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A Financial Advisor’s Perspective On Including Alts In Your Portfolio w/ Josh Wright

ILB 12 | Alternative Investments

Josh Wright is an experienced financial advisor who uses alternative investments as a key pillar for his clients. In this interview, we dive into why Josh loves private alternatives and why most financial advisors avoid them, despite many advantages of private alts, including greater diversification & potentially higher returns than the public market.

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A Financial Advisor’s Perspective On Including Alts In Your Portfolio w/ Josh Wright

We are joined by our guest, Josh Wright. He is a registered Investment Advisor who loves alts.

That’s a horse of a different stride there. Most investment advisors don’t know anything about alts. This is the insider’s view of the investment advisory space. How it works and how they deal with alts.

This was a longer interview but it was good to the end. We could have kept it going for at least another hour because Josh is so knowledgeable about this space. He’s one of the sharpest guys that I’ve ever met in the financial planning and investment advisory space. He talks about how he uses alts for his traditional financial planning clients. He uses alts with real estate investors. He breaks down a bit of why the industry is scared or tepid with alts, and how he uses them with his clients. It’s a great interview. You guys are going to love it. Understanding a bit more of how the general mainstream media looks at these, and how he uses them specifically. Enjoy this conversation.

Welcome to the show. Our guest is Josh Wright. We’re very excited to have him in person. Josh, thanks for joining.

Thanks for having me.

We’re excited about this interview. We’ve worked with Josh for several years. He is a registered Investment Advisor here in Kansas City. He loves alternative investments, which we’ll get into later. It’s pretty unique in the whole world of investment advisors. The whole goal of this show is to look at what are the ultra-wealthy doing? What are the billionaires doing with their investment strategies and how are they generating their wealth?

One of the biggest differences between the ultra-wealthy and the average investor is alternative investments. We’ve pulled up stats before Josh where family offices, pensions, and these larger institutional investors sometimes have 40% to 60% of their portfolios into private alternatives like hedge funds, private equity and real estate.

We’d love to hear your story, Josh. Maybe a quick little bio so you guys can get excited because Josh has some amazing thoughts in this space. He has been an investment advisor for many years and worked for a long time in the traditional wealth advisory space. In 2017, he started his own firm. He has had a lot of success. He has a background in real estate, growing up in the hotel business. He saw the importance of having diversification in real estate early on. He has developed expertise in 1031 investment exchanges. His views on planning and investing are unique in this space.

He’s a board member for the Kansas City Estate Planning Society. He’s active with the Alzheimer’s Association. He has a wife, Nicole, and a pug named Stella. Josh, give us a bit of background on your evolution in this space, being an advisor and growing up in the more traditional sense, but then eventually moving into alternatives as a core piece of what you’re doing for your clients.

I started out in a business the traditional way. I was in a commission-based world. I started out at a big wirehouse. It’s a very salesy world, to be honest.

You got commissions when you sold some stock to somebody.

Yes. Hefty commissions. I told somebody that when I started in the business, the commissions on mutual fund sales were over 7.5% upfront. Imagine trying to make money for your client if you take a 7% or an 8% haircut out of the gate. No matter how many times you told them and explained to them how those fees work, they’d still call you the next day and say, “I put $100,000 in. Why does it show $92,000 on my statement?” I started out on that side of the business.

At that point, were you aware of the state of what you’re doing like, “This is great to make some money?”

I wasn’t that aware of it until I got to the business. I had no idea how salesy it was until I got to day one. I grew up in Kansas but I started my practice in Phoenix, Arizona, with the bright idea of starting a relationship-based business in a city where you don’t know anybody. It’s a terrible idea. I wouldn’t recommend it. My first manager was an old-school sales guy from New York. He was all about the sales numbers. I struggled. I spent a year pounding the pavement seven days a week, day and night, trying to build a business.

I’ll tell you a quick story. This will sum up what the business was like then. One of the first clients was an older lady who came in. I met with her and she had $50,000. She wanted to put it somewhere safe. She had plenty of other money but she said, “I want a guaranteed rate of return.” My first thought is, “You’re in the wrong place.” I could offer her a money market fund where I got paid a bit of commission or I could offer her a CD where I got paid nothing through the firm that I was at. I did the CD. The rates were the same even though I didn’t get paid. My hope was to build a relationship and hopefully, get some investment from her down the road and make a long-term client.

Expectations are different when the market's up or when it's down. You need to start a proper plan and have some targets. Click To Tweet

The next morning at our sales meeting in front of sixteen other advisors, my primary manager came in, smacked me in the back of the head in front of everybody and told everybody what an idiot I was. That’s how I would sum up what the business was like. He told me it was still suitable to put her in a money market fund, even though the CD was more appropriate, in my opinion. That’s what the business was like in the beginning.

