In this week’s edition, I’m going to focus on how an alternative investment strategy in Opportunity Zones can act as a stabilizing force and asset to offset chaos in client’s equity holdings.
Stock markets are widely understood to be capable of becoming extremely overbought as well as being extremely oversold. Against a wild stock market landscape, there are 9,600 mutual funds and over 6,400 Exchange Traded Funds (ETFs) all vying for a piece of the 3,670 stocks in that are listed in the U.S. Couple this log jam of supply and demand with the fact that over 70% of daily volume is controlled by high-frequency trading prop shops and you have a recipe for sudden disaster when a black swan event comes along. So, why should anyone be surprised by current events? I’m not.
It gets even more extreme. Of the 3,300-plus hedge funds that operate by their own mostly unregulated set of rules, many are deploying 10-20 times leverage of principle, better known as portfolio margin. And guess what the most favored trading strategy of these “smartest guy in the room” hedge funds has been for the past three years? You guessed it – selling volatility. As of this week, these same hedge funds have met the grim reaper up close and personal with several firms eviscerating investor capital when the CBOE Volatility Index (VIX) traded above $83 on Monday.
Meanwhile shares of my company’s publicly traded Qualified Opportunity Fund, Belpointe REIT (BELP) were priced at $100 back on November 30, 2019, and today, they trade at $100 per share. There are no high-speed trading firms playing the spread, or mutual funds and ETFs crowding in and out of the stock. Why? Because it’s a publicly-traded growth and income tax shelter that doesn’t fit the profile of what 99.9% of the market is invested in.
To call Qualified Opportunity Funds unique is an understatement. RIA’s are always on the hunt for that one asset class that is truly not correlated to the stock market. Other than Treasuries and gold, there aren’t any. Think about it for a minute. What hasn’t gotten crushed this past week? Investment grade corporate bonds? Crushed. Conventional REITs? Crushed. Utilities? Crushed. Consumer staples? Crushed. Healthcare? Crushed. All the traditional defensive sectors that are supposed to be the go-to places to rotate capital into have all been obliterated due primarily to forced liquidation by highly leveraged pools of capital and sheer fear of the short-term impact of COVID-19.
RIA’s need to look no further than the “Melatonin effect” a well-managed Qualified Opportunity Fund can have on a client’s portfolio. When all hell is breaking loose, such as the present, your money is quietly revitalizing communities with long-term benefits for both the occupants of those neighborhoods and for investors looking for a blended annual income yield coupled with a possibility of annual appreciation.
Here’s the situation as I see it. An amazing setup trade for RIAs to pencil out and be ready to act on. Once there are signs the Coronavirus caseload is going to plateau in the U.S., the stock market may experience the mother of all snapback rallies – maybe 7,000 points for the Dow in a very short period of time. That can take the blue-chip index up to its 200-day moving average that is now trending down.
Consider preparing clients with substantial short-term and long-term capital gains that want to lessen their equity exposure to sell into that momentous market rebound and roll those gains into an Opportunity Zone Fund within 180 days that entitles the investor to defer the taxes on those gains out to 2026, immediately step up their cost basis in the QOF by 10% and position some of their capital into tangible income-producing commercial real estate with a 5-10-year investment horizon that strives to show a projected total return averaging in the teens and possibly more. That, my friends, may be the most coveted trade of 2020.
RIA’s first and foremost responsibility to their clients is the preservation of capital and the safeguarding of capital gains. Clients are in shock and awe of the destruction of capital within their portfolios and it is incumbent upon RIAs to come up with alternative strategy when your client calls and asks bluntly “what’s the plan?” This is when the old saying of “if we fail to plan, we plan to fail” comes to the forefront.
Investing a portion of their capital gains derived assets in Qualified Opportunity Funds may be the proper plan for achieving the twin goals of lowering portfolio volatility and providing total return. Sometimes less is more, and in the coming months when the market does provide a relief rally, locking in some of the capital gains in your clients accounts and investing it in a Qualified Opportunity Funds in my view can not only enhance the client’s net worth, but also provide for a much smoother ride.
The best time to have that discussion with a client is to call them before they call you. It sends a proactive message that the ground under the stock market has indeed changed and there is an action plan to preserve gains, shelter taxes and grow capital in U.S. commercial real estate with the full blessing of federal and state government incentives.