Our Goals for your Financial Success in 2019

Jan 11, 2019 | Investment Management, Investment Philosophy

As we enter 2019 and people lay out their goals for the year, we thought of highlighting some themes, or goals, we have for your capital this year.

As you may know, we are not very concerned with the market return. However, for reference, the market’s total return, as measured by the S&P 500 in 2018, was -4.37 (minus 4.37 percent). In comparison, we continue to build out portfolios with line items (investments) that generate reliable cash on cash returns.  Depending on what type of investment they were (investment grade debt, strategic debt, equity, alternative, etc.), cash on cash returns per line item in 2018 ranged approximately from 2% to 18%. Many of our clients sought returns of 6-7% from their portfolio, and these investments were blended together to meet their objective. This was done all while avoiding much of the market volatility experienced through other investments conventionally used to achieved these returns.

With that, our goals heading into the new year are to:

1.Continue our investment process that seeks to build portfolios, generating cash-on-cash returns in the 6 to 7 percent range

Regardless of market returns being up 10 percent or down 10 percent, the cash flow of underlying securities accumulates (hence our agnosticism as it pertains to worshiping the market gods…)

2. Continue seeking opportunities with double-digit total return profiles

Some investment objectives (even with strong cash flow yields) require greater returns – as does our own personal capital we manage. Therefore, we are always on the lookout to acquire assets that we feel offer attractive risk/reward

Examples of this are owning an office building in Bloomington, Minnesota and secured lending to a cellular tower owner/operator in Ohio. Both situations are currently yielding double digits and provide equity upside.

3. Apply an institutional risk management process to mitigate downside risk in portfolios

Our risk management process sizes each investment by numerous qualitative and quantitative factors including type, quality, and objective of investments.

4. Improve our portfolio reporting process

We are currently investing money into a portfolio reporting system that we once utilized while at a life insurance company we were once employed at. Our goal is to provide clients easy-to-digest portfolio reports, as well as more clarity in the construction of your portfolio.

 

We think if we can achieve solid cash on cash returns and find/acquire value-add ideas, while properly managing risk and reporting all this to you in a clear manner, then 2019 will be a successful year (regardless of whether or not the S&P has a successful year)! To take a look at what we accomplished in 2018, click here.

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07/2018 Market Commentary

Aug 2, 2018 | Market Commentary

Triple C Priced to Perfection

We opened a market brief on Bloomberg (no public link available; for anyone with a terminal: {NSN PCQ8R66K50Y0 <GO>}) by accident to close out the month on July 31, but it made us pause. Key lines of the brief are as follows:

  • CCC yield fell to 7.89% (lower since Sept. 22, 2014) after the steepest drop since Dec. 30, 2008.
  • CCC spreads are closed at a 4Y low of +512, the biggest decline in 10 years.
  • Morgan Stanley warned investors about ‘significant potential downside’ in CCC credits.

For starters, we don’t often find ourselves in the camp on Morgan Stanley, and yet here we are. Investors are still evidently zealous for yield. This surprises us with all the talk of bond bubble, record weakness in covenants, and zombie companies. We think there are a lot of places to not be invested at this point in the cycle and this part of the credit curve is (generally) one of them.

We think yield-starved investors continue to push capital wherever yields surface. We suspect the biggest conduits and investors to be Business Development Corporations (publicly traded small and medium enterprise lenders) and Collateralized Loan Obligations (CLO), and they are the primary enablers for this market. The former is available to and popular with retail investors, while the latter has been hot with institutional investors.

CLO's are Forever

Until they are not. Quantitative minded investors have been effective at observing historical losses of the asset class and calculating excess returns. If you are an institution looking for good relative value, this has been the place to be. With the recent resurgence in CLO interest (since the last cycle end – Great Financial Crisis), many new CLO managers have surfaced and met rising demand for their product. The problem is the CLO owner is beholden to many things out of their control, and when the market turns, liquidity goes away. It is not until then that investors will find out how good their CLO manager is – only with hindsight. And those historical losses – we’ll see if the next is the same as the last. In the meantime, sounds like the CLO market started to flash warning signs.

Tesla Tesla Tesla

A reference to the Brady Bunch or summoning Candyman? Elon Musk was summoned by a critic of Tesla, writing under the pseudonym Montana Skeptic on Seeking Alpha, and Musk silenced the critic. The analyst and an editor of Seeking Alpha both commented on the event and confirmed. Montana Skeptic, to keep his employer from public scrutiny, as well out of legal wrangling, agreed to cease writing about Tesla.

