Anthony Speciale Stock Market Analyst

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The Under the Radar Income Strategy You Need to Know About

I read all of the stuff the big private equity firms put out, as they’re on the front lines, so to speak, of the markets, the economy and valuations. If you have an idea of what they’re doing with their cash, you get a better idea of where to look for bargains.

KKR & Co. Inc. (KKR) has been doing this since 1976, with returns of over 25% a year on their funds, so if they’re moving in a certain direction, you want to pay attention.

Now, KKR just had their third annual interview with the chief investment officers of insurance companies to see what they’re doing with the trillions of dollars of wealth they have under management and what’s going on in their industry.

And in their report, titled Dream Big, KKR sees the insurance industry as being a lot like the banking industry. There are a lot of players, but most of the business is going to larger companies, and the competitive advantage belongs to larger companies because they can spend more money.

They have more assets under management bringing in more fees, they can spend the money on digital technology and automation and they can gain access to better investment talent because they can write bigger checks. So, they have all sorts of advantages.

Now, here’s the truth about the insurance business… The only real way to grow in the insurance industry is to acquire other insurance companies to gain those accounts. There’s almost no way to grow earnings at a pace that Wall Street’s going to find acceptable except to do deals and make acquisitions.

That opens up some avenues of opportunity for us, just like it has in the banking industry. The insurance industry is not that far along, but it’s going to happen. We’re going to see consolidation continue to move across both the property and casualty and life insurance industries.

The other thing that the insurance companies need to do is invest with a longer-term eye on some of the bigger trends out there. You want the tailwinds from things like artificial intelligence, energy transition, infrastructure development, etc.

So, we’re going to see takeovers in the insurance space, and we’re going to be watching that very closely. But when it comes to their investment portfolios, it’s getting a little tricky.

KKR also released a five-year forecast of their returns, and they’re a bit better than some of the ones we’ve seen, but they’re still not great. However, their macroeconomic team has been very accurate with their forecasts.

They’re saying that most traditional investments are not going to perform well over the coming years and that alternative income strategies are really the way to go.

Dream Big or Go Home

We can replicate what these insurance companies are doing, and we actually have a massive advantage over them. We do not have to keep a lot of cash on hand to meet claims that are going to need to be paid out over the next several years. We can commit all of our income capital to higher-yielding alternative income situations.

My favorite alternative income plays right now are in real estate credit and commercial mortgage REITs, and my favorite company in that space is Apollo Commercial Real Estate Finance, Inc. (ARI).

These guys are affiliated with Apollo Global Management, Inc. (APO), which is one of the largest private equity and alternative investors in the country. They are also very large real estate and private credit investors. They know the real estate space and the lending space, and they know every deal-maker on the planet, which gives them a huge advantage.

Now, ARI is a little bit different in that it has 40% of their portfolio invested in Europe. I really like that because Europe is running a few years behind the United States, as far as the expansion of the economic cycle, so I think that property loans in Europe are going to do very well as the European economy recovers.

They do have a lot of exposure to hotels and offices, but that isn’t such a big deal. The loan to value measure is at 61%, so the portfolio has to drop dramatically in value before Apollo even thinks about taking a loss on the loan.

The loan to value is low enough that these properties can decline by a huge amount before the lender needs to worry about it. The buildings can be repurposed or even sold in most cases for more than we actually lent on the property in the first place.

With a solid portfolio trading at about 90% of book value, we’re getting a 9.6% dividend yield. There’s upside to a slight premium over book value should rates continue to hover around current levels.

A lot of the loans are floating-rate, so we don’t have to sweat rising interest rates too much, and most of the loans are also first-mortgage loans, the bulk of the portfolio, so we’re in a pretty good position if something does go wrong.

So, ARI is safe, looks fantastic, generating a very attractive yield, it’s an alternative to traditional income investments, it’s earning a much higher multiple and you do have some upside over time.