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Helping Clients Understand the Key Milestones for Non-Traded Alternatives

You can help your clients make more informed decisions about non-traded alternatives—and avoid surprises—by talking through key stages in advance.

For investors, knowledge is power. As an advisor you can help increase their knowledge about specific asset classes. They probably understand the basics about investments like stocks and bonds. They probably understand what “buy and hold” means, and why market timing is almost always a bad idea. But for other asset categories, like non-traded alternatives, you may need to explain more about the typical lifespan and key milestones of a particular investment.

This is particularly true given that some non-traded alternatives are long-term investments with limited liquidity. After all, the more informed your clients are, the less likely they’ll be surprised by changes in the investment over time, and the more they’ll see you—their advisor—as a trusted partner.

Broadly, non-traded alts have life cycles that span multiple years, with three distinct stages that make up a clear beginning, middle, and end. Each of those stages gives you a chance to clearly spell out some critical information.

Phase 1: Raising capital (1-3 years).

This initial period is when clients first make the decision to invest. At this point in the process, the investment program is focused on buying and managing assets that line up with its investment strategy. Depending on the area of focus, the company may be acquiring private companies, real estate or other assets.

At this stage, your conversations with clients should aim to explain the investment strategy and how the particular asset could fit into their portfolio. It’s also a chance to emphasize the long-term nature of the asset, which key milestones are coming, and approximately when they’re likely to occur. (Of course, you’ll want to revisit each of those milestones as they get closer.)

You can also talk about some of the nuts-and-bolts aspects of the investment. For example, you can tell clients that initial statements may show their investment value net of any front-load fees that may apply. (For more on how to talk about fees with clients, see our recent post on the topic.) You can tell them that distributions may occur in the form of cash, stock or a combination of the two, depending on how the investment is structured. This is also a good time to remind your clients that distributions are not guaranteed and may not always be covered by the investment’s performance, especially during the early stages while assets are being acquired.

Phase 2: Managing the portfolio (2-3 years).

Once the investment has raised enough capital and is closed to new investors, the company shifts gears to start managing the portfolio of assets. Depending on various factors, cash distributions typically continue during this phase. However, it’s not uncommon for share distributions to end. This typically occurs because the investment program is no longer taking on new investors or making new investments through a distribution reinvestment plan (DRP). Essentially, new shares would result in slicing the same sized pie into more and more pieces.

Also, you can clarify that the actual lifespan of the investment may change. In some cases, the company’s board of directors may decide to shorten or extend the offering, which will affect the length of investment and the period during which liquidity is limited.

3. Exiting the investment (1-2 years).

During the third stage, the company works with investment banks to sort through options for an exit strategy, which include listing the investment publicly or liquidating it. If it has not occurred in the previous phase, all distributions, DRP and SRP, typically end during this period primarily because managers want the portfolio’s capital to be fully invested in an effort to maximize its value and minimize any cash-management requirements. This is the time when management looks to enact the details of its exit strategy. If a liquidation occurs, assets may be sold piecemeal in an effort to maximize returns. Any potential proceeds may be distributed as one-off special distributions or all at once when the liquidation is complete. Public listings increase shareholder liquidity and will provide a new prospectus that may outline future plans for distributions.

As with all client communication, you should tailor your message to the needs and sophistication level of individual clients. Repetition and clarity are key. Clients may not remember the initial conversation when you recommended a particular investment, so you need to make sure they have a strong understanding of the process at each stage.

That kind of communication takes time, but it pays dividends in the form of clients that are more informed and educated about how their money is being put to work.

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