Real Assets Adviser January 2015

J a n u a r y 2 0 1 5 | A p u b l i c at i o n o f I n s t i t u t i o n a l R e a l E s tat e , I n c .

High Hurdle Advisers Wayne McCullough and Keith Beckman raise the bar at Benchmark Bank

Blind Spot

HNW investors can plow into the commercial property sector, but caveat emptor

Rough Cut

Diamond investing takes work, but can preserve value over a long-term hold

REITs Roll Dice

Esoteric new structures are testing the limits of the REIT world

KBS REIT III continues its public offering

KBS REIT III is a non-traded real estate investment trust encompassing up to:

200,000,000

SHARES OF COMMON STOCK* AT A CURRENT PRICE OF $10.39 PER SHARE KBS REIT III will use the proceeds to invest in and manage a diverse portfolio of real estate and real estate-related assets, including the acquisition of core commercial real estate properties.

KBS STRATEGIC

OPPORTUNITY REIT II has commenced an initial public offering

KBS Strategic Opportunity REIT II is a non-traded real estate investment trust encompassing up to:

100,000,000

SHARES OF COMMON STOCK** AT A PRICE OF $10 PER SHARE KBS Strategic Opportunity REIT II will use the proceeds to invest in and manage a diverse portfolio of real estate and real estate-related assets located in the United States and Europe.

This announcement is not an offering. No offering is made except by the prospectus filed or registered with appropriate state and federal regulatory agencies, including the Department of Law of the State of New York. Neither the Attorney General of the State of New York nor any other state securities regulator has passed on or endorsed the merits of the offering. Any representation to the contrary is unlawful. *Up to 200,000,000 shares of common stock are currently available in the primary initial public offering for $10.39 per share, with volume discounts available to investors who purchase more than $1,000,000 of shares through the same participating broker-dealer.

Discounts are also available for other categories of investors. Up to 80,000,000 shares are also being offered pursuant to a dividend reinvestment plan at a purchase price currently equal to $9.88 per share. **Up to 100,000,000 shares of common stock are available in the primary offering for $10 per share, with volume discounts available to investors who purchase more than $1,000,000 of shares through the same participating broker-dealer. Discounts are also available for other categories of investors. Up to 80,000,000 shares are also being offered pursuant to a dividend reinvestment plan at a purchase price initially equal to $9.50 per share.

For additional information about these offerings, please contact your financial advisor or KBS Capital Markets Group. You can also learn more about these offerings by visiting www.kbs-cmg.com.

KBS Capital Markets Group Member FINRA & SIPC 660 Newport Center Dr., Suite 1200 Newport Beach, California 92660 (866)-KBS-4CMG (866-527-4264) www.kbs-cmg.com

Contents 34

Jan uary

20 15

VOLUME 2 | NUMBER 1

features

34 | High Hurdle

Advisers Wayne McCullough and Keith Beckman raise the wealth management bar at Dallas’ 50-year-old Benchmark Bank.

By Ben Johnson

40 | Blind Spot

I nvestors often overlook direct investment in commercial property, but why?

By Jennifer Popovec

44 | Rough Cut

Diamond investing takes some work, but can yield attractive returns over the long term.

By Joseph Dobrian

50 | Coming of Age

40

44

New platforms, changing sentiment and ongoing quest for yield have the infrastructure asset class sprinting toward adulthood.

By Alexis Petrakis

56 | REITs Roll the Dice

Esoteric business spaces have spawned new REITs, making for an interesting year ahead.

By Brad Berton

50

56

Wayne McCullough and Keith Beckman lead Benchmark Bank’s new wealth management division in Dallas.

Photo Credit: James Olvera

realAssets Adviser | JANUARY 2015

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1

Contents

Jan uary

20 15

re a l a s s e t s a dv i s er . com

News & views

26

28

30

32

Real Estate

Infrastructure

Energy

Commodities

26 | Griffin REIT Merges Griffin Capital snaps up Signature Office REIT

28 | Hawaii Takes a Dip Retirement system commits $50M to infrastructure

30 | Pensions Commit Institutions approve $475M for new energy funds

32 | Gold Loses Luster Lower demand drives down pricing by 2%

27 | Texas Fund Gets Driven Teachers fund commits $200M to automotive real estate

29 | CalPERS Expands Pension investing $5B over next three years

31 | Wind Assets Auctioned Largest offshore wind auction set for Jan. 29

33 | Swiss Miss Gold-based referendum defeated by Swiss Parliament

27 | Blank Retires Veteran leaves Urban Land Institute after 17 years

29 | Airports Build Traffic New visa policy drives more gateway travellers

31 | Crude Continues Plunge Major MLP indexes dip amid supply glut

33 | Citrus Peels Out Alico buys three major citrus groves for $350M

26 | Blackstone Sells Big PE firm is net seller of $8B in assets

28 | Index Launches New IPD/MSCI index tracks global trends

30 | Megamerger Time Two large oil & gas mergers set 15-year record

Coming Next Month

departments

4 | Notes & Trends

14 | The Big Picture

59 | Ad Index

8 | Contributors

22 | Up Front

61 | Editorial Board

24 | people

64 | Last Word

12 | Market View

32 | Timber Falls CalPERS’ timber portfolio falls short of benchmark

heck out our 2014 C Year in Review feature.

The publisher of Real Assets Adviser, Institutional Real Estate, Inc., is not engaged in rendering tax, accounting or other professional advice through this publication. The opinions expressed in articles or columns appearing in Real Assets Adviser are those of the author(s) or person(s) quoted and are not necessarily those of Real Assets Adviser or Institutional Real Estate, Inc. Advertisements appearing in the magazine do not constitute or imply endorsement by Institutional Real Estate, Inc. Although the information and data contained in this publication are from sources the publisher considers reliable, its accuracy cannot be guaranteed, and Institutional Real Estate, Inc. accepts no responsibility for any errors or omissions. No statement in this magazine is to be construed as a recommendation to buy or sell any security or other investment.

The contents of this publication are protected by copyright law and may not be reproduced in whole or in part or in any form without written permission. Š 2015. All rights reserved. Printed in the USA.

2

realAssets Adviser | JANUARY 2015

Bridging the divide between retail investors and institutional quality real estate investment programs

AR Capital sponsors sector-specific public real estate programs focused on core investment strategies and durable income. Each company is led by an experienced management team targeting the following investment objectives:

Target investment sectors include:

■ Durable Income

■ Healthcare ■ Grocery Anchored Shopping Centers ■ Hospitality ■ Oil and Gas

■ Prudent growth

■ Mezzanine Debt

■ Private / public arbitrage

■ New York City Office and Retail

■ Principal Protection

■ Power Centers

■ Diversification by tenant,industry, property

■ Sale Leaseback

FOR MORE INFORMATION, PLEASE CONTACT:

AR Capital

405 Park Avenue, New York, New York 10022 Web Site: www.americanrealtycap.com – or – Sameer Jain: Phone: (646) 861-7726 | email: SJain@arlcap.com

THIS IS NOT AN OFFER TO SELL NOR THE SOLICITATION OF AN OFFER TO PURCHASE A SECURITY OR AN INTEREST IN REAL ESTATE.

[

notes & trends

By Ben Johnson Managing Director, Editor-in-Chief Real Assets Adviser

]

What Can We Expect in this Bold New Year?

Prognostications abound as we enter the unknown realm of 2015, but who really knows, right?

T

his is my favorite time of year. Period. The end of every year brings with it the closing of one chapter in time and the promise of a new chapter yet to be written. All bets are off, or on, depending on how you look at it. Hope and promise springs eternal. It’s much like the age-old sports analogy, where every team starts their new season undefeated with a perfect record of 0-0.

This is also, by far, the most popular time of year for forecasts of all kinds. Of course, one of the major challenges with any forecast is that it’s just that: at best an educated guess and at worst a shot in the dark. How often do you see post-forecast tallies of their accuracy? Ultimately, I always ask myself how many prognosticators accurately forecast the most recent mortgage crisis and the resulting downturn in the global economy. Uh, not so many.

One of my New Year traditions is taking some time to rediscover what was written 10 or more years ago and compare that coverage to the present-day investment environment. That’s perfect for me since

Last year saw the continued emergence of real assets as a more mainstream investment class.

I’m a huge collector of magazines, many dating back decades. Call it a hobby. Or an illness.

4

One item that caught my attention, in particular, was a July 1996 report on the state of real estate investment trusts, or REITs. It’s almost comical to read the headline on that report cover: “As long as the stock market continues its robust march to 6,000 and beyond, and glamour high-tech IPOs reap the lion’s share of attention, REIT stocks will remain undervalued. The good news: real estate fundamentals can’t be ignored forever …”

Much of that special section tied the growth in REITs with the upcoming 1996 Summer Olympics in Atlanta, focusing on how REITs were also competing for investor attention with traditional stock sectors. At the time, there were a total of 199 publicly traded REITs and their total market capitalization was a paltry $88 billion.

Consider what has transpired in the 18 years since that report. First, the overheated technology sector led to the dot-bomb era that caused the 2000–2003 recession, followed by the go-go latter part of that decade that culminated in the Great Recession starting in 2008. But the ever-resilient U.S. economy has recovered, and the REIT industry has matured and grown exponentially. Today there are 202 publicly traded REITs with a market cap of some $670 billion.

While reviewing industry trends is fascinating stuff, looking back over our own past three issues, it is also time for us to take stock of where we have been and more importantly, were we are headed. I can tell you this: Every issue of Real Assets Adviser will realAssets Adviser | JANUARY 2015

Real Assets, Real Diversification,

Real Yield

SM

Follow the Corridor www.corridortrust.com

Corridor is a Montage Investments manager

[

notes & trends

]

be dedicated to providing investment advisers with actionable information across all of what I lovingly call the “four food groups” of real assets, namely real estate, infrastructure, energy and commodities.

Today’s hot topic is oil prices. Here again, who really and truly knows where they will settle over the course of 2015? Columnist Jonathan Ruff of AllianceBernstein provides his own take on this topic in a column starting on page 12, in which he predicts stabilized pricing of around $80 a barrel this year.

In our December issue, we discovered what is on the minds of many investment advisers when it comes to what trends they will be watching in the year ahead. In general, the health of the U.S. economy is obviously on everyone’s minds, but so too are potential changes in the U.S. tax code and the ongoing struggle to achieve maximum returns in an uncertain future interest rate environment. For real assets investing, advisers continue to monitor the risk/reward characteristics and potential diversification benefits due to negative correlations to more traditional investments in client portfolios.

Next month we present our review of major trends in real assets investing in 2014. Last year saw the continued emergence of real assets as a more mainstream investment class, as a subset of the broader alternative investments category.

And before you leave this space, I would like to provide a few thought starters that are sometimes useful for those awkward, break-the-ice business lunch conversations. I present to you a few specific milestones in the coming year: • The Magna Carta turns 800 • Lithuania becomes the 19th country in the eurozone to adopt the euro as its formal currency • Mobile phone roaming charges will be abolished within the European Union • The Americans with Disabilities Act celebrates its 25th anniversary • The world’s current tallest building, the Burj Khalifa in Dubai, turns five years old • NBC’s Saturday Night Live celebrates its 40th anniversary • Television channel VH-1 started 30 years ago • The iconic movie, The Sound of Music, turns 50 • Yahoo! celebrates its 20th anniversary in business • HSBC celebrates its 150th anniversary • The world’s first restaurant, the Monsieur Boulanger, opened near the Louvre in Paris 250 years ago • A total eclipse will occur on March 20 • Expo 2015 starts in Milan, Italy on May 1 With all of this mind, here’s wishing you and yours a very happy new year!

There were a total of 199 publicly traded REITs and their total market capitalization was a paltry $88 billion.

On Twitter: @RealAssetsAdv and @Bjohn9

6

A publication of Institutional Real Estate, Inc.

president & CEO Geoffrey Dohrmann CHIEF Operating OFFICER Erika Cohen Managing Director, PUBLISHER & editor-in-chief Ben Johnson SENIOR VICE PRESIDENT, MANAGING DIRECTOR of business development Jonathan Schein EDITORIAL DIRECTOR Larry Gray ART DIRECTORS Maria Kozlova Susan Sharpe COPYEDITOR Jennifer Babcock Contributing Editors Drew Campbell Loretta Clodfelter Reg Clodfelter Mike Consol Denise DeChaine Jennifer Molloy Andrea Waitrovich vice president, marketing Sandy Terranova marketing & client services Michelle Raab Brigite Thompson Michelle Tiziani Caterina Torres BUSINESS DEVELOPMENT Elaine Daniels Salika Khizer Karen McLean SPONSOR SERVICES Wendy Chen DATA SERVICES MANAGER Ashlee Lambrix DATA SERVICES Justin Galicia Derek Hellender Karen Palma Administration Andrew Dohrmann Jennifer Guerrero

realAssets Adviser | JANUARY 2015

ACTIVE REAL ESTATE INVESTMENT

We combine the in-the-field knowledge of the world’s largest commercial real estate services network with the operational expertise of our investment professionals to actively build and manage our clients’ investments throughout market cycles.

CBRE GLOBAL INVESTORS – REAL ESTATE IS OUR NATURE

www.cbreglobalinvestors.com

[

contributors

] Joseph Dobrian Rough Cut (page 44) Joseph is an award-winning business journalist. He covers a broad range of topics, most notably real estate, the debt and equity markets, investment, management, luxury retailing, politics, and sports. He has authored two novels — Ambitions and Willie Wilden — and the bestselling collection of essays, Seldom Right But Never In Doubt.

Jim Keene How RIAs and Family Offices View Alts (page 14) Jim is the founder of Atherton Consulting Group and is an investment management leader and coach with 25 years’ experience in wealth management, venture leasing and commercial real estate investing. He facilitates vision setting for organizations and provides strategy and management consulting, leadership assessment, and executive coaching services.

Jennifer Popovec Blind Spot (page 40) Jennifer is an award-winning journalist and for the past 15 years has focused on business journalism with a specialty in commercial real estate, finance/investing, retail, hospitality and healthcare. She has more than 1,000 bylines to her credit and lives in Fort Worth.

Jonathan Ruff Asymmetric Risk in Oil (page 19) Jon is lead portfolio manager and director of research for AllianceBernstein’s real assets strategies. He joined the firm in 2004 as a senior portfolio manager, was appointed a director of the wealth management group in 2006, and to his present position in 2010. Jon was previously the senior investment professional for a large family office.

ISSN 2328-8833 Institutional Real Estate, Inc. Vol. 2 No. 1 January 2015 PURPOSE Real Assets Adviser is dedicated to providing actionable information on the real assets class and facilitating important business connections for investment advisers, wealth managers and family offices. Through print, online, conference and data p ro g r a m s , R e a l A s s e t s A d v i s e r provides thoughtful, cutting-edge analysis, helping advisers make informed decisions to diversify clients’ portfolios, provide long-term income and hedge against inflation.

Real Assets Adviser (ISSN 2328-8833) is published 12 times a year for $195 per year, by Institutional Real Estate, Inc., 2274 Camino Ramon, San Ramon, CA 94583; www.irei.com; Tel +1 925-244-0500; Fax +1 925-244-0520.

CHANGE OF ADDRESS: Send address changes to Real Assets Adviser, 2274 Camino Ramon, San Ramon, CA 94583 USA. Copyright © 2015 by Institutional Real Estate, Inc. Material may not be reproduced in whole or in part without the express written p e r m i s s i o n o f t h e p u b l i s h e r.

Copyright Permission: Larry Gray, Tel +1 925-244-0500, x119; l.gray@irei.com Circulation or Subscription Inquiries: Direct all subscription inquiries, payments and changes of address to Client Services, Tel +1 925-244-0500 or Fax +1 925-244-0520; circulation@ irei.com. Subscribers have 30 days to claim issues lost in the mail.

Editorial Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com Advertising Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com

Calvin Schnure Commercial Real Estate Outlook (page 12) Calvin is vice president, research and industry information at NAREIT. He began his career in the early 1990s as an economist at the Federal Reserve Board. He was also vice president for U.S. economics at JPMorganChase, a senior economist at the International Monetary Fund and director of economic analysis at Freddie Mac.

8

Sponsorship Inquiries: Ben Johnson, Tel +1 925-244-0500, x162; b.johnson@irei.com Requests for Reprints: Susan Sharpe, Tel +1 925-244-0500, x110; s.sharpe@irei.com Visit us online: RealAssetsAdviser.com

realAssets Adviser | JANUARY 2015

Opening

VIEW

Heartland Harvest

As commercial property pricing reaches stratospheric levels on both coasts, mega-deals are moving to the central U.S., and Chicago has become a major hot spot.

[

Market View

By Calvin Schnure

]

Commercial Real Estate Hinges on Key Fundamentals Investment performance has been strong, but advisers must gauge uncertainties that lie ahead.

C

ommercial real estate has been a bright spot on the investment horizon, with all property types posting solid gains in earnings and with property prices reaching or exceeding pre-crisis peaks. In terms of investment performance, equity REITs posted a total return of 27.8 percent through the first 11 months of 2014.

Yet there are uncertainties about the path ahead.

The overall economy is shifting from the early stages of recovery from the financial crisis, to the middle and later stages of an economic expansion. As the recovery matures, the outlook for commercial real estate will depend on key developments in the fundamentals of supply, demand and valuations.

Supply is clearly on a strong uptrend as new construction gets under way in cities across the country. In terms of the total inflation-adjusted dollars

What’s going to happen when all this new supply starts hitting the market? of spending on commercial construction, activity rose 12 percent in the first three quarters of 2014 compared to the same period a year earlier. These increases come on the heels of several years of solid growth; in fact, construction activity is up 50 percent from its low point in 2011.

