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This episode is the audio version of the keynote address from the Alts Expo 2021 with Andy Hagans, as he discusses the reasons to be bullish on alternative investments heading into 2022.
Andy Hagans is Chief Operating Officer at OpportunityDb.com, and the founder of AltsDb and The Alternative Investment podcast.
Click the play button above to listen to our conversation.
- How the current moment represents an inflection point for alternative investments.
- The potential for attractive returns in alternatives over the next five years, especially relative to traditional asset classes.
- The three “traditional” reasons for maintaining an allocation to alts, including higher expected returns and lower drawdowns during periods of higher volatility.
- The search for asset classes that “zig when the stock market zags.”
- The potential to realize meaningful tax benefits via investments in alternatives such as Qualified Opportunity Funds and Delaware Statutory Trusts.
- How inflationary trends and negative yields further make the bull case for alternative investments.
- How being a part of positive social impact projects is fueling interest in alternatives, from High Net Worth individual investors, up to major institutional investors.
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Industry Spotlight: OpportunityDb
OpportunityDb provides world-class tools, education, and analysis to help individual investors, family offices, real estate developers, and industry service providers navigate the ins and outs of the Opportunity Zone program — empowering them to help create positive social impact in under-invested areas of our country.
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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: We’re ready to get officially underway with our keynote address this morning. So, my co-founder and partner in this endeavor, Mr. Andy Hagans, is going to be presenting the full case for alts, and why you, as a high-net-worth investor, should consider adding alternative investments to your investment portfolio. Andy, how are you doing this morning?
Andy: I’m doing great, Jimmy. It’s a cold day here in beautiful southwest Michigan. It’s actually snowing outside, but, you know, I don’t mind the snow in December. I get sick of it by February, but the first snow of the year is always exciting. And I’m really excited for this first-ever event at AltsDb.
Jimmy: Excellent. Well, we don’t get a lot of snow down here in Texas. It’s few and far between, our snowstorms. But let’s dive in, Andy. Why don’t you take it away with your presentation today on the bull case for alts, and especially considering our current macroeconomic climate as we head into 2022? I know you’ve got a lot of interesting things to say there, so please take it away.
Andy: Absolutely. And, you know, obviously, I’m bullish on alts, right? I’m the founder of AltsDb, the co-founder of The Alternative Investment Podcast. But one thing I would note is that I think the entire investment industry is waking up to the bullish case for alts. And I really think this moment in time is an inflection point for the alternative investment industry. You know, I run our news coverage at AltsDb, and this quarter it’s been story after story after story for almost every segment in the entire alternative investment landscape about huge inflows into qualified opportunity funds, record-setting inflows to Delaware Statutory Trust, DSTs, record inflows into non-traded REITs, interval funds, crypto, just all over the map, it’s been a banner year for inflows. But here’s the interesting thing, Jimmy, is that as good of a year that 2021 was for alts, I think that 2022 will be even more expansionary, and we’ll set even higher records for inflows. And I also think a lot of investors are poised to have very attractive returns over the next 5, 10, 15 years, especially compared to those prospective returns for traditional asset classes. And so, you know, I’m gonna jump right in, two things I wanna cover today.
First, what’s that traditional case for including alts in your portfolio? And I have four reasons, the traditional reasons, maybe three traditional reasons plus a bonus reason that I think is gaining traction. And then I also wanna talk a little bit about this inflection point. Why now? What about the macroeconomic picture, the policy picture? What are these additional things that are pouring fuel onto the fire, quite frankly? So, let’s start with these traditional reasons why high-net-worth investors are attracted to alts? And that first reason, of course, is higher returns, right? Investors love alpha, and if we look at a lot of the asset classes within the alternative investment landscape, many of them have posted very high, long-term, historical returns. But the other interesting thing is, a lot of them have been quite durable during all types of macroeconomic and market conditions, meaning periods of higher inflation, periods of stock market drawdowns. So, you know, I’m thinking of, like, farmland, agro-business, multi-family, and other types of very solid, investable real estate. These are asset classes that have not only performed very attractively over a long period of time, but they’ve also done so consistently and durably, especially when you compare them to those traditional equity markets. And this is something that David Swensen of the Yale Endowment, he learned early on, and I think family offices and many ultra-high-net-worth investors have also known this for a long time. And I think accredited investors really of all portfolio sizes are waking up to this illiquidity premium.
