Qualified Opportunity Zone Funds

The Tax Cuts and Jobs act of December 2017 created a new type of capital gains exemption for investors in low-income areas.  Qualified opportunity zone funds (QOFs) have proliferated since that time, and are worth investigating and understanding.

In order to maximize the tax benefit, the investor begins by selling appreciated securities.  If invested into an qualified opportunity zone fund within 180 days, the capital gains tax on the realized gains will be deferred until 2026 (or as long as the investment in the QOF continues).  This date is important, because the capital gains tax is also reduced by 10% if the QOF investment is held for 5 years, or 15% over 7 years.  In order to hold the investment for 7 years, an investment into a QOF made from appreciated realized gains must take place by the end of 2019.

As implied above, another key to this tax reduction strategy is long term investment into the opportunity zone fund.  Taxes on the gains from the QOF are eliminated after 10 years.  The IRS has released several iterations of guidance on how these funds or companies must be set up and managed in order to meet the requirements for tax exemption.

For an investor considering a QOF investment, the taxes and holding period are far from the only considerations.  Most QOFs are real estate development projects, although they can also be other types of businesses.  Some funds include a single property or development, while others include a specific list of projects.  Blind pools are also available, meaning the sponsor will choose the properties or businesses and the investor does not know what they are at the time of investment.  Another important detail:  if the QOF is dissolved prior to the 10 year period, the tax benefit is lost.

QOFs are set up similarly to traditional real estate deals.  There are varying minimum investment requirements.  The sponsor will usually charge management fees ranging from 0.375% to 2% of fund assets per year.  There may be placement fees of 1-2% paid to brokers.  There is a preferred return set to be paid to all investors, often in the range of 5-8%.  The payouts for these funds are lower than those seen in traditional real estate, probably due to the tax benefit.  QOFs also include “promote,” which is similar to carried interest.  Once the preferred return is paid, the sponsor will retain the promote, often 20-30%, of any additional profits.  In this way, QOFs are similar to hedge funds or private equity, but with a very long (10 year) lockup period and the attractive tax exemption.

Obviously, the due diligence requirements for these funds are substantial:

  • What is the fund investing in?  Is it possible to evaluate those properties or businesses?
  • Who is the sponsor?  Do they have the proper capabilities?  Will they be an ongoing concern in 10 years?
  • Has the sponsor invested in the QOF?   As Taleb would say, “skin in the game.”
  • What assurances does the investor have that the QOF will, in fact, meet the IRS requirements?  It would be an unpleasant surprise to get to the end of 10 years and find out that the exemption is disqualified.
  • Can the investor afford the 10-year lockup period?
  • What are all the fees and costs associated with the QOF?

The benefits of these qualified opportunity zone funds accrue not only to the investors, through tax benefits, but also to the low-income communities that are targeted, through additional infusions of investment.  The idea here seems to be a win-win.  However, investment professionals looking with a more cynical eye may see a 10 year lockup and an investment structure created by a real estate developer.  Regardless of your view on the concept, this is definitely a case for “buyer beware.”





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Stay in the Game

Just read this.


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Market Timing

As of this writing, August 2019, the US and global equity markets have made substantial gains and hit all-time highs year-to-date.  However, the yield curve inversion earlier this year and other leading indicators are flashing warning signals of possible recession within the next few months to a year.  Based on these indicators, the Fed recently cut rates. We know that recessions are always accompanied by equity drawdowns. Is now the time to sell?

Let’s look at some data.  After making new all-time highs, do markets tend to revert to the mean or continue to grow?  From Dimensional:

Average Annualized Returns After New Market Highs
S&P 500, January 1926–December 2018


In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.

This chart strongly suggests that selling following all-time highs may not be the best strategy or timing tool.

Can we glean any useful market timing information from the Fed rate cut? Data is mixed.  From DailyFX.com:


Although the average and median returns are all positive for every time period studied here, there is a great deal of variation. Most troubling, the 2 recent Fed rate cut cycles show the only negative returns, and they each exhibit a very different pattern from the older data.  Has something changed over more recent history? Or will our current cycle revert to previous patterns?

Dimensional recently studied the performance of actively managed mutual funds and found that even these teams of money managers are not beating the market: over the last 20 years, 77% of equity funds and 92% of fixed income funds failed to survive and outperform their benchmarks after costs. Although market timing is not likely the entire explanation for this, it is certainly a component.

When considering technical or quantitative analysis methods, we can look at many rules-based ETFs.  ETFDB.com lists 83 ETFs as momentum- or quant-based.  Of these, only 19 (23%) lag their Yahoo Finance category returns YTD.  However, if we look at one-year returns, which include the drawdown in December 2018, a whopping 73 of 83 ETFs (88%) are underperforming their category (data from Yahoo finance).

