Where wealthy clients are stashing their cash

Robert J. Frey, a former managing director at hedge-fund firm Renaissance Technologies Corp., is trying to preserve his wealth by taking on moderate risk and investing in international bonds. “You have to branch out now and be opportunistic in this low-rate environment,” said Frey, 56, who runs Frey Quantitative Strategies, an asset-management firm, and splits his time between London and Port Jefferson, New York. “But you can't be overconfident and take on unacceptable levels of risk to hit home runs.” For U.S. investors looking for yield, advisers are recommending investments in international bonds, non-agency residential mortgage-backed securities, bank loans and master limited partnerships. They may offer investors yields ranging from 6 percent to 10 percent. Since these investments are complex and come with liquidity and credit risks, they're most appropriate for high-net-worth investors who work with experienced managers, according to Alan Zafran, co-founder of Los Angeles-based Luminous Capital, an investment advisory firm that manages $3.5 billion for about 250 families. These “pockets of opportunity” are integral to a portfolio now because the more traditional ways of maintaining wealth, including U.S. fixed-income investments, money-market funds and savings accounts have such low rates, Zafran said. ‘Going Backward' U.S. 10-year notes, which fell to a 19-month low of 2.42 percent Aug. 25, were yielding 2.56 percent as of Sept. 23 and 2-year notes were yielding 0.42 percent, according to BGCantor Market Data. Money-market funds, which are sold by brokerage firms and aren't backed by the Federal Deposit Insurance Corp., were averaging 0.04 percent as of Sept. 21, based on data from iMoneyNet Inc., a research firm in Westborough, Massachusetts, which tracks money funds. The average interest paid on savings, checking, money- market and certificate of deposit accounts fell to 0.99 percent in July, the first dip below 1 percent in a decade, and declined to 0.92 percent in August, according to researcher Market Rates Insight in San Anselmo, California. That means some investors are being pushed out of their comfort zones “to counteract the motion of the train that is holding their cash going backward,” even if they're still scarred by losses from 2008, said Michael Sonnenfeldt, a founder of Tiger 21, which is a New York-based peer learning group of 140 members, most of whom have a net worth of at least $10 million. Interest rates won't rise until a year from now, which makes these investments attractive in the longer term to investors willing to accept the credit risks, said John Lonski, chief economist at Moody's Capital Markets Group in New York. Dollar Hedge For Frey, the former hedge fund managing director, bonds from Norway, New Zealand, Canada and Brazil denominated in foreign currencies offer attractive yields as well as a hedge against the U.S. dollar. He said he prefers bonds from countries that have good debt to gross domestic product ratios and are commodity-based economies. Retail investors may have to pay more than institutions for the bonds and currency conversions when purchasing the bonds directly, so they should invest in funds with strong performance records, such as the Templeton Global Bond Fund, which has returned 11 percent this year, said Zafran of Luminous Capital. T. Rowe Price U.S. Treasury Intermediate Fund has returned 9.9 percent this year. U.S. investors added $2.65 billion to world bond funds in August compared with $2.21 billion in July and emerging market bond funds had $1.11 billion in inflows, based on data from Chicago-based research firm Morningstar Inc. Brazil Bonds Some Brazil and Australia bonds are attractive because those countries' currencies should appreciate longer term against the U.S. dollar, said Charles Ryan, a partner and portfolio manager at New York-based Evercore Wealth Management LLC, which buys individual bonds directly for clients' portfolios. Evercore Wealth Management is a subsidiary of investment bank Evercore Partners Inc. International bonds generally comprise as much as 15 percent of the overall 50 percent allocation of clients' portfolios to bonds, said Ryan, whose firm has about $2 billion in assets under management. He said they select bonds that typically have maturities of 4 years to 5 years and are yielding from 7 percent to 9 percent. Non-Agency Opportunities The $1.4 trillion market for non-agency mortgage securities, which lack guarantees from government-supported Fannie Mae and Freddie Mac or the federal agency Ginnie Mae, offers yields of 6 