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T i m e ly i n s i g h t s f r o m R e IS A

WINTER 2014 VOLUME 8 , ISSUE 1

Reg A Redux: What is Regulation A and

How Has it Changed

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REISA 2014 Spring Symposium Modeling Large Endowment Investment Strategy: Intellegent Use of Alternative Asset Classes

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March 16-18, 2014 Sheraton San Diego Hotel & Marina

Register today! reisa.org


Table of Contents REISA Editorial Board Chair

Brandon Balkman Orchard Securities Linda Dewlaney Preferred Partnership Services Eric Perkins Perkins Law PLLC Brandon Raatikka FactRight, LLC

1

President’s Letter

3

Executive Director’s Letter

4

Reg A Redux: What is Regulation A and how has it changed?

7

How to Keep Your Best Clients

8

Delaware Statutory Trusts

9

Master Limited Partnerships

10

Modeling Large Endowment Investment Strategy

REISA 2014 Spring Symposium

BC

You can find PDFs of past FYI issue at reisa.org. FYI is published by REISA. Views expressed in the articles are not necessarily endorsed by REISA.

Contact Information

Copyright © 2014 By REISA, formerly the Tenant-In-Common Association. All rights reserved. Readers may copy sections of this publication for personal use. However, it is a violation of U.S. copyright laws to copy substantial portions of the publication for any reason without permission. The Copyright Act of 1976 provides for damages for illegal copying. If you wish to copy and distribute sections of this publication, contact Jennifer Fitzgerald at jfitzgerald@reisa.org.

REISA 10401 N Meridian St., Suite 202 Indianapolis, IN 46290

Adam Abubakr Director of Accounting & Data Systems 317.663.4177

Direct: 317.663.4180 Toll Free: 866.353.8422 Fax: 317.815.0871 E-mail: reisa@reisa.org

Tanisha Bibbs Education & Meetings Coordinator 317.663.4174

John Harrison Executive Director 317.663.4172

Jennifer Fitzgerald Director of Marketing 317.663.4175 Tony Grego Director of Business Development 317.663.4173


President’s Letter REISA is Moving Forward. The Time is Now. The World is Changing.

A

s REISA embarks on 2014, I look back at the themes of my three presidential predecessors. In doing so, I have realized that the old saying, “The only thing constant is change,” applies very much to our industry and our association.

REISA, as most of you know, morphed from the original TICA, when the sole focus was 1031 exchange products. In becoming REISA, we opened our minds and reach to include all things real estate in the alternative investment world. In doing so we became a stronger, healthier, broader association. The alternative investment world which we serve has continued to grow and offer new innovative products like BDCs, NAV Products and an ever-expanding array of programs wrapped inside of LLCs and Limited Partnerships. So today REISA continues to morph and grow with an ever-expanding view of who we are and what we represent. Certainly the word “alternative” is somewhat problematic as what we know as “alternative” is becoming more and more mainstream. “Alternative” investments today take on many new forms and include countless more opportunities than just a few years ago. Advisors, broker-dealers and reps have adapted their use in portfolios, even as

Mark Kosanke Concorde Investment Services

regulators struggle to define their proper place in the current day portfolio. Our world really is changing. Today we see the equity markets enjoying a nice bull run. This run tell me that “the time is now” for alternative investments to establish themselves as a regular part of portfolios. We have progressed beyond the point where alternative are an “afterthought” to be used only by some reps. Portfolios employing these additional strategies give themselves the best possibility for stability, growth and diversification long term. The skills and innovation brought to our industry by our sponsors the past few years provide the perfect offset to a potential bearish market in the future. New development, new products and new ways of thinking, along with learned lessons of the past, point to a bright future for alternatives. REISA is a national trade association of decision makers that influence over 20,000 professionals who offer and manage alternative investments. Thanks to the work of the Board of Directors and the many volunteers, REISA today is a strong, financially fit, and growing association. Over the past few years, we have recovered from what many called the “Great Recession,” and today we see dramatic growth in membership, conference attendance and involvement. REISA’s reputation for providing robust advocacy, strong education and the best networking events in the industry is unmatched. As products change and new products are introduced, REISA is committed to providing the best education available to the reps and broker-dealers in our industry. Our conferences are continually being designed with education at the forefront. Syllabuses will now be a part of every conference session. This is proof of our mission FYI WINTER 2014 1


Executive Director’s Letter WRAP Up Your Decisions

to provide education at the highest level, using the top professionals in our field. We are also in constant dialogue with our industry regulators, keeping them and ourselves abreast of the challenges in maintaining the integrity of the members we serve. Finally, there is no better way to network with the top professionals in the alternative investment world than by attending the national REISA events. This year’s events will top 1,000 attendees in a dynamic environment, offering relevant information and bestowing expertise to the rep and broker-dealer community that can’t be found anywhere else. As the year progresses, look for REISA to adapt. Like any entity, we are working hard to continually improve, to grow and to be more representative.

John Harrison Executive Director, REISA

To that end, I personally challenge my brokerdealer cohorts to get your reps involved. Assure that your reps are belonging, attending and participating in REISA. Take advantage of the education, the networking and the energy! Great times are ahead for all who do. The benefits provided by REISA could not be done without the timeless energy of the many volunteers that fuel the excitement of our association. I want to thank each and every one who contributes in so many ways. From the committee members, Board of Directors, session owners, panelists and sponsors, my heartfelt “thank you” goes out to all. And, of course, our staff and executive director have stabilized us in so many ways and prepared us for the challenges ahead­—thank you! I look forward to seeing everyone at the conferences this year. I especially look to see more of our broker-dealer and registered reps attending these very worthwhile events. Spread the word, share the story, and encourage your peers to join. Together the future is bright, our industry is strong and the association is growing to take you to the next level.

2 FYI WINTER 2014

D

ecision science is a popular area of study in business schools. At least a beginning level course in decision science is required; thus,

there’s no deciding whether to take it or not— and that’s probably a good thing, for how is one to decide properly before having the course about decision making? Despite its leaning toward the mathematical (and sometimes I believe business and social sciences scheme up excess math involvement just to appear more “scientific”), the art and science of how we make decisions is fascinating. Two business professors (who are also brothers, one on the East Coast and one on the West), Chip and Dan Heath, recently published Decisive: How to Make Better Choices in Life and Work. An easyto-read summation of their research, the work boils it all down to a useful everyday formula approach. Their formula is W.R.A.P., and its tenets apply to companies, individuals, small groups and investors. Not to mention helping me chaperone my teenage kids with their decisions on courses, colleges and the like. “We are nothing but the summation of our choices,” the adage goes, and it’s good to have a quick formula to apply. The W in the W.R.A.P. formula stands for “Widen


the Options.” That is, decisions we regard as “whether or

parts: first, the data (usually some sort of Likert scale—the

not” are, well, often not whether or not. Can the decision

respondents rated this feature 4.5 on a scale of 5), and just

be reframed as X AND Y instead of X or Y? If there are

the data within their qualifying limits. Then, later, I examine

many options, keep them all open until an obvious point of

any open-ended comments for insight and suggestions.

