developers, operations professionals and product managers, to name a few - and are therefore outwardly-focused and desirous of help and assistance. Their confidence and esteem is built through the successful mobilization of the team and results in business getting done, often requiring far more collaboration and extra-group interaction than developers cranking out code. Business people can generally speak the language of many different types of people - except developers - while developers generally don't speak the breath of languages given their intense focus, job requirements and mind-set. Clearly I am making some sweeping generalizations but I think I'm capturing the character of the compare/contrast of these two different, yet critical competencies necessary for making a technology-based company achieve to its full potential.

The Yahoo!/Microsoft deal: A cultural train-wreck

Now think of what might happen through a Yahoo!/Microsoft merger. Two vastly different companies with vastly different DNAs. One has been about creating and delivering value via the Web since inception, while the other was and still is largely a software company. One has a long had a whimsical, hyper-creative, Silicon Valley culture, while the other has had a much more restrained, process-oriented software engineering culture. One has been built upon short product release cycles, the other on multi-year release cycles. One has been trying to optimize its core offering against a ferocious competitor, while the other has been involved in trying to re-invent itself and diversify away from its core product for the past decade. In short, Yahoo! is running a football locker room while Microsoft is operating a baseball locker room. Yahoo!: Extroverted, open, trying to figure out how to enhance the business in a ever-changing market. Microsoft: Introverted, we-know-best, buy our way to the answers in an ever-changing market. I can see the logic for the acquisition on paper, but when the cultural disparities are considered, it is difficult to imaging how two such distinctly different companies could come together and win. And I am not alone in my concerns.

Is a Successful YHOO/MSFT Merger Possible: Yes, but don't hold your breath

So how can a combined Yahoo!/Microsoft win? The same way a technology-start up can win - by creating a new and unified culture that respects the skills and talents of each group without forcing each group to completely lose its identity. Easier said than done. This is clearly possible in a start-up, where the healthy and positive behaviors arising from a "company first" mantra can be inculcated before the problems of "we/they" thinking, and insular, group-based cultures infects the firm's DNA.  In two established companies with over 30 years of combined legacy and tens of thousands of employees across dozens of locations spanning the globe, the issue is obviously much more difficult to address. Each firm already has its own DNA and is dealing with its own demons, and I'm not sure that the genetic engineering required to meld them is even possible. And even if it is, the probability of success is woefully small. I know that Microsoft has the best of intentions going into this deal. But my concern is that even the best of intentions can end up in failure, and in light of the cultural hurdles required to make this deal a success my heart goes out to Microsoft shareholders. Because if even if they win they lose. And my bet is that it won't be pretty.

Who REALLY Benefits from Volatility

Most articles on volatility, its genesis and characteristics, are quite scholarly yet fail to drive home a simple yet essential point: the key beneficiaries of volatility are those with liquidity and an understanding of value, plain and simple. I'm not talking about flow traders who want volatility so they can capture more bid/offer spreads, or position traders who swing for the fences in volatile markets so they can create a winning bet. I'm talking about investors who have discipline, protect their capital against crowded trades and think independently from the rest of Wall Street. It is these people for whom the sun is shining when for others it is raining cats and dogs (and bears), who quietly sit back until the fear across the market is so palpable you could hear a pin drop and then swoop in and deploy capital at precisely the time it is most counter-intuitive yet profitable to do so.

A prime example of this might be Berkshire Hathaway's recent establishment of a municipal bond insurance unit, at precisely the time when the rest of the industry is melting down. By starting a new vehicle without a legacy of ill-conceived expansion into new (and unprofitable) business lines, it has the ability to garner a Triple A rating and to rapidly secure high-quality (read: profitable) business that the market leaders simply cannot. In fact, it is questionable as to whether the MBIAs and the Ambacs should even be raising capital to defend their Triple A ratings, which essentially results in current shareholders bailing out current management at the cost of stunning dilution to their equity interests. In fact, some have even argued that it might be best for the established firms to shift into run-off mode, paying off risks as they come due and delivering the remainder to shareholders. I think the arguments are pretty compelling, but that's not the point. The point is that insurers are panicking, issuers are panicking, stockholders are panicking, and Berkshire Hathaway sees gold amidst the detritus that is now so obvious but was so hidden until they said "we're in business." And the reason they could do this is because of liquidity and a deep understanding of value.

Is there a reason why most asset managers, hedge funds and Wall Street firms have established pools to buy up busted mortgage paper and other distressed assets stemming from the subprime debacle? Yes, exactly for the reasons I stated above. The fact is, however, that the opportunity will be a lot less compelling for these folks, as there is already a huge amount of capital chasing these assets. The beauty of the Berkshire Hathaway example is that it combines liquidity, a sense of value AND specific business knowledge. Professionals with cash that understand mortgage paper and distressed debt are not that rare - they don't grow on trees but some reside within virtually every major financial institution of every stripe. The same cannot be said for those within the bond insurance business (at least those who know how to do it well). These situations are also examples of information arbitrage, where distinct knowledge together with liquidity and market opportunity creates maximum value. And it is these people that thrive on volatility and fear.

There is going to be a lot of money made in the next 12-18 months by a precious few, at precisely the time when most are getting brutally hammered. Long live volatility! If you can take advantage of it...

Alpha Today, Gone Tomorrow?

