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Summary
In this conversation, attorneys Roland Wiederaenders and Sarah Florer invite the audience to join them in understanding the distinction between public and private securities and how risk is managed differently. They explain the concept of liquidity risk and how it varies depending on the type of alternative asset. They also emphasize the importance of considering the time horizon and return calculations when investing in alternative investments. The conversation touches on the qualifications for investing in alternative assets and the role of accredited investors in managing risk. In this conversation, Sarah and Roland discuss the risks of investing in alternative assets. They highlight three main risks: liquidity, information, and management. They explain how these risks can impact investors and provide insights on how to mitigate them. They also emphasize the importance of thorough disclosure and due diligence when investing in alternative assets. The conversation concludes with a call for feedback and engagement from the audience, encouraging them to be active participants in their financial education.
Takeaways
- Risk is a critical consideration when investing in alternative assets.
- Liquidity risk varies depending on the type of alternative asset.
- The time horizon and return calculations should be carefully considered when investing in alternative assets.
- Accredited investors have certain qualifications that allow them to manage risk more effectively.
- Liquidity risk, information risk, and management risk are the main risks associated with investing in alternative assets.
- Potential Investors should carefully consider the liquidity of the underlying assets and the quality of the information provided by the investment promoters when evaluating investment deals.
- Management risk can be mitigated by having a succession plan and involving multiple individuals in the project.
- Thorough disclosure and due diligence are essential when investing in alternative assets.
- Engaging with financial planners and seeking feedback can help investors make informed decisions.
Chapters
00:00 Understanding Risk in Alternative Assets
05:31 Managing Liquidity Risk in Alternative Assets
09:28 Liquidity and Alternative Assets
12:09 Liquidity in Hedge Funds
14:40 Liquidity in Commercial Real Estate
17:41 Liquidity in Private Equity
21:30 The Risk of Liquidity in Alternative Investments
23:47 Introduction to Risks in Alternative Asset Investing
26:15 Importance of Disclosure and Due Diligence
30:14 Mitigating Management Risk
32:39 Considering the Liquidity and Exit Plan of Underlying Assets
37:13 Management Risk and Succession Planning
43:46 Evaluating Leverage in Real Estate Investments
46:43 Importance of Thorough Disclosure
49:01 Engaging with Financial Planners and Seeking Feedback
CREDITS:
Sponsored by
Real Advisers, Austin, Texas
Real Advisers, Austin, Texas
Special thanks to:
Visit us at: AltInvestingMadeEasy.com
Please contact us: info@AltIvestingMadeEasy.com
Roland Wiederanders: Roland@grablemartin.com
Sarah Florer: sflorer@grablemartin.com
Disclaimer: “This production is for educational purposes only and is not intended as investment or legal advice.”
© 2024 AltInvestingMadeEasy LLC All rights reserved
Creators & Guests
Host
Roland Wiederaenders
Co-founder of the Alt Investing Made Easy podcast, investment advisor, and corporate securities attorney with expertise in private investment funds, corporate/securities issues, mergers and acquisitions, partnership structuring, and federal income tax matters. Roland is also a member of Grable Martin PLLC.
Host
What is Alt Investing Made Easy?
Join attorneys Sarah Florer and Roland Roland Wiederaenders as they navigate through the maze of market jargon and reveal the secrets of diversifying your portfolio. Whether you're a seasoned investor or taking your first step toward financial freedom, we empower you with the knowledge and insights you need to thrive in the dynamic landscape of alternative assets. Get ready to transform how you invest, inspiring a new way of thinking about your finances, and discover how to make your money work harder. Dive in with us, and let's make investing in alternative assets easy, giving you the confidence to navigate the financial landscape, one episode at a time.
Welcome to Alt Investing Made Easy, where we explore the complex world of alternative assets. I'm Roland, a securities attorney, investment advisor, and your co-host.
And I'm Sarah, an investment advisor and corporate attorney and your other co-host. We'll guide you through real estate, private equity, and more, making complex topics accessible.
Tune in for insights that empower your financial journey.
Let's make Alt Investing Easy, one episode at a time.
(...)
R:
Today, it's Sarah and I talking to you about a topic that's essential for any discussion about alternative assets.(...) Today, we're talking about risk.
(...)
S:
And risk is really one of those critical things, isn't it, Roland, that in the back of everybody's mind when they invest their hard-earned money is what's going to happen to it. And that's essentially what we mean when we say risk.