elimination. Too often we get into a false dilemma of get

This is to combat the tendency to go to the comments

product X for cheap or get product Y for expensive, without

first, seeking sensationalism or feeding a confirmation bias.

considering other alternatives. This is where opportunity

Comments may distract from or even overshadow the data

costs come in. I have used this one with my kids, “Dad, why

even if the data may be overwhelming in their indication.

don’t you buy a new Jaguar? They’re so much cooler than

The A is for “Attaining Distance from the Decision.” Most

your Honda.” My answer, “the opportunity cost—or the

of this is about removing short-term emotion from decision

foregone savings—would be at least a year of college tuition

making, defeating the impulse buy or loss aversion (two

for a certain student we all know and love,” and that ends

sides of the same coin). One technique the authors point

the conversation.

out is asking 10/10/10. How will the decision feel in 10

Another way of widening the options is to find someone

minutes, in 10 months, in 10 years? This is a way of asking

who’s already solved the problem. This is where associations

the timeless question “What would our successors want us

like REISA come in. Talk to a trusted colleague who’s solved

to have done?” Here, we attain distance from short-term

a similar problem. They may relate options you’ve not yet

emotions but get closer to longer payoff emotions about

thought of. We are all subject to confirmation bias; that

the future and what we regard of ultimate importance.

is, running around looking for an isolated example which

Although not mentioned by the Heaths, my take here is

confirms our way of thinking—example: because this is

that the attaining some vertical distance (i.e., a higher view

a really cold winter, there can’t be such a thing as global

to keep things in perspective) should also be part of the

warming. Find a way to look for and ask disconfirming

“Attaining Distance” methodology.

questions about your hunches. Because there’s an example

The P stands for “Prepare to be Wrong.” In other words,

of one person playing a single number on the roulette

what happens if we make the wrong decision? Important to

wheel and winning, doesn’t mean that’s a good strategy

minimizing the damage, according to the authors, is to set

for choosing. Suffice it to say, the odds of making the best

“tripwires” such as we will allocate x amount of money and y

decision (in a given amount of time) are directly proportional

amount of time to the project, and then fish or cut bait. The

to the number of options considered.

Heath brothers treatment of decision making confirmed a

The R stands for “Reality Check.” Here we look for the

tripwire I set long ago in reading business literature: I give

likelihood of a particular outcome. Also, the concept of

any book 100 pages, and if it’s a good read at that point I

testing a particular decision: Is there a way to run a small

keep going.

experiment to see what the outcome will be instead of just

I can’t do justice to the examples and the creative style by

guessing? The authors here seem to go out of their way not

which the authors brought Decisive: How to Make Better

to use any math, where some math with decision trees and

Choices in Life and Work to be a meaningful approach to

the like tends to be useful. The authors bring in the useful

decision making on many levels. It was a good read at my

method of considering the opposite for a course of action

tripwire of page 100, and I’m glad I decided to read all 300

which seems to be based solely on the someone’s “gut.”

pages. After all, gathering knowledge (and much of that by

Ask, what would have to be true for such an option to be

networking) is what REISA is all about—and your joining in to

the very best choice? If the truth assumptions are too “out

help that knowledge grow is an easy decision to make.

there,” then the presumed path is not so wise. Here also is where questioning data becomes important. When I look at survey results for example, I do it in two FYI WINTER 2014 3


Reg A Redux: What is Regulation A and how has it changed? By Robert R. Kaplan, Jr. and T. Rhys James, Kaplan Voekler Cunningham & Frank PLC

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egulation A (Regulation A or Reg A:) under the Securities Act of 1933, as amended (the Securities Act), dates to the 1930s, and was originally promulgated under Section 3(b) of the Securities Act, which generally permitted the Securities and Exchange Commission (the SEC) to exempt classes of securities from registration, so long as the aggregate dollar amount of such securities issued pursuant to a Section 3(b) exemption do not exceed $5 million in any one year. It is important to understand that Regulation A exempts the securities themselves from registration, rather than relying on the method by which they are offered. This is extremely important. Since the securities get the pass, the issuer is not restricted by such things as the identity of the offerees, how broadly the offering is advertised or the investment intent of the investor. In short, Regulation A, at a minimum, has three significant advantages:

1. General solicitation in a Regulation A offering is

permitted;

2. Securities offered under Regulation A may be offered

and sold to non-accredited investors; and

3. Securities purchased in a Regulation A offering may be

freely traded by investors.

In March, 2012, Congress passed the Jumpstart Our Business Start-ups (JOBS) Act. Prior to the JOBS Act, Regulation A failed to gain much attention because of its limitation to $5 million in a 12-month period. Title IV of the JOB Act required that Section 3(b) be amended to provide for the traditional Reg A exemption under Section 3(b)(1) of the JOBS Act, and created a new Section 3(b)(2) which increased the amount of securities that can be issued in a 12-month period under this exemption from $5 million to $50 million.1 This new exemption is commonly referred to as “Regulation A+.” This was a watershed event because increasing the cap given the potential for an “intermediate” and disciplined public market to develop in the United States which could provide a multitude of business opportunities for issuers and financial professionals alike. Pursuant to statute, Regulation A+ securities would continue to be freely tradeable. Additionally, a Regulation A+ offering could still be marketed publicly, and there were no investor net worth (such as accredited investor requirements) or investment limitations under the statute.2 Title IV mandated that the SEC promulgate rules to implement Regulation A+.3 On December 18, 2013, an open meeting of the Commissioners of the Securities and Exchange Commission approved proposed rules for implementation of Regulation 4 FYI WINTER 2014

A+. The approach to the proposed rules the SEC has taken has been to build upon existing Regulation A, rather than create an entirely new regulatory scheme, and follows where possible that existing regulatory regime. In so doing, SEC has followed the same general scheme set forth in the statute (referenced above) and has created a twotier system under Regulation A: “Tier 1” being the pre-existing 3(b)(1) exemption for offerings up to $5 million, and “Tier 2” for the 3(b)(2) exemption for offerings up to $50 million. Tier 1 would still operate under the same disclosure rules for pre-JOBs Act Regulation A. Tier 2 builds off the existing forms and requirements by creating additional requirements or heightened standards as compared to Tier 1 of disclosure under the new rules. An issuer planning an offering of $5 million or less, nevertheless, could opt to file under the Tier 2 standards.4 Some of the highlights of the proposed rules include:


Eligible Issuers

Tier 1 is available for any entity that (i) is formed in the United States or a province of Canada, (ii) has its principal place of business in the United States or Canada and (iii) is not subject to registering and ongoing reporting under the Securities Exchange Act of 1934 (the 34 Act), as amended, immediately before the offering. At the same time, the following issuers are also “ineligible” to offer or sell securities under Regulation A:

1. any issuer that is a development stage company

that either has no specific business plan or purpose, or has indicated that its business plan is to merge with an unidentified company or companies (known as a “blank check company”);

2. any investment company registered or required to be

registered under the Investment Company Act of 1940; and

3. any entity issuing fractional undivided interests in oil or

gas rights, or similar interests in other mineral rights, and

4. issuers subject to disqualification under existing Rule 262

of Regulation A for specific items of improper conduct.

