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Posts Tagged ‘REIT’

We certainly don’t need another case to justify the mistrust that consumers have of all things financial.  There’s been no shortage of scams, lawsuits and perp walks over the past couple of years.

Here is a recent example of a slew of cases involving broker-dealers selling either private placements or other illiquid securities that have ended up burning investors.

As reported in the Wall Street Journal and Financial Advisor magazine earlier this week (June 1), an independent brokerage firm with representatives across the country, has been accused of misleading elderly and unsophisticated investors without proper consideration of whether the investments were suitable.

The article reports that the brokerage firm sold billions of dollars of non-traded Real Estate Investment Trusts (REITs) to individuals since 1992 and pocketed more than $600 million in fees. Sales of these investments generated more than 60% of the firm’s total revenues.

Now there is nothing wrong with a REIT per se. They are great ways to buy into a diversified portfolio of real estate. And there’s nothing wrong with illiquid investments either.  They serve a purpose and have a place in a portfolio assuming that it makes sense for the individual.

The problem comes from the way these investments are sold by some in the industry who do not have the best interests of the client at heart. When there is a profit motive involved, there is the potential for misbehavior arising from this basic conflict of interest.

Brokerage firms are held to a certain standard called “suitability” which is a sort of legal test to see if a particular investment makes sense for an investor.  Presumably, a broker working for a brokerage firm will ask a range of questions about the investor’s income, other assets, investment goals and time frame.  Then a brokerage firm’s compliance department will review the information and the application for the investment before the purchase.

Red flags would be if an investor has a large chunk of money to be tied up in any one type of investment or asset class.  Another might be if the investor indicates that they need the cash for some specific goal on a certain date but the investment is tied up longer than that and thus subject to an early redemption penalty.

Apparently in this case, the brokerage firm did not even do this type of “due diligence” on the investors buying into the REIT.  For many who were not knowledgeable of things like asset allocation or reading complex investment documents, they allegedly simply relied on marketing materials provided by the brokerage firm.

In previous cases, we have seen how there has been an incentive by brokerage firms to not complete any significant due diligence on an investment product that is sold by their representatives. Investors who think that they are protected by a firm’s “compliance department” have often found that no one was really checking on the investments being offered.  And like the fox guarding the hen-house, there is the potential for hanky-panky.

And the one who pays is the investor.  In many cases, the brokerage firm gets paid twice:  A 1 to 2% “due diligence” fee paid by the investment’s sponsor and then from the 5% to 10% commission paid by the investor. And in some cases the brokerage only pocketed the fee instead of hiring the team of due diligence analysts.

There is a battle going on in the financial industry especially since the passage of the Dodd-Frank financial regulation reform bill.  While not the greatest, it did offer change.  And one key change was to implement a universal “fiduciary” standard on those working with clients.

Right now, stand-alone registered investment advisers (RIAs) and specifically fee-only financial planner and advisers already subscribe to a “fiduciary” standard.  The standard is a higher legal duty to do what is “best” and “right” for the client and not what is the highest profit option for the adviser’s firm.

In the recent David Lerner Associates case as well as many others, the inherent conflict of interest between profit for the firm and the products sold to the consumer is glaring.

In all likelihood, consumers searching for higher yields heard the sales pitches from brokers.  And remember that when it comes to investing, the motivations are either fear or greed. In this case, the “greed” of the consumers looking for higher rates of return met the “greed” of the brokers looking to sell the product.  It should be no surprise that supply met demand.

But it also clearly shows how the most vulnerable need special help.  While they may go to a broker or agent thinking that the nice guy is going to do what’s right by them, they end up paying a price because they don’t realize who is representing them in the transaction.

As investors search for yield they need to do more due diligence.  And they should not be afraid to be working with a fiduciary who can help them with a second opinion.

Brokers are not all bad.  They serve a valuable role in our financial system.  But consumers really need to know that not all financial professionals are alike and the help of a fiduciary may keep them from getting burned by their fear or their greed.

Now’s as good a time as any to once again get back to basics:  Protect yourself from scams with this guide from the CFP Board of Standards.

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Just when you thought it was safe to get back into the investing waters, talk of deflation has creeped back into conversation.

