Asset Profiles

Six Key Alternative Asset Classes:


Tax Liens

What:  Interest bearing instruments issued by local governments in order to fund shortfalls caused by delinquent property taxes.  They are generally considered to be very low in terms of risk (due primarily to superior lien position, and purchase values that are often low relative to the underlying property).  Generate an interest return in most cases; occasionally result in taking possession of the underlying property.  Returns from this asset class are not directly correlated to any exchange or even the real estate market itself.

Who:  A good diversifier for most any portfolio.  The combination of low risk and higher returns (usually 2-4x what mortgages are paying) makes a very compelling case.  The lack of correlation is also a strong positive.  Most investors do not have access to multiple asset classes with better performance characteristics, so tax liens are a solid choice in a wide range of circumstances.

Special Considerations:  Since liens do not trade on an exchange, they are more or less illiquid for the year or two (on average) that they are active.  Also, in practice tax liens end up being something of a hybrid between financial asset and operating asset.  It is usually necessary to purchase them where they are physically located.  This can introduce both logistical complications, as well as limited supply.  Then in the case of property forfeiture, it is necessary to recover the investment through the “collateral.”  For these reasons it is not unusual for investors to use the services of professional managers, or seek pooled opportunities (usually limited partnerships or trusts) to invest in the asset class indirectly.


Notes/Foreclosures (i.e. bank assets)

What:  For a variety of reasons (often related to regulatory or staffing concerns), banks sometimes find themselves in the position of wanting to sell assets to get them off their books.  These may be loans which are still active but approaching a potential default of delinquency, or collateral which has been foreclosed upon in settlement of a broken loan.  Either way, the bank’s motivation for divestiture usually goes beyond the merely financial; and it is not unusual for them to discount these assets as an aid to moving them quickly.

Who:  Assets of this type can vary widely from one to the next, given that there is such a broad range of loans that a bank could conceivably make.  In addition to choosing assets which are an appropriate size for a given portfolio from a diversification/concentration standpoint, the collateral involved is often the determining factor.  A loan collateralized by inventory or equipment might be favored by investors with existing operations, or at least experience, in a related field.  Whereas those collateralized by real estate may be favored by those with property experience, or those who have physical proximity to the property.  Given the range of possibilities in the specifics of the loan type and collateral, this asset class presents perhaps the widest variation in the types of investors that might be interested.

Special Considerations:  The purchase of bank assets typically comes about in such a way that whatever rights the bank had become the rights of the purchaser.  Ditto, the limitations.  It is therefore important to review the specific documents associated with the particular loan or seized collateral, and have an awareness of the rights and limitations available under the foreclosure laws of the state where the loan was made, and in the case of real estate, where the property is located.  Individual underwriting of each transaction is a must.  Even deals which look similar on the surface can have material differences down in the loan document’s fine print.  A knowledgeable lawyer is a big help (some would say a must).  Investors who do not have direct experience with rehab, management and liquidation can usually hire those services out at cost-effective levels.


Life Settlement Contracts

What:  The sale of a life insurance policy by the person who took it out to an investor with the wherewithal to keep the policy in force and ultimately receive the death benefit as a return on the investment.  Typically arise in cases where a policy owner either a) needs/wants cash now for some purpose (often medical), or b) is facing the prospect of having to resume premium payments on a policy which was formerly believed to be paid-up, and doesn’t have the financial resources to do so.  If the payments aren’t made the policy lapses and they lose whatever they put in over the years.  Typically policies sell for more than the surrender value, so it represents a better liquidation option for the policy owner than cashing it in with the insurer.

Who:  For individuals with a net worth less than $5M, purchase of fractional interests is probably the better option.  Purchase of whole policies can run to several hundred thousand dollars or more, each.  So the price tag limits the whole-policy playing field to those with a substantial net worth and professional portfolios (like endowments, hedge funds, etc).  Fractional interests make it possible to construct a diversified portfolio via “pieces” of several policies, with a smaller overall investment.   For those with a net worth of $500K and up, these instruments are worth considering.

Special Considerations:  Under any circumstances, life settlements should be viewed as a multi-year investment.  Fast liquidation of these assets is not always possible; and even when a resale is possible, they almost always take place at a discounted amount.  Even in cases where the hold period is not a problem, it is important to understand that pricing and yield projections are tied to the life expectancy of the insured person.  Life expectancy is re-projected at the time of sale by one or more independent actuaries, to account for the insured’s current medical condition.  That said, actuarial work ups are always just estimates.  To the extent that the insured lives longer, it will reduce the overall yield for the investment.  More importantly, it may necessitate the payment of policy premiums for longer than initially expected.  The only cashflow coming in to a life settlement investor is the death benefit; all other cash flows go in the opposite direction.  These factors make it doubly important that investors not over-weight this particular asset class, so that additional funds can be brought in later if necessary.  They also enforce the general need to diversify, this time in the form of multiple policies, ideally with differing expected maturity dates.  This approach can set the stage for shorter-term paper paying out before cash is needed for any longer-term policies, or those that go past expectation.  It also creates a mechanism for reinvesting proceeds from earlier maturities, and keeping the capital more consistently deployed.