Okay. That brings me to the second reason that alts have been historically attractive to high-net-worth investors, and that is portfolio diversification. I went into that a little bit with that first reason, higher returns, and so the concept here, Jimmy, is that as investors, if you’re managing your personal portfolio, especially as that portfolio grows, you wanna look for asset classes that will zig when the stock market zags, right, so, the context of that overall portfolio, looking at returns on a risk-adjusted basis. Now, here’s the thing, some of these asset classes are correlated to the stock market. Let’s not pretend that they are not. However, some of them are also lightly correlated or less correlated, some of them are…a few of them are negatively correlated, and there’s also a few asset classes that are non-correlated to the stock market. And I think another aspect here is behavioral and psychological, which is, when you invest in an alternative investment, typically, you have that longer time horizon of 5, 7, 10 years for that investment to go full-cycle, during which that investment will be illiquid. And so, I also think there’s that psychological benefit, right? When I recently invested into a QOF, you know, I know going in that that’s illiquid over the next 10 years, and I’m okay with that in the context of my overall portfolio. So, the next time that there’s a market drawdown, there’s no behavioral risk that I’m gonna sell low, right?
So, let’s move on to the third reason, that high-net-worth investors have historically been very attracted to alternative investments, and that is the tax benefits. Looking up and down today’s agenda, Jimmy, with all these different products, almost every type of alternative investments is going to have a tax benefit. In some cases, they will have many significant tax benefits. For instance, qualified opportunity funds, those have just monster, massive tax benefits, but also other types of real estate investments, Delaware Statutory Trusts, or even just a regular old direct investment in real estate with the pass-through depreciation, investing in farmland, there are tax benefits, just all over the map. I think investors are waking up to a couple things. One, if you look at our deficits with the United States government, tax rates, in the long run, they can’t really go down, right? I mean, they may go down temporarily, but in the long run, they’re likely to go up. And if you live in a higher-tax state, like I’m thinking of blue states like California, New York, New Jersey, Connecticut, that stacked all-in tax rate, including state, local, surcharges, the top income tax bracket, that’s up near 50%, right, which is higher than many countries, or most countries, even in the EU.
And so, with that tax rate up towards 50%, all-in, stacked, investors have to put that tax benefit front and center when they select an investment. I’m not saying you would select an investment only because of tax considerations, but of course, it has to become a primary factor. So, investors, high-net-worth investors, once you run out of tax advantage space in an IRA and in a 401(k), and now we’re talking about a taxable account, you have to look at that triple net return, right, that return net of inflation, net of fees, and net of taxes. And I mean, especially, Jimmy, looking at bond funds right now. What’s the 10-year yielding, 1.3%? It’s absurd. We are in a period of financial repression, right, where bond yields, even with junk bonds, are not tracking to the inflation rate, and then consider that with a junk bond fund, right, if the yield is 4%, an investor is going to be taxed on that nominal income, right, never mind the fact that once you factor in inflation, the yield will already be negative, but then once you pay taxes on that income, the yield will be driven even further negative. Now, let me be clear, I’m not saying that investors should not hold bonds in their portfolio, right? I myself have bonds in my portfolio, and to me, that bond allocation is ballast. It represents dry powder. If there’s a market drawdown, then, you know, you can use that dry powder as a buying opportunity. I’m of the Ben Graham School, which says that even if you do adjust that bond portion of the portfolio down, you know, you should have that minimum percentage that you always keep in bonds. But let’s be real, during a period of financial repression, the yield on that will be negative, and how much of your portfolio do you want to be allocated to this asset class that is shrinking, right? So, during this period of financial repression, we also have to deal with that implicit tax of inflation.
