S2, E5: Donating complex assets: Alternative investments

This is the fifth of six episodes in our second Philanthropic Insights series that offers advisors everything they need to know about making the most with gifts of complex assets. Throughout this series, we will discuss the various areas of complex assets such as real estate, business interest, passion assets, alternative investments, and qualified appraisals – and we will bring in top experts in these fields. 

 In this episode, Katie and Kim talk in-depth about alternative investments. 

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Transcript

Kim Ledger:

Welcome to Ren's Philanthropic Insights video podcast series made to help financial advisors make the most of their client's charitable giving. I'm your host, Kim Ledger, Ren's VP of Complex Assets, and this is my co-host and fellow complex asset expert, Katie Collin, Complex Gift and Grant Director here at Ren. Throughout this series, we are discussing the various areas of complex assets such as real estate, business interest, passion, assets, alternative investments and qualified appraisals, and we are bringing in some of the top experts in these fields. In this episode, Katie and I will discuss alternative investments. Katie, thanks for joining me.

Katie Collin:

Great to be here again, Kim. Thank you.

Kim Ledger:

Yeah, great. Well, we've had just such a great series so far and this alternative investment, I thought it was important to break this out to be different from the business interest. Well, we're often, when we're looking at business interests, often we will lump alternative investments in that, but I felt it deserved its own space. So just to set the stage for alternatives, I guess when I am talking about that, what comes to mind for me is hedge funds, private equity, real estate investment trust and venture capital.

Katie Collin:

Yes.

Kim Ledger:

So just to set the stage.

Katie Collin:

Yes, that's a perfect description.

Kim Ledger:

Okay, great. From a donor advice fund perspective, as we look at that, what are the things that we are considering or why... Actually, let me back up. Why would a donor consider making a gift of an alternative investment to a donor advice fund? And I guess when I say I'm talking about making a gift gift, they could also make investments into alternative-

Katie Collin:

That's correct.

Kim Ledger:

... investments as well. So I don't know if you want to hit both of those at the same time.

Katie Collin:

Sure. Right. It's a good distinction to make. So if someone is already in an alternative investments, owns it and wants to gift that investment to the donor-advised fund, permissible, and similar to a business interest gift, you're looking at capital gains and how you can save capital gains taxation on doing that. So charitable deduction, capital gains, and it really can be a great tool to then continue to grow assets inside the donor-advised fund so that the individual then has more to give through their donor-advised fund, more grants that they can recommend through their donor-advised fund. So win-win all around with that one.

The other way, like you were saying, is to have the donor to the donor-advised fund recommend, hey, this is a really great investment. I would really like to grow the assets inside my donor-advised fund. So can I take some of my liquidity in the donor-advised fund and ask the fund to invest inside of this alternative investment because I've seen the performance, it's done really well and I'd really like to grow those dollars again so that there's more to recommend in terms of granting for myself, for my family, depending on the plan and legacy planning they're doing inside the DAF.

Kim Ledger:

Right. And I find that advisors who typically have worked those alternative investments in the client's portfolio already, it's just a natural extension to include that in their donor-advised fund portfolio as well to help level out all the reasons that they use alternatives in their own personal account are good reasons to use them in a donor-advised fund as well. Obviously you want to make sure that there's some liquidity in there because again, the purpose of a DAF is to make grants.

Katie Collin:

To make grants, right.

Kim Ledger:

Yeah. You want to make sure that there's some liquidity.

As a donor-advised fund and you do a lot of the review on the alternatives, what are the things that you look at and that you consider when someone is recommending a grant to either invest in or to looking at making a gift?

Katie Collin:

So one of the first things that we're looking at as a team is time horizon. So if you're gifting the alternative investment, how much time is there still? Some of them are time limited, term of years, some of them are perpetual in nature and you can come in or come out, sometimes monthly, sometimes quarterly, sometimes annually. So trying to understand if it's a gift, where are we coming in that cycle? What do we have to pay attention to? What do we need to make sure on a quarterly basis or annual basis, we're making sure we're having those conversations with the advisors? What are you thinking for the portfolio? How are you feeling about this overall? This is our perception of it, let's come to an agreement.

