DIVERSIFY OR DIE
Humans are impatient when faced with situations in which performance takes time to manifest. This is especially evident in the current economic climate. Howard Marks summed up what’s at play here very well when he said, “In the world of investing, nothing is as dependable as cycles.”
The problem for many investors is that they only want to invest in the best-performing share, so they stick to what they know and what has worked lately. For business owners, this means sticking to their own businesses and thus, their majority shareholding. The most perplexing aspect of cycles is that there is no rhyme or reason to their length or magnitude. It is possible that the business you own will continue its strong relative performance and deliver the expected results for a number of years to come. Or, it could end tomorrow. No one really knows.
Bill Bernstein provides a simple solution for this, saying, “I cannot predict the future, therefore I diversify.” Diversification is a hallmark of intelligent investing. Although it adds a layer of complexity to one’s investment activities, diversifying outside of one’s business and into other asset classes is worth the effort on several fronts.
Diversification is a technique that reduces risk by spreading one’s investments among various financial instruments, industries and countries. The advantage of investing in other asset classes and diversifying globally is that this minimises the risk of a home country bias. Most businesses are headquartered in a single geography. The microeconomic and political risk factors specific to this location may have a negative impact on the business. Investing in the market allows you to earn returns that are not based on a single region or portfolio and ensures access to global shares. It further allows you to diversify across the board in different industries and assets, creating a range of investment options that a single business cannot offer.
Investing in the market has its risks. However, the market has always risen over the long run, despite short-term setbacks. The cycles and drops are a very regular occurrence, but despite this, the market has still ended up achieving a positive return 75% of the time. The biggest danger for business owners isn’t a correction or a bear market, it’s being out of the market!
Diversifying could mean selling a minority or majority stake in your business, as opposed to a full exit. Many business owners have considerable net worth, however, a lot of this value is often tied up in the business and is thus illiquid. Selling a portion of the business converts the business owners’ equity into cash. Unlocking this equity through liquidity may reduce the seller’s risk by diversifying his or her portfolio and allowing the seller to free up more cash and invest in other asset classes. It further allows the business owner to invest consciously and pursue his or her personal interests, which could lie in other businesses, private equity ventures or 12J funds.
‘Diversify or Die’ is a warning to businesses about staying in the same place for too long. In these challenging economic times, diversifying can be a risky strategy if you are not partnered with the right advisors. Caleo is a business that partners with its clients on the advisory side, exploring private equity opportunities as well as managing their wealth globally. The wealth and return accumulated from your single business share will most likely not equate to the return on the market. However, it will allow you to minimise risk and preserve your wealth and your legacy for future generations.
Garth Wellman, Co-founder and joint CEO, Caleo Capital