From there, I went on to build up a highly successful product and business at an investment bank trading and structuring reverse mortgages. Recently, my team and I were the first to create a loan product that was secured by Bitcoin, so a crypto backed loan back in 2016.

So I’ve really gone through a variety of just unusual types of investments and have continued that through today, that sort of untraditional path in an entrepreneurial venture, forming our own investment advisor with some colleagues called A3 Financial.

Robert Leonard  3:08

Yeah, it’s really interesting once you get off that beaten path of just equities and real estate to see just how many other different assets that you could invest in that are out there. There are so many different alternative assets in investing.

What was the genesis for A3 Financial? Why did you want to become an entrepreneur and a founder, rather than just continuing to be a traditional individual investor working at a hedge fund and just staying where you were?

Gregg Bell  3:33

We recognized the problem and we wanted to build a solution, not just for ourselves, but for others as well. My partners and I had been immersed in the investment management business for many decades, and several of them had had their own entrepreneurial ventures that were very successful.

About two years ago, we looked around at each other and realized that whether you’re an individual or an institution, there was this big problem that was glaring. It’s a real dilemma and it was around income.

We exist in this near zero rate environment. There had to be a better way to provide income for those that are trying to build portfolios that provide a cash flow. That was really the foundational components around A3 Financial. It’s an interesting world we live in today.

90% of government bonds trade at yields less than 1%. That’s a crazy figure. You look at upwards of 25% in the past year of bonds that have been trading at negative yields. And you compare that to stocks.

The S&P 500 is an example that has its dividend yield of 1.82%. These are just small figures and it’s difficult for a large population, especially our parents, my parents and aging populations that are naturally migrating their investments from equities to more fixed income investments to fund their lives.

That was a problem that we said, “Hey, we can, we can find a better way.” It’s off the beaten path, which is where I’ve kind of always found it needs to be this excess debt environment. We’ve got crazy amounts of sovereign debt. We’ve got record high household debt. We’ve got record high corporate debt.

This debt, which everybody is aware of, is sometimes difficult to quantify. It creates these just very interesting supply and demand dynamics that can be very favorable to investors in the right markets.

What I’ve always found is that where I’m able to find smaller, nice products away from the herd, especially those that can benefit from non-traditional drivers, like demographics as an example, then you get really favorable environments. It’s a really exciting place to be.

Robert Leonard  5:53

We’re going to dive deep into your fund and the underlying investments that you’re making, and just overall, what this type of investment means and looks like. But before we get into that fund a bit more, for those listening who aren’t familiar with credit and income funds, please explain what a credit fund is and also what alternative credit is.

Gregg Bell  6:12

So a credit font is simply just a portfolio of debt or loan investments. There are two broad types. There are the income based products. Those that rely on the cash flows from an individual or business, your personal income from having a job or the sales from a business.

Then there’s asset based credit or asset based lending, which is derived from some percentage value of an asset like a house.

So those are those kinds of broad characteristics and then a fund is just a portfolio of those. We mentioned a little bit about how much debt there is. But it’s difficult to quantify.

You look at the equity markets in the US and that certainly dominates the headlines. That’s it in the US being the largest equity market globally, it’s 38 trillion. That’s a huge figure, but the bond market is actually bigger. The debt markets are much bigger, it’s 41 trillion in the US alone. Then when you include foreign debt, a lot of which is denominated in dollars, then you’re actually looking at a figure that’s 114 trillion.

So it’s this huge part of the market that from an individual’s perspective is often kind of more on the sidelines because it’s difficult to gain access to debt markets that usually require a lot more capital. That’s why you see mutual funds and hedge funds that sort of dominate these spaces, but it does not have to be that way.

That’s one of the goals of my firm to help gain access for individual investors to products that they may not have otherwise gain exposure to. I really think they should, because there are great advantages to that, especially when you’re talking about drivers like demographics.

Demographics are something that personally I find just really fascinating. I sort of talk about this a lot on my personal Twitter feed, but they tell the story. We’re at a place now in the US and globally where aging demographics are changing the economic landscape.

We’ve got people that are 65 years and older for the first time in over 100 years that are out now for those that are under the age of five. You’ve got these huge populations of *inaudible* accumulators. There is an interesting stat I saw from the Financial Times, only a week or two ago, and it was comparing the household wealth that millennials have today versus the household wealth that was built by the parents generally, baby boomers.

