Wave Theory For Alternative Investments: Riding The Wave with Hedge Funds, Commodities, and Venture Capital (PROFESSIONAL FINANCE & INVESTM) - Hardcover

Walker, Stephen Todd

Hardcover

ISBN 10: 0071742867 ISBN 13: 9780071742863

Publisher: McGraw Hill, 2011

Synopsis

A Strategy That Helps You Weather Any Economic Storm

"Wave Theory for Alternative Investments is not just a guide; it is the holy grail for understanding alternative investments." -- Matt Emmens, Chairman, President, CEO of Vertex and Chairman of the Board of Shire

"Walker's book provides investors and managers with an intriguing walk through the history of venture capital as an alternative asset class, while demonstrating the important contribution VCs have made and continue to make to innovation, economic growth, and job creation." -- Bryan Pearce, Americas Director, Ernst & Young Venture Capital Advisory Group

"If you want to learn about alternative investments, there is one book which must be on the very top of your reading list, Wave Theory for Alternative Investments. The author delves behind mere analytics and algorithms with a behaviorably based, verifiable tool." -- Stephen M. Goodman, Senior Partner and Cofounder of the Emerging Growth Practice, Morgan Lewis & Bockius LLP

"If you want to understand the history of venture capital in the context of its current manifestation, there is only one book: Wave Theory for Alternative Investments." -- Bo Peabody, Managing General Partner, Village Ventures

"Venture capital helps fuel the growth of America's finest companies, the leaders of tomorrow. Wave Theory for Alternative Investments is a must-read for [entrepreneurs and] those who wish to invest in the technologies of the future through the venturecapital process." -- Mark Heesen, President, National Venture Capital Association

The 2008 crash taught quite a few intelligent, high-net-worth, and institutional investors the hard lesson thatequities and bonds can carry a fair degree of risk. Many of these investors mistakenly cashed out of their plummeting investments at precisely the wrong time--and completely missed the recent wave of recovery.

Wave Theory for Alternative Investments helps avoid poor decision making and costly mistakes. Consistently ranked among the nation's top wealth managers, Stephen Todd Walker explains how to catch the waves of potentially lucrative yet volatile alternative markets--and ride them to unprecedented profits.

Wave Theory for Alternative Investments is an insider's guidebook to some of the fastest-growing segments of the investment world, including hedge funds, commodities, and venture capital. Wave Theory for Alternative Investments is your first lesson in usingalternatives to keep surfing--and avoid wiping out in the next financial meltdown. This excellent resource includes:

• A brief history of alternative investments
• Numerous risk/return profiles
• Critical tools, including fundamental and technical analysis

Walker shares his extensive knowledge, top-tier experience, and proven strategies to help you maximize return-on-investment on a consistent basis.

The complex process of alternative investing can take years of practice to master. Wave Theory for Alternative Investments helps you adjust your approach right now, so that you'll be in prime position to catch the best waves in the next financial storm.

About this title

About the Author

Stephen Todd Walker's clients include Forbes 400 members and some of the most affluent families in the world. During his 20-plus years in finance, he was one of the youngest directors in Alex. Brown history. He served as a Senior Vice President, Corporate Client Group Director and was a member of Morgan Stanley’s Chairman’s group. In 2009 and 2010, Barron’s listed Walker among the Top 1,000 Advisors in the United States. The author lives in Bryn Mawr, Pennsylvania.

Please visit the author at Stephentoddwalker.com

Excerpt. © Reprinted by permission. All rights reserved.

Wave Theory for Alternative Investments

Riding the Wave with Hedge Funds, Commodities, and Venture Capital

By STEPHEN TODD WALKER

The McGraw-Hill Companies, Inc.

Copyright © 2011 Stephen Todd Walker
All rights reserved.