That was not it though, as a lot happened during July for Tesla. Remember, Tesla’s cash flow has been of critical focus, and many suspect the company will need to do raise capital – which Musk has strongly denied. In addition to the silencing mentioned above, we summarize the month here:

  • Tesla is thinking about building a Tesla Gigafactory in Europe. This could provide cover for capital raise…even though it is not needed…
  • Tesla is thinking about building a Tesla Gigafactory in China. This could provide cover for a capital raise…even though it is not needed…
  • There were more high profile executive departures.
  • There was distraction with sending help (ultimately determined unneeded) and equipment to the Thai cave rescue.
    • Elon Musk then, very publicly, skirmished with the rescue lead and certain divers about ego things.
    • Elon Musk disparaged at least one diver in an unacceptable way, deleted the Tweet, and publicly apologized.
  • Car sale prices increased in China.
De-FANG-ed?

The FANG index, comprised of the crème de la crème of tech high fliers (Facebook, Apple, Netflix, Google, Amazon, Twitter, Tesla, et al), was soaring, but it hit turbulence in late July and has plummeted to correction territory. Leading the charge lower was Netflix, Facebook, and Twitter with poorly received quarterly financial results. While the index may not be Icarus, some of the constituents may be. The result is something we recommend staying away from. We continue to strategize ways of expressing our views around these select names in ways that are productive to accounts, but these are expensive times in the tech investment world.

GDP Hits 4.1%

Where is the beef? It is one quarter, and the reading spikes on occasion. Not to mention, it is often later revised as lower. The annual reading is likely to be no different than the previous few years. While headline unemployment is giving people something to cheer about, employment slack is a huge overhang for the next few years. Wages, in real terms, have treaded water (at best) for the last decade. Inflation is not budging. Celebrate not. We are not out of this yet.

Marginal Buyer. Minsky Moment?

For several years, China-based investors were the marginal buyer in capital markets. In real estate, market valuations are viewed in terms of cap rates (or the discount rate with which to value a property given its net operating income). A lower cap rate translates to a higher value and vice versa. Rewind a few years and US investors were already taking pause at the historically low cap rates. Then, China-based investors entered, and they drove cap rates even lower. Risks were mounting at home in China, and investors were prepared to take big risks overseas. In an already highly valued (real estate) market, they became the marginal buyer and were seemingly prepared to pay anything. Fast forward to today and these China-based investors are now sellers. But who is the marginal buyer today? Will they pay even lower cap rates?

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Permanent Loss of Capital

Aug 1, 2018 | Investment Management

At Ballast, hopefully you have seen many blog entries talking about our investment philosophy, investment ideas and portfolio construction.  These are things we talk about daily on the investment desk.

 

However, one thing that we have yet to discuss (which runs through our veins and is likely why we have overlooked writing about) is permanent loss of capital.  Permanent loss of capital is exactly what it sounds like – a permanent loss of capital.  If you pay $10,000 for a new widget only to discover that the best anyone will pay for that widget is $5,000 (and there is no alternative economic value exceeding $5,000), then you have permanently lost 50% of your capital.   There is no way to replace that $5,000 loss unless you find another asset that can create $5,000 of incremental value.

 

This might be overly simplified, but this thought process is core to constructing a portfolio that will meet a return goal while also mitigating risk.

 

To us, risk is the chance of permanently losing capital. It is not correlations, volatility, diversity of funds. It is making sure we have a reason why something is in your portfolio and sizing that opinion to make sure any bad decision doesn’t affect your overall portfolio as it pertains to permanent loss of capital.  We want cash flow to always move a portfolio forward each year, and we will make investments with growth in mind but ensure that any one investment doesn’t ruin a whole year’s worth of effort.

 

What many don’t understand or appreciate is that to effectively and properly execute this process, there are multiple hours on investment function required daily. Whether that is analyzing fundamentals of an asset, evaluating types of securities or evaluating a portfolio’s goal with the investment opportunity at hand, there is a great deal of time required.  Every day is spent – in some capacity – on the front lines of your portfolio in order to avoid this permanent loss of capital.

 

 

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About Assets

Jun 4, 2018 | Investment Philosophy

Purchasing a good asset at a good price is an ideal investment proposition.

Purchasing a good asset at a bad price can be an investment that works out over time.

Purchasing a bad asset at any price tends to destroy one’s capital.

 

These three statements seem to be some simple rules to invest by – buy good assets, stay away from bad ones and get the best price possible.  How hard can this be? Every purchase decision requires the investment team to assess both the quality of the asset and the proper price to be paid for that asset.  Ballast spends time on this every day.

