The market has spoken. It is clear that interest in managed funds is disappearing. Actively managed funds have faced net outflows of $500B since 2015, a trend that is showing no signs of reversing. But where is the money going? It’s certainly not going into ETFs. Vanguard, the index ETF giant, has seen net client flows of $112B in the first half of 2018, down 48% year over year. The fact is, there has never been more opportunities for investors to earn a high yield on their investments. From real estate to startups to private debt, savvy investors are diversifying their exposure to maximize their portfolio.
Unlike the public markets however, the alternative investment opportunities mentioned above have little to no regulatory oversight. This means investors need to practice extra prudence when conducting due diligence on the investment offerings. At Cadence we are focused on only sourcing and providing opportunities that we would put our own money money into. In an effort to be as transparent as possible, below are our rationale and criteria for selecting our partner originators.
An Emphasis On High-Yield Assets
Like other savvy investors, we believe many alternative investments can provide better returns than the conventional savings accounts and CDs. Due to a pervasive low rate environment, yields in traditional bank products have struggled to even keep pace with inflation. This means you are actually losing value by placing cash into these accounts. Alternative assets, however, have emerged as reliable investments. Many have outperformed traditional bank products on an annual basis since the financial crisis.
However, rather than providing our investors with exposure to volatile assets (think venture equity or commodities), we focus on highly predictable cash-generating assets. For those with a greater appetite for risk, there may be a place in a portfolio for these direct equity investments, which carry greater upsides but more dangerous downsides. However, For those who want to take a more measured approach, our cash-generating assets are a far more prescriptive and reliable option. A core part of our criteria for selecting our originators is the specific type of alternative assets they’re able to source. Each and every one of the originators we select specializes in sourcing assets that generate recurring cash flow (yield) for our investors. It’s our way of giving you the flexibility you deserve to manage your finances on your terms.
Delivering Uncorrelated Alpha
The recent uncertainty in the public markets has emphasized the importance of uncorrelated alpha. Uncorrelated alpha is the ability of an investment strategy to beat the market with little or no correlation to the public market’s performance. It is the holy grail of investing, because its success is achieved independently of market sentiments. We have made it a key strategic objective to partner with originators whose assets’ performance is not dependent on public market behavior. So what do these assets look like? Here are three examples of assets that have the qualities we look for.
1. Purchase Order Financing
That gluten-free cookie brand you love receives purchase orders (POs) from major retailers such as Whole Foods or Costco. Through good times and bad, Whole Foods and Costco will continue to operate. This is because people prioritize buying food over all other goods and services (non-discretionary spending). However, the cookie company needs cash to manufacture and deliver their goods. Financing companies can then use the cookie company’s Costco purchase orders as collateral to receive financing. Ultimately, this process can lead to advantageous financing opportunities, often resulting in market-beating yields for investors. These attributes led us to partner with an originator who specializes in financing consumer packaged goods (CPG) brands.
2. Invoice Factoring
Small and medium sized enterprises (SMEs) are always trying to scale by securing large contracts from larger corporations. However, large corporations need to run through layers of bureaucratic approval to pay an invoice. This causes a delay in payment which can be devastating for SMEs that need immediate cash flow to survive (e.g. making payroll).
In a good economy, SMEs may be able to get by. However, in a downturn, any cash infusion becomes their lifeline. Due to the financing needs of small businesses, we have partnered with an originator who specializes in paying SMEs’ invoices in advance. The originator then collects payments from the large corporations at a later date. By doing this, our partner originator establishes another cash-generating asset that creates an opportunity to capture uncorrelated yield.
3. Litigation Financing
A relatively new, yet rapidly expanding opportunity exists in commercial litigation financing. Unlike common personal injury litigation financing, we believe commercial litigation financing is a far more predictable asset class. Nearly 90% of US companies are engaged in some form of litigation, at any given point in time, with multiple cases happening concurrently. These lawsuits occur regardless of what part of the economic cycle we are in, and their financing has consistently been a lucrative asset class for the few investors who were privy to gain exposure. A fragmented asset class in every sense, litigation financing has only a handful of players in the space. We have made sure to partner with originators who can make these rare investment opportunities available to you.
Providing Diversification Across Asset Classes
For the same reasons as why you should diversify your traditional portfolio, you should also avoid concentrating in just one type of alternative asset. Over the course of the next year, you will see us onboard originators who specialize in PO financing, invoice factoring, small business lending, litigation financing, and more.
Within each of these sub-asset classes, we will also provide exposure to various industries. For instance, invoice factoring is a fairly broad category with originators targeting many industries (healthcare, retail, technology, etc.). While the asset class as a whole is uncorrelated to the overall market, there is always a greater risk of volatility when you concentrate your positions, even if they’ve consistently performed in the past. Our goal is to provide you with as many options as possible. It’s prudent that investors not only invest across sub-asset classes, but across industries within the same asset class as well. This attention to diversification enables investors to effectively hedge against potential performance risks.
Creating Short Duration Opportunities For Inherent Liquidity
Liquidity from our perspective means having a choice. We seek to partner with originators that enable us to structure a short duration product with varying rates of return (3 months, 6 months, 9 months, etc.). Oftentimes these will be structured as bundles of assets that roll over in pre-set intervals to mirror the investment and maintain the flexibility you want. You will be able to choose the maturity that fits your needs without having to lock-up your hard-earned cash for years at a time. Cash is king when there’s market uncertainty and through our investments, you’ll be able to move in and out of positions with ease.
At Cadence, the four attributes mentioned above work together to create a powerful addition to any well diversified investment portfolio.
We Seek Originators Who:
- Place an Emphasis on Yielding Assets
- Deliver Uncorrelated Alpha
- Provide Diversification Across Asset Classes
- Create Short Duration Opportunities for Inherent Liquidity
The next few years will likely prove to be challenging for the overall global economy. We promise to do our part to help you generate reliable returns in these uncertain times.