R:
Yeah, exactly. And one thing before we get into the topic, Sarah, I just wanted to remind people who we are, and we said it just in the introduction that we're both attorneys. And between us, we have over 40 years of experience.(...) So we're very experienced attorneys. But we also went to the trouble of registering as investment advisors. We've talked about this in the past, but what this does is it gives us an opportunity, a license specifically under a new exemption in 2013 to the US federal broker dealer rules. We can offer our client securities on their behalf in a way that wasn't available in the past. And so we've done this specifically both to educate investors. We're making this webcast as an educational tool.(...) And then also as a way that we can zealously, even more zealously, advocate for our securities law clients by helping them sell their deals. But the one thing that we didn't, you know, episode two, we didn't remind people of this is that this is for educational purposes and entertainment. Maybe you might, maybe entertained.
(...)
We are. We're having fun doing this for sure.
(...)
But we're not providing legal advice, right, Sarah?
S: Then it's important to note that because every investment, every specific deal you might be promoting, those are specific circumstances with specific facts. And essentially, you deserve to have specific legal advice and you need that.(...) And of course, we can't give you general advice, not even being there are a lot of restrictions on what we could or couldn't do until we engage with you formally as a client to advise you. But in any event, one reason we really like doing this webcast is because even though we practice law and we provide our clients with, you know, services to the best of our abilities, as is required of us under our professional conduct rules, we also really have learned a lot about this entire area of investing in private securities, which also ties in closely with people developing their private wealth.(...) And maybe you could even take it back further to, you know, today, a lot of us are trying to educate kids and young people about financial health in general. And so that becomes private wealth, that becomes private investment. And we are really passionate about making sure that everyone understands that you can understand all of these different things that are related to private securities and private investments just with a little effort and maybe somebody to help you break down some of the ideas so that it doesn't seem like a huge legal area that you don't want to try and touch.
(...)
R: Yeah, I mean, that's the whole purpose of making this. We want to create a resource for people.
(...)
S:So to that end, what are we going to talk about today, Roland?
R:Well, yeah, risk. Let's move on. And this is an important topic because we're talking about, again, as a reminder,(...) alternative assets.
(...)
And unless you're talking about collectibles,(...) cryptocurrency is another one that I thought of, Sarah, that you can own directly real estate. There are some alternative assets that you do to own directly as personal property. But security is a personal property as well. But what we're talking about with alternative assets, really, it's investments in private securities.
S: (...) Which means investing with other people.
R: Yeah. Yeah. And that's a really good way of putting it. You know, we went through the federal Supreme Court case that talked about the specific definition. So, you know, for our audience, when you invest with other people, you know, think about it, you're buying a security, typically a private security.(...) And we talked last episode, we made the distinction between private securities on the one hand, and they're contrasted with public securities, right?
S: Mm-hmm.
(...)
And we talked about some of the technical details of why those are different. But I think today we wanted to focus on risk for a number of reasons, but also to highlight the main, one of the main distinctions between a public and a private security is how risk is managed.
(...)
R: Yeah. And we talked last time about the costs that are associated with being a public company and the cost of registration. And then there's a whole involved process that you have to go through with the SEC to register your company's shares and make them public. The legal fees for that could run from $500,000 to a million dollars, and the process could take a year longer.
(...)
But then not even counting those costs, ongoing compliance costs will run, you know, $100,000 at least, more than that maybe, because once you become a public company, you're obligated to file the 10 Qs, the 10 Ks, and an 8K whenever anything material happens to the company.
(...)
S: And you also have to typically pay a lot of people to support you in making all of those filings, because the information that you file needs to be correct and not just based on guesswork or, you know, you need to have reliable financial accounts. There's a lot of things that go into it that make it something really doable for a company that's working on a larger scale.
R: (...) Yeah, and that's the scale is just you've got the bigger companies, the public companies, and they're big enough because they're generating enough revenue to justify paying these legal fees. But the deals that we work on, and we talked about size too, they're smaller typically.
(...)
We may do an offering memorandum, all the work associated with that's necessary to sell securities for a deal that just is raising a million dollars. But, you know, we're addressing the exact same issues there. It's just we don't have as much historical information that needs to be presented as typically the case with a public company.
