MICRO CAPS IN THE PORTFOLIO ASSET ALLOCATION

The notion of asset allocation has increased in complexity and scope over the past decade. In the beginning it was stocks versus bonds and how much of each was appropriate for a given investor. Over time, many other asset classes were introduced. Oftentimes these other asset classes were recognized because they started out in the portfolios of a narrow group of institutional investors. As the diversification benefit of these asset classes became more widely known, they moved into a larger number of investors’ portfolios. Over time, indexes were created to track the performance of these new asset classes, and the investments became available to an ever larger number of smaller investors.
Real estate is a good example of this asset class evolution. When originally introduced to institutional investors, only the largest and most progressive used real estate in their portfolios. As real estate’s low correlation to stocks and bonds became better known, the asset class found its way into a larger number of institutional portfolios. Over time, no self-respecting fiduciary would have a diversified portfolio if it did not include real estate. The emergence of the real estate investment trust (REIT) asset class over the past 20 years has made it possible for smaller investors to enjoy the benefits of owning an interest in a diversified portfolio of real estate. Now even the smallest retail investors can include a REIT mutual fund among their holdings and have the positive diversification of real estate. In many ways, the emergence of the micro cap asset class will allow smaller investors to benefit from the diversification of venture capital through the inclusion of micro cap investments in their portfolios just as the emergence of REITs as an asset class has allowed a similar diversification into real estate. The largest and most sophisticated institutional investors have allocated a portion of their portfolios to venture capital. A study done by Uniplan Consulting found that as of December 31, 2003, pension plans in the $1 billion to $10 billion range had allocated on average 7 percent of their assets to venture capital. This was down from 11 percent as of December 31, 1999, which was likely the peak of venture capital investing among these institutions, and that peak largely coincided with the peak in technology and Internet investing.