Again, Tier 2 would follow this general scheme, but it has been proposed for Tier 2 offerings that the more expansive “bad actor” rules under Rule 506(d) of Regulation D would be applied in lieu of more narrow current Rule 262. The proposed amendments would also make Tier 2 unavailable to issuers that have not filed with the SEC the ongoing reports required by the proposed rules during the two years immediately preceding the filing of a new offering statement (assuming they were required to do so), and issuers that are or have been subject to an SEC order denying, suspending, or revoking the registration of a class of securities under the Exchange Act. The Commission however, has requested commentary on whether Tier 2 should be made available to foreign issuers with operations in the U.S. Finally, an issuer would be precluded from offering assetbacked securities under Tier 1 or 2, but can otherwise offer equity securities, debt securities and debt securities convertible into or exchangeable into equity interests, including any guarantees of such securities.

Investment Limitation

The proposed rules impose an investment limit for Tier 2 offerings requiring that investors be limited to no more than 10% of the greater of the investor’s annual income and net worth.5

Liquidity

Regulation A may be used by an issuer to conduct a primary offering of its securities with the proceeds to be used by the

issuer, as well as to conduct a secondary offering of securities on behalf of selling security holders. For Tier 1 offerings, Rule 251(b) prohibits affiliate resales if the issuer has not had net income from continuing operations in at least one of its last two fiscal years and limits the offering amount to $1.5 million offered by all selling security holders. The SEC has proposed for Tier 2 offerings eliminating the prohibition on affiliate resales unless the issuer has had net income from operations in at least one of the last two fiscal years, and increases the amount to be offered by existing security holders to $15 million. The SEC has also suggested that the reporting associated with Tier 2 securities could meet the requirements for public information under Rule 144. As such, if an issuer were to qualify a class of equity securities and comply with requisite reporting for the same (discussed below), then any restricted securities otherwise complying with Rule 144 may be traded in the secondary market. 6 SEC has also proposed that the review of the mandatory ongoing reporting would be sufficient to satisfy a brokerdealer’s obligations under Exchange Act Rule 15c2-11 to review information about an issuer in connection with publishing quotations on any facility other than a national securities exchange.

State Securities Law Requirements

Title IV of the JOBS Act provided that offerings conducted under the 3(b)(2) exemption would be treated as “covered securities,” and not subject to state blue sky registration or review, if the securities are sold to “qualified purchasers” or listed on a national securities exchange. SEC has proposed to define “qualified purchaser” to include offerees in a Tier 1 offering and all offerees AND purchasers in a Tier 2 offering. What this means is that the SEC intends to treat as exempt as exempt from state regulation the marketing process for Tier 1 securities (but not the outright sale), while both the marketing and sale of Tier 2 securities would be exempt from state regulation. While the Tier 1 exemption is problematic in that state registration would still be required prior to taking funds, the Tier 2 exemption is extremely important, as the one of the biggest factors which have inhibited the use of Regulation A previously have been the $5 million limitation and the regulatory burdens associated with state blue sky compliance.7 The SEC, however, has suggested that the qualified purchaser definition applies to the offering and not secondary activity. That said, the SEC has requested commentary specific to this point. We would encourage REISA members to comment to the SEC in support of the qualified purchaser definition also being applied to secondary activity. Without the qualified purchaser definition being applied to secondary FYI WINTER 2014 5


activity, sellers would need to avail themselves of exemptions under the blue sky laws for those trades, which could slow development of the secondary market.8 NASAA is expected to oppose this vociferously in commentary to the proposal. We will be commenting in strong support of this aspect of the proposal and would encourage the readers to do the same.

Exchange Act Rules

The proposed rule would not exempt securities sold pursuant to Tier 1 or Tier 2 from the Section 12(g) Exchange Act threshold for required registration and reporting of 2,000 holders of record in a given class of equity securities, 500 of which can be non-accredited.9

Offering Circular

The proposed rule would retain Form 1-A’s current structure, but would make various revisions to the form. Currently, Part II of Form 1-A provides issuers with three options for narrative disclosure (Model A, Model B, and Part 1 of Form S-1). The proposed rule would, for Tier 2 offerings, eliminate Model A and preserve and update Model B. Model B requires disclosures of basic information about the issuer; material risks; use of proceeds; an overview of the issuer’s business; an MD&A type discussion; disclosures about executive officers and directors and compensation; beneficial ownership information; related party transactions; a description of the offered securities; and two years of financial statements. While these areas of disclosure are similar to much of the same information seen in a public registration, they would continued to be scaled down in their particularity and complexity to meet the intent of Regulation A. For Tier 1 offerings, audited financial statements would be required only to the extent they were prepared for other purposes. For Tier 2 offerings, audited financial statements are required. For Tier 1 offerings, the auditors of financial statements must meet the independence standards but need not be PCAOB-registered. For Tier 2 offerings, audited financial statements must be audited in accordance with PCAOB standards. The proposed rule would require offering statements to be submitted and available through SEC’s EDGAR system. An issuer or broker-dealer would be required to deliver only a preliminary offering circular to prospective purchasers at least 48 hours in advance of sale when a preliminary offering circular is used to offer securities. A final offering circular would continue to be required to accompany or precede any written communications that constitute an offer in the postqualification period. In instances where delivery of a final offering circular is required, in lieu of mailing a paper copy of the final offering circular to the investor, an issuer may instead provide the investor with a notice including the URL where the final offering circular, or the offering statement of which it is a part, may be viewed. The proposed rule would permit confidential submission of offering statements for first time offerings under Regulation A. The initial confidential submission and subsequent confidential amendments and SEC 6 FYI WINTER 2014

correspondence regarding the submissions would be required to be publicly filed as exhibits to the offering statement not less than 21 calendar days before qualification of the offering statement.

Ongoing Reporting Requirements

Issuers in Tier 2 offerings would be subject to an ongoing reporting regime. Similar to the ongoing reporting regime that the SEC proposed in connection with issuers that conduct “crowdfunding” offerings, Tier 2 issuers would be required to file annual reports, semi–annual reports, current reports when certain events which constitute “fundamental changes in the nature of business” and other major events occur. Special financial reports may need to be filed to acccount for gaps between financial disclosure in the offering circular and regular financial reporting. The structure of the reporting requirements is intended to be analogous somewhat to the reporting scheme under the 34 Act, but less burdensome from a substantive perspective. Commentary on the proposed rules remained open through mid-February. Very important steps have been taken by Congress and the SEC to make Regulation A a meaningful way to raise capital and engage in the securities business. While issues will remain for the private market to solve, what has been proposed presents enormous opportunities for issuers, financial professionals and investors alike should support strongly these rules and look to what Regulation A might hold for them in the future.