S: We also talked about last time about how that's why in the alternative investment space, people, the individuals behind deals, their reputations,(...) other people who are their known, you know, historical partners in other deals or other companies, all of that becomes more important. And your reputation is really important. And obviously, the main key part of your reputation is that you're a true and good actor and not conducting questionable activities or funny business or anything like that. So, but that actually is the other side of what we were going to talk about with when we talk about risk and another factor we wanted to mention about public securities is that what you get when you register, and part of the reason companies do that is that then as an investor,
(...)
the risk, a lot of the risk assessment or the risks that come with investment in general are eliminated. And the main one being, of course, that you can buy that security and sell it in the same day.(...) So, or the next day or however long it takes to close the transaction. But very quickly, you can get your money out of the public markets almost as quickly as you can put it in.
R: Yeah, I would say that this is the granddaddy of all risks really. And it really just highlights the distinction between public and private securities is this idea of liquidity.
S: Right.
R: I mean, it's just what Sarah said that I can buy a share of stock today and I can sell it on the same day. And maybe there's been a movement in price in the intervening periods. I may have lost money or made money, but I've been able to convert it to cash instantaneously or practically immediately.
(...)
And to do that, you need to have this listed exchange where all of the actors meet certain criteria and that's what the SEC regulations do. They make a long, long, long checklist in this IPO registration process, which I've worked on many years ago, different IPOs. I think you did too, Roland. They're very exciting when you're a young lawyer because you feel part of something really big. And then you get to see the listing happen and the trading ticker happened and all of that. It's cool. But the reason we need that is that then people who don't want to put too much into their wealth management or investment portfolio have have protections that are in place so that they can invest and develop their portfolios and get their money out whenever they want to for whatever reasons they need to. And that really works well for some people.
(...)
S:Although we would, you know, we're here to talk about why there are other alternative assets to consider, even if you're fairly conservative minded.
(...)
Roland?
(...)
R:Yeah, for sure. And, you know, the liquidity risk is something that it's not inherently bad or good, but it's just something that you must be aware of when you're investing in alternative assets.
Right.
And yeah, go ahead.
S: Well, tell me, why don't you define liquidity risk? Like what you and I know what it means. And probably a lot of our audience does know what it means. But if I didn't know what it means, I don't want to make the wrong assumptions.
(...)
R: Yeah, for sure. And so, you know, you touched on it already. Just liquidity, of course, is the ability to convert any asset into cash. And how readily can you do that?
(...)
So with the public company stock, I buy a share of Apple today. And like we said, I can sell it today if I want to. And I can immediately convert that to cash. Upon the sale of that share of stock, it's converted to cash. I have cash instead of the stock.(...) And that's what liquidity is. With the private assets, the private securities that we're talking about, the liquidity is really going to be more tied to the lifespan of the asset. And so then you have to be really aware of what it is that you're investing in.
(...)
S: And what does that mean? So a lifespan of an asset.
(...)
R: Right. So let's just take the main classes of alternative assets that we talked about. And we brought this up last time. We're talking really about investments in hedge funds, private equity funds, or real estate funds. For a hedge fund,
(...)
that is the place where you can expect to probably have the greatest liquidity. And the reason for that is that hedge funds invest typically in public securities. Right. And so the hedge fund itself has that liquidity that we were just talking about because it's investing in publicly traded shares that are registered. It can buy, you know, a lot of the hedge funds that you imagine, they do engage in high frequency trading where they're just doing a lot of trades, you know, in and out, maybe from the same position in one day.
Right.
(...)
S: So because they're investing in things that are highly liquid, then they can turn around and offer better liquidity terms to their investors than private equity or real estate.
Exactly. And I mean, there are probably going to be some restrictions just while we are kind of talking about hedge funds. You're not going to be able to take your money out on a daily basis because the investment strategy of the hedge fund is dependent on the plans of the managers. Right. And they may not want to give you, you know, that kind of a right. But typically you'll be able to get it out, you know,(...) in a shorter time period of a month or two months or something within a year. Maybe
R: before we go on from the hedge fund example and talking about the liquidity that's available there, I would just note to people that historically you should have expected a one to two year lockup of your money. So when you invest your money, there's a period before which you can make a withdrawal request.
S: Right.
(...)
So that's what I think you should expect if you're looking at a hedge fund investment is that your money is going to be locked up for at least a year or two. And then typically it's maybe quarterly withdrawals are permitted, but you have to give notice, you know, maybe like up to 90 days notice in advance of the day. You want to make your withdrawal effective. But yeah, Sarah, let's move on to the commercial real estate because it's kind of at the other end of the spectrum.
