Most individual investors’ portfolios include only 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 well over the most recent ten years from 2011 – 2021.
Today it is hard to imagine this strategy will continue to do well, given that interest rates are at all-time lows all over the globe. Low-interest rates affect bonds and stocks since stock yields relate to risk-free rates (the mechanics we will save for a future conversation). Most asset categories have prices that reflect the probability of providing less return over the next few years.
The last time long-term rates were this low was in the ’60s, 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 suitable for investors. Unfortunately, many investors have been encouraged to take on more risk than they would otherwise and don’t seem to recognize their exposure.
This dilemma makes the science behind modern portfolio theory even more critical, requiring us to add new return streams that can provide solid returns and unique risk characteristics to protect wealth.
Investment professionals who use the science know they must find investments that offer riskier/higher returns similar to stocks and provide diversification properties that will allow investors to maintain or even reduce risk. At Atlas Fiduciary Financial, we have been developing a group of enhancer asset classes for this purpose. Our clients hold six of these unique assets, and we have been slowly introducing two more.
The two asset classes are Alternative lending and Private Equity. The funds we are currently using to represent these asset classes 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. As interval funds, 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 the funds are oversubscribed, meaning the redemption requests from all investors exceed 5%, they will not redeem all the shares on our list but 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 if you decide to participate.
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 excessive redemptions prevent the fund managers from optimally investing.
LENDX is the Alternative Lending fund sold only to institutional investors, including registered investment advisers (“RIAs”), that meet specific qualifications and have completed an educational program and only in the US. The fund buys small consumer, business, and student loans through online lending platforms like Lending Club, Square, Sofi, etc. They make loans to high-quality borrowers with average FICO scores above 700. While there is still risk associated with this asset class, the source of the risks is different. Where traditional fixed income is sensitive to interest rates, Alternative Lending is much less sensitive. Instead, Alternative Lending would be more sensitive to unemployment, although the Pandemic hit did not affect the fund.
Since the loans this fund purchases are too small for traditional banking channels, the interest rates on the loans are relatively high. Recently the fund had an exceptional year producing returns of almost 40%, well above the expected 6% returns. This bonanza was due to SoFi and Upstart going public and their stock performing well. We do not expect a windfall like this in the future but still find the core lending business attractive.
The Private Shares Fund invests in private, late-stage, growth companies. Investing in late-stage VC-backed companies has been shown to provide better returns overall than waiting for an Initial Public Offering. While access to private companies was traditionally only available to high net worth investors through high-minimum and complex structures, the Private Shares Fund provides all investors access to these companies. It has a daily NAV, a quarterly redemption program, no performance fees, and simple 1099 tax reporting, which means you don’t need an accountant to sort through K1s.
The fund holds companies in many industries such as Analytics/Big Data, E-Commerce, Aerospace, Healthcare/Biotech, Enterprise Software, Security, and Finance/Payments. Their top holdings are Axiom Space, Space Exploration Technologies, Marqeta, GrubMarket, Fundbox, NextRoll, Dataminer, Trax, Udemy, and Farmers Business Network.
Both Lendx and The Private Equity Fund offer further diversification to our client portfolios. We have done extensive research and due diligence leading up to selecting these funds, and we will continue to monitor them. We also remain vigilant in searching for other asset classes offering potentially higher returns with unique risk characteristics than all the other portfolio holding. Consistent with our risk management philosophy and the role we assume as the Investment Committee at Atlas Fiduciary Financial, preparing for the un-anticipated using diversification and a dose of humility remains our number one goal.
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