What is going to happen when all this new supply starts hitting the market? Past decades have all

12

too many episodes of overconstruction flooding the market, driving down rents and property prices. So far, though, construction activity does not appear to have outpaced fundamentals, as these increases in commercial construction activity look like a boom mainly when one compares them to the years immediately following the crisis, when there was very little activity. Taking a somewhat longer perspective, total construction spending adjusted for inflation is still well below where it was in the middle of the 2000s, and, indeed, is still 30 percent below the lowest levels it reached over a decade ago following the 2001 recession.

The new supply would become a problem, moreover, only if it gets ahead of demand. One of the best single economic indicators for future trends in demand for commercial real estate is the growth of payroll employment. After all, not only do new workers generate a need for additional office space, but the paychecks they receive also help support retail spending in shopping malls and community centers, and increase workers’ demand for apartments and other services. The news here is encouraging about the outlook for real estate. Monthly job growth accelerated from 185,000 to 195,000 in 2012–2013, and to 240,000 in the first 11 months of 2014. This acceleration of jobs and incomes will lift the demand for commercial space, helping markets across the country to absorb the new supply as it comes on line.

While there may be certain areas where new supply gets ahead of demand — the apartment market in realAssets Adviser | JANUARY 2015

CONSTRUCTION SPENDING, ADJUSTED FOR INFLATION, IS STILL 20% BELOW ITS LEVEL 20 YEARS AGO

350 300 250

200 150

Washington, D.C., comes to mind — these dislocations are likely to be short-lived in an economic environment such as we face today. On a national basis, the strength in demand is likely to push occupancy rates and rents higher, boosting earnings growth.

The third fundamental issue for the outlook for commercial real estate is valuation, especially as interest rates respond to the end of the Federal Reserve’s bond purchases and, eventually, as the Fed begins increasing short-term interest rates. After all, interest rates are a true “fundamental” for real estate because they determine the current value of future rent receipts — and higher interest rates translate into a lower present value of a given stream of future rents.

The outlook for interest rates remains benign, however, with moderate increases in both shortterm and long-term rates expected over the next two years. There are few signs of inflation pressures and, according to senior officials at the Federal Reserve, there appears to be considerable slack in the labor market that will allow the economy to continue to expand. The interest rate environment for the next few years will likely be quite favorable for real estate investments.

Any increases in interest rates that do occur, moreover, will be against a backdrop of a stronger economy — which, as discussed above, will likely boost earnings. History shows that real estate often performs well during periods like this.

For example, the last time the Fed began raising interest rates was in 2004, following a period when rates had been held at what had been, up to that point, an unusually low level for an unusually long time (sounds familiar!). Over the subsequent two years, the Fed raised short-term interest rates by 425 basis points. The commercial real estate market thrived over this period, as the growing economy boosted occupancy rates and rent growth. Indeed, commercial property prices rose 35 percent over this period, and REITs posted a 69 percent total return. realAssets Adviser | JANUARY 2015

100 50

0

1993

1995

1997

1999

2001

2003

2005

These fundamentals of supply, demand and valuations apply to varying degrees across all property types. As a result, nearly all sectors of listed REITs posted returns of 20 percent or more in the first 11 months of 2014. Apartment REITs led the way with a 37.4 percent total return, as the pent-up demand for rentals that built up during the housing crisis has lifted occupancy rates to new highs. Other sectors with total returns in excess of 20 percent include health care and self-storage (both above 30 percent), lodging and resorts, infrastructure, retail, office, and diversified REITs, while industrial REITs were close behind with an 18.2 percent return. Indeed, the only sector with single-digit returns was timber, at 6.4 percent for the year, as a soft recovery in home construction has dampened demand.

The year ahead will no doubt have some surprises for commercial real estate and for the economy at large. But with the supply pipeline in check, grow-

2007

2009

2011

2013

Multifamily Health Care Commercial Office Lodging Billions of dollars, seasonally adjusted annual rate, adjusted by chain price index for investment in nonresidential structures Source: U.S. Census Bureau, U.S. Bureau of Economic Analysis, Haver Analytics

Nearly all sectors of listed REITs posted returns of 20 percent or more. ing demand supported by jobs and the macroeconomy, and a relatively benign interest rate environment, the prospects for commercial real estate remain bright.

Calvin Schnure is vice president of research and industry information at the National Association of Real Estate Investment Trusts.

13

[

The Big Picture

By Jim Keene

]

How RIAs and Family Offices View Alts Investing A recent survey of advisers finds that sentiments and motivations on using alternatives differ across firms.

M

ajor university endowments’ stellar investment performance in the last 25 years has popularized alternative investing. David Swensen’s Pioneering Portfolio Management laid out in a compelling and understandable manner the benefits that real assets, venture capital, private equity, hedge strategies and the like could bring to portfolios. With the proliferation of alternative investment managers and increased access to alternatives, even the most reluctant advisers offer some alternatives to clients.

Atherton Consulting Group completed a survey of 20 wealth managers (15 RIAs and five family offices, geographically dispersed with total AUM of $37.6 billion) to determine how they view, evaluate and use alternative investments. Here are the key findings.

Even the most reluctant advisers offer some alternatives to clients.

APPROACHES VARY WIDELY Firms have differentiated approaches to alternative investments based on investment philosophy, capabilities and marketing perspectives. The four primary groupings are: • Little to no alternatives. Little commitment to, belief in or expertise in alternative

14

investments defines this group. One manager viewed their role with clients as that of “risk manager/capital preserver,” and that can be done with mostly traditional investments (2 percent of surveyed AUM).

• Staying liquid. The increasing breadth and depth of ’40 Act alternatives has allowed firms to offer exposure to “alternatives” that they could not have five or 10 years ago (e.g., hedge strategies, commodities, REITs, private equity, timber, oil and gas). Some firms stop here, stating, “investing in illiquid alternatives with outside managers puts our firm’s reputation at risk.” It is a matter of control — liquids can be sold easily (21.4 percent).

• Endowment model. Accessing a range of alternatives, mostly through third-party managers with limited liquidity vehicles (hedge funds, commodities) to very illiquid partnerships (real estate, venture capital, private equity/debt), often supplemented with public vehicles, including REITs, commodity mutual funds and/or energy-related MLPs (52.1 percent).

• Alternatives differentiate us. Highly proactive firms with higher allocations to alternatives (opportunistic, secondary market, deep value, private equity/debt, direct investing in real estate and operating companies) defined more by in-house expertise at the asset level than at the realAssets Adviser | JANUARY 2015

Breakdown of Alternative Approach by Firm Numbers and AUM 90% 80%

30%

24.4%

ALTERNATIVES AS DIFFERENTIATOR

70% 60%

asset allocation and manager due diligence level (24.4 percent).

Five of the six firms in this category are direct investors, mostly in real estate. They source, perform due diligence, negotiate and structure the asset acquisitions. Complexity of portfolio construction is also greater for this group. One firm developed an investment approach that groups managers into 10 “portfolio building blocks.” Groupings include real assets, public alternatives, private alternatives, private real estate, private equity and an endowment model.

Most offerings are through private label or partnership structures where the firm is the general partner, charging a nominal 1 to 5 basis point annual fee. Part of their alternatives strategy is very opportunistic and tactical, investing heavily in discounted real estate equity and notes.

In-house experience includes dealmakers from the investment banking industry — a skillset most wealth management firms do not have.

RATIONALE FOR PORTFOLIO INCLUSION Based on wealth management experience and informal surveys several years ago, we observed alternative investment allocations generally between 10 and 15 percent of total portfolios, with some as low as 2 to 5 percent. In our research, we were surprised to find a weighted average target allocation of 24 percent. RIAs were at 21.2 percent and family offices were at 35.0 percent of the client portfolio. Admittedly, the sample size is not huge and these are target allocations (different than actual allocations which are usually lower), but we were surprised on the high side.

Ninety-five percent of the firms surveyed include alternatives for diversification value.

Roughly 79 percent of firms also seek enhanced returns from alternatives (typically above public equity market returns). Twenty-nine percent of RIAs also offer alternatives as a way to “keep” realAssets Adviser | JANUARY 2015

ENDOWMENT MODEL (a)

20%

50%

STAYING LIQUID 52.1%

40% 30%

40%

20% 10% 0%

21.4% 10% % of Total Firms

2%

L ITTLE OR NO ALTERNATIVES (a) One firm represented $17 billion in AUM. The Endowment Model total firm AUM excluding this firm was $2.62 billion; average was $873 million. (b) Total AUM excluding largest firm was $20.64 billion; average AUM was $1.086 billion.

% of Total AUM

client assets, so they will not invest those funds elsewhere.

DIRECT INVESTMENTS’ ROLE Of the 20 firms interviewed, eight are involved in direct investing (40 percent). One firm invests directly in operating companies, while all eight invest in real estate. In these direct investments, the firms are either managing the assets (real estate) or influencing operating company strategy (equity interest), requiring a skill set beyond asset allocation and manager selection.

Many RIAs and MFOs use in-house investment expertise to select a portion of clients’ portfolio investments, typically for selection of individual equity and fixed-income securities (including liquid alternative investments). In our informal discussions with these firms, however, there also appears to be an expertise increase in direct investing (taking direct ownership in an asset without an outside manager). Two firms run hedge funds in-house: One firm invests in direct private operating companies (biotech), and one firm invests directly in oil and gas. We believe the level of direct investment comes as a result of the in-house capabilities developed or acquired by these firms as opposed to a reaction to investor demand.

Interestingly, three of the firms investing in direct real estate differentiate their brand this way. The AUM size of direct investing firms

15

[

The Big Picture

]

Factors Firms Consider in Evaluating Third-Party Alternative Managers

RIA

FO/MFO

TOTAL

0%

20%

TRACK RECORD REPUTATION TIME IN BUSINESS ALIGNMENT WITH CLIENT GOALS PHILOSOPHICAL FIT WITH FIRM

40%

60%

80%

100%

ranges from $120 million to $2.6 billion. Firms are geographically dispersed and have been in business from two to more than 30 years. Most of these firms commenced from pairs or teams of professionals lifting out from predecessor brokerage or advisory firms. Firms serving HNW clients have an opportunity to differentiate themselves through direct investment offerings, but they must consider the costs. Considerations for moving to direct investing include having the skills to source, evaluate, negotiate,

There are as many approaches to investment decision making as there are investment philosophies in the industry. close, manage and dispose of assets. Investment volume, fee structure, profitability, investment thesis and business model alignment need to be considered, too.

16

DECISION MAKING ALL OVER THE MAP There are as many approaches to investment decision making as there are investment philosophies in the industry. Firms differ in sourcing approaches, vetting, due diligence, allocation of rights, investment approval process and third-party input. The inconsistency in process across firms surprised us.

One family office had four committees involved in the entire process. Alternatively, at the other end of the spectrum, a similar sized firm had one group responsible for bringing new ideas to the investment committee (IC) where they were vetted. A majority vote among the three IC members was all that was needed for inclusion in portfolios, although a “practical” consensus was required.

Access to a wide range of alternative investments among wealth management groups of all sizes has increased significantly in recent years.

New and expanded “alternatives” platforms from firms like Fidelity and others make it easier for wealth managers to access and manage alternatives portfolios. The proliferation of ’40 Act funds and ETNs covering a range of alternatives strategies has made a huge impact on the use of nontraditional investments. Ultimately, the main factors affecting the view and use of alternatives are based on firms’ business models, investment philosophies, real portfolio benefits and internal capabilities of professional staff. On the client side, it will be driven by increased access to products (both liquid and illiquid), better education, the need for more stable portfolio performance and income in a low interest rate environment.

CLOSING QUESTIONS Based on the research, we see some key questions for firms to answer: • What is your firm’s approach and philosophy to alternative investments for clients?

•A re your alternative allocations consistent with your philosophy?

• How do you consider direct investing, particularly in real estate, in your value proposition?

• What are the implications for individual skill development and in-house/out-sourcing decisions?

•H ow does your firm view its investment process?

• What is the impact of liquid alternatives on the illiquid “comparables?”

Jim Keene is managing director at Atherton Consulting Group in Atherton, Calif. realAssets Adviser | JANUARY 2015

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Asymmetric Risk in Oil: Back Toward $80 in 2015

The Big Picture

]

By Jonathan Ruff

Despite short-term volatility, long-term investors should not overlook oil-related investments.

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olitical, cyclical, and secular factors combined to cut the price of crude oil in half, from a high of $107 per barrel in mid-June to under $60 per barrel in December. While it could fall lower in the next couple of months, oil is likely to be back toward $80 sometime in 2015, in our analysis. If not, oil prices may be well over $100 per barrel in three to five years.

Behind the Price Drop The secular factor driving down prices has been the relentless rise in U.S. oil production from shale oil fields, made worse in recent months by cyclical weakness in global demand: emerging economies weakened, Japan’s economy slipped into recession and Europe’s outlook tumbled.

The political factor has been Saudi Arabia’s attempt to impose discipline on the rest of the nations comprising the Organization of the Petroleum Exporting Countries (OPEC) and the U.S. shale industry (and, perhaps, put pressure on the Russian and Iranian economies). The Saudis kept up production as Libyan supply miraculously recovered amid a three-way civil war, and then they dropped prices to defend market share as supply burgeoned. These moves were meant to slow U.S. shale investment and send a signal to the rest of OPEC that they would have to share in future production cuts needed to accommodate non-OPEC supply.

realAssets Adviser | JANUARY 2015

The Short-Term View In the next few months, we expect the price of oil to fluctuate on speculation around OPEC intent, the odds that a deal with Iran on nuclear power will lift sanctions on Iranian oil, and other difficult-to-analyze issues. Options markets currently imply a 15 percent chance that the price of oil will fall another $10 per barrel early this year. But as 2015 goes on, shale cost economics and OPEC budget math should put a floor under prices and push the price of oil toward $80 a barrel by year-end.

Shale oil producers will delay projects if low oil prices make them uneconomical. The lower the price of oil falls, the higher the number of shale projects that will be shelved — and the lower the supply growth six to 12 months later. About 10 percent of the new shale wells planned for 2015 would only break even economically with oil above $80 per barrel. Nearly 25 percent need a price of at least $70 (see chart on p. 20).

Oil prices may be well over $100 per barrel in three to five years.

While cost deflation and technological innovation may eventually push these breakeven points down, higher financing costs already have pushed them up. Many shale operators are unable to fund

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The Big Picture

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U.S. Shale Breakeven Share of planned 2015 production 100%

98%

100%

92% 80%

78%

84%

60%

40%

20%

0%

39%

19%

$ 60 Source: Wood Mackenzie

$ 65

$ 70

$ 75

$ 80

$ 85

$ 90

$/barrel WTI

investment out of cash flow, so they borrow in the high-yield bond market. The bond market is not blind to the risk from low oil prices. High-yield bonds for energy producers are now yielding the widest spread relative to the rest of the high yield bond market in at least a decade.

Supply discipline in 2015 also may come from the major oil-producing countries: Few of them can sell oil at $80 per barrel or less without running massive budget deficits or dramatically cutting spending. Financial markets likely will balk at ever-larger budget deficits for countries like Venezuela; local populations might take to the streets if social spending is cut. The short-term alternative to fiscal stress or social unrest is a shared production cut among OPEC members and possibly Russia. It’s in their interest to let oil rise above $80 some time in 2015.

For long-term investors, it makes sense to have exposure to long-term oil prices.

The Long View If prices decline further and do not rebound in 2015, there may be a dramatic price spike three to five years ahead. Projects with high breakeven points and long lead times are already

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being deferred; this trend will accelerate if prices fall further.

The world needs the oil that deferred projects would produce. We estimate that in three years or so, OPEC would have to draw down spare capacity to make up for the supply “lost.” As OPEC spare capacity falls, prices will rise, and deferred shale projects will come back online. If nonshale producers delay too many long lead-time investments then shale oil supply alone will be insufficient to meet demand beyond 2018: OPEC would have to draw down spare capacity to dangerously low levels.

Under such delicate conditions, even a minor geopolitical shock could propel prices above $150 per barrel. Let’s be optimistic and assume that geopolitical conditions are calm in the three to five years: Prices would still have to rise well above $100 per barrel to compensate for the risk of a shock and to attract enough investment to make up for years of underinvestment.

There are three risks in our view that oil prices, if they do not rise modestly in the next year, will rise sharply in three to five years: • First, sanctions on Iran could be lifted and Iranian oil production return to market; this would delay upward pressure on prices.

• Second, the Saudis could conclude that it is in their long-term interest to maximize current production and thus current revenues forever more. Our analysis suggests that such a seismic shift is not in the Saudis’ interest: They would be far better off if they can get the rest of OPEC to agree to a modest shared production cut.

• Third, drilling technology could take another step-change forward, dramatically lowering the breakeven on shale wells. But the R&D spending required for such major technological breakthroughs is more likely to occur in a high-price environment.

In sum, there may be considerable volatility in oil prices over the next few months. But any shortterm downside risk is more than offset by longer term upside potential. For long-term investors, it makes sense to have exposure to long-term oil prices, either directly through long-dated energy futures or indirectly through long-horizon public and private energy equity.

Jonathan Ruff is lead portfolio manager and director of research for real asset strategies at AllianceBernstein. realAssets Adviser | JANUARY 2015

advocacy / collaboration / education / resources / awareness

Leadership for the Direct Investments industry.

The Investment Program Association (IPA) was formed in 1985 to provide the Direct Investment industry with effective national leadership.

We support individual investor access to asset classes generally not correlated to the traded markets, and historically available only to institutional investors. Our membership includes product sponsors, broker-dealers, investment banks and service providers that manage and distribute a wide variety of Direct Investment products including: > > > >

Non-Listed REITs Business Development Companies (BDC’s) Oil & Gas Programs Equipment Leasing Programs

Since 2003, IPA member firms have purchased 443 million square feet (US & international) of commercial Real Estate Assets and corporate debt with a value of approximately $87 billion.

