3 TRENDING ALTERNATIVE INVESTMENTS FOR 2018
According to the Huffington Post i, investor allocation to alternatives will grow nearly 10% per year for the next five years, reaching $13 trillion in volume by 2020.
For high-net-worth investors, it’s not a question of if you should buy alternative investments. Rather, it’s “which alternative investment asset type” will work best for your particular situation and long-term investment objectives.
To be clear, an alternative investment is an asset that is not one of the conventional investment types, such as stocks, bonds and cash. Furthermore, due to the complexities surrounding alternative investments, they’re generally held by high-net-worth individuals or institutions which qualify as accredited investors.
Accredited investorsii are those who can demonstrate an annual income exceeding $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income in the current year, or satisfy other requirements.
TRENDING ALTERNATIVE INVESTMENTS FOR HIGH-NET-WORTH INDIVIDUALS
“In order to diversify your financial portfolio, it’s generally recommended that a high-net-worth individual encompass assets that are truly uncorrelated with the stock market,” said Matt Ran, AWMA® a Financial Life Advisor with Telemus.
“This approach is intended to lower the chances of experiencing large losses and reduce portfolio volatility, particularly during deep market downturns. At Telemus, we invest in a highly diversified mix of alternative investments for our clients, with the overriding goals of preserving and growing a client’s investment portfolio, creating alternative forms of income, and minimizing tax obligations.”
According to Ran, one or more of the following three alternative investments could be a nice addition to an investment portfolio for 2018 due to their non-correlation with traditional financial markets. Of course, this is dependent on the market environment at the time, as well as the individual investor’s needs, goals, time horizon, and risk thresholds.
- Alternative Lending
- Energy-Oriented Master Limited Partnerships (MLPs)
#1 – REINSURANCE
Reinsurance, quite simply, is insurance for insurance companies. The business of selling reinsurance has been around in its modern form for more than 150 years. The driver of profit is simple: on average premiums are generally higher than claims over long periods of time.
Telemus utilizes an investment fund that allows investors to enjoy the economics of being a systematic, well diversified seller of reinsurance, without the noise of a reinsurance company. Investors in the fund bear the risk of insured losses from natural disasters and accidents, which have reliably low correlation to stocks, bonds and real estate.
A FINalternativesiii article offers the following reinsurance property risk policy example, in the instance of earthquakes, assuming the reinsurance fund is targeting a maximum drawdown of 22% based on a once in a 100 years occurrence:
“For this level of downside volatility, the fund would potentially accumulate insurance policies that would generate an 18% return from premiums assuming no claims and a 10% return based on the historical average claims for similar historical risks. The nice thing about property insurance is that perils tend to be very geographically isolated, which means that earthquakes tend to affect very small areas. As long as the portfolio is geographically diversified, and the liability is limited in each specific geographic area, one large earthquake should not have a large impact on the portfolio.”
#2 – ALTERNATIVE LENDING
Alternative lending refers to loans provided to borrowers, typically without the involvement of a traditional bricks-and-mortar bank. Originally, alternative lending was known as peer-to-peer lendingiv or marketplace lending. More recently, institutional capital has emerged as the primary source of funding for alternative loans.
Small businesses are a big driver behind the demand for alternative lending. Oftentimes, business owners can’t obtain loans through a traditional bank. Lack of credit is just one reason.
While large commercial banks occasionally make loans to small businesses, it simply isn’t profitable for them to make business loans of less than $1 million, according to a recent Inc. article.v The article quotes one report saying, “Big banks have reduced the volume of loans to small businesses by more than 38 percent since 2006.” Alternative lending then becomes a natural choice for some business owners.
For high-net-worth individual investors, alternative lending can be appealing when interest rates are low, as they are now, often providing higher yields with less duration risk than traditional bonds.
#3 – ENERGY-ORIENTED MASTER LIMITED PARTNERSHIPS (MLPS)
“Telemus likes energy MLPs, which have ample growth opportunities thanks to shifting sources of supplies of crude oil and natural gas,” said Ran. “However, unlike other energy companies, MLPs tend not to take on commodity exposures; therefore, reducing portfolio risk and cash flow volatility within a financial portfolio.”
According to Forbes,vi, MLPs are often recognized for their tax benefits since they are pass-through entities that generally avoid corporate income tax at both state and federal levels since they are classified as partnerships.
To qualify for these tax benefits, MLPs must earn at least 90% of their income from “qualified sources” such as natural resources. The article adds, according to the National Association of Publicly Traded Partnerships, qualifying natural resources include:
- Oil, gas and petroleum products
- Coal and other minerals
- Any other resource that is depletable under section 613 of the federal tax code
- Industrial source carbon dioxide
- Ethanol, biodiesel and other fuels (transportation and storage only)
ANOTHER TRENDING NON-TRADITIONAL STRATEGY
“We’re also interested in international equities,” said Ran. “After a seven-year run, U.S. stocks are now more expensive, based on price/earnings ratios, than foreign shares. Forecasts show that foreign stocks in developed markets such as Europe and Japan are likely to return 6.3% a year, after inflation, over the next decade, versus just 1.2% for the S&P 500 index of U.S. shares. Emerging market stocks are expected to do even better at 8.1% annually.”
ALTERNATIVE INVESTMENT ASSET CLASSES
There are essentially three different types of alternative investment asset classes,” said Ran. “It’s important high-net-worth investors understand the dynamics between the different classes in order to determine which strategy is best for your investing philosophy and overall risk tolerance.”
Independent research firm Morningstarviidefines an investment as “alternative” if it falls into one or more of the following three buckets:
#1 – Nontraditional asset classes (commodities and currencies)
#2 – Nontraditional strategies (shorting or hedging)
#3 – Illiquid assets (private equity, private debt)
Also, a good alternative investment is one that produces positive risk-adjusted returns (over a reasonable time frame) and exhibits a lower correlation to traditional investments. Furthermore, the “legal” structure does not define the investment, e.g., hedge funds aren’t necessarily alternative, and mutual funds aren’t necessarily traditional, according to Morningstar.
If you have questions about alternative investments, or would like a second opinion about your investment approach, please contact us. Our mission at Telemus is to help you leverage your wealth to achieve a more enriched life.