Opportunity Zones: Beyond the Hype

This piece was originally published on WealthManagement.com.

Opportunity Zones are the subject of endless speculation and conference fodder, especially in commercial real estate investment circles. As most know, these zones allow investors to defer and reduce taxes on any gains from property or business equity from investments in Qualified Opportunity Zones. A recent Prequin survey found that to date, capital raised by private real estate has reached $946 billion, with $124 billion raised in 2018 alone.

Despite the hype, wealth advisors and financial professionals need to be diligent in how they research and evaluate Opportunity Zone investments before recommending them to clients.

I’ve found that as the excitement grows around an investment vehicle, and advisors and reps are inundated with endless marketing spin, it can be hard to see the forest for the trees. Capital gets raised too quickly and is funneled into projects that meet the tax benefit criteria, but do not meet other fundamental requirements for sound investing. Before recommending an Opportunity Zone investment to a client, it is critical that you have a firm understanding of the investment in question, and the OZ program itself.

Understanding Tax Structure

There are three main benefits offered by Opportunity Zone investments: temporary capital gains tax deferral, a step-up in basis, and permanent exclusion of taxable income from OZ capital gains. It is important to note that temporary capital gains tax deferral is only pertinent to capital gains that are reinvested into a Qualified Opportunity Fund. In addition, investors must recognize their deferred gain prior to the OZ disposal date or before December 31, 2026. As with any client counsel, it’s important to determine if an investment of this length is suitable for that individual. It’s also equally important that the client understand what this expiration date means and can adjust other investments to ensure they meet their capital needs for everyday life.

On this topic of liquidity and how it relates to an investment cycle, the second benefit is a step-up in the basis for any capital gains reinvested in an Opportunity Zone project or business. I am constantly troubled by the apparent lack of understanding surrounding these nuances. Keep in mind that the basis is increased by 10% only as long as the investment is held for five years. If the OZ investment is held for seven years, the basis goes up by an additional 5% for a total of 15% — no small sum when we’re talking large investment opportunities and real estate developments.

The third and final benefit is a permanent exclusion from taxable capital gains income from the sale of an investment in an OZ Fund, as long as the investment is held for 10 years. This is relatively straightforward, but still must be communicated effectively to clients who may not realize just how long their investment is illiquid.

Beware of Misrepresentation

In order to meet the criteria to become a “Qualified Opportunity Fund,” a corporation or partnership must invest 90% or more of their holdings in a Qualified Opportunity Zone. The investments that qualify include partnership interests in businesses that operate in a QOZ, stock ownership in a business that conducts most of their operations within a QOZ, or ownership of assets that sit within an Opportunity Zone, like machinery or real property. All of this must be articulated by an advisor directly to their client so they know what they’re options are and what’s suitable for them.

Opportunity Zones work best as long-term investments that benefit both the investor and the local community. What I’ve found to be effective is moving capital gains from other investment opportunities into the right OZ Fund or property development, not just jumping into the OZ sphere with no regard for traditional fundamentals and due diligence.

Because of the tax benefits offered by Opportunity Zones, the term has become a popular buzzword in financial and real estate circles. Advisors and their investors need to be cognizant of the developers and money managers out there using the hype around OZs to raise capital, and act accordingly. As always, be thorough in your due diligence to determine whether a money manager is putting lipstick on a pig or providing a sound investment opportunity.

As a financial advisor, it is ultimately up to you to determine which of your clients might benefit from Opportunity Zone investments, even if real estate tax-deferral or reduction is the goal. If your client needs liquidity, or if they need to realize gains before the five, seven, or 10-year holding periods, OZ investments might not be the best choice.

Ari Rastegar is the Founder and CEO of Rastegar Property, a vertically integrated real estate investment firm, and Light Tower, a newly launched educational resource for investors.

Would You Take Warren Buffett’s Bet?

Tadas Viskanta, editor of the must-read Absolute Returns blog, asked the following question: “Let’s say Warren Buffett re-ups his famous decade-long bet. (He’s not.) He takes the S&P 500. What would you take (and why)?”

There were several really insightful answers (which you can read here). But the consensus seemed to be that the S&P 500 would crush the hedge funds.