References 1 Jumpstart Our Business Startups Act, Pub. L. No. 112-106, §401(a)(2), 126 Stat. 306,323-24 (2012). 2 Id. 3 Id. 4 For example, an issuer may want to use Tier 2 to avoid state securities regulation, discussed below. 5 As proposed, this 10% limitation is applicable on a per offering basis; however, the SEC has solicited comment on whether this limitation should be applicable in the aggregate across all Regulation A offerings. We would urge REISA members to comment in support of the SEC’s “per offering” proposal. In addition, as proposed, the issuers may comply with the 10% investment limitation by relying on representations made my prospective investors. As part of its proposal, SEC has requested comment as to whether issuers should be required to conduct additional investigation to comply with the 10% investment limitation. We would urge REISA members to comment in support of the proposed rule allowing reliance on investor representations. 6 This will be important for operators of closely held business and private funds to consider qualifying a class of securities to provide an element of liquidity for all investors. 7 See Senate testimony of Robert R. Kaplan Jr. at http://www.banking. senate.gov/public/index.cfm?FuseAction=Hearings.LiveStream&Hearing_ id=c2fe9f9a-0e5e-4b44-a566-4a8cef26c06e. 8 We will be communicating to the SEC that we believe no distinction as to accreditation should exist for this number. Further, this calculation will likely result in many offerings being conducted in “street name.”.


How to Keep Your Best Clients Practical Ideas for Building Strong, Long-lasting Relationships By John A. Rhodes, Jr., Ph.D. CNL Capital Markets

Identifying the clients who are most vital to your business is the first step toward retaining them. These relationships must be nurtured continuously to keep them strong. This information is designed to give you practical ideas for achieving both goals. The Importance of Client Information Take a moment to think about your client list. Some advisors may characterize their “best” clients as the ones who are easiest to work with, while others may look at net worth. Regardless of how you define “best,” imagine just how different your practice would look without these key individuals. Paying special attention to them has its advantages.

can become the ‘quarterback’ “ofYou your clients’ professional team, earning their trust.” A quick look at the numbers will tell you who your most profitable clients are. Which relationships deliver the bulk of your revenue? Are there 10, 20 or 30 of them? With this targeted list in hand, you can search for additional value within your client base. To uncover changes in clients’ lives that may impact their financial situations, you can institute an annual questionnaire or survey. The information you collect can be used to strengthen relationships and expand your service offerings. Also, it is likely that your best clients—particularly those with a high net worth—have more than one professional advisor, such as an attorney, accountant or insurance agent. By connecting with these advisors, you can become the “quarterback” of your clients’ professional team, earning their trust, gaining clarity of their needs, and secondarily, creating referrals. Sharpening Your Focus Through Classification While all clients are important, they are not all equal in value. Using the information that you collect while fact-finding, you can classify your clients. This will allow you to sharpen your focus on areas where the highest potential for results exists. There are a number of ways to establish classification. Some advisors use a numeric scale (1, 2, 3) or an alphabetical approach (A, B, C), while others follow more unique systems such as Platinum, Gold and Silver, or AAA, AA and A. Regardless of the format, criteria must be established. This does not need to be complicated to be effective. You can start by considering the following factors: • What is the level of current investment under your management? • Is there strong potential for growth in investment (and thus, your business)? • Are they easy to work with? Do they heed your advice?

While classification is something you may or may not share with clients, it can help you prioritize your time, determine where relationship-building efforts or budget would be best spent, and more. Adding a Personal Touch with Customization From the apps on your phone to the way you take your coffee, practically everything can be customized these days. A “one size fits all” approach is not right for everyone. As such, your clients—especially the best ones—deserve products and services personalized to meet their needs. One of the easiest ways to do this is to ensure that your clients are taking full advantage of the services you offer. Though a client may come to you requesting a financial plan, he or she may have unidentified insurance, estate planning or charitable giving needs as well. If these are services you provide, are they aware of this? Client information is crucial to identifying these opportunities to expand your services. Communication is another area that can be easily customized. Determining how clients like to receive information and delivering it as requested can help cultivate relationships outside of face-to-face meetings. Which format—phone calls, email, printed newsletter, etc.—do they prefer? How frequently do they wish to hear from you? In addition to preference-based communication, many advisors also find sharing their own personal information beneficial. Your clients have trusted you with a portion of their financial future. Sharing stories about your family, travels and hobbies may help foster a better sense of connection, in turn, increasing the trust that they have placed in you. Making Client Appreciation Meaningful Everyone likes to feel special. You can demonstrate that you care through a well-planned client appreciation program. Consider personalizing these efforts for your best clients to achieve the greatest impact. The key is obtaining “heart information.” What are your clients passionate about? What activities do they enjoy? Once you have this information, draw inspiration from it and act. For example, if a client mentions that she adores dogs, take note. Perhaps there is an upcoming event that benefits a local animal shelter. You may wish to purchase tickets for your client and a guest to attend. Likewise, if clients mention they have planned a fishing trip in search of a fish they have never caught, you could remember this, seek an expert’s advice, purchase the correct lures and ship them to your clients’ vacation spot for delivery upon their arrival. Small touches such as these can go a long way toward demonstrating that you value your relationship with the client as much as you value their business. Summary A deep understanding of your client base helps prioritize your time and focus your effort, ensuring that your “best” clients are getting the attention that they deserve. Though you may already be implementing some of the practices mentioned in this article, taking action on even one new idea may be your key to building a better best client-focused business. After all, finding more best clients starts with taking care of your current best clients. FYI WINTER 2014 7


Delaware Statutory Trusts Have Become the Structure of Choice for Fractionalized Section 1031 Exchange Programs in an Expanding Real Estate Marketplace By Louis Rogers, CEO, Capital Square Realty Advisors, LLC

S

ection 1031 exchange programs, which raised over $3.5 billion of equity at the peak in 2006, and then nearly disappeared during the recession, are back in a big way. The Delaware Statutory Trust (DST) has taken the place of Tenants in Common (TIC) as the structure of choice for fractionalized Section 1031 exchange programs. Equity raised for DST programs has increased dramatically coming out of the recession as investors have sought to defer federal and state income taxes through qualifying Section 1031 exchanges. The primary goal is the same as before the recession– tax deferral— but the vehicle has changed to a DST from a TIC structure.

Why the Increase in Exchange Activity?

As the U.S. economy has slowly recovered from a painful double dip recession, the demand for investment real estate has increased dramatically. With substantially more buyers in the market, there are more sellers who desire tax deferral in Section 1031exchanges. Prior to the recession, the Commercial Mortgage-Backed Security (CMBS) market provided financing for billions of dollars of commercial real estate, including most TIC programs. During the recession, the CMBS markets froze and stopped real estate lending. Banks, life insurance companies, agencies, and other sources of real estate financing dried up as well. However, over the past two years, lending markets have unfrozen; real estate financing is available again on favorable terms from CMBS lenders, banks, insurance companies and agencies. While interest rates have increased recently, interest rates remain historically low. Also, as the economy has recovered, the fundamental economics of real estate investing have improved, driving demand for new real estate investments. In these ways, the economics of real estate have begun to normalize, increasing the appetite of buyers to acquire investment real estate. On the other side of each buyer is a seller who may desire tax deferral from an exchange. In addition, a meaningful number of old TIC and DST programs are selling their real estate as the programs go “full cycle.” Because investors in TIC and DST programs tend to have low tax basis, they frequently structure their exit as another Section 1031 exchange to continue the tax deferral. Moreover, billions of dollars of old TIC and DST programs will be sold in 2014-2017, when their loans mature. This is likely to produce substantial additional exchange activity over time.

