Investors Should Learn About and Embrace Alternatives
During many conversations with individual investors over the years, it becomes apparent that some find it difficult to understand alternative investments, therefore missing out on opportunities to enhance their portfolio. Today’s article will cover some of the common concerns expressed by investors when discussing alternative investments, look into the reasons why these concerns are expressed, and offer some reality-based solutions so that you know what to look for.
Example Using Farmland Investing
Investing in Western Canadian farmland has been of growing interest, for both retail and institutional investors, for at least the past 5 years. During conversations with various investors, it sometimes becomes apparent that the investor just “gets it”, as far as the opportunity is concerned. They roll up their sleeves, ask the right questions, and learn to appreciate why institutions such as pension plans love farmland investing. Other times, through no fault of their own, they fail to grasp the opportunity. Here are a few reasons given, against the farmland opportunity, and why these are unfortunately misguided.
- The lock-in is too long– Driven by the mentality of instant liquidity, some will balk at an investment with a 5-7 yr hold period, for example. What they fail to realize is that this lack of liquidity can actually enhance the stability of a portfolio. By owning assets that are not fundamentally correlated with the stock market, when stocks go down, these illiquid assets such as farmland may not be affected by the decline. A great example was 2008: When stocks globally were down 30 or 40%, Saskatchewan farmland actually increased in value by 15% that year.
- Small size of the fund– Many times, when a fund is small (say $10-$20 Million in size), the manager can be nimble and extremely choosy in selecting assets to purchase. As a fund grows in size, opportunities for outperforming a benchmark become tougher and tougher, as smaller opportunities for profit disappear. Being smaller can actually be a tremendous advantage.
- There are other ways to get into agriculture like ETFs– This is a very common misperception. Many do not realize that publicly traded companies, like the ones found in an ETF, cannot physically own farmland. Also, when the stock market declines, you are not going to be able to hide in an Ag ETF. This is because the correlation grows amongst all equities during market corrections. An Ag ETF is a completely different investment than buying pure farmland. It is like comparing apples to oranges.
Example Using a Private Energy Fund
Investors tend to paint broad strokes over an entire asset class. A great example is energy. Headlines paint the demise of Western Canada’s oil industry. Publicly traded western-based oil and gas stocks have been plummeting. Therefore I have noticed that the average investor tends to think all energy investments must be suffering. True, many public companies have been suffering, especially the juniors. A combination of leverage, and declining commodity prices, have decimated many small companies’ balance sheets. Let’s say you are a junior with some extremely high quality assets on the books, but you have financed to expand, and the bank just raised reserve requirements. In order to avoid bankruptcy you need to sell assets. Not just any assets, but the best ones, to stay afloat. On the flip side of the equation, there may be a private equity fund, with plenty of cash to purchase these assets. A fund with well-connected management, expertise in asset valuation, and the ability to optimize assets, is going to love the type of economic environment that has resulted from the recent crash in oil prices. Rather than viewing all energy investments as suffering, we must realize there is a lot of money that loves this environment, and is poised to profit handsomely. If we can find these alternative investments, we too can find ourselves on the right side of opportunities, presented in energy today.
Example Using a Private Solar Fund
Investment in Ontario’s solar industry has skyrocketed over the past 5 years. This has been primarily due to government subsidies, in the form of FIT (Feed-In Tariffs), which guarantee an above-market payout per Kilowatt hour generated. A growing number of operators have profited handsomely from this environment. There have been two major misperceptions many investors have made regarding solar in Ontario:
- Thinking government subsidies will be repealed– Some potential investors feel that the FIT contracts already issued will be cancelled or repealed in some fashion. The truth is that these agreements are based on contract law which is extremely rare and difficult to repeal. In addition, when Tim Hudak was campaigning against alternative energy subsidies prior to the 2014 election, he generally stated that existing contracts would be grandfathered. The only contracts he actively suggested eliminating were future ones- existing contracts still remained as a viable investment opportunity. Another huge consideration deals with some of the major investors in Ontario’s solar industry, being TransCanada and Enbridge, with a combined approx. $1 Billion relying on these contracts. One must consider that it is highly unlikely these large institutions would invest so heavily if the contracts could not be counted on as reliable. As investors we need to see through the rhetoric caused by inflammatory media reports and examine the facts.
- “Solar is bad because all it does is jack up my utility bill”– Again the media has inflamed this political hot potato. Many ON residents blame the Green Energy Act for higher bills, and this has them angered, understandably. However, upon further examination, we find that for every $250 an ON resident pays for power only approx. $3.00 goes towards these subsidies. Sifting through the political rhetoric, and thinking like a disciplined investor, will allow you to make informed choices.
When examining any alternative investment, or really any investment for that matter, a valuable question to ask yourself is “What would a pension plan think of this investment?”- the answer to which may be contrary to first impressions. Also notice that almost every misperception cited above ended up travelling down the path of emotional decision-making. When we take a step back and analyze facts instead of playing into “groupthink”, this allows for proper decision making, much closer to the way institutions analyze alternative opportunities. Many times we may find the correct decision being contrary to the path most investors take.
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