Now I migrated back to Kansas City. I found a mentor. I began to partner with him and buy into that from overtime. I was in the firm for thirteen years. I began to build a business. It was all financial planning and investment management. I took that firm fee-based in 2005. That was very early to the fee-based world. Everybody thought I was nuts. I told them, “We have to remove conflicts of interest if we’re going to grow this.” I’m a planner by nature. My other partners in the firm are much more salespeople but fee-based made sense to me. Of course, the whole world went that way.

The difference is you charged a fee like a very small percentage of assets under management. You’re not getting commissions based on what you’re putting them in, versus the old way which was getting commissions. You got more commissions for different investments than you did for other investments. You are incentivized to put them in certain things versus other things. It creates a conflict of interest. You took a fee-based, which is you get paid the same no matter what.

In a fee-based world, we get paid the same no matter what. We’re getting paid to give good advice and give results but also manage risks too. I always tell my clients, “Being fee-based ties my faith to your faith.” People always think about the upside when you’re fee-based, but you need to think about the downside. If we go through 2008 and I lose half of your money, that means my paycheck went down 50%. It’s hard to live if your paycheck goes down 50%. There’s a strong incentive not to lose money. In a fee-based world, you can be holistic. You’re on the hook to give the best advice possible.

You’re not incentivized to make their money either.

They’re not going to be a client very long if you don’t make them something. I’ll tie that back to my philosophy. To finish that background, I spent a number of years in that firm and took us fee-based in ’05. I set up our first RIA or Registered Investment Advisor in 2012. Eventually, I sold my interest in that firm and started my own RIA in 2017. Along that way, we’ve been primarily focused on financial planning and investment management. As you guys alluded to, alternatives are a huge part of my practice as well as the real estate side of my practice. I think alternatives are great, so we can dive into that.

That’s super unique, as Ben pointed out at the beginning of the show. One of the biggest differences between ultra-high net worth and normal people is the way they invest and primarily in their use of alternatives. The very large investors typically invest something on the order of 50% of their investments into alternatives and the little guys don’t. One of the reasons the little guys don’t is because of the advisory space. They simply don’t do it.

We’ve had investors who were very excited about investing in alternatives in Aspen, for instance. They take it to their investment advisor and get a, “Don’t turn this down. Run from this.” They terrify these people about what has been a very safe investment. It makes a lot of sense. They scare the pants out of people. The space is very much anti-alternative. Give us your perspective. How did you make the shift?

There are two parts to that. The first part of how I made that shift was based on my first bear market, which should be everybody’s shifts. I came into the business at the tail end of the tech bubble blowing up. That was my first taste of that. When I was in school, I thought I was going to go into portfolio management. I focused all of my schooling on portfolio management. I always say modern portfolio theory and we can go in any direction you want to go.

My experience with stocks was diversification in stocks helps when markets are going up. When markets are going down, it’s like a flushing toilet. Stocks are one big bet at the end of the day. There are plenty of statistics to back that up. In the ‘08 experience, I was building out my own investment strategy prior to the ‘08 experience but I can tell you, people who went through 2008 who lost 50%, 55%, whatever number of their assets, diversification amongst stocks, the old school pie chart of US stocks, international stocks, bonds, etc., you still lost 30%, 40%, 50% of your money.

Those experiences are why I built my strategy and migrated much more towards alternatives because I view things from a financial planning perspective. This is born out of the first client I had that intended to retire right before a bear market happened. They take a large loss and all of a sudden, they’re not retiring. That experience was enough for me to say, “I need to do something different for my client.”

I went through a whole journey of looking at other strategies and alternatives until I came to a place where I found the strategy that worked for my clients. It was based on the financial plan. With my clients, we start with a plan first, and then we fit the strategy into the plan. Here’s the reason we do that. If you sit down with a client and they tell you, “I don’t need a plan, I just want you to go make me money,” my first response will be, “What the hell does that mean? It might mean one thing to you but something completely different to me. Let me tell you. Expectations are different when the market’s up and when it’s down.”

ILB 12 | Alternative Investments
Alternative Investments: In a fee-based world, financial advisors get paid the same, whether they give good advice, offer tangible results, or manage risks.

I start with a plan because we got to have some targets. We all agree we’re moving that. I need buy-in from their side of the table. Once we build that plan, what are the two things that blow up a financial plan? The first one is too large of losses. The second one is too many consistently negative years in a row for return. Those two things will blow a plan up. I logically went to the step of saying, “What strategies can I build and melt together that’s going to keep losses small but let my winners run?” That’s what I’ve done. That’s where alternatives came into play.

We can talk about the stock and bond side of my strategy, but alternatives for me are that consistent workhorse. Not to mention a good alternative is truly non-correlated to stocks, bonds, commodities and other asset classes and that’s what you need. Not to make you guys feel too good but I pitched the Aspen Income Fund to a new prospective client. I had done some real estate business with him. He’s a great example. He owns a lot of real estate around the country.

