Is High Inflation Driving Alts’ Growth?

The Federal Reserve recently announced a 50bps rate hike, in the wake of a CPI spike that has reached a forty year high.

But as both bond and equity markets have nose-dived, alternative asset managers continue to show momentum. Could inflation actually be helping to accelerate the growth of the alts market?

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Episode Highlights

  • Details on the continued growth of the alts market in 2022, even against the backdrop of high inflation and economic uncertainty.
  • Why financial repression is causing more High Net Worth investors and advisors to reallocate portfolio funds into alternatives.
  • Specific alt segments that have had record quarters already in 2022.
  • Two types of alts that investors believe are highly resilient to inflation.
  • Why the alts space should see continued growth for the next several years, regardless of how the economy is managed (or mismanaged!)
  • Andy’s four alternative picks that HNW investors and their advisors should consider.

Today’s Guests: Jimmy Atkinson & Andy Hagans, AltsDb

About The Alternative Investment Podcast

The Alternative Investment Podcast covers new trends in the alternate investment landscape. Hosts Jimmy Atkinson and Andy Hagans discuss tax-advantaged investment strategies to help you grow your wealth.

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Show Transcript

Jimmy: Welcome to The Alternative Investment Podcast. I’m Jimmy Atkinson.

Andy: And I’m Andy Hagans.

Jimmy: Andy, today we’re talking about inflation and the state of continued growth into alternative assets in 2022. So, Andy, to kick things off, let’s talk inflation. What’s going on? We’ve got the highest inflation level in over 40 years. It’s at over 8% now. Andy, are you on Team Transitory or is inflation here to stay with us?

Andy: Well, you know, Jimmy, I don’t know that anybody’s left on Team Transitory anymore. I think Team Transitory might be like the Cleveland Browns or something. That team doesn’t look like they’re going to win very many games this year. But no, in all seriousness, I don’t think hardly anyone thinks that inflation will be returning to 2%, 3%, 4% in the next few months.

I think the real question is, is it going to return to normal or at least closer to normal in 2023, in 2024? And if you look at a lot of the catalysts for this higher inflation rate, right, some of it was just dropping, you know, billions of dollars of money into the demand side, right, but a lot of it was driven by the supply chain, by shortages.

We had the COVID lockdowns, right, which created, not only in the United States, but internationally, and those take a lot of time to unwind, Jimmy. I mean, 12, 18, 24 months. And so some of those are still unwinding, like lockdowns from, you know, the spring and summer of 2020.

But if you look, for instance, in China right now, there are still major cities that are parts of the global supply chain that are still on lockdown, right? There are, you know, all sorts of ships, cargo ships that are sitting in ports, either with cargo to unload or pick up. And then you have, you know, the energy side. We have the war in Ukraine affecting the energy production and energy trade as well as food.

And, you know, back to China, you have the Chinese Communist Party is not letting some farmers farm out in the fields even though they’re alone and potentially wearing masks. I mean, honestly, some of this is self-inflicted, it’s policy-driven. And if these policies are still occurring right now and they take 12, 18, to 24 months to unwind, then I think we’re in for continued and sustained higher inflation for another year or two.

So, that’s my prediction. That being said, my one caveat is, in the long term, talking about a timeline of, you know, decades, of 10 years or longer, I do think we have a lot of deflationary pressures. So, I’m not suggesting to people that we are in for, like, a lifetime of hyperinflation or anything like that.

Jimmy: So, you are on Team Transitory, it sounds like.

Andy: Well, it depends.

Jimmy: If you zoom out and take a broad enough view of a broad enough time horizon, right?

Andy: If transitory means five years, then I might be, you know, Team Transitory, I guess.

Jimmy: Okay, fair enough. Well, so let’s shift gears a little bit here, talk about the markets. Bond and equity markets have been nosediving this year. I think the Dow was down, you know, 2% or 3% earlier today, last I checked. But what about alts, Andy?

How have they been performing so far this year?

Andy: Well, their performance has…you know, it depends on the segment, of course, but the performance of alts overall in many segments within the space has been very strong, especially when you compare them relatively to bonds or to equities. And the other thing is, you know, from the industry perspective, the industry continues to amass assets.

