The New Diversification: Intellectual Property Assets and the Magic of a Barbell Portfolio

Franklin Parker
Sep 8 · 4 min read

My grandfather served in the US Navy after World War II as a sonarman. Apparently, the Pacific Ocean was a quiet place after 1945 because while on watch he would pass the time teaching himself card tricks. 50 years later, those card tricks were the source of constant entertainment for a young boy in central Texas.

What so fascinated me was that the tricks appeared to be magic, but are based on a few very simple techniques. Those basic techniques can be adjusted and combined to build just about any effect desired. Magic, as I learned from my grandfather, is about knowledge and experience, not mystique and the supernatural.

So, let me show you a magic trick.

We flip a coin 100 times, when it lands on heads we get 2x our bet, and when it lands tails our bet is cut in half. We are paid out at the end of the game, so no walking away early!

Of course, this seems a silly game to play. The expected payoff of the game is $0 (i.e. we should expect to get no gain), but the payoffs will vary wildly. The plot below shows one simulation of this game where we begin with $1, but by the end, we’ve lost 99% of our wealth — an unlucky outcome, to be sure.

But there is arcane magic in volatility.

Rather than betting all our wealth on every flip of the coin, if we expose only half of our wealth to the coin flip and hold the rest in reserve, this game becomes immensely profitable. By simply rebalancing our wealth after each coin flip, the odds of the game change entirely, delivering a positive outcome almost every time. In the plot below, we have the same coin-flip series from above, but this time with a rebalance after each flip.

What was a loss of 99% has been transformed into a gain of 15 times our original wealth!

This is not magic, of course, it is a studied quantitative technique called “volatility harvesting.”

Volatility harvesting is the rationale that underpins a barbell portfolio. By pairing assets that have very different volatility profiles, the barbell portfolio can generate returns by harvesting that difference in volatility — very much like our coin-flip game.

However, the benefits of volatility harvesting are significantly reduced when the correlation between assets is high. This is part of what makes our current market regime so difficult for investors. When asset prices have dropped, they have tended to do so in tandem, and when they have moved up, they have tended to move up separately. This gives investors the worst of diversification with few of the benefits, and it has driven the search for truly non-correlated assets.

Intellectual property assets, especially in the early stage, tend to have a life of their own — often divorced from the short-term swings in sentiment that drives public market prices. Because they are driven by different fundamentals and traded by highly informed investors, IP assets tend to be uncorrelated to public markets. They can, therefore, add considerable value to a broader portfolio.

When Aventurine targeted early-stage intellectual property assets as a return driver, we also recognized the inherent possibilities their volatile nature presents. Rather than just accept that volatility as the price of admission, we saw it as a potential driver of return in its own right, if only it were properly harnessed.

To that end we have constructed a barbell portfolio, taking advantage of the high volatility and low correlation of intellectual property assets. A large percentage of the fund’s assets are invested in conservative public market investments and managed by an industry leader. The balance of the fund is dedicated to early-stage IP assets. Investors thereby gain the benefits of Aventurine’s expertise in identifying profitable IP, as well as the benefits conveyed by the mathematics of volatility in a barbell portfolio.

Of course, no strategy is assured — risk is a prerequisite for earning any investment return. Profitably investing in intellectual property requires triangulating numerous disparate variables, and it requires a long holding period to harvest and maximize those hard-won gains. That is why experience in the industry and experience with the assets themselves is so critical.

Even still, while we see ample opportunity in the intellectual property space, we also see the opportunity to build a unique portfolio. Rather than run from volatility, we see an opportunity to make volatility work for us.

And this is the lesson of my grandfather’s card tricks played out in real life: experience and technique can combine to produce magical outcomes.