S: Right. Right.
(...)
R: So so what's the life you've worked on a lot of these deals.
(...)
Sarah, what's the lifespan that our clients typically talk about with their commercial real estate deals?
S: I think we normally see minimum three years. Right. But usually it's going to be five and probably with the kind of outset expectation of it could even be seven. Right. Just depending on how much development is involved in the project, which really speaks to how many moving parts there are to a project. Right. And then, you know, in some of those assets as an investor, you might be fine with that because it's you know, you've invested in multifamily property and you've got nice, you know, the rents are going. Everything's going well. So in the end, you know, provided that the terms of the deal give you some kind of an annual return, you know, you're in a good deal and you're happy to have your money there. So, but it is, you know, probably a lower return that what you get from a hedge fund, but it's probably a really secure return because also underneath it all, you have a piece of property that's giving the entire investment inherent value, not just what's done to the property or, you know, how the revenues from the property are optimized by the management and that kind of thing. So, I think, contrasted and I think you can see this too in the popular culture, right? That sometimes there are movies about hedge fund managers and sometimes they're, you know, celebrated other times they're vilified. But in the end, that kind of investing is one kind of investing that can be done very well by many people. And then the commercial real estate investing is something that maybe is considered like a good gateway into alternative assets because it's,(...) you know, a lot of us are blessed to understand kind of certain fundamentals about real estate just from what we, our own families might own. And so you kind of get the basic idea of rents and, you know, costs of property ownership and that kind of thing. And then that turns into, you know, maybe the building blocks of a good alternative investment strategy.
R: Investments in private equity, I would say we're going to have a very similar liquidity terms to real estate and maybe even longer term.
S: Yeah, it can be, you know, I worked in private equity, you worked in private equity. It's actually, I find it really exciting because you kind of are close to the activities of business that make money. But, you know, if the economy has gone bad, you're not going to be in private equity where there's an exit that, you know, you're going to be in an asset management situation where you hold onto that asset to keep it alive while the economy or the market's not doing well. So I think it could go either way, really. Depends, I think maybe private equity is most sensitive to the day to day nature of the economy or the marketplace, what's going on.
R: So it's good to kind of have that time horizon. If you're investing in alternative assets, know that your money is going to be locked up for, let's say, at least a year in a hedge fund. And it might be as long as 10 years in a commercial real estate or private equity deal.
(...)
S: And what we want to emphasize, though, is that if your money is locked up, the terms of your deal will determine whether that's a good or bad thing. It may be that you don't want your money to be locked up, but it doesn't mean it's gone.(...) It should be generating some returns for you all that time. Now, obviously, in another episode, I think we're going to talk about, you know, things that can go terribly wrong. And well, you know, right now we're talking about risks, which is thinking about things that you have to consider in advance of investing. There are real case scenarios of what actually has gone wrong with investing, and we'll get into that eventually. But for the moment, I think this is what we're talking about with liquidity, is that whether it's purely about how you get your money back.
(...)
Now, things can go wrong, but also things can go pretty well. You just didn't want to be tied up in that for 10 years as opposed to five years, but you still make money off of it. So this is, I think, something to really consider when you look at the terms of any deal that's presented to you, is to consider that.
(...)
R: Just like Sarah said, that a longer term investment isn't necessarily bad or good, but just determine what your return is based on the timeline. And just always remember that an IRR calculation is something that incorporates that time element. I could say that I'm going to buy something for a dollar and I get $2 20 years from now.
(...)
That's not necessarily a good investment. I think there's the rule of 72 to calculate what kind of return you need to double your money in X number of years. But if you look at the target projections from the deal sponsors, make sure that they're using a return model that incorporates the time elements so that you know, you can compare apples to apples. You buy that CD for 4% per annum. That's your return. 4% per annum is the IRR calculation. After a year, you've made $4 on that $100 investment.
(...)
So just make sure that when you're looking at the return calculations that they incorporate the time element.