And the other side is if it will be the DAF investing in the beginning, a full subscriber, we're looking at things like again, term length. So if you're taking liquid funds from the donor-advised fund and you're setting it aside for 10 plus years, which is the term for most of these funds, some of them also have an extension period on them as well, those are dollars that won't be available for granting. And so how are we thinking about that globally? How is that being communicated to the donor recommending those grants, because they need to understand, yes, it's still part of your portfolio, but it is tied up in this investment and can't be moved. I've been part of the solution team figuring out how someone was moving between DAF providers and moving one of these alternative investments that was a term limited investment that hadn't finished completing capital calls on the investment and what had to happen to move it from one DAF platform to the other.

 We were able to do it. It was very time-consuming. There was extra cost associated with that. And those are the things you're looking for, making sure, okay, we're going to take this on and you have to understand what this means for the long term.

Kim Ledger:

And if they're making a gift in one of these alts and they're still in the investment phase, so we anticipate that we're going to have capital calls, we're going to need to make sure that there's cash in the donor-advised fund to meet those capital calls. Those are dollars we're going to set aside and make sure that they're not available for granting-

Katie Collin:

That's correct.

Kim Ledger:

... because we're on the hook for that capital call. So we have to make sure.

Katie Collin:

And I think what can be difficult with capital calls too is you usually only have five to 10 business days to turn that around from the date you get the notice or the date that's on the notice. So you really have to be careful and we're going to make sure that we are talking with the financial advisor to understand who's getting the notice. Did one of us get it but not the other? How are we working in step to make sure those are paid in a timely manner?

Kim Ledger:

Yes. Now we work with a lot of family offices and with that we often have worked with quite a few hedge fund managers or someone who is a partner in one of the hedge funds. So let's talk about how that's a little different than let's say you own 0.004% of a very large REIT, for instance, how in some of these private equity, I'm thinking private equity and some of these hedge funds, as we work with these individuals, there's a little extra that we have to really pay attention to. Can you speak to that?

Katie Collin:

Right. So we really want to make sure we're understanding what is this person's exact role. So many of these hedge funds, the underlying entities, the general partner have very similar names. So you're trying to make sure, do we know who all the parties are, what is actually being gifted? Is it the carried interest that might be part of the GP structure? Is it just standard shares within the fund or units depending on how it's delineated, what's the actual gift? And trying to then make sure we talked about excess business holdings before, we're trying to understand, of all of these different parties, what's the ownership structure and how can this be considered if it's inside of the DAF and it's held with this individual who's attached to the fund and they have family members in the fund or a trust who's in the fund, we're working to make sure we understand that structure. So we're avoiding excess business holdings or coming up with a solution before that becomes an issue.

Kim Ledger:

Because those are pretty harsh penalties.

Katie Collin:

Right. They really can be.

Kim Ledger:

And I think it's important for advisors to understand and for the donors to understand, we have to ask these questions, we have to make sure that we understand it, and we have to make sure we know that we keep up to date on that, that we understand that structure and the ownership percentages of each. Because again, it not only hurts us because when I say harsh, they're harsh.

Katie Collin:

They are harsh.

Kim Ledger:

And they're harsh to us and to the donor. So it's important that we are all working towards monitoring that. And that we're in compliance.

Katie Collin:

Right. Because the goal is not to pay penalties. The goal is to grant dollars out to charity.

Kim Ledger:

Exactly. And we would do everything we can to make sure that we're all in compliance and everybody has a good expectation upfront of the things we need to monitor. So far, we've had just excellent donors and advisors who have worked closely with us because nobody wants that.

Katie Collin:

Nobody wants that. That's correct.

Kim Ledger:

Exactly. So something else with alternatives that we should probably talk about that I think also surprises people when they're gifting alternatives is the requirement for a qualified appraisal.

Katie Collin:

Yes. Yes. So very similar to a business interest. Again, it's an ownership you have and it's a non-cash asset. So the IRS uses form 8283 to monitor gifts of non-cash assets. So it's very important that everybody understands you're holding this as an investment, yes. However, it's considered an asset and you have to follow these IRS rules. They are in place. You need to make sure you and your tax professional are going over those. It's something that I know we would help identify for people, but that's not the job at the DAF to do any of that process for you. There is a separate form, that 8282, when the asset is sold, that is the responsibility of the DAF. But leading up to all of that, getting the qualified appraisal, filling out that original form, I've had individuals who have provided me a blank 8283.

Kim Ledger:

Yeah, we can't do that.

Katie Collin:

No, you have to start filling that out so that the charity then is one of the additional signers on there.

