“Whenever the heat’s on, my whole life, I’ve just kind of learned to focus a little more” – Jordan Spieth
Congratulations! If you survived July 2023, you just lived through the hottest month on record and likely the hottest in 120,000 years. [BTW, RIP Paul Ruebens, who we lost near the end of the month, unrelated to the heat, but Pee Wee’s Big Adventure will stand the test of time] Cool. Offer that insight to a group of your peers, and I’d expect healthy doses of finger-pointing and dismissiveness, depending on their beliefs of the root causes of these higher temperatures. Fortunately, however, we’re not here to debate climate change. The recent heat wave is merely a segue into talking about “hot topic” investments in Alts: what I’ve been hearing about lately, as well as opportunities that may arise because of the continued evolution of the Earth and the perpetual energy needs of humans. Here we go!
We’ve talked about private credit many times in Alt Blend before, and it’s an asset class I’ve been fascinated with for many years. From where I sit, the space has generally met or exceeded expectations during the tumultuous market environment we’ve endured since the start of 2022. That performance has resulted from the characteristics inherent to the private credit space (at least where we focus our attention): diversified portfolios of (typically) senior-secured, floating-rate loans with reasonable leverage and robust underwriting processes.
Private credit pricing also isn’t subject to public fixed-income markets’ more volatile daily price swings (simply a function of private-market pricing processes). In the aggressive-rate-hiking year that was 2022, the prices of private loans were indeed marked down (i.e., the values of our loans were reduced); however, the high current interest rates more than offset the price decline, making private credit stand out in 2022. You may recall that high-quality bonds were down -15.76% in 2022 (source: Tamarac, Bloomberg US Corp Investment Grade index), so even a modest total return in the mid-single digits meant outperformance of about 20% over the bonds that are in people’s portfolios as a form of risk mitigation [and, through 8/3/23, that same index remains over -14% underwater since the start of 2022].
In addition, the aforementioned private credit markdowns are temporary as long as the loans are ultimately repaid on schedule. That phenomenon is very similar to any other bond: if you can purchase a bond at 95 cents, but it’s repaid at a dollar, that price appreciation benefits the bondholder. Thus, in 2023, private credit investors have had the opportunity to buy into portfolios of “money good” loans marked below their actual value (due to rising rates) and participate in the recovery (again, assuming the loans are repaid as expected).
I’m using this as a catch-all for the concept of private markets stepping in to finance the evolution of energy and infrastructure solutions. Still, solar lending is a good example and one I have some familiarity with. Private equity/credit managers are always looking for opportunities, and new projects provide fodder for consideration. As with the opening paragraph, one is entitled to their opinions on climate change and the actions humanity needs to (or doesn’t need to) take. However, it’s undeniable that related initiatives require capital – and capital allocation is what private investing is all about!
Like many other major construction projects we witness daily, there are equity (ownership) and financing (lending) components to solar farms. Solar financing isn’t a space that I know of many managers to be involved in, and more limited competition may mean better terms for those willing to lend in that arena (e.g., higher yields and tighter covenants). As always, aligning risk, return, and liquidity expectations is vital. Thus far, the solar lending structures I’ve seen have been too illiquid for the level of income/return (if you’re going to invest in something illiquid, then maybe there are better alternatives), but I assume offerings will continue to expand and potentially become more attractive in the coming years.
Slicing and Dicing
About a year ago, I wrote about securitization (fractional ownership via securities, like stocks) occurring in areas – like art and real estate – where I expected we’d have to wait for tokenization (fractional ownership via tokens/blockchain solutions) to provide a viable solution (The Future is Off the [Block]chain). I still think there will be a powerful evolution of fractional ownership that incorporates tokenization and continues democratizing private investing, but not until some regulatory issues get ironed out. Regulators understand securitization but have yet to wrap their minds and policy around tokenization. While we watch all of that play out from the sidelines, a new area I’m interested in learning more about is fractional ownership of franchises. Can I own pieces of well-known brands in a passive, diversified way that still offers an attractive risk/return/income proposition? We’ll see. Stay tuned for future updates.
Hot Topic, actually
As my fellow former-‘90s mallrats will be able to attest, many stores of our youth have gone by the wayside. But one that continues to stand the test of time is Hot Topic. The first store opened in the late ‘80s in Montclair, CA, but the edgy retail chain was a staple of Pittsburgh malls just a short time later (i.e., by the time I spent much of my free time at the mall). With a blog post title like today’s, I’d be remiss if I didn’t mention it, particularly because – you guessed it – there’s an Alts tie-in. After operating as a public company for about 17 years after its 1996 IPO, Hot Topic was purchased by the “private equity firm Sycamore Partners for $600 million” in 2013. It’s yet another example of private equity’s role behind the scenes of our daily lives.
As we try to enjoy the rest of the summer, like Jordan Spieth, we can use the heat to focus more. Practice more, learn more, go harder, do better, and improve our lives and the world around us – perhaps even through the Alts we choose to invest in. Alternatively, we can sit idly indoors and at least practice gratitude for TV and air conditioning (both of which I’d imagine had some private investments powering them at various points in their respective evolutions).
Until next time, this is the end of alt.Blend.
Thanks for reading,