For a weekly summary of the biggest news articles across the Direct Investment industry, sign up at: www.smartbrief.com/ipa

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up front

CFA INSTITUTE SIGNS BLACKROCK TO STANDARDS CODE

NUMBER OF RIA FIRMS GROWS 3.7% OVER TWO YEARS

World’s largest asset manager joins more than 1,000 firms in adopting the Institute’s code of conduct.

Ranks of SEC-registered advisers now totals 10,895, according to the Investment Adviser Association and National Regulatory Services.

Retirees Still Feeling Effects of Great Recession Market Crash

Among the countless victims of the “Great Recession” of 2008‒2009 were the retirement expectations of many Americans. New research from the nonpartisan Employee Benefit Research Institute (EBRI) has quantified just how much those hopes suffered.

The report revealed a nearly 23-percentage-point drop in workers retiring early or close to their expected retirement after the markets crashed. Specifically, EBRI found that before September 2008, 72.4 percent of workers retired either before or shortly after (no more than one year) their expected retirement.

However, that dropped to 49.6 percent after September 2008.

“Various studies have shown that there is a trend which precedes the Great Recession that people are staying longer in the labor force,” says Sudipto Banerjee, EBRI research associate and author of the report. “But this shows that there has been a big increase in later-than-expected retirements following the recession.”

The EBRI analysis is among the first to look at longitudinal survey data that compares the expected and actual retire-

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ment for the same group of workers. It finds a majority (55.2 percent) of these workers retired within three years (before or after) of their expected retirement.

Specifically, the longitudinal findings show that 38.0 percent retired before they expected, 48.0 percent retired after they expected, and 14.0 percent retired the year they expected to retire. They also indicate that more people (35.9 percent) actually retired after 65 than expected (18.9 percent), and among those who expected to retire after 65, 56.6 percent did so.

The study also shows that in 2012, the expected probability of working full-time after age 65 among men and women working full-time was 48.7 percent and 46.0 percent, respectively. But only 12.7 percent of men and 6.0 percent of women worked full-time after age 65 in 2012.

The EBRI study uses data from the University of Michigan’s Health and Retirement Study, which is sponsored by the National Institute on Aging and is the most comprehensive national survey of older Americans.

Full-Cycle NT REITs: How They Fared

Blue Vault Partners, in collaboration with the Real Estate Finance and Investment Center at The University of Texas at Austin’s McCombs School of Business, has completed its third annual research study analyzing the performance of 35 nontraded REITs that completed a full-cycle event between 1990 and July 1, 2014.

Similar to the 2013 study, the new results show that, in general, those nontraded REITs with shorter time periods from inception to a full-cycle event performed better than those with longer holding periods. Also, the shortest time between being declared effective by the SEC and completing a full-cycle liquidity event declined from 3.75 years in the 2012 study down to 1.9 years in the 2014 study.

Here are the key study findings: • Th e average annual distribution yield for the 35 REITs analyzed was 7.05 percent, slightly lower than the average of 7.26 percent in the 2013 study.

•H igher average rates of return and low cross-sectional correlations between nontraded REITs and the S&P 500 Index and the Intermediate-Term U.S. Treasury Bond Index suggest potential portfolio diversification benefits.

•C omparisons of returns for the full-cycle nontraded REITs to the NCREIF and FTSE NAREIT benchmark returns over time show generally higher correlations with the publicly traded index returns.

• Th e average annualized return for the 35 nontraded REITs was higher than the average return for the S&P 500 Index and the Intermediate-Term Treasury Bond Index when compared over matched holding periods. realAssets Adviser | JANUARY 2015

NORTHWESTERN MUTUAL COMPLETES RUSSELL SALE

GLOBAL UHNW POPULATION JUMPED 6% IN 2014

Big life company has sold off the asset manager after 15 years of ownership to London Stock Exchange Group for $2.7 billion.

Total ultra-high-net-worth individuals are now at all-time high, with combined net worth of $29.7 trillion, says a Wealth-X/UBS study.

Report: Rethinking the Smart Highway of the Future

Imagine if you could make a seamless, integrated journey by electric bus and driverless car — all paid for easily through your smartphone. Imagine if the highway beneath your car repaired itself, reducing disruptive road construction. Imagine temperature-sensitive road markings that warn you of icy conditions, a parking garage that doubles as a solar panel, or pavements that turn footsteps into electricity.

These are some of the scenarios that London-based architecture firm Arup envisions in its new report, Future of Highways. The publication explores the forces that are shaping roads, now and in the future: climate change, urbanization, technological innovation, demographic shifts and the changing behaviors of travelers.

Understanding these trends is key to radically rethinking travel and future-proofing our highways, notes Arup. In the future, vital road infrastructure will enable economic growth, as it will be resilient, energy-efficient and sustainable.

What is driving the change? According to Arup, more cars, for one thing — the world’s vehicle count is expected to grow by 3 percent every year until 2030. Many of these vehicles will take to the streets of megacities, because the proportion of people living in cities will reach 75 percent by 2050. This means cities can no longer be designed around cars; vehicles must fit into cities.

realAssets Adviser | JANUARY 2015

New technologies will open up new possibilities. For example, concrete that uses bacteria to heal cracks could significantly reduce the cost of a structure.

Roads could become giant solar panels and recharge cars wirelessly as they travel. They could even include LED lighting and heating elements to melt ice and snow.

Arup also notes that growing, aging and more affluent populations will choose different ways to travel. Why bother with the hassle and expense of owning a car when you can pay just for the time it takes a smart, driverless, electric car to take you safely to your destination?

Much of the innovation needed to address these challenges is already happening. In other words, the ideas in the Future of Highways report are not total science fiction, and it includes realworld case studies of radical design and forward-thinking technology.

Energy Survey: $80 Long-Term Oil

ITG, a leading independent execution broker and research provider, released a survey of leading energy industry executives and investors. The survey was conducted at the ITG Investment Research Play by Play Energy Conference in Houston in early December. Survey highlights included: • Natural Gas Forecasts: Nearly 80 percent of the industry executives and investors have long-term NYMEX natural gas price forecasts of $4.00/MMbtu, while 14 percent forecast $3.00/MMbtu and fewer than 6 percent forecast a price of $5.00 or higher.

• Long Term Oil: 60 percent expect $80/ bbl WTI crude, while 20 percent expect prices below $80 and almost 20 percent forecast $90/bbl.

• Rig Counts: A majority of respondents expect higher rig counts in the Permian Basin and lower rig counts in the Haynesville, Marcellus and Utica plays.

• Long/Short Plays: More than 50 percent of respondents would like to have long exposure to the Permian Basin in 2015, while 17 percent would like to be long South Texas plays (including Eagle Ford). 51 percent of respondents would choose to have short exposure to the Tuscaloosa Marine Shale.

• E&P Sector: Only 38 percent of respondents expect the Exploration & Production sector to outperform the S&P 500 in 2015.

• Keystone XL: Only 27 percent of respondents expect the Keystone XL pipeline to receive U.S. approval before the next president takes office in January 2017.

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people

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Goss Wealth Management Joins LPL Financial Platform One of Louisiana’s largest wealth advisers, Goss Wealth Management, has joined the broker-dealer and hybrid RIA custodial Jerry Goss platform offered

by LPL Financial the nation’s largest independent broker-dealer. The move involves four Goss financial advisers and four support staff, as well as a chief financial officer.

The firm previously supported client brokerage and advisory assets of approximately $520 million.

Founded in 1981 and based in Baton Rouge, La., with a sister office in New Orleans, Goss Wealth Management provides customized, holistic financial planning to mass-affluent and high-networth clients, and also serves retirement plans, estates and endowments. Founded

by Jerry Goss, an industry veteran with more than 33 years of financial advisory experience, the firm practices tactical asset allocation combined with active portfolio monitoring and readjustment, and it

manages several discretionary portfolios designed to match a range of investment objectives. It also utilizes third-party managers to provide its clients with exposure to specific niche areas, in order to complete their comprehensive, individualized investment needs.

Precipitating the move to LPL was Goss Wealth Management’s decision to establish its own registered investment advisory and pursue its vision to bring the independent hybrid RIA adviser, or “super-OSJ” (office of supervisory jurisdiction) model to the Gulf South region. Goss Wealth Management’s goal is to provide experienced advisers with the advantages of independence while benefiting from the support and working environment traditionally available at a wirehouse branch office.

“We are pleased to welcome Goss Wealth Management to LPL Financial,” says Steve Pirigyi, executive vice president of business development. “We are happy to help them fulfill their vision of bringing the independent hybrid RIA adviser model into the Gulf South, which is a geographic region that we believe the model has not yet substantially penetrated and where we are eager to see them succeed.”

Jerry Goss, founder and CEO of Goss Wealth Management, says he is looking forward to working with LPL and growing his business. “We believe that the future of the financial adviser industry lies in the independent channel, but not with individual advisers going out on their own,” Goss notes. “Rather, we believe that as part of a network of advisers that can give them full service and support, independent advisers will be able to devote their energy to the areas where they are most effective. Essentially, we think that we can offer the best of both the independent and branch wirehouse worlds — a ‘wirehouse-lite’ solution.”

Goss says he found several specific advantages to affiliating with LPL. “We were impressed with their dedication to finding the best available technologies and making them accessible to its independent advisers, while at the same time LPL’s open-architecture structure allows its advisers the freedom to choose the systems they wish to adopt. Also, we believe that partnering with a broker-dealer that also serves as the custodian for our RIA assets will simplify our reporting and compliance requirements.”

Richard Berry has become executive vice president and director of dispute resolution at the Financial Industry Regulatory Authority (FINRA). Berry reports to Richard Ketchum, FINRA’s chairman and CEO. He is replacing Linda Fienberg, who retired on Nov. 30. Berry joined NASD in 1995 as head of dispute resolution’s Los Angeles satellite office and was later promoted to director of case administration in NASD’s New York City office in 2001.

board of governors. FINRA governors are appointed or elected to three-year terms and may not serve more than two consecutive terms. Earlier in his career, Levine served as chief technology and operations officer at E*TRADE, where he led an effort to rearchitect the firm’s technologies by moving to open source. Levine is currently a managing director of Kita Capital Management.

Scully serves as an independent director on several public company boards, including KKR & Co. ACE Limited, and Zoetis. He also serves on the board of dean’s advisers of Harvard Business School and the New York advisory board of Teach For America. Scully served in several senior positions at Morgan Stanley from 1996 through 2009.

David Bloom joined Wilmington Trust as managing director and senior private client adviser in the firm’s wealth advisory division.

He serves Wilmington’s high-net-worth clients in the Greater Philadelphia region and is based in Villanova, Pa. Prior to Wilmington, Bloom worked for J.P. Morgan Private Bank.

FINRA also announced that Joshua Levine and Robert Scully have been named as new public governors to the 24-member FINRA

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Luis Castellanos joined BNY Mellon Wealth Management as a managing director for business development in the firm’s Miami office.

He leads the growth of the business with a team of wealth directors in Miami, Fort Lauderdale, Boca Raton and Palm Beach Gardens. Castellanos was previously a managing director at Bank of America’s Merrill Lynch banking organizations, where he developed realAssets Adviser | JANUARY 2015

and managed the firm’s structured lending business for high-net-worth clients in Florida and international markets.

Josh Crossman and Ginny Neal, both formerly with J.P. Morgan Private Bank since 2010, joined Barclays Wealth and Investment Management’s Palm Beach, Fla., office as directors and investment representatives for the firm’s wealth and investment management division. They work with high-net-worth individuals and institutions, and will report to regional manager John Cregan.

Dan Farley, a managing director and senior portfolio manager for the Private Client Reserve high-net-worth unit of U.S. Bank, was promoted to a leadership role as head of the investment team and business in the Twin Cities, Minn. Prior to joining the Reserve in 2010, Farley was a vice president with Dougherty Commercial Properties, where he led joint venture deal structures, acquisition due diligence and institutional funding.

Jack Frencho joined U.S. Bank as a wealth management adviser for the Private Client Reserve high-net-worth unit in Columbus, Ohio. Frencho was previously a vice president and relationship manager for Key Private Bank.

Alexander Garcia Jr. has joined Institutional Property Advisors, a division of Marcus & Millichap, as senior director covering the Inland Empire. A senior director of Marcus & Millichap’s National Multi Housing Group, Garcia joined the firm in 1989. He was promoted to senior associate in 1994 and to senior vice president investments in 2008.

Ygnacio Garcia-Saladrigas has joined BNY Mellon Wealth Management as a senior wealth director in the firm’s Miami office. He was previously a private banker with J.P. Morgan Chase.

Merrill Lynch hired two advisers managing $325 million in assets from Raymond James and J.P. Morgan. Ricardo Guerrero left J.P. Morgan to join Merrill Lynch’s office in San Antonio, Guerrero previously oversaw $100 million in AUM. He had been at J.P. Morgan since 2006. Raymond James & Associates adviser Jay Higgenbotham, who previously managed $225 million in assets, joined Merrill’s Birmingham, Ala., office The moves follow Merrill’s acquisition of an adviser team managing $500 million in assets from UBS. The team joined Merrill’s Private Banking and Investment Group in Chicago. realAssets Adviser | JANUARY 2015

Stephanie Hackett has joined Evercore Wealth Management as a managing director and portfolio manager. She was most recently at Brandywine Group Advisors, a multi-family office, where she worked for eight years as an investment director. Previously, she worked for seven years at J.P. Morgan, where she focused on alternative asset management and private banking.

Hackett has significant experience in managing portfolios for high-net-worth individuals and families that invest in both alternative and traditional asset classes, including public equity, fixed income, hedge funds and private equity strategies.

Mark Hathaway has joined BNY Mellon Wealth Management as a senior wealth director in Los Angeles. Hathaway was previously a managing director with Apheta Business Management, where he oversaw business development with a focus on family offices, legacy planning and investments.

Jeffrey Havsy, a leading analyst of commercial real estate, has joined CBRE as Americas chief economist. The position is new, and Havsy will work with CBRE’s research team to develop insight, analysis and a viewpoint on economic, financial and market trends impacting commercial real estate. He joins CBRE from the National Council of Real Estate Investment Fiduciaries (NCREIF), where he was director of research.

Havsy will also lead a team of economists at CBRE Econometric Advisors (CBRE EA), the company’s real estate forecasting unit. He will work closely with Richard Barkham, CBRE’s Global Chief Economist, Bill Wheaton, the co-founder of CBRE EA, and Spencer Levy to further align CBRE’s forecasting and market research activities. Havsy held senior real estate strategy positions at Property & Portfolio Research, Equity Office Properties and LaSalle Investment Management.

James Hulburd joined UBS Wealth Management in Walnut Creek, Calif. He will operate as part of the Golden Gate Group with UBS adviser Brian Sharpes in UBS’ private wealth unit. Hulburd previously managed more than $1.5 billion in assets at Bank of America Merrill Lynch.

Laura Kiesel, an assistant vice president in the Private Client Group of The Commerce Trust Co., was promoted to vice president.

Her responsibilities include account administration and customer service related to personal trust and investment management services.

Gregory Lentini joined BNY Mellon Wealth Management as a senior wealth director for business development in Garden City, N.Y. He was previously a vice president and private banker at J.P. Morgan Private Bank.

Merryll McElwain joined BNY Mellon Wealth Management as a wealth director in the firm’s Los Angeles office. She was previously a financial adviser with Morgan Stanley.

Myles McHale Jr. joined U.S. Bank’s Private Client Reserve high-net-worth unit as a wealth management adviser and managing director in Naples, Fla. He leads a team of wealth management advisers and consultants throughout Florida who work with individuals, business owners and nonprofit institutions. Previously McHale was a managing director of Wilmington Trust Investment Advisors’ consultant relations liaison group.

Advisers managing a combined $560 million in assets have left D.A. Davidson and Morgan Stanley to join Raymond James & Associates. Trenton Morton joined Raymond James’ Seattle office as managing director and senior vice president, investments. Previously Morton managed $290 million in client assets. Scott Hitchcock, an investment portfolio specialist, moved with Morton. Also, the former Morgan Stanley brother/sister adviser team of Robert and Lynne Pehl have joined Raymond James in Chehalis, Wash. They managed more than $265 million in client assets.

Thanh Nguyen has joined U.S. Bank as a vice president and private banker for the private client reserve high-net-worth wealth management unit in Denver. She was previously a private banker at Front Range Bank.

Carolyn Simon joined BNY Mellon’s wealth management team in Madison, N.J., as a wealth director responsible for generating business in the New Jersey region. Simon was previously vice president and senior relationship manager at PNC Wealth Management.

Greg Steele has joined Capital One Financial Corp. as managing director in Capital One Securities Inc. Steele will be responsible for growing Capital One’s real estate investment banking practice, leveraging its existing commercial real estate banking platform and client relationships. His focus will be on REITs nationwide across all major property types.

Steele was previously managing director, real estate, at BMO Capital Markets.

25

R ea l E stat e news

Blackstone Sells $8.1B Industrial Portfolio, $2.25B NYC Skyscraper

T

he Blackstone Group has sold its U.S. industrial platform IndCor Properties by funds affiliated with Blackstone Real Estate Partners VI and BREP VII for $8.1 billion. The buyers are affiliates of Singapore’s sovereign wealth fund, GIC. As a result of this transaction, IndCor will no longer be pursuing an initial public offering. IndCor owns and operates a portfolio of 117 million square feet of high-quality industrial properties in key markets throughout the United States.

In a separate, but equally significant deal, Blackstone sold a 42-story skyscraper in New York City for approximately $2.25 billion to an Ivanhoé Cambridge venture. The Manhattan office property is located at 1095 Avenue of the Americas on Bryant Park between

Beacon Capital Buys 50% Interest in Manhattan Office Boston-based Beacon Capital Partners has purchased a 50 percent partial interest in the office located at 85 Broad St. in Manhattan. The seller, MetLife, will retain the remaining stake.