Aging Baby Boomers Face Exchange Challenges

Aging baby boomers own billions of dollars of highly appreciated investment real estate. Many have owned their property for decades and have a very low tax basis. Many would like to sell but do not want to pay the federal and state 8 FYI WINTER 2014

income taxes that would be due on such a sale. With retirement on the horizon, aging baby boomers with low tax basis (and some with mortgage balances) structure exchanges in increasing numbers; many desire a more passive form of real estate ownership. Many taxpayers in this group would like access to a higher quality “investment grade” replacement property with the potential for highly stable returns but do not have sufficient funds from their relinquished property to acquire a larger whole property; few have access to investment grade properties. Many investors actively manage their investment real estate. The classic case is a couple who have owned rental property for decades, actively managing the property on their own as they built wealth through appreciation. Many such investors have financed and refinanced their property a number of times over the decades. Some have “exchanged up” over the years, for example, by selling a single family home and exchanging it for a duplex or quad, structuring Section 1031 exchanges along the way to defer income taxes from sale to sale. It is common for real estate investors, especially aging baby boomers, to have low tax basis in their investment property. Many purchased property years, even decades, ago at very low prices compared to the current value. Most have reduced their cost basis with many years of depreciation deductions (some on an accelerated basis). Finally, the situation is compounded by substantial appreciation in value. The result—low initial cost basis reduced by depreciation deductions over a long period and compounded by substantial appreciation—high rates of income taxation on sale. Many taxpayers view the current rate of federal and state income taxation as punitive—punishment for decades of hard work and savings. They have found Section 1031 exchanges to be a solution to the high rate of taxation on the sale of investment property.

Section 1031 Exchange Solution to Punitive Income Taxes

A properly structured Section 1031 exchange solves the first problem—income taxes—by providing tax deferral for the aging baby boomers and other taxpayers who want to sell their low basis investment property but do not want to pay punitive federal and state income taxes. However, to qualify for tax deferral under Section 1031, taxpayers must make a new real estate investment. This could take the form of another “whole” replacement property or a fractionalized property, such as a DST.

Section 1031 Exchange Ramifications

Many taxpayers do not have the time, skill or desire to find replacement property, not to mention conducting due diligence, and negotiating replacement property financing. The challenge is compounded by the strict rules under Section 1031 to “identify”


Master Limited Partnerships; Real Assets­— Real Returns replacement property within 45 days of transferring their relinquished property and to close all replacement property within up to 180 days. Taxpayers frequently struggle if left on their own to comply with Section 1031 rules. Further, to qualify for tax deferral, taxpayers generally must offset debt secured by the relinquished property with debt secured by the replacement property; any reduction in debt is taxable. While replacement property debt is required for most exchangers, many smaller real estate investors still struggle obtaining replacement property financing. Also, many older TIC and DST programs that are going full cycle have relatively high loan-to-value. This means the replacement property generally must have an equal level of debt to avoid taxation (taxpayers may contribute cash from another source to offset debt). While individual taxpayers may struggle obtaining financing, DST program sponsors have access to numerous sources of real estate financing. A small group of sponsors are presently structuring DST programs for taxpayers who seek qualifying replacement property for an exchange. An exchange program must have adequate debt to produce the desired tax-deferral. Today, virtually all lenders favor DSTs and will not finance a TIC-owned property. The presence of available financing for DST programs has led to their widespread use for exchange programs; the absence of TIC financing has essentially killed the TIC structure for fractionalized ownership programs. DST programs satisfy the demand from aging baby boomers and others for high quality investment grade replacement property. These properties are presented to investors as a turn-key solution to the Section 1031 requirements.

DST Has Become the Structure of Choice for Section 1031 Exchange Programs

Prior to 2008, TIC syndications were the most popular structure for fractionalized 1031 ownership, but flaws in the TIC structure were exposed during the recession. Lessons were learned by sponsors; the DST structure is believed to be superior for 1031 investors in several important respects. DSTs, which allow for many more investors than TICs, typically have low minimum investment amounts. This means that DSTs can be used to reduce risk through greater investment diversification. DST sponsors have greater control to make important decisions, and investors are far more passive than in a TIC offering. The typical DST investor is tired of managing their own property, such as a duplex or farm, and do not want to actively manage their real estate; they favor DSTs with passive ownership of real estate. Demand continues to grow for DSTs from aging baby boomers and other investors who want stable income and potential for appreciation from their investment real estate, while avoiding the headaches of active management. DSTs have become a turn-key solution to the demand for quality Section 1031 replacement property.

By Clay Womack, Adageo

For the last seven years, including through the Great Recession, Master Limited Partnerships (MLPs), have been on a capital formation tear. This investment vehicle has become the entity of choice for natural resource-related capital formation, from an industry market cap of about $35 billion in 2006, to a market cap in excess of $500 billion today. Traditionally, the largest MLPs have primarily been involved in the “midstream” sector of the energy industry––pipelines, terminal storage facilities, etc. However, there has been an explosion in Private Letter Rulings from the IRS which has broadened the definition of “Qualifying income” to enable a wider array of businesses to use the structure. What is a MLP? A Master Limited Partnership is a pass-through investment vehicle that has a friendly tax treatment of qualifying income distributions. The bulk of the distributions are treated as return of capital and therefore not taxed. Taxable income is often quite low because deductions such as depreciation and depletion are also passed through to individual partners. MLPs can be publicly traded on one of the national exchanges, or they can be privately held. They can also be structured as Limited Liability Companies (LLCs). There are over 120 Publicly Traded Partnerships according to the National Association of Publicly Traded Partnerships, a trade association for the industry. Over half of these partnerships are natural resource oriented and include the “midstream” component (pipelines, terminals, storage facilities, etc.), the “upstream” component which is comprised of oil and gas exploration companies, and the “downstream” component which includes refineries and distribution facilities such as convenience stores. In addition, there are now MLPs which own Frac sand mines and distribution, saltwater handling and disposal facilities, and fertilizer manufacturing and distribution operations. The MLP Parity Act Historically, renewable energy companies have been precluded from utilizing the MLP structure for investment capital formation. The MLP Parity Act, a bill recently introduced by Sen. Chris Coons, D-Del., has large bipartisan support. The bill would allow renewable energy projects to structure themselves as MLPs in order to attract capital and provide liquidity—significantly enhancing the growth prospects for the industry. The MLP Parity Act simply expands the definition of “qualified” sources to include clean energy resources and infrastructure projects. Included are those energy technologies that qualify under Sections 45 and 48 of the federal tax code, including wind, closed and open loop biomass, geothermal, solar, municipal solid waste, hydropower, marine and hydrokinetic, fuel cells, and combined heat and power. The legislation also allows for a range of transportation fuels to qualify, including cellulosic, ethanol, biodiesel, and algae-based fuels, as well as energy-efficient buildings, electricity storage, carbon capture and storage, renewable chemicals, and waste-heat-to-power technologies. This legislation, if passed, will greatly expand the investment opportunities available to high net worth investors as the entrepreneurs in this industry will be seeking the lowest cost of capital possible to finance these ventures.