Why does it matter? Well, how you position your portfolio to deal with these two scenarios will make a big difference to your personal bottom line.

With inflation, your money is worth less the longer you hold onto it. So you’re more likely to spend in the now because prices may be moving up.

With deflation, your money may buy more later the longer you hold onto it as prices continue to drop. (Not good for a seller but a better deal for a buyer – just ask someone trying to sell a house in Florida these days).

Since consumers respond differently to these two opposing forces, the ultimate direction of them can have a decidedly different impact on how the recovery progresses because of the way consumers react and business respond to their actions. Ultimately, this will impact how to position an investment portfolio accordingly.

The Right Hook
During a fight a boxer may expect to be hit from both the right and left. It’s just not known when and with how much force. But a good boxer, like a Boy Scout, knows to be prepared.

First the economy has been peppered with jabs from the right that could result in higher inflation: expanding money supply, ballooning government deficits, higher commodity prices, weak currency value.

Given the huge inherited, current and projected government deficits here and abroad, the conventional thought has been that all of this government stimulus will ultimately result in “crowding out” private investment and raise the ugly head of higher inflation down the road. The prospect of higher taxes to pay for these past deficits also lends support to these thoughts.

Recent run-ups in certain commodity prices like oil and energy products have resulted in a rise in consumer prices in January bolstering fears of inflation.

The Left Hook

Now comes the left hook – the deflationary threat: asset prices continuing to fall, increasing slack in industrial capacity, and continuing pressure keeping a lid on labor expenses because of high unemployment.

Credit is still tight with bank lending down. While dollars have been pumped into the economy through the TARP program, it’s mostly sitting in bank vaults. Money that isn’t circulating isn’t a cause of inflation.

Recent economic reports have indicated that core consumer prices actually are flat, well below the 10-year average of 2.2%.

Despite some recent reports, housing prices and rents are down and still expected to fall in key markets, dampening the immediate threat of inflation.

Defensive Portfolios: Lessons from Spencer

The best and strongest home depends on your environment and the threats faced.

Each evening before putting our infant son, Spencer, to bed, we read a story. The favorite for now is


    The Three Little Pigs
(undoubtedly because of Spencer’s dad’s animation).

We all know the story: Three pigs, three houses built from different materials, one pig survives because of his well-built brick house.

The same can be said for portfolios. Heck, a house of sticks can provide some shelter in some circumstances but what happens if a big bad wolf shows up?

Since we don’t know which type of bad wolf will be showing up at the door (inflation or deflation), it makes sense to be positioned to survive either threat.

The elements of a portfolio will likely be the same regardless of an investor’s mind-set. The differences will be in the proportion of the components used.

Inflation Protection Portfolio
To protect this type of portfolio consider elements more likely to retain value even as inflation increases. Example: Commodity funds or ETFs; inflation-linked fixed income funds that include TIPS and/or floating rate notes; Real Estate Investment Trusts or REIT funds (10%); Cash to take advantage of higher short-term interest rates.

Deflation Protection Portfolio
The majority of this type of portfolio is positioned in long-term Treasurys followed by cash and municipal bonds. As consumer prices and interest rates fall, the fixed income stream from the bonds would be worth more.

To protect against surprise inflation, a smaller proportion would be set aside into TIPS, commodities and higher-quality/large cap US stocks.

Little Pig, Little Pig, Let Me In
Not sure where the market will go? Not sure which threat to expect? Learn from the third little pig: Build the strongest house possible.

If there is inflation, the economy will be expanding. As such equities will be the place to be. So consider an allocation of 20% to 25% in the US and a like amount in foreign equities. A portion of these equities should include high-quality firms that are dividend-paying. Commodities and cash will likely benefit from inflation so a 10% allocation to each is prudent. The fixed income component can include some exposure to TIPS (5%) as well as intermediate high-quality bonds (20% – 30%).

To hedge against the risk of deflation, a portfolio with exposure to municipal bonds (5%) and long-term Treasurys (5% – 10%). And some of the equity portfolio should include exposure to consumer staples that tend to do well in such an environment.

To provide some added diversification consider adding positions in companies that focus on infrastructure and firms that can maintain pricing power like utilities, pipeline operators and the like.

Taking these steps should allow an investor to sleep better at night. At least it works for Spencer.

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