The Holy Grail of Private Funds with Tyrone Shum

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The Holy Grail of Private Funds with Tyrone Shum Freedom Warrior
Tyrone Shum and I are back together chatting about all things investment and alternative investment. In this week’s episode, we cover private funds and how I discovered this investment strategy.

Private funds differ significantly from the funds that trade on the stock exchange (i.e. real estate investment trusts and funds). They’re different because they’re usually run by professional investors who have specific access to a particular type of deal or strategy – deals that are out of reach of most regular investors.

We cover:

– different types of funds,
– how I got investing into a private fund,
– why very few people explore private fund investments, and
– why I love the alternative space.

Show Notes:

00:00:00 – Intro

00:02:18 – Salena’s First Experience Going Into a Private Fund

00:03:04 – The Concept of Funds

00:04:34 – Types of Private Funds

00:05:09 – How Salena Discovered her First Private Fund Investment

00:06:14 – Are Private Funds Meant to be Regulated?

00:08:13 – Salena’s Private Fund

00:09:52 – Why Few People Invest Into Private Funds

00:12:23 – Finding the Right Private Fund For You

00:14:59 – Why Salena Went Into a Particular Fund

00:18:40 – Why It’s Challenging to Set Up a Fund in Australia

00:22:43 – Why Salena Loves the Alternative Space

00:24:13 – How Private Funds Obtain Wealth

00:26:25 – What Percentage Do You Get Back?

00:28:03 – Is There a Minimum Timeframe to Be in a Private Fund?

00:28:44 – Are Private Funds More Suitable for those nearing Retirement?

00:31:17 – Outro

Q: Can you talk a bit about your first experience of investing in a private fund?

  • Discovering the world of private funds has been the Holy Grail of my discoveries. It’s been the vehicle that has allowed me to access more excellent opportunities but that are run by experienced investors.
  • So there’s a huge “sleep at night” factor because these experienced investors do a far better job of asset selection than I could ever achieve on my own.
  • So I get amazing opportunities, and I can leverage other people’s “genius.”

 

Q: Could you explain what funds are and how you essentially found them?

  • I started investing in this sort of stuff in 2009 and got plenty of cuts and bruises along the way. And then as you become more experienced around how these things work and you know what questions you need to ask, you just start to meet good people, and then good people introduce you to other good people. It then becomes easy to distinguish between A-grade players and B-grade players.
  • The essence of a private fund is that there’s a group of investors that work with a fund manager (or sophisticated investor). And instead of investing in a single asset, the group can acquire a series of assets.
  • The assets can range from apartment complexes and single residential family housing to storage facilities, landing banking, business loans secured by real property and purchasing debt or lending as a concept.
  • So, there are so many permutations.
  • Part of the challenge for me at the beginning was making sure that I fully understood the fund manager’s strategy and making sure, from a risk point of view, that it was palatable for me.

 

Q: Are there different types of funds?

  • Private funds can exist across the spectrum. For example, there are private funds that focus on investing in small-cap businesses.
  • I tend to lean into the private funds that are backed by real estate.
  • But yeah, there are far more private funds than just property investment types of funds.

 

Q: How did you come across the first private fund that you invested in?

  • A few years ago, one of my mentors invited me to come and spend some time with him and his clients. During that time, I recognised that there were a lot of people leaning towards these private funds because there was access to epic deal flows.
  • Truthfully, I could never fund these deals on my own, nor would I have the inclination to build the network needed to find these kinds of deals. But, through the private fund, I could still participate in these types of epic deals.
  • And over the last ten years, I have realised that private funds, syndications and joint ventures are the playgrounds for super high net worth individuals and families who want premium returns without having to spend all day figuring it out themselves.
  • So, the world of private funds for me has opened up and cemented the idea that it’s not what you know; it’s who, you know.

 

Q: Do private funds need to be regulated, or can any experienced investor set up a fund?

  • So, these funds aren’t listed on stock exchanges, and they’re only allowed to carry a certain amount of capital – I think it’s up to $100 million.
  • There’s regulation regarding how they report, what kind of investors they’re allowed to work with and so forth.
  • They have to create a private placement memorandum which is effectively an overview of how they charge their fees, how the fund is structured, what they invest in and what strategy they’re using. This way, investors can get some insight into what the fund is all about.
  • But, because they sit below the real estate investment trusts that trade on the Stock Exchange, they can be a lot more nimble in the way that they deploy capital. So, that’s why they get better returns.
  • One of the problems with the real estate investment trusts that trade on the Stock Exchange is they’ve got such huge amounts of capital, but they don’t have the infrastructure and administration to break that up into lots of micro deals. They’re just looking for a few deals to throw their money into – and the returns on the huge deals are much more capped.
  • So, what excited me about the private fund space is that, depending on the fund and its goal, they can buy individual houses, apartment complexes and all sorts of different assets that big fund managers would overlook.

