1) Due to illiquid & inefficiency premium, historically private assets have outperformed public ones.
That doesn't mean you should rush out today, pile money into a fund & join the capital raising bubble. Apply common sense!
Here is a thread on what we did last 4 years & why.
That doesn't mean you should rush out today, pile money into a fund & join the capital raising bubble. Apply common sense!
Here is a thread on what we did last 4 years & why.
2) The global stock market is up 59% including dividends over the last 4 years, as measured by $ACWI.
That's a 12% CAGR.
We've managed to outperform using RE mezzanine debt deals with a 16%+ CAGR over the same period.
We even paid a 20% withholding tax — twice in 4 years!
That's a 12% CAGR.
We've managed to outperform using RE mezzanine debt deals with a 16%+ CAGR over the same period.
We even paid a 20% withholding tax — twice in 4 years!
3) Therefore, that is not even an apples to apples comparison.
The stock market CAGR is a gross return while the mezzanine debt investments I'm discussing are a net, after-tax, return.
Side by side the gross returns were 12% vs 18.7% CAGR. Never mind — let's go with it anyway.
The stock market CAGR is a gross return while the mezzanine debt investments I'm discussing are a net, after-tax, return.
Side by side the gross returns were 12% vs 18.7% CAGR. Never mind — let's go with it anyway.
4) In hindsight, the stock market did very well.
However, it wasn't so clean & clear in recent years. The stock market experienced a blow-off in 2017 & entered a downtrend, mainly due to two key catalysts: Fed overtightening & Trump's tariffs on China.
Even the yield curve...
However, it wasn't so clean & clear in recent years. The stock market experienced a blow-off in 2017 & entered a downtrend, mainly due to two key catalysts: Fed overtightening & Trump's tariffs on China.
Even the yield curve...
5) ...eventually inverted (still remains there).
While the global stock market performed well in 2019, in hindsight, it could have very easily played out another way.
After all, before the Fed's monetary policy pivot, it was looking like 2019 was a bear market year.
While the global stock market performed well in 2019, in hindsight, it could have very easily played out another way.
After all, before the Fed's monetary policy pivot, it was looking like 2019 was a bear market year.
6) Allocating our family office capital, we acknowledged downside risks & the potential for the late-cycle to turn into a recession.
While we weren't extremely bearish — like many others — we understood that money can still be made if invested wisely and with proper protection.
While we weren't extremely bearish — like many others — we understood that money can still be made if invested wisely and with proper protection.
7) Protection.
Real estate mezzanine debt deals have the so-called "buffer" or downside protection depending on the capital stack & leverage.
Our protection was around -20% to -25% on various deals. This meant if the projects suffered setbacks or price declines of 20% or...
Real estate mezzanine debt deals have the so-called "buffer" or downside protection depending on the capital stack & leverage.
Our protection was around -20% to -25% on various deals. This meant if the projects suffered setbacks or price declines of 20% or...
5) ...more, we would break even. If it suffered a -15% decline, as an example, we would see the return on our capital in full, plus the return of all our principal.
Now, if the stock market declined by -20%, as it did in the last quarter of 2018 or the way growth stocks came...
Now, if the stock market declined by -20%, as it did in the last quarter of 2018 or the way growth stocks came...
6) ...down hard during Q3 of 2019, you are actually down.
Of course, one might panic & crystalize the loss or stay hopeful the price will make a comeback. That is beside the point.
The point is: there is no downside protection owning stock, share or equity in any asset class.
Of course, one might panic & crystalize the loss or stay hopeful the price will make a comeback. That is beside the point.
The point is: there is no downside protection owning stock, share or equity in any asset class.
7) However, there is a protection holding debt.
In the capital stack, there is a payment priority for lenders & financiers over the equity owners.
At the same time, lenders don't enjoy unlimited upside the equity owners have.
Clearly, different risk & return characteristics.
In the capital stack, there is a payment priority for lenders & financiers over the equity owners.
At the same time, lenders don't enjoy unlimited upside the equity owners have.
Clearly, different risk & return characteristics.
8) I'm not arguing that private debt is a better asset class relative to any other strategy. There is a time & a place for everything depending on the business cycle.
One has to ask, how do you continue performing as the recession risks rise?
We all have different strategies.
One has to ask, how do you continue performing as the recession risks rise?
We all have different strategies.
9) One thing is for sure.
I have no doubt the next bear market in US equities (as well as the global index) could produce at least a -30% drawdown.
Due to the central bank's artificial monetary policy for so many years, we could get an even nastier downside surprise.
I have no doubt the next bear market in US equities (as well as the global index) could produce at least a -30% drawdown.
Due to the central bank's artificial monetary policy for so many years, we could get an even nastier downside surprise.
10) Therefore, not only do we continue to favor mezz debt over listed equities — but in recent times (as the risks in real estate rise), we have started to move towards the lower risk, senior debt.
As we take these precautions with our portfolio, it also means we are...
As we take these precautions with our portfolio, it also means we are...
11) ...also sacrificing the ability to achieve very high rates of return on the long side from here onwards.
As the old saying goes, you can't have your cake and eat it too.
This investment cycle is now approaching 11 years in the US, so we are overdue for a recession.
As the old saying goes, you can't have your cake and eat it too.
This investment cycle is now approaching 11 years in the US, so we are overdue for a recession.
12) Being overdue versus predicting one, or even betting on one, are different things.
Some of the asset-backed senior debt deals we are now entering have very strong downside protections -40% to -50% & potential returns of 7-11% p.a.
Until recently, our portfolio also...
Some of the asset-backed senior debt deals we are now entering have very strong downside protections -40% to -50% & potential returns of 7-11% p.a.
Until recently, our portfolio also...
13) ...hold some shares, too. However, with the way markets have been trending up for the last 4-5 months, we have dialed down our exposure significantly.
Recent disclosure right here:
Recent disclosure right here:
14) In my eyes, there are 4 key indicators that I am paying attention to. They might warn us if the end of the business cycle is upon us.
First, US consumer confidence deteriorating. This would impact consumer spending & housing — both important pillars of the economy.
First, US consumer confidence deteriorating. This would impact consumer spending & housing — both important pillars of the economy.
15) Second, the US employment conditions. This includes weekly jobs claims (4-week MA) as well as the US unemployment rate.
The first sign of trouble is a meaningful rise of jobless claims year over year. The second blow would come if the U.R. rises above the 2-year MA.
The first sign of trouble is a meaningful rise of jobless claims year over year. The second blow would come if the U.R. rises above the 2-year MA.
16) The last two indicators I'm watching are the corporate equity prices and corporate credit spreads.
While never perfect, both of these indicators could tell us — sometimes even ahead of time — that the economy is slowing rapidly and the recession risks are rising.
While never perfect, both of these indicators could tell us — sometimes even ahead of time — that the economy is slowing rapidly and the recession risks are rising.