And lastly, now, on a more positive note, that brings me to the fourth reason that high-net-worth investors are so attracted to alternative investments, and that is impact. I think more and more, this is a growing trend. Investors, of course, they want alpha, they want portfolio diversification, they want tax benefits, but they also wanna know that their investment is making a positive impact on our country, on the world, right? And so, I think for instance, with sustainable farmland and agriculture, that’s a story that a lot of investors love being a part of. They love the returns, but they also love being a part of that story. Or how about qualified opportunity funds? You know, a lot of these funds are making an incredible impact on underprivileged communities around the United States. Recently, we published a story at OpportinityDb about Pinnacle Partners, who had the first OZ project, I believe it was in Seattle, and what a positive impact that that project is having on its local community. So, I think, you know, this is a trend that it really spans the entire spectrum, Jimmy, from accredited investors up to ultra-high-net-worth, and even institutional investors. I think they’re very, very interested in that impact part of alternative investing. And, of course, I don’t wanna overstate that case. I think it’s that balance of all of those factors. I want higher returns, I also want portfolio diversification, I want to max out triple net returns with tax benefits, and I wanna make an impact on the world with my portfolio. So, Jimmy, those are the traditional reasons that high-net-worth investors have been attracted to alternative investments.
Jimmy: No, that’s great, Andy. I think those four reasons resonate with me, and I’m sure they resonate with a lot of the other attendees on our session today, the great reasons why any high-net-worth investor should consider adding alts to his or her portfolio, I think. And those reasons hold true in any time, but especially given today’s macroeconomic environment, Andy. I see that there’s, like, an ongoing shift from traditional assets into alternative asset classes. So, my question to you is why are so many high-net-worth investors making that rotation right now from traditional into alts?
Andy: Yeah, that’s a great question because we talked about this inflection point, right, and I think the inflection point for alts right now, going into 2022, that relates to the macroeconomic picture, that relates to the policy environment, the political environment that we’re dealing with right now. So, Jimmy, I’m gonna talk about several things, right, driving this inflection point. Number one is the stock market has had an incredible bull run both since 2008, but even since the lockdowns of last year. And so, a lot of investors are sitting on very large capital gains with their equities portion of their portfolio, and I think they’re keen to maybe take some chips off the table to lock in those gains and then redeploy them into different asset classes. And especially with this December 31st deadline coming up for opportunity zones investing, I think a lot of investors are taking this opportunity to lock in the capital gain, then redeploy it in a tax-advantaged manner into opportunity zones projects. But I also think they’re re-deploying into all kinds of different alts, whether it’s DSTs, interval funds, sustainable agriculture products. You know, that brings me to my second point, which is, we are in a period of high inflation right now, and this kind of inflation, we haven’t seen this, frankly, in decades. And now, I don’t wanna overstate the case for long-term inflation because I think we can be maybe even agnostic about that and say, we still may be in this long-term secular deflationary cycle, but then within that long-term cycle, I think more and more investors and family offices, and institutional investors are realizing that this current higher inflation rate is likely to sustain itself for the next two or three years, right?
The reason why is we’re seeing inflation begin to be de-coupled from monetary policy a little bit. Of course, all these stimulus payments drove the inflation rate up, but the bigger driver, I think a lot of investors believe, are the supply chain problems. And these supply chain problems, number one, they’re driven at the policy level at both the federal level and state level, and even frankly, international level. But so, if the policies aren’t changing politically in our federal government, then how are these supply chain pressures going to unwind? And even if those decisions and policies changed right now, that might take 18 to 24 months to play out and reflect back into these metrics and to the market. For instance, with energy policy, the policy, number one, it hasn’t been smart, but it hasn’t even been consistent, right? Some policy decisions seem to be saying we want lower energy prices, some of them seem to be saying we want higher energy prices for the long run, and then what kind of action are we taking? We’re gonna release some petroleum reserves. I mean, that’s a very limp policy action that had such little effect, and I think investors are kind of waking up to the fact that we’re bringing a knife to a gunfight here, trying to fight this supply chain-driven inflation without changing any of these policies.
So, forgetting about that long-term cycle, if inflation sustains even the next two and a half to three years, I think a lot of investors are saying, “Do I really wanna have a huge allocation to bonds for the next two and a half to three years if the real value of that allocation is shrinking by 6% a year?” So, I think investors are taking an opportunity, maybe keeping bonds in their portfolio as ballast, but starting to re-deploy them into these alternative asset classes. I mean, forget alpha, it’s even capital preservation, right? Because this inflation, it really is a wealth tax by another name. It’s a tax on savings. And my philosophy is, don’t get angry, don’t get political, just acknowledge it for what it is, and then make investment decisions accordingly.
