Investors Dilemma

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Most individual investors’ portfolios are dominated by two asset classes: public domestic equities and bonds, the “risky” and “safe” asset classes, respectively. This traditional portfolio (colloquially referred to as the “60 / 40” reflecting a typical allocation to equities and bonds) did not perform well from 2000 – 2010 but did perform well over the last 10 years.

Today it is hard to imagine this strategy will continue to do well given interest rates across the developed world are at all-time lows. This does not only effect bonds but also stocks since stocks yields are priced relative to risk-free rates (the mechanics of why this is so could be a conversation for another time). In other words, low rates mean that all assets are now priced to earn lower returns.

The last time long-term rates were this low was in the 60’s and as interest rates climbed to higher rates in the 80s, investors suffered, experiencing a 1.4% return over that period.

Whether history repeats itself, economists agree that a rise in rates would not be good for investors. To make matters worse many investors have been encouraged to take on more risk than they would otherwise and don’t seem to recognize how difference in this current situation.

This situation makes the science behind modern portfolio theory even more important requiring us to add new return streams that can both provide returns and but unique risk characteristics resulting in diversification that protects wealth.

Smart professionals know they must find investments which offer riskier/higher returns similar to stocks, but can provide diversification properties that will allow investors to maintain or even reduce risk. This is what we have been doing with the enhancer asset classes and this continues to drive better return for the level of risk we have exposed you are clients to.

Two of the investment vehicles we have been introducing into client portfolios are, Alternative lending and Private Equity. These funds are “interval’ funds. They register with the SEC under the 1940 Investment Company Act, and therefore they are publicly traded mutual funds meeting SEC disclosure and transparency requirements. There is no limitation on purchasing the funds, but there is a limitation on their redemption. The funds will only redeem (repurchase) 5% of their shares every three months. Additionally, they typically must be notified in advance of how many shares we want to liquidate. If they are oversubscribed-redemption requests from all sources exceeding 5%, they will not redeem all the shares on our list but will allocate the number of shares among all the parties that requested redemptions. We are cautious with these two funds, and we will ask you to sign off on a statement that confirms your acknowledgment of the limitations.

The rationale behind this sell restriction is related to the nature of the investments these two funds hold, individual loans and non-public stock. Managers of the funds first need to know that they can commit the capital they receive from the fund investors for long periods to benefit from the investments. They will also need time to liquidate the holdings if there are redemptions.

The two funds which we discuss in this video are:

LENDX is the Alternative Lending fund which is sold only to institutional investors, including registered investment advisers (“RIAs”), that meet certain qualifications and have completed an educational program and only in the US. The fund buys small consumer, business, and student loans through on-line lending platforms like Lending Club, Square, Sofi, and others. These loans are made to high quality borrowers with average FICO scores above 700. While there are still risks associated with this asset class, the source of the risks are different. Where traditional fixed income is sensitive to interest rates, Alternative Lending is much less. Instead Alternative Lending could be more sensitive to unemployment, although the Pandemic hit did not effect the fund.

The Private Shares Fund is another 1940 Act, closed-end interval fund which invests in private, late stage, growth companies. While traditionally, such access to private companies was only available to high net worth investors through high- minimum, complex, the Private Shares Fund provides all investors access to these companies, with a daily NAV, a quarterly redemption program, no performance fees and simple 1099 tax reporting which means you don’t need an account to sort through K1s.