ISBN: 978-0-07-174286-3

Contents

Acknowledgments
Disclaimers and Disclosures
Introduction
PART 1 Waves
Chapter 1 Wave Theory
Chapter 2 Surfing Alternatives Waves
Chapter 3 Wave Action, Reflection, and Mastery
PART 2 Venture Capital
Chapter 4 Defining Venture Capital
Chapter 5 The History of Venture Capital
Chapter 6 Venture Capital Market Dynamics
Chapter 7 Private Equity: Venture Capital Advantages and Disadvantages
Chapter 8 Venture Capital Performance
Chapter 9 Venture Capital Investment Vehicles
PART 3 Commodities 235
Chapter 10 Commodity Overview
Chapter 11 Commodity Investing
PART 4 Precious Metals (Gold)
Chapter 12 Gold Overview
Chapter 13 Gold Waves and Investments
PART 5 Hedge Funds
Chapter 14 Hedge Fund Overview
Chapter 15 The Hedge Fund Market
Chapter 16 Hedge Fund Advantages and Disadvantages
Chapter 17 Hedge Fund Performance
Chapter 18 Hedge Fund Investment Vehicles
Notes
Index

Excerpt

CHAPTER 1

Wave Theory

Wave theory is simply the belief that all securities move in waves (patterns,cycles, or trends). History sometimes repeats itself, but with alternatives aninvestor can typically see similar waves repeating themselves. Equities move inwaves. Fixed income moves in waves. Cash moves in waves. There is now enoughdata to support the notion that alternatives also move in waves. Besides theseasset classes, there can even be styles such as "value" or "growth" investingthat move in waves. Securities can also move in tandem, forming huge waves inepic downturns or sharp rallies. Realizing this, one can either make a lot ofmoney or lose a lot of money while investing. After the Dow Jones dropped from14,164 to 6,469, many investors sold securities at precisely the wrong time andlost trillions of dollars. Ironically, when the market started to recover andpassed 10,000, many of these same investors attempted to jump back in and chasethe market after they sold at the very bottom of the market. The individual whocoined the expression "buy low, sell high" was not unintelligent. Yet investors(ones who are not paying attention to waves) frequently follow the news mediaand make the erroneous mistake of buying high and selling low.

Waves are found among all asset classes, including the fastest growing andcompelling asset class: alternatives. In other words, there are distinct wavesfound within the alternatives asset class. Since more data became available inrecent years, it is apparent that waves exist with alternatives. Those of themain alternative groups—hedge funds, commodities, and private equity(venture capital) — all have identifiable waves. One must be cognizant ofwaves found with alternatives to lower risk and maximize returns. Otherwise, theresults can be lackluster if not devastating.

Mergers and Acquisition Waves

There is very little written about waves in finance, and although severalindividuals have touched on the subject, none have written about alternativesand waves. Alternatives are a relatively new asset class and can be difficult tounderstand. Those who have discussed waves in the past tend to review them withregard to various aspects of finance, not asset classes. For example, Allen,Brealey, and Myers's Principles of Corporate Finance explained thatthere are merger and acquisition waves:

Mergers come in waves. The first episode of intense merger activity occurred atthe start of the 20th century and the second occurred in the 1920s. There was afurther boom from 1967 to 1969 and then again in the 1980s and 1990s (1999 and2000 were record years). Each episode coincided with a period of buoyant stockprices, though there were substantial differences in the types of companies thatmerged and the ways they went about it.

Robert F. Bruner also wrote about waves in Applied Mergers andAcquisitions, in which he describes "five periods of heightened mergeractivity; hereafter, I will call these 'waves'." The fifth wave, or his Wave 4b(which I will call Wave 5), was caused by a few large scale mergers andacquisitions (M&A) deals. According to Bruner, "Following the 1990-91 recession,M&A activity increased briskly in all segments of the economy and all sizecategories. The announcement of a few large deals signaled to some observers a'paradigm shift' in M&A where old rules about strategy, size, and deal designwere being replaced with new rules."

The graph in Figure 1.1 shows M&A activity in terms of deals and depictsone of the M&A waves described by Bruner. If one combines all of the M&A wavesover the last century, Figure 1.2 depicts a long-term trend of M&A waves(patterns, cycles, or trends).