[there is a gap here- some missing info from the recording]
S: So I think all of these things come back to liquidity, right? And this being, again, taking back to the risk. And so the risk of the liquidity risk and alternative investments or alternative assets is how long your money will be tied up before you can get it back. Or to what extent can you get it back because you have an emergency and you need that money. So we're going to talk about a little bit later, the qualifications for people who invest in alternative assets. And this is an important feature of that that we'll have a conversation about because your tolerance for having your money tied up is a factor of your net worth. And so there are regulations that take that into consideration. If you have enough money invested in other things potentially or enough income, then having your money tied up won't be essentially detrimental to you in your day to day life. Whereas if it's your only money,
(...)
then there are other risks. The liquidity risk becomes magnified and you really need to be,(...) as much as you might want that money to turn into more money in a short amount of time. The reality is that might not be in your best interest to take that kind of a short term approach. So the laws that, you know, when we start to talk about accredited investors a little bit later, Roland, we're going to talk about that. And this is one reason that we have all of those requirements for accredited investors or sophisticated investors or et cetera.
R: People thinking about private securities will start to think about those accredited investor rules. And it really does have to do exactly with what Sarah was saying is how people can manage risk. And do you have resources? Sometimes managing risk can be expensive.
(...)
S: Yes.
(...)
Sometimes you lose on any investment. Also in the private, I mean, in the public stock market, you can put all your eggs in one basket. And that basket breaks.
R: Right. Well, yeah. And so the idea of managing risk and who's best equipped to do that, it's people that can hire advisors to tell them, hey, should I put my eggs in that basket?
(...)
So hiring advisors, and that's not necessarily what we would do for people.
(...)
But there are people that do that more. And that's more of the people that have served in the role of financial advisor or financial planner.
S: Right. So a financial planner. And I guess that speaks to your portfolio as a whole and how you manage the risks in that portfolio. And there's theories and there's the science and economics behind how all of that came to be modern day. We all talk about balanced portfolios. Anybody who has even a small amount of savings at the bank, they're going to start marketing to you about investing in balanced portfolios and this kind of thing. And all of that, I think it's essentially good because it's all about an individual and their financial health and hopefully motivating them to start that journey as soon as possible rather than later in life.
(...)
R: Yeah. And it's funny, Sarah, when we're talking about this, you start seeing all these ideas interconnecting. And we talked the other day about modern portfolio theory. And that really just speaks to having a diversified portfolio with the goal of generating as high returns as possible with as little risk as possible. It's measuring your returns against your risks. Exactly.
S: (...) And so we've now we're talking about so there are a lot of different risks, I guess you can talk about, especially if you're speaking very much in a technical sense with the risk management team of a big company. They have a very classic and auditor oriented version of how you assess risk. And then when we as lawyers talk about risks, we have a different set of risks. And then, of course, whoever you're talking to will have a certain set of risks to highlight to you, including your financial planner. But in this context, when we're talking about alternative investments, we do want to make this note repeatedly that although this is not legal advice from us,
(...)
you need to be mindful of the risks. Because and that's why alternative investments are somewhat maybe considered more the area where you kind of go to after you have a little bit of experience investing in the public stock markets or in other kind of bonds or anything that would have the lowest amount of risk. Then you start to be able to become comfortable as an investor and start to trust yourself to do other kinds of investments.
(...)
R: What that sort of leads to is the next risk that I think we should should circle back around and talk about.
(...)
We talked a little bit about it before, but just information risk.
(...)
And so noting that all the information that's publicly available about a registered security like Apple or any of those shares that are listed on the national securities exchanges that are quoted regularly.
(...)
There's a lot of information available about those stocks and the exchange act of 1934 requires companies to publish certain information periodically. We talked about that.
Yeah.
But with the private securities that we're talking about, all the information that you're going to get from the companies is obtained in advance of your investment, the time of your investment. And we talked about this, the offering memorandum, the PPM, you get that before you make the investment decision.
(...)
And then it's also the availability of the information about the company is going to be defined by contract. So in the agreement that you sign when you buy the investment,(...) there'll be something about how frequently the deal sponsor is going to be coming back to the investors with information about the company. And we talked about this before. Typically, I like to encourage our deal sponsors to make commitments to come back to their investors at least quarterly.
S: Right.
(...)
And for sure annually with the financial statements. And then if anything comes up material, it's just like the exchange act of 1934.
(...)
They don't need to file an 8K, but we can just write an email to all our investors and we can help our clients craft the message, but just say, hey, one of our team members became disabled and we don't have his services anymore. We just thought everybody should be aware of that and why you might not be able to offer them a chance to redeem their investment because they're so concerned about the consequences of that disability.
(...)
