The easiest way to double your money - BDO

BDO Simpson Xavier Private Wealth Management
Investment Update — 19.06.2008
The easiest way to double your money
The safest way to double your money is to
fold it over and put it in your pocket or so Kin
Hubbard opined back in the early 1900’s. In
the current environment, many believe his
advice makes a lot of sense.
A week may be a long time in politics but for investors (who
believe they have a long term investment horizon) the last
12 months seems like an eternity. In the early part of 2007,
markets were in a euphoric phase. There were just not enough
investable opportunities around for those with capital. Yet, in
the space of 12 months, with bank coffers nearly $400billion
lighter, commentators and analysts are tripping over
themselves to get the sound bite that is the gloomiest. On a
daily basis, news bulletins focus on keeping us up-to-date on
the annals of gloom. We hear how poorly the stock market is
performing, how much house prices are falling, how weak the
dollar is and how quickly the price of oil is rising etc, etc.
What does this mean for us
as investors?
There is little doubt that global economies are under strain.
Years of low interest rates, cheap money and ridiculous
lending practices have led to what is now known as the credit
crunch. Credit is available; it’s just that no one wants to give
it to you. The knock on impact of a re pricing of credit and
investor risk appetite is that many investors and investment
banks who took on too much risk chasing those fantastic
returns, are left holding investments that they did not envisage
holding. Factor in that these investments are falling in value
daily and suddenly a severe hangover emerges from the party.
The buying and selling spree came to an abrupt end in the
second half of 2007. So, yes the doom and gloom that we
read in the press is warranted as it is an accurate reflection of
daily events. In addition, investors have seen the value of the
investments fall over the last 12 months, but how important is
this as medium to long term investors?
In our opinion the daily market snapshots from media and
market commentators are nothing more than unnecessary
noise that serve to give us indigestion. Mindful of the
performance of investment portfolios over the last 12 months,
here are our observations:
1 The market is the market.
Benjamin Graham, the legendary investor and mentor to
Warren Buffet used the metaphor of “Mr Market”. To quote
him, “...[an investor] should always remember that market
quotations are there for his/her convenience, either to be taken
advantage of or to be ignored”. At BDO when we meet clients
in almost all cases, clients will have an investment horizon
of 5 years or more. However, in each and every case, the daily
gyrations of the markets cause them concern. Investors should
remember that the market is there to allow them to invest
or liquidate as they see fit. It is also the best estimate of the
collective wisdom of investors at a point in time as to the
value of any particular company or otherwise. However, just
because someone is willing to put a value on an investment,
doesn’t mean that this is the true value of the investment. It’s
merely a value at that point in time that someone is willing to
pay; is there for our convenience; and more importantly factors
in the sentiment of the market of the day. If you have no
intention or requirement to sell, then treat it as Ben Graham
advised, to be either taken advantage of, or ignored.
2 Investors should adapt their investment approach.
Most of us as investors have approached our investments
on what at BDO we term as a transactional approach. Yes,
our investment advisors told us we were diversifying but the
reality was that we were simply buying one transaction after
another, typically either a share or great property opportunity,
or so we were told. Investors need to take stock of their current
asset allocations, particularly given the barrage of perceived
opportunities that are available. If we are over exposed to
one asset class, in the current environment, increasing this
exposure may not be wise. We should use the opportunity to
put shape on our portfolios by preparing an investment plan
as a roadmap for future investing and start again. The evidence
clearly indicates that 91.5% of a portfolio’s return over time
comes from asset allocation rather than security selection or
market timing. Clearly, spending time on asset allocation is
worthwhile.
More importantly though, in the future investors need to
adapt the selection criteria they use to assess investments.
Believing that a particular transaction offers value merely
because the price is lower than it was 12 months ago is likely
to cost you money.
3 Follow the smart money
It’s always interesting to see what smart money is doing in the
current environment. Equity withdrawals by private investors
from public equity markets hit a record of $75billion for the
first quarter of 2008, higher than the withdrawals at the height
of the dot com bubble. Over the same period though, private
equity funds continued to raise finance and when added to
what Citibank believe is $500 billion of yet to be deployed
capital, clearly there is a lot of capital on the sidelines waiting
to be put back to work..
Before, we look at where smart money is going, we firmly
believe that the private markets will offer significantly more
attractive opportunities than the public markets.
Table A illustrates the returns for private equity versus two
public markets, the MSCI World Index and S&P 500. As can
be seen, the returns from the private markets outperformed
those of the public markets. Over a 10 year period, the private
markets delivered between 10% and 11% versus between 7%

and 8% for public markets.