A wealthy gentleman sold his company in 2020. I said, “What did you do with all that money?” He said, “I day traded it in 2020. I realized I’m not good at this. Let’s talk about strategy.” We walked through planning first, “What are you trying to accomplish? Are you doing enough? Are you on track or off track?” That’s what my job is. I don’t need to dive deep into the details unless you want to, but I need to make sure you’re on track because we don’t want to have that conversation if he wants to retire at 60. He’s 57 and I’m saying, “You didn’t do enough. There’s no time to make that up.”

We had a discussion around what are the goals? First, let’s fit the strategy to the goals. I showed him what we do in the stock and bond space. I showed him Aspen Income as an example of an alternative we would use and here are the reasons why. When I talked about volatility, I talk about the yield off that fund. I said, “If my target is 8% average return during the accumulation years and I get 9% yield off this fund as an example off the Aspen Income Fund, whatever that number is. By the way, the share price doesn’t move a whole lot. It’s not correlated at all to what we do in the stock and bond space.”

The light bulb was clicking for him. He said, “That makes a lot of sense.” He asked me, “Does that correlate to all of my real estates?” He owns a lot of direct real estate investment. I said, “Frankly, no. It doesn’t because that Aspen Income strategy, its return and risk characteristics are completely driven by that strategy directly. It has nothing to do with what’s going on in these other spaces.” That’s a good example of the way that we look at alternatives and insight. They did not pay me to say any of that stuff. It happened right before I came here. It was a good example.

A couple of things I want to hit on here. You mentioned correlations and this is critical. Traditionally, in the 60/40 portfolio, you invest 60% in stocks, 40% in bonds. The idea is they’re uncorrelated so that stocks or bonds go up or down, but they’re completely independent. The reality is of the recent downturns, correlations all went to one. It means fully correlated. Everything went down purely. I would argue, macroeconomically speaking, that is probably going to continue because there is so much liquidity in the world and it goes into the same things.

When that liquidity evaporates, there is it got no place to go but down. You see increased concentration risk. When you look at the amount of ETF investing that’s going on, how much of the stock market is controlled by these ETFs, which are concentrated in a few stocks? The entire market is wired to be correlated together. Your point about alternatives being truly uncorrelated is valid. In my opinion, you’ve got to get something that is not publicly traded to avoid those correlations.

The stock and bond side of our management process is fairly uncorrelated by virtue of the way that we do manage. Sometimes that means going risk-off, taking chips off the table, and coming out of the stock market. You can’t have your cake and eat it too. I tell clients this all the time, both the stock and bond side, the alternative side, you can’t have that plus-30% year when the stock market’s up 30% and not get all the downside that comes with it. It’s impossible. If I could do that, we wouldn’t be having this conversation. I’d have my own island and check out.

The problem with stocks is its human emotion component. It is the people that drive price in stocks in alternatives. Click To Tweet

A good alternative has to be private, number one. The pricing of that alternative and how that share price is configured has to be based on an appraisal of the asset’s actual value. You can’t have human emotion coming into it and the stock market is human emotion. Do economics play into stocks? I think they do over long periods through things. I’ll give you an example of what I told this gentleman. I said, “Show them a chart of the S&P 500 going back 125 years.” I’ve shown you this chart, Ben. You can find this online anywhere.

On there, you mark the periods where the market was up and green, and the periods where the market was flat and red. You put the number of years in each of those segments. What’s crazy is you see these stretches of time, 12 to 15 years at a pop where the market gave you nothing. Imagine if you hear some statistics about the stock market. The market averages 9% a year over time, whatever number somebody throws out there. That might be true if you’re looking at 125 years of history, but having lived with clients and worked with clients for many years, here is the reality of that. You don’t live 120 years. You don’t invest for 120 years.

If you’re lucky, you get 30, 35 years to save and invest prior to retiring. That’s assuming you don’t have three kids in college at the same time like my father did or you lose a job and it takes three years to get back on your feet, or you do what I did and start a business in the middle of your career. All those things. Now you’re 30, 35, 25 or 28. When you stretch that timeframe down, the statistics look different. Now, fifteen years at zero out of 30 years to save is a serious problem.

I always tell people, “It’s not that the market won’t come back. It may not come back in your lifetime, the time you need it to. That’s the real problem.” If you can take a good stock and bond strategy, and then take an allocation to alternatives around that, that have their own drivers of risk and return and yield, I’m a big fan of yield, so we can talk about that too. That is why I like real estate as well. You can get to that number you need to get for the plan much more consistently.

Also, if your losses are smaller, you can get them back much quicker. Imagine if you went through 2008 and you were down 5% instead of 56%. You probably would have been above even by the end of the year if you were a buy and holder in that type of scenario, which how many people will sit through 56% and not panic.