percent to 10 percent after projected losses, according to a Sept. 17 note by JPMorgan Chase & Co. analysts. Although there are significant credit and liquidity risks, the inefficiency in the market creates opportunities for skillful managers, said Darell Krasnoff, managing director of Bel Air Investment Advisors in Los Angeles, who counsels clients with at least $20 million in investable assets. The best way for investors to buy non-agency debt is by investing with a manager in a fund that is buying these securities such as Angelo Gordon & Co. in New York or San Juan Capistrano, California-based Rimrock Capital Management LLC, and they should focus on bonds with durations of no more than three years, said Zafran of Luminous Capital. Agency mortgage-backed securities aren't as attractive because of lower yields. They're also more likely to be affected by government policies on standards for refinancing by homeowners, which could make agency bond prices decline, Zafran said. 25% Return Further Lane Securities offers managed accounts investing in these securities for high-net-worth investors that contain a mix of high-grade residential mortgage-backed securities and lower credit issues, according to Jim Midanek, portfolio manager and head of research for the New York-based firm. The accounts have returned 25 percent since November 2009, Midanek said. Los Angeles-based TCW Group Inc. also offers investors non- agency mortgage-backed securities through separate accounts and other investments including the TCW Total Return Bond Fund, which allocates about 35 percent to this type of investment. The fund's N share for retail investors has returned 9.7 percent this year and has a minimum investment of $2,000 and an expense ratio of 0.74 percent. Interest Rate Hedge Leveraged loans, which are syndicated business loans to non-investment grade borrowers, are generally floating rate securities with maturities of 5 years to 7 years. If properly managed, they can offer investors about 6.5 percent yield, said Sam Katzman, chief investment officer of Constellation Wealth Advisors in New York, whose clients have a minimum of $10 million in investable assets. The loans are typically secured by all of the assets of the company. Inflows to bank loan funds, which are pools of short-term leveraged loans, were $432 million in August, Morningstar said. They provide an interest rate hedge because if rates move higher, the coupon also will increase. Prices on many of the loan portfolios have remained stable, and typically account for 3 percent to 5 percent of an investor's portfolio at Evercore, Ryan said. Eaton Vance Floating Rate Fund, which has returned 5.7 percent this year and comes with a sales fee of 2.25 percent and expense ratio of 1.12 percent, and Fidelity Floating Rate High Income Fund, which has returned 4.4 percent and has a 0.75 percent expense ratio, are the top fund picks in this category by Morningstar. Pipeline Investments Master limited partnerships typically are organized around energy and natural resources. They invest in assets ranging from pipelines to ships transporting commodities and are traded on exchanges such as the New York Stock Exchange or Nasdaq. The yield on the Alerian MLP Index, composed of about 50 of the 90 publicly traded partnerships, is about 6 percent. Investors are pouring into energy-related MLPs, increasing their market capitalization 20 percent as of July to $183 billion from $152 billion in 2009, said Michael Blum, a managing director at Wells Fargo Securities, a unit of San Francisco- based Wells Fargo & Co. The yields, quarterly distributions, which are similar to stock dividends, and tax-deferrals on most of the income received make them attractive to wealthy investors. The benefits of investing in these partnerships coupled with low interest rates has made the space “somewhat overcrowded leaving us very selective,” said Ryan of Evercore. Risks of investing in MLPs include a lack of liquidity because a few trade below 100,000 units a day, said Mark Easterbrook, a Dallas-based analyst with RBC Capital Markets Corp., who covers the group. Another is share volatility, especially partnerships whose income relies on commodity prices rather than fee-based contracts for transporting them. Hunkering Down “I think people are making a mistake in how they're trying to be defensive and only staying in high-quality munis and Treasuries,” said Krasnoff of Bel Air Investment Advisors. “They think they can hunker down and be safe, but they may get a big surprise when they see the purchasing power of their wealth declines because of dollar deterioration.”