Opportunity Zone Pitch Day - March 23rd
The Alternative Investment Universe, With Tony Chereso
Alternative investments can offer portfolio diversification and long-term capital gains, but they aren’t for everyone. These investment structures require the right infrastructure and expertise to balance their risks. Even so, the “alts” space represents a tremendous growth opportunity for investments beyond traditional asset classes that continues to grow and evolve.
Tony Chereso is President and CEO of the Institute for Portfolio Alternatives (IPA), a trade organization that is committed to expanding access to real assets and creating more opportunities for retail investors to effectively balance their portfolios.
Click the play button above to listen to our conversation.
- The importance of portfolio diversification and knowledge of the different types of alternative investment securities.
- Why alternative investments make a portfolio more resilient in times of market volatility and recessions.
- How to rethink investment operations to avoid more volatile, traditional equity markets.
- How to develop investment strategies that carefully balance risks and rewards and how they fit in with financial and lifestyle goals.
- The future of alternative investments, and the importance of strategic management in the industry.
- How High Net Worth self-directed investors can get started in the alternative investment universe.
Featured On This Episode
Industry Spotlight: Institute for Portfolio Alternatives
Through advocacy and industry-leading education, the Institute for Portfolio Alternatives (IPA) is committed to expanding access to real assets and creating more opportunities for retail investors to effectively balance their portfolios. The IPA provides national leadership for the Portfolio Diversifying Investments (PDI) industry.
Learn More About The Institute of Portfolio Alternatives:
- Visit The Institute for Portfolio Alternatives
- Follow Institute for Portfolio Alternatives on LinkedIn
- Follow Institute for Portfolio Alternatives on Twitter
About The Alternative Investment Podcast
The Alternative Investment Podcast covers new trends in the alternate investment landscape. Hosts Jimmy Atkinson and Andy Hagans discuss diversification opportunities in the alts universe, including direct investments, DSTs, opportunity zones, private equity and more.
Jimmy: Welcome to The Alternative Investment Podcast. I’m your host, Jimmy Atkinson.
Andy: And I’m your co-host, Andy Hagans.
Jimmy: Hey, Andy. Good to be here back with you again. Joining Andy and I today on the podcast is President and CEO of the Institute for Portfolio Alternatives, Tony Chereso. Tony joins us today from South Lake, Texas. Tony, thanks for joining us, and welcome to the podcast.
Tony: Thanks, Jimmy and Andy. I’m glad to be here with both of you.
Jimmy: Glad to be here with you today as well, Tony. You joined me on my other podcast, the Opportunity Zones podcast a couple years ago. Had a good episode discussing how opportunity zones fit into the larger alts universe. I’ll be sure to link to that episode in the show notes for today’s episode at altsdb.com. But to start us off, let’s talk about alts, Tony. So the IPA has a lot of members and you cover a specific set of alternative investments. Alternative investments is a big term that can be defined in many different ways. It’s a really big universe. So help us out here, Tony. What does the IPA, your Institute for Portfolio Alternatives, cover specifically and who are your members?
Tony: Well, Jimmy, we cover several different investment strategies. All of them are non-traded and are only sold through registered financial advisors. So they include publicly-registered, non-traded REITs, publicly-registered, non-traded business development corporations, a private offering, which include and we’ll get into more specific later, strategies like 1031, conservation, easements, energy, opportunity zones, private equity, private preferred securities, and then closed-end funds and interval funds primarily focused around real estate and real estate credit. Obviously, when we talk about private equity that’s outside of the real estate but I would say the majority of the investment strategies or the theses are focused on commercial real estate.
Jimmy: Gotcha. And then who are some of your members or what types of investments do they represent specifically?
Tony: So our members range in I would say size. Some are very discreet boutique firms that focus on a very specific investment strategy like 1031, like exchanges or opportunity zones. And they bring out… They may be serial issuers of private offerings. But their offerings may range anywhere between $5 to $50, $75 million dollars. And they may have one or two offerings a year. And then we have on the other side of the spectrum large institutional players. There has been a significant shift in the size in the scope of the offerings that have come into the private alternative universe, firms like Blackstone, Brookfield, Starwood, Nuveen, JLL. You know, I can go on PIMCO, for example, they’re usually bringing out very significant perpetual life programs focused on real estate and real estate credit, and more on the publicly-registered non-traded REIT and BDC side. They also have the interval funds, which are perpetual life programs as well.
