Investing outside the box

November 3, 2008

By: Joe Gardyasz

Whenever someone approaches Don DeWaay to offer their sympathy about the economic crisis, he just has to smile.

"Yesterday, two or three people told me, 'It must be tough right now,'" said DeWaay, founder of DeWaay Capital Management in Clive. "But actually, it's the most incredible time for our firm right now."

As the markets continue to take a beating, DeWaay Capital Management's niche in alternative investments continues to provide the fee-based wealth management firm and its clients with plenty of reasons for optimism.

"The opportunities (in alternative investments) have probably not been this attractive in 25 years in this space," DeWaay said. "These are the things that can really gird your portfolio against significant (market volatility). A lot of times, they don't correlate at all with the market; sometimes they're actually countercyclical. While other firms are losing clients by the truckload, they're coming over here."

Alternative investments, also known as market alternatives, can range from hedge funds, derivatives and other complex instruments to more straightforward investments such as equity positions in private companies or stakes in energy infrastructure projects. They might include venture capital or direct investments in real estate developments. Some of these opportunities may require so much upfront investment that only the largest institutional investors can take advantage of them. For individuals, these investments are often limited to those deemed under securities regulations to be "qualified" wealthy investors, typically people with $1 million or more in assets.

DeWaay's firm, which during the past four years has grown from 18 investment advisers to a staff of more than 110 with satellite offices in several states, works primarily with clients with net worths between $1 million and $50 million.

"We believe in a philosophy of going a mile wide and an inch deep, so that you're not concentrated in any one thing or sector," DeWaay said.

With market efficiencies essentially guaranteeing that an investor will pay "full retail" for every stock, private equity provides opportunities in which an investor isn't competing with millions of other investors.

"When you look at the wealthiest people in this country, they didn't get there by owning stocks, bonds and mutual funds," he said. "They got there by one of two ways: direct ownership of businesses or real estate, or both. The liquidity of the market is what makes it attractive; aside from that, you don't get much value. You tend to get much greater value in private assets."

More accessible
Over the past five years or so, some market alternatives have become more accessible to investors in the $400,000 to $500,000 net-worth range, said Steve DeVenney, branch manager of Raymond James & Associates Inc.'s West Des Moines office.

"We've seen investors use them to lower volatility, as opposed to trying to increase returns," DeVenney said. "With the Standard & Poor's 500 down now about 35 percent, had investors owned other investment classes other than stocks and bonds, they probably wouldn't have felt as much of a pinch."

The $23 billion Yale University endowment is probably the poster child for this class of investments. As of June 30, Yale's endowment fund had generated $1 billion in earnings for the past fiscal year - at the same time that global markets declined by double-digit percentages - from a portfolio steeped in alternative investments.

"That has probably helped as much as anything to bring alternative investments to the forefront of people's knowledge," DeVenney said. "That's really gotten the attention of people: 'Wow, can I do some of that?'"

One drawback of alternatives is that they're not as liquid as most investments.

"With some alternative investments, you can get out once a year, once a month, or sometimes not at all," DeVenney said. "In some cases, even if you die, your heirs would inherit it and there would be some future disposition of the assets."

Alternative investments "aren't voodoo," said Dan Ochylski, owner of Growth Financial Partners, who specializes in commodities trading and market alternatives.

He said he's able to find affordable alternative investments for his clients, the majority of whom are middle-class, rather than high-net-worth, investors.

"I think that's important, because people feel that alternative investments are only for high-net-worth investors, and that's not the case," he said. "I think more people need to hear that message, though."

One type of investment he is able to offer that doesn't carry a qualified investor designation is small private equity stakes in real estate. It offers a return of 12 percent and matures in four years, he said. "And if the property ever went south, the property is the collateral. So the worst that would happen is that they end up owning a very small piece of a property in Maui."

Greater value
"The real challenge for people is that they may never get exposure to (alternative investments), but even if they did, the requirement for investment is huge," DeWaay said. "What we do is bring some of the resources and opportunities that some of the wealthiest people in the country have, at a level that a much broader audience can take advantage of because the investments are oftentimes very modest. We bring it down to bite-sized pieces." Most commonly, those pieces will be investments between about $25,000 and $50,000, he said.

