Alternative Assets, US Mega Caps, Financial Success in 2022
Executive Summary
Alternative Assets
– What are they? Alternative assets tend to be a “catch-all” category that includes things like Real Assets (Commodities and Private Real Estate), as well as things like private equity, private debt, hedge funds and liquid alternatives. Sam gives us a good break down of all these investments.
– Why are they important? Alternative assets can act as an inflation hedge and allows you to follow the old rule of “If the price of things is going up, invest in things”. Most Alternative assets have something tangible behind them that can do well when inflation heats up.
They also can give you an Uncorrelated return, which means that when other parts of the portfolio are doing poorly, this asset can help balance it out. Traditionally this was the job of fixed income in an investment portfolio. However, we have seen that stocks and bonds have started to move in the same direction which leaves investors looking for a new type of investment to add to their portfolios. The old 60% stock/ 40% bond portfolio just does not work in today’s world.
We saw an environment where rates were low last year and inflation was high, which set up Alternative Assets for a big year. It looks like 2022 might be setting up for a similar type of year. We see supply/demand imbalances are likely to stick around which should keep inflation higher than historical norms, along with historically low rates (even with the planned hikes from the fed). This all could provide some headwinds for Alternative Assets. Sam breaks this all down and gives some interesting insights into the commodities and private equity market.
US Mega Caps
– What is the impact of having such large companies?
Today, there are 10 companies in the S&P 500 that make up 30.5% of the index. That is nearly double what it was in 2016. Apple for example is now bigger than the entire FTSE 100. The effect this has on the market is dramatic. The period following the March 2020 market crash is a perfect example. The market bottomed out and within a month or so we had a full recovery, and the market was continuing to move up. On the surface it looked like all stocks were doing well and everything had rebounded, but when we looked behind the curtain there were about 5 large stocks that were doing really well and dragging the market along with them. Since the index is weighted, the rise (or fall as we are seeing early in 2022) of the market can be dictated by just a few companies.
Setting yourself up for financial success in 2022
Tyler shared some quick tips on how to set up 2022 for success.
Build a budget – Tyler dives into the importance of starting with the basics. While building a budget isn’t going to be the most exciting thing you do in 2022, it can be the most important “small step” to help you reach your financial goals. He discusses why these little baby steps can have a dramatic impact on your behavior and be the building blocks to a better you. Tyler also stresses the importance of not making the budget a “set it and forget it” process, as he believes the most valuable part of making a budget is comparing it to your real-world spending.
Checking Beneficiaries – If you did not update your beneficiaries last year, make sure to look at them to start 2022. These act as will substitutes and will allow the assets to skip probate and go directly to the names listed on the account. Your heirs will thank you!
Automated Savings – One of the reasons that workplace retirement plans have been so successful is because the contribution to them is done automatically. You can set this up for yourself and have the money set aside for savings. By doing this, it removes the temptation to spend the money before it can ever get to that account. You don’t miss what you don’t see!
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Full Transcript
Tyler Hafford:
Financial discretion advised. I have a guest host on today with us, Sam Chaplin. It’s not the first time he’s made it on the podcast. Hey Sam, glad to have you.
Sam Chaplin:
Yeah, thanks for having me.
Tyler Hafford:
Going to tackle some topics that I think are going to be important for 2022. Alternative assets, I brought this up in other podcasts, but really what are they and how can they benefit us in our portfolios? I want to have a conversation with Sam about just US Mega Caps. We’re hitting something unique in the market we’ve never seen. And some companies that are larger than entire stock markets of entire countries, and just what impact that can have for our investments. And then some financial planning strategies at the end. But Sam, before we kind of get started, you’re the portfolio manager for Penobscot Financial Advisors, you live in the investment world day-to-day. I don’t think we’ve ever asked you, how’d you get to this point? What’s your background?
Sam Chaplin:
Sure. I took a big jump. I was a Sugarloaf Snowmaker there for a while, so that’s where it all began. And then I decided I wanted to get into banking somehow, I’m not sure that happened. But I was a teller at a bank for a while, then came over here, just down the street, did some Hedge Fund work, mostly on the accounting administrative side, down the road. And then I was lucky enough to get in over here, Penobscot, originally to help out on the administrative side, kind of get performance recording up to speed, stuff like that. Have since hired some help in that area, moving towards the management side. That is about the short of it.