FYI WINTER 2014 9


Modeling Large Endowment Investment Strategy: Intelligent Use of Alternative Asset Classes By Daniel Wildermuth, Wildermuth Advisory LLC

O

ver the past several decades, large college endowments employing a more diversified investment strategy have enjoyed tremendous success through various market conditions, economies, inflationary periods, and interest rate environments. The well-documented performance and volatility characteristics of high profile endowments such as Yale, Harvard, and Stanford have led to widespread emulation by smaller endowments, institutions, high net worth individuals and increasingly, individual investors. As the success of endowments becomes more widely known, demand for new investment opportunities by investors of all sizes is driving rapid development of investments that provide easier access to the asset classes targeted by endowments. Improved access to investments in different asset classes is critically significant because endowment investing success appears to result more from the overall strategy and access, than skill or luck in selecting managers. A Journal of Wealth Management study concluded that even Yale’s endowment, the originator and most famous practitioner of the strategy, showed little skill or luck in selecting managers outside of the category of private equity.1 A 2013 study revealed a similar outcome. Ivy League schools outperformed the average endowment by 330 bps per year while top-SAT schools enjoyed a performance edge of 200 bps per year.2 Both of these groups of endowments notably employed investment strategies utilizing broad diversification consistent with the “endowment model.” The study concluded that “These results indicate that the asset allocation of elite institutions and top-performing funds is the single most important determinant of their superior returns during the last two decades.”3 Essentially, the strategy makes the difference, not access to special investments.

Measuring

In analyzing endowments for this article, the super-endowments of Yale, Harvard, and Stanford are used as examples. These schools were chosen because of their familiarity as top schools in the U.S. as well as their portfolio sizes that place them among the 10 largest endowments. Some large endowments in the top 50 have performed better than these three, and some have performed worse. Investment performance was not considered as a selection criterion. As with nearly all endowments with greater than $1 billion in assets, these schools implement strategies consistent with the widely diversified endowment model. Please see footnote for more information and logic regarding data use and selection.4

Endowment Investing Model

The more progressive and sophisticated investment approach employed by endowments has been emerging since David Swensen, the Chief Investment Officer for Yale University since 10 FYI WINTER 2014

1985, began diversifying Yale���s investment portfolio much more broadly. Since the strategy’s adoption by Yale, rather than holding only U.S. stocks and bonds, the endowment diversifies across six different asset categories—U.S. stocks; foreign developed market equities; emerging market equities; real assets, including real estate and natural resources; private equity; and absolute return investments such as hedge funds and managed futures. The allocations are generally held in roughly equal amounts with many sub-groups within each category. Large endowments usually invest only about 25 to 30 percent of their portfolios in U.S. stocks and bonds. Historically, Yale went even further. In 1989, 70 percent of Yale’s endowment was committed to U.S. stocks, bonds, and cash. By 2013, targets for the same assets totaled only 10 percent.5 The portfolios of larger endowments generally share several common characteristics. Investments focus on multiple different asset classes that are expected to provide strong returns net of inflation and possess minimal performance correlations with each other. Many of the asset classes enjoy higher expected returns than equities and often are expected to perform well during inflationary periods, which can boost returns. But, often their key contribution is diversification through reducing performance correlation with other assets in the portfolio, resulting in less expected downside risk. Beyond early diversification into international equities, endowments made their biggest change with the adoption of alternative investments, which are frequently less liquid and often less correlated with traditional assets and each other. In addition, potential increased returns were sought through purchasing illiquid investments at significant discounts to their more liquid equivalents, and later converting them into liquid holdings that commanded higher valuations. Relaxing liquidity requirements also expanded the investment opportunities and enabled investments in various alternative non-traded asset classes such as real estate and private equity. The potential for illiquid investments to positively impact portfolio volatility was also recognized. Illiquid investments are rarely valued with high frequency. While their true liquidation values may change constantly, the lack of mark-to-market pricing generally limits their pricing volatility, which can add a highly desirable element of stability to portfolios, particularly during times of high volatility. With diversified performance assets providing less portfolio volatility, managers seized on the opportunity to reduce fixed income holdings without raising portfolio risk above acceptable levels. As of July 2013, Yale held only 5 percent in fixed income and cash while Harvard seemed almost over-weighted at 11 percent (Stanford hasn’t published data for the year).6 Using the endowment model design, even a severe reduction of fixed income may still result in a portfolio with lower volatility than the


standard 60/40 stock and bond portfolio. The opaque nature and infrequent reporting by endowments eliminate many traditional volatility and risk assessments, but annual reports still facilitate an analysis of annual maximum drawdown. Since 1993, Yale has lost money one year, Harvard has had four declines although one was only five bps, and Stanford has earned negative returns three times. The 60/40 stock and bond model has lost money in five years. In 2001 during the dotcom crash, the traditional model lost over 9 percent, while none of the super-endowments lost more than 2.7 percent. Yale even enjoyed a gain of 9.2 percent in 2001.7 From July 2000 to June 2002, the traditional model lost over 13 percent8, while all three super-endowments enjoyed gains with an average increase in portfolio value of over 10 percent during the three year period ending June 2003 (the least favorable timeframe).9 The only exception to the pattern of avoiding or minimizing losses remains the financial meltdown of 2008-2009. During the time period ending June 2009, the super-endowments lost an average of 25.9 percent, exceeding the 20.1 percent loss of the 60/40 stock and bond portfolio. While the endowment investment model appears to provide a very attractive risk versus reward trade-off, it’s not infallible.