Table A. Pooled Performance as of 31 December 2006
Investment Type
10 Years
All U.S. private equity* 11.00%
All European private equity † 10.1
MSCI World* 7.6
S&P 500* 8.4
*In U.S. dollars
† In euros
Sources: Thompson Venture Economics; Bloomberg; Standard & Poor’s
But were these returns enough given the illiquidity of the
private markets? Table B, illustrates that there is a large
difference between the best managers in the private markets
and the rest. As can be seen from the table, by investing with
top quartile managers for example, in US venture funds, your
annual return over the 10 year period would have been 82.7%
versus the S&P 500 of 8.4%.
Table B. Top-Quartile Performance as of 31 December 2006
Investment Type
10 Years
U.S. venture funds* 82.70%
U.S. buyout & mezzanine funds* 22.9
European venture funds † 26.7
European buyout & mezzanine funds † 31.4
MSCI World* 7.6
S&P 500* 8.4
*In U.S. dollars
† In euros
Sources: Thompson Venture Economics and the National Venture Capital Association
Hence, private markets have historically done better than
public markets, critically though, success depended on where
or with whom you invested.
4 What are we seeing?
Consider the approach of one of the worlds largest and most
successful fund managers. For them, it is about risk and
reward. Take this simplified example. The government backed
mortgage agencies lent billions to the US housing market. The
housing market is under severe strain with record foreclosures
and largest annual price declines in some parts of the US for
nearly 20 years. Hence, property as an asset class is under
strain and is significantly cheaper than before.
However, these managers are not buying property, they are
buying the debt of the mortgage agencies that provided the
financing to the property market.
One can see their rationale:
1) They want a return of their money as well as a return on
their money.
2) The debt is guaranteed by the US government.
3) The debt of these mortgage lenders is as cheap as it has
been in over a decade.
4) For them, the better bet is that they will be able to profit
from the debt faster than the property.
Why buy the house, when you can buy the debt of the bank
that funded the house, with a guaranteed competitive return
and guarantee of your capital back? Many private equity
companies are also purchasing what are called leveraged
loans (loans provided to private companies) because of their
perceived value. The thesis is, that if markets recover in the US
the debt market/loans market will recover faster than some of
the traditional asset classes, because unless the debt markets
recover, neither will the traditional asset classes.
These are just two examples but the point to take away
is that, as we have said before, often the most attractive
opportunities are not accessed via the most obvious routes. ‡
Consider also the following. Across the globe, initial public
offerings (IPO’s) by private companies have plummeted for
2008 as a result of the credit crunch. Take the Nasdaq market
in the US as an example. The value of IPO deals for 2008 (as at
May) was c$620million. The value of IPO’s for the equivalent
period in 2007 was $8.7billion. Using the Nasdaq as a proxy for
IPO activity, it is clear IPO activity has fallen off a cliff.
So where is the opportunity? It goes back to the private
versus public market position set out earlier. Clearly, there
are some companies that as a result of the credit crunch
will not make the grade to IPO, though predominately, many
companies have merely postponed their IPO’s.
For these, while they wait for a more opportune time to come
to the market, their critical requirement is to have enough
funds to enable them to continue in business until they IPO.
Unfortunately, for these companies, their traditional equity
raising/financing channels, i.e. the investment banks are shut
for business. Fortunately though for them, the Venture Capital
(VC) and Private Equity (PE) firms are stepping up and filling
that void. As VC and PE firms are the few that are willing to
provide finance, the terms they can negotiate are particularly
more attractive that might have got in the past for a company
that was about to and still is likely to, IPO.
To Conclude:
In our opinion, that over the next 24 months, opportunities
will be found in the private markets and these market
conditions are likely to be a once off opportunity for these VC
firms. Had the credit crunch not occurred, these companies
would have IPO’d and have become public companies. Hence,
there is a temporary market anomaly between public and
private markets that will rectify itself once markets return
to functioning normally. As investors, can you access these
opportunities alongside these VC companies in the private
markets? Yes you can.
Talk to us at BDO Private Wealth Management Ltd.
Tony Morley Investment Director
Michelle O’Keefe Partner in Charge
tmorley@bdosx.ie | 01 4700264 mokeefe@bdosx.ie | 01 4700330
www.bdosx.ie
BDO Simpson Xavier Private Wealth Management Limited is regulated by the Financial Regulator as
an Authorised Advisor and as a Mortgage Intermediary. Whilst all reasonable care has been taken in the
preparation of this brochure, we do not guarantee the accuracy or completeness of the information contained
herein. The information contained herein is strictly for information purposes only and does not constitute an offer
or an invitation to invest. Any opinion expressed may be subject to change without notice and is provided on the
basis of publicly available information. The value of investments may fall as well as rise.
Private Wealth Management Ltd
‡Note, this is for illustrative purposes. It is not a recommendation to purchase mortgage bonds,
nor is it a view on the property market.