investment
Learn to Invest like Harvard and Yale What do the managers of endowment funds know about investing that you don’t? By Charles Tralka
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f you’re like most private investors, you invest your money in traditional Wall Street products such as stocks, bonds, and mutual funds; bank investment products such as savings accounts or CDs; or insurance company investment products such as whole life policies or annuities. You might even have consulted with a financial planner and found that they tend to recommend these traditional options as well. Endowment fund managers at big universities have the same fundamental goals that investors like you and I have—namely to get the best possible return for a given level of risk. Although the funds they manage can be very large (billions of dollars in some cases), they pursue these goals partly through many of the same traditional investment options used by private investors. However, would it surprise you to learn that they invest more than half of the money they manage in a category that you’ve probably never even heard of before? In fact, managers at the biggest funds (such as those at Harvard and Yale) direct more than 60% of their money towards this category and, according to a study published in January by the National Association of College and University Business Officers (NACUBO), their allocation has been increasing for years. This strategy has been successful. For example, the Yale endowment fund, lead by legendary fund manager David Swensen, has averaged a 13.7% annual return for the last twenty years. By the way, university endowment funds aren’t the only class of big investors who allocate money to this category. Other big institutional investors have also climbed on board the bandwagon and have directed large sums towards this group of investments as well. So what is this mysterious category that has the attention of top money managers across the country? It is called “alternatives,” and it includes investment options such as energy, private equity, commodities, and real estate. Professional fund managers choose these options because they believe that the proper mix of traditional and alternative investments can provide a level of true portfolio diversification that traditional investments alone cannot. Proper diversification can reduce risk and increase total returns over time. 44 | INDIA CURRENTS | June 2013
One important sub-category of alternative investments is real estate. Almost everyone knows that real estate went through a major boom-and-bust cycle a few years ago and now is trending upwards again. In fact, according to a recent headline article in the San Jose Mercury News, the value of real estate in some neighborhoods in the Bay Area has already exceeded its “pre-bust” levels and is continuing to rise. While many private investors are familiar with real estate, most believe that the only way to invest in real estate is to buy property, lease it out, collect rent, and wait for it to appreciate. Certainly that’s one approach, but for many busy Silicon Valley professionals the amount of time required to find the right property, bid on it, fix it up, lease it out, manage the maintenance, and take care of tenants just isn’t practical. So after thinking about real estate for a little while, they give up and go back to traditional stocks, bonds, and mutual funds. Is there a way that a busy professional can invest in the real estate market despite their hectic schedule? The answer is “yes”, as there are many other ways to invest besides owning property. Options range from owning shares in publicly-traded Real Estate Investment Trusts (REITs), to buying notes, to trust deed investing. Each of these is a large topic, so we’ll focus on just one them for now—trust deed investing, which is also known as “private lending.” The definition of private lending is simple: private investors lend money to borrowers who either own or are in the process of buying real estate. The loans made by the investors are secured by liens against the real estate (often called a “deed of trust” or “trust deed”). The borrower pays interest and repays principal according to the terms of the promissory note used to define the loan agreement. In California, these transactions are managed by a licensed mortgage broker (who arranges the loan) as well as third-party title and escrow services. The broker or another third-party might also service the resulting loan (usually for a small monthly fee), collecting payments from the borrower and remitting them to the lender. Here are some of the characteristics that can make private lending an attractive invest-
ment option: • There is a well-established set of laws supporting private lending in each state. Transactions are generally managed by experienced, licensed professionals in the mortgage, escrow and title business. • The loans are secured by real property. Few other types of investments are secured by tangible assets which are reasonably liquid and have well-established values. • Interest rates paid on the loans are typically much higher than rates paid for other income-producing options, and some lending models (described later in this article) have the potential for even higher returns. • Private lending returns have a low correlation with other investment classes, making this option a good choice for overall portfolio diversification. • The returns also tend to have “low volatility,” which simply means that the income generally comes in steadily, rather than moving up and down like a stock price can. As with all investing activity, private lending does entail risks, and smart investors must carefully evaluate them before making investment decisions. These risks can include late or non-payment of interest and, in extreme cases, default on repayment which could lead to foreclosure on the property to recover the loan principal. Private lending is a way to invest in real estate without the hassle of owning property, dealing with maintenance issues, or managing tenants. It focuses on the financial aspects of real estate investing by allowing individual investors (by themselves or as part of a fund) to essentially become the bank and to finance real estate transactions using the security of the real estate as collateral. Savvy investors have been participating in private lending for years—using it as a way to provide a level of portfolio diversification that’s difficult to achieve with stocks and bonds alone. n Charles Tralka has been investing in real estate for more than twenty years, and he writes, blogs, and speaks regularly on a variety of investmentrelated topics. Together he and his business partner, Tom Braegelmann, manage a real estate investment fund in Campbell, CA. http://www. gcaequitypartners.com/