John Mauldin continues his 'Train Crash' series, by discussing more specific strategies that can be taken to cope with the forthcoming 'Great Reset'

John Mauldin continues his 'Train Crash' series, by discussing more specific strategies that can be taken to cope with the forthcoming 'Great Reset'

By John Mauldin*

We are all on a debt-filled train that is eventually going to crash, and if you are on it, it won’t stop to let you off first. Jumping at the last minute is not a good option, either. So what do you do? You take action now, while you have time.

Last week I gave you some rules to follow with your investments. They were necessarily general because I’m writing to a broad audience. Today, I will get more specific by discussing some possible strategies for high-net-worth “accredited investors.”

(You can catch up on all of the 'Train Crash' articles here)

However, you should read this important information even if you aren’t wealthy. You might get there someday and it will help prepare you for it. “Someday” could be sooner than you think, too. The Great Reset will rearrange much of the world’s wealth and some people will see their financial condition change quickly, either for worse or better. There will be some enormously positive opportunities.

And as we will see, many strategies that are currently available only to accredited investors are slowly showing up in lower-cost, publicly accessible ETFs and other instruments around the world. There is truly a fintech-driven revolution going on in the financial industry. For we who make our living in that world, the changes seem to intensify almost daily. 

The broader point: Whatever our current circumstances, we can all do things to prepare for the radically different world I think will unfold in these years. You need to make the most of what you have. I want to help by meeting you where you are. Fortunately, I have multiple ways to do that, as you’ll see below. Stick with me and we’ll get through this together.

Take a Deep Breath: It’s Going to Get Better

Now, I know I have used a train wreck metaphor for this series. That sounds pretty bad, doesn’t it? And the portfolios of most investors truly will look like they have gone through a train wreck. But you don’t have to be one of them.

The world itself is not going to be a train wreck. The world will be much better in 20 years, and in many ways even in 10 years.

  • We will still be eating—both going out and cooking in—and that means there will still be agriculture and ways to bring that food to you. Now, the way your food is grown and harvested and delivered to you may very well change. That will happen in the background. You just want your food to show up when you’re hungry, be well prepared, taste fabulous, and keep you healthy.
  • We will still get together with friends. Travel will be easier, communications will be cheaper and faster and better.
  • I can’t even begin to explain how much better healthcare and biotechnology will be. I’m willing to bet a considerable sum that cancer will have been reduced to a nuisance in 10 years, but I really think it’s more like five years. Other mind-boggling treatments are coming. Nobody will want to go back to the good old days of 2018.
  • We will have fantastic investment opportunities in this new world. There will truly be massive fortunes made and you will have the chance to participate. And while I’ve talked about the disappearance of many jobs, most workers will adapt and survive. New jobs will appear, although some of us old dogs may have to learn a few new tricks.

In short, I am an optimist about the future but a realist about our portfolios. Business (and investment) as usual is not going to cut it. If you are holding the traditional 60/40 portfolio, thinking it will get you to the other side of The Great Reset, I think you will be disappointed.

My goal—and it is a deeply personal, almost spiritual quest—is to help my friends and readers reach that brighter future with their spending power intact in a very tumultuous economic and financial world.

Let me put it this way. Imagine I had come to you in early 1929 and told you about the Great Depression. If you believed me, you would have changed your life and your investments, preparing to protect your assets and take advantage of opportunities.

So I’m whispering now. Get prepared. We have time.

Too Much Protection

Ideally, the investment process for two otherwise similar people would be much the same whether each has a little money or a lot. The only difference would be the number of shares they own. Unfortunately, it is not that simple.

One reason: The government tries to protect small investors from making mistakes or being defrauded. That’s not entirely bad. I am actually a believer in financial regulation. Swindlers frequently prey on the uninformed and desperate. But in the US, our laws do it by making certain kinds of investments available only to “wealthy” people.

You may have heard the term, “accredited investor.” This means certain kinds of businesses, or individuals with:

  • Net worth over $1 million, excluding the value of their primary residence, or
  • Income over $200,000 in two of the last three years (or $300,000 with spouse) and reasonable expectation of same this year.