Performance

As Chart 1 reveals, the super-endowments have achieved solid long-term success, and the returns earned by the endowments are relatively similar to each other. Figure 1 compares the annual aggregated returns of the endowments with a standard 60 percent stock and 40 percent

Chart1 Super-Endowment performance ending June 2013

12.5%

11.3%

12.0%

Reality for Individual Investors

Endowment returns are net of all fees and expenses. In contrast, the 60/40 stock and bond portfolio measures only theoretical

Figure 1 Annual returns for Super-Endowments and 60/40 Stock/bond portfolio through June 2013

Average SuperPeriod Yale Harvard Stanford Endowment Length 1 year

bond portfolio. Note that both stock and bond returns are calculated July 1 – June 30 to retain consistency with endowment reported returns. As Figure 1 shows, the super-endowments have performed much better than the traditional stock and bond portfolio over longer timeframes, but have not strongly outperformed since the economic meltdown. Over the five year period, endowments have even managed to notably underperform the more traditional portfolio model. Yet, recent lack of outperformance is easy to understand with minimal analysis. The endowment investing model’s primary emphasis remains widespread diversification emphasizing a limited allocation to domestic equities or fixed income. Yale’s total U.S. equity holdings for 2011 were 6.7 percent and their domestic fixed income allocation totaled 3.9 percent.10 Since the financial meltdown, U.S. equities and bonds have both generated strong returns, particularly in comparison to nearly any other asset class. By contrast, most other investment categories have underperformed U.S. stocks. Many other large sector allocations targeted by endowments are at different points of their market cycles, which normally lag the fast reacting U.S stock market. While valuations can always stay depressed for extended time periods, reversion to historical norms is likely and should richly benefit endowments. Endowments’ ability to generally keep up with high flying stock and bond models over this time frame remains impressive given their limited holdings of these assets.

11.9%

14.00% Super-Endowment Average 60/40 stock/bond

12.00% 11.94% 11.81%

12.37%

11.75%

11.60%

10.00% 3 years

12.8%

10.5%

11.5%

9.99%

11.6% 8.00%

5 years

3.3%

1.7%

3.3%

2.8%

10 years

11.0%

9.4%

9.6%

10.0%

20 years

11.5%

12.0%

11.8%

11.8%

7.52% 6.00%

6.22%

6.15%

4.00%

2.78%

2.00%

0.00% 1 year Source: The Yale Endowment Report for years 1993-2012, Harvard University Financial Report for years 1993-2013, The Stanford Management Company Report for years 1993-2012. (Note: Endowments measure returns from July 1st through June 30.) Yale and Stanford 2013 numbers from Press Releases.

3 years

5 years

10 years

20 years

Source: The Yale Endowment Report for years 1993-2012, Harvard University Financial Report for years 1993-2013, The Stanford Management Company Report for years 1993-2012. Yale and Stanford 2013 numbers from Press Releases. (Note: Endowments measure returns from July 1st through June 30.), U.S. stocks refer to the S&P 500. All data used was supplied directly by Standard & Poor’s. Bonds returns are calculated from the Barclays Capital U.S. Aggregate Bond Index, and all bond data was supplied by Barclays Capital.

FYI WINTER 2014 11


Chart 2 Dalbar underperformance through December 2012 Period Stocks Length 1 year

-0.42%

Figure 2 Annual returns for Super-Endowments and 60/40 Stock/bond Portfolio with Dalbar calculated fees through June 2013 14.00% Super-Endowment Average 60/40 stock/bond with Dalbar Fees

Bonds 0.47%

12.00% 11.94% 11.75%

11.75%

11.60%

10.00% 3 years

-3.24%

9.99%

-3.34%

9.09%

8.00% 5 years

-2.50%

-4.31%

10 years

-1.05%

-4.01%

6.00%

4.00% 3.92% 2.00%

20 years

-3.96%

2.78%

3.00%

2.99%

-5.36% 0.00% 1 year

Source: DALBAR, Inc., “Quantitative Analysis of Investor Behavior (QAIB),” April 2013, www.dalbar.com, www.qaib.com.

3 years

5 years

10 years

20 years

Source: The Yale Endowment Report for years 1993-2012, Harvard University Financial Report for years 1993-2012, The Stanford Management Company Report for years 1993-2012. Yale and Stanford 2013 numbers from Press Releases. U.S. stocks refer to the S&P 500. All data used was supplied directly by Standard and Poor. Bonds returns are calculated from the Barclays Capital U.S. Aggregate Bond Index, and all bond data was supplied by Barclays Capital. DALBAR, Inc., “Quantitative Analysis of Investor Behavior (QAIB),” April 2013, www.dalbar.com, www.qaib.com.

returns from indexes. Unfortunately, taken in aggregate, individuals routinely and consistently underperform indexes by dramatic amounts. Data compiled by Dalbar Inc., the data research and consultancy company, reveals a consistent pattern of individual investor underperformance dating back decades. If the individual investor underperformance data is added to the equity and bond market returns, the adjusted 60/40 stock and bond results decline significantly as shown in Figure 2. Individual investors who remained in the market have done relatively well versus the endowments in the short term while the longer term performance of endowments looks even better when a more realistic proxy for performance is used.11 For individual investors, returns including Dalbar underperformance are likely far more relevant than comparisons to non-investible indexes, and the results illustrate the shortcomings of the standard investment model for many investors. Moreover, the numbers displayed above are likely overly optimistic. The volatility of the markets meant that an unfortunately large pool of individual investors missed the market’s incredible recovery after they had fled to the sidelines. Another expected advantage of the endowment strategy for individuals, resulting from both greater diversity and some illiquid investments, is the greater likelihood of investors to stay the course through inevitable market disruptions.

also generating solid long-term returns. And retirees have advantages including predictable social security income and possibly pension payments. By contrast, endowments receive alumni gifts, but these tend to dry up during periods of economic uncertainty, adding to their cash needs when they can least afford them. Circumstances suggest that there are far more similarities in portfolio requirements, including near-term income needs, than differences between endowments and individual investors. Furthermore, many of the differences in timeframes nearly disappear once investment horizons exceed five to 10 years, during which nearly all investments available to retail investors provide them complete liquidity. Constant development is also bringing increasing options and better quality to individual investors. Still, individuals need to remain realistic. Nearly any portfolio with a much broader universe of investments will see greater variance in returns than a more traditional portfolio, and investor returns will never exactly match any endowment’s return. Moreover, the individuals can face higher investment fees and costs than large endowments. Still, the differences are often not as great as many investors and advisors assume, and the costs associated with many alternatives can be significantly less than fees many investors pay on more traditional assets such mutual funds.

Applicability

Including Sectors

As radical or as difficult as it may sound to apply the approach used by multi-billion dollar endowments to individual investors, execution and ongoing management is neither difficult nor daunting. Endowments face many of the same constraints as individuals. They must provide short-term income while 12 FYI WINTER 2014