 

Q: What kind of fund have you invested in?

  • I love that you can put a bit of money into different funds – so that’s what I’ve done.
  • What’s interesting about these private funds is that you can invest a minimum amount of $100 with a 10% net return – depending on the fund’s mandate and who’s running it. With other funds, the minimum amount may be $250,000.
  • There are also funds where you only have to commit for a year and others where you have to commit for ten years.
  • So, there are many permutations out there.
  • But, what I love about funds is if you’re an investor who doesn’t have the bandwidth to deal with the day to day management of investments and want to be a professional investor in a more passive way, private funds lend themselves beautifully to that sort of thing.

 

Q: So, how come many people don’t jump into these kinds of funds?

  • Well, I have one foot in the Australian investment market and another foot in the US investment market. And from a private fund perspective, Australia is nowhere near as evolved as the States.
  • People don’t do it because they don’t know about it.
  • When you talk about funds to the average Australian, they’re thinking of managed funds – where, to be honest, the results are quite boring and uninspiring. And even if the managed funds generate a good result, the focus isn’t necessarily cash flow.
  • Whereas with the funds that I invest in, the focus is predominantly on a cash flow strategy.
  • There’s one fund that I invested in that had a very diversified approach – it invests in projects which deliver income and projects that create forced appreciation. They have a minimum commitment of $100,000, and they invest in things like loans, flipping projects, commercial debt, equity investments and multifamily self-storage – there’s a whole range of things.
  • What they’re trying to do is offer investors an overall return of 10% to 13% net per year. And I have good downside protection inside the fund because I’m getting a 7% return before anyone else gets paid.
  • So, as an investor on the journey to developing annuities and consistent, predictable income, I think funds are a great vehicle.
  • The big challenge is finding the best private funds out there because there are hundreds and hundreds to choose from.

 

Q: So, what is your approach to finding the right fund?

  • Before you invest a dollar into anything, you have to have a crystal clear understanding of what you want to get out of the investment.
  • I’ve met so many opportunistic investors who end up with a mish-mash portfolio because they never took the time to establish what they were trying to achieve.
  • I would suggest breaking it down into two or three concrete things like X amount of passive or Y amount of equity.
  • And then, secondly, you need to invest in something you understand. For example, I think many of us, including myself, jumped into Bitcoin without knowing what it’s all about. But for me, education is number two! If you’re happy to take a gamble on an investment, then great – go for it.
  • So, number one: identify what you want. And number two: educate yourself on what’s out there and make informed decisions.
  • For example, you’re not going to start chasing strategies that deliver cash flow when you have no capital. You have to get your foundations right, and the Australian market lends itself beautifully to that.

 

Q: What was your attraction to the private fund you’re currently investing in?

  • I went into this particular fund because I loved the fund manager – he was all about adding value and helping you become a better investor.
  • I’d never heard anyone speak about investing the way he did – he was so clinical about it, and there was no emotion around the way he allocated capital. But he gave a huge amount of consideration to each acquisition. Whether it was a $70,000 investment or a $7 million investment, the thought process and mechanics were the same.
  • So, part of the journey is getting into the heads of these fund managers and understanding what they are thinking.
  • If a fund manager isn’t able to articulate their asset selection criteria, that’s a bit of a red flag for me.
  • You also need to establish how they structure their fees. For example, do you, as the investor, get paid first? Or do the fund managers get paid first?
  • Around 2010, someone approached me because they knew I was interested in these kinds of investments, and they asked me to be the face of their fund. I couldn’t believe the way that they had developed this prospectus – all of their fees were hidden.
  • For me, I want complete transparency about how the fund makes its money.
  • You want to see fund managers make a tiny bit at the front and then get paid at the back end – same as us. So many funds don’t work like that, and the fund managers take a huge clip upfront for just securing the asset.
  • Good fund managers will understand that the investors are taking risks, so they need to be cared for first.
  • So, that’s a big consideration for me.
  • And if your fund manager isn’t investing alongside you, they can’t believe in their own product.

