In this time of turmoil we've all seen a flight to quality and liquidity. Yet a majority of portfolios are still in deficit and millions of clients are in the red. The market may have made a remarkable recovery since March 2009, but in our experience, you have to actually participate-that is, take some risk-to reap the benefits. Not every client is doing so.

Norm Boone, president of Mosaic Financial Partners in San Francisco, agrees. "Our clients fared quite well through the downturn on a relative basis," he says, "but we feel a responsibility to help them rebuild their portfolios and get them back on track to reach their goals. Clients realize that we must maintain a reasonable level of risk in their portfolios, and look outside our traditional comfort zone to make it happen."

Some alternative strategies provide interesting opportunities, such as distressed debt and real estate, and the always fascinating "global macro" funds. But it is important for advisors to discern and avoid the perils of what may be temporal and esoteric.

Distressed asset funds may be a compelling short-term tactical strategy, but they take advantage of temporary mispricings and the dramatic dislocations wrought by this economic cycle. These funds don't constitute an asset class per se, and as there are enormous amounts of capital currently chasing those opportunities, they should be approached cautiously, and knowing that the game may not last very long.

In addition, although returns from global macro funds can be fantastic, for the average advisor with a mass-affluent clientele it can be very difficult to explain the benefits of that yen/euro volatility trade and why clients' hard-earned retirement funds should take part.

So, where to find upside growth potential and enhanced risk-adjusted returns? We believe that late-stage venture capital (VC) investments represent an enormous, very compelling and complementary opportunity for advisors and their high-net-worth clients, and a valid alternative to small- and micro-cap growth funds. And yes, it is our business-but here's our logic.

THE TROUBLE WITH SMALL

Whether or not one buys into modern portfolio theory, it sets out wise basic principles. Diversification still makes sense. Traditionally, those seeking additional growth would consider increasing exposure to small- and micro-cap equities to juice up potential returns.

The problem, though, is that this asset class just ain't what it used to be. The Sarbanes Oxley Act of 2002, hastily passed in the aftermath of the Enron debacle, has created an environment where the most innovative companies-despite lots of promise, strong backing from venture capital firms and growing revenues-are opting to stay private until they are more mature. The reason is simple. The bill's promoters estimated the costs of SOX compliance at $90,000 per year. But, according to some sources, compliance now costs a company over $3 million per year. The cost hurdle for going public is so high. And certainly, the initial public offering "window," mostly closed for the last two years, has also kept many promising companies private longer.

What's left in publicly traded micro- cap, the group that once defined the future of America, is a bit of a used car lot. To a great extent, the micro-cap space was diluted by mature companies whose businesses are flat or declining. Today, over 40% of the companies in the index are in financial services, durables, consumer staples or utilities-not sectors typically equated with high growth.

For those seeking the risk/return characteristics that small and micro-cap used to exemplify, we believe the best opportunity resides in the private marketplace of late-stage venture capital. Late-stage venture investments-not buyouts, not secondaries, but primary investments directly into growth companies with promise, skeletal fortitude and real revenues-are the means to secure direct exposure to companies that in former days were the stars of micro-cap.

ACCESS TO THE BEST

Where are these great companies? Cash-strapped entrepreneurs like to say that all money is green, but those are typically the guys who were just turned down by Kleiner Perkins or Benchmark. It's a fact: Not all VCs are created equal. In fact, for the past 30 years, the top decile VC firms have consistently outperformed the rest of the field-by a lot. And the firms in the top decile don't seem to change much year to year. So when making late-stage investments, co-investing alongside the top VCs is the single most important driver of returns.

We at Huntington Allen sought some data to validate our notion that late-stage venture investing may be an effective (or superior) substitute for public small and micro-cap equities. We ran an efficient frontier for a portfolio constructed of four core indexes: the S&P 500, Barclays Fixed-Income Index, the Wilshire REIT Index and the Wilshire Micro-Cap Index. In the baseline analysis, the allocation to micro-cap increased as the portfolio return was optimized for additional levels of risk. We then added Cambridge Associates LLC U.S. Venture Capital Index, which is based on returns data compiled for more than three-fourths of institutional-quality venture capital funds formed between 1981 and 2008. Adding the index squeezed micro-cap out of the portfolio all together! That is, the allocation to the Wilshire Micro Cap index went to zero.