Long before Bruner, Joseph Schumpeter noted "cycles" with M&A activity.Schumpeter originated the concept of creative destruction. His ideas have beenwidely applied to theories of evolutionary economics. Understanding M&A waveswith economics is helpful because of their effect on alternatives. Alternativeasset classes (such as venture capital or leveraged buyout funds) depend on theM&A market because it is an exit strategy or a means to take a profit or cashout. The M&A market has shown distinct waves, especially over the past 30 years(Figure 1.3).

Whether one measures the number of M&A deals or the dollar value of these deals,it is apparent that waves exist.

Initial Public Offering Waves

The discovery of waves with alternatives might be beneficial to a plethora ofinvestors from retail and high net worth to institutional investors. Also, waveswith alternatives might assist venture capital-backed private companiescontemplating going public as well as investors in venture capital (pre-initialpublic offering [IPO]) or even buyers of IPOs. Wave Theory can help a lot ofdifferent people, including entrepreneurs who would like to take a companypublic. Chief executive officers (CEOs) of fast-growing emerging companies(e.g., health care, technology, consumer), should be aware of the point at whichthey are approaching a wave before going public. Depending on where a venturecapital-backed company stands with regard to a wave, the CEO or venture firmmight decide to wait or hold off for a more opportune time to gopublic—that is, be one of the first to go catch the wave. IPOs at thepinnacle of any market tend to have precipitous drops.

Similar to M&A, there are distinct waves with the IPO market. Whether oneexamines the number of IPOs or value in IPO deals, it is quite apparent that theIPO market (like the M&A market) travels in distinct waves as depicted inFigure 1.4. Hilary Kramer wrote the following about IPO waves inAhead of the Curve: "IPOs are big waves that should be surfed only byinvestors who can stomach the big-wave risks associated with them ... IPO wavescan be big, and the payoff can sure be big, too."

Before 1999, there was a strong wave correlation between M&A and IPO markets.After this time, the M&A wave was robust, whereas the IPO market suffered. Therewere a number of variables that explained this phenomenon. The Sarbanes-OxleyAct was introduced to regulate new companies. However, it made it more expensivefor young, fast-growing companies to arrange an IPO. Many went public in foreignmarkets (such as the London-based Alternative Investment Market) to save money.Others elected to become part of a larger conglomerate (M&A) to help themfinance growth. Thus, M&A increased while IPOs decreased after 2002. Figure1.5 portrays the number of M&A deals versus the number of IPO deals.

One can clearly see from this graph the huge growth in M&A deals since 2000. TheIPOs during this period declined precipitously.

Waves and Economics

Investment waves were first depicted by the Russian economist Nikolai Kondratiev(1892-1938). Besides his wave ideas with investing, he is known for being aproponent of the New Economic Policy—a program during the Lenin years thatallowed a small bit of capitalism. Kondratiev was imprisoned and later executedfor his economic views. David Barker summarized Kondratiev's theories in TheK Wave:

The first matter to be covered when considering the Kondratieff long wave'seffect on investments concerns timing. An economic cycle of 50 and 60 yearsduration is questionable as a precise investment-timing instrument. You cannotuse the K Wave to say what will happen next month or even next year withprecision in any market. However, the K Wave's long-term trend impact onfinancial markets is critical information. The K Wave's impact can make or breakan investor's long term returns—and even determine a company's survival.Investors should incorporate the most important elements of K Wave Theory intotheir general decision-making process.

Other economists wrote about reoccurring waves or cycles. Waves are inevitable,just like mortality. We cannot avoid waves just like we cannot escape death. AsHerman Melville described in Moby-Dick, "... the waves should rise andfall, and ebb and flow unceasingly; for here, millions of mixed shades andshadows, drowned dreams, somnambulisms, reveries; all that we call lives andsouls, lie dreaming, dreaming, still; tossing like slumberers in their beds; theever-rolling waves but made so by their restlessness." Life is filled withwaves, both good and bad. Even if there is an occasional bad wave, it is not theend of the world because it is a "cleanup process," as referred to inChevallier's Greenspan's Taming of the Wave:

Greenspan emphatically proved in the 1990s that, even if down waves can't beescaped overall, depressions can be avoided. Thus, creative destruction can bemade to work in your favour. In other words, the clean-up process can beshortened by adequate monetary policies and depression need only be endured asworst-case scenarios. Hence, what the world needs in the future will be centralbankers able to tame the wave, 'a la Greenspan.'