I’m a total math nerd and I’ve seen stats about how much money the stock market earns you over time. The numbers that people quote are all over the map. How can that be? The difference is when is your start point and when is your endpoint. That changes it by order of magnitude. If you mark it from 2000 or 2001 versus 1995, it’s a huge difference in return. Timing matters. If you buy a market when it’s low, your returns are good. You buy the market when it’s high, your returns are poor.

I have a scatter plot chart that shows that the ten-year return of the S&P 500 based on its PE ratio. There is a reverse correlation. You make more money if you buy the market when it’s lower on a PE basis. You make less money if you buy when it’s higher. It’s a fact but people don’t understand the importance of timing. You’re avoiding the timing concern by using alternatives, which have a completely different pricing mechanism.

We’ve talked about it before too is you can talk about average return numbers. Assume you can solve the timing issue, which is a very big issue. Most investors aren’t getting the average return of the S&P. One, because you have diversified in stocks and bonds. Two, you have fees. Three, the drawdowns have an inordinate impact on what you’re trying to hit as your target. If you lose 50% in your portfolio, it takes you 100% return to get back to break even. You talk about that with clients a lot too which is minimizing those losses. Kudos to you in 2008. You were not down that much.

ILB 12 | Alternative Investments
Alternative Investments: You can’t have alternatives plus 30% per year when the stock market’s up to 30% and not get all the downside that comes with it. It’s just impossible.

We had some positive returns.

Did your client base grow up after that?

Those clients are clients for life at this point. What’s the struggle is we don’t have years like that every year. I tell clients, “Markets go up like stair steps but they come down like elevators.” Until they’ve lived through an elevator-dropping period, they don’t understand it. I think we do a good job of communicating with our clients’ proper expectations. I tell clients right up front, our prospective clients, “If you want what the market’s giving day in and day out, the only way to get that is to go buy the market. You don’t need us for that. You can go buy an S&P 500 ETF for almost nothing but you need to understand what you’re getting. You get the upside but you get all the downside.”

The other thing though is you got to take taxes into account as well. Real returns are quite different from paper returns before taxes. This is why alternatives can be good. This is why we find real estate very good as well. When you can get tax benefits like depreciation pass-through and things like that, you get a 7% yield off a private real estate fund, and 90% of that is tax-sheltered because of write-offs. Now your real return looks quite a bit better.

I’ll give you a story on this real quick. I have a real estate client doing a $3 million real estate sale. They’ve got a big stock and bond portfolio that they’re managing elsewhere. They said, “We may not do a tax-free 1031 exchange. We may sell it and pay the tax and invest in the market.” I said, “What are your plans there?” They said, “Do you think it’s a good idea?” I said, “What’s your tax going to be when you sell?” They gave me an estimate, which I think was low, which everybody underestimates.

I said, “Let’s assume you pay 20% in taxes, which I think will be a lot more. Now you got 80% of your money. Where are you going to reinvest that?” They said, “We’ll put it in the market.” I said, “Do you work with an advisor?” They said, “We’re interviewing 2 or 3.” They began to tell me two stories from two different advisors they got. One person told them he was going to make them 14% a year. I kid you not. This is going to lead to a story of why compliance is so crazy in our industry. I said, “If he can make you 14% a year, I don’t know why he needs you. He could do that with his own money, but what risks are you going to take to get that?”

The next gentleman said 10%. These people are in their mid-60s. They’re retiring. Think about the client. How are you going to go get a 10% market return year in and year out? I said, “What’s your goal?” They said, “We need cashflow from this money to live.” Think about that. This is all stocks. They don’t know anything about alternatives. I’m getting ready to discuss alternatives. I said, “You’re going to have to go invest that money in the stock market.”

Ten percent dividend-yielding stock.

“You’re going to try and get a 10% return.” They’re not even thinking about dividends. They’re thinking about getting 10%. I said, “To get income, you’re going to have to sell stocks. Assuming you’ve made your money, you made 10%, you’re still going to have to sell. That’s a big assumption. If you’re going to have to sell that, you’re going to have to pay cap gains on every dollar you take out. By the way, what happens when we go through a drawdown year where you’re down 20%, 25%, 30%, whatever, and you’re taking another 5%, 6%, 7% withdraw from that account? Now you’re down 28%, 38%, whatever it is. You can’t make up that money.”

We walked through what the math looks like. We began to have a discussion around alternatives. Where we end up going is I explained to them, “If you see a 10% return on a stock, 9% of that might be appreciated, 1% might be dividend yield.” You look at an alternative fund that owns real estate or credit or whatever it is. A 10% return, maybe 7% or 8% of that was yield and 2% was appreciation. It’s quite a bit different.

