N o v e m b e r 2 0 1 4 | 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 .
Time
Tested Fee-only adviser Norman Boone has a mission: To lead by example in coaching the profession to the next level
Adopting Alts
Alternatives are hot, and real assets are the main beneficiary
Paying the Toll
Toll road investors are driving back into the fast lane
Core Assets Why it’s good to own oil and gas producing assets
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.
Contents 34
November 2014 VOLUME 1 | NUMBER 2
features
34 | Time Tested
Norman Boone has seen much in his 20+ years as an RIA, and with $625 million in AUM under his wing, he is keen on coaching the profession to the next level. By Ben Johnson
40 | Adopting Alts
Investors and their advisers are diving deeper into alternatives, and real assets is the beneficiary of this movement. By Jennifer Popovec
46 | Back in the Fast Lane
Toll road investors have traveled a rocky road of late, but experts believe the future holds promise. By Denise DeChaine
40
46
52 | Core Assets
With energy demand on a continued growth trajectory, here is why it is good to own oil and gas producing assets. By Paul Anthony Thomas
52
On The Cover Norman Boone imparts his wisdom about the advisory profession after two decades of serving investment clients as an RIA. Photo Credit: James Brian Fidelibus
realAssets Adviser | November 2014
1
Contents
November 2014
reala s s e t s a d vi s er . com
News & views
26
28
30
32
Real Estate
Infrastructure
Energy
Commodities
26 | Blackstone Sells Huge private equity firm sells core Boston asset
28 | Survey Says Global investors commit more to infrastructure
30 | Gas Drops Pump prices to hit four-year low by year’s end
32 | Aussies Grab Ag Global funds target agriculture Down Under
27 | CalPERS Commits Pension fund budgets $5.4B for real assets
29 | M&A Recovery Global activity expands with economic recovery
31 | Clean Returns Clean energy index returns 11.63% in one year
33 | Timber Deals Grow Timber firms gear up acquisition programs
27 | Storage Performs Self-storage REITs beat REIT equity index
29 | Travel Diary Tales of roads, rockets and Russians
31 | Climate Summit Institutions commit to decarbonize by $100B
33 | China Hits Gold Shanghai launches exchange for foreign investment
26 | Office Investors Return Economic growth is driving demand for properties
28 | Meeting the Prez Institutional investors gather at White House summit
30 | Oil Demand Slides Behind the remarkable drop in oil demand
Coming Next Month
departments
4 | Notes & Trends
17 | The Big Picture
56 | Ad Index
8 | Contributors
22 | Up Front
60 | Editorial Board
24 | people
64 | Last Word
13 | Market View
32 | Gold Dips Prices drop below $1,200 in major sell-off
ead what top R advisers are predicting for real assets in our 2015 forecast.
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 2014. All rights reserved. Printed in the USA.
2
realAssets Adviser | November 2014
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
[
notes & trends
By Ben Johnson Managing Director, Editor-in-Chief Real Assets Adviser
]
An Ode to Ostrich Farms and Llama Ranches: R.I.P.
History must be our greatest teacher when it comes to the viability of today’s alternative investments.
I
t startles me every time I see it or think about it. No, not the daily rollercoaster ride otherwise known as the stock market. Specifically I mean my still-pristine copy of the March 1983 issue of National Tax Shelter Digest. Waaaaay back in the day, I was just starting out in the world of business journalism as a lowly associate editor of this esteemed publication, for all of about a year as I recall. Raise your hand if you remember — or have at least read about — the go-go 1980s and the era of “if it moves, we can turn it into a limited partnership.” Today’s generation might opine something to the effect of “LOL” and “OMG” at the notion, but back then, the investment world was testing itself, as well as the bounds of financial regulation. It wasn’t rocket science. It wasn’t even sane
The really good news about today’s investing environment is the prevalence of continued skepticism, and questioning. (upon hindsight). It was often nothing more than a tax shelter dodge/frenzy. Oh, the times they were a-different. Consider that in the early Reagan years, the U.S. economy
4
was mired in a deep recession, and the Penn Square Bank collapse sent shockwaves through the global financial system. The mid- to late1980s recovery and resulting economic hubris spawned Bonfire of the Vanities and the savings and loan crisis later in the decade. Investors were rightly concerned about the future and diversification was a primary mandate. In general, the financial planning ethos was something akin to hiding as much money from the federal government as possible, legally, of course, thanks to a few nifty loopholes crafted into U.S. tax code legislation. That all came to a screeching halt in the mid-1980s, thanks to the passage of the Tax Equity and Fiscal Responsibility Act, famously known as TEFRA. That was followed by the Tax Reform Act of 1986, which formally eliminated tax shelters. So the days of wine, roses and thoroughbred fractional interests came to an abrupt end. While the months and years following TEFRA’s wrath saw a once strong economy fall into yet another recession in 1990-1991, it actually brought about much-needed change. In other words, depending on your perspective, we are all better off for it. The thing is, I look back now and cringe, not because it seems as though 30 years has passed in the blink of an eye (it has), but because I cannot believe there were so many unscrupulous operators that survived for so long. There is only one reasonrealAssets Adviser | November 2014
There’s more than one road to prosperity. Broadstone Real Estate offers real estate investment options for yield-driven advisers and accredited investors seeking an alternative to the public markets. Visit Broadstone.com/RAA to download an investor kit.
[
notes & trends
] A publication of Institutional
| History
is a great teacher, and we learned a lot from the track record of LPs in the 1980s.
able explanation for that: There was a general lack of good old-fashioned skepticism at a time when it was needed most. I have always believed that history is the best teacher, and given the track record of those early-day LP structures, today’s investment advisers and their clients are rightly a bit skeptical when it comes to any investment avenue that strays from Main Street stocks and bonds. Skepticism is most often a good thing, especially when it is in the name of safeguarding the future of one’s finances. I don’t have to “sell” the merits of real assets. As with any asset class, there are winners and, unfortunately, there are also losers. You really can’t have one without the other in this world, and one makes the other stronger, hopefully, over time. Our job at Real Assets Adviser is to vet the programs that make sense for investors of differing investment parameters and time horizons. That is to say, are all nontraded REITs bad? Not quite, but sometimes the products are painted with the same negative brush. Ultimately, real assets are just that, they are “real.” They are tangible. And yet they come in many forms, be it real estate, infrastructure, energy or commodities. For some investors, real assets come in the form of a direct investment in a shopping center that they can actually see and touch. For other investors, it means owning a share of a regional mall through shares in a publicly traded retail REIT. Or units in an energy MLP managing wells scattered across the fertile oil fields of West Texas. Or shares of a mutual fund or ETF invested in infrastructure developments. The really good news about today’s investing environment is the prevalence of continued skepticism, and questioning. “Is it safe?” is not only the wise investor’s mantra, it is a phrase that represents how we view the landscape, and we hope we are able to impart that view in the pages of this magazine every month.
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 Contributing Editors Drew Campbell Loretta Clodfelter Reg Clodfelter Mike Consol Denise DeChaine Richard Fleming Jennifer Molloy Andrea Waitrovich vice president, marketing Sandy Terranova marketing & client services Suzanne Chaix Elaine Daniels
Ultimately, real assets are
Karen McLean
just that, they are ‘real.’
Michelle Tiziani
Brigite Thompson Caterina Torres SPONSOR SERVICES Wendy Chen Salika Khizer DATA SERVICES MANAGER Ashlee Lambrix DATA SERVICES Justin Galicia Derek Hellender Karen Palma Administration Andrew Dohrmann
On Twitter: @RealAssetsAdv or @Bjohn9
6
Jennifer Guerrero
realAssets Adviser | November 2014
Real Assets, Real Diversification,
Real Yield
SM
Follow the Corridor www.corridortrust.com
Corridor is a Montage Investments manager
[
contributors
] Jennifer Duell Popovec Adopting Alts (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 a 1,000 bylines to her credit and lives in Fort Worth.
Stacy Schaus Inflation-Hedging Strategies (page 17) Stacy is executive vice president and leads PIMCO’s defined contribution practice. She has written extensively on defined contribution issues, including her 2010 book, Designing Successful Target-Date Strategies for Defined Contribution Plans. Stacy is the founding chair for the Defined Contribution Institutional Investment Association.
ISSN 2328-8833 Institutional Real Estate, Inc. Vol. 1 No. 2 November 2014 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.
Kevin M. Hogan Non-listed REITS: The Evolution of Income (page 64) Kevin is president and CEO of the Investment Program Association. Previously he was senior vice president of product development and marketing for LPL Financial, where he was responsible for brokerage product sales and marketing including annuities, mutual funds, alternative investments, retirement plans and cash products.
CHANGE OF ADDRESS: Send address changes to Real Assets Adviser, 2274 Camino Ramon, San Ramon, CA 94583 USA.
Denise DeChaine Back in the Fast Lane (page 46) Denise is special projects editor at Institutional Real Estate, Inc., where she has spent the past four years expanding her knowledge of the infrastructure and real estate investment markets. In addition to her writing and editing projects, Denise directs IREI’s video platform, and has edited/produced more than 50 videos over the past two years.
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.
Copyright © 2014 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
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
Abigail McCarthy REITs Can Provide Real Diversification (page 20) Abigail is vice president, investment affairs and investor education for NAREIT working with financial intermediaries and individual investors. She also oversees the partnership between NAREIT and FTSE for the FTSE NAREIT U.S. Real Estate Indexes and is the liaison between FTSE, EPRA and NAREIT for the FTSE EPRA/NAREIT Global Real Estate Index.
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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 | November 2014
Opening
VIEW
10
realAssets Adviser | November 2014
Riding High
realAssets Adviser | November 2014
New York City is officially the hottest real estate investment market in the U.S., with sky-high rents and building sales showing no signs of decelerating.
11
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[
‘Fit’ Is Equal to Valuation in Business Sales
Market View
]
By Richard C. Wilson
Selling a family business involves many facets of the human experience during the transaction process.
W
hen evaluating the merits of a proposed business sale transaction, it is unfortunate how often analysts, dealmakers and investment bankers discount the importance of cultural and personal fit, especially one that requires the approval of a founder. Founders are very protective of their businesses and often spurn economically attractive offers for reasons beyond valuation. Would-be buyers need to make a strong case that a deal is in the best interest of the owner’s family and/or the company’s long-term viability. Companies that are controlled or managed by the original founders or descendants of the founder are especially in need of persuasion, and there is likely to be an inherent skepticism of any offer, especially an unsolicited one. Even in the corporate arena, unsolicited bids and even competitive auctions may be rebuffed for factors other than the offer price. For example, Yahoo and Microsoft did not merge largely because Yahoo founder Jerry Yang refused, and Microsoft’s Steve Ballmer’s aggressive pursuit of the target failed to win support from Yang, Yahoo board members or shareholders at large. Considering that Microsoft’s 2008 offer represented a 61 percent premium over Yahoo’s then share price, it is hard not to assume that personal reluctance by Yang to sell factored into the rejection of the bid. Ultimately, Yahoo rebuffed the offer because Yang and his board believed they would be better off going it alone, rather than merging with
realAssets Adviser | November 2014
Microsoft — although it is worth noting that Yahoo made overtures subsequently to invite a second offer from Microsoft. Jerry Yang was pilloried for refusing to take the deal at the time, but given that Yahoo’s share price has surpassed the Microsoft offer, there may be some merit to Yang’s insistence that Microsoft was undervaluing the company he created. Regardless, the technology would certainly be different if Ballmer’s Microsoft had successfully managed to entice Yahoo and its board and relieve their reservations over the deal. In smaller, more personal deals, where a founder is still actively managing or at least overseeing the company, buyers and sellers face less public scrutiny and
There are countless stories of founders who sold the family business under structures that were inefficient for the sellers. pressure than in large corporate mergers. This places the emphasis on executive-to-executive communication, rather than public overtures such as the poison pen or a public plea on CNBC. In these more private interactions, the buyer has the opportunity to clearly make its case for an acquisi-
13
[
Market View
]
tion. There is a great deal of attention paid to cost savings, synergy, growth and the EBITDA multiple offered, but these factors are only part of the puzzle. Many executives prioritize other considerations that an investment banker or private equity executive might overlook or at least discount in favor of financial terms. These issues include: Family Members and Potential Succession: An unsolicited bid may take a private business’s founder by surprise and disrupt succession plans that have been in the works for years, even decades. Buyers who ignore the family’s history and long-laid future plans will face an uphill challenge in completing the deal, as family members with expectations of running the company will work against the deal. Successful buyers go to great lengths to assuage concerns that the family will be completely removed from the company and may offer to include family members in the company’s executive management or board.
Buying and selling a business is about more than EBITDA multiples, aftertax proceeds and other financial considerations. Future Planning: There are countless stories of founders who sold the family business under structures that were inefficient for the sellers. Many founders are wary of a sale because they want to avoid huge, unexpected tax bills; inadequate wealth for the family’s long-term needs; a mistimed sale; undervaluing the company; and other mistakes. A founder is usually the patriarch or matriarch of the family and feels responsible for ensuring that immediate family members and future generations benefit from the transaction to the greatest degree possible. The best investors I know have a gift for structuring deals carefully with full consideration
14
of the family’s concerns and even future generations. If there is any doubt whether the deal may expose the family to a surprise tax penalty, cut the family out of future gains or undervalue the company in any way, the owner will likely lose sleep until he or she ultimately nixes the deal. “Giving Your Daughter Away”: The founder of a food business compared the experience of selling his company to giving his daughter away. He felt uncomfortable parting with the company because he had invested significant time and energy into building it. In some ways, the company represented his life’s work, and he wanted to make sure that even if he sold his interest, the next owner would be just as passionate about the business. This may seem odd if an owner has sold his entire stake in the company, but many employees stay on through the deal, the founder’s name may still hang on the door, and there are a number of ties binding the founder to the business even after a sale. Buyers should keep in mind the personal attachment felt by an owner and take care to assuage any concerns about how the company would be managed post-closing. A “Perfect Fit”: Many founders are waiting for a successor, whether in the family or from outside it, who shares their ambitions and vision for the company. Too many owners are left waiting for decades before the perfect fit comes along. Ideally, the successor is within the family, but often the offer comes from a rival, an investor or an entrepreneur looking to carry on the owner’s legacy. Many times owners have said they would be willing to take less from an acquirer that was the perfect match over a higher bid from a less suitable buyer. It can be hard to build rapport with an owner, but great investors will go to exceptional lengths to visit with the owner, share their personal stories and demonstrate why they would be great candidates to buy the business. In the end, buying and selling a business is about more than EBITDA multiples, after-tax proceeds and other financial considerations. Any deal involving an owner or committed management team is about the legacy of the business, the years of personal investment in building the company and the continuation of that tradition under new ownership. Richard C. Wilson is founder of Family Offices Group and CEO of Single Family Office Advisors, Billionaire Family Office and Family Office Executive Search. realAssets Adviser | November 2014
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
www.IPA.com
Covering the institutional real estate industry for more than 25 years. The Institutional Real Estate Letter — Americas
InstItutIonal Real estate letteR THE
AMERICAS
Climate change at land’s end Real estate investors like targeting coastal cities, but so does a seething Mother Nature
October 2014 Institutional Real Estate, Inc. www.irei.com
The Institutional Real Estate Letter – Americas is IREI’s flagship publication and has been around for more than 25 years. It has stood the test of time and continues to be the must-read publication for gaining insights, news and data on the institutional real estate marketplace. Although written for institutional investors, by reading it investment advisers get a true, deeper understanding of how investors are thinking, strategizing and planning. Try it out for FREE at www.irei.com/tirelam_trial. Your trial includes: • The next 2 issues of The Institutional Real Estate Letter – Americas • 24/7 access to all of our back issues on our website • Access to our publication app, which is available in the Apple iTunes App Store and Google Play, so you can read issues on your tablet or smartphone.
INSTITUTIONAL REAL ESTATE, INC.
