Recessions are an inevitable part of progress, and any up cycle is ultimately followed by a downturn. Even though the stock market fully recovered in three years following the 2008 Recession, many investors have developed a heightened sense of risk aversion, and want to access different investment options that have low correlation to the performance of the stock market.
For many investors, diversification into investments with low stock market correlation is a way to protect their investment portfolio in the case of an economic downturn. Typically, low correlation opportunities will not experience the same degree of volatility as the stock market, and provide a potential safety net for most investors who have traditionally had limited investment options.
We sat down with our Founder and President, Michael Weisz, to discuss how Yieldstreet’s investment opportunities might perform in the event of an economic downturn.
We often talk about the value of a non-correlated investment in the event of a recession or a market downturn. How can such an investment help reduce the impact of market volatility on an investor’s portfolio?
MW: We work with our originators to find opportunities which we wouldn’t anticipate being affected by stock market fluctuations. In the event of a market downturn, having a non-correlated investment may provide investors with a source of more predictable returns while the rest of their portfolio is tied up in the stock market.
All real estate offerings on Yieldstreet are debt-based. What would happen to a real estate offering in the event of another recession?
MW: Yieldstreet structures our real estate opportunities in order to try and minimize the impact of a loan default on Yieldstreet investors. We take a data-driven approach to make sure key due diligence metrics are met, and safety checks are in place to protect Yieldstreet investors and to reduce exposure of the principal balance to the greatest extent possible.
One of the ways we do this is by working with borrowers in urbanized areas like the NY metro area, which typically withstand downturns better than rural areas. This is because rental demand tends to remain high in urban areas despite economic conditions, and property cash flows are less likely to be affected by economic conditions.
In the event that a Borrower’s cash flow does get impacted by stock market volatility, and they are unable to keep making payments to the Originator, the Originator will be faced with a decision: to keep working with the Borrower until their financial situation improves, or to begin foreclosure actions. In either case, it’s possible that Yieldstreet will experience a delay in cash flow, and may not get payments for an extended period of time.
And what happens in the case that the Originator decides to foreclose on the loan?
MW: The value of investing in an asset-backed opportunity is easily demonstrated in a foreclosure. In this case, if the investment was secured by a first lien on the associated property, the Originator may decide to enter default proceedings and liquidate the underlying property to recuperate the outstanding loan value.
As mentioned, Yieldstreet looks for real estate opportunities in urbanized areas, which are shown to be less impacted by economic downturns. Properties in these areas are typically highly sought-after by buyers. It is Yieldstreet’s belief that in the case of a foreclosure, the Originator will be able to more easily liquidate the property to cover outstanding principal on the loan. In addition, Yieldstreet works to reduce this risk by structuring the deals in such a way that the underlying collateral far outweighs the value of the loan. If this loan-to-value ratio is low enough, investors should see most of their principal and, in some cases, even some interest recuperated.
How would the dynamics change in the case of a litigation portfolio?
MW: Litigation finance is quite a bit different. The underlying asset that backs the loan is itself generally uncorrelated to the stock market, although as always broad market trends necessarily impact the valuation and marketability of other assets, such as real estate and fine art. During the Great Recession, litigation finance as an asset class was not impacted, but we did see that some states and government bodies reduced legal funding as a result of the crisis. The reduction affected how many clerks and judges were on the bench, and therefore the duration of some active cases was extended for a longer period than expected. We didn’t see that the associated Obligors were affected by the credit downturn because they were such powerful players – major insurance companies, pharmaceutical companies, etc. – so they didn’t have an issue making payments. Thus, most cases were settled and paid out according to plan.
Yieldstreet strives to structure its investment opportunities in a way that makes them minimally affected by credit cycles. While some aspects of the investment – the regularity in payments, or the overall length of the investment – may be impacted, investors will typically not experience the same degree of volatility and loss that they would in equity markets.
Diversifying into non-correlated assets, like debt investments designed to have low market correlation, can be a great way for investors to provide padding and protection against the impact of market downturns on their portfolio.
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