So, we’re seeing more and more assets flow into the alternative investments space, in many cases, at a much faster rate than they’re flowing into competing markets from these, you know, traditional asset type products. So, for instance, Jimmy, I have this link here, I’m on thediwire.com, and this is reporting on fundraising for non-traded alternative investments.

And, of course, the alts world is a little bigger than that but at AltsDb, we tend to focus on the non-traded alternatives. And so, you know, that fundraising totaled $32.9 billion in the first quarter of 2022, according to Robert A. Stanger & Company, you know. And so that number includes non-traded BDCs, it includes interval funds, it includes DSTs.

You know, and the largest player in the non-traded REIT space is Blackstone, of course. So, their funds just had an incredible quarter in terms of fundraising and I’m going to give you a quote from Kevin Gannon, who is chairman of Stanger. And he says, “We’re projecting $120 billion in 2022 fundraising for all the alternatives that Stanger covers, and that includes $45 billion for non-traded REITs and $40 billion for non-traded BDCs.”

So, Jimmy, that’s just a couple of little corners of the alternatives world, especially the non-traded segment. And those segments of the market are doing great, they’re continuing to amass assets and they had an incredible year in 2021, a lot of these non-traded segments, and that’s looking to continue in 2022.

Jimmy: Yeah, I think that’s right, Andy. I think we’re well on our way to $120 billion in alternative assets. And as you mentioned, they don’t cover the entire alternative asset universe, they only cover those big slices that you mentioned. I don’t believe they cover Qualified Opportunity Funds actually. So, I’ll get to that in a minute.

And just to kind of back up what you mentioned about Blackstone, I’ve got that article pulled up on my monitor right now too. It looks like, for the first quarter, Blackstone, as an investment sponsor, raised $12.94 billion in capital. What is that? That’s more than a third of that total $32.9 billion number. Andy, what about alternative-focused ETFs?

Did you want to get to that now?

Andy: Yeah, let’s talk ETFs. And, you know, we usually don’t cover ETFs at AltsDb. We’re more on that illiquid side. But, Jimmy, you can see the shift and I know you have the data, but a lot of these alternative-focused ETFs are seeing inflows. And even though some of the more traditional ETFs, equity ETFs, bond ETFs, are still seeing some inflows, the rate of capital is a lot stronger, a lot larger into these alternative-focused ETFs, at least so far into 2022, according to the data that I’ve seen.

Jimmy: Yeah. And so the data I have pulled up here on wealthmanagement.com cites that. And by the way, this isn’t even for Q1. So, this is just year to date, through February 25th. This data is already a little bit old. Commodities ETFs gathered $8.5 billion of net ETF inflows, which is incredible considering that’s less than 60 days into the new year.

I mean, if you want to project that out to the entire first quarter to kind of make it apples to apples with the other numbers, we’re talking about probably looking at like $12 billion or $13 billion I would guess, if I’m extrapolating that data. Does that sound about right to you, Andy?

Andy: Yeah, I think so, Jimmy.

Jimmy: Yeah. I want to back up and talk more about that study from Robert A. Stanger & Company and actually go through the exact data that I have from that report as reported by The DI Wire. So again, it’s $32.9 billion in the first quarter, NAV REITs got $12.2 billion, BDCs, business development companies, got $8.9 billion, interval funds right behind them with $7.1 billion, DSTs rounding us out with $2.9 billion.

One glaring omission from that list that I’ve identified as a big opportunity zone guy is Qualified Opportunity Funds. So, to fill in the gap there, I’m turning to Novogradac, they survey a small portion of the total Qualified Opportunity Fund universe. So, they don’t survey all Qualified Opportunity Funds.

According to their most recent report, which is through Q1 of this year, just like our other numbers, the funds that they are surveying have fundraised $3.97 billion and they estimate that the actual numbers, since they’re only surveying a small portion, is probably three to four times that amount.

So, call it probably closer to $10 billion flowed into Qualified Opportunity Funds in Q1 2022, Andy.

Andy: So, Qualified Opportunity Funds, it’s like your baby, Jimmy.

Jimmy: It is.

Andy: It sounds like your baby is all grown up now.

Jimmy: It’s growing up quite a bit, yeah. It took a little bit of time to get it off the ground. We had some delays and some setbacks. It’s a newer program, but it’s becoming more and more popular. Yeah, absolutely.