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people data insights
[
Designing DC Menus with Inflation-Hedging Strategies
The Big Picture
]
By Stacy Schaus
While inflation may be tame in today’s environment, inflation hedging remains a priority for retirees.
I
n 1978, when then-candidate Ronald Reagan likened inflation to a mugger, it struck a nerve. Inflation was running at a 9 percent annual clip, on its way to nearly 15 percent two years later. Inflation was a harsh reality. Today, inflation is tame, and the voices of monetary hawks have been drowned out. Nonetheless, when it comes to investing for retirement, consultants concur: Inflation is one of the greatest risks, and inflation-fighting assets should be part of retirement portfolios. Although inflation may seem a distant threat, we believe inflation-fighting assets are critical to defined contribution (DC) plan portfolios because inflation often strikes without warning. Moreover, for retirees who often depend on income that does not adjust with inflation, even relatively tame inflation can be devastating. Consider that after 20 years of 3 percent annual inflation, $50,000 in retirement income would buy only about $27,000 worth of goods and services; with 5 percent inflation, the value shrivels to only about $18,000. This helps explain why 89 percent of respondents to the 2014 PIMCO DC Consulting Support and Trends Survey support offering an inflation-hedging choice in a DC plan’s core investment menu. Inflation-fighting asset classes can help portfolios in other ways, too: They may diversify risk from traditional stocks and bonds, reduce portfolio volatility and mitigate downside risk.
realAssets Adviser | November 2014
CONSULTANTS FAVOR COMMODITIES, TIPS, REITS For core menus, a majority of consultants polled by PIMCO suggest the addition of a multi-real-asset blend. The blend may include commodities, Treasury Inflation-Protected Securities (TIPS) and real estate investment trusts (REITs), which consultants view as most valuable in fighting inflation. Less than half advocate adding discrete inflation-hedging asset classes to core menus. Notably, more than a quarter of the consultants (27 percent) suggest a global tactical asset allocation strategy that combines both real and nominal assets; this strategy might also state an outcome objective or secondary benchmark (e.g., CPI plus 5 percent). The chart on page 18 shows the inflation-fighting asset classes that consultants most favored in core lineups.
When it comes to fighting inflation, a multi-pronged approach may be best. IMPLEMENTATION CHALLENGES Regrettably, adding inflation-hedging assets to DC menus is a potentially complex challenge, one that requires thoughtful analysis and preparation. For one, individual inflation-fighting assets respond
17
[
The Big Picture
]
Consultant support for inflation-fighting assets Multi-real-assets
60%
TIPS
40%
REITs
31%
Global tactical asset allocation
27%
Commodities
4%
Natural resource equities
4%
Private real estate
4%
Infrastructure
2% 0%
Currencies 0%
As of December 2013 Source: 2014 PIMCO DC Consulting Support and Trends Survey
10%
20%
30%
40%
50%
60%
70%
to inflation in different ways. Then there is the “1 over n,” or naïve diversification, problem — i.e., the tendency of DC participants to allocate their assets evenly among fund choices. Broadly speaking, we suggest offering a balanced menu of investment choices designed to boost the odds that participants create reasonably balanced portfolios even when blindly allocating equal sums across menu options. Before plan sponsors can responsibly add inflation-fighting assets to core menus or target-date strategies, however, we believe that measures such as inflation beta, equity correlation, volatility and downside risk need to be evaluated. EVALUATING REAL ASSET STRATEGIES Let’s take a look at how inflation-hedging asset classes and blends perform against these measures: • Inflation Beta: We believe asset prices are much more sensitive to inflation surprises than actual levels of inflation; i.e., investors react strongly when outcomes differ from expectations. Historically, inflation spikes have occurred quickly and unexpectedly. Therefore, we believe the most important factor for DC participants in selecting a real asset is its sensitivity to inflation surprises. Asset classes with a positive beta to inflation surprises have historically tended to perform well, thus preserving purchasing power, during inflationary market environments. The inflation beta of a stock/bond portfolio (composed 70 percent of the MSCI World Index and 30 percent of the BAGG) was –2.07 as of March 31, 2014. By contrast, all of the asset types and blends except for infrastructure showed a higher inflation beta. Commodities, gold and natural resource equi-
18
ties stood out with the highest inflation betas. •E quity Correlation: To reap the potential diversification benefits of real assets, each asset type and blend should be evaluated for its correlation to equities. Viewed through this lens, the stock/bond portfolio shows a tight correlation, 0.95, to the S&P 500 Index, while other assets or combinations show lower correlations (thus offering improved diversification potential). Assets with the lowest correlations include TIPS, gold and other commodities. • Volatility: Selecting an individual asset class or blend with relatively low volatility is important to lessening the risk of participants selling out with a sudden shift in returns •D ownside Risk: Although there are many ways to measure tail risk, we suggest evaluating risk exposure by assessing Value-at-Risk (VaR) at a 95 percent confidence level (VaR estimates the minimum expected loss at a desired level of significance over 12 months). Applying this measure, we observe that the stock/bond portfolio has potential downside risk of –19.3 percent. Other asset types and blends may have less downside risk. TIPS, bank loans and the expanded multi-real-asset blend stand out again. COMPARING THE BLENDS By comparing asset classes across these metrics, when it comes to fighting inflation, a multi -pronged approach may be best. The consultants PIMCO polled are most supportive of adding multi-real-asset strategies to a DC plan’s core lineup. Relative to the stock/bond portfolio, both the multi-real-asset and expanded multi-real-asset blends offer inflation-hedging (positive inflation betas) and potential diversification benefits (i.e., equity correlations less than 1.0). What’s more, both blends show the potential for lower volatility and less risk of loss (measured by VaR) than the stock/bond portfolio. Whatever choices are made, selected assets or blends should be designed to deliver the primary benefits of inflation responsiveness, diversification relative to stocks, volatility reduction and downside risk mitigation. To deliver these and ward off the inflation robber baron, plan sponsors may find multi-real-asset blends attractive both as core options and as additions to asset allocation strategies such as target-date funds. Stacy Schaus is an executive vice president and leads PIMCO’s defined contribution practice. realAssets Adviser | November 2014
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IREINewsCloud.com is a hub for all of the news and content that IREI produces, aggregates and curates, including video, podcasts and newsfeeds. • Global coverage: Newsfeed segments include Americas, Asia Pacific, Europe, Dealmakers and Infrastructure. • The Home of IREN: IREI’s premium newswire, Institutional Real Estate Newsline (IREN) lives on IREINewsCloud. IREN produces only original stories, so if you are not reading IREN, you are missing some valuable news. • Videos/Podcasts: Conducted with industry experts, economists and futurists, you’ll be sure to hear some familiar voices. Download our IREINewsCloud media kit at www.irei.com/newscloudmediakit to view your advertising opportunities. Banner advertising space is available in a variety of price points to fit into your budget. Contact Jonathan A. Schein at j.schein@irei.com or Brigite Thompson at b.thompson@irei.com to discuss your banner ad schedule.
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people data insights
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The Big Picture
By Abigail McCarthy
]
REITs Can Provide Real Diversification
Today’s investors crave lower correlations to the U.S. stock markets, and REITs can fill the bill.
I
f you are reading this article, you are probably already researching ways to gain exposure to real assets to diversify client portfolios. Commercial real estate is a fundamental asset class that should be part of every investor’s portfolio, and stock exchange-listed equity REITs provide an effective and efficient way of achieving diversification to potentially increase long-term portfolio returns and reduce portfolio volatility through ownership of income-producing real estate. Perhaps unlike other real assets such as commodities, listed REITs are total return investments, providing a steady stream of dividend income and the potential for long-term capital appreciation. Equity REITs generate rental income from the tenants that occupy their real estate, and can also potentially produce gains from buying and selling assets over time. They are required by law to distribute at least
A critical question that arises is how much real estate is appropriate for investment portfolios based on years to retirement. 90 percent of their taxable income each year to their shareholders, and in practice many distribute 100 percent. Thus, REITs tend to be among those companies paying high dividends. For decades, defined benefit pension plans have been using real estate, including REITs, within their investment portfolios. “Fundamental asset classes such as equity, fixed income, cash and real estate...
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are the basic asset classes that must be held within a diversified portfolio,” says Mark Anson, former chief investment officer of the country’s largest public pension plan, writing in the Handbook of Alternative Assets. A critical question that arises is how much real estate is appropriate for investment portfolios based on years to retirement. Many investors believe that a reasonable portfolio allocation to equity REITs is between 5 percent and 10 percent. However, multiple studies from research firms such as Wilshire, Ibbotson and Morningstar have shown that the optimal portfolio allocation to listed equity REITs may be higher. For example, research by Wilshire on the role of real estate in target-date funds found that the optimal U.S. REIT allocation in a retirement savings portfolio was at 15.8 percent for an investor with a 40-year investment horizon, and then gradually declined as the investment horizon shortened, ultimately to 7.1 percent for an investor at retirement. The Wilshire portfolios would have produced an ending portfolio value nearly 10 percent higher than a portfolio without REITs over the 35-year period from 1976 through 2013. Optimal portfolio allocations to global REITs were found to be comparable. According to Wilshire’s calculations, a $10,000 initial portfolio using REITs in a target-date fund would have generated $415,335 in retirement savings over this period, or $41,492 more than a portfolio without REITs, while also reducing portfolio realAssets Adviser | November 2014
Wilshire Optimal Allocations of Listed U.S. Equity REITs based on years to retirement U.S. Bonds
Non-U.S. Dev’d Mkts
Non U.S. Bonds
Emg Mkts
Large Cap
U.S. REITs
Source: Wilshire, The Role of REITs and Listed Real Estate Securities in Target Date Fund Allocations
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
40 yrs
35 yrs
30 yrs
25 yrs
20 yrs
15 yrs
10 yrs
5 yrs
Years to retirement
risk. Cleo Chang, managing director and head of investment research for Wilshire Funds Management, who conducted the study, called REITs, “a triple play asset class, providing income, capital appreciation and inflation protection.” The dividend component of REIT returns accounts for the strong total return performance for most comparative periods compared with other stocks and bonds. And because rents tend to rise during periods of inflation, REIT dividends also tend to be protected from the long-term corrosive effect of rising prices. As a result, REITs have increased their dividends by more than the rate of inflation for 20 of the past 22 years. As of September 30, 2014, the dividend yield of the FTSE NAREIT All Equity REITs Index was 3.75 percent, or nearly double that of the S&P 500 Index. Some investors believe that since REITs are part of the stock market, you cannot truly achieve diversification with REITs as opposed to other real assets. It turns out that REITs are one segment of the stock market that provides dramatically lower correlations to the broader market over longer holding periods such as those of retirement savings. A NAREIT analysis using public market data to compute correlations for various industry sectors versus broad market benchmarks over 22 years found that REIT returns are very different from those of other sectors. For example, the correlation of listed equity REIT total returns (as measured by the FTSE NAREIT All Equity REITs Total Return Index) and the Dow Jones Total Stock Market Index was 66 percent over six-month investment horizons, but it fell to only 26 percent over 60-month periods. And for the S&P 500 Index, the correlation with REITs was only 20 percent over 60-month periods, making REITs a potentially beneficial asset for portfolio diversification for investors with longer-term horizons. realAssets Adviser | November 2014
0 yrs
5 yrs
10 yrs
15 yrs
Years in retirement
Finally, REITs as real estate companies are tied to the commercial real estate cycle, which by its nature is long term, lasting up to 18 years on average. Although it is well known that far too many housing units were built in the U.S. leading up to the 2008 financial crisis, it is less widely recognized that commercial property markets did not experience a construction boom; rather, commercial real estate markets remained in balance throughout the biggest real estate bubble in the U.S. since the 1920s. There is evidence to suggest that REITs have provided stabilizing effects to the overall commercial real estate market. Research by Professor Tim Riddiough of the University of Wisconsin School of Business found that over the past two decades, the securitized U.S. commercial real estate market has become a model of a disciplined, well-functioning real estate market largely as a result of increased transparency, the requirement that REITs distribute most of their taxable income in the form of dividends and the disciplined use of scarce capital by listed equity REITs. This has moderated construction boom and bust tendencies and thus reined in
There is evidence to suggest that REITs have provided stabilizing effects to the overall commercial real estate market. the potential oversupply of properties — providing support to the durability of commercial real estate cycles and to REIT occupancy rates, rental income, and growth of dividends and total returns. Abigail McCarthy is vice president, investment affairs and investor education, at the National Association of Real Estate Investment Trusts.
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up front
MORNINGSTAR MOVES DOWNTOWN
MORE BILLIONAIRES ACROSS THE GLOBE
The investment researcher is pulling up its Midtown stakes for shiny new 4 World Trade Center in downtown New York City.
The number of global billionaires has grown to 2,325, or 7 percent, from June 2013 to June 2014, says a UBS survey.
REISA Becomes ADISA: What’s in a Name, Anyway?
FINRA in Hot Seat
Reflecting the broader change in the real assets marketplace, the former REISA (Real Estate Investment Securities Association), a leading trade association serving the alternative investment and securities industry, announced a new name change, to the Alternative and Direct Investment Securities Association (ADISA). Why the move? ADISA executive director/CEO, John Harrison told Real Assets Adviser that, “The change better reflects our organization’s mission and what we provide to the alternative investment industry. Our association represents thousands of individuals in alternative investments from all types and sectors, and we strive to provide the best education, networking and advocacy for these professionals.” The new name was unveiled at ADISA’s 2014 Annual Conference at Caesars Palace in Las Vegas, attended by nearly 1,000 alternative investment professionals and more than 70 exhibitors. ADISA’s membership and events have grown by more than 20 percent in the past two years, according to ADISA staff. ADISA was founded in 2003 as TICA, but the organization grew beyond a single investment product type (tenant-in-common programs) to broader real estate-based products, and was given
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the name REISA. “REISA’s new name, ADISA, shows the evolution to handling even more areas of investment products,” says Harrison.
The biggest ADISA conference buzz surrounded the pending new rules created by the Financial Industry Regulatory Authority for nontraded REIT sponsors. Essentially, FINRA’s rule 2340 will force these sponsors to disclose all fees upfront on investor reports, as well as provide an independent valuation of portfolios within two years of the initial fund raise. This new level of transparency has incensed many broker-dealers. During one panel discussion, Tom Selman, executive vice present of regulatory policy and legal compliance officer with FINRA, was queried repeatedly about the need for such a rule and why it is being implemented. His reply was simple: “I appreciate your comments, but your issue is a non-starter. This is going to happen in all likelihood.” In other news, FINRA promoted Andrew Perkins as new chief hearing officer for disciplinary actions. He joined FINRA in 1996.
SEC Serves Notice ADISA influences more than 20,000 professionals who offer and manage alternative investments, such as nontraded REITs, private placement programs, oil and gas interests, securitized real estate investments, BDCs and more. Members include sponsors/issuers, broker-dealers, registered representatives, investment advisers, registered investment advisers, due diligence officers, accountants, mortgage bankers, institutional lenders and others.
Recent SEC crackdowns regarding compliance violations have many investment advisers on edge. Major firms, including Wells Fargo and Barclays Capital, have been grabbing headlines of late, thanks to fines and penalties levied in recent months. These cases reflect a more aggressive regulatory environment, as SEC examiners have put the industry on notice that they will not hesitate to take enforcement action against firms as well as individuals. With this in mind, advisers should seriously consider reviewing their compliance efforts, scheduling mock audits or discussing ongoing compliance support with consulting firms that specialize in the business. realAssets Adviser | November 2014
HARVARD REal estate STRATEGY PAYS OFF
TOP CITIES FOR MILLIONAIRES
The Harvard Management Co. endowment earned a 20.4 percent return from its direct real estate investment strategy in fiscal 2014.
Dallas tops the latest list of U.S. cities with the most millionaires, according to Capgemini and RBC Wealth Management.
