Remember the old line about the “elephant in the living room” and how it referred to a subject no one wanted to address even though it was obviously something that should be discussed? Well, there’s an elephant in the alternative investment (AI) industry living room right now, and he’s been there quite a while. But in this case, the first firm to start talking about him will benefit by gaining substantial sales!
The elephant is AI share valuations. Silence. Crickets. The third rail in some circles. Why is the AI industry (asset sponsors, B/Ds and large RIAs alike) loathe to discuss share value in any terms other than offering price or NAV? Because the FMV of illiquid non-traded assets is typically much lower than either NAV or the current offering price. This is due to the fact that a true FMV analysis takes into account that a client holding shares of a typical alternative asset cannot convert their shares to cash on any given trading day. And they certainly cannot convert their shares into cash equal to NAV or offering prices. Even most redemption programs require the client take a haircut on the price paid to redeem if they are able to redeem at all.
Consider secondary market trading in AI assets. How do those prices compare to the asset sponsors’ reported NAVs or offering prices? They are often twenty to fifty percent less than reported NAVs. However, these prices are more indicative of true FMV since they represent third party willing buyers and willing sellers coming to terms on a price for the asset.
Everyone understands the desire of AI sponsors and selling B/Ds to only deal in terms of NAV and offering price because it’s less scary and doesn’t make it appear they’ve lost money for clients. The common fear is that showing a FMV substantially lower than the current offering price or most recently updated NAV will upset clients. However, this type of thinking results in significant lost AI sales opportunity.
FMV is the required value for all tax reporting instances when an AI shareholder engages in some taxable event with their shares. Thus a low FMV is an attractive feature to clients when a taxable event occurs! Such taxable events can be Roth conversions, IRA distributions, estate tax calculations, gift and estate tax planning scenarios and more. AI sponsors and others are so busy making sure they only report NAVs and offering prices that they are in fact harming many clients that could substantially benefit from the reduced FMV figure for tax purposes. Sure, each individual client can go out and retain their own appraiser to provide a FMV, but the client must bear the cost and administrative hassle. They or their advisor also must realize that such an opportunity is available. Many do not.
Therein lays the advantage to the firm or firms that start talking about the elephant before the competition. For example, an advisor is considering between two similar AI products for their clients. One firm educates the advisor (and maybe even the client) on the differences in NAV and FMV, highlights the tax planning benefits of knowing both numbers and offers to provide both figures on an ongoing basis. The other firm gives the same old sales pitch about non-correlated returns, asset diversification and institutional quality management. Not only will the advisor place the business with the firm that added significant value to his practice and clients, but he will also recommend the client increase their allocation to the AI to take advantage of the extra tax benefits in addition to the investment performance.
Understanding and talking about these additional benefits inherent in many AIs can also increase the number of referral sources for both advisors and the AI sales teams. Attorneys and CPAs needing tax planning solutions for clients will seek out advisors and AI sponsors that understand these concepts and can help apply them to their client cases.
AI sponsors, selling B/Ds and large RIAs have a unique opportunity to be first in their field to highlight these advantages and use them as selling tools. The firms that embrace the opportunity as early adopters will reap the lion share of new business before the competition even realizes what is going on.
Author: Joe Luby, CFP®
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P.S. Shameless sales pitch – Jagen™ has consulting programs designed for AI sponsors, B/Ds and large RIAs that want to be introduced to the elephant and significantly increase sales. We are only accepting four such clients into our 12-month program during 2012 (program runs twelve months from engagement, not on calendar year). If you want to be one of the first in the industry to take advantage and increase sales by understanding and marketing these unique opportunities, contact us today. For more information you can also visit our consulting services page by clicking here.