You're informing them of the fact. And one thing that is always good is providing that information.(...) You can immediately provide the proposed solution. We're going to hire a full-time business manager to replace the services of our founder that we lost or whatever it is. But communicating to your investors that while there's a problem and an issue, this is what we're going to do to solve it.
(...)
S: And I think that goes back to what we discussed, right? That the purpose of the rules isn't to say this is what you should or shouldn't do as a promoter. It's to say what you need to do is tell people what you're doing. So whatever that choice is, whether it's to hire a business manager, whether to take that work on yourself and keep it the work of someone already known to the investors,
(...)
or even in more dire circumstances if it's time to wind up the project,(...) what really is essential about it is making sure that there's communication and that it's correct. It's true communication. Even if it's bad news, it's still communicated. And this, I think, is what puts people at ease also, right? We all understand that things can go wrong and a person can be no longer with us, for example. But the way that you mitigate all of that fact is by just sharing the news with people. And I think when people get upset, when investors get upset is when they don't know what's going on.
(...)
R: So liquidity may be something that is very hard to manage in the sense that we've got this asset that is not liquid, but the information risk is something that our clients really can manage. And we encourage people to really over disclose.
(...)
And it's just what Sarah said that the investors that we've seen who are angriest are the ones for sure that lost money. But they're the ones who haven't been kept informed of what's going on. They feel like the ball has been going on or that the manager has been either intentionally or negligently withholding important information about the business. And if they had only informed the investor earlier on about what was going on, it may have managed the investor's expectations a little bit better.
(...)
So anyway, the information risk is something that can be managed a lot easier than the liquidity risk.
S: Right. And just to add something to that, because there's different parts. There's the communication of information and there's also the inherent quality of that information.(...) And that's another thing just to mention, which is it's not a requirement to have audited accounts, for example, for some of these investments.(...) However, the larger the investment project, the more of a budget there would be to have an auditor and likelihood that a good manager would want to have an auditor because that's a way to give themselves assurances that the books are neat and tidy and correct. And tax purposes also are taken care of. And then also all that information can be communicated to investors who are then happy. So this is another area where you've got when you're talking about information risk, you need to be concerned about the amount, the frequency, the validity of the communication channels, but also the substance of what that communication is to0, like, if it just absolutely doesn't make sense, it's fair to have great communication and get your quarterly reports. But the numbers don't really add up over time. So those are the kinds of things I think you have to keep an eye on if you're an investor. But also if you're the one who's promoting the deal and providing that information, think about how to allocate resources to make sure that that information is the best quality it can be. And so that it doesn't come back later to bite you.
R: That's a really good point, Sarah. You know, I pulled out some of these other risk factors and I think we can just start going down the list, so to speak.
(...)
Another one I brought up just before, and it has to do with liquidity.
(...)
And we mentioned it already, but it maybe bears repeating is the underlying assets, you're investing in a company that's doing something with your money. It's taking your money and going off and investing in something else to make more money.(...) And so thinking about what it's doing will really give you a guide to how you can think about liquidity. But not only is an investment in the LLC, the membership interest units, those are not liquid. You can't sell them. The company also can't necessarily sell its assets.(...) And so, you know, let's just take real estate for an example. One of our managers may think, well, yeah, in three years, we'll reposition this. We're going to renovate all the units and increase the rents,
(...)
increase the value. But in three years, the interest rate environment, just as we've seen, can be completely different.
(...)
Demand for the property, whatever, could be decreased. And so the expectations about when something could be liquidated maybe aren't met. And so you really have to be thinking about, you know, what is the liquidity of the underlying asset? You know, and then private equity, this is something we didn't specifically mention before, but I want to bring it out. What's the exit plan? You know, is the exit plan to go public or is it to be acquired?
(...)
So these are questions that you can ask that will inform you more about, well, if they're locking your money up, but you have a really liquid underlying asset, you know, well, then maybe it's reasonable for you to ask for better liquidity terms in the investment.
S: Exactly.(...) And I think, you know, just like we've now we've talked about two major risks, right? We've talked about liquidity and there's different subcategories of that. And then we've talked about information risk. And I suppose the critical thing to keep coming back to about risk in general with alternative assets is as an investor in alternative assets or promoter, you know, you're probably also an investor then. You need to you do have to think about these things more than if you invested in publicly traded securities.(...) Now, you might want to think you're really involved in the risk decisions about your publicly traded securities and you've got to make the decisions about your portfolio, et cetera. But this is a different level of just thinking through things. But it's but again, one reason we're talking about this so much is that we don't think it's a difficult thing to do.