The total property value was $350 million, or $318 per square foot. Beacon Capital will pay approximately $175 million its 50 percent stake in the 1.1 million-square-foot office. Current tenants include investment bank Oppenheimer & Co. Several high-priced Manhattan offices traded in December 2014, including Blackstone’s purchase of 1750 Broadway for $605 million from Vornado Realty Trust.

26

Times Square and Fifth Ave. Major tenants include Verizon Communications, MetLife, law firm Dechert, iStar Financial, Lloyds Banking Group, Instinet and Standard Chartered USA. Whole Foods Market is a tenant in the retail space.

Kahn & Jacobs designed the building, which is the 61st tallest in New York City.

From 2006 to 2007 the tower received a $260 million renovation, which upgraded the office space from class B+ to class A. At press time in mid-December, the New York City office sector had seen 54 office properties sold in the fourth quarter totaling $5.32 billion, according to data by Real Capital Analytics. Approximately 104 offices exchanged ownership during the third quarter of 2014, totaling $6.97 billion in sales price.

The 1095 Avenue of the Americas acquisition is the highest-priced single office property to be sold since the General Motors building changed hands in 2008 for $2.8 billion.

Other high-profile New York City office deals in 2014 included Norges Bank Investment Management purchasing a 50 percent interest in the Citigroup Center, and SL Green Realty Corp. purchasing a 50 percent stake in the Citigroup headquarters at 388–390 Greenwich St. from Ivanhoé Cambridge.

Blackstone also sold commercial property in Boston, recently selling Cambridge Park to CBRE for $163 million. The two-building office complex totals 436,000 square feet in Cambridge.

Griffin Capital REIT Merges with Signature Office REIT Griffin Capital Corp., on behalf of Griffin Capital Essential Asset REIT, has entered into a definitive merger agreement with Signature Office. The merger was unanimously approved by each REIT’s respective board of directors. The proposed transaction requires formal approval by Signature shareholders, receipt of required regulatory approvals and other customary closing conditions, and it is expected to be completed during the first half of 2015.

The vast majority of Signature’s net asset value is embedded in a real estate portfolio comprising 15 buildings — encompassing over 2.6 million square feet and situated across eight states — which were all originally

acquired from late 2010 through 2012, near the bottom of the current real estate cycle.

Signature was represented by the Eastdil Secured group of Wells Fargo Securities, and Houlihan Lokey Financial Advisors acted as financial advisers to Signature.

Robert A. Stanger & Co. provided GCEAR’s board of directors with a fairness opinion for the transaction. realAssets Adviser | JANUARY 2015

KSL Capital Launches Fourth Fund Denver-based KSL Capital Partners has launched a fourth fund, according to an SEC filing. Thus far, KSL Capital Partners IV, which will invest in hotel and leisure properties, has raised $33.1 million. An equity target was not disclosed in the filing.

KSL Capital Partners IV’s predecessor, KSL Capital Partners III, held a final close in 2011 with $2 billion, exceeding its $1.5 billion equity target. The fund specializes in investments in travel and leisure businesses.

Previously in 2006, KSL Capital Partners II closed with $1 billion, exceeding its $750 million equity target. The fund’s first investment was the Rancho Las Palmas Resort & Spa, a 444-room resort in Rancho Mirage, Calif.

KSL Capital is also marketing its first credit fund, KSL Capital Partners Credit Opportunity Fund, which raised approximately $378.5 million in January 2014.

KSL Capital was formed in 2005 by Michael Shannon and Eric Resnick, who currently serve as the firm’s managing directors.

The firm invests in hotels and related businesses in the United States and Europe. A recent transaction was KSL Capital’s acquisition of the St. Regis Monarch Beach Resort in Dana Point, Calif. Washington Real Estate Holdings sold the 400-room hotel for $316.9 million.

realAssets Adviser | JANUARY 2015

Texas Teachers Invests $200M in Automotive Real Estate

The Teacher Retirement System of Texas has committed $200 million to a fund that invests in car dealership properties. The pension fund is investing in the $651 million BSREP CARS Co-Invest Pooling, a vehicle set up by Brookfield to invest in Capital Automotive, which provides real estate financing for car dealerships.

Capital Automotive has invested $4.3 billion in 440 U.S. facilities and has a 16.3 million-square-foot portfolio in 35 U.S. states. The firm was previously owned by DRA Advisors.

Stephen Blank Retires from ULI Stephen Blank, the senior fellow of finance at the Urban Land Institute, retired effective Dec. 31, 2014, after 17 years with the institute.

Blank’s primary responsibilities included expanding ULI’s real estate capital markets information and education programs; writing real estate capital markets commentary; participating as a principal researcher and adviser for the Emerging Trends in Real Estate series of publications; organizing and taking part in real estate capital markets programs at ULI events worldwide; and participating in industry meetings, seminars and conferences.

Prior to joining ULI, Blank served from 1993 to 1998 as managing director, real estate investment banking, at Oppenheimer & Co. Prior to that, from 1989 to 1993, Blank served as managing director of Cushman & Wakefield’s real estate corporate finance department. In addition, he was a managing director at Kidder, Pea-

body & Co., president at KP Realty Advisers and a vice present of corporate finance at Bache & Co. Blank is a member of the National Association of Real Estate Investment Trusts and ULI; serves as a member of the board of directors and chair of the audit committee of MFA Financial; serves as a member of the board of directors and chair of the audit committee of Home Properties; and is nonexecutive chairman of the board of trustees and chair of the nominating and governance committee of Ramco-Gershenson Properties Trust. In addition, he acted as ULI’s representative to the Green Building Finance Consortium.

Blank has served as a guest lecturer for the Harvard University Graduate School of Design Advanced Management Development Program, the Boston College Graduate School of Business Administration, and the Cornell University Program in Real Estate.

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Infrastructure news

Private Market Infrastructure Index Launches

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PD and its parent company MSCI have launched the IPD Global Infrastructure Direct Asset Index. The index describes the investment performance of infrastructure investments irrespective of the investment vehicle structure in which those investments are held.

“The index database [comprises] 132 investments around the globe with an enterprise value of $49 billion and represents a significant milestone for the infrastructure sector as it provides a robust measure of return performance that can be compared with competing asset classes and used to benchmark performance across investments,” IPD notes.

The index comprises investments located in Australia (44 percent), Europe (43 percent) and North America (8 percent) and spread across the transportation (47 percent), power (24 percent) and water (22 percent) sectors.

“The IPD Global Infrastructure Asset Index is a significant information tool for the infrastructure asset class as it will aid

the sector in the areas of investment market cycles and trends, asset pricing, benchmarking analysis, attribution analysis, and risk modeling,” says Anthony De Francesco, executive director and head of IPD infrastructure products.

The index was developed from the IPD Australia Infrastructure Fund Index, which was launched in November 2012, representing investment performance of unlisted infrastructure funds and mandates that are domiciled in Australia.

In conjunction with the launch of the index, IPD and MSCI hosted a webinar to discuss the index and current market conditions, including a panel comprising Mark Weedon, vice president with MSCI; Scott Auty, director with Deutsche Asset & Wealth Management Infrastructure Europe; Serkan Bahceci, executive director, head of infrastructure research, with J.P. Morgan Asset Management; and Kim Thompson-Springer, senior manager, private investment assets, with the Alberta Investment Management Co.

The webinar panelists covered a range of topics including the impact of the index for the market and the current price and transaction environment.

One of the difficulties investment managers have encountered in raising capital from investors for investment in infrastructure is a lack of a third party–produced equity index that shows infrastructure investment performance over time.

Convincing investors to invest without that kind of data has been a challenge for investment managers.

“The index gives us that data that we can use to match the desired characteristics with the right clients,” Auty says. “Marketing financial products without the performance data to support the marketing claims we’re making is a challenge.”

Despite those challenges, managers have raised significant amounts of capital over the past several years from investors who are comfortable with the asset class, and that capital is being called and invested, panelists noted.

Hawaii Makes First Infrastructure Investment The $14.1 billion Employees Retirement System of the State of Hawaii made its first-ever infrastructure investment, a $50 million commitment to KKR Global Infrastructure Investors II. The commitment, which HIERS will house in its real return bucket, is the retirement system’s first infrastructure play. The KKR fund, which also received Merced County (Calif.) Employees’ Retirement

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Association’s first infrastructure investment in September, is a $2 billion fund whose predecessor targets a wide range of global infrastructure including midstream energy, renewable energy, utilities (water, power and gas), social infrastructure and select transportation-related infrastructure.

“We liked that the fund has a good income component to it, it has reasonable

leverage, and we liked the deal pipeline, the propriety resourcing if you will, that KKR was able to bring to the table,” says Vijoy Chattergy, chief investment officer with HIERS. HIERS will likely make two or three new commitments to infrastructure funds in the next 12 to 18 months, according to Chattergy. realAssets Adviser | JANUARY 2015

U.S. Pensions Increase Commitments to Energy Infrastructure

CalPERS Expanding Infrastructure Program The California Public Employees’ Retirement System is planning to grow its infrastructure portfolio by $5 billion in the next three years, increasing the program from $1.8 billion to $6.7 billion by fiscal year 2016–17, according to documents prepared for the retirement system’s November board meeting.

CalPERS infrastructure portfolio returned 22.8 percent for the year ended June 30, 2014, beating its benchmark, the Consumer Price Index plus 4 percent lagged one quarter, by 17.2 percentage points. The program has had an even greater five-year return, 23.3 percent, beating its benchmark by 6.7 percentage points.

During the past year, CalPERS made $682 million in infrastructure commitments and launched its first nondiscretionary infrastructure separate account, a mode of investment that, along with direct investment, the $300 billion pension fund is looking to expand in the coming years.

CalPERS is looking to invest more than $700 million into California infrastructure in the coming years, following a plan approved in 2011 to invest $800 million into the state’s infrastructure. The pension plan has reviewed 73 opportunities and bid on five totaling $1.0 billion during the past three years, but it has only invested $136 million to date. Currently, 43 percent of CalPERS’ infrastructure portfolio is invested internationally, primarily in Canada and the United Kingdom. realAssets Adviser | JANUARY 2015

Two U.S. pension funds have increased their commitments to energy infrastructure, committing to funds from The Blackstone Group and NGP Energy Capital.

After committing to The Blackstone Group’s real estate funds in the past, the New Mexico State Investment Council (NMSIC) has turned to the firm’s energy fund series, committing $75 million to Blackstone Energy Partners II. BEP II, an energy and natural resources vehicle, will reportedly be larger than its predecessor, which closed in September 2012 after raising $2.5 billion. BEP I seeks control and control-oriented equity investments within the energy and natural resources sectors globally.

“There are a lot of attractive things about the fund,” says Charles Wollmann, director of communications with NMSIC. “Blackstone has a successful track record in the space, we are looking to increase our real assets allocation and we have a couple of investments with Blackstone on the real estate side that are doing quite well.”

NMSIC committed $75 million to Blackstone Real Estate Partners VII in 2012 and $50 million to Blackstone Real Estate Partners Asia in early 2014. The investment council has a 10 percent target allocation to the real return asset class.

Meanwhile, the $17 billion Teachers’ Retirement System of Louisiana has com-

mitted $50 million to NGP Energy Capital’s Natural Resources XI and has also committed a $2 million follow-on investment to an infrastructure co-investment with The Blackstone Group, says Maurice J. Coleman, director of private markets with TRSL. The commitment is TRSL’s first commitment to the NGP fund series, but this is not the retirement system’s first investment in energy. TRSL has committed a total of $175 million to Blackstone’s energy fund series, with $75 million going to Blackstone Energy Partners in 2011 and $100 million going to Blackstone Energy Partners II in September 2014. The commitment will be housed in TRSL’s commodities bucket, which has a 2 percent target allocation and a 1 percent actual allocation at this time.

The pension system also made a $2 million follow-on investment to its infrastructure co-investment with Blackstone.

East Meets West: U.S. State Department Streamlines Visa Application Process for Chinese Travelers A recent U.S. State Department deci- Leading U.S. Gateway Hubs sion regarding the visa application process for Chinese Travelers (Airport Authority) between the United States and China is credit positive for U.S. international gate- Los Angeles Department of Airports — LA International Airport Enterprise way airports, “which will see more business, The Port Authority of New York and New Jersey student and leisure travelers, and increased revenues.” The credit briefing also notes San Francisco Airport Commission that Chinese visitors to the United States Hawaii Airport Enterprise spend the highest amount per visitor — A.B. Won Guam International Airport Authority approximately $5,400 per passenger — in Port of Seattle, Washington the United States among the 10 countries that are the sources of the most visits to Source: Moody’s Investors Service the United States, according to the U.S. National Travel and Tourism Office. The expects to be most positively affected by the table shows the airport authorities Moody’s State Department decision.

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e nerg y n e ws

2014: Year of the Energy Megamerger

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wo of the largest mergers in the oil and gas industry since Exxon and Mobil’s 1999 megamerger were announced in 2014.

Kinder Morgan completed the $76 billion acquisition of the outstanding equity securities of its three master limited partnerships (MLPs), and Halliburton, the second largest oilfield services company, acquired Baker Hughes, the third largest oilfield services company, for $34.6 billion.

Kinder Morgan’s acquisition of Kinder Morgan Energy Partners, Kinder Morgan Management and El Paso Pipeline Partners is the second largest energy transaction in

history and makes Kinder Morgan the largest midstream and third largest energy company in North America.

Kinder Morgan projects a dividend of $2.00 per share for 2015, a 16 percent increase over the 2014 KMI dividend budget of $1.72 per share, according to chairman and CEO Richard Kinder. The company expects to grow the dividend by approximately 10 percent each year from 2015 through 2020, while producing excess coverage of more than $2 billion.

Halliburton’s acquisition of Baker Hughes should allow the two parties to better com-

Chevron Draws First Pull from Gulf Project

U.S. Pension Plans Commit $475M to Energy Funds

Chevron has begun drawing both crude oil and natural gas from The Jack and St. Malo, two of the largest fields in the Gulf of Mexico.

The St. Malo and Jack fields were discovered in 2003 and 2004, respectively, and production from the first development stage is expected to increase in the coming years to approximately 94,000 barrels of crude oil and 21 million cubic feet of natural gas daily, according to Chevron.

“The Jack/St. Malo project delivers valuable new production and supports our plan to reach 3.1 million barrels per day by 2017,” says George Kirkland, vice chairman and executive vice president, upstream, Chevron Corporation.

The two fields can be found 280 miles south of New Orleans and are located within 25 miles of each other.

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Amid growing interest from institutional investors for the energy sector’s high annual returns and income potential, U.S. pension plans committed almost half a billion dollars to energy funds in November.

In one case, the $65.5 billion Virginia Retirement System committed $250 million to energy, divided between two managers: Sheridan Production Partners III received $150 million and PetroCap Partners II received $100 million. SPP III received a $200 million commitment from the Washington State Investment Board in September as well.

Also, the $11.8 billion Orange County Employees Retirement System committed $100 million to the Kayne Private Energy Income Fund, launched earlier this year to take advantage of historically low natural gas prices. OCERS also invested $70 million into Kayne Anderson Energy Fund VI in August 2012.

pete with Schlumberger — the largest oil field services company by a wide margin and still more than double the size of the combined entities — and better cope with rapidly falling crude oil prices that have dropped from more than $100 a barrel in June to below $70 a barrel in December and have worn on profit margins industry wide. Once fully integrated, Halliburton expects the merger to save the companies nearly $2 billion annually through operational improvements, North American margin improvement and R&D optimization, among other factors.

The stable long-term returns offered by North American energy funds through the United States’ shale revolution have been very attractive to institutional investors. realAssets Adviser | JANUARY 2015

Going Once: DOI Plans Largest Offshore Wind Auction The United States Department of Interior has announced the nation’s largest competitive auction for offshore wind assets, as more than 742,000 acres off the shore of Massachusetts will be offered for commercial wind energy development in a Jan. 29, 2015, competitive lease sale.

“This sale will triple the amount of federal offshore acreage available for commercial-scale wind energy projects, bringing Massachusetts to the forefront of our nation’s new energy frontier,” said Secretary of the Interior Sally Jewell, in a statement.

According to the U.S. Department of Energy, the area being offered could support up to 5 gigawatts of commercial wind generation, which is enough electricity to power more than 1.4 million homes. Currently, 12 companies have qualified to participate in the auction.

“We are pleased to once again see strong commercial interest in offshore wind development, especially given the number and size of lease areas offshore Massachusetts available for potential development,” adds Bureau of Ocean Energy Management acting director Walter Cruickshank.

The BOEM has awarded seven commercial wind energy leases off the Atlantic coast to date, and it is planning to hold another competitive offshore wind auction off the shore of New Jersey sometime in 2015.

realAssets Adviser | JANUARY 2015

China’s Coal Demand Not Peaking Soon

Despite recent public commitments to move away from polluting energy sources and toward renewables, including a commitment to have 20 percent of its energy come from renewables by 2030, China’s demand for coal is not likely to peak in the next five years, according to the International Energy Agency.

Coal use in China has only decreased twice in the last 30 years and not since 1997, according to the IEA, and the nation produced 81 percent of its electricity from coal in 2013, according to the World Coal Association. Despite recent declarations to move away from carbon-heavy energy sources, China remains not only the world’s biggest producer of coal (producing nearly four times more annually than the United States, the world’s second largest producer), but also its biggest importer worldwide.

Still, the IEA warns that coal demand in China could peak in the next five years, but that would be contingent on one of a number of unlikely events occurring. This includes but is not limited to annual GDP growth in China slowing to 3 percent from 2015 onward (despite being no lower than 3.8 percent since 1978) or China producing 2,500 TWh of additional power generation from gas, nuclear or renewables.

That is the equivalent of four times global wind generation or 18 times global solar PV generation in 2013.

The IEA notes that “while of course past performance is no guarantee of future results, neither development has been observed, not even closely, in recent history,” in a recent sneak preview of its Medium-Term Coal Market Report.

