Why do we include community banks as an alternative investment?

Are community banks alternative investments?

That question requires a deeper understanding of liquidity, structure, and broader market correlation. Before we start, it’s worth noting that the Chartered Alternative Investment Analyst (CAIA) Association has a specific definition for alternative investments.

“Alternative investments are sometimes viewed as including any investment that is not simply a long position in traditional investments,” CAIA notes.

“Typically, traditional investments include publicly-traded equities, fixed-income securities, and cash. For example, if a particular investment (such as private equity) is not commonly covered as equity in books on investing, then many people would view it as an alternative investment.”

I think that community bank stocks qualify on several levels.

Are Community Banks Alternative Investments?

The answer to this question is “yes.”

First, they tend to be small and very illiquid, especially for larger institutional investors.

Second, nobody talks about them in the mainstream financial media. Long-term ownership of community banks looks more like private equity or hedge fund investing than traditional liquid securities investing. It is an asset class that fits the definition of “specialized.”

It also requires highly specialized knowledge to achieve a high level of success.

Small community bank stocks are also the best example of illiquid value stocks as reviewed by Yale Professor Roger Ibbotson. The professor explored illiquid value stocks in his study” Liquidity as an Investment Style” in 2013. The study found that illiquid value stocks outperform liquid growth stocks by a massive margin.

Illiquid community banks, almost by definition, fit the bill as an alternative investment.

Community banks have very little correlation to the stock market. As an asset class, the universe of community banks with less than a $1 billion market cap has a beta of just .50.

In spite of the credit crisis that hit banks hard in 2008-2009 over the last 20 years, the universe has outperformed the S&P 500 with average annual returns (as of 10-15-2019) of 14.06% compared to the 4.33% average annual return of the index.

The Bottom Line

Finally, it may be unconventional to consider community banks as alternative investments.

Then again, so are the returns that the handful of investors specializing in the space have earned for themselves and their investors. With that said, those gains have been significant since the ongoing consolidation phase began back in the mid to late 1980s.

• Tim Melvin

How to Invest in Community Banks

To start trading in community banks, check out the DailyAlts Community Banking letter.

Melvin’s community banking letter taps into the deep value provided in the U.S. financial sector and has averaged 12.9% compared to the S&P 500’s 9.9% since inception. This newsletter taps into the major trends in community banking that have fueled remarkable consolidation and immense profits for investors. His dual portfolios have delivered dozens of 100% winners while maintaining a Beta of roughly 0.06. He has also never experienced a losing trade with this strategy. Learn more, here.