Waves and Mathematics

Waves are not new to mathematics. In fact, Figure 1.6 shows that simplemathematical waves can be added together to create a graph that resembles one ofan alternative wave.

The exact formula used to create this wave is not important. The centralimportance is the general shape of the graph. Although these waves arehypothetical, similar waves in real life might represent a spike in prices froma war, hurricane, or other significant event.

A number of famous mathematicians wrote about waves. For instance, the Fibonaccinumber sequence was developed from the Italian mathematician LeonardoFibonacci's book, Liber Abaci, which helped explain natural phenomenon.Mathematician Leonardo de Pisa (Fibonacci sequence of numbers) first wrote aboutpatterns that were later used for analyzing alternatives.

What may be surprising is just how pervasive the Fibonacci numbers are inElliott's analysis of the stock market. Tracing most bear markets, he found thatthey move in a series of 2 impulsive waves and 1 corrective wave, for a total of3 waves [like the beginning of the series]. On the other hand, his researchshowed that a bull market usually jumps upward in 3 impulsive waves and 2corrective waves, for a total of 5 waves [following the Fibonacci sequence]. Acomplete cycle would be the total of these moves, or 8 waves.

Albert Osborne, a wave mathematician from the University of Turin, wrote aboutrogue waves. Just like the securities market, normal waves can become unstable.It is believed that huge waves can leap up out of nowhere. "Quantum physics hasat its heart a concept called the Schrodinger Equation, a way of expressing theprobability of something happening that is far more complex than the simplelinear model." Schrodinger's theory, "An Undulatory Theory of the Mechanics ofAtoms and Molecules," published in the Physical Review (December 1926),was based on the research of L. de Broglie in what he called phase-waves("ondes de phase"). This view was essentially that material points are wavesystems.

Waves and Securities

It is fairly well known that equities (both foreign and domestic), fixed income,and cash have identifiable waves. Ralph Nelson Elliott described "waves" withthe stock market long ago. Elliott was born more than a century ago on July 28,1871, and observed waves with the securities market. Elliott's observations ofstock market behavior began coming together in 1939 into a general set ofprinciples that applied to all degrees of wave movement in the stock priceaverages. Elliott believed the stock market is affected by repetitive waves.Further, Edwards and McGee wrote Technical Analysis of Stock Trends,which was first published in 1948. Essentially, the book showed that stocks movein identifiable patterns, which repeat themselves as a result of supply anddemand. Finally, money management firm BlackRock depicted trends or patternswith equities, fixed income, and cash over the past 20 years in Asset ClassReturns: 20-Year Snapshot (Table 1.1):

BLACKROCK

Large Growth versus Value Waves

From the above BlackRock graph, one can see that large-cap growth investing waspopular from 1989 to 1991. From 1992 to 1993, large-cap growth investing did notdo as well but rallied from 1994 to 1999. However, large growth then remainedout of favor from 2000 until 2006. In 2007, large-cap growth was the best-performing asset class. Growth moves in waves. When large-cap growth investingdoes well, value investing typically does not. The contrapositive is true; whenvalue investing does well, growth does not. Figure 1.7 helps show waveswith the Russell 1000 Growth versus Russell 1000 Value.

Large- versus Small-Cap Waves

In 1999, before the bubble imploded, growth was in vogue while value did poorly.If one invested heavily in growth at this time (after a long growth wave), onewould be investing at an all-time high, which Alan Greenspan described as"irrational exuberance." The value wave then took over from 2000 until 2007— a really long wave to ride. Frequently, when there is a large-cap wave,small caps do not perform as well. The antithesis is true: when small caps arein favor, large caps usually do not do as well. Figure 1.8 exemplifieslarge-cap outperformance versus small-cap outperformance.

