The big idea and why it matters: Alternative investments pre-date publicly traded markets and will continue to be an important part of investing as a means to obtain attributes (risk/return) unavailable in more traditional holdings.
“We need to keep doing the basics well.” – Mason Mount (English footballer)
Road trip, anyone?
California is a long state, and glancing at a map may lead you to believe it’s the longest state in the US. However, it comes in third behind Alaska and Hawaii (which stretches a long way across all its islands). Running most of the length of California – stretching from LA all the way north to Tumwater, Washington – is the 101 Freeway. Like California, it seems long, running along most of the US West Coast, but the 101 ranks only #14 on this list of US north-south highways. It would have made the top 10 in its original form, but the 5 (Interstate 5, for our East-coast readers) rendered the original 101 obsolete between LA and San Diego.
So, what is the longest north-south highway? That award goes to Route 1, which stretches from Key West into Maine. But, if you’re interested in the longest roads, east-west highways hold all of the top spots, including US-20 at 3365 miles (Oregon to Boston), I-90 at 3021 miles (WA to MA), and I-80 at 2900 miles, which gets an honorable mention for a) having been America’s first transcontinental road, b) because it begins five minutes from my front door in Teaneck, New Jersey, and c) brings us full circle as it ends at a California intersection with the 101 in San Francisco.
It’s highway or the byway
If you weren’t enthralled with my above highway trivia, sit tight while I drag you further into the depths of boredom. When I was a kid, I always heard the phrase, “It’s my way or the highway,” which was back in the days when I liked to think kids actually listened to their parents. But, if not option 1 (“my way”) or option 2 (“the highway”), what’s next on the list? That would be the byway, which is a side road. [I’ll come clean and admit that I never thought about what a byway was, although I’ve heard the phrase “highways and byways” hundreds of times.]
Without highways, we’d be relegated to byways, which would be terrible for our economy and road trips. The same Teaneck-to-San Fran journey that only takes 42 hours via I-80 would take 63 hours if you avoid interstate highways (I’m now officially the first person in history to use the “avoid highways” feature in Google Maps). Advances in infrastructure and technology are a wonderful thing.
But don’t be fooled. Google isn’t answering the real question, which is: if you remove all of the interstate highways, then how long would it take to cross the US from the world’s busiest bridge, the George Washington, to one of its most recognizable, the Golden Gate? I’ll guess about 63 days instead of 63 hours, given that forcing all of America’s current traffic onto byways would amount to a nationwide parking lot.
Gratitude for infrastructure
Roads are one example, but it’s very easy to take the all-encompassing infrastructure we enjoy in modern society for granted. The amount of work involved in creating our interconnectivity via roads, bridges, tunnels, railways, water, sewage, airline routes, electricity, cables, towers, and satellites is unfathomable. A massive current focus is on developing data centers and figuring out where all the electricity will come from to power them. A near-endless amount of Alts investing is inseparable from infrastructure development, and that won’t change any time soon.
Back to the basics
Keeping with our numerical theme and with a bit of inspiration from our client, Jeff T. (thanks, Jeff!), I’ll dedicate the remainder of this edition to “Alts 101” – something I haven’t done since the first edition of Alt Blend, nearly 4 years ago.
When first presented with the idea of “alternative investments,” a common initial reaction is that they sound esoteric, complicated, or even scary. That’s all fair (and sometimes accurate), but connecting Alts to something more tangible, like infrastructure, can be helpful. In my experience, it was historically true that many investors’ introduction to Alts was with strategies like hedge funds. Fortunately, That has changed (sorry, hedge funds) with the advent of more palatable private investment offerings, as we discussed in the last edition. But what does all of that even mean? Read on for a refresher.
The What
I’ll keep this straightforward and broad: an alternative investment is anything other than a stock or bond, which means owning (stock) or lending (bond) to a publicly traded company. Even owning stocks or bonds in different ways, like shorting them (i.e., betting they will fall in value rather than rise in value), immediately bleeds into Alts territory. So, perhaps I spoke too soon, and if you allow me to refine the above definition slightly, then Alts are investments that offer different risk/reward characteristics from what we can obtain in public markets.
The Why
First, why do Alts exist? That’s a broader philosophical question, like asking, “Why do humans create?” Depending on your belief framework, that answer can have profound theological or other underpinnings. What isn’t debatable, however, is that humans love to create, do create, and will continue to create. Much of that creation will not involve publicly traded stocks and bonds, and the role of Alts within investment portfolios is seemingly more important than ever.
More pragmatically, “Why Alts?” is the real question. Nicely aligned with “The What” covered above, Alts introduce different characteristics into one’s portfolio: Different risk/return/income sources, but also different tangibility. We can literally touch real estate or much of the infrastructure mentioned above. That tangible nature can help us understand why we own what we own (Remember WYOWYO?), vital to maintaining investments through whatever crises the world throws at us.
The How
As covered in Let’s Be Real, it may be easy to wrap our minds around certain areas, like real estate, but that’s very different than saying investing in those areas is easy or passive. Thus, if you aren’t a large institution (and even if you are), most Alts will come packaged as a fund. Funds allow us to pair investor capital with the resources and skillsets needed to implement a strategy: opportunity sourcing, research, analysis, underwriting, finance, structuring, tax, monitoring, reporting, legal, operations, etc.
Aside from the underlying investment strategy, funds can vary significantly across attributes like how quickly capital is called/returned, liquidity, income/yield, expected life (years), size (assets and # of investors), fees, tax reporting (1099 vs. K-1s), etc. And those various attributes can require different levels of “investor sophistication” to permit investment in the first place.
Rubber meeting the road
From a more practical perspective, it might be helpful to consider some investment attributes we look at when selecting Alts solutions. Even something that sounds straightforward, like a “real estate fund,” doesn’t tell us anything about what it is or does. For example, it could be:
- A fund investing in liquid real estate instruments (aka publicly traded Real Estate Investment Trusts, or REITs) that can be bought or sold daily and is evergreen (perpetual).
- A fund investing directly in commercial real estate properties that accept investment monthly offers a monthly income stream that allows for limited liquidity each quarter and is evergreen.
- A fund investing directly in commercial real estate properties that calls capital from investors over 4 years, invests it for 4 years, then sells all holdings and returns all capital to investors over the subsequent 4 years. It offers no cash flow or liquidity along the way.
The above strategies will have different investor qualification requirements, use cases, risk/return characteristics, and opportunity sets – and none of that speaks to the specific type(s) of real estate they’re investing in (which we did an 11-part series on last year).
Revisit the basics
Continuing to “do the basics well” isn’t rocket science, but it does require discipline and consistent reminders not to stray from that path. It’s catching the ball before running with it (e.g., every Sunday in the NFL) or throwing it (poor Aaron Judge). For an overview of Alts 101, the first four editions are still my suggested starting point for beginners. It’s also worth a refresher for veteran investors to remember what we’re out here trying to accomplish in the world of Alts.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
