Alternative Investments as a Hedge in Volatile Markets

 

Volatile markets create opportunities in several ways. Traders use spreads to accumulate new positions and sell off other positions. The price dips enable investors to dollar cost average into equities or fixed income investments with otherwise sound fundamentals. However, the perspective gained from market volatility may provide the greatest returns of all.

The financial crisis of 2007-2008 serves as a stark reminder that understanding the sources of risk is crucial to managing volatility. Drops in portfolio value and income from nearly a decade ago continue to shed light on the value of alternative investments in managing volatility. Much of this perception surrounds identifying and hedging risks to minimizing losses. However, alternatives to traditional choices can also boost returns and be a fixture in portfolios for all seasons.

From commodities to high yield funds and trust deed investments; hedging against volatility starts by understanding the sources of risk.

These include:

  • Market Risk
  • Interest Rate Risk
  • Prepayment Risk
  • Reinvestment Risk

Market Risk

Disappointing earnings. Sector weakness. Rampant speculation. Each of these can drop net asset values (NAVs), whereas the opposite will boost NAVs. Some of the culling with volatility is healthy. Debt issuers or equities with poor balance sheets or fundamentals are exposed.

Unfortunately, many investors react by selling off an entire asset class in down markets or over-weighting their portfolios in bullish periods. The net result is volatility often causes short term responses that do not match long term goals. High yield mutual funds or a REIT may deserve places in portfolios but irrational fear may cause these holdings to be sold off altogether.

Thankfully, there are investment alternatives that provide a hedge against both market risk and fear- based selling.

Pooled mortgage funds and individual trust deeds are examples of high yield investments with stable NAVs through various market conditions. Why? This REIT alternative is not publicly traded and the underlying investments are held to maturity, which is typically 3 years or under.

Additionally, attractive yields are paid monthly to facilitate generate cash flow and bargain shopping during volatile markets.

Interest Rate Risk

Attractive bond coupons are a snapshot in time. New debt is issued based on prevailing interest rates. Rates on the rise? Mortgage backed securities and real estate investment trusts face capital flight as investors redeem shares to purchase new issues with fatter yields.

Prepayment and Reinvestment Risk

Declining rates? Prepayment risk arises as issuers retire debt and issue new bonds at a lower coupon. Reinvestment risk ensues as investors seek comparable yield-risk profiles.

In short, both fixed income issuers and investors face challenges to adapting with interest rate changes they have no control over.

High yield mutual funds and REITs have limited flexibility to adapt with rate shocks. Shareholders will redeem shares or stop investing as more attractive yields become available, which limits liquidity for strategy shifts.

Of course, a short-term MBS or Equity REIT may still warrant a place in portfolios. The negative correlation to equity indices make these attractive choices for those seeking diversification. Despite yield volatility, these securities provide cash flow that supports budgets.

Deeds of trust are structured to further reduce interest rate risk and increase cash flow. Because certain real estate investors do not want to be locked into longer term bank loans, there is often high demand and limited supply of these short term real estate loans. The result is attractive coupons secured by real property at a loan-to-value (LTV) that is 65% or less in many cases. This can be thought of as a 35% protective equity cushion in case repayment is not made over the short maturity of these loans; typically, 3 years or less.

Flexibility is another feature of trust deed investments to create a hedge against rate changes. For example, the manager of a pooled mortgage fund investing in short term mortgages and deeds of trust may make new loans at current rates to offer high spreads versus risk-free treasuries.

Contact Wilshire Finance Partners at (866) 575-5070 to learn more about alternative investments as hedge against volatile markets.
 

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* ADDITIONAL DISCLOSURES:

The information contained on this Website (the “Overview”) is not an offer to sell or the solicitation of an offer to purchase trust deed or mortgage investments, or the securities of the WFP Income Fund, the WFP Opportunity Fund or other securities or investments (individually and collectively, the “Investments”) offered through Wilshire Finance Partners, Inc. (“Wilshire”). The purpose of this Overview is to provide an overview of one or more Investments and its private placement. Persons interested in learning about one or more Investments and their private placement will be provided with the Private Placement Memorandum, Operating Agreement (as applicable), Subscription Agreement and other related documents (collectively and inclusive of exhibits and any supplements thereto, the “Memorandum”) prepared by Wilshire, which provides a description of the particular Investments, the terms of the private placement, a discussion of risk factors, and other information related to such Investments. To the extent that there is any inconsistency between the information provided in this Overview and the Memorandum, the Memorandum shall control. This Overview and the Memorandum contain certain forward-looking statements regarding the Investments. The forward-looking statements are based on current expectations that involve numerous risks and uncertainties which are difficult or impossible to predict accurately and many of which are beyond the control of Wilshire’s management, including, but not limited to, national and international economic conditions, changes in legislation, and other factors that can disrupt economic stability. Although Wilshire believes that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the forward-looking statements will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements, the inclusion of such information should not be regarded as a representation by Wilshire, any placement agent, or any other person, that the respective objectives and strategies of investing in one or more Investments will be achieved. Investments be made solely by accredited investors (which for natural persons, are investors who meet certain minimum annual income or net worth threshold), who are provided with the Memorandum and who complete, execute and deliver the subscription documents included therein. The Investments are securities and each of the Investments are being offered in reliance on an exemption from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), provided by Regulation D, Rule 506(c), and are not required to comply with specific disclosure requirements that apply to securities registered under the Securities Act. Neither the Securities Exchange Commission nor any state securities regulator or agency has passed upon the merits of or given its approval to the securities, the terms of either offering, or the accuracy or completeness of any offering materials. As securities offered in an exempt transaction, each of the Investments are subject to legal restrictions on transfer and resale and investors should not assume they will be able to resell the Investments. Past performance is not indicative of future results. The Investments involve substantial risk, including loss of investment, and is not suitable for all investors. Loans are made by Wilshire Finance Partners, Inc., Bureau of Real Estate Broker’s License number 01523207. Loans made by Wilshire Finance Partners, Inc. outside California will be made pursuant to licenses, authorizations or exemptions in each other state.

 

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