Study: One-Third of Investors Need More Advice
FPA Elects President, Three Board Members
Results from a new Cerulli study of U.S. retail investors confirm what most advisers already know – there is increasing demand for their services. Here are a few key themes covered in the U.S. Retail Investor Products and Platforms 2014: Matching Product and Distribution Strategy to Client Demands study: • More than one-third of investors say they need more investment advice • Ensuring comfortable standard of living in retirement, protecting current wealth, and healthcare costs are top three investor concerns in 2014 • Nearly 50 percent of investors
cite cost of healthcare as largest economic concern • Trust in financial firms is at highest level since 2008 crisis • Willingness to pay for advice continues trend upward, nearly 50 percent agreement in 2014 • More than 50 percent of investors indicate they have a formal retirement income plan in place • Nearly 11 percent of all households’ financial assets, or roughly $3.4 trillion, are held in cash equivalents at a bank •R eferrals are the #1 reason clients begin a new relationship with their primary bank.
Households’ Asset Allocation Plans by Channel, 2014 Type of Channel Traditional Advisory Channel
Direct Channel
All Households
U.S. equities (stocks and stock mutual funds)
39%
42%
40%
Cash (checking, savings, money market, CDs)
23%
18%
21%
Real estate (commercial and residential)
13%
12%
13%
U.S. fixed Income (bond and bond mutual funds)
11%
11%
11%
Foreign/global equities (stocks and stock mutual funds)
6%
7%
6%
Collectibles
2%
2%
2%
Foreign/global fixed Income
2%
2%
2%
Commodities (precious metals, agriculture, energy, etc.)
2%
2%
2%
Alternative investments (hedge funds, private equity, managed future funds, etc.)
2%
2%
2%
Derivatives (options, futures, etc.)
1%
2%
1%
Asset Allocation
Sources: Phoenix Marketing International, Cerulli Associates
realAssets Adviser | November 2014
The Financial Planning Association elected Pamela Sandy, CFP as its 2015 president-elect for a one-year term, beginning on Jan. 1, 2015, succeeding incoming 2015 FPA President Edward W. Gjertsen II, CFP. Sandy has been providing financial advice to clients for nearly 25 years and is the founder and CEO of Cleveland-based CONFIANCE, LLC, a boutique advisory firm that offers financial planning and wealth management services to individuals across the country. FPA also elected three new members to its board of directors, each to serve a three-year term beginning Jan. 1, 2015: •C arol S. Craigie, MA, ChFC, CFP – associate professor at the College for Financial Planning in Centennial, Colo. Craigie has served in many national and local volunteer positions and is the current chair of board for the FPA of Colorado chapter. •C atherine M. Seeber, CFP – principal of Wescott Financial Advisory Group, LLC in Philadelphia. Seeber has served on several national committees and task forces and as past chair of the FPA of Philadelphia/Tri-State chapter. • J ack D. White, CFP – president of Fidelis Financial Planning, LLC in St. Charles, Mo. Besides serving on several national committees and task forces, White has been a longtime leader in the FPA of Greater St. Louis chapter. The 2015 Board will total 14 members, including the three newly elected members and FPA executive director/CEO Lauren M. Schadle, CAE.
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people
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CalPERS Names Ted Eliopoulos as Chief Investment Officer The California Public Employees’ Retirement System (CalPERS) has appointed Ted Eliopoulos as its new chief investment officer, permanently assuming responsibility for leading the investment office at the nation’s largest public pension fund. He currently serves as CalPERS’ interim chief investment officer. Eliopoulos takes over the position from the late Joe Dear and was previously the senior investment officer for real assets at CalPERS. “Ted distinguished himself during the selection process as the best candidate for this position,” says Rob Feckner, president of CalPERS’ board of administration. “He has the intellect, temperament, leadership ability and investment experience necessary to succeed in this position — qualities he has consistently demonstrated during
the past year in his role as interim CIO. I look forward to continue working with Ted in this role and congratulate him on this achievement.” As CIO, Eliopoulos will be responsible for managing an investment portfolio of approximately $300 billion and an office with nearly 400 professional staff. The CIO works closely with the CalPERS board of administration to determine prudent, forward-thinking investment strategies in accordance with CalPERS fiduciary responsibilities, policies, and corporate governance standards. “The CalPERS investment office has gone through a period of tremendous change and transformation in recent years,” says Henry Jones, board member and chair of CalPERS’ investment committee. “In addition to his remarkable talent, Ted will provide steady
leadership and bring further stability to the office, so he and his staff can focus on achieving long-term, risk-adjusted returns for our members.” Eliopoulos joined CalPERS in January 2007 as senior investment officer for real assets. In this position, he was responsible for investing in and managing all of CalPERS’ $26 billion in real asset investments, which include real estate, infrastructure and forestland. He was appointed as interim CIO in June 2013. Prior to joining CalPERS, Eliopoulos served in the California State Treasurer’s office as deputy treasurer and then chief deputy treasurer, from 2002 to 2006.
David Agnew has joined Macquarie Group’s Macquarie Infrastructure and Real Assets division as managing director, government affairs. Agnew previously served as White House director of intergovernmental affairs and deputy assistant to President Barack Obama. He is based in MIRA’s New York City office.
Nancy Brackmann has been appointed as a senior trust officer for U.S. Bank’s Private Client Reserve high-net-worth unit in Chicago. She was previously a vice president and fiduciary officer with JP Morgan Private Bank.
Gary Cindrich joined BNY Mellon Wealth Management as a wealth director for business development in the firm’s Pittsburgh office. Cindrich was previously partner and senior vice president of sales at Virtual Officeware, a medical software company he founded and sold.
Janessa Biller left Goldman Sachs to accept the role of vice president of relationship management at New York City–based independent advisory Dynasty Financial Partners. In other news, Kara Valentine is the new director of marketing at Dynasty; she joins the firm from U.S. Trust. Eric Blake joined Viewpoint Bank in Plano, Texas, as a financial adviser. He was previously a financial adviser with Allstate Financial. William L. Boatwright and Craig A. Diamond joined Wells Fargo at its branch in Woodland Hills, Calif. They were formerly with UBS and managed more than $259 million in client assets and a combined $1.6 million in production.
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Brian P. Brice and Timothy M. Brice have joined Morgan Stanley. Formerly with Merrill Lynch, their Brice Group has more than $4.5 billion in assets. Joining them are Rebecca Wolfe, vice president and group director; Ray Fortin, vice president and business development director; Stephanie Mills, institutional consulting associate; Diane Roegner, senior client service associate; and Julie Pawlowski, consulting group analyst. John Cadigan has been appointed head of national sales at Behringer, where he will direct the company’s sales organization offering specialized and alternative investments featuring closed-end funds and 1031 exchange programs.
Lee Dubinsky joined Wells Fargo Advisors in Melville, N.Y. He was previously with UBS, where he managed more than $140 million in client assets. Zeynep Fetvaci is joining Hodes Weill & Associates as principal. Fetvaci will be based in London and have responsibility for coverage of institutional investors in Europe. Previously, she served as head of business development and investor relations at Peakside Capital Advisors. Brian Gant is now vice president of asset management for Mesirow Financial’s institutional real estate direct investments business.
realAssets Adviser | November 2014
Steven Greene joined U.S. Bank’s Private Client Reserve high-net-worth unit as a wealth management adviser, based in Chicago. Previously, he was with Rappaport Reiches Capital Management, providing financial advisory services to high-networth individuals, families, foundations and non-profits. David Hein joined U.S. Bank as a portfolio manager for the Private Client Reserve high-net-worth wealth management unit in Cincinnati. He was previously an acquisition program manager with the United States Air Force. Thomas Hwang is now senior director of asset management at New York Life Real Estate Investors. Based in the firm’s San Francisco office, Hwang is responsible for running a portfolio of institutional assets throughout the western United States. He reports to David Cumming, head of asset management for the division’s Madison fund. Mary Jensen has joined Spirit Realty Capital as its vice president of investor relations, based in its Scottsdale, Ariz., headquarters. Jensen will report directly to Mike Bender, CFO of Spirit Realty Capital. Kristina Kazarian has joined Deutsche Bank as a director and lead research analyst covering the master limited partnerships and natural gas sectors within the bank’s markets division. She is based in New York and reports to Steve Pollard, head of research for the Americas. Craig Martucci and Todd Adams, cofounders of Martucci Adams Wealth Advisors, have joined Washington Wealth Management in San Diego with $220 million in assets under management. They were formerly with RBC Wealth Management. Washington Wealth now has $1 billion in assets under management. Diane Peterson McNeal has been named senior private banker with Wilmington Trust. Prior to joining Wilmington, McNeal was the alternate group manager for Florida Private Banking for Comerica Wealth Management. Jon M. Miller and Douglas A. Kunzman left UBS to join Wells Fargo with a combined $410 million in assets under management. They are joined by senior registered client associate Tracie Beck, also from UBS. realAssets Adviser | November 2014
Debora Oberling joined U.S. Bank’s Private Client Reserve high-net-worth unit in Chicago as team leader in wealth management advisory. Previously, she was a managing director and market manager for JP Morgan Private Bank.
Adam Sumrall and Kevin Watson have joined Legacy Capital Co. as vice president and executive vice president, respectively. They will assist founder Steve Saxon and principal partner Peter Aberg to identify and source new investment opportunities.
John Patrick joined Countybank in Greenwood, S.C., as a financial adviser. He was previously vice president of Park Sterling Wealth Management at Park Sterling Bank.
Sarah Tiedt, Mark Vlasic and Jeff Maher have joined Mariner Wealth Advisors as senior wealth advisers. Previously, Tiedt was with the Private Client Reserve of U.S. Bank, Vlasic was a director at McGladrey Wealth Management and Maher was a regional director with MFS Fund Distributors.
William Peragine and John Biondo joined Wells Fargo Advisors in Melville, N.Y. They most recently managed more than $830 million in combined client assets at Morgan Stanley. Laura Peterson joined Ascent Private Capital Management, the ultra-high-networth wealth management unit of U.S. Bank, as managing director of Client Experience in Denver. Peterson was with Citi Private Bank. Charles “Chip” Pisoni Jr. has joined RBC Wealth Management as a senior vice president and financial adviser in its Scottsdale, Ariz., office. He brings assets under management of more than $250 million and $1.5 million in production. Debbie Papa has also joined the firm as a senior client associate. Both were previously with Merrill Lynch. Steven Reed has joined MVP REIT as president. He was formerly product manager at ARC Realty Finance Trust and was with NorthStar Realty Securities as divisional vice president. William Rhind has joined World Gold Trust Services, a wholly-owned subsidiary of the World Gold Council, as its chief executive officer. James J. Ryan has been appointed head of national accounts at Behringer. Previously, Ryan spent three years as managing director and national accounts director in the RIA and independent channels for Invesco Ltd. Teresa Seiwert was appointed as a wealth management adviser at U.S. Bank, where she was the former vice president and private client relationship manager. She is based in Chicago.
Michael Weil, RCS Capital Corp.’s president, has been appointed chief executive officer, effective immediately, succeeding William M. Kahane. Weil will be responsible for developing and implementing RCAP’s strategic vision and overseeing the execution of RCAP’s business plan. Kahane will remain a director of RCAP. In other news, Bill Dwyer has been appointed CEO of Realty Capital Securities, an operating division of RCAP. Dwyer will be responsible for overseeing the development and execution of RCAP’s wholesale distribution strategic plan. Prior to joining RCAP, Dwyer enjoyed a 20-year tenure at LPL Financial where most recently he served as president of LPL Financial Independent Advisor Services. Additionally, John H. Grady has been appointed chief strategy and risk officer of RCAP. Grady will be responsible for developing and implementing important strategic initiatives across the RCAP platform. He will also oversee the risk functions associated with the retail and wholesale distribution businesses and supervise all compliance and risk management programs across the business. Grady previously held various executive management positions at RCAP and AR Capital LLC. Sanjay Yodh has been appointed executive vice president of RCAP liquid alternative investments where he will be responsible for overseeing RCAP’s liquid alternative sales strategy. Prior to his role at RCAP, Yodh was head of institutional sales at ProShares. Christopher White and Joshua Zierten have joined Veritas Investments to lead acquisitions and financings for the firm. White was most recently at Stockbridge Capital. Zierten was formerly with W. P. Carey.
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R ea l E stat e news
Investors Return to Office Market as Leasing Activity Increases
W
ith markets across the country continuing to recover and positive economic momentum picking up steam, corporate confidence has been increasing and higher levels of hiring occurring, according to a third quarter U.S. office sentiment survey conducted by JLL. Creative space, amenities and density are driving leasing activity. Respondents to the survey stated that 35 percent of the markets during the third quarter were driven by growth. But 99 percent of markets indicate a preference for higher den-
sity overall companies. And the preference for creative space is leading landlords to make capital improvements to buildings and build out spec suites. Amenities and collaborative workspace are top tenant preferences. For example, in Boston, where the technology demand is strong, businesses want a working environment that is flexible to personal and business needs, creating a home away from home. The increased leasing momentum and tighter fundamentals helped boost sales
activity, but markets such as Long Island, N.Y., San Francisco and Tysons Corner, Va., are seeing fewer assets come to market. In approximately 70 percent of the markets surveyed, the increased capital is flowing to core suburbs, followed by core CBDs (43 percent of respondents), a shift from recent quarters where CBD activity dominated. Institutional investors have dominated the sales market, followed by developers, while foreign buyers dominate the gateway markets.
Inland Real Estate Corp. Transactions Total $1.4B Two real estate investment trusts of Inland Real Estate Corp. are shedding assets and inheriting more. In September, the REITs completed deals totaling more than $1.4 billion in assets One transaction was a portfolio comprising 52 upscale extended-stay and selectservice hotels with approximately 7,000 rooms. It sold for $1.1 billion. The seller was Inland American Real Estate Trust, and the buyer was a joint venture between NorthStar Realty Finance Corp. and Chatham Lodging Trust. NorthStar will have an approximate 90 percent ownership interest in the portfolio, and Chatham will own an approximate 10 percent minority interest. The portfolio transaction is expected to close in the fourth quarter of 2014. NorthStar has been an active buyer. In August, the firm agreed to acquire Griffin-American Healthcare REIT II in a cashand-stock deal valued at about $4 billion.
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Blackstone Sells Another Boston Asset The Blackstone Group has sold 100 High St., a trophy-quality, 28-story office building located in Boston’s Financial District. The new owner is a fund sponsored by CBRE Global Investors. Real Capital Analytics confirmed the sales price as $282.5 million. The 546,336-square-foot property is 64 percent leased to tenants including technology companies, law firms and insurance companies with long-term leases. The acquisition also includes a 273-space three-level on-site subterranean parking garage. CBRE Global Investors plans to upgrade building systems and add its signature 5-Star
Worldwide service and amenity program, including conference facilities and outdoor meeting areas. The sale follows Blackstone’s disposition in May of five Boston-area high-rise office towers to a venture led by Oxford Properties Group, the property investment arm of the Ontario Municipal Employees Retirement System, for approximately $2.1 billion. Also earlier this year, Blackstone sold Rowers Wharf, a mixed-use asset with 345,000 square feet of class A office space, a 230room four-star hotel, 100 luxury condominiums and marine facilities. realAssets Adviser | November 2014
Four Self-Storage REITs Trade at High Multiples Self-storage REITs were trading at the highest price-to-FFO multiple of all REIT sectors as of Sept. 10, at 22.1x — higher than the SNL U.S. REIT Equity index price-to-FFO multiple of 19.1x, according to data collected by SNL. For the one-year period ended Sept. 10, U.S. self-storage REITs posted a total return of 15.1 percent, which lagged behind the SNL U.S. REIT Equity index and the S&P 500 Index by 4.3 percentage points and 5.9 percentage points, respectively. For the five-year total return, all four SNL-covered public self-storage REITs were among the 25 U.S. REITs with the strongest results. Extra Space Storage posted the highest total return at 522.4 percent, followed by CubeSmart, which recorded a five-year return of 236.9 percent.