You look at about 3% wealth that’s accumulated in millennials, and that was 21% for our parents. And so, there’s a lot of impacts of that wealth accumulation. They have these assets now that they’re going to be migrating just naturally as they age, which gets to these supply demand dynamics that I was talking about when you have these huge populations of older people that are retiring and deciding that, “Hey, maybe I’m going to reallocate some of my equities into a debt product.”

Then you have funds and you have a trend, that is part of the investment thesis that we try to look at and profit from being on the right side.

Robert Leonard  9:30

So let’s walk through a couple of those examples or specific investments that you guys have made. How do you look at potential investments?

Gregg Bell  9:38

When we’re talking about credit and certainly niche credit, which is sort of the asset classes that are away from the $16 trillion Treasury market or $10 trillion mortgage market or $9 trillion corporates. You’re talking about these smaller things that are influenced by unique value drivers, taxation demographics, and insurance or unusual collateral. It’s about looking at the downside protection, because credit is when you’re lending someone money and your return is capped, you’re going to get back, if all things work well, your principal will not be lent to them plus some interest.

But your risk, if there’s a default, is far greater generally, then you’re upside. And so, it’s really downside protection, first and foremost. That’s where we look at the ability of somebody the borrower to pay the collateral form.

So if they don’t pay, there’s an asset that can be seized and sold and liquidated to recover some of the loss. Then a process of weighting those probabilities and trying to find a scenario where the general macro trend is in your favor, such that you are able to profit both from the interest.

In some cases, you can sell that asset at a premium. That’s a game of sort of musical chairs, if you will, where you’re originating a product and if somebody has an appetite to buy that from you at a premium, then you can capture a little bit more return that way.

That’s what you’re seeing largely in the treasury markets today, where you have these people that are so hungry for yield, even if it’s negative, that they’ll buy a negative yielding asset because they think that somebody tomorrow will pay more for it, because rates are going further down. It’s a really unique world that we live in today.

Robert Leonard  11:32

So can you give some examples of the specific types of loans that you’re essentially investing in? Are you essentially lending money like a mortgage, give me some examples of specifics?

Gregg Bell  11:41

A great example of one of the largest concentrations that we currently have in our fund is a reverse mortgage. So reverse mortgages, if you turn on CNBC, have probably seen the fonts from Happy Days, or Tom Selleck pitching this product to senior citizens that are 60, 62 and older. It’s a way for a retired person to turn their home into an ATM to fund their life in the most basic way.

It’s actually quite an expensive product for a consumer. But from an investor standpoint, it’s really interesting, especially in a world where you see a high unemployment scenario where there are businesses that are struggling, that risk reward for lending people cash has been changed dramatically this year.

And so, for a reverse mortgage, the borrower is already retired, the borrower actually isn’t making monthly payments. So you’re not having the same risk profile as you have in a traditional mortgage product where somebody is paying their monthly interest and principal with reverse mortgage it’s actually accrued.

A borrower’s basic example takes out half of the value of their house. They use that to fund their life. Each month, rather than making a payment to the bank, the amount that they owe increases. That increases and increases every single month, until they pass away. They die or they sell that home and then pay the entire lump sum of the amount owed. The accrued interest is repaid to us. So it’s really an interesting and unique investment from the standpoint that it could accrue rather than require monthly payments.

It also comes with a government guarantee, and that this is a triple-A rated investment. This is backed by the full faith and taxation power of the United States government. So from a credit perspective, credit risk perspective, it’s the same as treasuries, it’s triple A rated, and that provides an insurance against the default to the borrower and failure to pay.

So we look for unique investments and small markets that have really interesting value drivers. In this case, demographic trend, older aging population, more supply coming to the market, a guarantee from a government body, in this case, the actual United States federal government, that’s guaranteed payments. Then a scenario where you’re less exposed to the major macro risks that we see in today’s markets.

With high unemployment, there’s a lot of credit products, loan products, whether it’s your mortgage or corporate loan that are under stress, because there’s uncertainty as to whether that borrower can continue to make their payments. So that’s one unique investment that we really like. Then we have a large position within our portfolio.

