February 2024
Jeff and Chris define resilience as an investment’s capability to withstand a variety of unforeseen scenarios without significant loss. Although uncertainty is inevitable, building a diversified portfolio can help investors navigate tumultuous circumstances.
Private lending, specifically equipment lease financing, can be a solid example of a resilient investment, as it may offer consistent returns and security even in downturns. Compared to bonds, private lending may be even more resilient due to its tangible collateral and structured repayment schedules. Studies show that people who invest with a long-term mindset generally perform better than those who get in and out of the market; therefore, it is important for investors to choose investments that will withstand different market conditions over a long period of time.
Watch previous episodes here:
Ep. 70 Different Ways to Access Real Estate: REITs vs. Private Funds
Ep. 69 Mastering the Balance: Liquidity vs. Illiquidity
Hello, everybody, And thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by CEO of Morton Wealth, Jeff Sarti.
We care a lot about resiliency as an organization. Being able to withstand the true test of time and all the uncertainty of the world, but also finding investments that are extremely resilient.
Tell me a little bit about when you think of resiliency, like what comes through your mind?
Yeah, it's a few things. One is it's investments that are really hard to break. So what I mean by that is, there's so much uncertainty out there. Investments zig and zag go up and down for a variety of reasons. What we're trying to find specifically are investments that just won't zig and zag as much, and march to the beat of their own drummer and just be okay.
Even in a variety of unforeseen circumstances. I think at its core, that's mainly what we're looking for.
You know, and I hear that from other firms and yeah, not trying to play devil's advocate a little bit, but other firms will say, Yeah, we care about that too. That's why we invest in consumer staples. Right. If you lose your job, you're still going to pay for your Internet because you need to search for a new job and you're still going to pay for your cell phone because you need to answer that call to get a new job.
And you're still going to shop at, you know, Costco or Target or wherever. And and so that's their viewpoint of resiliency. But that resiliency is extremely volatile. So you look at resiliency different, very differently.
I'm glad you brought up that example. Right. A lot in our industry, they point to, as you mentioned, dividend paying stocks. And we, of course, invest in those types of companies as well. But those are not at their core resilient investments. So in environments like 2022, all stocks move up or in those environments down together.
So even though theoretically those are more conservative, solid companies, if you will, they're still incredibly vulnerable in stock downturns, right? Yeah, I wouldn't quite call those resilient investments.
So we'll get into more in terms of how we look at resiliency or what that means to us, not only from our investment philosophy, but maybe even some specific examples with investments. But the reason why we're so focused on resiliency is because the uncertainty that we face in the world. Now, just to recap it, over the past six years since the financial crisis, we lived for a long time in a zero interest rate policy world, and not just here in the U.S. but around the globe, interest rates were even negative in most of the parts of Europe.
Mind blowing. You know, you lost money by loaning it to somebody else. But that's a whole nother story. But the things that happen from being in an a zero interest rate policy, the amount of money that was being printed just to try to stimulate the economy, then you've got, you know, wars, elections, a pandemic. And you've got so much uncertainty out there.
When we're looking at resiliency, you know, talk a little bit about what that means as as far as it addresses all of the headlines that are out there that could prevent you from wanting to make a decision to invest.
As you mentioned, uncertainty is a given, right? It's always going to be there. But in looking forward to 2024, we think potentially uncertainty is even somewhat heightened. You mentioned geopolitical risk. I mean, geopolitical risk is without a doubt heightened with everything that's going on
Deglobalization.
People wanting to say, hey, we don't want to rely on you for our goods and services or our supply chain, so we want to bring it back in-house. That creates all sorts of tremendous changes in the geopolitical economy.
Inflation and interest rates are obviously still a wild card as we're talking today. The Fed is going to meet today to define their path of interest rates. Truth is, who knows what direction that's headed? And then the real wild card of the election in the fall, which is just, you know, tremendous uncertainty and potential volatility around that.
So a lot of things coming down the pipeline in terms of geopolitical events, again, the economy and what can cause really heightened uncertainty.
At its core, what we're looking for are investments that will be insulated from those types of events, most traditional investments. And again, we're investing in a lot of these traditional type of investments.
So mainly talking about stocks and bonds, but at their core, they will move up and down in line with the economy, GDP growth. What I mean by that, is as the economy grows, stocks tend to do well. If we hit a recession, stocks tend not to do well or with heightened uncertainty or volatility. What we are looking for are investments that are outside of that framework that will be much more insulated if economic growth falters for whatever reason.