Kim Ledger:

Yeah. We affirm that we received this gift is what we're doing. And then the appraiser signs it saying that this is what they gave and this is the value I've assigned to it. And some of those, if the gift is over 500,000, it has to be attached to the tax return.

Katie Collin:

Exactly.

Kim Ledger:

So it's important to get it right.

Katie Collin:

It definitely is.

Kim Ledger:

It's always important to get it right. But when you're dealing with the IRS, you want to make sure. We'll get into that more in episode six too. So we don't need to spend a lot of time on that, but I did at least want to mention that. Our guys from the valuation firm will speak to that as well.

Katie Collin:

Perfect. That's going to be a great episode.

Kim Ledger:

I think so too. So when we, as a donor-advised fund, I have this list of documents that I request. So let's walk through those. We typically ask for prospectus in any supplements. The PPM always helps make your life easier, does it not?

Katie Collin:

It really does. It really does. We're looking for those details of how long is this going to last? What are the fees associated with this? What are we expected of as an investor, I always like to see a pitch deck as well, especially if we are taking any of these proposed investments to a committee that has to have an understanding and making a final decision. That pitch deck is usually a really beautiful visual summary of what is happening, that has history, that has data, that has bios of the individuals who are managing the fund. It's a really great way to gather all of that information.

A lot of what I like to see too when I'm looking through a pitch book is have there been prior funds? So is this fund five? And while I know all the materials say, can't always rely on this, but it's good to see what's your track record moving forward. But it's also important to know if this is the first iteration of this fund, the DAF should know that going into it, this is going to be a riskier investment, still within the bounds of what the DAF can do, but you have to be prepared for that.

Kim Ledger:

Right. And we do have some minimum requirements. So because of the complexity of alternatives, we do require that a donor have a minimum account balance or DAF balance of at least a million dollars. There's just a lot of ongoing administration and monitoring that has to take place. So we do request that it be a minimum of a million dollar account. If we're going to hold it for any length of time.

Katie Collin:

Right. And I think that seems fair. Like you said, the administration really can be time-consuming, especially if it is an investment where the DAF is getting in at the ground level, doing the subscription documents for the first time. Capital calls are procedure, like we said earlier, and managing this and working and partnering with the financial advisor to make sure this meets the needs of the DAF and meets the future grant recommendations for their client.

Kim Ledger:

We have a really great team who helps with that subscription agreement. And that's one of the due diligence items too, is making sure we understand what we are getting into.

Katie Collin:

Exactly.

Kim Ledger:

And some of these we'll have good redemption, but you can't always count on that.

Katie Collin:

You can't always count on it. And I think that's what's really important to read. As we're digging into the meat of some of those deeper documents, like the PPM that you referenced, we are trying to understand what are the availability for redemptions liquidation? How often are they occurring? What documentation or requests format does the DAF have to follow, because some of it can be very detailed. It's not just emailing the general partner. There are forms to sign, there are requests to put into place, and sometimes it requires signatories at different levels. And so we're really trying to make sure we understand how are we moving through this? And again, what's the overall idea for building this investment, having that extra money created inside the donor-advised fund, and then putting those dollars out.

So if the donor has in their recommendation plan, "I'd really like to start gifting larger sums in the next five years," we have to compare that to the alternative that's held in there. Will you be able to do that? Will you be able to make those recommendations? And if not, how can we work with them to help structure things a little differently?

Kim Ledger:

I think it's also important to note that not all alternatives are going to be held on a platform. Some of them are going to be held directly, and so the advisor needs to be aware of that.

Katie Collin:

That's very important. You can't always, depending on the structure of your platform, it sounds like it should be able to happen, but it just can't for certain limitations of what the platform's designed for and that it is held outside. And a lot of times you can get a feed or you can take statements from the alternative. So it shows up on your client's overall statement.

Kim Ledger:

And a lot of them are giving us access to portals now. And that has made our life-

Katie Collin:

So much better.

Kim Ledger:

... so much better. Yeah.

Katie Collin:

So much better.

Kim Ledger:

Love that. Especially if it's held directly, and I'd say we have quite a few of those that are not. So the advisor needs to be aware of that, that it may not always sit on your company's platform.

Katie Collin:

And I think the other piece that goes along with that is some of these alternatives are reporting behind a typical schedule. So reports and statements come out a quarter behind, two quarters behind. I've worked with alternatives where the statements were almost a full year behind just from how they were accessing all of the different funds that built up into the one fund that was the primary investment. It's really trying to understand, how is this reporting structure, when are statements coming so that you can clearly then delineate for the DAF, okay-

Kim Ledger:

A value, 'cause we have to have a value.

