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I read the cover story in Research on Wealth — “Low Yields: How Advisors Can Help Clients Adjust” by Michael Finke — and I believe the topic of alternatives deserves consideration.

As Dorothy in “The Wizard of Oz” was quick to point out, I don’t believe we are in Kansas anymore. The securitization of asset classes formerly available only to large pools of money, e.g. pensions, endowments and foundations, has left behind modern portfolio theory, which was limited to three classes — stocks, bonds, and cash. It has opened a whole new opportunity for investors to diversify their holdings.

In 1985, the Yale University endowment — considered by many to be the gold standard of investment performance and asset allocation — was approximately 60% invested in domestic equities. By 2015, that number had been reduced to 10%.

What took the place of traditional equity investing? Simply what is known today as “alternative investments,” i.e., private equity, hedge funds, non-traded REITs and business development companies (or BDCs) to name just a few.

Why? Because long ago, endowments recognized the need to create regular cash flow to honor their commitments for funding regardless of the yield curve. Clearly, having a 30-year bull market in bonds masked the reality that today’s investors face — a low interest rate environment with pending rising rates. Today’s aging investors face the same challenges — how to create income regardless of the yield curve.

Here are three quick ideas that offer investors relatively high yields with some modicum of safety and liquidity. First, business development companies — these “non-bank” banks provide much needed financing to middle market companies. The publicly traded BDCs offer yields between 4-8% and are liquid daily.

Second, private equity — this is the genesis of most wealth created in this country. Private equity is the “risk” money that allows entrepreneurs to build a business before bank financing can be acquired.

The third founder of Apple (in addition to Steve Jobs and Steve Wozniak) was Ronald Wayne. Sadly, Ronald Wayne tendered his stock and was bought out two weeks after the founding of Apple for $1,500. Today, his 10% stake in Apple would be worth over $60 billion.

Liquidity in private equity is typically given on a quarterly basis after a one-year holding period and taking it early can mean significant penalties. Some private equity sponsors provide current cash flow ranging from 3-10% paid monthly.

Third, non-traded REITs — traditional real estate investment trusts that are publicly registered but not publicly traded. These REITs typically have a two to three year “capital raise” period. These REITs pay a distribution rate of 3-9% and are invested in assets such as office buildings, apartments (aka “multifamily”) and retail centers. Additionally, there are new specialty REITs that invest in parking lots and storage centers.

Clients participate in both the income and capital appreciation if there is any. Typically, these have a maturity schedule that allows investors to get out on an annual basis subject to other considerations.

In 2008 as the markets crumbled and liquidity went to nil, the “beta” of all asset classes moved to one. Thus, an added benefit of non-traded assets is their lack of correlation to traditional markets.

Many firms limit individual investor’s participation in alternative investments to 10% in any one product and 20% across the board.

The old “Kansas” has been replaced by the new frontier of alternative investments. These types of investments may be suitable for both retirement accounts and cash accounts. While they are not suitable for all investors, they offer a compelling look for those who can handle the lack of liquidity.

James E. “Jeb” Bashaw
CEO, James E. Bashaw & Co.


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