Another is finding unique collateral forms. As I mentioned, downside protection is really one of the big focuses that we look for when we’re investing in credit. If you can lend to somebody that has an asset, and if you’re able to find an asset that is difficult to lend against, then you have a benefit from the supply demand dynamics.

That was the case with the Bitcoin product that we alone backed by Bitcoin that began back in 2016. So here’s an example where you take basically half of the value of an asset. Similar to first mortgages, in many ways, you’ve got this asset. That’s a baseline thing. So half of the value comes in the form of a loan.

You have a lot of built in cushion for the volatility, you can see a house go down in value, you can see Bitcoin go down in value. But as long as you have a sufficient cushion to protect the principal, then that volatility is less of a factor. You can focus more on the return profile of the interest income that you have from being able to lend.

Robert Leonard  15:37

So we talked about it being a credit fund and income fund, how does a reverse mortgage product or investment provide you guys income, if they’re not making any payments, if that’s just accruing over time? How are you gaining income for that type of investment?

Gregg Bell  15:51

So that’s where the benefits of a fund versus an individual loan investment comes into play. So we actually have a portfolio where we have exposure to hundreds of 1000s of loans and homes across the United States that are backing these reverse mortgages.

As a result, you get a really diverse population of cash flows and that has created this income stream that we see on a monthly basis, because there’s different seasoning and different ages of the borrowers.

So with a reverse mortgage product, the older the borrower is, the more of their home value the access. A 95 year old is able to access more of their home value, but their maturity, then typically, they’re in the unfortunate death, or the choice to sell the house to move into a retirement home occurs earlier than, say, somebody who’s 65. You then get this portfolio construction of my diversified longnecks.

Robert Leonard  16:55

So you’re one of the guys behind the A3 Alternative Credit Fund, which launched back in October of last year, and it’s traded on the NASDAQ under ticker AAACX. The fund has shown strong performance through the economic and public health crisis that we’ve been experiencing, which is rare for income funds. What do you attribute this to?

Gregg Bell  17:15

I would say it’s the unusual, unique value drivers that we’re focusing on. Those being things that are away from what is driving market narrative broadly in other asset classes. It’s hard to find an investment thesis that doesn’t involve the words Fed policy XYZ in today’s market.

We try to avoid that because hopefully, what the Fed does with rates doesn’t affect a senior citizen’s life and doesn’t put their life in jeopardy. The cash flows from reverse mortgages, as an example, are really based on the long longevity of the borrower.

And so, if they die, that’s unfortunate. That’s a cash flow event. We actually benefit from longevity.

I like being on the reverse mortgage side these days versus the life settlements where I started my career because of the life settlement space. That was more life insurance policies where you’re profiting off death, which I prefer, profiting off the longevity, which we see this product, but it’s unique.

It is the finding of drivers like insurance, taxation power, like demographics, that can be an investment thesis, rather than a PE multiple of a stock or business model. It’s a niche market.

Robert Leonard  18:35

The fund has also had relatively little volatility during the last six months of turbulence that we’ve seen, with your credit fund only dropping about 6% or so from late February to late March, mid March, late March, when we saw the S&P down about 30% or so what about the credit fund causes it to be more stable than other financial instruments? Do you expect this to continue into the future with this type of fund?

Gregg Bell  18:59

The fund was quite a bit in the early part of the year over 10% and that cushions some of the pullback that we saw in March and kept us positive year to date. We’re up double digits and are currently outperforming the S&P 500 with a fraction of volatility.

I think that has to do with the income and the value being driven from the coupon or yield of the portfolio rather than the appreciation or depreciation of the assets themselves. So it’s a different type of investing, you’re investing really in the cash flow rather than a speculative position on the value of the asset itself.

Central banks are here to really have been quite successful in calming the market volatility that has been driving this financial asset recovery, but it’s just in such far contrast to what we’re feeling in the real economy that continues to be in contrast to unemployment figures. It continues to be in contrast to delinquency data for loans.

I worry about the confidence level it feels like markets are at this point of having high confidence and moments of overconfidence rarely and gracefully. That’s where I find there to be comfort in a portfolio that is highly rated.

In our case, we have over 90% of our investments that are triple A rated, so we move up in credit quality and that helps to reduce a lot of the volatility throughout cycles that isn’t fully insulated.