What about valuations, such as the Shiller CAPE/10 or other similar growth/value metrics? John Hussman has studied these extensively.  His current hypothesis is that valuation metrics cannot be used as a timing tool.  He is studying other market metrics to combine with value, hoping to find the market timing holy grail.  Here is the latest market commentary which details these thoughts:  https://www.hussmanfunds.com/comment/observations/obs190714/

Once you successfully sell at or near a market top, what are the indicators that it is time to buy back into the equity market (presumably at a lower level)?  It’s important to remember that market timing success requires that the timing is correct on two successive transactions, not just one.  It is not safe to assume that the market low point is somehow identified by just the reverse, or inverse, of whatever timing tool is used at the top.  In other words, your model needs to be proven at both extremes to be successful.

For many advisors and clients, the simplest and most time-proven method of success in owning equities is simply to hold through the downturns, small and large.  Regardless of any other metric, more time in the market is associated with a greater likelihood of positive returns.  Again, from Dimensional:


Frequency of Positive Returns in the S&P 500 Index

Overlapping Periods: 1926–2018


In US dollars. From January 1926–December 2018, there are 997 overlapping 10-year periods, 1,057 overlapping 5-year periods, and 1,105 overlapping 1-year periods. The first period starts in January 1926, the second period starts in February 1926, the third in March 1926, and so on. S&P data © S&P Dow Jones Indices LLC, a division of S&P Global. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Past performance is no guarantee of future results. Actual returns may be lower.



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On Writing


The above is from Dan Martin via FPA blog.

1.) Write Like You Speak

2.) Read It Out Loud

  • First, it can help you practice and ultimately, master Tip #1 (writing like you speak).
  • Second, it can help you identify the areas where you need to add some qualifiers to simplify and clarify certain thoughts.
  • Third, it’s the best way I’ve found to ensure that content is conversational enough for your audience, and for the objective of the piece. Reading aloud will help you identify the areas of your work that really lend themselves to a conversational style (i.e., something that you, or at least some human being, might actually say), and those that need some adjusting.

3.) Edit, Don’t Sterilize

My last piece of advice on engaging writing is to remember that the small imperfections and quirks in your writing style are not necessarily bad things. I think some of these quirks make up an important part of anyone’s writing style, and not all of them should be eradicated through the editing process.


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Time to diversify?

Following the pullback at the end of 2018 and subsequent recovery, most analysts agree that we are likely near the end of the bull market. The 10 year – 2 year yield curve nearly inverted in December, and the 10 year – 3 month yield curve inverted in March. Other leading indicators have been mixed, as well.

Over the last several years, the best performing asset, by a lot, has been US large cap stocks. For those investing with a home bias, this has been a winning strategy. For those investing with global diversification, it’s been a long hard road.

Looking at valuations, it appears that emerging markets have the best opportunity for higher forward-looking returns, followed by international developed, with US equities coming in last (see https://mebfaber.com/2019/01/25/the-biggest-valuation-spread-in-40-years/). P/B, CAPE, and cyclically-adjusted CAPE values all suggest that the S&P 500 is due for a rough 10 years ahead.  However, this has been true for at least the last 3 years. John Hussman has been predicting low returns for far longer. If you examine his analyses (at http://www.hussmanfunds.com), they are clearly well researched and make sense. But they haven’t worked.

One unaccounted-for variable has been central bank interventions. This includes not only our Federal Reserve, but actions of the central banks of Europe and Japan as well.  You can find a monthly update showing the close correlation of the S&P 500 to the total of these balance sheets at yardeni.com. Since October 2017, the Fed has been reducing its balance sheet. Will this cause the US markets to decline? It appears that instead, the other central banks will increase their holdings to make up for at least part of it. The correction in December 2018 has been variously credited oil prices, revisions to 2019 earnings estimates and/or Fed balance sheet reduction. Of those three options, we have many years experience with two of them, and zero experience with the third.

One way to determine a sensible action plan is to think through possible outcomes and consider their likelihoods. Start with some assumptions:  Economic conditions are likely to either stay stable for the foreseeable future or weaken. Although it is possible for conditions to further improve, it seems unlikely based on most forecasts.  Central bank interventions will likely be contingent on economic conditions, which may include market conditions.

What are the possible outcomes of stable conditions vs. weakening conditions? We know that economic recessions are nearly always accompanied by market corrections. We also know that the US market is more richly valued than other markets, which may result in a larger over-correction in the next bear market. OR NOT! In Meb Faber’s article referenced above, notice that the US has been over-valued now for about 7 years. How long can this continue? Is it related to the Fed or to something else?