As West Texas Crude Plunges, MLPs Slog Through MLPs pushed through a tough Q4 2014, as market consolidation and rapidly falling oil prices saw the Alerian MLP Index lose 3.1 percent in November and the S&P MLP Index lose 9.62 percent in the first two months of 2014’s final quarter.

Amid a glut of supply, West Texas crude oil spot prices dropped below $70 a barrel at the beginning of December — a fouryear low — but widespread MLP consolidation had a hand in the quarter’s volatility as well, according to Alerian. Beyond Kinder Morgan’s massive merger, October saw Enterprise Product Partners agree to buy the general partner of Oiltanking Partners, and both Targa Resources Corp. and Targa Resources Partners agree to buy Atlas Energy and Atlas Pipeline Partners in a move that consolidated both companies’

Permian Basin and Gulf Coast gathering and processing assets, according to Alerian.

The tough quarter likely will cause the Alerian MLP Index to underperform the S&P 500 and the FTSE NAREIT All Equity REITs Index (which had returned 26.44 percent through 2014 to Dec. 1) in 2014, though it has still outperformed both REITs and the S&P 500 over a five-year and 10-year basis.

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Commodities news

CalPERS Timber Portfolio Underperforms Benchmark

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hile timber has been a strong performer during the past year, not every investor in timber has done equally well. The California Public Employees’ Retirement System, the nation’s largest public pension fund with total assets of $295 billion has seen lackluster results in its timber holdings.

Recent board documents reveal that CalPERS’ timber program, which has a net asset value of $2.3 billion, had a one-year net return of 2.5 percent (as of June 30, 2014). Not bad, unless you consider that the retirement system’s benchmark for the portfolio — the NCREIF Timber Index

— had a 9.8 percent return over the same period. CalPERS’ three-year return (–1.0 percent) and five-year return (–0.8 percent) also trailed the benchmark.

According to board documents, one of the reasons CalPERS’ portfolio trailed its benchmark is that the retirement system’s holdings are quite different from the make-up of the NCREIF Timber Index.

The retirement system’s forestland portfolio is held in two separate accounts — a domestic portfolio managed by Lincoln Timber with holdings in the southern United States and an international portfolio managed by

Gold Demand Falls 2% in Third Quarter

Cotton Production Up Significantly in 2014

Demand for gold fell in the third quarter by 2 percent, according to the World Gold Council’s third quarter 2014 Gold Demand Trends report. The report notes that gold price volatility during the quarter was muted, at annualized three-month volatility of 10.8 percent — down from the longterm average of 16 percent.

The WGC notes that investor behavior contributed to the circular movement within the asset class: “The lack of a clear price signal caused investors to hold back from buying gold, which in turn dampened down price moves.”

Jewelry demand was down 4 percent, yearon-year, although Indian jewelry demand jumped 60 percent on the back of positive sentiment in India following the election of Prime Minister Narendra Modi.

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Cotton production is forecast at 16.4 million 480-pound bales, according to the November Crop Production report from the U.S. Department of Agriculture — a 27 percent increase from 2013, which saw production of 12.9 million bales. While production is up, yield is expected to average 797 pounds per acre, a decline of 24 pounds per acre. By Nov. 2, 50 percent of the cotton crop had been harvested, slightly behind the five-year average.

Upland cotton is forecast to total 15.8 million bales, up sharply from 2013, while Pima cotton is forecast to total 578,000 bales, a drop of 9 percent from the 634,000 bales in 2013.

Sylvanus with holdings in Australia, Brazil and Guatemala. By contrast, the NCREIF Timber Index has no international holdings and also includes a broader array of U.S. regions.

The $61.2 billion Massachusetts Pension Reserves Investment Management Board, another major institutional investor in timber, recently reported outperformance for its $1.6 billion forestland portfolio, which had a one-year return of 11.5 percent (as of Sept. 30, 2014), as well as a three-year return of 5.8 percent and a five-year return of 1.4 percent.

The top cotton-producing state is Texas, with 2014 production forecast to hit 6.4 million bales, followed by Georgia at 2.6 million bales and Mississippi at 1 million bales. California is the top producer of Pima cotton and is responsible for the entire drop in Pima production. California Pima production fell from 610,000 bales in 2013 to 510,000 bales in 2014. realAssets Adviser | JANUARY 2015

Swiss Vote Down Gold Referendum A widely discussed Swiss referendum that would have required Switzerland’s central bank to hold one-fifth of its assets in gold was roundly defeated by voters. The initiative would have had wide-ranging impacts on the country’s monetary policy, as well as the demand for gold.

The country’s central bank holds $550 billion in assets. A requirement to hold onefifth of that, or approximately $110 billion, in gold would have required the purchase of some 1,500 tons during the next five years

— about 10 percent of global production annually. (The Swiss National Bank reportedly has about 7.7 percent of assets in gold.)

While polling prior to the vote suggested the decision may have been too close to call, ultimately some 77 percent of Swiss voters decided against the initiative.

Timber REITs Underperform Broader REIT Index

Outlook for Latin American Metals and Mining: Stable Fitch Ratings has forecast a stable outlook for the Latin American metals and mining sector in 2015. The region is expected to demonstrate resilience as producers focus on reducing operating costs, allowing them to compete in a year of lower metals prices, according to 2015 Outlook: Latin America Metals and Mining — Transitional Year Ahead.

One of the firms making a move in Latin America is Vancouver-based Fortress Minerals Corp., which raised C$200 million ($175 million) in a private placement to acquire and develop a gold mining project in Ecuador. The firm’s offering comprised 50.13 million subscription receipts at C$4 ($3.50) per unit.

Fortress is acquiring the Fruta del Norte project from Kinross Gold Corp. for $240 million, comprising $100 million to $190 million in cash and $50 million to $140 million in shares of Fortress.

In addition, the Lundin Family Trust has committed up to $100 million to fund the acquisition. According to Fortress, the project is among the largest and highest grade undeveloped gold projects in the world. It is located in southern Ecuador, near the Peruvian border. realAssets Adviser | JANUARY 2015

Real estate investment trusts focused on timber returned just 0.22 percent in November — the lowest return of any sector or subsector in the FTSE NAREIT All Equity REITs Index, which saw an overall return of 2.34 percent.

The lackluster November performance has cemented the timber sector’s position in last place among sectors in the index. In the first 11 months of 2014, timber REITs had a total

return of 6.36 percent, underperforming the All Equity REITs Index, at 26.44 percent over the same period.

Timber REITs make up a small slice of the broader U.S. REIT market. The five timber REITs included in the FTSE NAREIT All Equity REITs Index, with an equity market capitalization of $31 billion, are just 3.9 percent of the $805 billion U.S. REIT market.

Alico Buys Florida Citrus Producers Fort Myers, Fla.–based Alico Inc. has acquired three citrus producers in Florida for $363 million. The acquisition is expected to make Alico the largest citrus producer in the United States, with production of 10 million boxes per year.

Alico has acquired certain assets and liabilities of Orange-Co LP for $274 million, comprising 20,263 acres of citrus groves.

The Orange-Co acquisition was financed with proceeds from the firm’s $97 million sale of sugarcane assets. The firm also acquired the 1,241-acre Gator Grove, located contiguous to the Orange-Co property, for $16.6 million. In addition, Alico acquired the 7,434 acres from 734 Citrus Holdings, also known as Silver Nip Citrus, for $72 million financed with a rollover of existing credit facilities and the issuance of new stock, which is subject to shareholder approval.

According to the November Crop Production report from the U.S. Department

of Agriculture, the U.S. orange production forecast for the 2014–2015 season is 6.96 million tons (up 3 percent from the 2013–2014 season). The Florida orange forecast is 2.34 million tons — a total of 108 million boxes. The report notes that citrus growing conditions in Florida “were ideal from the beginning of the citrus bloom to the start of the 2014–2015 season harvest.”

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eft to right: Wayne McCullough, L Keith Beckman and Rawles Bell.

High Hurdle 34

realAssets Adviser | JANUARY 2015

By Ben Johnson

Advisers Wayne McCullough and Keith Beckman raise the wealth management bar at Dallas’ 50-year-old Benchmark Bank.

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fter 50 years in business as a community financial institution, Dallas-based Benchmark Bank is breaking into the wealth management business.

The move is symbolic of a growing trend among the nation’s banks. According to a 2014 survey by American Banker, roughly a quarter of U.S. banks are gearing up to offer wealth management services in the next two years.

The onus is a simple one. In an attempt to both grow revenue sources and leverage the scale of existing client bases, quite naturally banks are seeking a larger slice of the wealth management pie. And that presents a golden opportunity for many advisers to bring their experience to bear and find a new place to call home.

For Benchmark Bank, it has meant forming Benchmark Private Wealth Management, or BPWM for short, in April 2014. BPWM is a wholly owned subsidiary of the bank and is regulated by the Texas State Securities Board as a registered investment adviser.

“We believe it is a superior model that brings together the reputation, culture and strength of a 50-year-old institution with the cutting-edge, open-architecture and conflict-free format enabled by being an RIA,” says Wayne McCullough, president and managing partner of BPWM. McCullough is a sixth-generation Texan and got his start in the advisory profession with A.G. Edwards back in 2000. Over the years, he migrated to other firms, including a stint at Deutsche Bank, and today he holds a CFP designation. realAssets Adviser | JANUARY 2015

He is joined at BPWM by managing partner Keith Beckman, a CFA with 15 years of experience in financial services.

CULTURAL ALIGNMENT Benchmark Bank, and community banks in general, put a great deal of stock in the “community” element of their name, building long-term relationships with clients over many years. This familial culture is what led McCullough and Beckman to join forces.

“Our culture is very family oriented, very relationship driven, and, coming from our two backgrounds, we really wanted to have that fiduciary relationship,” says Beckman.

“We believe this is the best way for our clients and our bank customers to have an alternative to the traditional brokerage relationship. We have gone to the RIA model where we are a fiduciary to those customers, and we think it is much better suited to the Benchmark Bank’s business model and culture.”

McCullough notes that the Benchmark model differs from more traditional banking extensions into wealth management. “Other banks run it somewhat as a trust company — or they have used trust department people to run their wealth management unit, and it hasn’t necessarily translated to true wealth management,” he says. “Remember that wealth management is very relation driven. That is where we are coming from, and that is the culture of the bank. Really it created a perfect add-on to Benchmark Bank. It is essentially run like a family bank, and that is really what we believe people are turning back to right now.”

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Everything came together near the end of 2013, and here we are.

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“Of anywhere I’ve ever been, this is the most familial, relationship-driven firm I’ve ever been associated with,” notes McCullough. “I’ve banked here since 2000, and it’s not a place where you just bank. I was very good friends with my banker. Clients are welcome to come in and have coffee and read the paper. You actually have a relationship. Once you bank here, you’re never going back to the bulge bracket bank. I loved everything about this place.”

That led to a discussion with Benchmark Bank chairman and CEO Mike Barnett. One thing led to another, and McCullough was tapped to spearhead the division’s launch.

Beckman was already employed at Bench-

mark since 2011 and was an ideal partner for McCullough. “Wayne introduced me to Mike Barnett about three years ago, and I came on to do a variety of things for the bank on the investment and M&A side and was a general strength bench player. Then it became apparent that we wanted to offer this to our clients and customers at the bank. Everything came together near the end of 2013, and here we are.”

One of the primary issues to tackle was the potential for cross-selling Benchmark Bank products and services as part of the new wealth management division. The duo purposely structured the new entity so that there are no financial incentives to steer or cross-sell banking products. McCullough realAssets Adviser | JANUARY 2015

and Beckman insist their structure as an RIA prevents that from occurring.

“As a subsidiary, we are not compensated, by design, for sending money into loans into the bank while we are here,” says McCullough. “We wanted to set it up as a really independent platform. So while the bank is here to support us, we aren’t directly compensated for sending a loan over or a banking customer.”

Beckman notes that BPWM does recommend bank loan officers and the mortgage department or title company to clients as needed, “because we think they are really good and hopefully they think the same way for us, but we are not trying to ‘crosssell’ or anything like that and definitely aren’t getting any compensation from those units for doing that.”

Instead, BPWM is compensated on a fee basis, charging a percentage of client assets under management. It does not sell insurance products, but does offer trust services as a client solution through an independent entity based in Nashville. BPWM custodians its client assets with TD Ameritrade and Schwab.

GROWTH STRATEGY It would be easy to say that BPWM exists to serve Benchmark’s existing customers, but McCullough and Beckman have a grander plan to grow business above and beyond the bank’s clients, and it is already happening.

“Of our roughly $20 million in assets, maybe 25 percent is from the bank,” says McCullough. “A big goal is to grow this completely independent, so we are capturing brand new customers for the wealth management side. Some of that comes from past relationships. I’ve been in wealth management essentially for 14 years straight with a short stint in private equity. We are trying to grow this as organically as we can and then be here for the bank customers as well.”

Beckman expects the banking client relationships to grow naturally as BPWM ingrains itself into the culture of the bank.

“Our business plan that we presented was a seven-year model, and it is all about growing organically,” he says. “We are not lookrealAssets Adviser | JANUARY 2015

ing to buy another wealth management group and, best of all, we have the time and resources to go do it. We achieved our goals for 2014, and we are uniquely positioned for 2015 because we have barely scratched the surface of tapping into the bank’s customers and our client base.”

To help them achieve their goals, they have a third team member, associate director and client adviser Rawles Bell, formerly with RBC. “He does everything,” says Beckman.

“We are keeping him very busy right now, let’s put it that way. He is wearing about seven different hats and then we are actually in the process of hiring a fourth person, somewhat of an admin/office manager, to help with marketing. We hired a third party to handle our back office support and a third party for our compliance. That is how the world has changed, in that you don’t have to build it all in-house today, and it is probably better that you don’t in a lot of ways.”

The end game for the team is simple yet lofty: Become one of Dallas’ top advisory firms, “If you look at some of the biggest independent RIAs out there, they have some significant assets under management, and I think we want to be in that category in the Dallas/Fort Worth area and in other parts of Texas such as Austin and others,” says Beckman. “And we have barely scratched the surface.”

McCullough expounds on the local advisory market opportunity. “If you look at our top four competitors, I don’t see any reason we can’t be as large as they are. The RIA space in Texas hasn’t moved as fast as Boston, Chicago, the East Coast and some parts of the West Coast, where they control billions and billions of dollars. We think that there is a shift coming in the South that we would like to be a part of. We have seen it.”

CUSTOM ALLOCATIONS To help achieve their growth strategy, McCullough and Beckman are not pushing cookie-cutter solutions.

“We are not building a model portfolio and then clients just invest in that and there is a performance related to that portfolio,” says Beckman. “We really are building individual, customized allocations for clients

based on their risk tolerances and their investment goals.

We build an investment policy statement, have a risk tolerance questionnaire and from that — and through discussions with the client — build an allocation based on their current portfolio, where they want to get to, how long they have until retirement, and other factors.”

Actual portfolio construction involves allocations to mostly liquid assets, including mutual funds and ETFs, but Beckman says the firm is exploring ways to get into the alternative space to provide greater portfolio diversification.

The key to the process is open architecture, says McCullough. “That is the beauty of an RIA. We can invest, assuming everybody can come to an agreement, with any manager, be it a mutual fund or potentially a direct private equity investment.

The beauty of the model is transparency with no conflicts. It’s open architecture.

While we are keeping the portfolios pretty straightforward, mainly with mutual funds, ETFs and SMAs, you would be amazed what asset classes you can cover just with those three instruments.”

REAL ASSETS Given his ingrained entrepreneurial roots, McCullough admits he has always been enamored with alternative investments. “I like the sense of what it adds to the portfolio, and I have always looked at it for myself just because my whole life has been exposed to the equity markets in some form or fashion,” he says. “Having the ability to find something that zigs when the market zags has always interested me. Of course being in Texas, we have to always be very cognizant of what is happening in the oil space or natural resources. But from a portfolio standpoint, essentially every portfolio we look at, while it is customized to the client and their risk tolerance, we generally have some form of alternative, be that a long-short fund, but we have even at this time added real asset funds of some sort, be it precious metals exposure, be it

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Education is a top priority for BPWM, as many clients learned hard lessons from the Great Recession.

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natural resources, be it MLPs. We are definitely interested in the real assets space and the alternative space. We think it plays a big role in all portfolios.”

Beckman is in alignment with the real assets theme. “While some people might be nervous about going into alternatives or those types of strategies, once you define what it is and the benefits to a diversified portfolio that they bring, they get it, and then they start clamoring for more because they understand that it does a lot of things.

It may generate yield, for example, in the MLP space. The goal in the portfolio is to have some negative correlations with everything so that you are not moving in lockstep, right? Sometimes you can’t avoid it, but for the most part, if you are putting these alternatives into clients’ diversified portfolios in the long term, they are going to really benefit from that.”

There is also a recognition that real assets are becoming easier for clients to understand and embrace. “Real assets becomes an easier explanation than the complex derivatives, for example,” says Beckman. “When you describe real assets to people, they get it. Real estate is tangible, they can feel it, touch it, see it. They understand what a particular commercial or land play or whatever it may be generates in income or what it doesn’t generate in income. The same with oil or energy. While there are complexities in there, it boils down to, What are you doing? Are you exploring for things or are you actually pumping things out of the ground? Are you mining for things? I think it becomes easier to explain to people and they get it, in contrast to the highly engineered products from pre-2008.”

McCullough admits that while the term “hedge fund” is currently out of favor, some form of hedging or alternative is key to today’s client portfolios. “Some kind of alternative in a volatile market is actually really important.

Most people wouldn’t think about it that way, but that is the reality.”

Beckman notes that BPWM’s trust solution is also very flexible and lends itself nicely to the real asset category. “The trust company has in-house experts for direct real estate and mineral interests, for example. However, we will not hesitate to rec-

ommend even more specialized outside advisers for very complex cases.”

