Private Lending As An Alternative Investment
Private lending is ascendant. It has evolved from a cottage industry where a few well-heeled lenders pool their funds and expertise to earn high returns. Today, it earns a slot in the pantheon of “Alternative Investments.” Today, it is recognized as its own asset class with high risk adjusted returns and low correlation with other asset classes. That’s just fancy talk for earning more money without doing crazy stuff.
The players have changed, too. The well-heeled with expertise have created funds making loans in areas where their knowledge and expertise can deliver solid returns, evading the turmoil of stock and bond markets.
In the low yield environment of nearly the last decade, Wall Street and hedge fund operators have jumped into this backwater of finance with both feet. Not a backwater anymore, billions of dollars have entered the private lending arena. Now, crowd funding sites are essentially brokering participations in all kinds of loans, some even secured with real estate. Many of these sites rely on hedge funds for much of their loan funding. Hedge funds buy the loans they want and the rest of the loans are sold to individuals on their site. Buyer beware.
Institutional investors are actively investing in private lending funds and a growing percentage have specific allocations to the sector. Check out their perspectives: https://www.towerswatson.com/en-US/Press/2015/10/alternative-credit-world-ripe-for-investment
Depending on the fund, its market niche, its risk profile, collateral, et cetera, returns can range from mid-single digits to mid-teens. As with other investments, risk and return go hand in hand. This asset class, however, shows higher returns relative to risk due to a degree of illiquidity (this varies with the structure of the investment vehicle) and the management skills of those running the fund.
If you are an accredited investor, you should probably consider the asset class for a prudent portion of your portfolio. As a fund manager (I am definitely NOT a financial advisor), I recommend you consider the following in your investment selection:
- Private lending is not a “black box” investment. It should be transparent and easy to understand.
- Is your investment an equity investment or a debt investment?
- For equity investments, is the fund leveraged? Is the leverage prudent given the character of the loan portfolio? Here’s a hint: anything with leverage that looks like a bank is crazy; that includes banks.
- For debt investments, is the debt secured?
- Be clear on your commitment period, or “lock-up” period. When can you ask for your money back? These are not short term investments, but it’s nice to know there is an emergency exit in the theater. And, if no emergency exit, at least you know how long you are committed to the investment.
- Who’s running the show? Do they know what they are doing? Do they have their own money at risk either side- by- side with your investment or subordinate to your investment? Are they accessible?
- Consider the return and how it fits within your goals and structure of your own portfolio.
- When do you get paid and how much will you receive? Monthly? Quarterly? Ever?
- What are the costs? This is not a Vanguard mutual fund, so be realistic.
- Read the offering materials, don’t just look at the pictures. Understandably, you are probably not a lawyer and certainly most folks are not interested in the arcane legal issues, but if you want to play Monopoly or watch a tennis match, you should understand the rules.
- Where does it fit in among your investments? Should it be a self-directed retirement account investment or a taxable investment? Is it carved out of your fixed-income holdings, equity holdings, or a bit of each?
- When the market takes a dive, will you feel better with an investment that doesn’t tank with the S&P 500?
- When bond portfolios lose more in value than they receive in interest (it’s coming, really), will you feel better with an investment paying regular income, remaining unaffected by this chaos?
I thought so.