California has the largest number of publicly traded self-storage REIT properties, at 644 as of Sept. 10. Texas has the second-largest exposure to self-storage properties, with a total of 493 storage properties. According to SNL, since 2004, the four publicly traded self-storage REITs have added 1,944 storage properties and about 140 million square feet, despite the economic turmoil of the recession.
CalPERS Commits $5.4B to Real Assets Apple REIT Closes Fund With $1.05B, Enters Energy Sector Apple REIT Ten raised $1.05 billion and closed the fund to new investors in August. The fund, which is part of the Apple REIT Cos., began selling shares to investors at $10.50 to $11 per share in 2011. It went on to sell more than 90 million shares. Apple REIT Ten has four hotels under contract that are currently under construction. The company anticipates it will close on the acquisition of these properties during the next 12 to 18 months. Apple REIT also moved into the oil and gas business, investing $100 million in Cripple Creek Energy. As of July 31, 2014, the Apple REIT Ten real estate portfolio included 49 Marriottand Hilton-branded upscale extended-stay, select-service and full-service hotels, with an aggregate of 6,188 rooms, diversified across markets within 17 states. Earlier this year it consolidated three of its previously closed funds into one new entity, known as Apple Hospitality REIT. As of June 30, the company owned 188 hotels (of which 99 were acquired with the Apple Seven and Apple Eight mergers, effective March 1, 2014). realAssets Adviser | November 2014
America’s largest pension fund, the California Public Employees’ Retirement System, has budgeted up to $5.4 billion for real assets investments for fiscal year 2015. The large real assets budget comes on the heels of CalPERS’ September decision to exit its entire $4 billion hedge fund portfolio. By property type, the multifamily sector has the highest allocation, $1.8 billion. The retail sector was not far behind with a $1.4 billion allocation, and logistics and office properties were each allotted $900 million.
Among the largest allocations to an individual manager, more than $1.2 billion was set aside for possible investment in Institutional Multifamily Partners, a joint venture between CalPERS and GID formed in 2010. Institutional Mall Investors, a core-oriented joint venture with Miller Capital Advisory that targets high-quality, market-dominant, fashion-oriented retail properties, received $900 million. Another $900 million was budgeted to Fifth Street Properties, an office joint venture between CalPERS and CommonWealth Partners.
Big Oregon Pension Approves $1B to Real Estate Another billion-dollar 2015 investment plan was approved by the Oregon Public Employees Retirement Fund, which aims to make commitments of approximately $900 million to $1.3 billion. The Oregon State Treasurer’s office is currently underwriting two different, but complementary, domestic private debt fund strategies for potential commitments of $100 million to $150 million each, as well as pursuing a niche domestic real estate fund for a commitment of approximately $100 million. All three would be value-add strategies. The State Treasurer’s office is also pursuing two separate account joint ventures, one to
invest in domestic multifamily and one to invest in domestic retail. Each joint venture would receive approximately $200 million to $300 million and would use a value-add strategy to complement OPERF’s core strategies.
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Infrastructure news
Infrastructure Consortium Meets at White House Summit
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lobal institutional infrastructure investors and investment managers met at the White House in September for the Infrastructure Investment Summit as part of the Obama administration’s Build America Investment Initiative. The meeting included investors expected to commit $50 billion in U.S. infrastructure and included several panel discussions on topics ranging from P3 to lessons
learned in infrastructure procurement to how to best match private investment with public infrastructure. For example, Jim Barry, head of global infrastructure for BlackRock, warned summit attendees, “If you don’t have the political consensus at the outset of a project, then it is likely to have a material impact on the progress of the project over time.” Lori Mahon, global head of infrastruc-
ture finance with CIBC World Markets, meanwhile, pointed to an example of a small P3 project to develop travel plazas, or rest stops, along highways in Maryland as how the public sector could let the private sector help solve problems. “Maryland had previous experience with P3s, and so the state got out of its way,” Mahon explained. “It didn’t design the travel plazas, and it let the private sector innovate.”
Investor Survey: Increasing Commitments to Infrastructure Institutional Real Estate, Inc. recently completed a survey with feedback from 40 global investors about their plans and expectations for infrastructure investment. It is IREI’s fourth such survey since 2010, when the first survey results were published during quite a different time for investors. During those cautious and confusing days of 2009-2010, the I3 Investor Survey participants indicated their average capital commitments to infrastructure in 2009 were $77 million, with expectations for $138 million in commitments in 2010. This year, survey participants said they committed on average $324 million to infrastructure investments in 2013, and they expect to commit on average nearly $283 million more per survey participant in 2014. That is quite an increase from four years ago, and it says a lot about not only a maturing infrastructure investment market where investors have a better idea of their
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objectives and investment managers are more attuned to those objectives, but also a lot about the relative stability of investment markets. The 2014 survey also found that committed capital is being put to work (a commitment becoming an actual investment) at a greater rate than in 2010. Survey participants indicated total capital invested in 2013 was on average nearly $700 million with expectations of $264.5 million in 2014. Each of these is far greater than investors tallied in the 2010 survey — total capital invested in 2009 averaged $57 million and expectations for 2010 at the time were for $67 million invested per participant. The infrastructure market has clearly changed since 2010 in ways that allow investors to commit capital to infrastructure investments with greater confidence that their interests will align with the vehicles in which they invest. realAssets Adviser | November 2014
Infrastructure Travel Diary: Roads, Rockets and Russians
M&A Index H1 2014: Beginning to Feel Like a Recovery Global merger and acquisition markets continue to experience recovery, albeit at different paces regionally and by sector, notes Allen & Overy. M&A in the United States, for example, remains strong as the practice of tax inversion is “driving considerable outbound activity.” The telecommunications sector led the pack with $342 billion in deals during the first half of 2014. Energy transactions were third with $139 billion in activity. While infrastructure and utility transactions equaled the previous year’s comparable periods, Allen & Overy notes, “we are seeing an uptick in pipeline activity behind the scenes, and we expect the rest of the year to be much busier.” One reason for the relatively muted utility and infrastructure deal activity in the first half of 2014 is new developments in capital markets, including a movement to diversify away from bank financing and toward refinancing while terms are favorable. “We have seen a deepening of the bond market interest in infrastructure and, away from listed issuances, significant growth in private placements in the U.S. and Europe, and the development of interesting new greenfield project bond structures,” according to the firm. Also, institutional investors are affecting the dynamics of utility and infrastructure deal flow by holding assets for longer periods of time. Many infrastructure funds are ending their lifecycle and are looking for buyers to monetize their investments, which helps grow transaction activity. “However, we expect that many of the second generation of infrastructure owners will be longer-term holders, with investors such as pension plans and sovereign wealth funds with no exit mandates being the obvious candidates,” Allen & Overy observes. realAssets Adviser | November 2014
First State’s senior global listed infrastructure analysts Ofer Karliner and Edmund Leung traveled to France, England, Italy, Spain and Switzerland and visited infrastructure companies and their senior management as well as government officials and regulators. The report reviews their impressions and insights into these markets and companies. Karliner and Leung note key highlights from their travels: •E uropean infrastructure stocks enjoyed a strong rally during the past year. Transport volumes have recovered and regulatory risks have declined, but valuations have gotten ahead of improving fundamentals. •G overnments are steadily selling and leasing infrastructure assets to private investors. Bidding has been aggressive, raising valid concerns. Examples of significant unrealized potential in public assets include Portugal Airports and Queensland Motorways. •F or an industry with long investment cycles, there is a great deal of change in
the satellite industry: new management at SES, new rocket launch providers and new technology are driving the prospect of better returns on capital. •E uropean airports have traditionally been active developers, but the influence of government shareholders and hub carriers holds them back from achieving their cost of capital. This is a marked difference from Australian airports where private investors by and large own the assets. • I n contrast to 2013, the regulatory environment in Europe is more certain, and regulatory risk is on the decline. •E uropean corporates are buying with confidence due to the beginnings of economic recovery and low interest rates, which is driving them to bid on government-owned infrastructure assets.
Scottish Parliament United by Law, Divided by Priorities Despite the Scottish people deciding they are better off inside the United Kingdom rather than out, the push for more autonomy from the British Parliament is expected to continue, and according to After the Big Decision, What Now for the Nation’s Built Assets, by London-based consultant EC Harris, “[The Scottish Parliament’s] increasing power to control a greater proportion of the Scottish economy will remain a factor in business decision making and infrastructure investment until more fully understood.” At issue is how the two parliaments will sort out funding and investment in the various infrastructure sectors. For example, Scotland spends 10 percent more than England
on its healthcare system, including the physical infrastructure of hospitals and other clinics. “Scotland’s health budget might come under increased pressure as Westminster exerts greater fiscal pressure toward the latter half of their austerity campaign,” EC Harris notes. Scotland’s decision to stay in the union might on the other hand give leverage to those who want greater investments in the country’s road network. “It has been promised that a no vote will lead to greater devolved powers for Scotland, and it will be interesting to see what effect this increased autonomy will have on the nation’s infrastructure,” EC Harris notes.
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ene r g y n e ws
Q3 Sees ‘Remarkable’ Drop in Global Oil Demand
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or the third straight month, the International Energy Agency trimmed its projection for the growth of global oil demand in 2014, dropping its forecast in September to growth of 900,000 barrels per day for the year. The agency called the drop in demand “nothing short of remarkable.”
The growth projection at the end of second quarter was as high as 1.3 million barrels per day, but a trimming of the projection every single month of the third quarter has seen it drop by more than 30 percent. The agency cited a “pronounced” slowdown in demand growth in the second quarter and a more critical outlook for
European and Chinese economies as reasons behind the lower projection. A drop of global supply in August of 400,000 barrels per day to 92.9 million barrels per day could not have helped either. The agency also trimmed its growth projection for 2015 by 1.2 million barrels per day to 93.8 million barrels per day.
Eagle Ford Shale Nets Texas Nearly $90B Spanning across southern and central Texas, the Eagle Ford Shale is estimated to have produced $87 billion of economic output, employed 155,000 people and provided more than $2.2 billion in state and local government revenue in 2013, according to a study conducted by The University of Texas at San Antonio (UTSA) Institute for Economic Development. Eagle Ford attracts more capital investments than any other shale field in the United States. Just this summer, oil production in Texas surged past the output of the entire continent of Europe at 2.9 million barrels per day, according to the U.S. Energy Information Administration and JLL Research — half of which comes from the Eagle Ford Shale, where oil and condensate production has grown from 581,000 barrels per day in 2008 to more than 1.5 million barrels per day as of August 2014, according to UTSA. And the growth is only expected to continue — by 2023, the region is projected to support more than 196,000 jobs and generate more than $137 billion for Texas.
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Gas Prices to Hit Four-Year Low by Year’s End A combination of weakening global oil demand and growing international oil supplies have continued to put downward pressure on U.S. gasoline prices, and now the U.S. Energy Information Administration projects U.S. average regular gasoline retail prices will drop to $3.18 per gallon by December, which would mark the lowest monthly average since January 2011. U.S. average gasoline retail prices reached a summer peak of $3.70 per gallon in June, $0.02 higher than a year ago, but fell to $3.45 per gallon on Aug. 25 as the summer rush waned, a full $0.10 lower than at the
same time a year ago, and the lowest price on the Monday before Labor Day since 2010. The price fell another $0.10 to $3.35 per gallon by the end of September, according to the EIA. The shale revolution has seen U.S. crude oil production increase dramatically from 5.0 million barrels per day in 2008 to nearly 7.5 million barrels in 2013. At the same time, the increased fuel efficiency of new light-duty vehicles coupled with a slow economic recovery have, among other factors, prevented demand for oil from increasing at the same rate. realAssets Adviser | November 2014
Wintershall Snatches $1.25B in Oil and Gas Assets from Statoil Germany’s largest crude oil and natural gas producer and a subsidiary of German chemical giant BASF has agreed to purchase $1.25 billion of oil and gas assets in the North Sea from the Norwegian company Statoil ASA. The deal expands Wintershall’s daily oil production in the North Sea from 40,000 barrels of oil equivalent to 60,000 barrels of oil equivalent. “We believe in the potential of the Norwegian continental shelf and clearly focus on our goal: We want to become one of the leading oil and gas companies in Norway,” said Rainer Seele, chairman of the board of
Clean Energy Index Returns 11.63% in One Year Despite a troubling September that saw four-week returns hit –11.22 percent as of Oct. 1, the NASDAQ Clean Edge Green Energy Index Fund has returned 11.63 percent for the 12 months ended Sept. 30. The index is a modified market-capitalization weighted index that tracks publicly traded U.S. companies engaged in manufacturing, development, distribution and installation of emerging clean-energy technologies such as solar photovoltaics, biofuels and advanced batteries. The index has been outpaced by REITs, as the FTSE NAREIT All Equity REITs index has returned 13.19 percent for the year ended Sept. 30, though this is entirely due to the NAREIT index escaping September slightly less scathed at –5.61 percent for the month. The S&P 500 Index has outpaced both with a one-year return of 17.21 percent, though, not coincidentally, it also escaped the rough September with the least damage of the three with returns only 270 basis points in the red for the month. realAssets Adviser | November 2014
executive directors of Wintershall, in a statement. The largest holder of oil and natural gas reserves in Europe, Norway’s oil production peaked at 3.4 million barrels per day in 2001 and declined to 1.8 million barrels per day by 2013, according to the U.S. Energy Information Administration. Wintershall’s purchase includes a stake in two producing fields Gjøa (5 percent) and Vega (24.5 percent), the development project Aasta Hansteen (24 percent), the Asterix discovery (19 percent), the Polarled pipeline project (13.2 percent), and equity in four exploration licenses near Aasta Hansteen.
Institutional Investors Commit to Decarbonize $100B The United Nations’ Climate Summit 2014 in New York City saw a coalition of institutional investors, including two of Europe’s largest asset managers and pension funds, commit to reduce the carbon footprint of $100 billion of institutional investments worldwide by December 2015. According to the U.N., the announcement is expected to signal to carbonintensive companies around the world that greenhouse gas emissions are not only a threat to economic stability but to their portfolios, though it should also signal to investors that billions of dollars of institutional capital could be divested away from carbon-heavy energy indices, funds and companies during the next 15 months. “Climate change is more and more recognized as a financial risk, and it is our duty, as trustees, to take concrete steps to reduce this risk,” Mats Andersson, CEO of the $38.5 billion Fourth Swedish National Pension Fund (AP4), said in a statement. It was AP4 that launched the coalition, which includes Europe’s largest asset
manager Amundi, the Carbon Disclosure Project and the Portfolio Decarbonization Coalition. The coalition will be aided by the U.N.supported Principles for Responsible Investment, which also coordinated the Montreal Carbon Pledge, which has been signed by the $300 billion California Public Employees’ Retirement System (CalPERS) and commits institutional investors to map their portfolio’s carbon footprint, starting with equities, by December 2015. “Climate change represents risks and opportunities for a long-term investor like CalPERS,” said Priya Mathur, CalPERS board of administration vice president, in a statement. “This pledge signifies our continued commitment to better understand our own footprint and help forge solutions to serious climate change issues.” Climate change does indeed represent risks and opportunities for investors, just as this coalition, advocating such a large movement of energy capital, should represent risks and opportunities for investors as well.
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Commodities news
Gold Prices Dip Below $1,200 per Ounce
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n October, gold prices dropped below $1,200 per ounce — erasing all gains for the year as the precious metal hit levels previously seen in late 2013. Strong U.S. economic performance — the labor market is posting employment gains and the Federal Reserve is expected to begin raising interest rates soon — is believed to be behind the trend. In an interview on Bloomberg TV, Citigroup analyst Ivan Szpakowski noted, “The Fed’s tightening policy, the end of tapering obviously at the next meeting
and the start of rate hikes next year is creating significant headwinds.” Rising interest rates are generally expected to have a negative effect on the price of gold. With a stronger U.S. economy, the Fed is likely to raise rates sooner rather than later. Goldman Sachs commodities analysts’ coverage of the market noted: “Despite renewed concerns over China and Europe, U.S. fundamentals remain strong. We maintain our views of higher real rates due to a strong macro backdrop, which drives our bearish view of gold denominated in USD.”
