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Is That For Real?

Sigma Investment Counselors

August 20, 2012

Several weeks ago I received a solicitation from a local community foundation officer suggesting that we might want to recommend to our philanthropically minded clients an investment in their donor-advised fund. They showed investment returns that, on the surface, appeared quite solid. As I studied their performance data though, I learned that a material segment of the portfolio was invested in private equity as well as other securities that do not trade on public auction markets such as the New York Stock Exchange or the NASDAQ. Hence, no readily available, market-based pricing data was available for these assets. Without the pricing data, I wondered, how were they calculating their investment performance? I learned that they relied on estimates of the securities’ values.

On August 15, 2012, FINRA (Financial Industry Regulatory Authority) issued an alert to investors on its website titled, “Public Non-Traded REITs – Perform a Careful Review Before Investing”. It notes, “As their name implies, non-traded REITs have no public trading market. However, most non-traded REITS are structured as a “finite life investment,” meaning that at the end of a given timeframe, the REIT is required either to list on a national securities exchange or liquidate. Even if a liquidity event takes place, there is no guarantee that the value of your investment will have gone up—and it may go down or lose all its value. Indeed, valuation of non-traded REITS is complex. Many factors affect the pricing, including the portfolio of real estate assets owned, strength of the trust’s balance sheet (assets versus liabilities), overhead expenses, cost of capital and more. The boards and managers of non-traded REITs might even rely on third-party sources to estimate a per-share value.”

In an article that appeared in the May 4, 2012 issue of the Wall Street Journal titled “The New Nontraded REITs” concerns were raised about estimated values. The author reported that “…one nontraded REIT that specialized in shopping centers, Retail Properties of America, told investors last fall their shares were worth $6.95 each. Last month, when the company converted to a traded company, the shares were valued at $3.20 before a reverse stock split. Retail Properties declined to comment.”

As we have said many times in our past blogs, BUYER BEWARE. If an investment, or investment performance, appears to be too good to be true, maybe it is. All things considered, if given a choice, I would prefer a market price to someone’s estimate of value. Similarly, I would prefer performance data predicated upon prices from legitimate exchanges and not an estimate of value. If you are contemplating such an investment you should keep these issues in mind.

All comments and questions are welcomed.

Bob Bilkie, CFA

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