Tyler Hafford:
Awesome. Yeah, we love having Sam on board mostly because he can tackle things that are much more complex than I can. So we have no problem putting the weight on his shoulders. But today Sam, I want to talk to you about alternative assets. For folks that are out there, they’ve been investing their entire life, it’s stocks and bonds, how do we balance that? How much do we put in stocks? How much we put in bonds? But that’s not all there is to be investing in these days, right? There’s this whole new sleeve. So, I was wondering if you could kind of let us know what are alternative assets?
Sam Chaplin:
Sure. Yeah. Great question. Definitely something that’s getting a lot of buzz lately and we’ll talk about why that is in a few moments. But I think what can get confusing about alternative assets is people just understand stocks and bonds, alternative assets kind of sounds just like one more version of that, but it’s kind of a catchall category for anything that’s not a publicly traded stock or bond. Some examples would be real asset investments, like commodities and real estate. When you’re thinking about commodities, generally comes down to energy investments and things like oil and natural gas, agricultural investments, corn, wheat, coffee, type of stuff. And then also precious metals as well, gold, silver and such. Go ahead.
Tyler Hafford:
Just kind of these real assets, right? They’re tangible. There’s something out there behind it.
Sam Chaplin:
Exactly. Yeah, just an evaluation on a company kind of thing.
Sam Chaplin:
Yep. And I would put private real estate in the example of real assets as well. I think the difference could distinguish there is that when you’re investing in public real estate, it’d be like investing in a company and you’re buying equity of that company that does real estate as their operations with private real estate. You’re investing in a fund that is directly building offices, residential places, stuff like that. So little bit of a different scheme there, seems a kind of real aspect categories. Yeah.
Tyler Hafford:
Yeah. Interesting. So, I mean, sometimes that can be looked at almost as an equity, right? If you’re purchasing a company that’s handling those things rather than the actual asset, or someone who owns the asset.
Sam Chaplin:
Yeah. Generally, if you’re buying like a real estate ETF or something like that, you’re actually just investing in companies that do real estate, not investing directly in real estate itself. Those act kind of differently. What else? Private equity and private debt. So investing in companies before they go public and get listed on exchanges is something that’s becoming more popular, more accessible. Talk about that as well. And then finally, Hedge Funds and liquid alternative funds. People probably have heard of what more aggressive trading, active management schemes. Liquid alternatives can have to deal with market neutral stress like arbitration and that type of stuff, which gets a little complicated, but is a way to invest in not necessarily going in the same direction as the market all the time.
Tyler Hafford:
Yeah. So it really is that kind of catchall. It’s not just gold and silver. It’s not just buying a REIT. There is a broad swath of things that you can be investing in here. Why is that important? Why do we need to start to work this into the portfolios?
Sam Chaplin:
Yeah. So to distinguish a little bit between different categories and I guess not treat them as monolith. I think, especially on the real asset side, things like commodities and private real estate is a really good inflation hedge going on there. I think the best way I’ve heard it said is, the price of things is going up, invest in things, and commodities, and real estate are things. If price of corn is going up at the store, then you can actually invest in corn and make money on the price of corn going up. So, that’s one point there. I think that’s a big point for those real assets, but in general, for alternative assets, I think what people are doing is they’re searching for uncorrelated return. In the past you could rely on fixed income, providing a little cushion in your portfolio.
Sam Chaplin:
If equities are going down, money would flow out of equities, those prices would go down. Money would flow into fixed income, those prices would go up. So, that’s how you achieve diversification there. However, where interest rates are so low right now, that’s not really the dynamic we’re seeing in the market. If first off the interest rates are low and inflation is high, you might be making 3%, would be a good return on a fixed income product right now. However, when inflation’s at 6%, your purchasing power just lost 3% of its money. So it’s not necessarily a good alternative to equities. You hear people talking about there is no alternative to equities right now, but these alternative assets are actually exactly what they say.
Tyler Hafford:
Yeah, they’re doing well.
Sam Chaplin:
Yeah. So there’s some strong diversification benefits there as a bit of a fixed income replacement generally and increasing that diversification.