Fixed-Income versus Equity Waves

Fixed income was the best-performing asset class from 2000 to 2002 and then wasone of the worst-performing asset classes from 2003 to 2006. Fixed income tendsto do well when equities are underperforming. For instance, fixed incomeperformed the best out of any asset class in 2008 (including cash). However,when equities have strong returns, bonds frequently are not performing well, asshown in Figure 1.9 with the S&P 500 versus Barclays Bond Index Fundfrom 1993 to 2009.

Foreign versus Domestic Equity Waves

Foreign equity moves in waves as much as domestic equity. Foreign equityinvesting performed poorly from 1989 to 1992. However, from 1993 to 1994, it wasthe best performing asset class. From 1995 to 1997, foreign equity moved out offavor but gained traction again from 1998 to 1999. Foreign investing moved outof favor again during 2000-2002. Foreign equity didwell from 2003 to 2007 but was one of the worst-performing asset classes in2008. It is interesting to note that foreign-equity investing over time hasbecome more closely aligned with domestic-equity investing primarily because theUnited States is part of a global economy. According to the 2009 "Top 100" inForbes, only 7 out of the top-20 largest companies in the world werebased in the United States. Historically, the number of U.S. companies on thelist was far greater. In fact, the United States had 11 out of the top-20 globalcompanies in 2005. This new wave might help investors learn the importance offoreign-equity investing and that the United States is an integral part of theglobal economy. One might be remiss to not own foreign equities in his or herportfolio. Figure 1.10 depicts the Dow Jones compared with the MSCI (ExUSA) from 1989 to 2009.

Long-Run versus Short-Run Waves

Although one can clearly see waves with value versus growth investing, equitiesversus fixed-income investing, foreign versus domestic investing, small-capversus large-cap investing, there exist larger waves from the market in general.For example, if one charts the Dow Jones from 1929 to 2009, a total of 18 wavesare identifiable (Figure 1.11).

Smaller waves might appear insignificant when examining waves over long periods,but they become much more traumatic or even exaggerated up close. The longer theperiod, the more likely the tendency to smooth out volatility for various assetclasses. In other words, one might not notice the asset class fluctuating as onemight see in the short run. Equities, for instance, appear attractive and lowrisk in the long run. But in any given year, equities can drop precipitously,such as evidenced in 2008. Time dampens the wild swings in the market so thatequities average 9% to 10%. One might be tempted to put all their money inequities after examining the S&P 500 because in the long run the market movesup. In the short run, there is volatility, and an investor can examine the rockywaves.

Hypothetically, if one examined the market for a shorter period (1995-2009), onecould see two massive market declines in which trillions of dollars were lost byinvestors and the United States experienced unprecedented volatility (Figure1.12).

If one peers closer as a scientist does while sharpening the focus of his or hermicroscope, one can see the waves even more vividly. For example, the uptrend ortrough-to-peak exhibited from January 1997 to March 2000 is distinct. The bullmarket rally revolved around the Internet and technology sector. During thisperiod, the market reached a historic high (Figure 1.13).

Yet we know nothing exists that can actually grow to the sky; there will be acorrection. The tide turned after March 2000, when growth investing turned tovalue investing (Figure 1.14). The nonstop barrage of negative newslasted several years, with many unforeseen events taking place one afteranother, such as 9/11, Enron, and Martha Stewart being hauled off to jail.

Cash Waves

Buying equities in this downturn would be tantamount to surfing in a parkinglot—it will not happen. Catching a falling knife is a bad idea. Whenstocks start falling, run for cover. One might argue that you cannot time themarket. However, it is quite clear from Figure 1.14 that investors werenot limited to a few days from which they had to exit the market or go to thesidelines; they had three years of warning signals.

(Continues...)

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Excerpted from Wave Theory for Alternative Investments by STEPHEN TODD WALKER. Copyright © 2011 by Stephen Todd Walker. Excerpted by permission of The McGraw-Hill Companies, Inc..
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Edition details

• Publisher: McGraw Hill
• Publication date: 2011
• Language: English
• ISBN 10: 0071742867
• ISBN 13: 9780071742863
• Binding: Hardcover
• Number of pages: 464