 

Q: What are the challenges that come with registering a fund in Australia?

  • There are definitely massive issues around compliance, reporting, and making sure that you’re doing the right thing in ASIC and all the regulatory authorities.
  • I have had a few people approach me and wanted to give me money and have me set up a fund because they weren’t interested in learning about all the “stuff” that goes into it.
  • But for me, if you want to build real wealth that will last beyond your own existence, you have to learn how to fish – you have to learn this stuff.
  • If you put your faith in somebody else, you’re immediately diluting the impact that you can achieve.
  • Plus, there’s no way I would ever want to make investment decisions and carry the weight of that burden for somebody else.
  • There are plenty of funds in Australia, and I get approached all the time to put forward my clients. But it takes me a while to build trust.
  • I’m very slow to put anyone as a trusted advisor in front of my clients.
  • The other thing I want to add is that I’m not putting huge amounts of money into any single investment when it comes to the alternative space. One of the reasons I love the space of alternative investing is that your capacity to truly diversify is immense.
  • You can put small amounts of money and small amounts of capital with 15 to 20 different dealmakers and advisors who are in different geographic locations, have different investment strategies, and different liquidity points. If any of these assets fell over, I’m not going to die in a ditch.
  • As much as I love Australian property, you end up putting a huge amount of capital in and just hope that the asset moves in the right direction.
  • So, I love private funds because you’re giving small amounts of money to lots of different people.

 

Q: How does the fund you’ve invested in now make money?

  • They invest in all different things.
  • There’s often a quarterly update, so I can see what projects are on the go at the moment.
  • This particular fund is always aiming to get a net return to investors of 10%to 13%. However, during 2020, it dipped a little below that – only because they took a more defensive approach and didn’t put as much money.
  • But in terms of how they make their money, they have a management fee and then when the projects generate cash, or as the assets are sold, the profits are split between the fund manager and the investors.
  • I’ve done the math on some of the better funds that I work with, and to be honest with you, it’s not a super lucrative game for them.
  • They’re all investors themselves, and it’s a relationship that’s mutually beneficial, but they need us less than we need them.
  • In this particular fund, there’s a performance split. Each investor gets a minimum of 7%, and then after that, there are different classes of shares depending on how much money you put in. So, generally, on a profit share basis, it might be an 80/20 split, meaning 80% of the profits come to me as the investor, 20% to them. Or a 70/30 split.
  • They call that the waterfall and good fund managers will stack that in the investor’s favour.

 

Q: Can you go into a little bit more detail behind that? When you say a 60/40 split, and you’ve invested say $100,000 into it – does that mean that 60% would go back to you and 40% will go back into the fund?

  • Yes. So, the first 7% of all the profit for the year comes to me.
  • After that, the profit on my share would be split 60/40.
  • So, I have the sense that I’m aiming for 10% to 15% net return per annum, but sometimes it’s above that, and sometimes it’s below that.
  • This fund is an interesting one, though, because whenever you’ve got a diversified fund that has income and growth, the growth assets are going to slow down the returns.
  • If you go into a pure income fund, then your returns are much steadier. If you go into a growth fund, the fund manager will return capital to you at the end of the deal.
  • So, you’ve got to understand the fund that you’re getting into, to get a sense of what your returns are going to be and when you’re going to get them.

 

Q: How long do you have to be in these funds? Is there a minimum time frame?

  • Most funds have a minimum time frame.
  • I tend to lean into the ones that have a 12 month to five-year time frame.
  • Some funds run for ten years and also some funds that let you exit with 90 days notice.
  • When I’m helping people figure out what will fit them, I establish what they need and then marry that with the opportunities.

 

Q: Would private funds be more attractive to people who are nearing their retirement?

  • I don’t think it’s an age or retirement thing; I think it’s a “stage of life” thing.
  • So, if you’re someone who likes the idea of having a very high income outside your business, then you could start doing this in your 30s.
  • It could be a retirement thing. But, if you’re someone who’s got a reasonable asset base behind you and you just want to start ramping up the income, then you could start.
  • I think it’s crucial to be thinking about another income stream at every stage of life, but it needs to be a viable option for the stage of life that you’re in.
  • But I think who could complain about an income stream that comes from somewhere else and gives you a plan B? Because that’s really what it is.

 

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