Jimmy: Gotcha. So some institutional players there certainly with some of the names you just mentioned. So the Institute for Portfolio Alternatives, one of your mandates or your mission is to be an advocate for awareness of portfolio-diversifying investments, and that’s one of the roles of alternatives is to serve as portfolio diversifiers. But why in addition to that should investors and advisors in your view, Tony, consider including alternative investments in an investment portfolio?
Tony: It’s a great question, Jimmy. What we’re seeing nowadays, and especially sort of this shift away from defined benefit plans that individuals like my parents, in my previous career when I worked at Verizon, I had access to. And those defined benefit plans, if you really look into them, had a very diverse portfolio. You had your stocks-bonds, as well as allocations to private alternative investments. And what you have seen actually over a period of time, both from an institutional perspective and in the benefits space, is larger allocations to alternative investment strategies, creating some diversification away from your traditional equity markets which tend to be fairly volatile. And we saw that volatility in the early onset of COVID last year, where the markets took a significant hit while the private sector wasn’t unaffected, but it wasn’t affected at the level that the public markets were and actually recovered quite quickly compared to the public markets. But today, when you look at the next generation, my kids, for example, they don’t have access to these plans. They have access to defined contribution plans. And those defined contribution plans offer them investment strategies like mutual funds and ETFs that, frankly, move with the equity markets. So their ability to diversify their retirement holdings and actually have a well-balanced investment portfolio has diminished as a result of some of the shifts in just retirement planning as one point.
The other interesting point to note is that when you look back in time, the average mainstream investor didn’t have access to these strategies. You had to be a High Net Worth family office, work with big banks, to be able to have access to commercial real estate credit, private equity, and middle-market lending. And what our members have been able to do is democratize what was institutional investment opportunities and put them in the hands or at least make them accessible to the main street investor. Again, the whole idea is to create a better-balanced portfolio. And again, I wanna stress one thing. These investment strategies are not for everybody, okay? They require, and that’s one of the reasons why I prefaced them at the beginning of our conversation, that all our members who structure and offer these alternative investment opportunities only distribute them through professional financial advisors, broker-dealers, registered investment advisors in the warehouses.
It is important that when you’re looking at making an investment in any one of these strategies, and it’s true for either stocks and bonds as well, you look at your portfolio, you look at what’s suitable, what’s not suitable, and your risk tolerance. And that requires a lot of thought and analysis and it varies and it changes over time. But one of the things that we have found especially as the market has continued to evolve and the strategies have continued to evolve, and we have provided more access to these different strategies, is that more people are gravitating towards these types of investments to provide that diversification that they didn’t have access to before. And part of that has to do with the fact that it provides several different things. Some of the strategies have an income focus, and some of them have a growth focus, and others have a combination of both. So although you can buy stocks with dividends that provide some income and you’re hoping for the growth, what these investment strategies are designed is for a specific need of an individual retail investor whether it’s income or growth.
Jimmy: Right. That’s really interesting, Tony, that shift that you identified from defined benefit plans being offered through your employer, typically to the shift toward defined contribution plans now for retirement plans. It really puts the burden of diversification and finding investment options on the investor or that investor’s advisors. So the fact that your members have helped democratize institutional investment opportunities for main street investors, as you put it, is crucially needed in large part because of that shift. That’s a really interesting point that you bring up. I wanted to discuss with you Regulation Best Interest or Regulation BI or Reg BI that was recently passed just a couple of years ago, and it’s still, kind of, undergoing some changes. How might any changes to that regulation impact alternatives and what are you expecting to unfold there?
