Risk. What a loaded, complicated, and multi-dimensional term as we use and understand it today. In this remarkable, strange new world that we’ve been thrust into almost overnight by COVID-19, our news feeds are filled with discussions of risk. Most importantly, health organizations, communities, governments, and researchers are all continuing to wrestle with difficult, real-time decisions made in an environment rapidly fluctuating with new information. Which path forward, with accompanying painful costs to bear, will lead to the most desirable, or in this case, least catastrophic outcomes? This is difficult, necessary work, and something I’m not qualified to discuss. There are some very smart people working very hard to better understand and manage these risks.
A bit farther down the list of importance, but still very important to all of us – particularly those of us who work in this field – is the discussion of investment risk. In the investment world, the lion’s share of attention is devoted to the public market (stocks, bonds, options, futures, etc.); and those tasked with managing portfolios of those investments use a variety of formal risk measurements to assess the relative risk of those portfolios – Alpha, Beta, Standard Deviation, Value at Risk (VaR), Conditional Value at Risk (CVaR), Sharpe Ratio, and more. All of this work, like the work done by their colleagues in the scientific community, is intended to help determine the best decisions to make in order to produce the most favorable outcomes. But when public markets suffer turbulence, as we’ve seen great extremes of in 2020, many managers are reduced to comparatively measuring bad outcomes to be able to assure their clients that the outcomes could’ve been worse, or simply weren’t as bad as their peers or competitors. But none of these narratives address what I feel is the ‘elephant in the room’, and a concept that simply isn’t as widely discussed on CNBC, Bloomberg, or other financial news outlets: Investing in the public markets isn’t your only option!
For the vast majority of the investing world, alternative asset investing is conveniently ignored. Your Edward Jones guy, your B of A/Merrill Lynch lady, your neighbor with Ameriprise, and even your 401k provider would prefer that when you think of investing you think of stocks, bonds, mutual funds, or ETFs. Or more importantly, that you simply put your funds with them so they can buy those same instruments for you since you can’t be trusted to do so yourself. A real-world example of this is my brother – a brilliant mechanical engineer, and Chief Engineer of a market leader in a strong industry. Prior to COVID-19, he came to me with what, on the surface, would seem to be a reasonable question: “I need to make sure I have enough money for retirement. How can I invest and make a good return in the working years I have left, but not risk losing it?” Isn’t that what we’d all like, in some form or another, no matter your age or circumstance? His options, as he understood them, were just the following: 1. Max out his 401k within the available options they offer, 2. Open up a brokerage account and buy some Tesla (he’s a mechanical engineer– like a moth to a flame) or other stocks he likes, or 3. Buy a duplex. As I mentioned, he’s a very smart man and even has access to the internet, but this is about as far as he’s been educated on investing. And this is as far as the investing industry would like him to be educated. He chose maxing out his 401k and getting a tiny bit of Tesla stock. It’s easy, convenient, and quick – and that’s no accident. The path to making this the average citizen’s default investment path is well-paved by the influential institutions that make up these public markets, and have the most to gain from it. The Duplex? Well, that’s a lot of work, and a bit of a hassle. And what if the tenants rip it up? What if the hot water heater goes out or the roof leaks? Too much risk compared to buying a few more mutual funds. Will this strategy achieve what my brother wants it to? Just as important, does it match his appetite for RISK? Hardly. And an exogenous event like COVID-19 makes this ever clearer.
Let’s go back to the subject of Risk now. Here’s what no one ever tells you: Stocks carry more risk than is ever conveyed to the average investor. Ray Dalio in his interview with Tony Robbins for Robbins’ book ‘Money: Master the Game ‘, emphatically and repeatedly pointed out that Stocks are three times more risky than Bonds. Most 401k options are simply stock and bond mutual funds, with some automated suggestions on how much you should have of each, based on your age. It’s not uncommon for older investors to be prompted toward a 50/50 split between them. Dalio, later in the interview, says this: “Tony, by having a 50/50 portfolio, you really have 95% of your risk in Stocks”. Do you think the average investor understands this? Does my brother? How many investors like him are out there, just looking for a place to get a reasonable return without taking unreasonable risk? An awful lot. How many have felt this pain through the roller coaster ride of the 2020 S&P 500? An awful lot. And in some cases that may be pain they can’t afford.
Here’s a little thought experiment:
- Asset #1: $100,000
- Year 1: Up 30% (Yay!)
- Year 2: Down 30% (Boo)
- Value after Year 2: $91,000
- Asset #2: $100,000
- Year 1: Down 15% (Boo)
- Year 2: Up 15% (Yay!)
- Value after Year 2: $97,750
- Asset #3: $100,000
- Year 1: 7% Yield on Cash
- Year 2: 7% Yield on Cash
- Value after Year 2: $114,000
What is your risk appetite? Has it changed in 2020? Do you want a lower risk profile for times like these? Do your circumstances demand it?
As you may have guessed, Altus’ focus is in finding and offering investments similar to Asset #3. These past few months have clearly illustrated the role of risk in investments in ways we’ve likely glossed over, forgot about, misunderstood or just taken for granted in years past. At Altus, our investing philosophy is built on cash-flowing real estate assets we believe are most likely to withstand economic shocks and shifts. This doesn’t mean that there isn’t risk associated with these types of investments, but by understanding the underlying fundamentals of the assets, risks can be managed and mitigated in most instances. We can be a source of these latter, risk-lowered returns. But we must all, investor and operator alike, come to terms with the fact that there are many sophisticated, professional investors that understand this role of risk and demand the latter type of asset in their own portfolios. As a result, as with any in-demand asset, the prices increase as investors see value and are willing to pay more for it, lowering prospective returns. We’ve seen this first-hand in our markets over the past 4-5 years. Will this continue as the markets adjust to a COVID-19 world? Will it accelerate in light of the volatility of the public markets and current interest rate policy? Will our assets continue to provide safety as the world changes? We don’t know these answers, but we are continuously educating ourselves in trying to identify and understand market shifts as they occur.
We certainly face many challenges ahead, as all of us do. However, we’re as committed as ever in understanding the role of risk in the lives of our investors, while working to provide investment alternatives to the public markets. You DO have options, and we’re grateful Altus is one of yours.
I’ll leave you with two of my favorite investing quotes, which seem apropos to our current day and time:
“The market can stay irrational longer than you can stay solvent”
– John Maynard Keynes
“The return is irrelevant if the risk of loss is too great to bear”
About the Author: Andrew Eicher is the Director of Acquisitions of Altus Equity Group Inc., responsible for sourcing new investment opportunities, as well as performing a multitude of supporting functions to bring each investment to fruition. In his previous life, he served as Director of Operations for a securities broker-dealer, giving him a broad view of securities, investors, regulations, and markets. Andrew has spent the last two decades in the investment world, researching, transacting, and supporting a broad array of investment vehicles, approaching each from perspective of financial responsibility. He can be reached at email@example.com.