Reviewing an alternative investments opportunity often requires a more specialized approach than vetting their traditional counterparts. Generally speaking, alternatives don’t behave quite the same way stocks, bonds, or cash do. And each different alternative investment requires different types of due diligence by a prospective investor.
Fortunately, asking a few strategic questions when you’re personally vetting an investment opportunity can take you a long way through the evaluation process. Below are six important questions, among others, which an investor should consider asking when evaluating an offering on our platform, or any alternative investment.
Put simply, assets are property a company owns or controls that can be expected to drive future value. For example, an art gallery may own blue chip art and, of course, a grocery store has its brick-and-mortar building and inventory. Often, investments derive their value from their claims on the underlying assets and the cash flows those assets generate.
When it comes to evaluating an investment, understanding the underlying assets helps address several considerations: what types of risks and returns an investor could expect, and whether the investment can provide diversification within an investor’s portfolio.
A business’ underlying assets can also hint at its risks and opportunities. Assets that create or hold value in many different scenarios may carry less risk than assets whose value may fluctuate or deteriorate in certain scenarios. Investors should also consider how underlying assets may or may not contribute to the diversification of their portfolios. For instance, adding an investment in art to a portfolio that already holds a lot of art investments won’t add the same diversification benefit as an investment that’s exposed to other markets, such as real estate.
Another consideration related to the underlying assets is when an investor is evaluating opportunities in the debt or lending space. For example, some private debt investments are secured by collateral. Collateral may help reduce the risk a lender has by giving the lender a claim on the assets if, for example, a borrower has trouble meeting the terms of their borrowing. (There are many types of collateral—we’ve broken down the different types of collateral used in real estate, art finance, and litigation.)
Certain steps to consider:
It’s critical that investors evaluate an investment’s target yield, which is the expected percentage of principal returned on your initial investment. Yield can apply to both equity and debt investments, however it is typically a much larger proportion of returns in debt investments.
Here’s a quick debt example:
Say a hypothetical borrower takes out a loan of $10M to finance the construction of a new office building. The lender expects the borrower to pay back the $10M in principal, plus $0.8M in interest. Dividing $0.8M by $10M gets you 8%, or the yield on the loan. Target yield, together with return of principal, is an important consideration for investors.
Gross yield is the top-line amount an investment is expected to produce. Net yield or annual interest rate to investors is the investment’s return after the deduction of a management fee and other expenses (if any). In our hypothetical example, if the management fee is 1%, the net yield for the investor will be 7%—the gross yield of 8% minus the management fee of 1%.
Timing of payments also affects how we think about yield. Investments on the Yieldstreet platform have varying target maturities, ranging from a few months to a few years. Investors can compare target yields on investments with different target maturities by annualizing the target yield, calculating what the target yield would be for an investment assuming it produced the same returns for a single year. You can read more on measuring investment performance in our guide on internal rate of return vs. return on investment.
Think of yield not just in absolute terms, but also as a way to compensate investors for risk. All else equal, investors typically can expect higher yields for investments with a greater perceived risk. To evaluate whether the target yield on an investment justifies the risk, investors should consider the credit quality of the underlying loan, where the underlying loan sits in the capital stack, the liquidity of the underlying collateral, the underlying loan’s term and the likelihood of a default or other adverse events, among other considerations.
Certain steps to consider:
Unlike traditional investments that tend to be highly standardized, private debt investments are more customized to the unique circumstances of both the lender and borrower of the underlying loan. This means some additional research on your part may be necessary to become comfortable with a specific loan’s unique structure and its timing of cash flows.
For example, Yieldstreet investments have a variety of payment structures and schedules, while the timing of final payments are expected shortly after a loan’s final maturity. Some investments pay interest before the principal is returned, typically on a monthly or quarterly cycle, and others pay all interest at maturity. Because each investment is unique, it’s important to review the relevant offering documents, such as the Private Placement Memorandum and Series Note Supplement or Investment Memorandum to better understand the schedule of cash payments and the risks of each investment.
