Ultimately, an assessment of an investment sponsor’s track record is about answering the question, has the sponsor done what they said they were going to do? This straightforward inquiry sounds like it should inspire an equally simple answer.
Unfortunately, gleaning accurate and reliable prior performance information from sponsors—both on an individual program and aggregate levels—proves to be difficult in the best of circumstances. Investment managers are notorious for picking and choosing how to show their prior performance in the best light. How does a financial advisor with limited resources get comfortable with a manager’s track record when audited financials and/or independently verified performance numbers are not available? Even if individual representations are substantiated, how can an advisor put them in the proper context?
Next week, in the second post of this series, we’ll discuss some key considerations to help you vet a sponsor’s track record as effectively as possible. But first, in today’s post, we’ll briefly review industry and regulatory approaches to mandating clear prior performance disclosure—which will underscore how difficult it is to assess sponsor track record.
In order to ensure consistent disclosure for investors and other interested parties, several industry regulators and groups have developed guidelines for sponsors and issuers to follow in presenting prior performance. Each of these approaches is laudable and substantive, but as we’ll see, may apply only to a narrow set of prior programs or pose other limitations.
What does the SEC mandate for public programs?
The SEC’s Guide 5 (and Topic No. 6) provides relatively specific guidance on what prior performance information should be included in prospectuses for public real estate programs, including non-traded REITs. Guide 5 contains templated disclosure tables and identifies required line items. One key potential benefit to this disclosure regime (and all the approaches covered in this post, really) is that theoretically, it should enable an advisor or investor to compare performance across various issuers. However, the specific programs to be discussed and duration of history to be disclosed are based on the number of and types of programs managed by affiliates. Thus, as no two sponsors’ syndication history is completely alike, nor will their disclosures be completely similar.
However, the SEC recognizes that complexities around presenting track record means that simply mechanical disclosure may not be adequate. In the end, the issuer is under an obligation to qualify the required tabular data by additional narrative if necessary to ensure that the information is not misleading. (After all, the prohibition against false and misleading statements in the context of securities transactions is the backbone of federal securities regulations.)
And ultimately, Guide 5 doesn’t govern how program performance is disclosed in the context of private offerings. Such representations are just subject to disclosure regulations generally.
One template for private program performance disclosure
ADISA’s best practices for Regulation D offerings addresses how private investment sponsors ought to disclose their prior performance in offering memorandums. The best practices provide helpful guidance, and in some ways mirror Guide 5 (the standard tables of which may be used by sponsors in lieu of templates provided in the best practices). Just like in Guide 5, programs with similar investment objectives to the one being offered are to be emphasized in the presentation; if the sponsor doesn’t have many such programs, all of the programs it has syndicated regardless of strategy should be included in the prior performance presentation.
As best practices issued by an industry trade association, it is not binding on private placement sponsors, and in our observation, not all sponsor members of ADISA (fully) comply with the guidance. For instance, one item we rarely see disclosed is sponsor compensation derived from past syndicated programs.
Other helpful, but somewhat limited standards
Recognizing the need for investment performance reporting uniformity and consistency in the public non-traded REIT industry, in 2018 the Institute for Portfolio Alternatives (IPA) issued Practice Guideline 2018-01 to provide guidance specifically to non-traded REIT management teams, advisors, and boards of directors with respect to the calculation and reporting of investment performance on a per-share basis for public non-traded REITs. Again, however, this applies specifically to non-traded REITs. (The IPA and Stanger & Co. recently launched the IPA/Stanger Monitor to track total return performance of non-listed REITs in accordance with 2018-01. Programs covered are currently operating, and the total return is partially based on program-provided net asset values.)
The CFA Institute designed the Global Investment Performance Standards (GIPS), a set of ethical standards used by investment managers when creating performance presentations to ensure fair representation and full disclosure of investment performance results. However, GIPS generally applies to institutional investment managers with at least a five-year track record. Rarely do we come across sponsors at the retail level who are GIPS compliant as it is not particularly well suited for certain asset classes, like real estate. Users and recipients of real estate performance frequently request only an aggregation of property-level performance, which is not consistent with the composite construction principles of the GIPS standards. In this case, compliance would present an additional cost burden.
Despite no shortage of these and similar guidelines, sponsor presentation of a track record continues to provide due diligence firms a challenge and—as we can tell you—it is often the subject of dispute between a due diligence professional and an investment sponsor. Next week we’ll share some of the biggest considerations to be aware of when assessing a sponsor’s track record.