I’m not so sure about that. While I would normally bet on the S&P 500, I’m a lot less enthusiastic about taking that bet with stocks at current valuations. The S&P 500’s return may very well be negative over the next decade, particularly if bond yields finally start to rise. Even cruddy mid-single-digit returns with 2/20 fees are likely to win this bet in that scenario.

Furthermore, the lopsided opinions here in favor of passive indexing gives more credence to idea that there is a bona fide index bubble forming here. It’s also worth noting that IPOs are few and far between these days, so the average S&P 500 is getting older, more mature and — likely — is less likely to enjoy past levels of growth. The world is awash in capital, which should lower the return on that capital for conventional investments.

We shall see. At any rate, here was my answer:

I would take Buffett’s bet on essentially the same terms: a basket of hedge funds vs. the S&P 500. I agree with Buffett that, over the long term, an index fund is likely to crush everything else, particularly after taking tax efficiency and transactions costs into account. But timing does matter, and today the S&P 500 is not priced to deliver positive returns over the next decade. Whether you’re looking at the CAPE, median price/sales ratios or any number of other indicators, they all suggest that the next decade will be disappointing. Even if a basket of market neutral hedge funds earning a mid-single-digit return will likely to beat the S&P 500’s return over the next decade. It’s not that most hedge funds are well managed or worth the cost; most are not. But there have been multiple stretches where market returns were negative or flat over ten years, and we may be in one of those stretches now. In a market like that, you win by not losing.

Alternative Investments Gone Wrong: The Story Of The Dallas Police Pension Plan


Alternative investments can both reduce risk and boost returns in a well-constructed portfolio, particularly at a time when traditional investments like stocks and bonds are expensive and priced to deliver disappointing returns.

But the key word here is can. Alternative investments can deliver that holy grail of higher risk-adjusted returns if chosen carefully and in prudent allocations. But if done poorly, alternative investments can just as easily take a wrecking ball to a portfolio and destroy years’ worth of gains.

As a case in point, consider the story of the Dallas Police & Fire Pension System (DPFP).

Dallas cops are in a dangerous line of work, a point that was made clear by the sniper attack this summer that tragically claimed the lives of five officers. But in exchange for the risks they take in keeping the rest of us safe, cops get certain perks, such as retirement at age 55 with a traditional pension plan. Well, today, those benefits are under serious threat.

After making a series of questionable investments during the go-go years of the real estate bubble, the DPFP took massive losses that effectively bankrupted the plan that over 9,000 current and former police officers, firefighters and their families depend on. Before the dust settles, Dallas taxpayers will probably have to shell out $600 million or more to keep the plan afloat, and the police and firefighters may be forced to work longer or accept benefit cuts. No matter what the final deal looks like, it will likely be a raw one for the police and firefighters… and for the taxpayers they serve and protect. And all of this is due to the incompetence of an investment manager.

What Happened?

Well, it made sense at the time…

Following the 1990s tech bubble and bust, the plan’s managers wanted to diversify outside of the risky stock market. But in order to make the targeted 8.5% return, bonds weren’t going to cut it. So the fund diversified into the wild, wild west of alternatives.

Hey, I get it. What was true in the early 2000s is even more true today. Stocks are expensive and looking wobbly, and bonds yield so little as to be unworthy of consideration for many investors. But what the fund’s managers did next is remarkable for its lack of basic prudence and common sense.

At one point, the fund had over half of its investments in alternatives. Now, in a vacuum, that’s not necessarily a bad thing. The Harvard University endowment fund has famously kept about half of its portfolio in alternatives for years. It’s the particular choices of assets that the DPFP held that should have been a major red flag. Among other questionable assets, the fund owned interests in the American Idol production company, luxury homes in Hawaii, a Napa vineyard and Uruguayan timberland.

I think there might have been some oceanfront property in Arizona in the mix too.

Not All Alternative Investments Are Created Equal

Apart from sheer strangeness (Uruguayan timber?), the alternative investments owned by the Dallas police pension had some other aspects in common. To start, all were extremely illiquid. Now, illiquidity is not necessarily a deal breaker. I’m comfortable with an asset being somewhat hard to sell so long as it is relatively safe and throws off consistent income. For example, the Dallas police would have probably been perfectly fine owning a diversified portfolio of rent-producing apartments or warehouses… but instead their managers bought them glitzy luxury properties and raw land held for speculation.