Bumper Crop for Soybeans
Investors Focusing on Agriculture Down Under
The 2014 harvest is set to be a bumper crop for soybeans. According to the USDA’s National Agriculture Statistics Service, U.S. soybean producers are set to produce 3.913 billion bushels this year, a 19 percent rise from the previous year. The USDA’s September Crop Production report projects a U.S soybean yield of 46.6 bushels per acre. Farmers had excellent weather conditions during the summer, which was quite wet in the prime soybean-growing regions. Soybeans are one of the major oilseed crops tracked by the USDA, and the increase in supply is pushing prices for the crop down. Soybean futures have trended downward on the Chicago Board of Trade. Other crops having a good year: corn and cotton. Both are on track to exceed their 2013 production rates.
Agricultural investments in Australia and New Zealand have attracted the attention of global institutional investors. The $11.2 billion New Mexico Educational Retirement Board committed $30 million to the Southern Pastures fund, an agricultural fund that targets dairy farms in New Zealand. “We looked at numerous alternatives from the U.S., Australia, Brazil, New Zealand and elsewhere and concluded the drivers behind New Zealand dairy will provide superior risk-adjusted returns in comparison to alternatives,” explains Mark Canavan, senior portfolio manager with NMERB. “Plus, it adds a great diversifier effect. The protein requirements of Asia, the increasing demand for milk, the increasing demand for food safety — all would point to a strong
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The dropping gold price could have a knock-on effect for the mining industry. According to Joseph Foster, a portfolio manager at Van Eck Global, many gold mines cannot support production at levels below $1,200 per ounce, and so a dropping price could lead to reduced output and mine closures. He told Reuters: “$1,200 is a critical level. The industry has geared itself around $1,200. If it falls below that level, then there are a lot of mines around the world that are really going to struggle.”
underlying demand for N.Z. dairy products.” Southern Pastures is one of the largest institutional farmland funds in New Zealand and is focused on free-range, grass-fed and animal welfare–based sustainable dairy farming. New Zealand is a global leader in dairy production that benefits from free-trade agreements and proximity to emerging Asia. Chinese investors have also gone Down Under for dairy and other agricultural products. The Beijing Agricultural Investment Fund, backed by the Chinese government, is set to invest A$3 billion ($2.7 billion) in dairy, beef, lamb and aquaculture assets in Australia. The Beijing Australia Agricultural Resource Cooperative Development Fund was formed in a joint venture with Yuhu Agriculture Investment. realAssets Adviser | November 2014
Timber Firms Acquire 75,000 Acres in the Southeast
AngloGold Ashanti Puts Restructuring Plan on Hold South Africa–based AngloGold Ashanti has abandoned plans to spin off its international operations, though the gold-mining firm continues to “evaluate all options to address debt levels and unlock value, taking into account the feedback from its shareholders and its business needs,” according to a statement. Shareholders had been vocally opposed to AngloGold Ashanti’s outlined restructuring, and the firm backed away from its initial spin-off and capital-raising plans. Its high debt load, however, means it is likely to consider other options. As the gold-mining firm notes in a statement, “Reducing current high debt levels and improving overall financial flexibility remain priorities.” AngloGold Ashanti owns 20 gold-mining operations in 10 countries around the world, with two-thirds of its revenues coming from outside South Africa. The firm was formed in 2004 by a merger between South African firm AngloGold and Ghanabased Ashanti Goldfields Corp. realAssets Adviser | November 2014
CatchMark Timber Trust, an Atlanta-based publicly traded REIT, has acquired 55,600 acres of timberland in the Southeast for $111 million. Some 95 percent of the acreage is in Georgia, with the remainder in north Florida. The acquisitions, known as the Oglethorpe and Satilla River assets, are 74 percent convertible pine upland by acreage, according to the REIT, which has acquired 100,000 acres of timberland so far this year. In other news, Atlanta-based Timbervest, on behalf of its Timbervest Partners III investment fund, has acquired more than 20,000 acres of timberland, also in the Southeast. The $480 million fund has institutional and high-net-worth investors, and owns 260,000 acres of timberland throughout the United States. Timbervest acquired 6,700 acres in northwest Alabama and 14,000 acres in Virginia, east of Interstate 95. The Jasper property in Alabama is described by the firm as predominantly “rolling hills and valleys with occasional steep terrains, ridgetops and well-drained bottomlands. Several tracts feature pine-covered ridgelines and steep-sloping hills with mature hardwoods.”
The Azalea property in Virginia is described as “typical of the upper coastal plain with much of the topography being flat to gently rolling.” In a statement, the firm notes, “The property offers some recreational and rural residential higher and better use opportunities at exit, but the majority of the acreage will remain in the timberland category for the foreseeable future.” This past summer, Timbervest received a ruling by the SEC that four of its principals had violated securities laws with respect to commissions paid out of the pension assets of one of the firm’s largest client, and was ordered to disgorge $2 million in illegal profits. In a letter to Pensions & Investments, Joel Shapiro, CEO of Timbervest, stated, “These supposed infractions represent less than 1 percent of the money in the 350-plus transactions completed during the last decade, which covered approximately 1.4 million acres of timberland costing more than $1.5 billion (including more than $140 million in timber harvests that have taken place).” Shapiro added, “the reality does not at all reflect the tale spun by the SEC. Although the allegations against us are few and frivolous, we have spent an extraordinary amount of money to date to clear our names.”
China Launches Gold Exchange for Foreigners China has launched a gold trading exchange that is open to foreign investment. The Shanghai Gold Exchange, which trades in yuan, started trading in September. The exchange is linked to China’s domestic spot gold market. The Wall Street Journal notes that China is currently the world’s largest producer and consumer of gold, but does not, as yet, have much clout in global gold pricing.
Russian Import Ban Likely to Have Little Impact on Beef Industry Russia’s ban on beef imports from the United States and Europe is likely to have little impact on the industry, according to a report from Rabobank’s food and agribusiness research and advisory group. Rabobank noted that Brazil is likely to be the main beneficiary of the Russian import ban. “There is largely positive news for the
global beef industry as strong demand and tight supply are showing no signs of slowing, pushing prices, in some cases record prices, even higher,” said Rabobank analyst Angus Gidley-Baird in a statement. Still, with supply tight and demand high, the U.S. beef industry is unlikely to feel much effect from the absence of Russian buyers.
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realAssets Adviser | November 2014
By Ben Johnson
Norman Boone has seen much in his two decades as an RIA, and with $625M in AUM under his wing, he is keen on coaching the profession to the next level.
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hat strikes you first about the offices of Mosaic Financial Partners in downtown San Francisco is the number of framed Worth magazine covers hanging on the walls throughout. This is a visual reminder that Mosaic’s founder, Norman Boone, is one of only three advisers to have been named among the nation’s best financial advisers in each of the 14 years the esteemed list was published. Today, Mosaic’s staff of 18 serves some 260 clients and oversees about $625 million in assets under management. Boone himself is low key and personable. He is certainly well schooled, having received his bachelor of arts degree from Stanford University and his MBA in finance from Harvard University. Over the years, Boone has made a name for himself on a national scale. Along with his wife, Linda Lubitz Boone, he wrote the industry standard, Creating an Investment Policy Statement: Guidelines and Templates. Together, they also developed IPSAdvisorPro, which was cited as the “Best Software of 2006” by Morningstar and which last year was acquired by fi360, a private company providing training in and advocacy for fiduciary standards in the advisory community. Boone has served on the national board of the Financial Planning Association, helped start the San Francisco Society of Certified Financial Planners, and has been president of the San Francisco chapter of the International Association for Financial Planning. He also served on the advisory boards for both Charles Schwab & Co. and TIAA-CREF’s institute.
THE EARLY DAYS Boone’s career, like many professionals, found him entering investment advisory through a combination of happenstance and sheer curiosity. After business school at Harvard, he went through a series of jobs, first as a banker at Wells Fargo and then working for a banking client as the CFO. “It was there that I realized how little I knew about financial planning,” Boone says. “So I started looking around and found the Certified Financial Planner program.” He earned his CFP designation in 1984 and realized he had found his future vocation. Three years later, he started working with a broker-dealer in the San Francisco Bay Area, and over time decided to open his own firm. “For me, it is a nice combination of education, of coaching and analysis,” he says. “I like teaching. I like helping people move from an elementary knowledge to a much higher level of understanding what they
It is difficult to get people to happily write larger checks on an ongoing basis for financial planning.
realAssets Adviser | November 2014
can do, what they can’t do, what they can control, what they can’t control. And I just like that process of helping people improve their lives.” Boone has coached junior baseball over the years, and finds some similarities between the rewards of winning in athletics to the world of financial planning. “There are a lot of similarities between working
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with an individual or a couple and helping them identify the things that they want to work on and where they want to go, and then helping them develop the skills to get them there,” he says. “I enjoy just the analysis of taking a particular problem and understanding the pieces of the problem and putting that together.” “For me, it is all about helping people,” Boone continues. “I had that streak in me. It is just a great combination of really being able to work with successful people who have generated a certain amount of wealth and know how to create at least some successes. I found that I could really help them accomplish what they want to accomplish, and that is gratifying for me.” Deciding to strike out on his own involved a series of realizations that many of today’s advisers also face. “As part of working for a broker-dealer, I figured it didn’t make any sense for me to be sending him money, when he is not helping me at all,” Boone says. “But I needed that guidance for a while to really learn what to do and what not to do. I couldn’t have done it without that and we remain good friends.”
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Boone formed his own shop, Boone and Associates, and kept his affiliation for six months before making a clean break as a true independent. A year later he hired a part-time assistant. Boone and Associates later became Boone Financial Advisors and in 2005 was renamed Mosaic Financial Partners. Boone quickly discovered that setting out on his own entailed some serious challenges. “Everybody who advises young advisers says to choose who you want to work with and don’t take people that don’t fit into that category because you really want to focus in and build your specialty. But the practical reality is when you are starving you will take anything that will generate income. So the idea of having minimums at that point or a real niche was not even a consideration. I was looking for anybody who wanted to become a client and allow me to work with them.” Boone started with no clients, but he had developed relationships with a number of professionals and people he knew from his former days as a banker. “It was hard at first. I pretty much starved for the first three years, but it eventually started to grow and develop and become successful,” he says. ADOPTING A FEE-ONLY MODEL After only two years in business on his own, Boone decided to make the move to a fee-only model in the mid-1990s. In that sense, he was a bit ahead of his time. “There were clearly other people that were doing it, but if you look at the numbers, we were out near the cutting edge,” Boone says. Fast-forward 20 years or so to today, and Boone has his own opinions on the profession’s ongoing debate over commission-based versus fee-only compensation. “While I have a lot of respect for the hourly fee model and I think when you are starting out that is not a bad way to pick up a few early clients, I am not sure it has an appeal for a real broad group,” he says. “I am just real comfortable with a fee-only model, so we get paid a fee for financial planning and we get paid investment management fees, and that is the only way in which we make any revenues.” He does admit that it is still a constant struggle to help clients understand the real
value of financial planning. “It is difficult to get people to happily write larger checks on an ongoing basis for financial planning,” he says. “They don’t know what they don’t know, and the benefit is not as obvious. It is not as quantifiable, and oftentimes you don’t see the benefit for 40 years.” Rather than creating a menu of financial planning options, Boone settled on a more holistic approach. “If you only address pieces, then you would end up not providing much in the way of service,” he notes. “The real value that we bring on the financial planning side is the comprehensiveness of understanding the entire picture. If you don’t have an opportunity to view this in a comprehensive way, I think you lose a lot of your effectiveness. I sense that the clients who have gone through it and seen us work with them for more than a few years do have an appreciation for the value that we brought. But up front, it is still difficult.” To provide the appropriate level of client service, Boone decided to structure his firm into distinct groups. “We have a group of people that we call planners who are junior advisers that partner with our more senior advisers and do the preliminary note taking and clerical work. They always sit in on the client meetings so that they have the verbal understanding and the relationship building,” he says. “We have centralized the investment research and operational aspects and decision-making process with one or two people within the firm. Then all of the professionals sit in on investment committee, so that we are hearing the debates about various kinds of issues and so that everyone is knowledgeable about the current situation.” Mosaic uses iRebal, a software system that allows its advisers to monitor portfolios and execute transactions. “The adviser always has the final say on each one of the investment trades to approve them or not approve them,” Boone says. “It’s a check-and-balance process that allows our advisers to really focus in on the client relationship and giving that client the best advice and service possible.” Interestingly enough, the demographics of Mosaic’s client base have mirrored Boone’s own life stages. “People are most likely to serve those demographics that are realAssets Adviser | November 2014
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most like them,” he says. “When I started in my 40s my clients were in their 40s. Now that I am in my 60s, most of my clients are in their 60s, with the bell curve, you know, kind of around in terms of age, so that 10 years plus or minus your own age is probably where your sweet spot is in terms of clients. It’s one of the reasons why it is important on a staff basis to have advisers of all ages.” A REAL ASSETS PROPONENT Boone is convinced that real assets are key to investment diversification, which explains why an average of 30 percent of Mosaic’s client portfolios are invested in real assets. “We have been and continue to be real strong proponents of real assets,” he confirms. Experience is a great teacher, and Boone learned a lot from the busted limited partnerships that were so prevalent in the 1980s. “When we think about what was hot in the 1980s, it was real estate limited partnerships and oil and gas,” he says. “I was fortunate to have started late enough that I didn’t get too into those, but one of the lessons that I learned from that whole process was that it is not the real estate and it is not the oil and gas that is necessarily the bad element here. It is the structure of the investment.” The term “liquidity” was a fairly foreign concept in these deals, and when investors wanted to get out they could not. “That was frustrating for me, it was frustrating for them, and I think damaging in a lot of ways,” Boone says. “We started doing REITs in the mid- to late 1990s with Cohen & Steers, and in 2002 we started adding commodities.”
bonds, long-term bonds, U.S. stocks (large and small cap), international stocks (large and small cap), emerging-market stocks and real estate/alternatives. Recently, Boone added business development corporations as an investment class. “We are looking for things that have attractive return characteristics, but which are relatively non-correlated to the stocks and bonds mix,” he says. “I am a strong proponent of modern portfolio theory, and one of the tenets that people tend to forget about modern portfolio theory is that the way in which you evaluate whether something ought to be added to the portfolio is not whether you like that particular thing or not; it is how it impacts on the overall portfolio if you include it or don’t include it.” Finding the right types of investments still represents challenges, especially when it comes to real assets and other alternatives. “All of the endowments and foundations and universities can do things that many of the rest of us can’t do,” Boone says. “The concept still works and you can still learn from those kinds of things, but our limitation was the products were not available. Also, since our average portfolio is about $2.2 million, that means that each class of real asset investment is only $66,000, and you can’t go out and hire the hedge fund manager with $66,000. “Our limitation then was really what is available on a daily price, liquid form,” Boone continues, “and our primary investment approach is to use packaged products including mutual funds and exchangetraded funds. We ended up using a lot of iShares originally because we felt they were the best structure. We have also been very careful to not get into ETFs that were small because one of the ways in which ETFs work effectively is they have plenty of arbitrageurs behind the ETF to be able to keep it at market.” Right now, Mosaic’s client portfolios include exchange-traded notes because those have better tax ramifications than owning the MLPs directly for most of Mosaic’s clients. “My guess is that most advisers don’t
We have been and continue
to be real strong proponents of real assets. Harkening back to his academic roots, Boone took an analytical approach to investing and started to focus on investment correlations. That explains why Mosaic has created 10 different asset classes for its client portfolios. They include cash, short-term bonds, intermediate-term
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know about the notes, and they certainly don’t understand them,” Boone says. In particular with real estate allocations, Boone is big on both liquidity and on REITs, so he uses mutual funds and Dimensional Fund Advisors to provide global real estate exposure to REITs. Timber is also on Boone’s real assets menu, and since there is no pure timber fund, he buys individual timber companies such as Plum Creek Timber and Weyerhaeuser, both structured as REITs. For agriculture and commodities, Boone uses long commodities and managed futures, but avoids agricultural land and products “simply because we haven’t figured out how to go about doing that.” “We are constantly scanning the environment for the right products, but part of our criteria, going back to my ’80s lessons, is that we want daily price, daily liquidity in our products, and we understand that we give up some illiquidity premiums in that regard,” he says. “But our clients’ lives change, and when they need cash and they need to raise cash in that way, it makes it really difficult. The other problem with things that tend to be illiquid is that because we rebalance relatively often it makes it difficult.” In answering the question of whether the investment advisory profession is prepared for the next downturn, Boone is characteristically blunt. “No. It is always a surprise,” he says. “I am not a believer that we are facing another major crash. I see the recovery as being so slow to build momentum that I think that we have another couple of years anyway to go, and I am not uncomfortable with where pricing valuations are based on forward earnings …” Boone believes the trend from commission to fee-only compensation is long term and will benefit the profession. “We are not licensed the way hairdressers are licensed, and we should be,” he says. “I don’t see that happening because the largest and best paid voices out there would scream bloody murder, but I think that’s where we need to be. Ultimately, I like to see the focus on people doing things the right way for the right reasons with their clients’ best interests as a primary motivator.” realAssets Adviser | November 2014
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Meet new sources of capital
Alts
Adopting By Jennifer Popovec
I
nvestors are increasingly interested in alternative investments, particularly real assets, and there is no sign that interest will diminish anytime soon. If anything, experts anticipate interest in real assets to increase significantly as more and more investment opportunities become available to retail investors. However, experts agree that evaluating alternative investments can be challenging. And finding the right alternative investments is difficult, even for sophisticated investors. Nonetheless, net flows
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Investors and their advisers are diving deeper into alternatives, and real assets are the beneficiary of this movement.