Andy: Yeah, and, you know, I don’t know if I’m jumping ahead to our next topic, Jimmy, but it’s easy to see why, right, that a lot of these high net worth investors and their advisors are looking for tax-advantaged products that provide income, that provide capital gains. And certainly, when you see a CPI print of 8.5%, you know, you figure you either need a tax-free 8.5% or you need a nominal 11% or 12% return, took the whole even on an after-tax basis.

Jimmy: Yeah. Yeah. I think that’s absolutely right, Andy. I think that’s really just helped to accelerate the growth into alternative assets, a trend that’s been unfolding for several years now. I’m going pull up one more report here. So, we seem to be report-heavy on this episode, but that’s okay. And by the way, we’ll have links to all of these reports in our show notes at altsdb.com/podcast, if you want to follow those links and read some more yourself.

But this report is from Preqin. They published it at the end of 2020. So, it’s a little bit old. It’s before inflation really started becoming a problem here about, let’s see, this is about 16 months old now at this point. They expected AUM growth in alternative assets to average 9.8% per year from 2021 through 2025. So, I mean, that’s just huge growth in alternative assets year over year, if you compound that for five years.

I think it adds up to… I saw someone else that had done the math and it came up to 62% growth in alternative assets, over just a five-year period, which is really incredible. So, Andy, you’re the big portfolio strategy guy here, right? Alts clearly are continuing to amass alternative assets or…sorry, asset inflows. Why is that?

Why are alts so popular here?

Andy: Well, I’m going to give you a couple reasons, okay? The first reason is structural. And I think there’s just…there’s a growing awareness of alternatives and there’s also just a larger universe of investable products that a retail investor, just your self-directed high net worth investor can now access that, you know, previously, it was more opaque, they were harder to access.

Even if they were around, you might not know of them. That’s not even to discuss, like, the crowdfunding offerings. Let’s put those aside.

Jimmy: Sorry to interrupt, but yeah, I’m just thinking back like 40 years ago, my dad was a stockbroker, to buy a stock, you had to, like, call up somebody who had access to the NYSE, right? So, imagine how much easier that’s gotten over the past, you know, 20, 30 years. And that same thing is kind of unfolding with the alternative asset industry too, I guess, right?

Andy: Exactly. And compared to the traditional assets, like, for instance, an index fund or an ETF, right, a private placement offering, it still takes some more effort to invest in, some more research to invest in. But again, directionally, there’s just less friction, there’s more information. So, I think high net worth investors are more aware of the products.

There’s more 506(c) products out there that, you know, investors, a self-directed investor can just directly invest in. But I also think wealth managers, RIAs, advisors, I think they are increasingly aware of these products. Increasingly, you know, they’re linked in with platforms that allow them to invest in some of these products more easily.

And to be to be quite frank with you, Jimmy, I think maybe in the alts space, we’ve gotten some of the low-hanging fruit, but there’s still a lot of work to be done to reduce that friction, to make it easier to raise awareness, both with the high net worth investors and with the wealth managers, the RIAs. And so, if anything, that makes me more bullish because it’s, like, think how much steam that this space has and it’s still, you know, compared to investing in a stock or an ETF, it’s still pretty hard.

There’s a lot of friction in investing in any of these private placement offerings. So, I think the first reason is just structural though. There’s more information and it’s just a more accessible space to a self-directed investor or to an advisor. But I think the other reason, right now especially, when you’re seeing the CPI print in, you know, 8.5%, the PPI is even higher, and I’m not on Team Transitory like I said.

I don’t think any of these investors are on Team Transitory. And if they were a year ago, I think maybe they’ve quit the team. And so we’re in a period of financial repression where, you know, bonds are paying 2%, 3%, 4%, and the inflation rate is at 8.5%, so if you put money in bonds, and by the way, I do still own bonds, so it’s not, like, I’ve abandoned bonds totally, but they’ve historically been ballast within a portfolio.

Now, they’re a tax in a portfolio, right? I mean, I think it’s really insidious to be… I mean, I would use the word, immoral.

Jimmy: That’s the backdoor wealth tax essentially right there, is it not?

