Structured Income

Structured income is an asset class that people should understand and consider when diversifying a portfolio.  Most people tend to only invest in Stocks, funds, or bonds.  That’s fine, but the problem is that most stock funds are highly correlated.  They tend to move together.   In looking to diversify, you might consider Bonds which sometimes move differently than stocks.  However, they are often more correlated with stocks than you might guess.  Conservative bonds also tend to have very low yields, which significantly hurts overall returns.  Another option is CDs and Annuities.  However, both of these options have low yields and poor liquidity.

This brings us to the large category of alternatives.  It’s been said that the public exchanges only represent about 35% of the investible universe.  Alternatives allow us to access that larger universe.  Institutional investors, like pension funds and university endowments do this all the time, holding as much as 30-40% in alternatives.  However, for a long time, the individual investor had a difficult time accessing these markets.  The minimums were often very high, the risk difficult to quantify, and often they were illiquid.  For instance, if you were to buy a building in NY City, it would take a lot of money, risk of location, tax changes, timing, and the property is not sellable with short notice. Alternatives are important because they can be strong diversifiers of a portfolio, some having near-zero correlation with stocks or bonds.

Alternatives in a broad sense is an investment that is not a stock, bank account, or bond.   Some examples might be commodities, like goal, trading strategies like hedge funds, debt funds, and real estate.  This alternatives world ranges from very speculative and risky to fairly conservative.  Commodities or hedge funds might be examples of very volatile and the mortgage on a fully occupied apartment complex might be more on the conservative side.

The financial industry has made several false starts in trying to allow retail investors access to this asset class.  There are several mutual fund versions of managed futures, hedge funds, and real estate, however, retail investors have struggled to understand the low liquidity and diversification aspects, expecting them to still behave like and comparing them to individual stocks.  Traditional “Old Style” REITs (Real Estate Investment Trusts) gave real estate fund exposure, but with almost no liquidity for many years and very little insight into the internal expenses.  There are mutual fund versions of REITs, but they have a high correlation with stocks, which lessens much of the diversification benefits.

Eagle West Group created a sub-group of alternatives, called structured income.  We gave them a functional definition, meaning categorizing them on how they are expected to act rather than on what’s under the hood.  We defined this group first by an expected yield of 5-7%.  The yield is not guaranteed since the particulars of mortgages or real estate have location, business and tax risk to name a few.  However, we have high confidence that this yield is supported by underlying fundamentals with a clear source of this yield.  Secondly, we looked for monthly or quarterly liquidity, since clients might want to change investments.  Here again, liquidity is not guaranteed, but it is anticipated.  Ultimately, the engine for returns is a piece of real estate or mortgage that’s not easily sellable, but the fund has made limited credit arrangements that allow people to sell monthly or quarterly.  If a large number of people wanted out on the same period, then it might take several quarters or longer to redeem shares.  This protects remaining investors from exactly what causes stock market volatility and tends to smooth out short term dislocations in the market.  Price stability was another priority in selecting alternatives for structured income.  The funds do recalculate and post their values frequently, and historically they have been much more stable than stocks.

We think they are something to consider in building a larger portfolio.  They seem to dampen volatility without giving up as much return as bonds.  So far this year, the consensus for stock returns appears to be 8% with substantial volatility.  If we could get 5-7% in structured income, with expected lower volatility than stocks, then allocating a portion to structured income seems appropriate, particularly for people nearing or in retirement.  Structured Income has a place in a larger portfolio made up of static stock/bond models and momentum models with protection point fuses.

If you would like to know more about our approach or our 3-dimensional asset care solution, register for our next webinar at www.eaglewestgroup.com/events or call our office at 877-834-1850.

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This represents a partial list of clients. They have not been compensated and were not selected based on duration, performance, account size.