Tyler Hafford:
So if these things tend to thrive or bonds tend to do poorly in environments where your interest rates are low inflation is high, these can kind of do well in high inflationary times. Sounds like 2021 to me. Obviously they probably had a big year. I know when I’m reviewing with clients, I’m looking kind of at asset classes, there’s a theme that sticks out. Your stocks probably did all right, pretty well. Bonds did pretty poorly. And then your alternative assets sleeve actually did quite well, sometimes outpace equities over the last year. Seems like we’re stepping into 2022 and we could be setting up for something similar. Do you think this is kind of the year where it looks a lot like 2021, where these asset classes or the alternative assets have room to kind of be important in your portfolio?
Sam Chaplin:
Yeah, absolutely. I think these alternative assets have historically been under owned, because people are really relying on that 60/40, it’s kind of been the traditional thing to do for quite some time. People might be rethinking that now and thinking maybe we do 60% equity, 30% fixed income and 10% alternatives or something like that. So there’s a bunch of flows coming into this area. They are becoming more accessible as well. We call it the democratization of alternative assets, where for a long time things like private real estate, private equity, private debt, were really only for super wealthy investors who could afford large purchase minimums and often used to have to be a qualified investor as well, which has certain qualifications as far as having a certain net worth and income and whatnot. And a lot of those things have been done away with, so it’s becoming a lot more accessible for individual investors.
Sam Chaplin:
And then there’s a lot of supply and demand imbalances, kind of ties into the inflation aspect we were just talking about, where these supply and demand imbalances kind of started from the stop start nature of the pandemic, but are likely to persist and have some longer term trends there. On the real estate side, I published a chart recently on our LinkedIn that talked about the lack of new real estate in the country, in the US, since the financial crisis and how we now have the older generations living to be older, and then the younger generations coming in and now we’re all bidding against each other on pretty much the same supply of houses. So on the real estate side, see a lot of room for that to continue. Commodities as well, have really been on a great run.
Sam Chaplin:
Recently, a lot of that, again has to do with the start stop nature and the fact that ramping up new bond production is a long process. We’re really short on green metals, they call them types of metals, and natural resources we need to make the energy transition from traditional energy to clean energy, getting those out of the ground, if you want to start a new copper mine, copper something we’re going to need a ton of. It takes five years, like at a minimum to get a mine approved, get it built and start producing. So there’s going to be some interesting dynamics going on in there. And the paradox there too, is that a lot of the reasons it takes so long is because the environmental regulations that go along with tearing up the ground and is a pretty environmentally terrible process to do. However, in the long run should benefit us. People in Maine probably heard about recently that main lithium deposit of $1.5 billion that is unlikely to ever get mine, because of those environmental regulations, and that’s kind of emblematic of a larger problem. So as the energy transition continues, there’s a reason that the supply and demand imbalances will continue. And also just as people pick up more allocation into commodities as part of their portfolio, will benefit the crisis as well. .
Tyler Hafford:
Yeah. And you kind of alluded to something along the way as well. You mentioned correlation. For folks out there, correlation essentially is how a new position will react to other positions you have in your portfolio, right? So if you have a portfolio that is a lot of stock and you added bonds, traditionally that would’ve given you some protection, if stocks fell, you would have shock absorbing through the bonds that you had in your portfolio. Hasn’t really been the case lately, right? These things tend to move together. What we saw in the crash of 2020 in March, bonds and stocks fell, the fed stepped in, gave us this really easy money environment where rates were really low, which doesn’t help your bonds, and stocks came back, bonds really done poorly, have really given you no shock absorber, unless the market really kind of tanks again. Adding something different into the portfolio can have profound effects on it for diversification, to help lower your risk, but also give you some new avenues for some growth opportunities when the economic environment kind of flips, like we’ve seen throughout the pandemic. So, awesome, interesting stuff. Before I kind of throw us into our next conversation, anything else on alternative assets?
Sam Chaplin:
No, I think you just put it really well. I think it’s the old analogy of you can reduce risk by not having all your eggs in one basket, but the equity basket and the fixed income basket recently have started to look very similar. So people are looking for this third basket of money to allocate to. Another area that I didn’t mention yet is the private equity area, which I think is really exciting too, because there’s been a trend going on where companies are staying private for longer before they go public. They can keep more control over the company that way. Once you go public you’re behold to all the shareholders and stuff. So a lot of that hyper growth that happens really early on in companies is now being captured completely before the company even makes it to the public markets, which is interesting. And like I said before, individual investors, it wasn’t easy for them to access those investments for quite some time, but it is becoming more accessible lately. And I think that’s going to be a big boom for the private equity markets.