Along the same lines, the assets they owned, in general, did not have observable prices. Now, again, that is not necessarily a deal breaker by itself. It’s silly and cost prohibitive to get real estate appraised every month, and appraisals might not be accurate in the absence of reliable comps. And investments in private equity or private individual businesses also lack observable prices. But this is why you keep investments like these as a small piece of your portfolio and, again, make sure that they throw off a reliable stream of current income.

Doing It Better

So, how can we avoid falling into the same traps that ensnared the Dallas police and firefighters? After all, with stock and bond prices still very elevated, the case for alternatives is stronger than ever. So how can we avoid investing in alternatives that blow up?

To start, use the same common sense you would use in a traditional stock portfolio and keep your position sizes reasonable. What is “reasonable” may be subjective, of course, but common sense applies. Putting 10%-20% of your portfolio in a single alternative fund may be completely reasonable if that fund is itself very well diversified and liquid. Putting 10%-20% of your portfolio into a single property or into an operating business in which you are a passive investor with no operational control is probably not reasonable.

When I put together an alternative portfolio, I generally like to see four conditions in place:

  1. The alternative investments should be uncorrelated to both the stock market and to the other alternative investments in the portfolio.
  2. The returns should be consistent and, ideally, have a current yield component.
  3. The assets should be relatively liquid. I don’t have to have 24-hour instant liquidity, but I need to know that my clients can get their money out in a month or two if they need it.
  4. The investment should have observable prices or, at the very least, accurate financial statements that give me an indication of financial health.

In the interests of full disclosure, I co-manage a liquid alternative robo advisor specializing in risk parity strategies. So, I’m obviously a believer in alternative investments and make them a major part of my practice.

The pension crisis has led many Dallas police officers to retire early and request a full distribution of their pension out of legitimate fear that the plan will fail. If you’re one of those officers, give my office a call to see if our liquid alternatives might be the answer for your portfolio.

Charles Sizemore is the principal of Sizemore Capital Management, a registered investment advisor based in Dallas.

This piece first appeared on Forbes.

Taking Their Pound of Flesh: How Much Should You Pay an Alternatives Manager?


My friend and colleague Ari Rastegar was mentioned by the Wall Street Journal this week.  You can read the full article here, but I’ve covered some of the highlights below.

If you think paying a 20% cut in profits is steep, try paying 25% or 30%, or how about 50%?

Ari Rastegar, who worked for Chelsea Hotels Chief Executive Ed Scheetz and real-estate investor Nate Paul, is striking out on his own to raise $250 million to $500 million for a fund that invests in income-producing real-estate assets like self-storage facilities and discount retail locations in secondary and tertiary markets, a person familiar with the situation said.

He is proposing a 1.2% management fee, and would take half of the profits above an investment return hurdle of 8%, the person said. The fund also deviates from standard private-equity practice in not charging commissions and fees on acquisitions and add-on purchases, or for monitoring investments, in the hope of ditching the complexities in fee structure and better aligning with investor interests, the person said.

Although it is an extreme example, Mr. Rastegar’s fee structure is a reminder that the two-and-20 compensation model that many private-fund managers typically employ is primarily a behavioral norm, albeit one that is deeply entrenched in investor mind-sets.


Charles here. As I recently wrote in In Defense of Hedge Funds, you shouldn’t automatically discard a hedge fund or other private investment because of high fees. If the fund is doing something truly unique, adding real diversification to your portfolio by being uncorrelated to your existing investments, and posting good returns, high fees might be completely reasonable.

Should you pay the standard 2% of assets and 20% of profits to a long-only large-cap growth fund? Absolutely not. In highly-liquid and efficient market like large-cap equities, you’re probably better off going with a Vanguard ETF or mutual fund because it’s highly unlikely the manager will outperform enough to justify the fees. But if your alternative manager is adding real value and giving you something you’re not getting elsewhere, you shouldn’t begrudge them their pay. They earned it.

In fact, a high incentive fee — if structured well — will incentivize the manager to work harder at creating value. Just make sure you understand the fee structure and that you’re not incentivizing the manager to take excessive risk at the same time.

