Advisor Series: Know Your Broker by the Thing He Sells

Bob Stowe |

        A potential client called recently and asked about our services. He explained that at retirement this year he became a client of a big broker and was interested in a second opinion of the portfolio they sold him. He has good reason for concern.

        Several clients who have transitioned to us from brokerages in the past few years have a type of security called a non-publicly traded real estate investment trusts (REIT) in their portfolios. Designed to be sold by brokers to small investors, many of these have failed to live up to investor expectations while lining the pockets of the brokers that sold them.

        Most, if not all, securities, stocks, bonds, mutual funds and exchange traded funds sold by fiduciary, fee-only registered investment advisors are publicly traded and very liquid. A fund traded through Stowe Financial Planning, LLC, a fiduciary company,  will be completed in a public exchange and will take about three days to clear. Non-traded funds are different. There is no public market for the funds. Sometimes the REIT itself will make some money available for repurchase but not nearly enough to create a liquid market. If you own the fund and it fails to perform you have no recourse but to continue to own it.

        Non-traded REITS became popular during the real estate boom that ended in 2008. The reason for buying them at the time was clear. For investors it was a way of getting a good dividend and participating in the red hot real estate market. For brokers, it was up front commissions of 5-10%. These REITS were generally supposed to last for 7-10 years and then cash out, be sold to another company or go public. So far some have cashed out, but valuations have been disappointing. Responding to recent pressure from the SEC, many have begun updating valuations. Because these are privately held funds, there is not day to day market pricing and companies have had reason to avoid revaluing their securities. Revaluation of real estate from 2008 to today’s prices are generally disappointing from an investment perspective.

        When questioned, my new incoming clients were unaware and uneducated about the issues around non-traded securities in their accounts. They generally liked the dividends but were shocked to learn that these could not be transferred to my custodian with their other investments, forcing them to maintain a relationship with the prior broker long after that relationship has soured. They were further dismayed when the security was re-priced much lower than it original sale price. They are unlikely to recoup that price.

        In my opinion, the reality is brokers who were masquerading as advisors sold investors a high commission product that just passed the suitability test. The investor fundamentally misunderstood their relationship with the broker, probably over the improper use of the word ‘advisor’. Trusting a broker is like trusting any other salesman. He is probably a good guy personally but he works for himself or his company, not for you. Brokers sell products with advice. The advice is conflicted by the need to close the sale in order to be paid. The sale of a product fatally contradicts a fiduciary role.

Here is an article on some of the fallout of non-publicly traded REITS:


Written by Bob Stowe, CFP®