I often get asked by clients for my thoughts about non-publicly traded investment pools, like mortgage investment corporations, private REITS (real estate investment trusts) and private equity investments.
More often than not, these “questions” tend to take the form of a declarative statement – something along the lines of “my brother invests in a pool that pays him 8% and never fluctuates in value. It just stays at $10 a share, so it’s way safer than stocks or bonds.”
The question being implied by this statement is whether these pools really are as good as they seem, or are they too good to be true. Surely having 8% deposited like clockwork into your account without ever having to worry about market fluctuations is a deal no one can afford to pass up, right?
Unfortunately, like nearly everything in the financial world, the truth is never quite that simple.
Guaranteed investments and government bonds currently pay about 2% a year. The reason the return is so low is precisely because they are just that: guaranteed. If you’re getting paid more than 2%, it means you must be taking some form of risk, to warrant the higher rate of return as compensation. So what exactly are the risks associated with investment pools that make it possible for the companies running them to pay such a seemingly high rate of return?
Before I get into the risks involved in these types of investments, in the interest of full disclosure, let me say that we have clients who are involved in all kinds of non-publicly traded investment pools. From time to time, we recommend mortgage investment corporations, private equity and specialized lending pools to our clients, usually for very specific purposes. All of these pools have share prices that rarely if ever change. And all of them come with certain risks.
The biggest risk that most investors need to contend with is also the one thing about these investments that most people cite as their greatest strength: a share price that never changes. Unlike private investment pools, stocks tend to move up and down on a regular basis. I’ve yet to hear a client complain about the “ups.” But the “downs” can be both stressful and annoying.
What you have to keep in mind is that a share price that fluctuates is evidence of a transparent, liquid and active market. Buyers and sellers come together every day to decide (rationally or otherwise) what the price of any given stock should be at that moment in time. Information flows freely in and out. Investors can then use that information to make their decisions about the current and future value of every stock that’s publically traded.
For example, if you want to buy a certain stock, you have to pay the going rate, or whoever’s currently selling that stock will just find someone else who’s willing to match their price. Similarly, if you want to get out of a particular stock, the only way to do so is by selling it at the price everyone else is willing to pay. Transparency and liquidity reign.
Private investments aren’t like that. Private investments have a fixed price, which is usually set based on information that’s held in one place – not openly available to everyone involved. The share price is generally set as a matter of convenience, and there are typically liquidity windows that allow the manager of the pool to raise enough cash to meet the expected number of redemptions.
Occasionally, one of these private investment pools goes from being worth $10 a share one day, to becoming insolvent the next. It’s a surprise. It shouldn’t happen. But sometimes it does.
Now, I’m not for a moment suggesting that the managers of these pools are deliberately depriving the market of information or liquidity. It’s just the nature of the investment. But for investors, the cost of that stable share price is a lack of transparency and liquidity – two qualities that I think most of us would agree are desirable (albeit stressful) things to know about the places where we’re putting our money.
When you’re deciding what portion of your portfolio to allocate to these types of investments, my best advice would be: keep things in perspective. Private investment pools are not risk free. And they’re not the answer to all our investment worries. They’re just a different type of investment, which comes with its own form of risk. Like all investments, we as investors need to look at that risk, and decide for ourselves whether those investments are right for us.
My personal bias is to put most or all of the growth portion of a portfolio into publicly traded stocks. A broadly diversified portfolio of stocks will, on average, give you somewhere between 6 and 10 times your money every 30 years. During that time, you will experience numerous temporary market ups and downs. But except for some very rare cases, investing in a diversified portfolio of public equities means you won’t ever have to worry about permanently losing your money.
I know that the stock market isn’t for everyone. I just happen to think that it’s the right choice for most.
Alan MacDonald, an investment advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.
For more information please visit www.alanmacdonald.ca or email Alan at Alan.Macdonald@RichardsonGMP.com.
All material has been prepared by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.
Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.