Katie Collin:

We do.

Kim Ledger:

In addition to looking at on an annual basis, the ownership structure. So that is something, I say ownership structure and percentage ownership of us and the donor and the related parties, we're looking at that, but we also have to have a value. And so sometimes you'll end up with some alternative holdings. And I'm thinking primarily private equity may not always, hedge funds are pretty good about that, but sometimes with private equity or venture capital, we don't get a lot of venture capital, but private equity may not always value on an annual basis, but we got to have something, there has to be some way that we can, for our books and records, we have to have some way of getting a value on an annual basis.

Katie Collin:

And having that conversation upfront is really important. So we're setting the right expectations. So if it is an early stage fund, and they haven't done anything like this before, helping them understand, we will need this as donor-advised fund. We can work with you on potential solutions or figuring out what could you have available as option B and C, but let's try and get to this point.

Kim Ledger:

I would also say that with alts, we've done a lot. We've looked at quite a few, not all of them. There are thousands.

Katie Collin:

Thousands, yes.

Kim Ledger:

So we've obviously not looked at all of them, but if we've already reviewed one, and it's one that we consider, I don't want to say on our platform to confuse people, but it's one we've looked at and we've done before, we don't necessarily need to go through that full due diligence process again.

Katie Collin:

No. We're really just looking to see has there been any changes?

Kim Ledger:

How does it fit with the staff?

Katie Collin:

How does it fit with the staff? And if the investment was done a couple-

Kim Ledger:

And the donor, again, back to-

Katie Collin:

Does it fit?

Kim Ledger:

... do they run the fund?

Katie Collin:

Exactly, yes. Do they run the fund? But thinking through, if the materials we have are a couple years old and they've been updated, we definitely want to look at updated materials. But the comfort level is there because it's been done before. And so we want to just understand any changes that have been made, how is this going to fit? What's the DAFs new percentage of ownership and in total on the platform, but also, like you said with the donor, what are their goals with this investment as part of their portfolio? We just need to make sure that that can still be accomplished.

Kim Ledger:

And I would say too, what we don't want, I don't want 18 alternatives in a $5 billion DAF.

Katie Collin:

No.

Kim Ledger:

That's way too much-

Katie Collin:

Way too much.

Kim Ledger:

... way too much work and complexity. So we will limit that. So anyway, important to note.

Katie Collin:

Yes.

Kim Ledger:

Can you think of anything that I haven't asked that you think that advisors have other burning questions about alternatives?

Katie Collin:

Probably it's good to think about what kind of distributions are coming off an alternative investment.

Kim Ledger:

Good point. Oh, and an offshore account. We always love any... Speaking of distributions makes me think of the tax perspective. So especially if you're investing in an alternative, I think it's great if you can look for the offshore option to limit the unrelated business income tax.

Katie Collin:

Exactly.

Kim Ledger:

When they're gifting, that's not always the option.

Katie Collin:

Exactly.

Kim Ledger:

The donor hasn't necessarily found that to be something that they needed to watch. So yeah, the gifting is a little different.

Katie Collin:

Right. But that's a question that came up on something you and I looked at a couple weeks ago. The fund itself was in Delaware, but it talked about an underlying fund that was offshore. So we had the conversation with the advisor, can we get into the offshore one instead? And while that wasn't a possibility, at least we know and we've made the ask and we're looking for potential additional solutions to save on taxation.

Kim Ledger:

'Cause again, you want more money to charity.

Katie Collin:

Exactly. Exactly.

Kim Ledger:

Yeah, great. Well, we are at time, so thanks so much for joining me again, and it was a pleasure to have you in studio.

Katie Collin:

Right. I'm thrilled to be part of the season. Thank you.

Kim Ledger:

Great. Thanks. Thanks everyone for watching or if you turned in via podcast, thanks for listening. If you want to learn more about REN and how we might be able to help with your philanthropic program needs, visit reninc.com or email us at consulting@reninc.com. We'd also love to hear if you have questions or topics about planned giving you want us to talk about. And of course, don't miss the great information we have in our Advisors Philanthropic Insights newsletter. Sign up at renick.com/advisorinsights. Find all the links mentioned in the show in the description, and you'll find expert tips daily on our social channels. Check it out. Until next time, I'm Kim Ledger. Give wisely.