Tony: Yeah. So as you noted, it was a long, drawn-out process. The IPA along with a number of other financial trades were actively engaged in some conversations with the Department of Labor as they’re moving the Reg BI initiative forward. And as you may know, going back in history, there was a group litigation that was successful. The SEC actually rolled out Reg BI guidelines, eventually rolled out some Reg BI guidelines. The one thing that never really sat well with one particular regulator, the state regulators, was, sort of, the scope of what the SEC implemented. And frankly, the state regulators continue to believe that the Reg BI has fallen short in delivering what was supposed to be more stringent guidelines, more of a fiduciary analysis, and I’d just say put the broker who’s representing these investment strategies more in a fiduciary role as it relates to making recommendations. Let me qualify that. So originally, when an advisor was meeting with a client, it was more of a suitability standard. Is this investment strategy suitable for a particular investor based on a variety of different metrics? Now, as a result of Reg BI, and actually it’s been a very good shift to a greater extent because it’s modernized investment strategies, provided additional options to retail investors, and frankly, it’s pushed the industry to more and more transparency.
That being said, the state regulators still believe that there’s been a significant shortfall in the implementation and, sort of, the broader representation around these investment strategies, or complex products, as they call them. And they’ve been advancing a variety of different initiatives. One specific initiative that they’re on their third phase of doing a market survey with those individuals, the broker-dealers, registered investment advisors that actually represent these products. And the implications of that, Jimmy and Andy are this. If they’re successful and the states can and have adopted individual state Reg BI requirements. A little bit different, maybe some of it is a restatement of what the SEC has adopted but in some cases have included some additional things that those licensed within the state are required to follow. But as they move and advance their surveys, what they’re…they just released a survey a couple of weeks ago where they’re advancing a conversation with the SEC, and the Department of Labor that what has been implemented from a financial advisory perspective around Reg BI falls short of what was intended by the SEC. And we’ll be proposing some very different standards and, hopefully, with the new leadership at the SEC, they’re hopeful that there’ll be a tightening of the standards.
Now, I say that all from this perspective. As you put additional standards and restrictions around those individuals, those financial professionals that actually meet with the main street investor, around particular investment strategies, and you add the level of risk related to them offering these diversified investment strategies, the financial advisory community has to ask themselves a question of whether that, they wanna include as part of a portfolio of investments that they’re gonna represent or offer to their clients whether they wanna offer these complex products. And frankly, what we have found because of state regulatory pressures, whether it’s this very loose bias arbitration process that’s out in the marketplace that a lot of brokers and advisors have moved away and stepped back from offering private offerings. Now, what that could do is have a chilling effect on, sort of, the future growth of this market.
Andy: That’s really interesting, you know, that you mentioned the potential chilling effect and that makes sense. I mean, what Jimmy and I have seen in working over at our other property, the Opportunities Zones Database, is that, at least on that particular sector, you know, a lot of growth in the direct-to-consumer type of sales cycle. And so it’s the listeners of that podcast, you know, they tend to be self-directed investors. And so in some cases, you know, they’re not even, you know, working with a financial planner. It is kind of interesting because another point you brought up, Tony, was that the trend of increase of democratization, right, some of the investment minimums for some of these alternative products seem to be going down over time. So, you know, it’s all relative but I kind of look at it, like, maybe a product that was only available to Ultra High Net Worth a generation ago is now available to any accredited investor, right? So it’s not quite truly mass market but is certainly moving in that direction.
And Jimmy and I, we launched the Alternative Investment Database and this podcast just a couple of months ago, and we’ve been almost surprised by how much interest there is in alts in this podcast. Obviously, we’re very bullish on it, or we wouldn’t have launched the property but even so, I recently published a new story about how non-traded REITs are seeing record inflows this year. And it looks like that’s also the case with DSTs so I’m working on a story on that for the site. So it seems like the industry overall is going gangbusters. So I wanted to ask you beyond just that regulatory trend that you mentioned, are there other trends that you would identify, for instance, certain wrappers gaining ground relative to other wrappers, especially different real estate products, or are there any other big picture trends that you’ve identified in the alts industry that you think could play out in the next couple of years?
