ADISA Video: Why Allocating to Alts is a Growing Trend
After being limited to high-net-worth investors for decades, the alternative investment space has been on the rise in the last few years.
“Just the word ‘alternative,’ I’ve tried for years with our association and others, it’s so embedded in the SEC [Securities and Exchange Commission] and FINRA [Financial Industry Regulatory Authority], we’re not going to get rid of that word,” Frederick Baerenz, president and chief executive officer of AOG Wealth Management, said in an interview with ADISA board member Greg Mausz. “I think it should be more mainstream than it is, and I think it’s actually becoming more mainstream.”
Although many have traditionally viewed the illiquidity of many alternative investments negatively, Baerenz argues that illiquidity can actually de-risk investments. New clients coming into real estate understand the basics of mainstream investing, but they don’t understand that non-traditional assets are historically less volatile.
“With the really poor performance of the 60/40 this year, some have speculated that’s been a bad idea for quite a while,” Baerenz continues. “Now more people are getting more open to it and looking to explore additional asset classes.”
Video Transcript
Greg Mausz 00:10
Welcome to another edition of focus on alternatives brought to you by ADISA, the Alternative and Direct Investment Securities Association. For more information about education and resources please visit adisa.org and check out the resource library. I’m your host Greg Mausz, and today I’ve Fred Baerenz he’s the CEO of the AOG institutional diversified fund, thank you for joining me.
Fred Baerenz 00:35
Good to be here, Greg.
Greg Mausz 00:36
So, we’re talking alternative investments, which is things that are not stocks bonds cash or funds or ETF’s made from those. And there’s been a lot of growing use of Alts among financial advisors and clients, but there’s still a lot of people that aren’t using it. Why do you think that is?
Fred Baerenz 00:55
Well, I mean just the word alternative, I’ve tried for years with our association others, it’s so embedded in the SEC and FINRA that we’re not going to give it to that word. So, I think it should be more mainstream than it is, and it’s actually becoming more mainstream. And in the past, it was largely the domain of ultra high net worth investors and institutional investors. And the average advisor average investor really didn’t delve into it. But now with the really poor performance at 60/40 this year some have speculated that that’s been a bad idea for quite a while. Now people are more open to looking into it and are beginning to explore the additional asset classes.
Greg Mausz 01:27
Good so let’s get into the nitty-gritty, how do you apply alts to a portfolio?
Fred Baerenz 01:32
So, our firm is managed an endowment style model for more than 20 years. And so, we’ve been utilizing commercial real estate, private equity, private credit, some hedging strategies for you know decades now. And so, we’ve you know been able to plug in and be able to find the firms and find the funds that we need to implement that model.
Greg Mausz 01:52
That’s really fascinating but you threw out some sophisticated strategies there. Those are normally only available to like qualified purchasers, big family office, institutions. Is that available to the retail mass affluent investor?
Fred Baerenz 02:06
So, you’re right, it’s probably been the last 10 to 15 years the last… 7 or 8 years when the major institutions have found a way to bridge the gap from institutions to retail investors. And in my opinion the the delivery vehicles are getting better and better all the time. So, you know it used to be you had to be at least an accredited investor to access some of these items, which is $1,000,000 or more of investable assets. In many cases you have to be a qualified purchaser, $5 million or more of investable assets. And the vehicles are getting better and better such that these very sophisticated strategies are now available at least in accredited investors not just the general mass affluent.
Greg Mausz 02:44
Well since institutions have been using Alts for now decades successfully, what type of best practices or lessons learned can we take from institutions and apply them to the retail investor?
Fred Baerenz 02:56
So, it really centers around two key phrases, there’s the illiquidity premium, the idea of you have two management teams one that has to report to stockholders every 90 days versus somebody who’s got 3 to 5 years in order to produce a change in the company. And so that second management team with that advantage of of having illiquidity they don’t have to give them money back right away can typically produce better outcomes. So, you have the illiquidity premium on the one hand. On the other hand many advisors and investors consider any illiquidity just risk risk risk which in fact used properly it can actually de-risk a portfolio.
Greg Mausz 03:34
You’re right, and you know from from some of the stuff I’ve been reading lately. You know investors actually have quite a long-time horizon. I believe the stat is Is that if there’s a married couple and they are both healthy at 65 there’s a 50% chance they’re going to one of them is going to be lives after 90. So even at 65 that’s a 25–30-year time horizon. Where you can ride through cycles ride through liquidity events and things like things like that. So, I agree with you but you know having some investments that have illiquidity can be a win.
Fred Baerenz 04:10
Well in fact hopefully all financial advisors are actually doing a financial plan. And so, as you test out the paths in that best behavior, timelines, and horizons whether they have pensions, Social Security, you know some other form of retirement. Most of my clients actually have an appetite for a significant portion of portfolio would be relatively illiquid, and so it it actually you know works in in favor. And in fact, some of these structures are bringing more and more liquidity all the time.