in the global alternatives market are expected to grow at an average annual pace of 5 percent during the next five years, according to a recent report by McKinsey & Co. The rapid growth of alternatives is not simply the result of investors chasing returns, says Ju-Hon Kwek, an associate principal in McKinsey & Co.’s financial services group. He points out that investors are seeking consistent, risk-adjusted returns that are uncorrelated to the broader market. In addition, they are also looking
for solutions to needs and situations they see on the horizon. Kwek says alternative strategies can deliver a range of solutions. For example, real estate and infrastructure can be a source of inflation-protected income, and hedge funds can be a tool to manage volatility. “The big thing that will drive investment in this space is for investors and managers to make a link between strategies and outcome,” Kwek says. “There’s a renewed interest in the space because of outcome-oriented investing.” realAssets Adviser | November 2014
Global AUM of key alternative asset classes, 2005-2013 $7.2 $ trillions Total $6.3
$4.9
$3.2 1.0
2.3
realAssets Adviser | November 2014
Real assets
11.3%
2.1
Private equity
9.1%
2.6
Hedge funds
11.4%
Fund of funds Retail alternatives1
5.6% 12.6%
Growth of traditional assets = 5.4%
1.6
1.1
INTEREST ACROSS SPECTRUM Last year, global assets invested in alternatives such as real assets, hedge funds and private equity hit an all-time high of $7.2 trillion, according to the McKinsey report. Titled The Trillion-Dollar Convergence: Capturing the Next Wave of Growth in Alternative Investments, the report draws on the findings of the firm’s 2013–2014 Alternative Investment Survey, which polled nearly 300 institutional investors managing $2.7 trillion in total assets and included more than 50 interviews with a cross-section of investors by size and type. “There’s a very obvious reason why investors are looking toward alternatives,” says Martha Peyton, head of global real estate strategy and research for TIAA-CREF. “There are still inefficiencies in alternatives related to access to deals and access to infor-
10.7%
2.4 2.1
1.6
CAGR 2005-13
1.1
1.4
2005 $0.5 $0.8
2008 $0.8 $1.1
2.0 2011 $0.9 $1.7
2013 $0.9 $2.0
1 Vehicles providing non-accredited investors with exposure to alternatives strategies via registered vehicles: mutual funds, closed-end funds and ETFs. Source: McKinsey Global Asset Management Growth Cube; Preqin; HFR
mation and expertise. These inefficiencies translate into premiums for investors.” The McKinsey report predicts alternatives could comprise about 15 percent of global industry assets and produce up to 40 percent of industry revenues by 2020. New flows into alternatives, as a percentage of total assets, were 6 percent in 2013, dwarfing the 1–2 percent rate for non-alternatives. In the aggregate, the investors McKinsey surveyed expect alternatives to account for an average of 26.2 percent of their total portfolio assets by the end of 2016, up from 25.1 percent in 2013. Institutions with at least $10 billion in AUM expect their alternatives allocations to top 29 per-
cent by 2016, a full 5 percentage points above 2013 levels. The ongoing shift toward alternatives is not limited to any one type of investor. Interest is strong across all classes of institutional investors, as well as retail investors. Flows to alternatives from four segments of investors — high-net-worth/retail investors, smaller institutions, large public pensions and sovereign wealth funds — could grow by more than 10 percent annually during the next five years. Institutional investors, which control approximately 60 percent of the money flowing into alternatives, have upped their allocations to alternatives in the past few
41
years. More than 75 percent of institutional investors expect to maintain or make meaningful additions to their alternatives portfolios in the next three years, according to McKinsey’s study. Retail flows, meanwhile, are expected to be three to four times those of institutional flows. McKinsey reports that demand has been strongest in the U.S. market (private banks, family offices and registered investment advisers) as well as in more global ultra-high-net-worth channels (e.g., private banks and multi-family offices). Interestingly, high-net-worth women are among the biggest fans of alternative investments, according to Investing Outside the Box, a study on trends in nontraditional investing from MainStay Investments, a New York Life company. The study, conducted by Harris Poll among a nationally representative sample of more than 800 high-net-worth investors ages 40 to 65, found that more women than men see alternatives as a “mainstream”
MainStay Investments. “For advisers, this trend presents a tremendous opportunity to help high net-worth women achieve their investment goals, while properly diversifying their portfolios.” More than half of the women surveyed (55 percent) said that they have increased their allocations to alternative investments during the past year, and more than a quarter (27 percent) of women say that within the next five years they plan to further add to their allocations. A majority of respondents invested in alternatives have had a positive experience (58 percent) and would recommend alternatives to their peers (89 percent). Further, 68 percent of women agree that as the economy continues to evolve, alternative investments may offer the best opportunity to diversify and meet their long-term objectives. “I think alternative investments are a little more approachable now,” says Jack Rivkin, CIO of Altergris, an alternative investment firm with more than $2.35
Flows to alternatives from high-net-worth and retail investors could grow by more than 10 percent annually over the next five years. option and expect alternatives to become a core investment holding during the next five to 10 years (60 percent versus 47 percent). “While all investors are growing more aware of the value of nontraditional investments, high-net-worth women are especially interested in the benefits alternatives offer,” explains Stephen Fisher, president of
42
billion in assets under management in client assets and $499 million in institutional assets. “And I think investors are beginning to see that alternatives offer a way to make money when the market is going up, as well as when it’s going down.” Rivkin adds that retail investors are increasingly looking to alternative investments to hedge downside risk and generate
income in a low-interest-rate environment. ALTERNATIVES GO LIQUID Although alternative investments have historically been limited to larger institutions, the creation of new liquid product vehicles such as mutual funds and ETFs has made alternatives accessible to smaller institutions and retail investors. This process has democratized alternatives, making it possible for smaller institutions and retail investors to achieve the kind of income and returns that larger institutions have enjoyed for years. As a result, the broad category of retail alternatives assets — which includes alternative-like strategies such as commodities, long-short products and market-neutral strategies in mutual fund, closed-end fund and ETF formats — has grown by 16 percent annually since 2005, and now stands at almost $900 billion. Latching onto the trend, Charles Schwab launched the Schwab Fundamental Global Real Estate Index Fund (SFREX) in early September. The new fund will track the Russell Fundamental Global Select Real Estate Index. Today, retail investors significantly lag their institutional counterparts when it comes to allocating funds to alternative investments. Some endowments have invested upward of 60 percent of portfolios in alternatives. Likewise, large institutions including pension funds and insurance companies have increased their allocations well beyond the 20 percent range. Retail investors, in contrast, typically invest 5 percent or less in alternatives. Experts contend that a lack of liquid investment opportunities, coupled with a lack of knowledge and comfort with alterrealAssets Adviser | November 2014
natives, are to blame. “In general, retail investors prefer liquidity,” Kwek says. “The challenge is taking a truly institutional-quality product and breaking it down and making it available to qualified and accredited investors.” Additionally, the professionals providing investment guidance are not familiar with the intricacies of alternatives investments, particularly real assets. However, some of the largest asset managers are working to educate RIAs and other investment professionals about alternative investments. McKinsey predicts retail alternatives will be one of the most significant drivers of U.S. retail asset management growth during the next five years, accounting for up to 50 percent of net new retail revenues. REAL ASSETS TO THE FORE Although growth has occurred across every alternative asset class, it has been particularly robust in real assets. “Global demand for real assets is mushrooming,” says TIAA-CREF’s Peyton. “Investors are carving out bigger pieces of their portfolio for real assets.” According to McKinsey, large endowments and insurers were early movers in real assets, pointing to benefits such as diversification, inflation protection, enhanced returns and long-term income streams. To that end, the firm’s recent study found that more than two-thirds of large investors plan to increase their allocations to real estate, infrastructure and real assets over the next three years. While a uniform definition of real assets is still on the horizon, Real Assets Adviser defines the asset class as including real estate, infrastructure, energy and realAssets Adviser | November 2014
commodities. The following is a brief overview of the future trends in each of these major categories. Real Estate Of all asset classes, real estate has garnered the greatest surge in interest, according to Brent Elkins, managing director of alternative investment strategies for BlackRock Inc. The investment manager surveyed institutional investors around the globe and found that 49 percent of them plan to increase allocations significantly or slightly to real estate in 2014, while only 5 percent plan to decrease it slightly and 0 percent plan to decrease it significantly. “No other asset classes came close,” says Elkins. “There’s great enthusiasm for real estate.” Elkins points out that several large institutions, particularly sovereign wealth funds, have had a bias toward direct investment in real estate over the past several
gled funds.” Retail investors are frequently seeking opportunities that are more liquid and shorter duration. Those liquid, shorter duration investments in real estate can be found in REITs, either in passive indices or managed funds. BlackRock, for example, runs the BGF World Real Estate Securities Fund and the US Real Estate Securities Fund, which are both active strategies, as well as several passive REIT index vehicles. Every year, the REIT universe grows in size and scope. The IRS continues to expand its definition of real property, and companies outside traditional real estate are taking advantage of REIT structures. “There’s a whole lot more room for niche property types to find their way into the REIT world,” says Peyton. Elkins believes REITs have become an increasingly important component of defined contribution plans such as 401ks, especially target-date funds, by contribut-
Today, retail investors significantly lag their institutional counterparts when it comes to allocating funds to alternative investments. years. However, that tendency is showing signs of receding. “There’s been somewhat of a pullback on direct ownership,” Elkins says. “Even those investors who have expanded their teams and developed strong internal management expertise have recognized the merits of partnership with professional operators and asset managers, including via commin-
ing both return and diversification benefits. Additionally, BlackRock is one of the most active groups pursuing opportunities for retail investors to gain exposure to private real estate vehicles such as its open-end U.S. equity fund within the 40 Act construct. Commodities
43
The world of commodities investing has changed significantly over the past several years, and industry experts say the sector will continue to evolve, mostly because of changes in ETFs. David Clayman, a wealth adviser with Concord, Mass-based Twelve Points Wealth Management who specializes in commodities investing, contends that ETFs have transformed the commodities markets. “They’ve made commodities available to the average investor, but they’ve also altered the market and made it more difficult for those investors who have always traded in commodities,” he says. “Now that more people are investing in these funds, the movements are very sharp and one directional, which is not how the market used to move.” Within the commodities sector, investors are seeing new opportunities in crude oil, as experts focus on mitigating of the risks associated with the first generation of crude oil ETFs, according to Mike McGlone, head of research at ETF Securities US LLC. He points to the next generation of ETFs that feature dynamic rolls to accommodate the nuances of the futures market. Although gold has been a popular investment for retail investors over the past several years, McGlone says investors are increasingly interested in more than gold. They are keen to invest in silver, platinum and palladium — metals that are in high demand in emerging markets. Investors are picking investments that give them diversified precious metals exposure, primarily ETFs. “Historically, precious metals have provided nice returns without being correlated to other asset classes,” McGlone says. “And it makes a lot of sense for investors to take
44
advantage of the demand for metals from emerging markets.” Infrastructure With every passing day, the need to build new infrastructure and update existing infrastructure grows more acute. Investors can see the need clearly, from transportation infrastructure such as roads and bridges to utility infrastructure such as electrical grids and water pipelines. Many institutions have laid out mandates to allocate investment dollars to infrastructure. However, making those investments can be challenging, according to Sam Enoka, managing partner at San Ramon, Calif.–based Greensparc Energy Advisors. “It’s not very efficient to invest in infrastructure today,” Enoka says. “I don’t think investors can get a well-diversified exposure to the asset class.” While institutions have the opportunity to invest hundreds of millions through special accounts, the challenges of infrastructure investment are even more significant for retail investors. They are limited to investing in infrastructure ETFs or mutual funds, and those funds could include a variety of companies, from large engineering firms to utility companies. The benefits of investing in infrastructure are similar to other types of alternatives, particularly those focused on long duration, income generation and hedging against inflation. Energy The emergence of oil and gas technology (horizontal drilling and hydraulic fracturing) is having a widespread impact, creating new opportunities for investors, according to Jay Snodgrass, managing part-
ner of Energy Access Capital. He contends that investors are attracted to the sector’s inflation protection, commodity exposure, portfolio diversification, current yield, capital appreciation and real asset exposure. Since 2010, roughly $13 billion in IPO equity has been raised in the oil and gas sectors, establishing the foundation for MLP mutual funds and ETFs. Today, the master limited partnership universe has a market cap of about $500 billion, similar in size to the publicly traded REIT universe. Historically, MLPs have been heavily retail-oriented, notes Mark Easterbrook, co-portfolio manager of the BP Capital TwinLine MLP Fund (BPMAX). Institutional investors turned their eyes toward MLPs about five years ago, shortly before the first MLP mutual funds launched. “A lot of these investors aren’t from the energy side,” Easterbrook points out. “They’re from the fixed-income side.” He adds that investors gravitated toward MLPs because they “throw off cash.” Easterbrook predicts the MLP universe is going to get even larger. “We haven’t seen a lot of the big energy companies spin off MLPs yet, but that’s coming,” he forecasts. “Shell, for example, just filed to create an MLP.” Snodgrass, meanwhile, says the newest opportunities within the sector are not within traded securities, but rather direct investments at the asset level. Due to new regulations, investment sponsors can target retail investors. As a result, investors are able to participate in these investments for as little as $25,000. Jennifer Duell Popovec is an awardwinning writer based in Fort Worth. realAssets Adviser | November 2014
Back
in
Fast Lane
46
the
realAssets Adviser | November 2014
By Denise DeChaine
Toll road investors have traveled a rocky road of late, but experts believe the future holds promise.
T
hese days it seems that traffic is everywhere, whether dropping your children off at school, taking a quick run for milk to the grocery store, traveling to your favorite vacation destination and, of course, the daily commute to work. There is always traffic on the drive to work. And it seems there is always even more traffic driving home from work. So what are you to do when you are fed up with the doom and gloom of the impending traffic jam? Answer: Take a toll road. The United States has approximately 5,695 miles of toll roads, operating
in 35 states. Usually, a toll road is a public or private roadway for which a fee (or toll) is assessed for passage. Investment in toll roads can take the form of a public-private partnership, better known as P3. Lately, there has been some news going around that a number of P3 investments are missing their revenue projections. “The more problematic projects have tended to be brownfield deals although greenfield projects have certainly had issues,� says Joseph Aiello, partner and board member at Meridiam Infrastructure.