Tyler Hafford:
Yeah, that’s fantastic. We’ve done other podcasts on just Robin Hood and just this age of allowing your average investor to have just a wide array of options for investments and getting into it. And they’ve cutting commissions on ETFs and stock purchases and those types of things, we are living in this age. Just a reminder to anyone listening to this, with all of this access, comes a responsibility to learn about what these options are and how it can benefit you. So, I agree with Sam, having opportunities to get into private equity is fantastic. Just know what you’re doing and do the research or be talking to someone who has done the research, mostly why I talk to Sam. So, all right, I want to dive into something that I find fascinating and that is the emergence, and I call it emergence, it’s been happening. But this idea that there are companies in this country that are so big, that entire country’s stock markets aren’t worth as much as they are. That is one, mind blowing to me, but two, must have effects on the market as a whole, on portfolios as how we invest, and really kind of the future of the US stock market. Want to get your ideas and thoughts on what kind of impact is this having for us?
Sam Chaplin:
Yeah, large impact. It’s interesting you know? Stocks used to be broken up into small caps, mid caps and large caps. So we had to create this whole new category of Mega Caps to explain this phenomenon of new companies that are so huge. You look at apple, took them 42 years to reach $1 trillion. They became the first $1 trillion company in 2018, I believe. And then they hit 2 trillion 2 years later, which is just an unreal amount of growth. And the result of that is it kind of skews the market to be a little top heavy, not a little top heavy, a lot of top heavy actually.
Tyler Hafford:
Yeah.
Sam Chaplin:
Something like the S&P 500. 2016, the top 10 constituents would make up about 15, 16% of the index, and now that’s over 30% of the index. So you might think when you’re buying S&P 500, you’re putting an equal amount of money into 500 different companies. However, really almost a 30 year money is going into 10 companies. And that makes it so the performance of those 10 companies really drags up or down the index. Recently it’s been definitely in the upward direction, but that can move against us, as we’ve seen over the last couple weeks.
Tyler Hafford:
Yeah. It was kind of the story coming out of the pandemic. March 2020 hits, market crashes, like a month, two months later, everything looks rosy again, we’re back up to our levels pre-pandemic or before the crash, and everything kind of looks rosy. But when you start to peel that back, wasn’t necessarily the case. S&P may have been hitting all these high numbers, but essentially there was four or five companies putting the rest of the market on its back and just trudging through, right?
Sam Chaplin:
Exactly. Yeah. I can’t remember the exact stat, but I heard recently the number of S&P 500 companies who haven’t beat treasury bills in returns over the last few years, and it’s a large amount. And when people look at the market again, it’s kind of a monolith when it really shouldn’t be. You look at the S&P valuations right now and they’re looking historical really high, but if you pull out the valuations, those top 10 companies, there seems to be still a lot of good value opportunity. And I think that makes a good case for active management over passive management right now to kind of make sure you’re picking those companies that are not at record valuations.
Tyler Hafford:
Yeah. I also think what’s interesting, because I have a lot of conversations with my clients that like to tie the health of the economy to how the market’s doing. Coming out of the pandemic was a lot of, well, geez, look how good things are, the stock markets kind of hitting all time highs and doing all those things. Well, yeah, there are some companies that did very well through the pandemic and continue to do well, a lot of that’s tech, mostly high growth companies, because it’s how we had to interact with the world throughout all this, so they obviously did pretty well. But it doesn’t tell the whole story of how the majority of the companies in this country are doing. So I think it’s important to find the distinction that the market isn’t really the barometer that tells us how the economy is doing.
Tyler Hafford:
So just to be careful of that folks. Sometimes five companies can be doing all the work, while the rest is kind of lagging, and to your point. So, what does this mean going forward? So when we’re building our portfolios, do you want to make sure you’re owning these types of companies? Do you want to be making sure you’re owning indexes that are having some exposure to these types of companies? If they can move the market, I feel like we want to be on board, but like you said, starting out this year, those companies are the ones taking the step backwards, and kind of pulling everything else with it.
Sam Chaplin:
Yeah. It’s tough to say. I mean, depends what your investment goals are. If you want to beat the S&P 500, you got to own some of these companies, which is kind of one of the dynamics that causes people to keep buying them, pushing the prices up higher, along with a lot of other factors. But I think, my opinion going forward this year is that we need to be a little more selective, just buying those 10 largest companies is more problematic, as far as valuations go, and the outlook on what interest rates going up tends to impact these large growth companies more than it does, something like the financials or energy on the value side.