And that has a lot to do with the fact that stocks and bonds have moved in correlation with one another in recent years. People used to be told that all you had to do is own stocks and bonds and you were very diverse. But that has not really been the case for the last 15 to 20 years.
Is 2022 is a great example of that, right?
Yeah, that's that's sort of where where I'm going with this. 2022 is a great example. I've got a decent chunk of my money in something that I and told is safe and that's called bonds are fixed income interest rates moved up unexpectedly more than they should have and safe money lost 13% for the year. I mean, at the same time, stocks were down close to 20.
Yeah, I'm not feeling very good. And if I have to make a decision to to live my life and replace my paycheck now I'm having to sell something in that environment.
You're selling something that's down, which is at the exact wrong time. You want to sell something, right?
And so when you're talking about resilience, you're talking about things in that type of environment, you know, aren't down 13 to 20% are potentially flat or even we were lucky, knock on wood, and some were even positive. And those things are resilient and sort of outside of those.
Yeah, a number of examples. Yeah. A lot of our lending instruments that were again generating consistent income even in that environment where bonds were down 13%, they were generating those call it mid to high single digit type cash flow returns.
And I know we talk about these as being alternatives or private lending investments.
Look, a bond is just a loan frame. It's a loan to a government or a corporation, a municipality. And because you're loaning them your money, they're going to pay you an interest rate. Right. So when you're talking about private lending, we're just making a loan to somebody that it's a private, private investment or discussion that that we that we chose to go into.
It's not something that was issued out to the public and raised through the capital markets.
But it's no different than a bond.
It's no different than a bond. I'm glad you mentioned that this just has sort of a better mousetrap. It's a better structure that we place around these vehicles that, again, results in better resiliency, better consistency from our point of view, much more reduced downside. And again, 2022 being a great example where safe bonds and I put safe in air quotes were, as you mentioned, down 13%.
Yeah. So one of the groups makes equipment and lease financing available to companies. So instead of companies having to come out of pocket to buy a fleet of tractors that cost, call it $10 million, they could lease those tractors to operate their business. And this group that we have, Keystone will go and they will spend the money to buy the tractors.
They will lease it back to that group, and talk to us a little bit about how that's resilient and your viewpoint on that.
Yeah, as a starting point, when you think about the purpose of that lease, that agricultural company that is leasing those tractors, that is critically necessary equipment, right? That is they need that those tractors to keep the lights on. So as a starting point, they're going to make those lease payments first and foremost so that that unto itself creates a very resilient lease or loan.
The other aspect that's really attractive about these equipment leases is they're typically three year leases. But the key point is the amortization schedule. What I mean by that is typically we assume Keystone in this example, as you mention, assumes zero residual value at the end of that three year loan. So what that means is over that three year period, let's say on the $10 million example you mention, in addition to the interest payment that they're getting on a regular monthly basis principal paid back to them so that over that three year period that there's full amortization of that $10 million.
There's now all of a sudden no more debt owed on this, you know, $10 million fleet of tractors, which is far different than a car lease. Right. I go lease a car for $60,000. Yeah. I make my $800 a month payment to pick the car up.
And then after three years, that's $60,000 car. I have an agreed buyout of, call it $37,000. And so, you know, if I choose not to buy that car, that car company now has to go out of the market and hopefully sell that car. In this example, it would have been as if I paid for the $60,000 car over that eight years.
And so now the car company has a car that's worth, call it, 35 or $40,000. And when they go and sell that down the road, it's all profit.
Correct. So I'm glad you brought up that car example that in that car example, that car company is in a vulnerable position. Right. They've been paid back some of their principal. But let's say only 20, $25,000 in your example, They now have to go release the car or sell that car if that car is out of favor, if we've had a recession and they can only sell that car for 25 or 30,000, they're going to take a loss on that loan.
Again, very different from this example in the equipment leasing that we're making. Let's say the agricultural company, for whatever reason, stops making their lease payments very unlikely because, again, they need these tractors. But let's make that assumption. Let's say they stopped paying after 18 months or two years because of the speed of the amortization of that loan. We've gotten back more than half, maybe even two thirds of our principal payments back.
And now we get the tractors back and we can release them in. The tractors are now only 18 months or two years old. They're still relatively new. We can release them or sell them at still an attractive price.