Many market observers, myself included, believed that this massive Fed balance sheet would cause sustained inflation above the Fed’s target 2%. We have been wrong. Before responding with, “CPI is measuring inflation wrong,” take a look at this article from Cullen Roche:  https://seekingalpha.com/article/4255137-hard-truths-inflation-truthers. His arguments debunking the idea are compelling. We have not experienced excessive inflation so far, but that doesn’t mean we can’t. Moderate inflation is possible, although hyperinflation in the global reserve currency remains unlikely. How to protect clients from inflation? The traditional answer has been real assets and commodities, with a newer option being TIPS.

Will the US dollar remain the primary global reserve currency through the next recession? Despite the ongoing buzz about how China and the yuan are taking over the world, the answer is almost certainly yes. This article explains why: https://www.thebalance.com/world-currency-3305931. What does that mean for our analysis? It means the dollar, and US Treasuries, are special compared to any other currency and any other security.

Conclusions for asset allocation:

  1. If you hold US government securities for diversification and stability, there appears to be a strong argument that they will continue to function well in this role.
  2. If you hold most of your equity allocation in US securities, this might be a good time to consider some diversification to a more global allocation, international developed and/or emerging markets. Please note, this involves home-bias risk, because clients will certainly see the underperformance of their portfolios if the current outperformance of the US market continues.
  3. If you have concern about possible inflation, consider a position in one of the traditional hedges, keeping in mind that while these positions have provided effective diversification over the past 10 years, this mainly means that they have been performing poorly compared to US equities and other investments.

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Rules of the wealthy

I’m not sure where “Family Wealth Watch” got this data or information, but it makes sense to me.

Focus on big wins (Edit: I think this should say Focus on Big Goals)

Working hard is not always the right answer. Working hard on the right things is how the elite compete.

Not thinking about retirement in your 20s? Think again.

There will be areas in your financial life that disproportionately affect your chances of achieving financial success. By paying significant attention to these areas – such as eliminating debt, building substantial savings and investing early – the wealthy are able to leverage big financial wins.

Action always beats inaction

Most people feel stuck when it comes to making decisions about money. Information overload and analysis paralysis lead to inaction, which can frequently be the greatest impediment for financial progress.

Being decisive regarding money is vital to building small wins along the way toward wealth. This type of momentum, or consistent progress, contributes to overall success, according to Harvard researchers.

Intangible goods are the greatest in value

How you spend your money matters.

Experiential purchases offer some of the highest returns on investment. By prepaying for trips, vacations, or concerts, you allow yourself to extract the pleasure of the purchase before the event and for years afterward.

Another powerful mechanism that offers high returns on your spending is to invest in yourself. Continuous self-improvement pays off in many ways — and over the long term.

Intangibles, like the financial freedom to make a career change or take a year off to travel, are much more rewarding than a quickly depreciating asset.

Delayed gratification trumps impulse

According to financial experts Thomas Stanley and William Danko, most American millionaires have never spent more than $400 on a suit or $200 on shoes.

Delayed gratification is a learned behavior. And it is often the strongest predictor of success.

Confidence is a commodity

Confidence can be mined. With a deluge of personal financial advice already in the market, creating confidence assists in the decision-making process.

Confidence-building techniques should be part of your daily routine. And according to research studies, there is a strong correlation between positive self-talk, confidence and performance. Additionally, inward questioning and regular rewards allow individuals to continually foster confidence.

This allows room for wealthy thinking.

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when to put down your pet

From NYT:

To help pet owners make decisions about end-of-life care, Dr. Villalobos developed a decision tool based on seven indicators. The scale is often called the HHHHHMM scale, based on the first letter of each indicator. On a scale of zero to 10, with zero being very poor and 10 being best, a pet owner is asked to rate the following:

  • Hurt: Is the pet’s pain successfully managed? Is it breathing with ease or distress?

  • Hunger: Is the pet eating enough? Does hand-feeding help?

  • Hydration: Is the patient dehydrated?

  • Hygiene: Is the pet able to stay clean? Is it suffering from bed sores?

  • Happiness: Does the pet express joy and interest?

  • Mobility: Can the patient get up without assistance? Is it stumbling?

  • More: Does your pet have more good days than bad? Is a healthy human-animal bond still possible?

Dr. Villalobos says pet owners should talk to their vet about the ways they can improve a pet’s life in each category. When pet owners approach end of life this way, they often are surprised at how much they can do to improve a pet’s quality of life, she said.

[Try Dr. Villalobos’s scale: Assess Your Pet: Is It Time to Say Goodbye?]

By revisiting the scale frequently, pet owners can better assess the quality of the pet’s hospice care and gauge an animal’s decline. The goal should be to keep the total at 35 or higher. And as the numbers begin to decline below 35, the scale can be used to help a pet owner make a final decision about euthanasia.


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