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The Danger of Overconcentrating in REITs and Private Equity

The opportunity costs for clients are great.

One of the most encouraging trends in the retail investing space over the past decade is the rising adoption of alternative investments among financial advisors and their clients. According to data from Cerulli, approximately 40% of financial advisors are now utilizing retail alternatives in some capacity. 

However, while this trend is positive, a troubling subplot has also emerged: Investor allocations to retail alts have become overly concentrated in REITs and private equity. Ironically, this means that the portion of many investors’ portfolios that is specifically intended to provide diversification through noncorrelated asset classes is itself suffering from a concentration problem.

Even worse, this blinkered approach often leaves investors out of major macro trends that could generate strong growth or income for their portfolios—with the rise of the renewable energy sector as one significant example.

One source of this problem is that broker/dealer product shelf managers, due diligence officers and other gatekeepers are fearful of approving products in new areas with which they are not familiar. This often means that they miss out on good opportunities because they don’t want to be first in getting into a new asset class, even though being early in a good investment may result in higher returns. Many organizations are still feeling their way when it comes to understanding retail alts products—and, in the meantime, they are content with ‘being first to be second.’

How can due diligence professionals and others chart a course to a more holistic perspective that will enable them and their advisors to meet clients’ needs more effectively? Here are some suggestions:

Revisit non-real-estate-related real assets. Over the past 15 years, developments in the real assets space—which encompasses hard assets that generate consistent and generally predictable cash flows—have transformed this segment into a significantly more accessible and sophisticated asset class for investors.

While, in the past, investors could add exposure to this category only indirectly—through purchasing stock in diversified energy companies, for example, or by investing in isolated muni bond issues—options have emerged in recent years that enable advisors and investors to participate in the sector on a much wider scale.

One of the newer areas for retail investors is investment in Infrastructure Related funds that invest in long-term contracted assets such as pipelines, toll roads and power plants to generate predictable cash flows for investors. Examples of this type of strategy are funds that invest in renewable energy power facilities that have long-term contracts to sell electricity to utilities, municipalities and corporations. Other options have evolved for assets, including timberland, farmland and even cell towers.

The broader availability of such vehicles today not only allows investors to expand into new asset classes, but it also enables them to take a diversified approach to incorporating these vehicles into their portfolios.

Leverage experience with real estate to capitalize on new opportunities outside of “traditional” vehicles. A growing number of advisors (and BD product platform managers) have become very familiar with the nuances of investing in real estate through REITs and other vehicles. For many of them, real estate has become the go-to strategy when they want to look beyond stocks and bonds on behalf of clients.

What many of these professionals don’t realize, though, is that their experience with investing in real estate is, in itself, a highly valuable asset. Just as REITs seek to securitize tenants’ lease payments to provide predictable income and growth for investors, new strategies have developed in the renewable energy sector and elsewhere that provide similar benefits by allowing investors to participate in the payments made by "off-takers" such as utilities, large corporations and others to the operators of green power projects.

To extend the comparison with real estate, many of these power projects have higher rates of "occupancy" (categorized as long-term contracts in place with creditworthy off-takers) than the majority of REITs.

Augment in-house risk assessment capabilities. One roadblock to broader inclusion of real assets-based retail alts and other similar vehicles on broker/dealer product shelves is the diversity of risk management considerations. The process of assessing and managing risk can vary significantly from one vehicle to another, and various product sponsors have different standards in terms of the information they make available to due diligence teams.

With this environment in mind, the challenges involved in understanding and managing risk for various real assets-based instruments frequently deter product platform managers from exploring investment options that could help their advisors and clients. Where it makes sense within broker/dealer budgets, though, firms should seek to bolster their risk assessment capabilities to help them cast a wider net in the retail alts sector, including by hiring new specialists, if necessary.

One of the hallmarks of our capital markets is the way in which they have consistently, quickly and efficiently empowered investors to participate in attractive opportunities to deploy capital to benefit from significant emerging trends. 

In order to enable investors to realize the latest opportunities, it is crucial to overcome some of the roadblocks that stand in the way of broader adoption for real assets-based investments.

Robert Sher is executive vice president of Capital Raising and Marketing for Greenbacker Capital, an investment firm focused on the sustainable infrastructure sector.


TAGS: Real Estate
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