So in this example, as you're looking at a specific investment and thinking of it in terms of resilience, it's paying consistent cash flow to us as the investors. Yeah, it's something that we can count on. But also, you know, if something were to go wrong, there's equity or some sort of collateral behind that and that feels a lot better than an IOU that's written on a piece of paper from a particular company.
And that brings it back to resiliency, right. In unforeseen circumstances, Again, rare circumstances, theoretically, that company will continue to make its lease payments. But if something goes wrong outside of really Armageddon type scenarios, we're just going to be okay. Because, again, we've been paid back a lot along the way. And then we have that collateral that we can grab and resell.
That's helpful. Obviously, when we're making investment decisions, we're not trying to be reactive to what's going on week over week, quarter over quarter. We're trying to think very long term, how do we build a company but also advice and investment solutions for our clients that can weather the test of time and the uncertainty, the things that we don't know, that we don't know that could happen.
Sure. You've got an interesting analogy about this. Walk me through that.
So, yeah, it was a couple months ago and my previous Perspective letter where I talked about surfing waves. Right. And how most individuals tying the analogy to investing when you're investing or surfing, you're trying to time the perfect wave, right? So it's like buying and selling a stock at just the right time or let's say the waves are too big.
You get a little bit nervous. What do you do? You go to shore and wait it out. That's kind of like going to cash.
Very different than our approach of instead of trying to hone our surfing skills and trying to time the perfect wave, what do we do that we actually just build a bigger boat? We we get out of the game of surfing? Yeah, maybe we're missing out on some thrills, if you will, but we're building a bigger boat with ironclad whole, redundant technology systems in case the waves get too big, etc..
And what that really means is a real diversified portfolio so that if the waves become larger than we otherwise would expect, we're just going to be okay. And we can stay in the water. That's the key, right? Staying invested over time, because if you stay invested and you compound returns with each passing year, you're going to be okay.
That's how you really generate income and wealth over time as opposed to surfing, getting in and out of the water sometimes timing things. Right, But often missing out as well.
Well, it's so hard to time things perfectly. Sure. Getting in and getting out and everything.
And it's exhausting.
Stressful. Yeah, I think. But there's tons of studies that say, you know, for people that are trying to be more active or get in and out, they don't do as well as people that kind of stay in the long term. Yeah, right. And so if you're committing to stay in it for the long term, why not try to build something that's going to weather most storms or, you know, a good portion of it, call it 20 to 30% of your portfolio, be really consistent and very resilient, almost like an anchor in any given year.
So I like that that viewpoint of resiliency. I mean, at the end of the day, you know, most people need these dollars for something either their lives or their kids or their grandkids lives, and they're at some point and they need to spend it. And so we need to best protect and generate income so that way they can live their lives.
I make most of my buying decisions based off the income that I have coming in. And if that income goes away, I don't feel very comfortable making that purchase, that that new purchase. And so if I'm trying to live my life or pay for my kid's education or take take a vacation, I want to make sure that I've got some certainty or some consistency when it comes.
To that predictability of that resilient cash flow stream from the investments that we make. I mean, that yeah, that is from a financial planning point of view. It's wonderful, right? It gives us a lot of certainty and confidence that we can meet the withdrawal needs, the living needs that our clients look to us, look to us with regards to living their lives.
Jeff, thanks for joining us. I know we're going to face a lot more uncertainty this year. It's an election year, geopolitical risks, there's inflation. There's even high valuations. The tech sector is kind of all over the place with earnings right now. It's going to be interesting. But at the end of the day, we can't make predictions, but we can make choices to invest in things that are going to weather most environments and help protect our clients. And that's what we're looking to try to do.
Yeah, that's what we're passionate about.
Disclosure: Information and references to specific investments presented herein are for illustrative purposes only and subject to change without notice. It is not intended as investment advice and should not be construed as an offer or solicitation with respect to the purchase of any security. Investment opportunities described may only be available to eligible clients and involves a higher degree of risk. Each investment opportunity is unique, and it is not known whether the same or similar type of opportunity will be available. Morton makes no representations as to the actual composition or performance of any security. All investments involve risk, including the loss of principal. Past performance is no guarantee of future results.
There is no guarantee that the investment objective will be achieved. Morton Wealth makes no representation that the strategies described are suitable orappropriate for any person, and should not be assumed that Morton will make investment recommendations in the future that are consistent with the viewsexpressed herein. You should consult with your financial advisor to thoroughly review all information before implementing any transactions and/or strategies concerning your finances. The viewsand opinions expressed by the speakers are as of the date of the recording and are subject to change.