By conducting extensive due diligence on thousands of potential projects, DeWaay's firm finds opportunities that range from hotel development projects, heavy equipment leases and energy infrastructure projects.

"What we've done very successfully is to network," DeWaay said. "We're talent scouts, in a sense. There are things that we do internally, and then there are things we recognize that we'd better find other people that have the resources and talent, so we can leverage on their experience."

In one instance, the firm partnered with a developer that's now constructing a 23-story Embassy Suites hotel in downtown Houston. The firm's involvement in the project enables it to offer its clients a piece of a project that will fill a demand for much-needed hotel rooms in that city, DeWaay said.

"There are great opportunities in real estate; we think there are great opportunities in multifamily housing right now, for instance," he said.

In another case, DeWaay's firm has invested in gas liquification plants in Pennsylvania, which condense natural gas so that it can be transported in pipelines.

"These plants can return between 30 and 100 percent on investment," he said. "It is through connections that you gain opportunities like that. We put up 25 percent of the money, the plant operator puts up 25 percent and the people sponsoring the deal put up 50 percent. So these are not like traditional limited partnerships, that historically are not done very well. These are legitimate deals where you're partnering with hard money with people that are really, really good at what they do and have a reputation that goes back many years."

'Hand in a glove'
DeWaay Capital Management recently launched its first private equity/venture capital fund, DeWaay Capital Partners, which will offer investors shares in a planned portfolio of about 15 private companies, among them Des Moines-based GCommerce Inc. The technology company specializes in supply-chain optimization software for clients in the aftermarket automotive parts industry.

Working with DeWaay to be part of the fund "fit like a hand in a glove," said Steve Smith, president of GCommerce. "It's just the culture we look for in investors. You want people that are going to fit nicely in the culture that you've designed for yourself."

Adam Claypool, managing director of DeWaay's investment banking division, said DeWaay Capital Partners is the first of several such private equity funds the firm expects to launch. The firm also intends to start two commercial real estate funds, he said.

"We are committed to doing what no other investment bank is doing in Iowa," Claypool said. "We intend to be a very big player in the private equity/venture capital area. We intend to pay attention to (investing in) Iowa companies, in addition to other opportunities outside of the state."

Claypool said this first private equity fund has raised about half of its $15 million target, and is within weeks of investing in GCommerce, which will be the third company in the portfolio. One of its first two investments is KemPharm Inc., a start-up biopharmaceutical company at the University of Iowa's Technology Innovation Center.

"Our investors generally lack access to private equity/venture capital," Claypool said. "We're trying to give them access to institutional-quality venture capital and private equity, by bringing our funds and other funds to our clients."

Having seen firsthand DeWaay's due diligence process, Smith and his wife also became personal investment clients of the firm earlier this year. They have invested in oil and gas deals, distressed debt and equipment leases, he said.

"They have incredible discipline in their due diligence process," he said. "They really ferret out their deals and make sure they're solid. They make sure they don't compromise their values and integrity at the expense of their investors."

DeWaay said a common misperception about alternative investments is that they are by nature higher risk than market investments.

"That's a total misconception about private equity," he said. "A lot of what we do is collateralized lending, first-mortgage money on real estate projects, the same kind of things the banks are doing, basically, and probably better."

Most real estate investments they hold are still returning 10 to 12 percent, DeWaay said.

The 21-year-old firm, which has expanded its client base exponentially during the past four years almost entirely through referrals, is now seeing a "huge surge" in referrals, DeWaay said.

"Everybody's telling their stories right now; they're commiserating on the market," he said. "These are the kinds of times we want to pop the corks of champagne, because this is when our strategy really bears out. There are great opportunities, especially now, to make money. We believe one thing very importantly: you make your money the day you buy something.

"You can get great fundamental listings in times like this that will persevere," he said. "Really, it's a good feeling to be able to help people like this, and they feel good about it."