Tony: Yeah. So look if I can, I wanna go back to something that you said and I’ll circle back and tie into your question. You said something really interesting. But generally speaking, about 85% of the current funds in the market require a professional financial advisor involved with the sale and the representation. The rest of it either are funds that haven’t been filed on a form D yet and/or are direct-to-consumer. There was a expectation a number of years ago that the direct-to-consumer strategies would potentially overtake the 506 B strategies that require or go through a financial advisor. And it goes to something you said, and it really actually goes back to what some of the regulators’ concerns are around the complexity of these investment strategies. So there are some sophisticated investors that have the capability of doing their own due diligence, managing their own portfolios. And for a direct-to-consumer strategy, it works well for them. But I will tell you the majority of main street investors would be challenged with going through the perspectives, really making sure that they clearly understand what they’re investing in, and also making sure how that fits into their overall retirement planning and portfolio.
So I wanted to, sort of, put that in perspective. Your point as you indicated, we’ve seen a surge in a couple areas this year, and a resurgence in one particular strategy. So specifically around publicly-registered, non-traded REITs, that market has exploded. It continues to explode and in large part is being led by Blackstone. They are certainly the primary market driver behind that. But because they have, sort of, sowed the ground, what we have seen are the Brookfields, the Starwoods, the KKRs, and a number of other firms that have offerings perpetualize NAV, or tender offer REITs that are in the market right now. So you’re going to continue to see that market evolve and grow. Year-to-date through August, you know, it was just shy of $25 billion of capital that’s been raised in that particular sector. What we’ve seen in our resurgence, and this is again being led by firms like Blackstone and a few others, is what we call BDC 2.0. And right now, we had a real chilling, cooling off of BDC capital flows a number of years ago. And it had almost ground to a halt in 2020, but year-to-date in 2021, close to $9 billion of capital.
And a large reason for that is the investment strategies and the structures have changed significantly. The access to retail investors through distribution channels like wirehouses and registered investment advisory committee has changed significantly. And the pedigree of the issuers has changed. When you have a KKR or Blackstone or the like coming into the market where they have a long history of executing these strategies on behalf of institutional investors, they’re bringing that pedigree down to the main street investor. So there’s an increased appetite on those particular strategies. Interval fund space has exploded. As a matter of fact, last week in New York, we hosted the first-ever closed end interval fund conference as a result of feedback from members saying, “This is a market that is on the cusp of taking off significantly and we need to better understand how we educate the market, best practices, standards, and guidelines so that we’re ahead of the curve.” This year to date, just shy of $12 billion has been raised in the interval fund space.
And then when we get into the privates, that breaks down into a lot of different buckets. And the numbers aren’t as huge but they are significant nonetheless. So, for example, 1031 exchanges, they’re projecting that this year is gonna be about a $6 billion marketplace. That’s a huge number. And when you think about the fact that up until I would say a month ago, maybe a little bit longer, there was a significant concern that that whole sector, that ability to do that [inaudible 00:20:07] kind of change, would be reduced or eliminated entirely. President Biden had proposed a very strong restriction on the ability to do 1031 exchanges. As you get into the different strategies, there’s a private equity and private debt that is an investment strategy that is wrapped in private placements wrapper that has gained in popularity.
Most mainstream investors didn’t have access to private equity. You had to have maybe a High Net Worth individual with strong connections at the big banks to be able to get in on some of these new and emerging companies. And that marketplace is gonna be somewhere around a $3 billion marketplace this year, and growing actually at a very significant pace. So not only are we seeing institutional players come in with what I would call 2.0 versions of the wrappers, REITs, BDCs, preferred stock offerings, interval funds, but you’re also seeing a broadening of, sort of, a distribution marketplace through registered investment advisors who’ve now better understood how they actually can use these investments to create a better balance and, sort of, buffers within their clients’ portfolios.
Andy: That makes a lot of sense. I mean, that’s our audience here that the Alternative Investment podcast is primarily self-directed High Net Worth investors as well as IRAs. And yeah, I think I’m spotting the same trends that you are that seems like everything is bullish right now in the alts universe. I was speaking at Oz Pitch Day, you know, the recent conference or event. And one of the things I mentioned was that if you take a typical bond fund right now that’s in an investor’s taxable account, even a junk bond account, the typical yield right now is negative on a real basis after you take into account inflation, and then never mind the fact in a taxable account, of course, you also pay taxes on the nominal income that the bond fund would generate. And so I think folks driving the shift into alts is simply a chase for yield, right?