Beckman cites a specific recent example of a $2 million trust with nearly 400 separate mineral interests. “Our trust partner put us in contact with a large mineral manager that actually developed the software package many large bank trust departments use for mineral management,” says Beckman. “This mineral manager would be brought on to manage the direct real asset piece of the trust as well as be integrated into the overall trust management solution that included BPWM as investment manager for liquid assets and the independent trust company as trustee and trust administrator. Again, we create an open, flexible structure that provides superior service for the client’s individual needs.”

THE NEXT DOWNTURN Education is a top priority for BPWM, as many clients learned hard lessons from the Great Recession.

“You still have a fair amount of people that are in cash or cash alternatives,” says Beckman. “I agree that there is also some shortterm memory as well. You can’t just push everything into real estate and oil and gas in certain frothy environments. You need to be patient. There are good entry points and this may be a nice entry point for energy right now and a way to deploy some cash.”

The real challenge for many cash-rich clients is delivering investment returns that are greater than zero. “The bond markets are difficult, definitely with rising rates on the horizon, so we get that question all the time: ‘Where should we put it? Are alternatives the right place to be?’ I think the answer is yes, you just need to be careful about some of your entry points,” notes Beckman.

The frustration to drive returns is palpable. “You can’t really get yield anywhere,” says Beckman. “Interest rates are effectively at zero, so you would like to enter the bond market, but we all know rates will go up at some point so it is really a conundrum. I would say that we are cautiously optimistic of what is going to happen, but we are trying to build bulletproof portfolios to some extent and that is where the alternatives come into play.” realAssets Adviser | January JANUARY 2015

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By Jennifer Popovec

Investors often overlook direct investment in commercial property, but why?

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s the number of high-net-worth and ultra-high-net-worth individuals continues to grow, so does their appetite for alternative investments, particularly real estate. Yet, most of these investors limit their real estate investments to residential property or real estate investment trusts (REITs) instead of direct ownership in commercial property. In overlooking direct investment opportunities, however, these investors are missing out on a very effective tool to create wealth, many advisers contend.

“Qualified investors should strongly consider direct investments in commercial real estate,” suggests Dennis Moon, head of U.S. Trust’s Specialty Asset Management group, which includes real estate, timberland, farmland, oil and gas, and private businesses. “It provides customization that can help them achieve their specific financial goals along with unique benefits — tax and wealth planning for example, that only derive from direct ownership that frankly other forms of investing can’t or are more challenged to offer.”

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realAssets Adviser | JANUARY 2015

GROWTH IN WEALTH Today, there are nearly 5.8 million high-net-worth individuals (HNWIs) in the United States, an increase of 46.8 percent from 2008 to 2012. These people, characterized by net assets of more than $1 million excluding their primary residence, hold a total of $21.6 trillion in wealth. That equates to 28 percent of the total individual wealth held in the country, according to global research firm WealthInsight.

By 2017, there will be more than 9.5 million HNWIs in America, an increase of 68 percent. And not only will there be more HNWIs in the market, the total wealth they possess will increase by 83 percent to just under $40 trillion.

While the number of HNWIs continues to grow, so does the number of ultrahight-net-worths (UHNWs) — those with net assets of $30 million or more, excluding their primary residence. WealthInsight expects their legion to increase by 67.7 percent, to reach 75,352 multimillionaires in 2017. Their combined wealth is projected to increase 83.3 percent to reach $39.6 trillion by 2017.

REAL ESTATE’S ROLE Over the past several years, HNWIs and UHNWs have become more interested in alternative investments, particularly real estate. Recently, a Morgan Stanley Wealth Management Investor Pulse Poll found that fully 77 percent of millionaire investors say they own alternative investments, and 35 percent say they own REITs. More and more HNWIs and UHNWs feel real estate is an attractive asset class, and have realized that real estate investment is a potential path to building greater wealth. After all, wealth and property have been inextricably linked throughout time.

Why aren’t more investors putting their money directly into commercial property?

But many investors, despite their financial sophistication and use of experienced advisers, never think about investing directly in real estate. The conversation is often limited only to securities, in the form of either REITs or REIT mutual funds.

Global real estate services firm Savills estimates the value of all world real estate totals around $180 trillion. Of that total, UHNWs have global real estate holdings of $5.2 trillion.

The overwhelming majority of investors own real estate, but their holdings are primarily residential in nature, in the form of their primary residence and possibly a second vacation home. Seventy-two percent is owner occupied.

Most investors consider this residential property to be an investment, but few put it in the same category as stocks and bonds. They make their purchase decision based on personal preference rather than investment acumen. For example, most people choose to buy a house or condo because they like it and want to live there. Their primary motivation is anything but investment driven.

Experts say investors feel more comfortable with residential real estate because it is familiar to them. It is where they spend their lives with their loved ones.

realAssets Adviser | JANUARY 2015

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“What they don’t realize is that commercial real estate is part of their lives too,” says Jonathan Hipp, founding president and CEO of Calkain Cos., a national real estate firm that specializes in net-leased property.

The influence of familiarity cannot be discounted. Hipp says many of Calkain’s clients choose their acquisitions based on personal knowledge of the tenants or location.

It is possible that investors are less intimidated by residential real estate because homeownership is so prevalent. In the United States, the homeownership rate exceeds 60 percent. For HNWIs, that number is likely much higher. On a global basis, nearly eight out of 10 HNWIs own residential real estate.

“Global real estate is mostly residential and held by occupiers,” notes Yolande Barnes of Savills World Research. “But in the world of traded investable property, private owners are becoming more important than institutional and corporate ones.”

INTIMIDATED BY COMPLEXITY About 17 percent of the property owned by HNWIs and UHNWs is commercial property, according to Savills. Investable commercial property totals around $20 trillion, of which about half is owned by private individuals, either directly or indirectly, and the remainder by corporate and institutional investors.

Why aren’t more investors putting their money directly into commercial property? Experts are not sure, but they speculate that investors and the people who advise them are intimidated by the complexity of the industry.

“I think a lot of people just get overwhelmed when they think about commercial real estate, and when they decide to invest, they look at REITs instead of direct ownership,” says Moon of U.S. Trust.

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Admittedly, commercial real estate is one of those industries that always has had a bit of mystique surrounding it, and for outsiders, it can be complex and overwhelming. Not to mention the fact that everyone has heard stories about people losing money on real estate.

Many investors eschew direct investment in commercial property because they do not want the hassle of managing it, Hipp says. This attitude is especially prevalent when it comes to management-intensive asset classes such as apartments and hotels. That’s why netlease properties are so popular among millionaires and multimillionaires, he points out. These investments allow owners to be hands off.

“We find a lot of investors represented by family offices want to partner with operators because they don’t want to be involved in the day-to-day operations of the real estate,” says J.D. Parker, first vice president and regional manager for Marcus & Millichap, a national investment services firm that specializes in the sale of commercial property.

More often than not, when investment advisers and wealth managers think about investing in real estate, they immediately think of REITs. And even then, they are drawn to REIT ETFs and mutual funds because many advisers and managers have only a superficial knowledge of this asset class.

REITs are compelling investments for many investors. They are attracted to the liquidity these stocks provide, along with the experienced management teams and high-quality portfolios. There is also the matter of dividends and the fact that REITs must pay out 90 percent of their taxable income to shareholders in the form of dividends.

By and large, investors view REITs as the safest way to invest in real estate. But REITs are not risk-free. Like any other publicly traded stock, they are vulnerable to market fluctuations. And over the past few years, the REIT sector has begun to move in concert with other financial stocks, increasing its volatility.

MORE DIRECT INVESTMENT There are signs that UHNWs are slowly coming to embrace direct ownership of commercial property.

More than 40 percent of participants in the 2014 Wealth Report Attitudes Survey said their clients had increased their allocation to commercial property in

realAssets Adviser | JANUARY 2015

2013, and 47 percent said it was set to rise further in 2014.

“We’re definitely seeing more activity with private, individual investors,” says Brian Ward, president of capital markets at Colliers International, a major global real estate services firm.

That is not the only change Ward has seen recently.

“In the past, it was rare for a high-net-worth individual to spend more than $20 million on a single asset, but today we’re seeing them do $100 million transactions,” he notes. “The line between individual investors and institutional investors is blurring, and here at Colliers, we’re trying to give them a level of sophisticated service and market intelligence that we would give to an institution.”

Fans of direct investment in commercial real estate sum up their enthusiasm in two words: customization and control. Customization is key for creating a diversified portfolio that achieves investors’ objec-

Fans of direct investment in commercial real estate sum up their enthusiasm in two words: customization and control. tives, whether they are looking for long-term growth or they are more interested in income, Moon says.

And it is particularly important for HNWIs because of the size and expansiveness of their investment portfolios.

Investors who pursue direct investment can customize their portfolios to their needs, beyond property type. They can choose location, size and even tenants. While it is true that the REIT universe has expanded to include a variety of property types, from traditional sectors like office to niche sectors like data centers, there is still a lot that REITs do not cover.

realAssets Adviser | JANUARY 2015

Though REITs offer exposure to commercial real estate, investors have very little control over their investments beyond buying and selling shares. They certainly have no control over REIT management teams and the decisions they make regarding their own portfolios. Investors have no influence over the business in any way.

“Wealth managers and family offices always want to put their clients into REITs, but REITs aren’t always the best option,” Hipp says. “It’s difficult to move the conversation away from securities to direct investment, especially if we’re not considered part of the adviser team.”

THE BROKER FACTOR In most cases, real estate brokers are not part of a HNWI’s team of trusted advisers. Brokers usually are brought in to execute strategies that other people have outlined. For example, once an investor and their advisers have decided they want to invest in shopping centers in Texas, they would share that strategy with a broker. The broker would then find properties that fit the investors’ criteria.

There is a push in the commercial real estate industry, however, for brokers to work with investors in more of an advisory capacity. The goal is to build long-term relationships versus focusing on one-off deals. Increasingly, brokers are interested in being part of the initial strategic planning.

“We want to work with investors on their overall investment strategy,” says Parker of Marcus & Millichap. “We view ourselves in more of an advisory capacity, and we advise on tax strategy, allocation and diversification.”

Moon acknowledges that HNWIs and their advisers are sophisticated investors. However, he is quick to point out that brokers can provide significant value.

“There’s so much information available to investors that it can be overwhelming, especially when it comes to commercial real estate,” Moon notes. “Real estate remains a local business, so having a broker with a local perspective to distill the information can be very helpful. Advisers should definitely take advantage of their expertise to help their clients.”

Jennifer Duell Popovec is an award-winning writer based in Fort Worth.

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By Joseph Dobrian

Diamond investing takes some work, but can yield attractive returns over the long term.

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ccording to a 2013 report by Bain & Co., increased demand from populous, developing countries will lead to a compounded annual rise in diamond prices of about 5.1 percent between 2017 and 2023. Color diamond prices could rise even more dramatically.

Expert opinions on the credibility of diamonds as an investment vary greatly, however. One problem in assessing the category is valuation of the individual stone, which is highly subjective. Another difficulty is that the category must bow to the whims of fashion, especially with regard to color diamonds. A third is that supply, which largely drives price, is unpredictable over the long term.

Paul Zimnisky is CEO of New York City–based PureFunds, which he describes as the first pure-play exchange traded fund to exclusively invest in the full lifecycle of the gemstone industry. Zimnisky says he does not see diamonds as an investment, but more as a means to preserve capital.

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“The same goes for gold, fine art, vintage cars, etc.,” he continues. “All of these items don’t pay a cash flow, and there are costs associated with holding them. That said, the highest quality examples of these items have historically maintained their value on a real basis. I see holding high-quality diamonds as a way to maintain stored wealth in a world of fiat currency degradation.

“Typical options for storing your wealth are equities, bonds, and real estate,” Zimnisky adds. “I would argue

realAssets Adviser | JANUARY 2015

that equities are unstable and relatively unpredictable. Debt yields are artificially low due to central bank policy. I like real estate, especially if it’s paying a cash flow, but it has associated risks and headaches.”

Very high-quality diamonds are probably the most valuable tangible item relative to their size, Zimnisky asserts. He acknowledges, however, that they have their drawbacks, including cost of carry (no interest or cash flow being paid); insurance cost; safekeeping cost — and most importantly the lack of liquidity.

realAssets Adviser | JANUARY 2015

Expert opinions on the credibility of diamonds as an investment vary greatly.

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“The cost to transact could be as high as 25 percent in and 25 percent out as a result of commissions and the bid/ask spread,” he warns. “Price transparency is lacking, too, since transactions primarily take place in private settings.”

Nina Held, marketing executive for the German branch of Vashi.com, a London-based jeweler, asserts that demand is on the rise. “Demand for diamonds is increasing, especially in the middle classes of emerging markets such as India or China,” reports Held. “Digging for diamonds gets harder but less profitable because of the huge costs of mining. Whoever has invested in physical diamonds or has diamonds in their portfolio should hold fast, due to the increasing value. But this doesn’t automatically apply to those who have invested in corporate bonds or shares of mining companies.”

Not every stone is worth its price, Held warns. Cut diamonds are priced based

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on the 4Cs: color, clarity, cut and carat.

Each gemstone-quality diamond should come with a certificate proving the value and authenticity of the stone. However, experts can have widely varying opinions on the value of a stone. Personal opinion, and even sentiment, can influence what an investor is willing to pay.

As for diamond funds, Held advises individuals to work through an institutional investor or an independent asset manager, especially if the individual lacks profound knowledge of gemstones and the industry.

Held notes she recommends diamonds either to very experienced individuals who have a solid knowledge of the market, or to institutional investors who have the best access to information and market players in an industry that is notorious for lack of transparency.

“Metals like gold, silver, platinum or copper are defined in units that come

with a fixed and official price and are traded on a daily basis in regulated capital markets,” Held points out. “Diamonds don’t have a fixed price per unit.

Several indices give a hint of the actual value of a diamond, but in the end each stone is individual and should be valued by experienced traders, cutters or gemologists.” Investing in derivatives, as can be done with precious metals, is still not possible with diamonds. But investors can look for funds that contain assets in physical diamonds, or shares and bonds of mining companies.

“High-quality diamonds are rarer than gold, and more valuable on a value-toweight-and-size ratio,” Zimnisky adds.

“But diamonds are less liquid, and pricing is less transparent. Since they don’t trade on a regulated exchange, you need to be educated or transact through a reputable source. A slight difference in quality or color can have a huge impact on the price

realAssets Adviser | JANUARY 2015

of a diamond. It’s like buying a fine vintage car: If you’re not a mechanic, bring a non-biased expert with you.”

Held and Zimnisky agree that individuals with new-found wealth in emerging economies (such as Russia and the Arab states), who are diversifying their wealth, are the primary driver of investmentgrade diamond sales.

“The growing middle class in Asian countries will become one of the most important and demanding markets for diamonds in the years to come,” Held says. “Some investors prefer diamonds as a safe haven to escape inflationary risks and the volatility of other investments due to various economic events.”

“Bear in mind, also,” Zimnisky adds, “that only a handful of new mines are set to open in the next five to 10 years, due to the challenging economics of diamond mining. If demand continues to increase or even remains stable, the dynamics

Asking them for pricing information is like asking a farmer about the price of wheat.

realAssets Adviser | JANUARY 2015

could be favorable for prices. So the next question is, how high can prices go before demand is eroded?

“The fundamental backdrop for diamonds as a natural resource is attractive,” Zimnisky continues. “But this will primarily affect engagement-ring-quality diamonds, in the $2,000 to $10,000 price range, which I would not characterize as ‘investment grade.’”

If you are investing in physical diamonds, Held advises, seek out a reputable diamond trader in Antwerp, New York or Mumbai, and compare and monitor indices such as Rapaport RapNet Diamond Index to gain an understanding of pricing and conditions.

“Make sure you have a trustworthy adviser and that you fully understand the product you’re investing in,” she urges. “The advantage of a diamond bond or share is that you’re investing in the performance of the diamond industry without having to store a diamond physically. Furthermore, floating shares on a capital market should be easier than selling gemstones.”

James Stedman, director of investments at Rapaport, a New York City–based diamond pricing organization, advises would-be investors to take advice from experts who are not trying to sell product.

His organization, he says, tries to categorize diamonds as much as possible, to commoditize them, to create clearer rationales for pricing.

“Diamonds do a good job of retaining their value,” Stedman says, “even though we’ve recently seen a pullback in pricing, as we’ve seen in gold. I’m speaking mainly about colorless diamonds. Color diamonds typically outperform polished colorless stones.

“Rapaport has no inventory,” he adds.

“Maybe 95 percent of the experts who comment on the industry are pushing product, and that’s fine, but asking them for pricing information is like asking a farmer about the price of wheat.”

Michelle Graff, editor of National Jeweler magazine, notes that organizations like Rapaport are looked at askance by some jewelers, who feel that pricing orga-

nizations are taking the romance out of diamonds by commoditizing them. But if that is a trend, it is making diamonds more interesting to investors who take a non-sentimental approach to the product.

“A number of diamond investment funds have been launched,” Graff notes, “but you don’t hear much about them after they launch. They don’t seem to have had the same level of success as gold funds, for example.

“Pink diamonds are currently popular as investments, though. It’s been reported that the average cost of a pink diamond was about $13,000 per carat in 2002, and now the average is $78,000.”

Pink diamonds may appreciate further in the next few years if one of their main sources — the Argyle mine in the East Kimberley region of Western Australia — closes in 2019 as planned.

Yaniv Marcus, vice president for Asia-Pacific & Investments at Leibish & Co. (Ramat Gan, Israel), a dealer in color diamonds, says he became interested in color diamonds for investment purposes because of his background in financial planning and investment management.