The investor role in toll road projects is only one piece of a larger puzzle.
realAssets Adviser | November 2014
47
“This is a very competitive market, and the key for investors when bidding is not just to bid to win but to win and to be able to achieve the targeted returns,” he adds. Some investors and developers have been rather unlucky, especially those who priced their project just prior to the great financial crisis, while others were simply too aggressive in estimating future driving trends. In the U.S., we have seen many 63-20 projects fail, says Aiello. (The 63-20 refers to projects classified as non-profit corporations for tax purposes.) “Some people consider the lack of true equity in those deals created a sense of developers playing with other people’s money. This is a difficult business, and one should enter only if all parties, public and private, are reasonably well aligned and incentivized for long-term success.” We all know the U.S. economy has been on a rollercoaster during the past few years, and that has affected investment worldwide in every aspect of infrastructure and real estate. Jennifer Aument, group general manager for North America at Transurban, says the turbulent economy explains why many toll roads have struggled. “A number of struggling toll road businesses in the U.S. are more of a reflection of a failed economy than a measure of the effectiveness of traffic and revenue projections,” Aument says. “The crisis had a substantial impact on the toll road industry. Developments came to a halt, and traffic growth stalled or declined across the U.S.” Getting the keys to the car The investor role in toll roads projects is only one piece of a larger puzzle — take the driving habits of younger generations, for instance. Generation Y, or the millennials, and Generation X are not earning as much as previous generations. According to Fortune magazine, Gen-Xers have taken out more debt and are reducing it at a slower pace than any other generation. Millennials owe more in student loans than any American generation, and perhaps as they age more debt will follow, but at the moment Generation X is the most indebted.
48
What does this mean for toll roads? It means that the generations of the future are becoming less likely to buy vehicles to drive, and given a choice between a “free” way and a toll road — well, you get the picture. According to “Transportation and the New Generation,” an article published in MotorTrend and co-authored by Tony Dutzik and Benjamin Davis, the problem begins with the assumption that youth moving back to the cities want entry-level cars when, in fact, they are more likely to spend on smartphones, tablets, laptops and $2,000 bikes. Young people also are returning to big cities and to near-urban, walkable suburbs, Dutzik and Davis report in the MotorTrend article, making them more likely to hop on a bus than into a car. They also state that many remain “connected” via smartphones for their commutes to and from work, and they are more interested in saving the planet, suggesting electric vehicles might help get them into a car — but until prices and the necessary infrastructure are available, the critical mass is still lacking. These young non-drivers are weaning themselves from cars, and will not necessarily rush to buy them when the job market improves. This notion seems to be shared by toll road investors/managers, but they advise there is more nuance to consider. “It’s important to look beyond one trend at the overall transportation outlook,” Aument says. “Generation Y may be purchasing vehicles at a lower rate than their parents, but a majority of Americans — including Generation Y and millennials — continue to drive alone. Another important trend is the increasing population generally. The number of miles individuals are traveling may be declining in some areas, but the sheer number of people traveling continues to increase dramatically.” Aiello seems to agree, identifying economic issues as a factor. “More troubling than the Gen Yers is trying to understand where the national and local economies are headed,” Aiello laments. “We are certainly beginning to see certain municipalities attracting the higher-wage new industries while others are struggling with low-wage economies. Trying to understand global realAssets Adviser | November 2014
A little history
realAssets Adviser | November 2014
A toll road in the United States, especially near the East Coast, is often called a turnpike. According to Wikipedia, the term turnpike originated from the use of pikes, long sticks that blocked passage until the fare was paid and the pike turned at a tollhouse. The U.S. Department of Transportation’s Federal Highway Administration’s history page states that, after the American Revolution, the national government began to realize the importance of westward expansion and trade in the development of the new nation. As a result, an era of road building began. This period was marked by the development of turnpike companies, the earliest toll roads in the
United States. In 1792, the first turnpike was chartered and became known as the Philadelphia and Lancaster Turnpike in Pennsylvania. The boom in turnpike construction began, resulting in the incorporation of more than 50 turnpike companies in Connecticut, 67 in New York state, and others in Massachusetts and around the country. A notable turnpike, the Boston-Newburyport Turnpike, was 32 miles long and cost approximately $12,500 per mile to construct. Fun fact: A practice known as shunpiking (not to be confused with toll evasion) evolved, entailing the finding of alternate routes for the specific purpose of avoiding payment of tolls.
49
The road to success is always under construction. — Arnold Palmer, professional golfer
pressures and how they play out for a resurgence in middle-class income growth is difficult.” Taxes, fees and prices Another factor affecting toll roads in the future is rising gas prices and a new “miles driven” tax that is circling state governments. Ross Israel, head of global infrastructure for QIC Ltd., believes this will be a problem in the United States. “The price of gasoline is a key driver for forecasting traffic,” Israel says. “With energy independence following the shale and unconventional oil and gas development in the U.S., there is likely to be less volatility on the price of gasoline going forward than in the past. This is a positive counterweight to changing behavior to car travel.” Aiello seems to agree, noting previous studies have shown that higher gas prices tend to produce at least two outcomes — those who continue to drive combine trip purposes, thereby reducing miles driven; others move toward alternatives such as public transit, when reasonably available. When it comes to a tax on vehicle miles driven, although drivers may not like it, it may be a great source of revenue for future projects. “Policymakers are exploring a number of means to generate transportation revenue,” Aument says. “We believe toll roads have and will continue to be an important tool to help finance, build and maintain infrastructure. What we’re seeing here in
50
the U.S. is significant growth in managed lanes, or high-occupancy toll lanes. For the first time, travelers are not just associating tolls with the funding of highways and bridges, but a means to get better transportation services — whether that’s a faster trip, more reliable travel or more convenient access to destinations.” The bright side of the road Recently, federal legislation has been proposed that will allow states more flexibility in establishing toll roads to collect revenues for repairs and improvements. The question is: How is this going to be received? “This initiative has been much debated for at least 10 years,” Aiello says. “Tolling existing free roads can be tough politically but can be done. One concern I have seen expressed is that the issue of how to pay for roads becomes a corridor-by-corridor discussion. Allowing more tolling is no way to help raise the national infrastructure spend in the short to medium term. I am not convinced this would produce as much investment opportunity in the next decade as would a $0.10 federal gas tax increase.” In Virginia, on I-95, the Virginia Department of Transportation has partnered with Transurban to add new capacity and travel choices to a critical and heavily congested corridor. According to Aument, there are ways beyond federal gas taxes to pay for projects. “With congestion plaguing our cities, aging infrastructure and declining gas tax revenues, policymakers need more tools
and greater flexibility to meet transportation needs,” Aument says. “More flexibility to toll interstates will help.” Public-private partnerships are another great option, Aument points out. “The state is leveraging public-private partnership to translate approximately $82 million in state tax dollars into nearly a billion dollars of transportation improvements,” she explains. “Expanding innovative financing tools such as TIFIA and Private Activity Bonds are also critical steps that will help states and cities make their transportation dollars deliver more for their constituents.” The future of toll roads According to Aument, availability-payment projects are the future of transportation infrastructure investing. Availability payments are best suited to projects such as transit or social infrastructure where the user-paid component is insufficient to make a material contribution to the cost of funding, the operating cost over time far exceeds the capital cost, or there are significant social equity issues involved. This can be an effective means to finance this infrastructure, but it does require states to assume long-term debt and does not inject any new capital into their programs. Israel adds that developing tolling technology and innovation to drive lower operating costs are just a few of the things to look forward to in the future of toll roads. Denise DeChaine is special projects editor at Institutional Real Estate, Inc. realAssets Adviser | November 2014
With energy demand on a continued growth trajectory, here is why it’s good to own oil and gas producing assets.
A ss
et
s
Co re
By Paul Anthony Thomas
52
realAssets realAssets Adviser Adviser| |November october 2014
M
y father was an investor, investment adviser and publisher who purchased his first public stock in 1926. Thereafter, he was hooked on investing as a profession. He studied the markets, read every book and The Wall Street Journal, went to school to study investing, and continued to invest his own money throughout the Great Depression and the 55 years following. He bought and sold raw land, coins, precious metals, currencies, art, real estate, commodities, cars — any form of investing, he would study the markets and trade. He went on to study engineering and geology, graduating from Oklahoma State University with a master’s degree in civil engineering, and then from Louisiana State University in 1940 with a Ph.D. in geology. He was a master investor: studious, intelligent, knowledgeable and experienced, with a vast amount of knowledge gained from first-hand investing activities during a 60-year career. From all his investing experience, his life motto became: “There are no greater assets to own, in certain or uncertain economic times, than producing energy in the ground.” During World War II, my father’s contribution to the war effort was in finding oil along the Gulf Coast of Texas, Louisiana and Mississippi. He was good at it, identifying prospects that routinely found new fields and astounding discoveries in one of the most treacherous geologic settings in the world, the highly faulted Gulf Coast. He was a staff geologist working for a major oil company when the company was finding, on average, a salt dome oil field a week. Unbeknownst to me, he started my investing career when I was about 13 by showing me how to contour geologic maps. Imagine a young person wanting to draw lines and pictures on a big piece of paper. Between geologic learning sessions, we read The Wall Street Journal together and discussed common stocks, bonds, commodities and currencies, their merits and pitfalls. Together we read books and edited his publications. We purchased all forms of public instruments and private assets, traded, made
realAssets Adviser | November october 2014 2014
money, and lost money. Throughout these decades of my financial education, we would research and invest. We would write about our experiences with these investments in my fathers’ newsletter, New Horizons for Investors. He would write, and I would read and ask him questions. This publication was a monthly newsletter sent to 10,000 paid subscribers throughout the world. There was a section dedicated to “Hot Stocks,” including fundamental analysis and the “new fad” of technical analysis, one section dedicated to our past recommendations and our current portfolio performance, one area about commodities, one section about upcoming currency trends, and another page about private programs on which we were working. These private programs included: prospecting for oil; investing in oil and gas leases; residential and commercial real estate; mining for coal, copper, gold and silver; pipelines; natural gas/oil arbitrage; art; coins; precious metals; and currencies; among others. What follows is a more in-depth examination of the key reasons to consider energy investing. CORE ASSET Producing energy is a core asset. What defines a core asset? From cellular division, which is fueled by nourishment, to the growing of food, the cleaning of water and the building of shelter, energy (in the form of oil, gas, coal, wood, fire, sunlight, waves or wind) is required for every living
If the economy fails, humans will need four things: shelter, food, water and energy. thing on earth to survive and prosper. If the economy fails, humans will need four things: shelter, food, water and energy. If the economy prospers, energy is the core requirement and the driving factor in every process known to man. In my discussions with audiences about energy, I challenge
53
every participant to think of a single item on the planet that does not require some form of energy to be produced, grow and survive.
HEDGEABLE One of the drawbacks of investing in any type of real estate is the ability to hedge price fluctuation, which can greatly impact the value of real estate, as seen during the market crash of 2008. The price of producing energy has the ability to be hedged against loss of value and, thus, loss of capital. By protecting the future price
A large percentage of the “easy” and cheap oil has already been discovered. 54
140.00 120.00
Heating and Electric Power Oil Products Oil Transportation Natural Gas Coal Nuclear Hydroelectric Other
Quadrillion B’
PREDICTABLE INCOME Predictable income is a common characteristic of the producing energy business. Once an oil and gas field has been established and defined, the future income of the property can be estimated using analysis of the production decline curve. The production decline curve shows the amount of oil and gas produced per unit of time for several consecutive periods and, if projected, will furnish useful knowledge as to the future production of the well. This analysis helps in valuing a property. In special situations, volumetric calculations (total storage capacity of the reservoir times the recovery factor per acre) is also used to estimate energy reserves. In the wind and solar energy business, future production of energy can be modeled using historical studies conducted for decades prior to installation of the generating facilities.
US Energy Consumption
Courtesy of the Energy Information Agency (EIA)
2.8
100.00 80.00
23
60.00
23
40.00
27
20.00 0.00 1950
3.4 4.1
13 1960
1970
received for the produced commodity — be it oil, natural gas or electricity — the investor may protect future profits by hedging the production price. For oil and gas, overthe-counter oil and natural gas commodity contracts and/or options (“puts” or “floors”) are used, where the counterparty is the market. For electricity generated from solar or wind power, this hedging is accomplished using futures contracts on electricity, with the counterparty being the actual distributor of the electricity, such as an electric utility company or, in the case of large commercial users of electricity, a manufacturing plant or mining operation. NATURAL INFLATION HEDGE Unlike luxury items, demand for energy is not materially affected by inflation. If inflation becomes an issue in the economy, luxury items suffer greatly and demand for these items declines. However, because of its core status, producing energy reserves contain a natural hedge against inflation. When money loses value, as has occurred with the U.S. dollar over the past many years, the price of energy automatically adjusts to compensate. When the buying power of the dollar drops 10 percent, the price of energy rises 10 percent, in keeping with the laws of supply and demand. In the oil and gas business, there is a theoretical break point where energy can become too expensive to purchase, but as inflation occurs and the value of the currency fluctuates, the value of energy compensates, and this theoretical break point has remained undiscovered and unproven.
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POTENTIAL FOR GROWTH As the above chart shows, demand for energy is endless. Due to constant growth in global demand and dwindling supply of oil and gas, which is limited and uncertain, the demand for energy continually rises. Because of its “core” commodity status, the demand for energy is omnipresent, regardless of the economy or the psychology of the marketplace, without concern to interest rates or government spending, irrespective of what happens to the value of the dollar. We always have a demand market for oil and gas. If it can get to the marketing point, the commodity will sell. With regard to supply, finding sufficient oil and gas (exploration and drilling) is the riskiest portion of the energy business. As a result of his 60-year global investing career, my father placed extreme value on a world-class oil and gas prospect, a prospective lease where chances favored the production of hydrocarbons in commercial quantities. He knew that the key to finding profitable oil and gas production was the quality of the prospect. Given the discovery of commercial hydrocarbons, the production process becomes a predictable and required activity. FAVORABLE TAX TREATMENT Due to its core commodity status and the risk required to find, exploit and produce oil and natural gas, today the oil and natural gas production business is blessed with some of the most favorable tax treatment from the Internal Revenue Code available to any global investor. Some of the ways realAssets Adviser | November 2014
in which this favorable treatment can be realized include: 1. Intangible Drilling/Workover Costs: The expense of drilling and completing (installing the well) or working over (repairing) a well may be expensed by the owner as “Intangible Drilling Costs” in the year that they occur. If you are a working interest owner (a partner that pays the bills), these expenses may be taken against the ordinary active income of the taxpayer. 2. Dry Hole Costs: All exploration expenses, including leasehold costs, may be expensed in the year spent if a dry hole is drilled. 3. Capital Depreciation: On producing leases, leasehold costs are generally capitalized along with the “tangible” portion of the installation or workover process, such as recoverable pipe, pumps, surface equipment and other equipment that may be salvaged when the well is plugged. These items are depreciated using short-term (five or seven year) depreciation rates, depending on the class of asset. 4. Percentage Income Exclusion from Income Tax: Once a well is put into production, only 85 percent of the gross income from oil and gas production is taxable as income; 15 percent is not subject to any form of income tax because it is considered depletion of the producing asset (known as the “depletion allowance”). For working interest (bill paying) owners, this income is offset by any expenses of producing the oil, liquids and natural gas (known as operating expenses), severance or property taxes, and required maintenance/workover costs. Intangible expenses (non-salvageable portion) are written off in the year spent while the tangible costs are depreciated. 5. Percentage Depletion Allowance Allowed Every Year: Another benefit not found in any other asset class is that the depletion allowance (15 percent of gross income) is available every year of production. Regardless of the owner’s basis in the property, the owner may take 15 percent depletion allowance off the top of the gross income for 100 years if the property produces in paying quantities for 100 years. The era of cheap oil is behind us. It is common knowledge that, during the next 100 years, oil and natural gas will give way to other realAssets Adviser | November 2014
energy sources such as solar, wind, waves and nuclear as they become affordable and manageable. The media would have one believe that the new horizontal shale production made possible by the use of hydraulic fracturing (“fracking”) will sustain the supply for oil and gas for the foreseeable future. In fact, horizontal drilling has been an industry standard since the 1970s, and the first reported fracking was conducted in 1865 with the Roberts Torpedo. It is true that shale production has unlocked many new producing hydrocarbon zones, but the truth is that the storage capacity of those reservoirs is extremely limited when compared to historical oil and gas production. The simple fact remains that a large percentage of the “easy” and cheap oil has already been discovered, with future production being more expensive to the extreme. An example is the East Texas Field, which produced 5.2 billion barrels of oil from 1930 through 2000 and continues to produce today. This field was the largest oil deposit discovered in the world until the giant fields of Saudi Arabia (estimated 77 billion barrels) and the Prudhoe Bay field in Alaska (estimated 25 billion barrels) joined the discovered sites. The East Texas field produced 5.2 billion barrels from 148,000 acres (an estimated 37,000 barrels per acre). In contrast, the newly developing Bakken Shale/Dolomite (including the Three Forks formation) of North Dakota and Montana covers 128 million acres and has estimated recoverable reserves of about 7 billion barrels. Although the extent of the recovery from the Bakken/Three Forks will not be known for a few more decades, it is currently estimated that the recovery will be about 50 barrels per acre. The difference between these two fields illustrates definitively that oil and gas will be harder and more expensive to produce in the future than they were in the past by several orders of magnitude.