In an alternative, the price per share is driven by the specific value of a real estate. Click To Tweet

To lead back to something you said earlier, Bob, why do advisors and firms look at alternatives so negatively? One, they don’t understand them at all. Two, the broker-dealers or the registered investment advisors that they work for don’t understand them. They avoid them like the plague. Three, when I first got into the business, the alternative world was the Wild West. You paid hefty upfront commissions to go into an alternative. I’ll give you an example, a non-traded real estate investment trust, a non-traded REIT.

It might have been good real estate but the premise of the product was we’re going to put it in a private fund. We’re going to raise cash for two years. We’re going to start buying real estate with that money. We’re going to close it in year three. We’ll finish buying out real estate, and then we’re going to manage it for 6 or 7 years. We’re going to sell it in year eight via an IPO. My first question would be, “How do you know your rate is the right year to IPO? What if it’s a bad idea?” This isn’t rocket science. There is no real answer to that.

What happened early in the industry was there was a lot of stuff was sold like that with promises that couldn’t be kept. There were people in that space that didn’t know how to manage real estate properly. Maybe they didn’t properly buy it because here’s the other thing. As a private fund manager in the alt space, this is very common. You would see them raise little bits of money through year one. Let’s say they’re going to raise for two years, so eighteen months in. In the last six months, they’d bring in as much money as they pull in in the prior eighteen.

I saw one fund once post-2008. This was early ‘09. They were buying multifamily assets all over the country. They were buying these things at $0.50 on the dollar. It was a good timing play. This was one fund I did use. They bought up these assets, but in the last 90 days, they got $200 million in the door. They are required and are going to spend that money. At that point, though, this was getting into late 2010, all those assets have already appreciated. Now they’re overpaying for assets. They erased all the gain on all the other assets they bought by the money they had spent in the last 90 days of that fund.

This is the alt space, especially back then and this was over a decade ago. Advisors don’t understand this because they don’t know how to do proper due diligence on a fund. You’ve got clients eight years later who are throwing a fit rightly so. Now they’re filing complaints. You have advisors getting complaints and you have broker-dealers and RIA is getting complaints. This is why the alt space from my side of the table is so complicated because there are a lot of people who don’t know what they’re doing. I think laws controlling alts are based on that.

Pull back the veil and look under the hood and see what’s there.

We solved a lot of this problem by having funds that aren’t tied to a timeframe. Perpetual life funds, whether it’s a credit or real estate, makes a lot more sense. Buy and sell assets when it’s a good time to do it not because you’re tied to something you promised an investor.

You said they don’t understand them. These are professional investors and professional advisors who are trained at the top schools, passed a test, the Series 65, which I studied for, and then decided not to take the test because it was so ridiculous at the end, just FYI. They don’t even learn about alternatives. That’s not even part of the test. It’s not even a thing. Is it true that investment advisors can avoid learning about alternatives and be legitimate?

When you’re in college, whether it’s your basic degree or an advanced degree, you’re not taught about alternative investments. Granted I was in college twenty-some-odd years ago. Maybe there is more in that space, but the basics of the CFP and the CFA, there is a lot of analytical work, but there’s not much of it that goes around alternatives. In Series 65, which I have, there is nothing on alternatives, hardly at all. You also got to imagine a broker-dealer or a registered investment advisor. Most people in that space don’t manage their own money. They outsource it.

Most compliance departments are these broker-dealers and RAs. Not all. There are some good ones. Let me say that. Most of them don’t know about real estate. They don’t know about credit. They don’t know about these alternative strategies, private equity. They’re not familiar with it but they are the ones who are approving funds that they’re letting their advisors go sell clients.

They’re advising people. The alts are huge and they don’t know about this space entirely and steer people away. The biggest reason individuals do not invest in alternatives is they don’t feel comfortable making their own decisions. The investment advisory space plays on those fears saying, “You don’t understand this.” In reality, they don’t understand it, so they stay away from the entire space. It keeps people out of what can be good.

I’ve had conversations with other advisors and conceptually, they love the idea of alternatives because you get the non-correlation. You can get way better yields in the private markets. It’s a business or an operational decision because it’s so difficult on the compliance headaches.

The operational issues are very difficult.

ILB 12 | Alternative Investments
Alternative Investments: If you see a 10% return on a stock, 9% of that might be appreciation, and 1% might be dividend yield. You look at an alternative fund that owns real estate or credit and it is a 10% return, around 7-8% is yield, and 2% is appreciation.

Through the back office and then, “I can go into my Ameritrade platform and push a few buttons and re-allocate everyone’s accounts so I can scale that easily.” Your clients don’t understand it. They’re all excuses but to me, it does not serve the client first, prioritizing a business or an operational decision because it’s easier. You’ve got against that. In fact, you’ve had a lot of pushback from regulators and saying, “You’re too heavily allocated to alternatives.” Talk about that a bit.