(...)
It's just another thing you need to do to be a responsible investor or responsible for your, you know, your private wealth journey.(...) And and it can be actually really rewarding to start to really understand some of the fundamentals of these kinds of investments. Private equity, for example, is a really exciting area because it covers all the different kinds of businesses that are out there. Right. Whether you're into energy or whether you're into alternative energy or, you know, all these different things have, you know, in large or small, have an element of private equity in them or can if they're if they're deciding to raise money that way. And so it can be very interesting.
(...)
R: For sure. And that's that's why this practice is so much fun for us. We have a lot of variety in this really. We do really. We're involved in an important sector of the economy, which is funding all these private businesses.
S: And like we talked about before, just to come back to it, you know, there's a lot of potential for win-win in this area.
(...)
You get to win, you know, if the company wins or the underlying asset wins, then you as the investor win.
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And this is a positive thing to grow our economy. And, you know, in so many different ways, depending on what your mission may be or may not be. But in the end, that's where jobs come from. And that's where our children can find employment, you know, all the things that concern us about being members of our societies. You know, its terrible when an idea fails for lack of funding, and this is where the funding comes from.
R: Yeah, exactly. And I think maybe that leads to the next risk that I would want to highlight is, you know, how do I decide on whether to invest in project number one or project number two? Well, I'm going to look at who the management team is.(...) One thing that's worthwhile. Notice noting here is that on some of the small deals that we work on, Sarah, sometimes there will only be one person that's putting everything together. And is putting the entire deal together.(...) You know, they've evaluated the real estate, whatever they engage the contractors that they'll need to do the rehab. They've engaged a property management company that will manage it for them. But they're really the one person that's running everything for the company. And I really try to discourage our clients from from having that. You know, I try to say, hey, is there anybody else that you can get involved?
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S: Yeah.
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And this is important. I think I know that we've had clients who are, let's just say, on the in the more twilight years of life and have addressed this risk full directly with their investors and have put together a succession plan that they disclose. And they share a lot of information about, which is, of course, ideal. But you also have to recognize that, of course, it's not just people who are, you know, have more decades under their belts that are vulnerable to things happening that you wouldn't want to happen. And so this is something that is always like you said, I think the way you mitigate that is by trying to ensure there's usually two or more actors behind everything. And that's the same for private equity, real estate, hedge funds. It can be, you know, perhaps arguable that you could leave behind a person could leave behind a strategy that another person can implement fairly directly. But that's that's not necessarily true. They're brilliant people who are very successful managing hedge funds and the whole thing's kind of dependent on them. So this is something you have to consider. And then, you know, I thought what you were going to say, Roland, when you started talking about people was, you know,(...) talking about the potential for bad actors also.
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And we have, maybe in the future, we'll talk about bad actors versus bad circumstances because we've touched on elements of those here.(...) But, you know, that would be something that, of course, can happen in anything. But really, it's fully mitigated by the more the quality of the disclosure, the quality of the process that you're going through as an investor. You know, you should be able to have cues about who might actually be a bad actor because in the end, the same sort of basic principles of wealth building, apply, which is there's usually no real secrets shortcut.
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R: Well, so just on this point about management, I would encourage our audience to ask who the people are that they're involved in the project. And if there's only one, what are the plans for, you know, if something happens to that person, you know, how do how do we preserve value in the deal?
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So ask those questions. But knowing knowing who the individuals are is probably more important on these private deals because just with a larger company, you presumably would have greater redundancy built into some of those companies. I mean, maybe you're a huge fan of Elon Musk, but I think that, you know, maybe the value of Tesla doesn't necessarily depend on his day to day services to the business.
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S: A good example is Apple, right?(...) Apple's continued to go from strength to strength really after a few hiccups.
R: (...) Yeah, for sure. You know, so so that's the thing. And that's that's a real distinction between public securities and the private securities that we talk about here.
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S: And I think we touched on it before, too, that, you know, this is where the individuals and their reputations and who they've engaged in business with and all of that information is usually, you know, in our clients, they're usually freely giving information about who they've worked with before, what projects have been done. How can you find out information about it? You can go Google this project, that project. And the more, you know, because the individuals involved are so important and their reputations are so important that, you know, people are quite, I think, conscientious about wanting to share information if they're a good manager.