Fixed Indexed Annuities

What:  Contracts issued by insurance companies that are intended to solve the age-old problem that investors classically have to face: that of giving up prospects for meaningful returns when there is a need to keep the principal safe.  The indexing concept basically ties the payment of contract interest to an external metric, such as the performance of the stock market.  The general proposition is that when the market rises, the account value does too.  But when the market falls or is flat, there is no adjustment made to the account (essentially, the contract just fails to earn any interest for that year).  Mechanically this provides for one-way movement (up, but not down); and in so doing lets contract holders essentially “sit out” negative years.  For most multi-year periods over the past 15-20 years, an indexing approach would have beaten the results achieved by traditional buy-and-hold stock portfolios, and do so with a demonstrably lower level of risk (since insurance companies have the legal wherewithal to guarantee against declines, whereas securities dealers and mutual fund companies do not).

Who:  There is no explicit limitation for any type of investor, though in practice these are more often seen as retirement planning tools.  These contracts are in some ways treated similarly to IRAs (though there is no limit on contributions) and as such carry the pre 59½ penalty common to qualified retirement plans.  Typically the purchaser of such a contract is 55 or older.  Good candidates are those who have saved enough money for retirement and need to get it out of harm’s way (in the form of market declines) but can’t (or don’t want to) accept rates that are typically paid for other “safe money” alternatives, like CDs and Treasury Bonds.

Special Considerations:  These are long term contracts and should not be entered into by people who need all of their money back quickly.  Not only is there the tax consideration for those younger than 59½, the issuing company can constrain access to the money via contractual means.  It is not unusual for these limitations to last for 5 years or more.  There are usually provisions for partial withdrawals, and in emergencies it is possible to have the entire contract liquidated.  So the money is not impossible to reach, per se; but liquidations and withdrawals that are outside the terms of the contract typically comes at the price of various fees and charges.  As for the indexing process, there are numerous formulas which represent variations on the general theme; a contract purchaser should be familiar with the set of terms/features being used by the issuer of the specific contract being considered.


Tax-advantaged Life Insurance

What:  Life insurance is typically thought of in terms of the basic need to provide family members with money should a wage-earner die prematurely.  But life insurance has some less commonly known legal and taxation features which make it an attractive chassis for a whole host of other applications which end up having little to do with the creation of a basic death benefit.  On the tax front especially, properly structured life insurance can be used as a place to accumulate earnings in an environment where taxes are not currently due.  Life insurance also has mechanisms for borrowing against the policy’s values (in essence you use a portion of the death benefit while you are alive) to create income which may also not be taxable.  Having this set of possibilities can provide for a lot of flexibility when people reach retirement and begin the process of determining which of their various “buckets” of money (e.g. brokerage accounts, IRAs, cash in the bank, etc) they are going to tap, and when.  Ability to control the amount of taxable income, even for just a few years, can lower the rate of taxation on Social Security distributions, make certain deductions which would otherwise phase-out still available, and impact the ability to execute certain Roth IRA transactions.

Who:  The wide range of applications makes this option a potential fit for a wide range of people; just keep in mind that such breadth of applicability increases the importance of custom tailoring to the specific situation.  An older person who wants to pass money they know they will never need to heirs should have a structure that reflects that goal; whereas a high-earner in their 50s who is trying to set the stage for tax-free income in retirement should go another route.  The key is configuring the structure based on a clear understanding of the goal(s).

Special Considerations:  Insurance costs money, so it is important to remember that any potential tax savings come at a cost.  Hopefully the cost of insurance is well less than the offset tax burden, making the act a logical one to take.  But the benefits do not come for free.  Also, in some instances the health of the person taking out the policy will be a limiting factor; though this is not always the case when the insurer knows that basic death coverage is not the primary goal.


Gold Bullion

What:  Gold is viewed by many as a measuring stick for wealth.  Gold’s value derives from its scarcity, and the fact that there is only a relatively small amount added to the world’s supply each year creates a sort of stability that is hard to find elsewhere.  Some people buy gold because they expect it to go up in value as overall economic growth takes place.  Others buy it because they believe it will hold its value in times of crisis, where assets from other classes may devalue significantly.  History has rewarded both of these points of view.

Who:  Depends upon whether or not the offense or defensive viewpoint is being taken.  Those buying for appreciation may benefit from tracking current pricing and having the ability to transact both buy and sell transactions quickly.  Defensive purchasers tend to buy-and-forget, or allocate a budgeted amount each month or quarter to incrementally increase their gold holdings over time.  For those with foreign currency exposure, perhaps due to the ownership of a business that operates in multiple countries, gold is sometimes viewed as a de facto currency to hedge fluctuation risks associated with the actual currencies in which they are doing business.

Special Considerations:  Those who champion the purchase of gold for defensive purposes recommend physical gold over gold funds or receipts.  They posit that in an economic crisis delivery may be delayed, and in extreme cases may never materialize at all.  Conversely, if you have the gold, then you have the gold.  Storage is of course a concern anytime a physical asset is involved.  The good news with gold is that it is a highly concentrated form of value: $20,000 worth of gold takes up about the same space as a roll of quarters.


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