As many of you know, we have tried utilizing numerous “alternative” funds over the years to attempt to diversify our stock market funds. We live in a world where bonds and bond funds have become ever more unreliable and vulnerable to low interest rates. With rates rising here in 2017, the situation has become all the more risky. In 2016 the aggregate bond index rose a very modest 2.4% but has LOST 2.2% just in the last 3 months (http://performance.morningstar.com/funds/etf/total-returns.action?t=AGG®ion=USA&culture=en_US.
If you are a retiree, the situation is just not good. Twenty or thirty years ago, the solution for generating income was simple: buy AAA bonds (or even CDs, 30 years ago) yielding 8% and enjoy reliable dividends and interest.
Unfortunately, alternative funds, bonds and CDs all have one sad thing in common today: they generate little or nothing in dividend or interest income. To make matters worse, some of the alternative funds have provided disappointing results and/or bad drawdowns, dashing hopes for some honest help with diversification. December 2016 was a great example of exactly that.
What Has Changed
Since the great recession in 2008, we have seen rapid (actually explosive, exponential) growth in what has come to be known as “peer to peer lending” investments. In simple English, peer to peer lending refers to people and small business (anything less than mega corporations) utilizing private sources instead of banks. Think of this as a product of technology, efficiency and competition. What was once an industry measured in the tens or hundreds of millions has grown into the trillions.
As a registered investment advisor, I have been involved in this new investment arena since the fall of 2013. During all this time, these investments were available only through private hedge funds requiring generally a half-million dollar or higher minimum commitment.
Finally, with the rapid rise in institutional participation, there are 2 mutual funds available, 1 of which is now approved and available to us. This fund, offered by the fund family Stone Ridge, opened in June 2016 and is today over $1.8 billion in size, an ASTOUNDING growth track. The fund will be available for clients of Kay Investments Inc as of February 1, 2017.
Like every other “peer to peer” investment that I have seen and studied, it has created steady dividend income and maintained steady principal, exactly as designed. Of course, on paper we must recognize that no fund could be considered immune to principal loss. Nevertheless, my three years of experience leave me more than impressed with how well designed these portfolios are toward stability of principal and steady outcomes.
How is a Peer to Peer Mutual Fund Different?
Most mutual funds can be bought one day and sold the next. The peer to peer funds belong to a special class, however, that restrict cash outs to quarterly. In other words, if/when you decide you wish to sell, you declare your desire to cash out units at the end of the next quarter. Further, funds will often state they may limit total cash outs any given quarter to 5% of their entire fund (example $90 million for Stone Ridge). In practice, I have not found this to be a problem, given that there is so much new money coming in, loans are always maturing and many investors seek to compound their dividends instead of receiving cash. It is often said that the high fund dividend rates are an “illiquidity premium”.
All in all, the peer to peer funds are an exciting alternative to bond funds and other dividend and income sources that may be very vulnerable to rising interest rates or bear markets.
What Are We Planning to Do?
My plan is to integrate the Stone Ridge portfolio into our fund models, reducing our use of alternative and bond funds. We would combine stock funds and steady interest yielding funds going forward – a true diversification. The goal is that we rise and fall as the markets rise and fall but we cushion the downside. As to stock funds, we worry about the next big bear market, but as of now there is no indication (yet) that 2017 is going to turn into 2008.
A Fact Sheet Published by Stone Ridge
Click here to review a client approved fact sheet published by Stone Ridge: fact_sheet