This article is authored by MOI Global instructor Keith Smith, Fund Manager of Bonhoeffer Fund, based in New York.
One of the features of alternative assets is little or negative correlation with most investors’ growth engine — equities. One issue with many alternatives is little or no return.
One asset class that provides negative correlations to stocks are bonds. Bonds represent first-lien claims on corporate cash flows associated with corporate assets versus the more subordinated claims of equities. There are certain equity securities that have first-lien claims that provide similar cash flow characteristics as bonds but have upside from either increasing cash flows or distributions, modest levels of leverage, or higher yields than similarly positioned bonds.
Also, given the high valuation of many equity markets today, the appeal of securities that have bond-like cash flows and reasonable to low valuations (i.e., higher and growing yields) is appealing. Some of these firms provide the financing of assets to firms who can deploy their equity capital to better uses elsewhere in their operations.
Examples include triple-net (NNN) leasing of properties for distribution, restaurant, or retail firms and leasing of aircraft to airlines or ships to shipping firms.
Other firms provide specialty lending to highly cash-generative firms who have few bankable assets and are too small to access the syndicated loan or public bond markets. Finally, there are firms that lease equipment that is shared among many users.
Examples include car rental and equipment leasing firms. Although this type of leasing is not a predictable as long-term contracts, other forms of risk mitigation are available via geographic clumping, economies of scale, and the use of technology to efficiently share the assets. A common characteristic among winning firms across all three of the categories of firms is a robust underwriting approach.
In each of these categories there are inexpensive firms. The first example is in the NNN lease real estate space. STORE Capital (NYSE: STOR) provides NNN lease real estate to firms across a large geographic area across the United States and across many retail verticals. This diversity effectively provides the investor with a diversified group of secured bonds that have increasing coupons over time.
There is a privately funded but SEC-reporting competitor call Broadstone Net Lease that sells for less due to resale restrictions (5% discount for five years), has tax deferral of depreciation, and has a more diversified customer base across retail, medical office, and industrial properties.
In each of these cases, these firms provide first-lien financing to the business they finance by owning and leasing the mission-critical real estate that these firms use in operations. Since the value of the lease is typically greater than the underlying property value, the key to analyzing these investments is the credit analysis of the lessor.
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About The Author: Keith Smith
Keith Smith, the fund manager, brings over 20 years of valuation experience to the Bonhoeffer Fund. He is a CFA charterholder and received his MBA from UCLA. Keith currently serves as a Managing Director of a valuation firm and his expertise includes corporate transactions, distressed loans, derivatives, and intangible assets. Warren Buffett and Benjamin Graham’s value-oriented approach of pursuing the “fifty-cents on the dollar” opportunities, underpins Keith’s investment strategy. The combination of his experience and track record led Keith to commit most of his investable net worth to the Bonhoeffer Fund model.
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