“The conventional wisdom in buying a diamond,” Marcus explains, “is that you should buy something you like, balancing the passion that you might feel for it — as you might feel for a work of art — with the practical advice of an expert. If an investor tells us yellow is his favorite color, we look at yellow as an investable color. There are many variations of yellow diamonds, and they’re not all investment grade.”

Prior to the late 1970s, Marcus says, fancy color diamonds were not considered desirable. Investors would weed them out, until they realized that fancy colors represent less than 0.1 percent of the world’s gem-quality supply.

“Nobody in the financial world understands this investment vehicle,” he adds. “With the Internet, people have been able to educate themselves: They can go to more than one person for information. Color diamonds are like a work of art, in that there’s no set price for them.”

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Diamonds create value over 10 years, 20 years, even a generation, depending on the rarity of the color.

For the past 10 years, Marcus continues, auction houses like Sotheby’s and Christie’s have been gathering information on diamond pricing, and thanks largely to their information, Marcus has been able to measure diamonds’ performance as investments compared to gold, the NASDAQ, S&P, the New York Stock Exchange, and even individual bluechip stocks like Berkshire Hathaway and Coca-Cola. Pink and blue diamonds, he asserts, outperform most other investment categories.

“Traditionally the difficult parts of investing in diamonds were the absence of a proper valuation method and liquidity,” Marcus says. “The saying goes, ‘Stock or gold, in five minutes it’s sold.’ But with eBay and Amazon.com getting involved, liquidity is less of a challenge today.

“Valuation is very subjective. You have 12 colors, different shades, shapes and qualities. There are maybe 300 variables that create thousands of possibilities.

Twelve analysts, all with the same information, might come up with 12 different valuations of a diamond.”

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Marcus notes, however, the same could be said for a share of stock, where the value can hinge on any number of variables, and might be more or less than the listed price to an individual investor.

“Diamonds are a passion investment,” he explains. “You’d have a similar conversation with a person who’s investing in whiskeys or violins: it’s pure supply and demand, how you quantify the value.

Everyone comes into an investment with certain assumptions.

“The diamond business has always been a closed community. That community has different objectives from the investment community, so there’s lots of misunderstanding. The former group wants to keep values secret, among them; the latter group wants transparency.

Many attempts have been made to create diamond funds, and all have failed because the originators were people from the financial industry who didn’t understand how this asset functioned.”

Marcus urges potential investors to educate themselves thoroughly about diamonds in general and color diamonds in

particular — and to never buy an individual stone unless it is in front of you.

“The human eye surpasses a computer,” he says, “and so does experience.”

Marcus also warns that it is easy to fall in love with a diamond that isn’t investment quality. In that case, it might be wise to create a piece of jewelry with it — and perhaps build a collection of fine jewelry around that piece.

“You don’t day-trade a diamond,” he insists. “It’s not a short-term investment.

Diamonds create value over 10 years, 20 years, even a generation, depending on the rarity of the color. You also have colors like orange, purple, green, which are ‘collectors’ colors.’ They’re extremely rare but there’s not enough demand for them to create liquidity.

“You want a balance of liquidity, rarity and valuation. Diamonds in the $100,000 to $500,000 range are ideal because you find plenty of buyers for them and you have a balance of value and liquidity. The higher the price, the less of a market there is.”

Joseph Dobrian is a freelance writer based in New York. realAssets Adviser | JANUARY 2015

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Coming

of

New platforms, changing sentiment, and the ongoing quest for yield have the infrastructure asset class sprinting toward adulthood.

I

nfrastructure as an asset class is really just a teenager, quips Danny Latham, co-head of infrastructure investment management with Colonial First State Global Asset Management.

Although some investor-parents may shudder at that thought, it just might be a fair analogy. Infrastructure and public-private partnerships are not entirely new, but at the same time infrastructure is hardly the mature, widely accepted allocation that some feel it should be — or soon may become.

This growing up may be happening right now, given the confluence of needs among municipalities, investors and society that is bringing things to a head. This alignment of interests is coming into clear focus, and, coupled with creative new capital markets vehicles and maturing investor sentiment, a new wave of capital may be on the brink of entering the infrastructure arena.

According to the I3 Investor Survey (conducted by Real Assets Adviser sister publication Institutional Investing in Infrastructure, or I3), investors are increasing their target allocations to infrastructure in 2014, but they have also increased their actual allocations. In other words, money is being called for investment and is being put to work right now.

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The I3 Investor Survey’s findings are supported by the second quarter Preqin Quarterly Update on infrastructure investing, which finds that institutional investor appetite for infrastructure funds appears to be increasing, with 83 percent of fund managers reporting greater interest from investors as compared to 12 months ago.

No question about it, institutional asset allocation continues to morph away from the tired 60-40 stock and bond model and toward risk parity concepts or absolute return approaches. “Institutions are increasingly looking toward real assets for up to 20 percent of their portfolio,” says Larry Antonatos, head of global equities with Brookfield Investment Management. He sees infrastructure grabbing a larger share of the real assets pie going forward with allocations perhaps rising toward 5 percent to 10 percent of a total investment portfolio.

Is it any surprise why? Institutions want assets that can deliver attractive yields, stability,

uncorrelated returns, a possible hedge against inflation and even growth. Recently, Moody’s Investors Service estimated that the 25 largest U.S. public pensions have an aggregate of $2 trillion in unfunded liabilities despite several years of strong investment results. On top of that, revised mortality estimates from the nonprofit Society of Actuaries confirms that life spans are getting longer. In the current low-rate, low-growth environment, traditional asset classes cannot provide the necessary returns that investors need, particularly with regard to yield and income requirements.

realAssets Adviser | JANUARY 2015

By Alexis Petrakis

Money is being called for investment and is being put to work right now.

In turn, real assets, and more specifically infrastructure, are where investors may turn to meet this need.

Shifting sentiment Beyond the obvious need for income and the other advertised characteristics of infrastructure investing, what are some of the factors behind the maturation of this adolescent asset class that are helping attract global capital? Some of it may be attributed to a change in investor sentiment and the subsequent entry of new players. realAssets Adviser | JANUARY 2015

Already an early adopter of infrastructure

by U.S. standards, the California Public Employees’ Retirement System announced a new $500 million global infrastructure partnership with UBS Global Asset Management in August 2014 and more recently announced its intention to increase its infrastructure portfolio from about $1 billion in investments to $6 billion.

The CalPERS infrastructure program seeks to provide stable, risk-adjusted returns by investing in public and private infrastructure, primarily within the transportation, power, energy and water sectors. Perhaps CalPERS is emboldened by strong returns — reportedly more than 23 percent over the past five years — and the ability to generate alpha from the retirement system’s infrastructure investments. At the time of CalPERS’ announcement, the pension fund held approximately $1.8 billion in infrastructure assets, with a total of $30 billion in its real assets portfolio.

That’s real money and a probable harbinger of future flows to the asset class.

Earlier this summer, the Teacher Retirement System of Texas reportedly made significant commitments to several Morgan Stanley vehicles to invest in transport, energy, utilities, communication and social infrastructure in North America, Europe and Asia. And there are countless notable examples of public pension plans and sovereign wealth funds that appear to be delineating infrastructure as its own asset class.

Brian Chase, principal with Campbell Lutyens & Co., points out that Norway’s sovereign wealth fund is talking about making direct investments in infrastructure assets (including renewable energy), which could have a substantial influence on future capital flows. Meanwhile, the Ontario Municipal Employees Retirement System has used its infrastructure expertise and track record to help raise money for a Global Strategic Investment Alliance, which is a co-investment vehicle that will target large, revenue-producing core infrastructure projects around the world. It is especially notable given that co-investor participants include Japan’s Government Pension Investment Fund, which manages more than $1 trillion. These are heavyweight investors who are showing an interest in the asset class.

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“Any shift in investment strategy away from fixed income and toward infrastructure indicates a sea change for Japanese investors and could create a knock-on effect for other investors,” Chase suggests.

The chicken or the egg?

Is this growing appetite being driven by investor desire for yield and growth, or society’s need for well-managed infrastructure to grease the wheels of commerce? Perhaps both, and it certainly does not hurt that politicians — also known as regulators — view infrastructure investing as an economic driver and job creator.

With increasing frequency, we are seeing announcements of new programs and platforms to encourage infrastructure investment around the world. The U.K. Pensions Infrastructure Platform is one such initiative that pools assets and aims to help its pension funds invest in lower-risk infrastructure assets. More recently, the World Bank has announced that it is aligning some of the world’s largest private managers and investors in a new Global Infrastructure Facility to unlock billions of dollars for infrastructure in the developing world. All these are clear signals of the momentum gathering to increase the opportunity set for investors.

Opportunities ahead The challenge for many investors is not so much convincing investment boards and constituents about the potential for real assets and infrastructure, but rather finding investment opportunities with the right risk-return characteristics. In other words, many believe the current challenge is less about drawing capital to the space, but more about improving the supply of assets. If supply indeed is the challenge, where should investors be sniffing around for opportunity?

Here are a few ideas: Across the pond: Many governments are capital constrained but have significant value in infrastructure assets, points out Larry Antonatos. The privatization of such assets is a well-established trend that continues to gain momentum. For example, many European airports have been privatized and are now owned and operated by public infrastructure companies. However, these trans-

52

actions are complex and can sometimes run into turbulence. Spain had planned to raise billions from the sale of 49 percent of its state-owned airports operator Aena through an IPO in late 2014, but the offering was recently grounded until next year.

Balance sheet repair is not just a theme for large, government-owned transportation assets in peripheral Europe. Thierry Déau, founding partner and chief executive officer of global infrastructure investor and asset manager Meridiam, suggests that infrastructure investors may have opportunities to put capital to work from the corporate divestitures of secondary assets. French utility EDF is a prime example looking to raise capital and sell assets.

In fact, wholesale changes in the landscape surrounding European utilities, along with “improvements” (for investors, that is) in the regulatory landscape should help create regional opportunities for institutional investors. In addition, the European Union’s com-

mitment to promoting energy efficiency and a lower-carbon economy through aggressive “20-20-20” targets should fuel robust investor interest in the renewables sector.

Even the return to favor of structured financing vehicles in Europe indicates the improving investor sentiment and ongoing maturation of the asset class, Déau points out: “Bank debt has been very volatile in the crisis and cannot propose the same terms as infrastructure-linked bonds, so I see this European infrastructure debt market stepping in to meet some of this investor demand and growing substantially in the years ahead.”

North American energy: The consensus among many investors is that the North realAssets Adviser | JANUARY 2015

territories with incentives to sell government assets to private investors and recycling a portion of the proceeds into new projects. The Port of Melbourne, government commercial properties and power transmission businesses may come to market and appeal to a variety of established direct investors, with Australian superannuation funds, Canadian pension investors, and sovereign wealth funds from Asia and the Middle East likely to be interested.

Other notable areas of interest are Latin America and more specifically Mexican energy markets, thanks to ongoing reforms that appear to be gaining traction. Emerging markets also offer a virtually endless opportunity given the tremendous need to fund projects in developing economies. The issue with the latter, however, is that any transaction in an emerging or frontier market is likely to add several layers of risk. Although the need for investment and infrastructure building is enormous throughout the developing world, the greenfield nature of developing these assets is much more of an opportunistic strategy, rather than the core, liability-matching yield play that so many institutions are seeking.

American energy markets offer another huge opportunity set for investors. With new (albeit controversial) techniques for extracting large stores of gas from shale formations, the entire North American exploration and production businesses are being revitalized, bringing the need for everything from new gas pipelines to storage facilities. Many of the assets appear to be natural fits for core investors with their potential for steady income and immediate operational benefits, but with tax-advantaged entities such as yieldcos in the mix, investors need to be careful to avoid getting caught up in the herd mentality bidding up these assets.

Looking Down Under: There will be numerous opportunities emerging in Australia over the next 12 to 24 months, according to Latham, thanks in part to Australia’s infrastructure asset recycling program, which aims to provide states and realAssets Adviser | JANUARY 2015

Mind the risks: 2015 Outlook Infrastructure investors routinely cite political and macro factors near the top of their list of worries. Changing political winds can either undermine a specific investment or conversely propel an entire segment of the market. The Foreign Investment in Real Property Tax Act, or FIRPTA, is often cited as an impediment to investment in U.S. infrastructure; however, efforts to reform the act along with the outcome of the recent mid-term elections are viewed as lowering the political risk in the United States, particularly around the energy sector.

In Mexico, the aforementioned reforms appear supportive of increased investment, while the recent victory by Indian Prime Minister Narendra Modi is seen as a possible precursor to less bureaucracy and greater investment in the infrastructure-starved Indian subcontinent. Conversely, market participants have greeted the narrow re-election of incumbent Brazilian President Dilma Rousseff with less enthusiasm. Elec-

53

All these are clear signals of the momentum gathering to increase the opportunity set for investors.

tion cycles and the regulatory environment will always matter, especially when dealing with “public” assets or those somehow tied to “national security” as transportation assets are often viewed in the United States. The political tides ebb and flow, but it appears that infrastructure investors must be willing to live with some level of political risk.

Rising interest rates also bear watching.

While quantitative easing appears to be waning in the United States, question abound whether central bankers in Japan and Europe are simply replacing such stimulus on the global level. Will these efforts keep global bond yields bouncing along their historic lows? If not, a rising interest rate environment can be expected to raise the discount rate applied for future cash flow of infrastructure deals. Not only could this have an impact on the prices investors are willing to pay for assets, but it may also cap the number of assets being traded.

Yet another risk to watch may result from the wall of capital that appears to be entering the asset class. History shows that any time

54

there is an unfettered growth spurt in the demand for certain assets, capital allocation decisions can get dicey. Core infrastructure could become a victim of its own popularity and success.

“The biggest danger is too much money comes into the space too quickly,” Déau explains. “Pricing matters.”

One need look no further than bankrupt Indiana Toll Road Concession Co. Paying too much for an asset and overestimating projections for rising highway traffic to offset construction costs can have painful results.

This example highlights the reality that there are very real execution and idiosyncratic project risk with infrastructure. It is not the same as buying a paper asset.

A recent article in The Wall Street Journal reported that South Korea’s sovereign wealth fund is changing its approach to direct investing due to some unfavorable experience in the energy sector, and elsewhere.

The article states: “Hongchul Ahn, chairman and chief executive of KIC, said in an email that the fund will change its approach to direct investing after ‘disappointingly lower returns.’ … Ahn blamed the poor returns on ‘deals with no back-up of research function, lack of knowledge and experience in [the] energy sector.’ He said the fund hadn’t done enough due diligence, hadn’t paid enough attention to risk management and had relied too much on recommendations from investment advisers.”

Such refreshingly honest statements can be a stark reminder that risk management is critical. For investors with the size, scale and intestinal fortitude, building teams of infrastructure experts or co-investing with others could pave the way for direct investment in infrastructure with strong results. For smaller investors or “newbies” to the asset class, an approach focused on listed securities could be a prudent way to enter the asset class before jumping into a commingled fund or co-investment. This may be a means to enter the asset class on a more measured basis,

diversifying broadly, benefiting from the daily liquidity of listed securities. And still others will prefer to rent the expertise from an established manager in a fund vehicle.

The options are many, and they appear to be increasing.

One key success factor may be the ability for investors to find the right investing model. Rajiv Sharma, a postdoctoral fellow at Stanford University’s Global Projects Center and a visiting research associate at the Oxford University Smith School of Enterprise and the Environment, has been studying some of the co-investment platforms, government-led initiatives and other models that are being used to fund infrastructure investment. He suggests that the fees and terms of some of the traditional private equity type models may have been too high.

Yet Sharma writes that the new models based on collaboration and pooling of public and private investors could offer a series of important benefits to institutional investors, including cost savings for due diligence and legal services, which can be achieved by pooling resources together, as well as better diversification and access to a broader portfolio of assets. In addition, there is the potential to earn higher returns by leveraging the local knowledge of a co-investment partner.

Of course the new models are not a panacea either, with a chief risk being that such broad collaboration among stakeholders with differing agendas could lead to an inefficient investment process. Ultimately, there are many questions that need to be answered by investors before entering such a platform.

Growing pains As always, the markets are trying to sort it all out. With the possible exceptions of the Australian and Canadian pioneers, the entire institutional infrastructure asset class is probably several decades behind real estate and just now playing catch-up. The question is whether the capital allocation decisions and growing pains will mirror that of a good kid, or will this teenager grow into an antisocial adult? Stay tuned.

Alexis Petrakis is a freelance writer and founder and principal of Teleon Communications, based in Berkeley, Calif. realAssets Adviser | JANUARY 2015

February 12 - 13, 2015 The Ritz-Carlton, Grand Cayman www.caymansummit.com

FEBRUARY 12-13 2015

For more information please contact: info@caymansummit.com

Industry Guest Speakers:

Special Guest Speakers:

Sir Richard Branson

John Mauldin

Founder, Virgin Group

Chairman, Mauldin Economics

Emmanuel Jal

Gregory Coleman

Renowned recording artist, award winning activist

Special Agent, FBI Case Agent, Wolf of Wall Street Investigation

Nouriel Roubini

Jacqueline Novogratz

Chairman, Roubini Global Economics

Founder and CEO, Acumen

Paul Lindley

Louis Hernandez, Jr.

