Investment performance should not be reviewed only on the basis of absolute returns. Money management results should be relative to the results achieved by others and the making of different decisions
Serious investors, especially those responsible for the investment of other people’s money, must always be aware of the “what if” results which might have been achieved if different decisions or policies were used. Of course, the performance of alternative investments must also be considered if optimization of performance and, accommodating risk tolerance levels are, portfolio management objectives.
The performance of an investment portfolio must be compared to market measures for publicly traded securities as well as to portfolios managed by other known investment managers. Indeed, for possible improvement, the managed portfolio’s total Internal Rates of Return (IRR) should be shown as both an absolute return, as well as a percentage compared to either or both the market indices or other comparable portfolios, in different time periods.
The various Lipper Mutual Fund Performance Analysis services which I created in Arthur Lipper Corporation and which my brother, A. Michael Lipper, well-continued in his firms, provided performance ranking data constructively.
The question the owner of the money or beneficiary of the investment activity should ask when reviewing performance results is “How could we have done better?” As there will always be those who have done better in the same period, the real question is “What have they done which we have not done?” Furthermore, it could be asked “What can we learn from studying the relative success of others? These questions and the answers are easier to address and analyze if the portfolios are of publicly traded securities because price and performance data about investments in privately owned companies are not as available or as well documented.
I once did an analysis for a major mutual fund management company’s CEO who himself managed one of his company’s two best performing funds. His fund consistently out-performed the other even though the competing mangers shared the same amount of information about the companies in their portfolios and the same general predictions for the stock market. In this case, his outperformance was due of the portfolio weighting of the holdings. The consistent winner owned relatively more of the companies selling at a lower Price/Earnings Ratio, based on the current year’s predicted per share earnings. In other words, the managers used very similar stocks, but held them in different portfolio weightings, meaning the better performing manager placed bigger bets on the stocks of companies requiring less expected earnings growth for better relative performance.
Now, as many of you will have expected, I observe that revenues are more easily accurately projected than per share reported earnings and therefore revenue royalties are the better bet, if the royalty is well structured.
The royalties we recommend have investor protections including: investors having 60-month cost based repurchase options, royalty collections required procedures providing payment simultaneously with the company’s revenue receipt, control of critical assets and, in some cases, assured minimum royalty payments.
We also recommend that royalty issuing companies have a right of redemption, permitting the acquisition of all outstanding royalties on terms negotiated at the time of drafting the royalty agreement.
Therefore, royalties can be expected to generate highly satisfactory projected returns with far less risk than is the case for equity investors. However, it is reasonable and acceptable to many that reduced risk justifies more modest levels of investor assured return. The objective is to create a structure balancing the royalty issuer’s anticipated return on the use of proceeds received versus the cost of the money, recognizing the absence of equity dilution in royalty transactions. For the business owner believing in a significant future increase in the value of his or her company, retention of as much ownership as possible, while still obtaining the capital needed, is of great importance. The more the business owner believes in the success of the company, the more of the company the business owner should want to own.
As a final observation, a royalty income fund holding royalties issued by established companies, having revenues should be able to assure investors against portfolio loss. Therefore, either or both the fund or investor could consider the use of leverage as a means of increasing return, especially in the low interest rate period we are now experiencing.
Arthur Lipper, Chairman
British Far East Holdings Ltd
858 793 7100
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