And that brings me to another point, Jimmy, which is, you know, we’ve had a lot of talk in Washington about how we’re going to raise taxes, and there’s been a lot of different policy proposals. And who knows what’s going to happen in the short term? Okay. We don’t actually know what will happen this year, what will happen next year. We do know that we have long-term deficits, the deficits are increasing, and it’s just very unlikely that tax rates are going to go down in the future with those unsustainable budget deficits. So, I think especially in these higher-tax states, in your New Jersey, your New York, Connecticut, California, investors really need to put tax strategy front and center. I think their advisors are definitely on that same page, especially ultra-high-net-worth, very-high-net-worth investors, you’re gonna run out of that tax advantage space in your IRA, in your 401(k), so in your taxable account, you’re gonna start to look at alts. So, I think all of those macroeconomic trends are driving some of this shift, and I think it’s happened already in 2021, and I think it’s likely to even accelerate into 2022.
Jimmy: Fantastic. Well, thank you, Andy. We only have a couple minutes, and we do have a few questions that I wanted to get to. So, one real quick here, and reminder, we only have two more minutes before we have to bring Jose on stage for our next presentation. But how much of one’s net worth should one put into alternative assets, in your opinion?
Andy: Oh, I’m not a financial planner, so, obviously, check with your competent professional to make sure that your portfolio allocation is geared towards your own personal goals. But I would say, in general, for a high-net-worth investor, I usually recommend 5% or 10% of one’s portfolio be deployed into alternative investments. And then as you kind of…as your portfolio grows, very-high-net-worth, ultra-high-net-worth, I think that allocation can increase to 10% or 20%. I mean, once you get into that upper reaches of ultra-high-net-worth, or institutional investors, Jimmy, there are many investors that are going majority alts, which is obviously something that David Swensen at the Yale Endowment, he pioneered. And I think a lot of ultra-high-net-worth investors are kind of using that as a personal model as well. But I think a great starting point is 5% to 10%, is the short answer.
Jimmy: I think that’s great. We have a question from one of our attendees, Matt, referring to taxes. I know you just referred to taxes a minute ago, Andy. But regarding tax rates, given the trend toward sustainability and impact, you mentioned as your fourth reason, could we see income taxes lowered and replaced with pollution use in carbon taxes? And if so, how might that affect alts? What are your thoughts there?
Andy: Well, I’d say that prediction is going into political prediction, which might be a little bit outside my wheelhouse, but if you’re asking me, honestly, I do not see income taxes being lowered on the federal level. Depending on your state, I could see them maybe being lowered in your state. I think the last year we’ve seen a lot of flight from higher-tax states to lower-tax states. So, I could see higher-tax states making that decision to be more competitive. Think of a California with so much flight to Arizona or Texas, Jimmy, with that question. But I wouldn’t bet on income taxes going lower in the future.
Jimmy: Fair enough. One more question here, I know you can talk about this for an hour, but real quick 60-second answer, what about crypto?
Andy: Oh, crypto. So, crypto is interesting because, if you just hold crypto, like, in a wallet, it doesn’t actually earn any yield, but a lot of investors are using different strategies with staking or lending crypto to actually earn yield on it. Frankly, Jimmy, I do think, especially if you’re very-high-net-worth or ultra-high-net-worth, you might wanna consider a small allocation to crypto, even if it’s just a half percent of your overall portfolio, just because there may be a symmetric upside. You also have to be comfortable with the fact that these crypto-currencies can draw down by 80% or more in any given year. So, there’s extreme volatility, it’s a very wild ride, so I wouldn’t invest any more than, frankly, you could afford to lose. But I do own a little crypto. I mean, I think it’s fun if nothing else, Jimmy.
Jimmy: Awesome. Well, Andy, thank you for joining me today. Bill just chimed in in the Q&A. He says that as a planner of a family office, he shoots for a minimum of 30% of private investments in our client portfolios, so that’s a little bit higher, but for those ultra-high-net-worth or family offices, I think that’s perfectly reasonable. Well, Andy, I’ll cut you loose here. Thank you for joining us today as the keynote presenter, and have a good rest of the day. I hope you’ll be watching the rest of the expo today.
Andy: Absolutely. I can’t wait to watch this first presentation.