The practical implementation of the endowment model for individuals can be relatively straightforward, but does require advisor competence in more investment categories. Advisors need to appropriately steer investors through many decisions that normally emphasizes skill in choosing investments rather


than ability to manage a single, smaller individual sector such as a U.S. stock portfolio. Equities and fixed income, whether domestic or international, can be easily added via individual stocks, exchange traded funds, or even mutual funds. This has been true for years. By contrast, access to alternatives has changed dramatically. Increased competition among providers appears to be raising the quality of offerings and many fees are coming down, which nearly always helps generate more attractive returns. Many of the offerings spring from firms that have historically served institutions and are now following the money migrating from pensions into retail channels via individual retirement plans. Non-traded real estate that more closely resembles holdings of endowments can be easily accessed through various vehicles ranging from non-traded REITs to limited partnerships. Beyond real estate, the most accessible real asset investments available to individuals probably remain oil and gas and traded commodity stocks. As with other areas, opportunities are rapidly evolving here. Once individuals move beyond real assets, finding direct substitutes for categories that endowments target can become somewhat more difficult, but remains feasible. Private equity offerings are expanding both through brokerage and RIA distribution channels, and strong retail interest continues to spur development. Some advisors may consider business development companies a proxy for private equity because of a similar market and likely correlation with the sector. Realistically, most current offerings resemble something much more similar to high yield debt. Still, the investment offers individuals access to an asset class with strong performance expectations and reduced correlation with other asset classes. The last major category, absolute return, is included by nearly all endowments to some degree via hedge funds and sometimes managed futures. For many investors and advisors, this area remains a category that is difficult to understand and even harder to access. Returns quoted for the category can be highly misleading, and diversification benefits can be difficult to assess.12 Managed futures can offer individuals more attractive opportunities as the funds available to individuals have generally performed more in line with institutional offerings. Individual investors should also continue to benefit from increased access to and availability of diverse alternative investment opportunities. The maturation of the retail industry as well as ongoing growth, competition, and regulatory focus should all combine to improve the quality and transparency of offerings.

Moving Forward

The different options now available to individual investors presents them with the opportunity to emulate the typical allocations of the larger and more sophisticated endowments. As important, the endowment investment philosophy that emphasizes broad diversification across multiple asset classes, including alternatives, still appears very sound particularly against the backdrop of

today’s fixed income prospects and higher U.S. equity valuations. In spite of less inspiring short-term performance numbers, the strategy should continue to serve its practitioners well in the future as various asset class performances likely gravitate back toward historical norms. Through the inclusion of some of the wide range of investments available to individual investors, implementing limited or more comprehensive parts of the strategy across parts or entire portfolios should be rewarded with enhanced performance for given levels of risk, particularly in light of risk versus reward parameters facing more traditional portfolio allocations. Finally, the illiquid nature of investments combined with smaller allocations to volatile investments should also help investors remain invested during inevitable market disruptions, and hopefully help them avoid common costly management mistakes.

References 1 Peter Mladina and Jeffrey Coyle, “Yale Endowment Returns: Manager Returns or Risk Exposure?,” Journal of Wealth Management, Summer 2010, p. 47. 2 Do (Some) University Endowments Earn Alpha?, Brad M. Barber, Graduate School of Management (UC Davis), Guojun Wang, Department of Economics (UC Davis), p. 11, May 2013. 3 Ibid, p. 25. 4 Including endowments other than the model’s most famous practitioner, Yale provides a more meaningful sample size. Yet, including all the data compiled by the National Association of Colleges and University Business Officers (NACUBO) would also be misleading. The NACUBO index aggregates the performance of 843 colleges and universities across the U.S., but 32% of endowments tracked are smaller than $50 million and more than 16 percent are smaller than $25 million. These smaller endowments often employ extremely simplistic defensive strategies that tend to mimic the conservative outlook of the educators who routinely administer them. (U.S. and Canadian Institutions Listed by Fiscal Year 2011 Endowment Market Value and Percentage Change in Endowment Market Value from FY 2010 to FY 2011, Data revised and updated on March 19, 2012, National Association of College and University Business Officers and Commonfund Institute.) Endowments with less than $25 million under management allocate only 10 percent of their portfolios to alternatives while the larger endowments with more than $1 billion under management allocate an average of 60 percent of their portfolios to alternatives. (Asset Allocations for Fiscal Year 2011, NACUBO-Commonfund Study of Endowments ) 5 http://news.yale.edu/2012/09/27/yale-endowment-earns-47investment-return 6 The Yale Press Release September 24, 2013 (http://news.yale. edu/2013/09/24/endowment-earns-125-return), Harvard University Financial Report for 2013. 7 The Yale Endowment Report for 2001, Harvard University Financial Report for 2001, The Stanford Management Company Report for 2001. 8 www.msci.com 9 The Yale Endowment Report for years 2000-2002, Harvard University Financial Report for years 2000-2002, The Stanford Management Company Report for years 2000-2002. 10 The Yale Endowment Report for 2010. 11 Dalbar calculates their underperformance numbers on a calendar year while the stock and bond numbers are calculated from July 1 to June 1. The affect is the same, but a small error exists because all time-frames measured technically report on time periods six-months out of phase from endowments and stock and bond figures. 12 A very thorough study provides some insight into challenges associated with hedge funds. The study analyzed 13,383 funds used by institutions from January 1995 to December 2009. Overall returns appeared fairly strong at 14.88 percent per year net of fees. But correcting for various biases reduced annual returns down to 7.7 percent. By comparison, the S&P 500 returned 7.9% per year over the same time period (www.msci.com). However, the authors noted that the smaller half of the funds earned returns of 6.85 percent per year, trailing the category average by 0.85 percent (Roger G. Ibbotson, Peng Chen, and Kevin X. Zhu, “The ABCs of Hedge Funds: Alphas, Betas, and Costs,” Financial Analysts Journal, vol. 67, no. 1, 2011 p. 23 and 18). And these numbers represent funds that were large enough to target institutions. Individual investors would likely end up with access to even less attractive funds.

FYI FALL 2013 13


Two Meridian Plaza 10401 North Meridian Street Suite 202 Indianapolis, IN 46290

REISA 2014 Spring Symposium

March 16-18, 2014 • Sheraton San Diego Hotel & Marina The three-day conference will include more than 40 sessions on a multitude of nontraded alternative investment topics: REITs, BDCs, MLPs, and private placements, such as 1031s, DSTs, TICs, oil & gas, equipment leasing, life settlements and more! You will also hear directly from top reps from FINRA, the SEC and State Regulators. Symposium Highlights

Educational Highlights

• Educational session designed specifically for broker-dealers, RIAs, registered reps and sponsors!

For Broker-Dealers

• Tracks organized by product types such as REITs, BDCs, 1031s and DSTs

• Updates on regulation from FINRA and SEC representatives • What’s new with alternative investment products in the marketplace For Registered Representatives/Individuals

• Other products include equipment leasing, oil & gas, life settlement and more • Many session offer CE credit, including CFP, CPA and CLE

• 1031 and DST Drill Down

• Learn about the issues affecting your business and the alternative investment space!

• Broad alternative investment education • Updates on regulation from FINRA and SEC representatives For Sponsors • Networking and exposure to leading industry broker-dealers • An annual check-in on what is new in the alternative marketplace • Updates on regulation, including Reg D, Reg A, General Solicitation and JOBS Act

Spring Symposium Keynote Speakers Ulrike Malmendier, Ph.D. Professor of Finance and Economics University of California, Berkeley

REISA’s 2014 Spring Symposium provides a wealth of educational sessions and networking opportunities.

Thomas M. Selman Executive Vice President, Regulatory Policy FINRA

Hotel Information

Space is limited. Register today!

reisa.org

The Sheraton San Diego Hotel & Marina is offering all Symposium attendees a standard rate of $199 per night plus tax. Reserve your room today at reisa.org or by calling 619.291.2900.


Fyi 2014 spring final