If you qualify by either of those standards, it is sort of like unlocking the next level in the video game your kids play. You can now enter new territory forbidden to others.

Note the assumption here: If you have this minimal amount of wealth or income, you are financially sophisticated and no longer need the kind of protection government gives the masses. This assumption is often wrong. We all know people who don’t have much capital or income but possess extensive financial expertise. There are also wealthy people who are, shall we gently say, naïve about money. Our regulatory structure gives too much protection to some and not enough to others. But it’s what we have so we must deal with it.

Behind the Door

So, what lies beyond the secret door that being accredited allows you to pass? Even those who qualify don’t always know. That’s because, in addition to forbidding banks and brokers from selling these investments publicly, the law sometimes says they can’t even talk about the investments publicly. Wealthy people often miss out on possibly great investments because they never hear about them. They, or their brokers and advisers, aren’t in the “deal flow.”

Some incredible deals (I see them all the time) actually aren’t that large, so the large “wire house” firms ignore them. They have so many brokers with so many clients, they stick with bigger offerings.

Regional brokers who can take the “smaller deals” are pretty jealous about their own deal flow. Many private deals are gobbled up by family offices and pension funds too quickly for the rest of us to get a chance.

As an aside, I’m a real fan of private credit and believe in the future it will be even bigger than private equity. Banks are being forced out of their traditional role of providing credit to businesses; and entrepreneurs are stepping in to provide it. Here again, access to deal flow is important.

The most common opportunities are in unregistered securities—shares of stock that don’t trade on exchanges and haven’t gone through the normal IPO process. An initial public offering is usually preceded by one or more private offerings in which wealthy investors can buy a company’s shares. Sometimes you hear about them because the companies are large and well-known. Uber, for instance, is a private company whose shareholders are all large investors and funds. They don’t have to file the kind of quarterly and annual reports required of publicly traded companies. Thousands of smaller start-ups have similar status.

It is not the case that all these companies are great investments. Many are not. But you can’t get to the attractive ones unless you are an accredited investor. Many gain exposure by investing in a venture capital fund, which gives you professional management and additional diversification. And diversification is important in these types of investments, as many fail and go bankrupt. Are Uber and Airbnb worth their last valuation round? I have no idea. We will find out one day.

Private equity is a similar category but typically involves more mature companies. You sometimes hear about a public company “going private” and delisting from the stock exchange. This usually means a group of investors bought all the shares, intending to restructure the business once it is out of the spotlight. You can be one of them if you’re accredited, either directly or through a private equity fund.

You really have to know who you are working with on private equity funds. Many use leverage that makes them riskier than they should be. These are for sophisticated investors who have deep pockets and even better advisors. There are as many varieties of private equity funds as there are breeds of horses, to use an odd analogy. But just as few of us would consider ourselves knowledgeable about horses, even fewer are knowledgeable about private equity funds. Don’t let your investment pay for your college tuition in private equity.

Hedge funds are another common accredited-only investment. The term is a bit misleading because many hedge funds don’t hedge. I prefer to call them “Private Investment Funds.” They work a bit like mutual funds, in that investors pool their money together under a professional manager’s guidance. But because the investors are all “sophisticated,” hedge fund managers have more discretion and far less oversight than mutual fund or ETF managers. That can be great if you are in the right one, but finding them is a challenge. I have spent much of my career helping investors do this and I still run across great funds I never knew about.

Full disclosure: somewhere north of 20% of my personal investments are in what is typically classified as hedge funds. I favour diversified trading funds and generally (though I’ve made exceptions) don’t invest in the classic Jones model “long/short” hedge funds today, because I think the alpha they once had has dried up for the time being.

Hedge funds (or whatever you call them) cover a bewildering range of asset classes and investment strategies. Someone out there has a fund doing anything you can imagine, in any part of the world you can imagine. Right now, it seems like everybody’s putting together new crypto currency hedge funds. Cannabis is hot (and for good reason). I have always liked “distressed” hedge funds that buy unwanted assets at ridiculously cheap (at least in hindsight) prices. A patient team of turnaround artists can unlock the real value. It is an art form and some of the most storied names on Wall Street are so-called grave dancers. But their clients are very happy.