Greg Mausz 04:38
Talk us through more liquidity, or how do you stage liquidity in portfolios?
Fred Baerenz 04:42
So typically, with the interval fund structure for example, well let’s start with REITs so probably better place to start. In the old days if you got into real estate trust fund non-traded you could get your income along the way. But if you wanted your principal back or your profits you had to wait until the fund either listed or was sold. Which sometimes you know typically would be an average of five to seven years sometimes sooner, unfortunately sometimes longer.
With the interval fund structure that attempts to provide 5% liquidity each quarter, but that also produces the cash drag. If you have a great investment thesis that you love for example, commercial real estate, private equity, private credit. You don’t wanna have 5, 10, 15% of portfolio hanging around just in case somebody wants to get out and not invested in that great thesis. So, there’s yet another innovation coming through NASDAQ. NASDAQ has what they used to call the auction fund and still call that by the with the SEC. But they’re describing it more than exit strategy, so the idea is that you get in when you’re ready to do that if the fund goes up and you want to get out and you collect your income along the way you get your principal and you get your profits and it’s much more efficient than the preceding vehicles.
Greg Mausz 05:51
Interesting, I look forward to learning more about that as that market develops.
Fred Baerenz 05:55
You’re going, you’ll be among the first to hear about it.
Greg Mausz 05:58
So, Real Estate is probably the most commonly used diversifier or alternative investments. So why is Real Estate the most common, and how does having… adding that to the portfolio really help reduce volatility?
Fred Baerenz 06:13
Well honestly for the new financial advisor a new client coming into real estate, and first of all you know 2/3 of the country owns their own home. So, they have some experience, now that’s not what we would call you know generally institutional quality real estate although there’s now some funds that are buying single family homes. But they have some background in it, so they understand that markets can go up and down that you want to hold it for a while that there’s some tax efficiency that there’s a nice income stream. But unfortunately, many advisors and investors when they approached this will try to approach it by buying and traded REIT, which there are times to own those and there’s times not to. So, for example in the graphic that’s shown, it looks a little bit like the Golden Gate Bridge. But you see over the last 40 years there’s only been four years when institutional real estate was down. The first was falling the savings and loan crisis, which is really a financial issue in the early 90s.
The second was during the Great Recession. So typically, when our financial system is in a grave attack that’s when you’ll see commercial real estate dip. So, the next slide will show you the S&P 500. And you can see the volatility, both asset classes average in the 8 to 10% range. But you can see from the graph there’s far more volatility with the S&P. Well then you lay in traded real estate trust funds, and again we use both. And while you’re trying to diversify portfolio and have non correlation or dampening affect less volatility, the traded rate doesn’t do that for you. It it’s very helpful at times, but you need non-traded real estate to really dampen that volatility. So that’s the last graph which is represented by NCREIF which is commercial real estate institutional funds.
Greg Mausz 07:49
And I think real estate is a great starting point, but I’m also seeing rises in debt funds and debt strategies and private equity. Are those also available for retail investors?
Fred Baerenz 07:59
Absolutely, and you know with private equity it’s really fascinating because you know many of us remember the 90s and the go-go days of the .com boom and then the .com bust. But frankly some really cool companies went public back in the 90s, things like Facebook and and and Yahoo. But they typically had to because in order to get the early investors out, the friends and family that was the only choice they had. So typically, a private equity fund would go public in about four years. Now because there’s so much money available, the typical private company doesn’t go public for about 14 years. And while there’s still a premium after buying an IPO, there is a lot more meat on the bone 20 years ago when you could access private equity after about four years and so kind of catch that that wave. So now to get that private equity premium if you will, you have to get in earlier. You can’t wait for the IPO and then benefit you have to go into actual private equity vehicles.
Greg Mausz 08:56
Right, so Fred I’ve been reading a lot of research about endowments, and how they’re using alternative investments and have put up some amazing numbers. Can you touch on that?
Fred Baerenz 09:07
Yeah, so Dave Swenson took over the Yale endowment fund in 86 and read his first book in 93 which I read while I was doing my training and that heavily influenced me. I thought you know, if he can do this for Yale and other endowment funds, are doing the same what if I could do this for regular clients. But even within the endowment world of universities, there’s a big disparity between the haves and the have nots if you will. The graph that you can see on the screen now shows that the small universities that have endowment fund say under $100 million, don’t have the same bandwidth they don’t have same talent to be able to pursue these strategies. And gradually as endowments get larger and larger their allocation to alternative investments also gets larger and larger which also helps their performance. And this graph is as true for last year as it was on the you know the last 10 years in the last 20 years. So even with the university endowment, there are the people that are little bit better at this and they’re not so good at this the same thing will be true with financial advisors and frankly with clients.
Greg Mausz 10:01
So, Fred thank you for sharing the thoughts on why more people should be using alternative investments.
Fred Baerenz 10:06
Thanks for having me here.
Greg Mausz 10:07
And thank you for watching. For more information about everything alternative investments please visit adisa.org, thank you.
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