I haven’t had any problems with regulators. There are hard and fast rules that regulators have in place. Each state has their own set of rules. The SEC has its own set of rules. Most of the states say you can’t have more than a certain percentage of your client’s assets in alternatives. That might be 10%, 20%, whatever that number is. It’s funny that it varies from state to state and is not even consistent in that number. The issue with broker-dealers is the first time a broker-dealer or an RIA gets a complaint about something that they are not that knowledgeable about, their immediate response is to say, “We’re not going to allow it. We check out.” They don’t have anything to do with it.

That’s one issue. The other issue is dealing with clients and things like liquidity. There were a lot of complaints around advisors in the early days just selling stuff but not being honest or setting proper expectations or something simple like that. That’s another issue. With respect to regulators, I understand what they’re trying to do. They’re trying to protect the client. The onus is some of it is on them. I think more of it is on registered investment advisors and broker-dealers. If you’re going to offer this stuff, you need to get more educated on it. We do very deep due diligence.

We built a due diligence platform on alternatives, real estate syndications, nuanced areas. As an RIA, I get phone calls from broker-dealer compliance departments asking our opinion of different alternative investments, different real estate syndications. I think to myself, “You guys have 1,000 advisors that are out selling this stuff. You should have that expertise already.” That’s the world we live in. When it comes to clients and alts in those regulations, if I could have my way, I would have a lot more allocation to alts across the board.

Some of the pushback from regulators has to do with experiences from many years ago. Alts today are completely different than they were years ago. Alt structures now have eliminated a lot of the complaints from regulators. The fact that there is some liquidity in alts period should eliminate a huge percentage of that problem from regulators. There has been a lot of bad actors who sold stuff that shouldn’t have different levels of risk or didn’t understand the risks. In my view, if you have good due diligence and you narrow down the alts to what is appropriate and understand them, my retired clients or my clients closer to retirement should have more alts than my younger ones, which is completely counterintuitive.

You’re saying they should have less.

Think about this. I have a couple that’s retired. They’re in their late 60s or early 70s. Their only goal at this point is cashflow to live living expenses. They want to leave a legacy for their kids. That’s it. The best thing I can do for them is to build a portfolio that can maximize yield and make the portfolio as low volatility and as safe as I can. That’s it. We all know you can’t go get yield anywhere in the safe world, CDs, short-term treasury bonds. You’re not getting the yield anywhere.

I could build them a portfolio that was safe, 50%, 60% alts, and then a very conservative stock bond commodity portfolio on the side, the way that we run it. I could get them a very nice yield with very low volatility in that portfolio on an ongoing average basis. If I build that portfolio and I go through my audits, which we go through audits with all the states we do business in, I know that would get called out, so I can’t do it. If I’m going to do it, I run the risk of getting in trouble with regulators.

The only thing that's true in stocks is the price. Somebody is willing to pay for it, and somebody is willing to sell it. Click To Tweet

Let’s talk about risks for one sec. Risk is an interesting topic. Let’s put risk in two categories. There are operational risks. The idea that you buy a bad piece of real estate as an operator. You do something stupid and you lose money. There’s then a liquidity risk, that something is illiquid. It seems like alternatives by the establishment investors are viewed almost universally as riskier. I’m thinking about the stock market. You’ve been through how many elevator drops on the stock market. I’ve been through more. Is that not risky?

I don’t understand this idea of risk. If you look in alts, they simply have less risk. You could argue because a stock is registered means that it’s gone through some due diligence process. I’ve gone through some registration processes. SEC is not that smart with those kinds of things. I don’t see where the establishment gets this idea of risk being that anything private is risky and anything that’s public is not risky. I don’t understand that. It seems completely nonsensical to me. What’s your view?

The problem with stocks is you have this human emotion component. It’s humans that thrive. It’s a herd mentality. It’s humans that drive price in stocks. There are good alternatives and there are bad alternatives. There are good strategies and bad strategies. In an alternative, the price per share is going to be driven by something specific to that strategy, either it’s the value of that real estate. It’s the value of that note or there’s a business risk. With an alternative, you can manage those risks. It’s very clear how to manage those.

If we’re underwriting real estate syndication and it’s a single property, we can look at the appraisal. Did they overpay or underpay right up front? My dad always said, “You make your money in real estate by what you’re paid upfront.” He is 100% right. If you overpay, you need everything to go perfect for it to work out. If you underpay, everything can go sideways and you can still be okay. It’s the same thing in an alt. If it was real estate, “What did you pay upfront? What does the tenant financials look like? What is the demographics? Who are the competitors? What are the assumptions of the pro forma for that alternative?”

In the credit space, as you guys know, in that income bond, “What did you pay for the note upfront? What does the credit look like on the person that’s in that property?” There are metrics that you can look at and drive risk. You can take more risks or take fewer risks. This is why I moved away from traditional, modern portfolio theory early in my career. When it comes to stocks, you can do all the work in the front-end. You can buy a stock and it can drop 50% tomorrow for no other reason than people panicked one day because of something else that happened.