As the WSJ continues,

Now that the investor conversation has focused on fees, it is hard to steer it back to performance. Rastegar’s fund is an attempt to do just that. So far, some high net worth investors and one public pension fund, the District Attorneys’ Retirement System of Louisiana, have signed up for the fund.


Charles here again. While I applaud Vanguard and other low-cost pioneers for saving their clients money, I do find it discouraging that cost is the only factor a lot of investors bother to consider these days. Fees matter — a lot — but performance and diversification can matter more. Most patients don’t choose their doctor or dentist based on the lowest cost. Cost is definitely a consideration, but they focus on quality and reputation first. I’d recommend you take the same approach with your investments. It’s perfectly reasonable to pay up, so long as you’re getting value for your money.

Why I Built a Liquid Alternative Robo Advisor

liquid alternative robo advisorMost financial advisors and money managers are terrified of robo advisors. And frankly, if your job description consists of selling expensive mutual funds for a commission, you should be worried. Your business model has been slowly dying for decades, and low-cost robos are the final nail in the coffin.

Technology and competitive capitalism are doing to the financial services industry what they have already done to countless industries before. They’re cutting out the middle men and passing the savings on to the ultimate consumer. That’s a good thing. A very good thing, because every dollar saved in fees is a dollar that remains in your clients’ account to compound and grow over time.

Upstarts like Betterment and Wealthfront (as well as old hands like Vanguard) can build decent traditional stock and bond portfolios that perform every bit as well as the average man-made portfolio. But where they have been less effective is in the alternative space. And this matters — a lot.

As I wrote recently for Forbes, the traditional 60/40 portfolio is dead, and it’s not coming back any time soon. With both stock and bond prices extremely elevated, returns are almost guaranteed to disappoint over the next decade. Bonds, in particular, have gone from offering a “risk-free return” to offering a “return-free risk.” So, investors wanting to earn a respectable return will be increasingly pushed into alternative investments, such as hedge funds (see In Defense of Hedge Funds…).

But the problem with hedge funds is that they are only available to the wealthy, and they tend to have high minimum investments and high fees, along with limited liquidity and transparency. While hedge funds can make all the sense in the world in the right portfolio — and I use them extensively with my accredited investor clients — they obviously won’t work for every investor.

And this is precisely why I created a liquid alternative robo advisor. I wanted my clients to have access to some of the same strategies used by multi-billion-dollar hedge funds. But I wanted to make them available to all investors rather than just the wealthy ones. And I wanted to do it at a reasonable price with full transparency.

Our liquid alternative robo advisor takes clients through a risk questionnaire, much like the more mainstream robo advisors. But rather than dump them into a generic stock/bond portfolio, it assigns them to a volatility-targeted risk parity portfolio. (For a longer explanation of the strategy itself, see our presentation.)

Our fees, at 0.80%, are a little higher than those of Wealthfront or Betterment. But remember, we’re not competing with these traditional robos. We’re competing with hedge funds and other alternative managers,  which generally charge 2% of assets and 20% of profits.  And our solution is held in separately managed account at a reputable third-party custodian.

Creating the liquid alternative robo advisor allows me to serve clients I’d otherwise never be able to serve. The biggest impediment to an advisor growing their practice is time. Your instinct is to try and serve every client that knocks on your door. But the reality is, you can’t. There aren’t enough hours in the work day to do sit-down meetings with clients that have only modest sums to invest. Time has a monetary value, and unfortunately, you actually lose money on smaller clients. And you have the same amount of regulatory compliance responsibilities with a $10,000 client as a $10,000,000 client. Arguably, you actually have more.

But a robo setup changes that. With a robo setup, you can still profitably serve smaller clients, get them the same portfolios you would give a high roller, and all the while keep the regulators happy. A robo setup also allows a larger client to “kick the tires” and try out your services before committing a larger portion of their net worth to your management.

The financial advisory business is changing — quickly. With the rise of the robos, there will be a lot of attrition, and a lot of marginal advisors will end up folding their practices. If you want to survive and thrive in this line of work, you need to bring something new to the table. My advice is embrace the robo and build one that leverages what you do best.

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital, an investments firm in Dallas, Texas.