Founder and CEO, Ella’s Kitchen

President and CEO, Avid

Keith Benedict - COO, A.G. Hill Partners, LLC Anric Blatt - Chairman, Global Fund Exchange Robert ‘Bob’ Borden - Managing Partner and CIO, Delegate Advisors David Bonderman - Co-Founder,TPG Capital Matt Botein - CIO and Co-Head of Alternative Investors, BlackRock, Inc. David Brief - CIO,The Jewish Federation of Metropolitan Chicago Tom Brown - Global Head of Investment Management, KPMG Gary M. Brown - CEO, CMG Life Services Inc. Anthony Cowell - Partner, Head of Alternative Investments, KPMG in the Cayman Islands Max Darnell - Managing Partner and CIO, First Quadrant Adi Divgi - President and CIO, EA Global LLC Chris Duggan - Vice President, DART Enterprises Ltd. David Einhorn - President and Co-Founder, Greenlight Capital Christophe Evain - Managing Director and CEO, Intermediate Capital Group Plc Johnston L. Evans - Managing Director and General Partner, INVESCO Private Capital Tim Fitzgerald - Head of Alternative Fund Services, Deutsche Bank James G. Glasgow, Jr. - Managing Member and Portfolio Manager, Five Mile Capital Jane Amanda Halsey - Founder and President, Roundtable Forum, LLC Lord Michael Hastings - Vice President, UNICEF UK Kenneth J. Heinz - President, Hedge Fund Research, Inc. Andrew Hoine - Director of Research, Paulson & Co. Inc. Constance Hunter - Chief Economist, Alternative Investments, KPMG Laird R. Landmann - Group Managing Director and Co-Director Fixed Income,TCW Eric Lloyd - CEO, Babson Capital Finance Robert ‘Bob’ Maynard - CIO, Public Employee Retirement System of Idaho (PERSI) James P. McCaughan - CEO, Principal Global Investors Andrew Mehalko - Founder and CIO, AM Global Family Investment Office Angela Moss - Director of Investments, UNC Management Company Mark Okada - Co-Founder and CIO, Highland Capital Management, LP Larry Powell - Former Deputy CIO, Utah State Retirement Fund James P. Rankin - Director of Investment Operations, PAAMCO, LLC Anne Richards - CIO, Aberdeen Asset Management PLC Mark E. Roberts - Managing Director, Ironside Asset Advisors/Biltmore Family Office Bill Rogers - Founder,TexWest, LLC Erin Ross - General Counsel and Chief Compliance Officer, Hitchwood Capital Management LP Parag Saxena - Co-Founder, Vedanta Capital LP Darsh Singh - Portfolio Manager, Satori Alpha Brian Sponheimer - Portfolio Manager, Gabelli and Partners Sally J. Staley - CIO, Case Western Reserve University Lisa Stanton - Legal Counsel, Man Investments Inc. Dr. Daniel Summerfield - Co-Head of Responsible Investment USS Ltd. Michael Underhill - Co-Founder and CIO, Capital Innovations, LLC Mark W. Yusko - CEO and CIO, Morgan Creek Capital Management Bruce Zimmerman - CEO and CIO, University ofTexas Investment Management Co.

The Cayman Alternative Investment Summit is produced by CAIS Ltd., a sister company of Dart Realty (Cayman) Ltd. Renowned for its longstanding commitment to thoughtful, sustainable development in the Cayman Islands, Dart Realty is the visionary behind a repertoire of high-end developments including the master planned community Camana Bay, the residential neighborhood Salt Creek and a Kimpton branded hotel and residences opening on Seven Mile Beach in 2016.

By Brad Berton

REITs

Roll the Dice Esoteric business spaces have spawned new REITs, making for an interesting year ahead.

D

oes the real estate securities sector’s budding embrace of highly specialized equity REITs suggest tax-exempt retirement funds and other institutions will soon be placing multimillion-dollar bets on publicly traded casino companies?

While the answer appears to be at least a tentative “affirmative,” the motivations underlying efforts by three large gaming companies to establish new REITs illustrate both encouraging and dubious drivers of niche REIT formations.

On the positive side, liberal IRS interpretations have broadened the definition of business assets qualifying as “real property” eligible for the taxadvantaged REIT corporate structure. Along with other benefits, including generally enhanced access to capital markets, the structure’s avoidance of federal income taxes at the corporate level continues to attract institutional equity amid a solidly performing domestic REIT universe.

Accordingly, companies competing in quite a collection of esoteric business spaces have formed REITs over just the past couple of years, lengthening a public equity REIT roster historically dominated by a handful of primary income-property “food groups.” Newcomer categories include the likes of data centers and related storage facilities;

56

telecommunications and energy infrastructure assets; timberlands and farming acreage — even a second publicly traded prison operator.

“REIT conversions and spinoffs have been a hot topic,” particularly among companies operating in niche spaces within the broader infrastructure arena, observes veteran REIT investment consultant Jim Sullivan, a managing director with prominent REIT research firm Green Street Advisors.

“It began with the timber companies, expanded to the data center companies, then to the cell tower owners, and now to companies in the energy and telecom sectors,” Sullivan continues. “And the number of ideas being discussed is only gaining speed, so 2015 is shaping up to be a very interesting year.”

Sullivan and other experts anticipate that growth-minded owners and operators of casinos, advertising billboards and other nontraditional fare will supplement further activities from the latest niche REIT sectors and subsectors.

“I think the door is open for more of this type of activity,” concurs Susan Persin, senior research director with property finance analyst Trepp.

“All kinds of businesses have significant capital tied up in their real estate, and I have to imagine that they are increasingly looking at REIT spinoffs.”

realAssets Adviser | JANUARY 2015

While management teams are challenged to explain their particular niche marketplaces and corporate profiles to investors accustomed to traditional REITs, many might view these newfangled investment vehicles more favorably than additional trusts targeting the core real estate sectors, Persin adds. “Some of these (new and proposed) REITs have compelling stories, strong growth potential, and great returns that can make them more attractive to investors than traditional REITs.”

COMPELLING PERFORMANCE Of course, it can’t hurt the cause that some of the specialty REITs have performed impressively for investors in their early fiscal quarters. This is thanks, at least in part, to Wall Street’s ongoing embrace of REITs amid the quest for decent risk-adjusted returns in the prolonged low-yield environment.

For instance, the three public trusts the National Association of Real Estate Investment Trusts (NAREIT) classifies as infrastructure specialists posted a collective year-to-date total return of 16.76 percent (and dividend yield of 1.46 percent) through 2014’s first three quarters. Among the other eight categories, only the scalding residential sector with its 20-plus total return bested infrastructure.

And that is not to mention the Financial Times Stock Exchange (FTSE) NAREIT Equity REITs index’s 13.96 percent total return (and 3.99 percent dividend yield) for the period — compared to the S&P 500’s 8.34 percent (and 2.06 percent).

On the other hand, the performance of companies competing within what tend to be relatively smaller (if growing) niche marketplaces predictably can be volatile. For example, while the handful of constituents comprising NAREIT’s timber category collectively posted an attractive total return of 7.86 percent in 2013, it was the only negative performer (at -0.68 percent) year-to-date through September 2014.

Indeed, professionals managing REIT stock portfolios on behalf of institutional investors need to keep in mind some nontraditional risks inherent in the wave of specialty REIT formations — whether executed via corporate conversion, transition, spinoff, initial public offering or some combination thereof.

Perhaps most notably their business models, asset portfolios and customer relationships — and in

The number of ideas being discussed is only gaining speed. turn, risk characteristics and income streams — can deviate significantly from traditional income-property landlord/tenant arrangements. Some specialty REITs also are particularly exposed to risks related realAssets Adviser | JANUARY 2015

57

to social responsibility issues (such as casinos), and others to public policy and political dynamics (such as private prisons).

Furthermore, over the longer term, there is no guarantee longtime REIT investors will bullishly embrace these new-wave trusts — nor for that matter that their nontraditional assets will continue to qualify as real property for REIT treatment under the federal tax code.

More immediately, the fate of one particular proposed casino REIT formation should offer a revealing read on how certain attractions of REIT status might prove more beneficial from management’s perspective than to prospective investors.

History has proven time and again that the improved access to debt and equity markets can allow companies with substantial property portfolios to deleverage — occasionally even those that might otherwise end up reorganizing (or worse) under Bankruptcy Court supervision. Hence, as certain struggling specialty players pursue REIT qualification more as a matter of survival than a sound operating strategy, investment advisers and institutional investment managers alike must determine whether it makes sense to buy their shares.

Forming a REIT can help a company attract equity and debt on more favorable terms than many other business ownership structures and hence “unleash value” not yet being realized, notes Jerry Ehlinger, North American REIT portfolio manager with institutional adviser Heitman. While this effect is often seen with traditional income-property owner-operators, it can also apply to struggling specialty outfits

There’s no guarantee longtime REIT investors will bullishly embrace these new-wave trusts. desperate to raise capital — as long as their assets qualify for REIT status, of course.

In fact, many securities analysts have reported that big gaming outfit Caesars Entertainment Corp.’s burdensome corporate debt is what really underlies management’s proposal to form a public REIT. The plan would split the corporation’s money-losing Caesars

58

Entertainment Operating Co. unit into a REIT with distinct rent-collecting landlord (property company) and rent-paying tenant (operating company) entities.

Although such so-called “OpCo/PropCo” splits can effectively improve overall capital positions, experts advise prospective investors to approach such leverage-driven stock (and bond) issues with particular caution — especially given ongoing analyst warnings of a potential Caesars bankruptcy filing ahead (voluntary or otherwise).

Even as the boards at both Pinnacle Entertainment and Boyd Gaming have likewise recently green-lighted explorations of REIT formations via OpCo/PropCo restructurings, experts also point out that the casino niche is inherently exposed to additional risks related to social responsibility issues.

As Ehlinger cautions, decision makers considering stocks of casino REITs should keep in mind that certain investors will tend to avoid gaming-related securities due to conscientious policies — limiting their investor universes and perhaps, in turn, potential valuations.

A FUNDAMENTAL ISSUE Perhaps the most fundamental risk related to the new niche stock offerings, however, pertains to traditional REIT investors’ willingness to embrace their nontraditional supply-demand fundamentals.

The standard metrics used to assess landlords’ space supplies, and tenants’ demand to physically occupy them, “will not apply, or will apply differently, to specialized REITs,” Trepp’s Persin relates.

For example, some of the newfangled telecom infrastructure REITs count just a handful of wireless carriers collectively as their major tenants. “And that tends to limit demand for the REITs’ assets based on technological advances … rather than on population growth,” Persin elaborates.

Likewise, a niche such as privately operated prisons tends to be far more exposed to the fickle whims of public policy than REITs in the core property sectors, she continues. “Their demand derives not just from a growing population that has a certain incarceration rate, but also from political policy [regarding] whether states elect to utilize private prisons” — perhaps explaining why this specialty includes just two public REITs to date. realAssets Adviser | JANUARY 2015

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Heitman’s Ehlinger for his part wonders whether some seasoned REIT investors will remain reluctant to buy stocks of companies that do not own fee-simple interests in (and hence long-term control of ) fixed real property assets that should appreciate over time, in addition to generating income from tenants or related customers. A company touting billboards or cell towers as its primary assets just won’t be able to tell the “straight forward” real estate story these traditionalists prefer, he cautions.

Green Street’s Sullivan likewise expresses concerns about the underlying complexity of niche marketplaces, and individual company strategies, relative to REITs in the core income-property sectors. “Among dedicated REIT investors, there has definitely been some pushback on some of the nontraditional property REITs.” Notwithstanding the pretty solid performance (and investor acceptance) of several new REITs in the infrastructure, energy and telecom specialties, “it remains to be seen what the appetite will be for REITs that own solar farms, electricity transmission systems, oil pipelines and fiber optic networks,” Sullivan continues.

As he and Ehlinger stress, it is incumbent on the brain trusts of niche companies to educate the REIT marketplace — especially on matters of growth prospects and volatility patterns within their specialized market spaces, and characteristics of risks to their particular cash flow streams.

CEO Sean Reilly acknowledged as much to con-

ference callers before big billboard owner-operator Lamar Advertising Co. officially merged with its REIT subsidiary Lamar Advertising REIT Co. in November. “We need to introduce ourselves to traditional REIT investors. We need to help them understand the fundamentals of our business, help them understand just how resilient and robust our business model is.”

For instance, one key difference between Lamar and REITs in the core property categories is that its capital expenditures are far more “optional and variable” because Lamar operates billboards rather than “big buildings with long lead times,” Reilly elaborated. And that difference is meaningful with respect to the ongoing “reliability” of the Lamar REIT’s cash flow and, in turn, its “ability to protect the (dividend) distribution … which is a very important point for traditional REIT investors.”

Over the longer term, national politics pertaining to tax policy could also become a threat to niche REIT investments. As Sidley Austin LLP partners David Miller and Christian Brause point out in their frequent tax updates, a Congressional agreement on comprehensive tax reform at some point effectively could reverse at least some of the IRS’s recent reconfirmations of nontraditional asset categories qualifying for REIT treatment.

Indeed, retiring U.S. House Ways & Means Committee chairman Dave Camp developed an extensive proposed overhaul of the federal tax code in recent years, which had come to include provisions restricting the definition of real property qualifying for REIT status to asset classes for which the current tax code allows depreciation lives of 27.5 years or longer.

That would tend to exclude billboards, cell towers and data centers from the qualifying real property definition; a separate provision would exclude timber and timberlands.

Although the moderate Republican’s own party has declined to take up Camp’s proposal, Brause and Miller “suspect future fundamental corporate tax reform may include similar proposals.”

As apparently will be the case with so many other aspects of the rapidly evolving REIT universe — only time will tell.

Brad Berton is a freelance writer based in Portland, Ore.

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realAssets Adviser | JANUARY 2015

[ Mary Adams

Hugh Kelly

Executive Director Defined Contribution Real Estate Council

Clinical Professor of Real Estate NYU Schack Institute

Norm Boone

President TIGER 21

Founder & President Mosaic Financial Partners

Brad Briner Director of Real Assets Willett Advisors LLC

Victor Calanog Vice President, Research and Economics Reis

Ron Carson Founder Carson Wealth Management

Sam Chandan President and Chief Economist Chandan Economics

Merrie Frankel Vice President, Sr. Credit Officer Moody’s Investors Service

Steve Gruber Managing Director Real Asset Portfolio Management

John P. Harrison Executive Director and CEO Alternative & Direct Investment Securities Association (ADISA)

Kevin Hogan President Investment Program Association

Julianna Ingersoll Director and CFO, RREEF Property Trust Deutsche Asset & Wealth Management

Sameer Jain Chief Economist & Managing Director American Realty Capital

Melissa Joy Partner, Director of Wealth Management Center for Financial Planning, Inc.

realAssets Adviser | January JANUARY 2015

editorial board

]

Jonathan Kempner

Vee Kimbrell Managing Partner Blue Vault Partners

David Lynn Co-Founder and CEO Everest High Income Property

Asieh Mansour Senior Advisor The Townsend Group

Gloria Nelund Chairman and CEO TriLinc Global, LLC

Martha Peyton Head of Research and Strategy TIAA-CREF

Stacy Schaus Executive Vice President PIMCO Defined Contribution Practice

Charles Schreiber Chairman & CEO KBS Realty Advisors

Amy Tait Chairman, CEO & President Broadstone Real Estate LLC

Michael Underhill Chief Investment Officer Capital Innovations LLC

Steven Wechsler CEO National Association of Real Estate Investment Trusts (NAREIT)

Robert White President Real Capital Analytics

Richard C. Wilson CEO & Founder Family Offices Group

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Revisiting the Value of Commodities Diversification benefits outweigh the sector’s recent lackluster results.

L

et’s face it: Commodities are out of favor. After a lackluster 2013, commodities (represented by the Bloomberg Commodity Index) continued their slide in 2014 — down –11.83 percent in the third quarter and down –8.68 percent for the year to date ending Oct. 31, 2014.

It is in times like these when investors might begin to reconsider why they hold a commodity allocation at all. In fact, many do abandon ship during an asset class’s darkest days and, unfortunately, this may result in the dreaded “selling low and buying high” syndrome that we humans are so good at!

Instead, I suggest we revisit the value of having — and keeping — a strategic allocation to commodities as part of a well-diversified portfolio. After all, in

Bloomberg Commodity Index Other Agriculture

Natural Gas

Wheat

LOW CORRELATION Commodities have not always been the black sheep of asset classes. In the year 2000 while we were all adjusting to the fact that the world did not end with Y2K, the Bloomberg Commodity Index returned a strong 31.84 percent, whereas the Russell 1000 Index was down –7.79 percent. Even a small exposure to commodities could have helped to offset the U.S. large cap equity losses.

Turns out, although the scenario from 2000 does not always play out that way — with commodities beating U.S. equities — historically commodities often have moved in a different direction from equities.

WTI Crude Oil

Live Cattle Sugar Coffee

Energy

Agriculture

31%

34%

Soybeans Metals

35%

Corn Zinc

Gold

Nickel Silver Aluminum

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most cases an investment in commodities is not a short-term tactical move but rather part of a long-term strategic allocation based on the principles of diversification and the long-term benefits commodities can provide.

A GLOBAL BASKET Another potential diversification benefit of commodities Brent Crude is that they are global: The performance of a basket of Heating Oil commodities historically has not necessarily tied to the Unleaded Gas economic or political conditions of any one country.

Of course, the performance of some individual commodities is more closely tied to a specific

By Noah Schmidt

country than others, but in aggregate, across the broad range of commodities, the returns have been less likely to be severely impacted by a single country crisis than you may think.

MORE THAN OIL AND GOLD Investors are reminded on a daily basis of how the price of oil or demand for gold is moving. But a diversified commodities portfolio can be composed of more than just oil and gold. For example, the Bloomberg Commodity Index tracks the price of commodities such as agriculture (e.g., soybeans, coffee, sugar), energy (e.g., natural gas, brent crude, unleaded gas) and metals (e.g., copper, silver, nickel).

THE BOTTOM LINE Wouldn’t it be nice to be able to time movements in and out of asset classes perfectly so that your clients only hold those assets that are rising and can sell them just before they decline?

Alas, that is simply not possible. And that is why diversification can be a long-term investor’s — and adviser’s — ally. A diversified portfolio composed of asset classes with different return patterns can help weather the inevitable ups and downs of the market — and can help your clients stick to their long-term plans.

Noah Schmidt is a consulting analyst for Russell Investment’s U.S. advisersold business.

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