Is alpha going the way of the buggy whip? Short answer: no. It is simply that the alpha generation game has changed, and has certainly become more competitive. Is the ability to extract alpha from conventional sources of information becoming harder? Of course - with more managers staring at the same news and data and more dollars chasing the same trades, what would you expect? And Reg FD in the U.S. hasn't made getting an edge any easier. But this just means that investors need to cast a wider net, think more broadly and to develop new approaches for making money. This might include:

• Expanding geography
• Incorporating new asset classes
• Moving down the liquidity spectrum
• Considering behavioral finance principles
• Investigating and extracting value from new and different types of data

Needless to say, simply doing these things is not a panacea and may result in value destruction - not value creation - if not done in an intelligent manner. Distraction and lack of focus is the root of most evil. The point is to leverage one's skill sets and competencies into related areas, where intellectual property that has previously  been focused on what are now over-trafficked areas are deployed against less efficient markets.

The Economist recently ran a piece discussing Lo and Patel's December 2007 study on 130/30 funds, the punch line of which seems to imply that active managers are simply not generating that much alpha relative to passive strategies.

Fund-management skill is becoming rather like the 19th-century concept of a “God of the gaps”. Once humans attributed the weather or earthquakes to divine intervention; then they discovered high-pressure systems and plate tectonics. The number of events that required a heavenly explanation (the gaps) grew ever smaller.

Skill, or alpha, is fast becoming a residual: the explanation that remains when all other factors have been discounted. That is not yet a crisis for the industry, mainly because it is still so hard for clients to distinguish skill from luck. But for any thoughtful fund-management executive, it ought to be a long-term worry.

I guess the operating word here is "thoughtful." If there are any fund-management executives out there that feel they are doing just fine and that innovation is not necessary, they should probably be shown the door (or suffer massive redemptions). As the provision and dissemination of information gets more uniform, it will require more work to unearth alpha-generating strategies. It could mean more intensive research in new markets and under-covered instruments. It might imply new quantitative approaches leveraging not only new sources of data, but new analytical frameworks to extract signal across these source types. As the world flattens, new markets emerge and previously inefficient markets become more developed, "chasing the news" is simply not going to cut it. But by the same token you can be sure that smart and thoughtful money managers will continue to innovate, and will always find ways to generate true out-performance.

The sentiment of The Economists' article reminds me of the quote (taken out of context, I believe, but powerful nonetheless) attributed to Charles Duell, the former U.S. Commissioner of Patents in 1899:

"Everything that can be invented has been invented."

It was a silly statement then and it is a silly statement now. Bright people the world over will always make innovation happen, and there are more and more of them focusing on making money from the markets every day. Alpha generation is a phenomenon that will always be available to the smart, hard-working, creative and deeply talented. And while it may be "harder," that only really means that it is harder for those who are either unwilling or unable to adapt to a changed environment. Value is value, and the best will always be able to find it.

 

EXPERT NETWORKS: Where is the industry going?

Gerson Lehrman is the big dog, but vertical communities, vertical search engines and alternative information platforms like Monitor110 are moving reputation-based information discovery online. And now the ad-based Google Knol. Just where is this industry going? Who are the up-and-rising players, which models will prevail, and is it possible for anyone to knock Gerson Lehrman off of their formidable perch? I'd really like to know what you think.

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This is part of the experiment I mentioned in a post a few days ago. I have asked this question on LinkedIn, Facebook and now here, on my blog. I think this is a really important topic that warrants spirited, vibrant discussion, but I'm not sure which venue will serve to generate the most and best content. I guess we'll see. I'll report back.

A Different Approach to Early-Stage Investment

I admit it - I am green in the world of early-stage investing. Three years experience, 18 deals, $1.5 million invested, three exits (one has happened but is not yet disclosed). That said, I feel like I am in and around the early-stage investment scene enough and have done enough to have an opinion. And it is somewhat different than the classic VC definition of early-stage investing that I'm familiar with. I've always been told that a VC perspective can be summed up as follows: "A successful fund is characterized by a few home runs and a bunch of failures. This is the nature of the venture business." That always seemed to me like a scary model. Swing for the fences every time, strike out a ton and hope to connect on a few in the World Series. Fred Wilson's post on the Union Square Ventures weblog did a better job describing what I expect is the more conventional VC return pattern, where roughly 1/3 of the deals fail, 1/3 underperform and 1/3 meet expectations. But does this mean that VCs are still swinging for the fences every time, but that there are some duds mixed in with the complete goose eggs and the home runs? I don't know, but I expect that most are striving for at least a 10x on each and every deal.

I have taken a somewhat different view of early-stage investing. I have sought to build a portfolio diversified not only by sector and business model but also by another key dimension of risk: exit path and timing. What this specifically means is that I actually invest in deals where I expect to generate a return of, say, 3-5x in a fairly short period of time yielding a high IRR and risk-adjusted return. What does this mean? It means that I invest in both intelligent, needed features and applications as well as potentially disruptive technologies and business models. Mytrade? Great application. TheLadders.com? Disruptive business model. Mashery? Great application (but with great upside). Buddy Media? Disruptive business model (combining real high-value, monetizable commerce with social networking? Huh?). My portfolio is littered with great applications and features that will likely never be billion-dollar companies but where the entrepreneurs are laser-focused on commerce, making money from their IP and business approach. These are the deals that get taken out quickly, for that 3-5x type multiple, and get bolted on to a larger company's core offering. Is this a failure because it wasn't a "home run" and failed to get a 10x? Hardly. I'll take those all day long. But I do want the disruptive bets in my portfolio, but I don't want them to dominate. And I don't want a 1/3 failure or 1/3 underperformance rate. I want a much, much higher batti