However, the fact that the return is really that cash flow basis, we try to target a double digit cash yield and cash flow and that helps to stabilize the portfolio over time.

Robert Leonard  20:45

It’s often said that more risk equals more reward and while I don’t necessarily agree with the idea that volatility is risk, it’s often used as a measure of risk. Is the lower volatility that your fund has had recently indicate that there may be lower reward or lower upside in the future?

Gregg Bell  21:04

It’s difficult to predict the future, of course, but I can tell you that few investors have exposure to these types of national investments. I really think they should, there’s very little correlation to traditional indices and that as a diversified and total portfolio has great benefit.

I worry about the comfort in sort of false diversification where a lot of investors buy bonds. When I say bonds, generally you’re talking about the big asset classes, the treasuries and mortgages and, and corporates and, of course, they all act differently in different environments, but they’re, in many ways, a hedge or viewed as a hedge to equities to try to balance the portfolio.

What we have seen, we certainly saw in marches, that there can be periods of high correlation just when you need that hedge to occur, and all of a sudden, everything is moving down in tandem. When you position a portfolio that has value drivers that are that are unique, then, oftentimes you’ll find that the volatility and the cash flows are also unique.

That causes low correlation that also helps stabilize and we’re not buying deeply discounted investments and hoping that they return to power buying investments that are performing that our government guarantees, and that we hope will meet our target yields. It’s an analysis around prepayment, or analysis around mortality, and life expectancy, which are risks that in many ways are more actuarial in nature.

And so, that provides a cushion and we try to target the yield of the coupon. So if we’re able to drive our return based off of the coupon, then there might be further upside as you’re reselling those assets or trading those assets into the future.

It’s a different framework, I think, than a position where an equity type of investment that doesn’t have the cap upside, that a credit investment passes.

Robert Leonard  23:11

I’m no actuary by any means, but when I hear that your portfolio is so driven off of mortality rates and life expectancy and things of that nature. I’m a bit surprised that the current crisis that we’re experiencing hasn’t added more volatility to your product specifically, you know, maybe if the housing market crashed, that wouldn’t impact you guys as much, because that’s not necessarily impacting life expectancy.

But when we have a public health crisis, like we’re experiencing right now, that is directly impacting people’s life expectancy, I mean, that’s probably bringing down people’s life expectancy, especially it’s impacting the older demographic more. So I’m curious to see why you think that might not have impacted your fund, if that’s potentially impacting your actuarial tables and things of that nature.

Gregg Bell  23:53

Right, you think about who is most at risk with COVID-19? It’s seniors. I think what’s unique here is that the reverse mortgage product is designed for those that want to stay in their homes and live in their homes rather than move to retirement communities. As a result, that is social distancing.

To begin with now, there has been an uptick in mortality as a result of COVID. But there’s more stability and historical reference points that we can rely on and use as a valuation metric. That’s where these probability weighted scenarios come into play.

What is the probability of a certain spike and in certain age groups or locations and things of that nature and it’s a highly uncorrelated factor? So it’s a unique experience and stress that this portfolio on this particular product has undergone this year.

Robert Leonard  24:59

AAACX sounds like a pretty unique fund. I know it’s not an asset that I’ve heard a lot of people invest in. Also, you mentioned that not a lot of people invest in it either. So where does it fit in an investor’s portfolio? Who is this type of investment or fund best for?

Gregg Bell  25:13

Institutional investors have a lot of access and a variety of different solutions to solving this income problem that we’re addressing. Mostly those come in the form of hedge funds or PE funds that have restrictions related to net worth, capital lockups, and generally are opaque type structures.

So we’ve tried to create a product that is more accessible, that is able to be invested without accreditation, and has a ticker, it’s through a closed end fund structure called an interval fund. This is a type of product that is becoming more and more popular, it provides a means to access our sort of mix of public and private investments in a daily valued transparent vehicle with current pricing, but it also has a quarterly liquidity.

So currently, we make available 10% of the funds assets to attend or offer to investors. There’s somewhat of a locked up capital and that allows us really to invest in these types of products that are generally longer in nature. So it’s not your money market fund as an alternative, but it is a really unique and what I believe it value asset within a broader portfolio of an individual’s makeup.