It’s completely out of your control. It’s very hard to manage risks. Our approach to stocks has been based on some economics and long-term trend. You can’t fight the trend. The only thing that’s true in stocks is the price. Price is what it is. Somebody is willing to pay for it and somebody is willing to sell it for that moment in time. I agree with you. How is that alternative riskier than that stock? I don’t know. I don’t think there is a good answer for that.

Let’s talk about liquidity risk. Liquidity risk is a real risk. That onus of that risk is not on the alternative investment manager. That’s on me as the investment advisor to do proper planning and plan for those worst-case scenarios when you implement a portfolio recommendation. We jokingly tell our clients about the way that we underwrite every alt. You guys know this because I asked you all the annoying questions all the time. We underwrite for the worst-case scenario forward. That’s how we think about stuff. We’re optimists by nature, but we build a plan from the worst-case scenario forward. We underwrite an alternative investment worst-case forward because we want to know if everything goes wrong that we can think of. Can we still be okay and still plan for some error in there? I don’t know if that answered your question or not.

Where does the mainstream idea that alternatives are risky and the stock market is not risky or as risky come from?

You’re asking me to speculate. My best speculation is that’s a narrative that’s been put out from Wall Street for years and decades. It’s strong and it still proliferates through the education system and a lack of knowledge on the alternative side.

We’ve thought about getting into residential rentals at some point in the future, single-family rentals. We’re looking at some private funds and what’s the yield and the net asset value and how they traded. We’ve looked at some publicly traded comparables at the exact same strategy. Most people are probably familiar with the price-to-earnings ratio, some evaluation metric. In real estate, price to book is a helpful evaluation measure. These particular publicly traded funds that were doing the exact same strategy, we’re trading at 2 to 3 times book value.

I buy $300,000 homes and I buy ten of them. I’ve got $3 million in real estate. I do an IPO with that. Let’s say that was possible. Now I’m priced at $900,000. The market is pricing those homes at $900,000 each because they went public. I’m paying three times what those homes are worth in order to have a stock that’s liquid. Is that insane? That’s stupid.

You buy publicly-traded REITs, you’re not buying real estate. You’re buying a stock and it’s not going to behave like real estate. It’s not true real estate exposure. Every alternative real estate fund we’ve ever used that did IPO, we’ve sold in the IPO. Every time. We never held one ever.

There is too much money chasing too little product.

It’s now stock and that’s not what we’re going to use for the stock and bond pieces of our portfolio at that point. We want to buy real estate for true real estate exposure.

In 2008, if that single-family rental stock was around, it was probably selling at $0.50 of book value. Now, it’s selling three times of book value, which is absolutely insane. Anybody that buys that has rocks in their head. Anybody that buys it in 2008 when everybody’s panicked was a genius. This idea that if something is public, it’s therefore not risky is ludicrous.

We need to be realistic about risk and return on all these asset classes. We never talk in absolutes with our clients and we never say this is 100% the best thing and 100% the worst thing. We always talk to them about all the good and all the bad of every investment we talk about. What synergistic effect we’re going to get by combining them together. What the risk of return looks like at the portfolio level. We talk about everything that can go wrong and the worst-case scenarios. We build forward and it’s worked well for us.

I think advisors in my space would do themselves a huge favor by getting better educated by spending more time with their clients just being realistic. I don’t think you’re going to scare anybody away by being honest. I’ll give you an example of the joke in our firms. We talk about a real estate deal with a client. Sometimes I’ll spend 30 or 40 minutes telling them all the bad stuff. They look at me and be like, “What’s the good stuff?” You need to understand what could go wrong in this deal. Here are the real positives and this is why we think it’s a good fit for you.

I’ve never had a client that complained about that. It’s always worked for us. Don’t get me wrong. I didn’t understand this when I started in the business. I had to learn this lesson time and time again as I grew my business over time. It’s proved out to be a good thing. I think in our industry, we could do a lot of good if advisors got educated.

Frankly, in some instances, insights become the alternative investment arm and the real estate investment arm for other registered investment advisor firms. This was never something I intended to do, but we began to get calls from folks saying, “Our firm won’t let us do alts anymore. Our firm won’t let us do real estate anymore. Can we bring you on and partner together to be that arm for us?” That’s because we have built those due diligence platforms and a reputation for ourselves.

It’s a lot of work. One of the things I love that you do though is not pigeonholing, “This is the world that I live in. This is what I’m going to look at.” You take an objective approach when you’re looking at all the different available options. The goal of this show is to bridge the gap between those that are only stocks and bonds and those that are only real estate. You are of the same thing where you’re working with clients in this in-between mode. There are good things about being invested in the public market. You’re not against that. You’re able to do that.