 

In today’s capital markets, it seems (actually it is more of a reality) that a lot of capital acquires assets without paying much attention to either the price being paid or the quality of asset being acquired.   Approximately 30% of money gets invested into the capital markets via a passive/allocation investment process.  Think of 401(k) contributions where RIAs method is to ‘asset allocate’ people into a model portfolio or some other passive investing strategy.  If you are in an ‘asset allocation’ you effectively are buying large swaths of assets regardless of the underlying value of those assets nor any assessment of the value of those assets. However, you are merely betting that (in aggregate) the group of underlying assets will achieve returns and perhaps (more accurately) the correlations of returns that repeat themselves.

 

An example of someone acquiring an asset whose underlying value has nothing to do with your personal investment objective is the Japanese 10 year bond.  This bond yields a negative 0.54%, which means you pay Japan 54 bps per year to hold your money for 10 years.  Ballast expects to be paid for others to use your money – not the other way around.  However, if your fixed income allocation is one of the Blackrock, PIMCO, Janus or American bond funds, you own something you wouldn’t likely own if you were more thoughtful.

These are the top holders of a Japanese bond that has a negative yield to it.  Some of the more widely known fund manager names are Blackrock #2, PIMCO #3, Janus #14, and American Funds #18.  Our point is when you own funds, you often own securities that you would never buy for yourself (since in this particular case we would not pay Japan 50 bps of yield per year to hold our money) and we don’t think you should either.

 

This leaves a lot of questions in our mind. What if history doesn’t repeat itself?  What if my starting point along that timeline is the wrong point in time? Is my investment objective then really just a function of broad asset classes?   In our humble but firm opinion, these questions are valid. Our answers to these questions suggest that acquiring an asset (security selection) and building a portfolio (institutional investing) is more intellectually thoughtful – and time intensive – than a simple mathematical model. 

At Ballast, we focus on not only acquiring assets, but also managing them. It means taking the time to analyze both the quality and the price of the asset itself. That is our method.

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More Regulation…Will it actually protect investors?

Jun 4, 2018 | Investment Soapbox

A couple of years ago, the U.S. Department of Labor passed what has commonly been know as the “DOL Fiduciary Rule.”  The document runs over 1,000 pages so I have never actually read the entire thing.  However, I have read a lot of commentary and explanations about it.  After every article, I would think, “What’s wrong with this? If institutions and individuals are doing what is right for the investors (consumers), then meeting the obligations of this should not be a problem.”  But a lot of parties out there that sell individuals products or services that “manage” retirement funds did not like this at all…for many different reasons.

One major reason for the gripes against the DOL Fiduciary Rule was the cost of compliance.  Compliance is already a major cost for many financial institutions, broker-deals, Registered Investment Advisors, etc.  Yet, we still have numerous bad actors in this space who invest people’s hard-earned savings into things they (the “advisor”) would never invest in themselves or that the client has no business investing in.

 

The courts have now vacated the DOL Fiduciary Rule, and the talk is that the SEC’s Best Interest Rule will cover what the DOL Fiduciary Rule was going to cover anyway. All “advisors” will have to meet a higher standard when investing their client’s funds.  However, after the SEC released its proposed Regulation Best Interest, one of the commissioners stated,

 

“The name of the rule, in and of itself, is confusing and can cause retail investors to reasonably believe that broker-dealers are required to act in their best interests.  Perhaps it would be more accurate to call this regulation ‘Regulation Status Quo’.”

 

In the end, you want an investment professional working for you that is putting your money to work in the proper way to accomplish YOUR goals – Not in a way in which meets the goals of someone who fits a profile that looks like you.  You don’t want an advisor creating the most commissions and fees for the advisor, broker, agent, and whoever else is involved in the structure, but you should want an investment professional that will leave most of the returns for the risks you are taking to YOU.

 

A lot of people think the more recognizable the name and the bigger the brokerage or institution, then the more compliance and oversight will be in place to ensure that your funds are being managed appropriately. However, almost every day I see headlines of those big institutions paying big fines to a regulatory agency for someone in their organization not doing the right thing for a client or a group of clients.  So, if we can’t rely on big organizations to create the compliance and oversight structure to make sure bad things are not done with good savers’ money, how do we ensure that our funds will be invested and managed appropriately for us?

 

I think the only way to solve this problem is to work with investment professionals that do the right thing…that you know do the right thing.  There are a lot of advisors out there that can talk a really good game and can sell a suite of funds or products, but is that really doing what is right for you?  Are they getting you the return you should get for the risk you are taking?  Is there proper risk management being performed on your individual account?

There are a lot of questions that savers and investors should be asking themselves.  Ballast Capital Advisors has investment professionals with years of experience that prove their ability to manage accounts appropriately.  We don’t have a sales team devoted to meeting “Asset Under Management” growth goals or sales goals.  We have a mission to not only do a great job for our clients, but also to get their investment portfolio properly allocated in order to provide them the cash returns that they can rely on (now and/or in the future).

– Steve Harms

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