And the other interesting thing is you mentioned, Tony, that most of the products or most of the sponsors in the IPA deal with real estate, right, or real estate credit, and we’re coming off a year where real estate as an asset class is up what, like, 20% or something. And typically, after a bull run like that might be the wrong time to put money in, right? But personally, I’m almost agnostic about it, right? Because who knows if inflation will sustain at 5% or higher for the medium term, who knows exactly where interest rates will go, etc., etc.? But my question is when you talk with investors or sponsors, is your sense that folks are really bullish about these products, or is it more almost like a defensive type move where investors are saying, “Well, I’m getting negative real yields on my bond funds so I’m gonna look elsewhere to see if I can get something, some kind of positive return?”
Tony: I think it’s a little bit of both, frankly. A lot of folks are starting to look at this and wondering where the markets are gonna go in the next 6, 12, 18 months, whether some of the volatility, this volatility may persist or we may see some significant changes in the markets as a result. So some of the legislation is moving forward in Congress and/or the upcoming elections, midterm elections, which could shift things significantly. And all of that has a chilling effect on the public markets, as you well know. So from a defensive position, I see that being, so logically why some folks are gravitating to alternative investments. But I think as you look at the different asset classes, when you look at the long-term benefits that commercial real estate and real estate credit has offered investors, it marries up and matches up really nice, especially with retirement savers. And so, going gone back to the conversation around defined benefits and defined contributions, we’ve had an initiative here at IPA, a board-level initiative for the last five years, working with the Department of Labor and others in pulling in coalition groups, but how do we replicate the diversification that was included in defined benefit plans in a defined contribution plan? And that’s because these investment strategies, all of them for the most part, whether they’re publicly registered, or in private wrappers, clearly line up with the long-term nature of retirement savers, and whether you have both from the standpoint of income as well as some of the tax benefits these strategies represent and offer.
Jimmy: Well, fantastic, Tony. I really wanna thank you for all the insights that you provided today. We’re getting close to running out of time here but before we go, you mentioned a few minutes ago, your closed and interval funds conference that you hosted. I think it was just last week actually, earlier this month in November. IPA puts on numerous events every year. What are some upcoming IPA events that you’re looking forward to in 2022 and where can our listeners go to learn more about them?
Tony: So the first event we’re launching is going to be in February of 2022. Specifically, it’s gonna be here actually in Grapevine, Texas. It’s gonna be held the week of the 15th. Actually, it’s gonna be Tuesday the 15th, 16th to 17th. It’s gonna be focused on private offerings. Earlier we were talking about 1031 exchanges, conservation easements, energy, managed futures, opportunity zones, preferred offerings, and, like, private equity. So it’s gonna have a very specific focused on not the publicly registered, but the private offerings. You can find information on the IPA website at ipa.com. Under conferences, you’ll see the details behind that. In June, back here in Grapevine, Texas, we’re going to host a publicly registered real estate symposium that will include investment strategies like the non-traded REITs, and it will pull in some further discussions around interval funds that have investments in commercial real estate. One is a publicly registered wrapper and then, another one is all the private wrappers that are not publicly registered. So we’re segregating those.
And as you mentioned, we have five different events a year. Two of them are our flagship events. One’s in DC. It’s in May primarily focused on, sort of, our advocacy, legislative and regulatory advocacy. And IPA vision is our largest event and that’s always held in September. So they’re very diverse in regards to the attendance from an entire alternative investment community and it represents the voices both from the distribution partner, asset managers, and the other stakeholders.
Jimmy: Excellent. Well, really valuable events for the industry. I’m looking forward to going to one or two of them next year as my schedule allows. And for our listeners out there today, please do head over to ipa.com to learn more about the Institute for Portfolio Alternatives and the events that they hold. And also, as always, I will be producing show notes for this episode on the alts DB website. You can find those show notes at altsdb.com/podcast. And there you’ll find links to all of the resources that we discussed today with our guest, Tony Chereso. Tony, thanks for joining us. Appreciate it.
Tony: Jimmy, Andy, thank you for having me.