Tyler Hafford:
Yeah. And we’ve been discussing this a little bit before the podcast, but some of this was, a lot of these companies need to be borrowing money to grow at the rates that they are, right? So any type of interest rate hike tends to impact them more than a valued company, a company that’s kind of more stable on the books. But I think you hit the right point there, there is no perfect answer for if you should be buying these or not. It comes down to what your risk tolerance is, what your goals are, what your portfolio is. So don’t get lost in that conversation of, well, you got to buy all these big cap companies. They can have a really good place for you, but you can live and die by them as well, right? They can kind of move everything for you.
Sam Chaplin:
Absolutely.
Tyler Hafford:
Interesting stuff. Going to move on to the financial planning piece of this Sam. But was there anything else on US Mega Caps or that phenomenon you think is important for folks?
Sam Chaplin:
No. I think that all wraps it up for me.
Tyler Hafford:
Yeah. All right. So 2022, we want to set up your financial success. A lot of this is on the financial planning side of the house. Just some things I think are really important to be doing to set yourself up for success this year. First thing, if you have never done this, sit down and make a budget. One of the most important financial planning aspects I think you can do, and one of the ones that people kind of shy away from, mostly because it’s not a fun thing to do. Sam loves using spreadsheets, not everyone loves using spreadsheets, so they kind to get lost in his. But knowing where your money is going can have such a profound impact on making adjustments, right?
Tyler Hafford:
So if you’re looking at it and you’re buying a latte every day and you’re just not thinking about, well, geez, well it’s only six bucks. That adds up, that can make a huge difference at the end of the day for you. So knowing where your money goes, I think is one of the most important things you can be doing right now. Additionally, going back and doing some of the things that maybe you didn’t do at the end of the year last year. So checking your beneficiaries on any retirement accounts. So if you have an account, the person listed there acts as a will substitute. So if you were to pass away, that will skip probate and directly go to the person listed there. So extremely important, make sure that’s happening. That can be on life insurance, retirement accounts, any insurance products. If you have banking accounts that aren’t retirement, you can have what’s called a transfer on death account, and that will act in the same way. You can add a name there, skip probates, send it straight to that person. So if you haven’t done that, certainly something to just check back in, make sure everyone’s alive, that you have listed there, or you still want the money to go to the person listed. So I think that’s important.
Tyler Hafford:
Additionally, if you didn’t make your contributions to your traditional or Roth IRA, you have up until the tax filing deadline to get those in for 2021. So go back, see if you made your contributions. Reminder, if you’re under 50, you can do $6,000. If you’re over 50, you can do $7,000, into those types of accounts. Just take a peek and make sure that you max it out if you want to. You have a little bit of time here before you file your taxes, where you can get those in. So I think that’s important. And then just kind of setting yourself up for success, moving throughout the year. And a lot of that is done through automation. If you want to have a savings goal, every paycheck have X amount coming out and going into your savings, or if you’re trying to hit that maximum contribution in your Roth IRA, automating that from your savings account or checking account into your investment account can make all the difference, right?
Tyler Hafford:
I am a big believer that most of the success of the 401k is because folks didn’t have to make the decision of putting money into it, it just came out of their paycheck, and the old line, you don’t miss what you don’t see. And it just keeps pumping money in the 401k. And now we’re getting to an age where there’s more 401k millionaires than there ever has been. And I have to think that a lot of that was automation. So automate your success for yourself, set your goals, set up that automation, and let it all do it for you. Those are just some thoughts for strategies going into 2022.
Tyler Hafford:
Sam, I want to thank you for coming on. Thanks for all the insight on alternative assets. I’m going to do a shameless plug for Sam. Sam puts up charts on LinkedIn and Facebook on our company page, check those out. They’re awesome. He loves to find something that’s unique that’s going on the market. Last one I was just talking about was housing stuff, but there’s valuations on the S&P, there’s inflation, there’s all these things. Make sure you check that out. I think it’s great. Make sure you subscribe, like and all that. But Sam, thanks for being on.
Sam Chaplin:
Yeah, it’s fun to be here. Appreciate it.
Tyler Hafford:
Awesome. Thanks man.
DISCLAIMER: The foregoing content reflects the opinions of Penobscot Financial Advisors and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security.