I mentioned private credit above, but that was generally about smaller loans. Some large hedge funds are essentially banks and can do very large deals indeed. Typically, they use about two times leverage and your capital will have at least a three-year lockup period. Never invest in a private credit deal that offers deep liquidity but lends long term. The initial returns may look enticing, but if there is ever a “run” on the fund it can collapse overnight. The terms of the investment capital and the loans should be roughly equal. You don’t want there to be a recession where everybody starts trying to withdraw their capital, forcing your fund to sell loans at ridiculously low prices to those distressed debt funds.

While I can’t mention the fund’s name, a very large fund marked down their portfolio well over 20% during the last credit crisis, but not one client lost money. They were all locked up. By the time the crisis ran its course, the loans had regained their value and everybody got paid and made the returns they expected to begin with. Capital and credit were properly aligned.

This is why you need sophisticated advisors to navigate this world. It is not for rookies. While hedge funds can be rewarding, many are complete disasters. As they say on TV, don’t try this at home, boys and girls.

That being said, look for funds where management has an edge that is not correlated to the market. There are more than you might imagine. This is what I mean when I say diversify trading strategies, not asset classes.

Real estate is another investment area increasingly dominated by accredited investors. I like income real estate that is not loaded down with leverage. I don’t personally own any, although my wife owns a few rental homes in her hometown. I watch from afar, as dealing with renters and contracts and all that is just too much trouble for me. Then again, I know people who have made serious money by patiently buying and renting homes over decades.

I don’t want to write a book about hedge funds (I did that some 15 years ago). They have a lot of drawbacks and many are just asset-gathering schemes to make money for management. Fewer than 20% of the funds out there would make it through my filters, and a fraction of those actually get my approval.

Cracks in the Wall

As you can tell, the current situation makes investment planning a lot more complicated for those with substantial assets. You have more options to consider. But those same assets also let you hire expert advice, which is definitely a good idea. I think almost all investors should have one or more investment advisors. Plus, read all you can from trusted sources. 

However, in the bigger picture, investment democracy is trying to assert itself. Bankers and marketers are finding ever-more-innovative ways to make products available to a wider audience. Strategies once found only in private hedge funds now exist in mutual funds and ETFs anyone with a few thousand dollars can purchase.

We also see venture capital and private equity increasingly held within otherwise conventional mutual funds. Regulators permit it so long as these illiquid securities represent only a small portion of the fund’s assets.

I suspect we’ll see these moves continue and governments should actually encourage them, simply out of self-defense. I’ve written a lot about pension problems and people not having sufficient retirement savings. The main reason is that neither workers nor employers are contributing enough… but it doesn’t help that investment returns are miserably low, too. Locking people out of the best opportunities simply “protects” them from building the assets they need to fund a comfortable retirement. It makes little sense and needs to change.

The Best “Strategy” for The Great Reset

We all want our portfolios to perform as well as possible. But simple reality says that apart from a lucky few who find an investment that really takes off and propels our total net worth, most of us need more.

Where is net worth truly created? Small businesses, often generational, some of which become medium and large businesses. More people have made more money all over the world by starting businesses than any other way. Their businesses will go through The Great Reset, maybe not in perfect ease, but come out the other side still generating profits for their owners.

Very few places are more open to entrepreneurs than the US but this happens everywhere. The bulk of the wealth created in China? New businesses. Of course, oligarchies in many Third World countries make launching new businesses tres difficile. Starting a business isn’t easy anywhere and most new businesses fail. Do your homework, make sure you have enough capital and consider taking the leap.

And if you are not the entrepreneur type? Then link up with someone who is, make him or her successful, and be sure you get a piece for your effort. With so many new business opportunities and technologies coming, there have never been more options. Look around at what you know and think how technology can make it better. Then create it. And when we’re together, tell me your story.


*This is an article from Thoughts from the Frontline, John Mauldin's free weekly investment and economic newsletter. This article first appeared here and is used by interest.co.nz with permission.