SUPPLY AND DEMAND IS ULTIMATE REGULATOR With regard to natural gas, one historical fact that seems clear is that “cheap energy prices are the cure for cheap energy prices.” As natural gas prices remain low, oil producers move to the higher priced liquid and oil products. As operators move away from natural gas, the supply diminishes and prices rise. Another factor affecting this scenario is commercial demand. As the price of natural gas lowers, electric utilities and commercial users move to natural gas as a cheap fuel causing increased demand. More natural gas vehicles are built. As demand grows and supply lessens (due to lower production following less drilling caused by the sustained low price), the price rises, causing oil and gas operators once again to explore and drill for natural gas, increasing the supply and, hopefully, stabilizing the price. In conclusion, the factors that drew our family to invest in producing energy are compelling. Energy is a required core asset with a predictable, hedgeable and protectable value; little reliance on the “psychology” of the global or local marketplace; an inherent indifference to interest rates or public market sentiment; possessing a natural hedge against inflation; providing favorable tax treatment; and with an uncertain supply and a continually increasing demand. These factors support our family mantra, “There are no greater assets to own, in certain or uncertain economic times, than producing energy in the ground.” Paul Thomas is a principal at Ledger Petroleum LLC, based in Abilene, Texas.
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[Sponsored Section] Two Oaks Investment Management, LLC is a registered investment adviser based in Fresno, Calif., with $26 million in assets under management.
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D
iversification is both a top priority and paramount concern for today’s investors. If nothing else, the most recent economic downturn reinforced the validity that a diversified investment portfolio has the best chance of weathering every type of investment climate. “Pursuing growth and income from diverse asset classes by utilizing common-sense investment disciplines” is more than a catchy phrase. It is the foundation for a core belief and strategy that can prepare investors for the future.
THE ROLE OF REAL ASSETS Studies confirm that the real assets sector is the fastestgrowing segment within the alternative assets space, and for good reason. With an estimated $4 trillion in market value, commercial real estate, for example, represents the largest asset class in the world. But until only recently, institutional-quality real estate has been unavailable to the investing public in a meaningful way. Institutional investors have long recognized the advantages of including commercial real estate in a balanced portfolio, for example, having doubled their average real estate allocations from 1997 to 2014, from an estimated 5 percent of total assets to 10 percent. Now more mainstream investors and financial advisers are adding real assets in a variety of investment structures to their portfolios for attributes that may not currently be available through other “alternative” investment vehicles. That explains why, today, private and institutional investors alike continue to embrace real assets for all the right reasons — steady monthly income, low correlation to publicly traded equities, and significant portfolio diversification. Two Oaks Investment Management has embraced these advantages and the real assets class since its inception. It is the basis for our investment philosophy — real assets give investors less volatility than investments solely in stocks and bonds thanks to the addition of a non-correlated asset class. This keeps clients invested and helps avoid getting caught up in the short-term emotions of the market, which can be detrimental to their financial health. This is borne out based on the returns from a portfolio comprised of a neutral allocation to stocks, bonds and real estate investment trusts over a 30-year holding period. Looking at a hypothetical portfolio invested onethird in stocks, one-third in bonds and one-third in REITs, and rebalanced to these weightings at the end of each month, reinforces the case for such a philosophy. Returns remain steady while portfolio volatility is reduced.
CORPORATE OVERVIEW Blake Todd was originally hired by the Santa Barbara Group of Funds to act as the portfolio manager of the Santa Barbara Montecito Fund (MONAX) on Nov. 1, 2005. Through a recently completed reorganization and creation of Two Oaks Investment Management, LLC in 2010, all assets of the Santa Barbara Montecito Fund have been converted to the Two Oaks Diversified Growth & Income Fund (TWOAX). The same investment philosophy is used in managing TWOAX, based on the following: Diversification Strategy • TWOAX invests in stocks, fixed income and real estate/real assets securities. • Utilizing our proprietary valuation methodologies, TWOAX maintains a 15 percent to 50 percent exposure in each of these asset classes. • Over long-term investment periods, our goal is to achieve reduced volatility while increasing capital and income. • Diversification does not assure a profit or protect against loss. Potential Cash Flow • TWOAX screens potential investments for dividends and income. • Investments must fit our proprietary investment strategy and show the potential to grow income over time. • We believe income streams can allow greater flexibility to weather market volatility. Seeking Quality • Our investments must meet stringent fundamental disciplines based on various metrics such as revenues, free cash flow, earnings and profitability. • These disciplines allow us the ability to filter through the vast investment universe and focus on securities we consider to be of highest quality. This is an actively managed, dynamic portfolio. There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses. To invest, please review the fund prospectus and contact your investment professional today. CORPORATE CONTACT Blake Todd CEO +1 888-806-8633 blake@twooaks.com www.twooaks.com
realAssets Adviser | November 2014
Return Comparison of Stocks, Bonds and REITs $250,000
$200,000
$150,000
$100,000
$50,000
1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
$0
Neutral allocation
S&P 500TR
Barclays US Aggregate
FTSE NAREIT TR
The referenced indices are shown for general market comparisons and are not meant to represent the Fund. Investors cannot directly invest in an index; unmanaged index returns do not reflect any fees, expenses or sales charges. The key is a long-term investment time horizon. In today’s real-time, “what is my investment doing today” mindset, most investors fall victim to the emotional aspects of the volatility of the market and do not stay invested for the long term. In fact, they tend to sell at the bottoms and buy at the tops. So the challenge is to keep invested to realize solid long-term returns. Lower volatility for investors’ entire portfolios will diminish the emotions of fear and greed that are the long-term investors’ worst enemy. ACHIEVING FINANCIAL INDEPENDENCE Professional investment advisers are focused on helping their clients achieve their financial independence. At Two Oaks, we define financial independence as “The assets you own produce cash flow in excess of your expenses.” We believe the most rewarding aspect of our roles as asset managers is the opportunity to work with clients to help them achieve financial independence, and we believe that a diversified portfolio including real assets provides investors with the greatest opportunity to reach their financial goals. Mutual funds that invest across a variety of asset classes, including stocks, real assets and fixed-income securities, can provide the best of both worlds — the benefits of a diversified investment strategy with the liquidity that many investors desire.
Blake Todd is the co-owner of Two Oaks Investment Management, LLC. Todd also was a partner at Crowell Weedon & Co. from 2006 to 2013. Crowell Weedon became a division of DA Davidson in August 2013. At Crowell Weedon, he manages individual portfolios for private clients and retirement funds under the Montecito Investment Portfolios program within the Crowell Weedon Asset Management Program. Prior to joining Crowell Weedon, Todd served as a senior vice president of The Seidler Cos. and a portfolio manager with Seidler Investment Advisors. Prior to joining Seidler, he was employed by Sutro & Co. – RBC Dain Rauscher from 1998 to 2005 as a branch manager, senior vice president and portfolio manager. From 1979 to 1998, Todd held various sales and portfolio management positions with Dean Witter Reynolds, Kidder Peabody and Shearson Lehman Bros. Jarrett Perez, CFA, is a co-manager of Two Oaks Investment Management, LLC. Perez also has worked at DA Davidson’s Crowell Weedon & Co. division since 2006. At Crowell Weedon, he is the assistant portfolio manager for private clients and retirement funds in the Crowell Weedon Asset Management Montecito Investment Portfolios program. Prior to joining Crowell Weedon, Perez held various sales and operational duties with The Seidler Cos. and UBS – Paine Weber beginning in 2002.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Two Oaks Diversified Growth and Income Fund. This and other important information about the Fund is contained in the prospectus, which can be obtained by calling 559.375.7500. The prospectus should be read carefully before investing. The Two Oaks Diversified Growth and Income Fund is distributed by Northern Lights Distributors, LLC, member FINRA. Two Oaks Investment Management, LLC is not affiliated with Northern Lights Distributors, LLC. Index: S&P 500: an unmanaged composite of 500 large capitalization companies. This index is widely used by professional investors as a performance benchmark for large-cap stocks. You cannot invest directly in an index. Barclays US Agg.: covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities. The index includes bonds from the Treasury, Government-Related, Corporate, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS sectors. The U.S. Aggregate Index is a component of the U.S. Universal Index in its entirety. The index was created in 1986, with index history backfilled to January 1, 1976. Source: barclayhedge.com. Diversification: There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses. Risk: Investments in Mutual Funds involve risk including possible loss of principal. There is no assurance that the fund will achieve its investment objectives. Investing in the commodities markets through commodity-linked ETFs, ETNs and mutual funds will subject the Fund to potentially greater volatility than traditional securities. There is a risk that issuers and counterparties will not make payments on securities and other investments held by the Fund, resulting in losses to the Fund. The U. S. government’s guarantee of ultimate payment of principal and timely payment of interest on certain U. S. government securities owned by the Fund does not imply that the Fund’s shares are guaranteed or that the price of the Fund’s shares will not fluctuate. In general, the price of a fixed income security falls when interest rates rise. Lower-quality bonds, known as “high yield” or “junk” bonds, present greater risk than bonds of higher quality, including an increased risk of default. The value of the mortgage-backed securities held by the Fund may go down as a result of changes in prepayment rates on the underlying mortgages. Prepayment may shorten the effective maturities of these securities, and the Fund may have to reinvest at a lower interest rate. Real estate values rise and fall in response to a variety of factors, including local, regional and national economic conditions, interest rates and tax considerations. In addition to the risks facing real estate securities, the Fund’s investments in Real Estate Investment Trusts (“REITs”) generally involve unique risks. REITs may have limited financial resources, may trade less frequently and in limited volume and may be more volatile than other securities. Securities within the same group of industries may decline in price due to sector-specific market or economic developments. If the Fund invests more heavily in a particular sector, the value of its shares may be especially sensitive to factors and economic risks that specifically affect that sector. Investments in lesser-known, small and medium capitalization companies may be more vulnerable than larger, more established organizations. realAssets Adviser | November 2014
4373-NLD-10/09/2014
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[
editorial board
]
Mary Adams
Melissa Joy
Executive Director Defined Contribution Real Estate Council
Partner, Director of Wealth Management Center for Financial Planning, Inc.
Norm Boone
Hugh Kelly
Founder & President Mosaic Financial Partners
Clinical Professor of Real Estate NYU Schack Institute
Brad Briner
Jonathan Kempner
Director of Real Assets Willett Advisors LLC
President TIGER 21
Victor Calanog
Vee Kimbrell
Vice President Research and Economics Reis
Managing Partner Blue Vault Partners
Ron Carson
Senior Advisor The Townsend Group
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)
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
Kevin Hogan
Chief Investment Officer Capital Innovations LLC
President Investment Program Association
Steven Wechsler
Julianna Ingersoll Director and CFO RREEF Property Trust Deutsche Asset & Wealth Management
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Asieh Mansour
CEO National Association of Real Estate Investment Trusts (NAREIT)
Robert White
Sameer Jain
President Real Capital Analytics
Chief Economist & Managing Director American Realty Capital
Richard C. Wilson CEO & Founder Family Offices Group
realAssets Adviser | November 2014
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Last Word
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Non-listed REITs: The Evolution of Income Record sales volume is driven by both investor value and performance.
T
oday, a confluence of factors is shedding new light on non -listed REITs and their place in a diversified investment portfolio. Many investors continue to recalibrate their portfolios to withstand historically low interest rates and a fickle stock market. And with some 10,000 baby boomers retiring daily, it is easy to see why so many are embracing income vehicles such as non-listed REITs to sustain and fund their lifestyles into retirement. As a result, in recent years non-listed REITs have surged in demand. In 2013 the industry recorded sales of $19.5 billion, up nearly 90 percent from the previous year. And through the first half of 2014, the industry is outpacing the previous year’s record first-half sales by another 2 percent, with approximately $8.7 billion through July 31.
Product performance continues to fuel interest in direct real estate. But while record sales growth is a strong indicator of healthy product demand, it is not possible unless the products are delivering value for investors. VALUE DRIVING DEMAND Product performance continues to fuel interest in direct real estate investments. In the past two years, 18 non-
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listed REITs, accounting for $34 billion of original investment value, have completed their full investment cycle and provided investors with an average rate of return of approximately 9.5 percent, according to Robert A. Stanger & Co. Recent projections show that $15 billion to $20 billion of maturing non -listed REITs will provide their investors with liquidity in the next 24 months. Along with performance, investors are finding the breadth of the non-listed REIT investment impact is expansive across America. Based on a review of publicly available 10-K reports filed with the SEC between 2003 and 2013, we know that 38 non-listed REITs purchased 443 million square feet of commercial real estate assets in the United States and abroad, carrying an investment value of approximately $76 billion. These are the shopping centers, office buildings, industrial warehouses and apartment complexes in your neighborhood. And at the end of 2013, more than 2 million individual investors held an average of $30,000 in non -listed REIT shares in their accounts. WHAT THE FUTURE HOLDS Product performance, favorable macroeconomic conditions and unprecedented demographic trends will continue to raise the profile of non-listed REITs. But so, too, will product innovation and the expansion of distribution channels. Updated industry standards for asset valuations and investor
By Kevin Hogan
account statements are positively influencing product development by investment sponsors. New products that offer daily pricing and multiple share classes, as well as trail commission options for financial advisers, are examples of the innovation driving wider adoption of direct investments. And, for the first time, we are seeing distribution agreements with wirehouse broker-dealers expand the reach of non-listed REITs in a potentially scalable environment. We know that investors are paying attention. Based on a recent study of 500 high-net-worth investors released by the IPA in February 2014: • 83 percent said commercial real estate will outperform or equal the equity market’s return over the next five years. • 45 percent of those surveyed who are familiar with non-listed REITs say they plan to include non-listed REITs in their future portfolio. As the direct investments industry continues to mature, the transformation of non-listed REITs into a widely accepted income vehicle is well under way, and the foundation for significant growth currently exists. Investor value, product performance, continued innovation, and positive macroeconomic and demographic factors will continue to be the catalysts for growth. Kevin M. Hogan is president and CEO of the Investment Program Association. realAssets Adviser | November 2014
ReISA is now AdISA Alternative & direct Investment Securities Association REITs / BDCs / 1031s / Private Placements / Oil & Gas / Equipment Leasing
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