1. Lecture 4: Investors are part of the problem Part II Jesse Reyes
NBA 5590
Lecture 4: Investors are part of the problem Part II Jesse Reyes

2. LPs at the Poker table

3. Takes Two to Tango Lessons Learned Or Lessons Forgotten
Takes Two to Tango Lessons Learned Or Lessons Forgotten? “LPs at the Poker Table”
“if I don’t stop committing at some point, I’ll wind up with long-term bond returns” Major Pension Fund LP Circa 1994

4. Difference in Risk and Uncertainty?
LPs at the Poker Table
Difference in Risk and Uncertainty?
Knight
Risk – we don’t know outcome but we know underlying distribution (rolling dice) – outcome is unknown but we can predict some probability
Uncertainty – we don’t know outcome, we don’t know underlying distribution (predicting terrorist attack or asteroid hitting the earth)
Common use
Risk – possibility of negative outcome
Uncertainty – possiblitiy of something happening either good or bad

5. Is there a difference in investment, speculation, gambling?
LPs at the Poker Table
Is there a difference in investment, speculation, gambling?
Investment manages losses as well as gains – r(maxi-min) – minimize volatility
Speculation: high degree of risk with high potential returns – volatility of outcome is part of the game. Soros says Investment is speculation gone wrong?
Gambling: Peter lynch says, “investing is gambling where you’ve tilted the odds in your favor”
Venture investing – aren’t the odds stacked against you, -- maybe just like poker to make money, you leave it to the experts?
Life insurance example – you are betting you are going to die in the next year, the insurance company says, I’ll take that bet because we know so much about people like you (the oddsmakers are not bookies but actuaries) that we don’t think you will die in the next year. As evidence, why is the ante so high or payoff so low if you try to get insurance at age 80 versus age 35? – Sure things, whether horse racing or football spreads have lower payouts.

6. Industry Forgot to Take Money off the Table
Cash Management usually is most successful by
Investing most at the beginning of an investment program
Investing smaller amounts as prices increase which keeps cost basis down so that even a large increase in price doesn’t affect profit much
But harvest some of the winnings
Invest Less as prices increase

7. Industry Forgot to Take Money off the Table
However the Lps during the venture boom (during 1990s)
Invested relatively little at the beginning
Then invested larger amounts as prices increased which increases the average cost
A small price decrease brings the whole thing down
Is buyout investing in the same position?
Invested More as prices increase

8. Industry Forgot to Take Money off the Table
Even worse…
As distributions outpaced commitments
LPs effectively rolled over distributions into new commitments
Effectively – doubling down with every new roll of the dice

9. So what is next?
Allocations to private equity will continue to be a vital part of the LP portfolio
LPs will continue to make commitments
Good investment managers will continue to be backed
LPs will have a more short-term focus in evaluation
LPs will be less forgiving of stumbles

10. So where are we an where are we going?
Is the Industry getting too big?
Average funds will find it hard to Raise money
Hard for LPs to get into the best funds they want
Industry Performance may scare off LPs no matter how long term focused they are–
Buyouts and early stage are at extreme end of the private equity spectrum but have similar challenges – you have to know who to invest in
Next stop – “looking over our shoulders”