Robert Leonard  26:49

So since AAACX has traded on the NASDAQ, can someone just log into their brokerage account and invest in the fund? If not, how can an investor invest in a fund like this?

Gregg Bell  27:00

As an entrepreneur building these new products, we put a lot of thought into what was the right format to use to take this strategy and bring it to the market. What I found was, there’s lots of walls that are up in our financial system. And so, depending on who you use as your broker and whether you use an investment advisor, you may be able to invest in it directly. That will hopefully increase over time as we get on more and more platforms.

However, today, there are some limitations. So if you’re interested in buying, and are having any problems, please reach out to us at our phone numbers 303-997-9010, you can email us at IR@A3.financial, or we’re in Denver, Colorado. So if you want to come by and have a conversation with us, we’d be happy to talk more about any credit products.

Robert Leonard  27:53

I’ll be sure to put links to phone numbers, email, website, everything in the show notes. So for anybody listening wants to contact based on that info, you can find that below in the show notes.

As we wrap up the show, Warren Buffett is famous for recommending investors focusing on and really only investing in things that are within their circle of competence. This seems like it could be outside a lot of people’s circle of competency, I’d probably have to study it a little bit more before I was comfortable to invest in it. And before it was within my circle of competency. So how can an investor become comfortable with investing in a security or fun like this?

Gregg Bell  28:29

I think it’s true and it’s interesting because for us, the AAACX is specifically designed to be non-traditional. That’s what I’ve always done in my career and found success. And so, being contrarian, and that’s where a lot of the value drop hidden is within the portfolio and within the securities. It’s not your grandparents’ bond fund. But it is an income fund that is designed to profit from your grandparents longevity, and demographic trends and taxation.

There are plenty of research materials that we make publicly available on our website that is or walks you through our process and how we look at our each of our investments because it’s about having an investment thesis, testing it, seeing how it performs over time stressing that thesis and saying under these various scenarios, how does this perform? Does this protect your investment? Does it provide the income stream that we anticipate and if not then reassessing that over time and reassessing the probabilities?

In today’s environment where there’s so much uncertainty, so much stress on cash flows from consumers to businesses, I think the downside probabilities and credit and loans and debt products generally have become unfortunately all that more likely. And so, it’s important to be comfortable with up the credit protections that are there and that’s where we like to have that asset that can be sold, or we like to see, you know, some structure or some sort of guarantees, whether it’s individual or from the federal government that provide greater assurances that we’re going to receive our money back when we expect it.

Robert Leonard  30:16

I think reading those research reports and understanding the thesis behind these investments will be super helpful for people listening, who are trying to understand this better. I know I’m going to go read them and see if I could add this type of investment or alternative asset to my circle of competency so I could look into potentially investing in it.

So where might somebody listening today be able to go and find those research reports?

Gregg Bell  30:35

Our website is a great source A3.financial, that’s the website, and you can reach out to us and we’re happy to direct you in other ways. I encourage all of your listeners to look for the stones that haven’t been turned over, because the investment universe is really, really very broad. There’s so much more than just stocks and mortgages and treasuries out there that can provide a lot of value and a lot of diversification.

Frankly, it’s a lot of fun to learn about and explore because you’ll be amazed at the creativity of investors and how people seek to make money from a cash flow.

Robert Leonard  31:14

I know a lot of the audience here likes to dive into these types of things and likes to spend the time researching. I’m sure they’ll get a lot of value and just probably honestly have a lot of fun from reading these reports and learning something new about an investment product that they never heard of.

It’s interesting, because you talked about how big the bond market is and that even doesn’t really get that much coverage on financial media or news outlets. You don’t see it that often on CNBC. It’s pretty much all equities. That’s the exciting, sexy part of investing.

So it is really interesting to have this conversation about an alternative asset and even have the opportunity to go learn about it. I’m thankful that there’s these publicly available resources that we can go learn and understand the thesis behind.

Gregg, thank you so much for providing those resources and for coming on the show and providing a bunch of great information.

Gregg Bell  31:56

Absolutely. It’s a lot of fun.

Robert Leonard  31:58

Alright, guys, that’s all I had for this week’s episode of Millennial Investing. I’ll see you again next week.

Outro  32:04

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