Finding the Low-Risk High-Return Unicorn

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There’s no such thing as a sure thing in investing.

Remember dotcoms, mortgage-back securities, and Bitcoin? Those were all sure things, right? Not exactly. Investors are continually getting burned by the sure thing syndrome, but it doesn’t mean they’ll stop looking for the next big thing.

When you get down to it, what investors are essentially seeking when they chase a sure thing or the next big thing is an investment with no risk that will generate above-market returns.
They’re chasing that elusive unicorn.

Are there any risk-free investments?

No investment is risk-free, but some investments are considered close to risk-free, like U.S. treasuries and CDs. But do these investments offer above-market returns? Definitely not.

Is there a unicorn out there that offers low risk but delivers above-market returns in any market condition? Maybe. Investors may just be looking in the wrong places.

Conventional investment wisdom measures risk-returns using two variables, alpha and beta. Alpha and beta have typically been used in public markets to measure the risk-return performance of public stocks and bonds.

Beta measures the systematic risk of a security or investment in comparison to the market as a whole.

Systematic risk is overall market risk. A value of 1.0 indicates a security or asset is closely correlated with the overall market, rising and falling almost in step with the market. A low beta means the investment is not closely correlated with the broader market. Like U.S. treasuries that pay no matter the market conditions, low beta investments are low risk, but they’re also low yield. CDs and money market accounts are also included in this low beta mix.

An investment with a high beta sits on the upper end of the risk-reward matrix. A beta of more than 1.0 means more volatility but can offer higher returns. Tech and cannabis stocks and cryptocurrency are examples of high beta investments.

Many investors are happy to invest in the beta playground. They invest for beta – meaning they either (1) look for investments like S&P index funds that mirror the market, (2) low-risk low yield investments to avoid volatility, or (3) embrace volatility and high risk to chase high returns.

Although many investors are happy to invest for beta, many investors think they can buck the trend. They want to beat the market. They are chasing relatively lower-risk investments that provide outsized returns.

How? Through skilled management using complex and innovative trading strategies to provide abnormal returns with relatively low risk. Hence, the rise of hedge funds and overzealous hedge fund managers.

Alpha is a measurement of the degree to which an investment or asset beats the market.

Hedge fund and portfolio managers are seeking to beat the market – measured by alpha. An alpha number assigned to an investment indicates the percentage by which an investment beats the market. And presumably beating the market can only be achieved through skilled management. For example, an alpha of 10.0 means the investment outperformed the market (typically the S&P 500) by 10%, while conversely, an alpha of -10.0 means the investment underperformed its benchmark index by 10.0%.

Alpha is influenced by management. Poor management results in below-market returns and skilled management can result in above-market returns. Despite the perch upon which hedge fund managers put themselves, the reality is far from perception in terms of their market-beating abilities. The data clearly suggests that hedge fund managers and portfolio managers are rarely able to achieve alpha consistently over the long run.

In fact, many hedge fund managers get fat from fees, while their investors lose money.

For investors avoiding investing for beta on Wall Street, is it even possible to consistently achieve a high alpha where most hedge funds fail to deliver? In plain English, is it possible for an investor avoiding Wall Street to achieve high-risk adjusted returns consistently and in the long-term? The answer is yes. You just need to know where to look.

Achieving alpha can be accomplished, but it’s not going to come from where many investors think. Achieving alpha can be accomplished through commercial real estate.

Commercial real estate offers the promise of high alpha or high risk-adjusted returns because it truly allows skilled managers to exploit market inefficiencies.

ommercial real estate is illiquid and shielded from market volatility. Expert management can unearth value from market inefficiencies, for example, by acquiring a property at below-market value, leveraging operational advantages to update properties to increase occupancy, and raising rents to market rates. Unlike hedge funds, skilled commercial real estate managers have consistently shown the ability to achieve high alpha.

Public markets rise and fall with macroeconomic shocks, the 24-hour news cycle, geopolitical events, shifts in monetary policy, trade wars, and other forces that shift investor perceptions in an instant.

Although no one can avoid a recession, it’s possible to invest in a way to lessen its impact.

Commercial real estate has long been used by the ultra-wealthy to reduce their exposure to systematic risk. They don’t invest for beta. They invest for alpha and have consistently achieved high alpha by allocating large portions of their portfolios to this investment class.

The unicorn is out there; investors just need to know where to look.

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