Yeah, for sure. And the rules actually require disclosure of biographical information. And we look to I always looked to reg. S.K., which is a federal regulation that governs the content of different registration statements. But the rule there for biographical information and control persons, executive officers, directors is all relevant work history and at least five years, five years previous work history. So, yeah, identifying the people and what what their background is that for sure is a way to mitigate risk here. And in our managers and what we tell our clients technically, they're required to disclose this information again as a subset of the general requirement that they disclose all material information about the investment and not fail to disclose anything where the failure would be material.
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R: And actually, you know, it's funny because when you're faced with a word like all material disclosure, it can be a little overwhelming.(...) What what does that mean? So it's actually quite useful to have these other regulations that give you specific details, because in the end, these are the rules. And if you follow them, you're going to be in the ideal position of protection as a promoter. And as an investor, if you know, you're the deals you're looking at, the people are following the rules and you have that much more level of comfort.
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Missing here - roland transitioning through other risks
R: You know, with with real estate, this is something to think about. And with all companies, it's a worthwhile question to ask the degree of leverage that's being used.(...) You know, we we help people raise the equity component. And then typically with the real estate in particular,
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the manager takes the equity and goes out and combines that with debt to buy the asset. We all know, though, what the risk of debt is, right?
S:(...) Yeah. So then, you know, that's when you start to have market forces at play that really impact your your investment. And I think in commercial real estate, you know, things move a little bit quicker, don't they, then, in saying the residential market, maybe you can sit where you are on the property you own until the interest rates improve. But in commercial real estate, that's not always going to make sense. And there are other considerations and, you know, permits you have to comply with and all kinds of things. So this the risk of the changes in the interest rate or any refinancing that you need to do being redone on really onerous terms that increases greatly.(...) And so you always want to ask questions about that because there's also a lot of sense in using leverage and real estate isn't there. It's one of the kinds of assets that using leverage for makes a lot of sense, as we as many people know from their personal lives with their own mortgages, et cetera. So but in the end, it's it's fair to say that that's, you know, as nice as commercial real estate can look in the books. This is a fundamental feature of of it, the interest rate risk that is always kind of lurking there in the background.
R: If you don't repay the debt, it gets foreclosed on and you can lose the property. Exactly. Yeah, well, there's that.
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But I mean, it really is worth mentioning. And it's why it's such an important thing.
S: Well, and just actually now that we're talking about the risks, because, you know, when we when we advise clients to help them prepare their offering documentation and prepare what we're calling disclosure in general, there are lots of parts and pieces to that. And one section is a specific long exhaustive list of risks. And some of them are so obvious. You probably wonder, why do I have to write it down? But that's exactly why you have to write it down is because it's so obvious that you need to focus the mind and make sure that even the most obvious is stated. And so this is probably one of those. And it's really important because you're putting your investors on notice about it. And also as a promoter, it probably causes you to think about it a little bit so that you have a plan or a risk mitigation plan in your back pocket to address what could come up.
R: Yeah, that's so important.
S: shall we summarize?
(...) We've talked about the main risk that we think in alternative asset space that people need to consider is is the liquidity risk and the different factors that go into that. Then we talked about information risk. So you need to receive information first off, but it also needs to be of a certain level of quality that you can rely on it.
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And likewise, for the people promoting a deal, they need to make sure that they have good information that they're using to manage the project or manage the investment. So that quality of information is important for everybody.
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And then the third main risk that we're talking about is who are the people, the managers, the managers.
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And then the third one is management risk. Who's involved in this? Is there a succession plan?(...) Is it overly reliant on an individual and their abilities? Is there at least a backup plan if it is one individual who seems the best place to get the job done?
R: Well, that was a good summary. And just as a takeaway, again, we want our audience to go and be able to talk to their financial planners about alternative assets armed with additional information. And hopefully today you have a better understanding about the risks associated with investing in alternative assets.
S: And to that note, actually, we would really like to hear from people in comments or if you have any feedback would be really interested. Where could some clarification be provided?
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Just bearing in mind that we can't give you specific legal advice without going through a formal engagement process on an individual level. But we are interested to hear back from everyone because the intention that we have here is to make sure that the more educated all of us are about this area, the better off we all are and the better off our economy and our society really is. So on that note, thank you all for joining us. And please follow us or like this video and otherwise stay in touch with us on social media, as you'll see down below our different channels.(...) And we'll see you next time.
R: And remember, everybody,(...) take aim with your alternative asset investing strategy.