Andy: Absolutely. And I mean, I would frankly use the word immoral or unethical or insidious, but it’s like it doesn’t matter, right? There’s no point in sitting around and stewing over it. Instead, I think a self-directed investor or an RIA needs to think, “What am I going to do about it? If the CPI stays at 8%, 9%, 10% for the next 12, 24, or 36 months, I can’t have 50% of this portfolio in bonds because it’s just going to get annihilated.”

So, I think, you know, that’s some of the pressure there. And I think when you look at high net worth accredited investors, especially very high net worth, ultra-high net worth wealth managers, they really need to look for tax-advantaged products, Jimmy, because they’re focused not on these nominal returns but they’re focused on triple net returns, you know, returns net of fees, net of taxes, and net of inflation.

And historically, you know, taxes have maybe taken the largest bite. Right now, I think inflation is taking the largest bite. But the thing is, when you have that 8.5% bite, you don’t want to be paying hardly any taxes on that return or else, you’re going to end up negative in real term. So, I think that’s where a lot of alternatives that have a projected IRR of 10%, 12%, 14%, 16% become very, very attractive, especially if they’re in some sort of tax-advantaged wrapper, like a Delaware Statutory Trust, like a Qualified Opportunity Fund, to where the investor or advisor can say, “Okay, I’m pretty sure that, you know, if I reallocate these funds into this alternative product, it will be illiquid, sure, but I can have some solid hope, maybe confidence, but at least some solid hope that it’s going to outperform inflation, deliver alpha, deliver that positive return.”

Jimmy: I don’t know, I think those are some good thoughts there. I would add one more macro trend is stocks may be overvalued right now too. So, if you’re looking for a safe haven, if you’re looking for some more value, maybe it’s not in the stock market right now. I don’t know where you find that value. It’s tough to find value these days. But well, let’s talk about, Andy, if I can put you on the spot, I’m curious, if you have some picks for us, what are your maybe two or three favorite alternative asset classes if you’re looking to hedge against inflation?

If you’re looking for triple net returns, you know, returns after fees, after taxes, and after inflation, what are two or three asset classes you really like?

Andy: Well, I’m going to give you two asset classes, Jimmy, and then I’ll give you two wrappers.

Jimmy: All right.

Andy: Okay? How’s that?

Jimmy: I love it. Let’s go.

Andy: I’ll give you more than you asked for. As far as asset classes, number one, multifamily, right? Multifamily is historically very, very popular space within alts, and it continues to be popular. And there’s a good reason because no matter what’s going on with the economy, people need a roof over their head. And historically, in periods of economic uncertainty, in periods of higher inflation, multifamily has just been this resilient sector that has still performed.

So, you get the good returns, but you also get that, you know, stability, right? And in other segments of the real estate world, I think, as an investor, they can feel a little bit more risky, right, where we had storefronts that were in some cities just closed for like a year at a time, like what does that do to retail?

And so I think multifamily within that space, maybe self-storage too, there’s just certain segments where you know the demand for this, there’s more demand than there is supply. That’s not going to change anytime soon. And even if, you know, a COVID 2.0 happened and there were more lockdowns or whatever, people still need that roof over their head.

So, multifamily. Number two, though, again, with the inflation, I like agricultural assets. I like farmland, right? And right now, we see food prices spiking. So, that’s sort of a short-term factor. But again, I think historically, if you’ve invested in farmland or agricultural assets with that long-term philosophy and are able to ride out some of that volatility and are able to stay illiquid for that longer period of time, I think that a lot of segments within the agricultural space have performed very, very well over time.

As far as wrappers go, I love DSTs, presuming that, you know, the investor or the client has that investment property that they want to exit just because it’s a great way to 1031 into a passive product. And then, of course, Jimmy, Qualified Opportunity Funds, right? That’s probably our favorite wrapper, at least for the time being, just because the tax advantages there are so massive.

Jimmy: Yeah. I’m a big QOF guy myself. If you’ve got gains that aren’t driven from property investments, then I think that’s a really good place to look. Okay, Andy, well, that’s some great insight there. I think we’ll cut you loose there and wrap up today’s episode. For our listeners, if you want links to all of the resources we discussed on today’s episode, you can access the show notes at altsdb.com/podcast.

And don’t forget to subscribe to the show on YouTube and on your favorite podcasting platform so you’ll be sure to receive new episodes as we release them. Andy, thanks so much for joining me today.

Andy: Thanks, Jimmy.