Certain steps to consider:
Traditional investments like traded stocks and bonds, and cash have the advantage of strong liquidity. Because these investments trade in active markets with many buyers and sellers, it tends to be relatively easy to enter or exit traditional investments at prices close to fair value.
While some alternatives such as commodities and currencies also have strong liquidity, private debt investments tend to have reduced liquidity, meaning that the investment cannot be quickly sold or exchanged for cash without the potential for a substantial loss in value. In contrast, investors in illiquid assets often have the opportunity to earn higher returns than when investing in more liquid assets (what is known as a “liquidity premium”). However, investors should consider how their own need for cash might affect their investment decisions, while understanding that less liquidity may prevent them from accessing their capital until the final term of the investment. Investors in illiquid investors should be willing (if necessary) to hold their investments for an indefinite or long period of time.
Certain steps to consider:
The capital stack (capital structure) is the ranking of different types of lenders in a loan according to their seniority in terms of payment and lien priority. Lenders at the top of the capital stack are more senior, and they can expect to be paid before lower-ranking investors. The lower a lender ranks in the capital stack, the greater the risk of loss. For example, if the underlying loan of an investment becomes impaired, lenders who are higher in the stack will have priority and a higher claim to be paid back before those lower in the stack, who are more likely to realize losses first. To compensate for the additional risk, lenders at the lower end of the capital stack tend to earn higher returns.
Certain steps to consider:
All investments carry risk, and understanding risk is a key step in any investment process. The definition of risk can vary for different types of assets. In private debt, investors typically consider risks in terms of defaults and permanent impairments. A default occurs when a borrower breaches some aspect of a loan agreement, for example by failing to make an interest payment on time. A default does not signify that the lenders will necessarily lose any interest owed or principal. A permanent impairment takes place when a loan incurs a loss that can’t be recovered.
Investors can use metrics like loan-to-value (LTV) ratio of the underlying loan to help them understand how serious the risks of default or impairment might be. Evaluating how concentrated or diversified an investment is can also help: Does the investment involve only one asset as collateral, or is there a substantial variety of underlying assets that helps spread around the risk?
While it’s fun to consider the potential rewards of an investment, especially one with an attractive yield, investors should carefully weigh what could happen in a downside scenario to reach a balanced and educated decision.
Certain steps to consider:
Investors in alternatives should carefully evaluate the risks related to each investment they’re considering, and have a strong understanding of the underlying assets, yield, timing of payments, liquidity, place in the capital stack, potential risks, among other factors.
1 Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in significant losses.
2 Represents a net estimated, unrealized annualized internal rate of return (IRR) of your portfolio and is based by reference to the effective distribution dates and amounts to and from the investments, as well as any outstanding principal and accrued and unpaid interest as of the current date, after deduction of management fees and all other expenses charged to the investments.[read more]
3 "Annual interest" or "Annualized Return" represents an annual target rate of interest or annualized target return and "term" represents the estimated term of the investment. Such target interest or target returns and estimated term are projections of the interest or returns and or term and may ultimately not be achieved. Actual interest or returns and term may be materially different from such projections. This targeted interest or returns and estimated term are based on the underlying investments held by the applicable.
4 Reflects the initial quarterly distribution declared by the board of directors on February 6, 2020, which will be payable to stockholders of record as of June 10, 2020, and the initial offering price of $10 per share.
5 The Fund will cease investing and seek to liquidate the Fund's remaining portfolio no later than 48 months after the Fund's initial closing. It may take up to twelve months thereafter to fully monetize any remaining illiquid investments in the Fund's portfolio.
6 Represents the sum of the interest accrued in the statement period plus the interest paid in the statement period.
7 The internal rate of return ("IRR") represents an average net realized IRR with respect to all matured investments weighted by the investment size of each individual investment, made by private investment vehicles managed by YieldStreet Management, LLC from July 1, 2015 through and including May 3rd, 2021, after deduction of management fees and all other expenses charged to investments.
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