There are good things about being in real estate. I’m trying to bridge this gap. There’s nothing on the table but also there are a lot of things that don’t end up on the table at the end because you take it to the nth degree on diligence. The last thing I’d love to hear from you is it feels like there have been broader tide changes in the move towards alts. It seems like the mainstream is becoming to accept alts as a possibility or at least conceptually and moving toward that.

Some of the regulation changes probably almost a decade now. The JOBS Act like our funds of 506(c) offerings allow us to publicly advertise and can share with accredited investors which didn’t exist before that. A lot of these were not available. There’s some shift there. There are still a lot of hurdles, but are you seeing at a broader sense more movement towards alts or is it hit or miss? What are you seeing from the client’s standpoint?

ILB 12 | Alternative Investments
Alternative Investments: The wealthiest people have owned real estate alternatives, and it is a bulk of their assets by a large margin.

To be honest, I have not seen a big shift towards alts. Let me preface that. The higher net worth folks that we work with when they come in, statistically speaking, mashed up to what you’ve said. By and large, they have the bulk of their assets and alternatives, real estate, hard assets. Stocks are always the smaller portion. The amount of stocks tends to ebb and flow along with whatever the stock market’s doing. When we had a good 4, 5 or 6 years, everybody thinks stocks are great. They own more. When we’ve had a bad 3, 4 or 5, they own less. It was crazy.

The most wealthy people I have ever met in my business have owned real estate, alt and businesses. It’s the bulk of their assets by a large margin. In those cases, we will use stock and bonds appropriately to diversify alts. Unfortunately, I haven’t seen a bigger move towards alts. I feel like as we’ve seen the proliferation of ETFs and more strategies getting shoved into an ETF, it’s more use of that because of the liquidity. I love liquidity but my problem with that is once we get into a public market, we begin to lose the characteristics of the alt, low volatility, yield, etc.

Maybe some of the reasons wealthier folks understand this is maybe they have less of a liquidity need to start with. They have more income and cashflow sources. That might be a driver to it. Stocks and bonds are a great way for folks who aren’t uber-wealthy to get a return. Even in the alt space, there is a lot more options, smaller dollars than there used to be. Unfortunately, there hasn’t been as much of a move there and I wish there was, but we’re happy to lead that charge. Everybody come on over to our shop. We’ll help you.

What’s the best way for folks to get ahold of you if they have an interest in learning more about what you guys do? We didn’t get into it but a huge part of your business is helping with 1031 exchanges for clients that have real estate that they’re selling and want to go passive. What’s the best way for people to get in touch with you or learn more about the things you’re doing in Insight?

They can check out our website, which is InvestWithInsight.com. We’ve got all of our information there. We’ve got a whole page on 1031 exchange and passive real estate work that we do. We’re happy to chat with anybody. You can contact us right through there. One of our team members will get right back to you then we’ll start the conversation. We’d love to talk to you about real estate. That’s a whole fun side to our story. We haven’t even discussed it. I grew up in the motel business as a kid. That was an interesting experience.

That’d be a part two.

I’ll tell you about scraping gum off of concrete at the motels. That was my first job.

Mine was peeling onions in a Japanese restaurant. I got you beat, maybe.

When I left for college, I told my dad I was going to go to college, so I never had to work in a motel again. He looked at me and he goes, “My job is done.” All that horrible stuff he made me do, unclogging toilets at 3:00 in the morning for motel guests were on purpose.

Thank you so much for joining us on the show. This is always so insightful, pun intended with your shop. Reach out to Josh and his team if you have questions. You would love to get in touch with them. They’re awesome. We love working with you guys and your clients. Hopefully, you’ll be back for part two here.

Thanks for having me. I would love it. We do have offices around the country and work with clients all over the country. We’re happy to work with you wherever you are.

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About Josh Wright

ILB 12 | Alternative InvestmentsJosh has been advising clients for 15+ years. After starting his career with a large investment firm, he co-founded a financial services company in 2007, a registered investment advisor firm in 2021, and ultimately his own firm in 2017. Josh has a history rooted in real estate growing up in the hotel business and saw first-hand the importance of having diversification and tax advantaged strategies. Over time he’s developed an expertise in unique investment strategies, alternative investments, 1031 exchange, and passive real estate investments. Josh believes strongly that planning must come first, but that plan is only as good as the investment strategy driving it. His views on planning and investing are unique and offer clients a truly one-of-a-kind solution to meet their needs.

Josh has many passions almost equal to that of investing. He is a Board Member for the Kansas City Estate Planning Society and active with the Alzheimer’s Association. He’s a mentor to the College of Business at Kansas State University. He loves to read, and you’ll often find him to two or three books going at once. He has equal passions for health, fitness, and fast cars. He lives with his wife Nicole and his pug named Stella in Overland Park, KS.

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