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To paraphrase the late Sir Angus Tait: to make money / create wealth, you either mine something, grow something (food), or make something. He did the latter of course.

Correct - All wealth comes from the ground.
We have maxed up on our leverage of what comes from the ground. And capitalism's only real course is more leverage....
Now what?

Well, I guess we're down to brewing craft beer and showing people our dying Kauri trees.

" All wealth comes from the ground . " ...... REALLY ?

... thanks to Steve Jobs a certain US based company yielded 50 000 % returns for it's shareholders , and turned itself into the world's first $US Trillion company .... thems Golden Apples folks ... Apple 's what never grew on trees ....

Not to mention all the wealth created by the Amazon .... which transmographied a $US 20 share price in 2002 to $US 1900 today .... the Amazon with no trees ...

... don't believe me ? ... don't believe that enormous wealth can be created without the need for " ground " .... GOOGLE it .... unless you're too busy on Facebook !

What about selling all investments and being cashed up for the "Great reset"?

I like the idea. The only question is when does the crash precipitate? When?

You could sit on a pile of cash forever waiting for things to crash, while every other investment class goes up in value.

Yvil
No - don't sell all investments and put all cash in one place.
Worse case scenarios for possible train crash outcomes for Joe Bloggs is loss in value of some equities and higher interest rates.
Personally, if I had a couple of leveraged rentals I would consider keeping the more desirable property in a train crash scenario (e.g. a property which is attractive to a working couple so if one losses a job most likely the other still has an income, one that would be more attractive to potential tenants if need be, one that is positive in terms of location such as a more desirable area or has good accessibility factors, etc) and sell the less desirable one and reduce debt on the more desirable one so that mortgage outgoings can be redily covered even if there was a significant increase in mortgage rates. The reality is that even in a train crash scenario people still need some where to live, and even if there is a fall in property prices this is most likely to be a short to medium term only; in the longer term I would be looking for the first signs of spring again and again look to re-leveragering again before significant price rises.
I would also be defensive in moving my KIwiSaver to a more balanced or moderate fund but not to a totally conservative cash fund - although if things deteriorated further one can accept some although lesser loss and shift further to a more conservative fund all the while looking out for the first signs of the spring that will surely follow and move back.
If I had a significant share holding I would be currently looking at my investment strategies and making changes to consider that a sharp downturn in the economy is a possible. This may be looking at companies most likely to continue favourably in a downturn - such as power companies for which there is still going to be demand - and moving away from those who could face a significant downturn in earning such as arguably Air New Zealand or other tourism based companies.
Cash funds - well if they are in term deposits I would probably leave them there but look carefully at the provider. Personally I would not be chasing that extra half percent or more that big four banks provide, and if your bank fails, then the outcomes are going to be pretty significant and the loss of your cash would be of a minor concern. There are plenty of people who sorely regret chasing that additional half percent or two in finance companies pre-GFC.
In summary, act prudently and defensively - accept that returns of the past decade are not going to be sustained but do not over react and panic.
Whilst that train crash may not eventuate - a possibility - your losses are not significant and likely a small price for security. For example; aggressive KS funds have been returning 10%+ over the last decade and arguably that is not sustainable. Even positive forecasts suggest that a 7% return p.a. in the medium term as a best case scenario; conservative and moderate funds in the past returning 3% are likely to show upside when cash is king even if the train crash doesn't occur but a tighter economic conditions reigns. So is the 2% to at best 3% more for far higher risk in a potentially train crash situation worth it.

Hi printer8,
Thanks for your lengthy reply, much appreciated.
From your comments I conclude we have vastly different views of what JM's "train crash" represents. It seems your view is some form of recession, my understanding is much more severe, where asset prices plummet, economies collapse, something much worse that the GFC.
Would you mind disclosing your background re finance and economy?
Thanks

Hi Yvil
What will the train crash be like?

No one knows for certain. A 10% to 15% drop in house prices and a 2% to 3% rise in mortgage interest rates (both very possible) could well be a train crash for someone with a very highly leveraged property consequently facing a mortgagee sale and financial ruin, but just a temporal blip for a more secure investor.

