RISK MANAGEMENT SERVICES

In today’s low interest rate environment, the search for yield is driving an increasing number of investment decisions. However, higher yield options are somewhat limited in more liquid investments, such as rated bonds or stabilized stocks or mutual funds, causing investors to seek out other avenues to achieve their income goals. Alternative investments are increasingly filling this need in today’s portfolio construction. However, such products are often selected based on quoted yield without taking into account the underlying risk-return tradeoff. The alternative investment industry may have lost track of appropriate compensation for the risk investors are assuming since stated yield often sells itself.

During my tenure at FactRight, we have conducted operational due diligence on more than 150 alternative investment sponsors. Some have been very large, some very small, and many in between. I consider myself very fortunate because I enjoy the work. I enjoy getting to know the people, learning about their experience, about their investment process and how they envision growing their business. Some of the due diligence process is inevitably tedious, and to a certain degree repetitive, but ultimately no two companies are alike and that is what makes it always interesting.

If you are thinking about putting an investor in a private placement one of the first questions you should ask is:

Lynn Lawson, Esq. is the founder of Advertising Regulatory Consulting, LLC, which provides advertising and marketing guidance to broker-dealers, registered investment advisors, product sponsors, and financial services industry associations. Prior to starting Advertising Regulatory Consulting, Ms. Lawson served as a manager in FINRA’s Advertising Regulation Department for 22 years. Ms. Lawson has advised product sponsors that FactRight has covered, and given her experience at FINRA, we believe she can be a valuable regulatory resource for product sponsors and wealth managers who are distributing alternative investments.

Many sponsors of DST programs are including section 721 UPREIT options in their potential exit strategies. Several factors are likely contributing to this evolution.

FactRight is seeing a trend in non-traded real estate investment trusts (REITs) that are seeking to diversify their funding sources by offering 1031 exchange investment opportunities with the potential to be UPREITed into the sponsoring REIT at some later date. The UPREIT transaction would be done under section 721 of the Internal Revenue Code, which provides for continued tax deferral of the original capital gains. These investment opportunities provide a significant opportunity to the right investors, and long as they understand the ramifications of such investments. Let’s look at the main considerations for determining whether investing in a DST program with an UPREIT option is appropriate for your client.

As far as true confessions go, this is rather lightweight: I love spreadsheets and financial models. There’s something about the designing, linking and debugging that is satisfying, even after several decades. There are always new analytic approaches and different formulas, not to mention Excel updates that add even more features.

Broker-dealers and RIAs need to have a robust due diligence process to satisfy regulatory requirements and make informed investment decisions with respect to private placements. And let’s face it, thorough due diligence of private placements does not always take a straightforward route. Investment strategies are wide ranging, transparency is typically limited, and offering structures often vary significantly, even for “similar” deals.

I’ve always been a big proponent of ongoing due diligence coverage on direct participation programs. Back when I was an assistant portfolio manager for a large mutual fund company, our coverage of a company certainly didn’t stop after the buy trade was processed. Later, as a product sponsor in the independent broker-dealer channel, I was struck by the disinterest in our selling syndicate once the selling agreement was executed.

Today, we’re talking about a place where the due diligence knowledge flows like wine, where the RIAs instinctively flock like the salmon of Capistrano. Are we talking about a little place called Aspen? No. We’re talking about the Fulfilling Your Fiduciary Responsibility—Research and Due Diligence for Alternatives panel at the Sealy Investment Securities virtual RIA Summit.