What do I think it will be like? Certainly we are looking at a new financial landscape, it will not be same-old, same-old as for the past decade, and what have been successful strategies for every man and his dog (such as investment in equities such as property and shares) will not continue to be the norm. Those that don't head the warnings and continue in the same manner are at increased risk (not certainty) of being burnt.

My background - the only experience I have is being old. I have lived through a few notable events such as Muldoon and wage and price freezes, first mortgage rates of 25%, the 1987 share market crash (which I avoided), share market where key people were praising their company while unloading their stock big time, at least three property booms (and some periods of 10%+ drop in house prices), and 18 years in rental properties which I am currently out of for a couple of reasons.

Should you take note of my suggestions without question - I'm the first to say NO, and there will have been plenty who will disagree with my views.

The one thing that I have learnt during my time is that, the future is uncertain and in which no one is correct all the time, there is risk in everything, and one needs to listen to a wide range of opinion but do so critically and come to their own conclusion. We will have different views, some times we will be right and other times wrong and it is for this reason we are not all exceptionally wealthy.

Why do I think that it wont be a major major train crash a la 1929? I feel that the RBNZ are already taking action such as the OCR and LVRs to ensure currently a stable housing market and, to some extent the government's aim to currently keep its borrowing down and its Working for Families will give our economy some latitude and on-going stimulus. But there again I could be well be wrong.

Some great advice. in the end it comes down to making your own choices and living with those decisions

I think your best bet is to own tangible assets. Being 100% in cash (assuming you mean bank deposits) makes you an unsecured creditor of the bank, at risk of being "bailed in".

Agreed, I actually mean Cash, dollar bills in a few safes in different locations. The Swiss have a CHF 1'000 bill = around NZ$1'500

Hmmm. It makes me wonder, let's say Aust/NZ banking system tips over, and there is a localised downturn in our region. Local currency values goes down against the greenback. If you're carrying debt, it might be handy to have some (small) amount of USD somewhere to exchange at the right time to pay down the debt, instead of using a rapidly inflating local currency. That way, you can provide your own personal debt relief, and maybe even end up in an advantageous position relative to your neighbours. If you're not in debt, but your kids are, then you can help them. Could be the difference between hanging onto the house or not. I guess this is what people do in strongman countries like Indonesia, Kazakhstan or Venezuela; when they buy USDs, they are hedging their risk to inflation.

Of course, if the crash goes global, then there's no point to that strategy.

"The world will be much better in 20 years, and in many ways even in 10 years... We will still be eating—both going out and cooking in.... We will still get together with friends. Travel will be easier ... I can’t even begin to explain how much better healthcare and biotechnology will be... We will have fantastic investment opportunities in this new world. There will truly be massive fortunes made..."

Nope.
Our standard of living is reliant on growing debt (to subsidise energy input costs)
To reset is to take away the subsidy => Living standards can only go one way

In front of me,I have an article from Psychology Today titled,Our Brain's Negative Bias. I will quote one sentence from it; "The brain,Cacioppo demonstrated,reacts more strongly to stimuli it deems negative. There is a greater surge in electrical activity.Thus,our attitudes are heavily influenced by downbeat news than good news".
In the investment world,this is called Loss Aversion and numerous studies by psychologists(Kahneman and Tversky,Ariely,Thaler and others)have shown this effect. What's my point? Simply that 'doom and gloom merchants' find it very easy to get an audience for their apocalyptic views.Of course,if you predict an economic meltdown for long enough,then one day you will be right,but when will that day come?
For investors like myself-and I qualify as an Accredited Investor-it's not hard to see big black clouds on the horizon in the form of global debt levels and major geo-political risks,climate change and so on.
I have lived and invested through many financial meltdowns and another one will come along-BUT I DON"T KNOW WHEN. So, my 'strategy' is roughly speaking,to keep calm and carry on. I have steadily increased my cash to around 15% of the portfolio,with some of that in NZ government bonds,my portfolio is largely defensive and concentrated in low debt companies with strong cash flows and stable dividends. I have a rental property and no debt. I keep things simple. Will that be enough? I don't know,but if I am on the train when it derails,then I certainly won't be alone.