Unit 5: other investment vehicles

what are exchange traded notes? (ETN)

1. Exchange traded notes are senior, unsecured debt securities issued by a bank or financial institution 2. therefore, they are backed only by the good faith and credit of the issuer 1. The notes track the performance of a particular market index, but do not represent ownership in a pool of securities the way share ownership of a fund does 1. ETNs are bond like instruments with a stated maturity dates, but they do not pay interest and offer no principal protection 2. instead, ETN investors receive a cash payment linked to the performance of the underlying index minus management fees when the note matures 3. investors are also exposed to market risk because the returns of ETNs are linked to the performance of a market index or a basket of securities

what are general partners (GP)? (type of limited partnerships)

1. GP have unlimited liability, meaning that they can be held personally liable for business losses and debts 2. their role is to manage all aspects of the partnership and have a fiduciary responsibility to use the invested capital in the best interest of the investors 3. in managing the partnership, they make decisions that legally bind the partnership, and they buy and sell property for the partnership; they are compensated for fulfilling these duties 4. they may not compete personally with the business, borrow money from the partnership, or commingle the partnership funds with their personal assets

what are limited partners? (Type of limited partnerships)

1. Limited partners have limited liability, meaning that they can't lose more than they invested 2. they have no business management responsibilities, and in fact, should they participate in any day-to-day management of the business, they can lose their limited liability status and be considered a GP 3. Limited partners have the right to vote on overall business objectives and the right to receive cash distributions, capital gains, and tax deductions generated by the business 4. they have the right to inspect all books and records, and if the GP does not act in the best interest of the business, limited partners have the right to sue the GP 1. Limited partners enjoy several advantages: -an investment managed by others (the GP) -Limited liability (can only lose the amount invested) -flow-through of income and certain expenses

what are the types of limited partnerships?

1. Real estate programs 1. Real estate programs can invest in raw land, new construction, or existing properties 2. depending on the properties held by the program, they can provide investors with the following benefit opportunities: -Capital growth potential: achieved through appreciation of property -cash flow (income): collected from rents -tax deductions: from mortgage interest expense and depreciation allowances for "wearing out the building" and capital improvements -tax credits: for government assisted housing and historic rehabilitation (tax credits are very strong incentives because they reduce tax liability dollar for dollar) 2. Oil and gas programs 1. include speculative or exploratory (wildcatting) programs to locate new oil deposits (generally considered the riskiest developmental programs that drill near existing producing wells in hopes of locating new deposits) and income programs that invest in producing wells (generally considered the least risky) 2. unique tax advantages associated with these programs include the following: -intangible drilling costs (IDCs): these are costs associated with drilling, such as wages, supplies, fuel, and insurance that have no salvage value when the program ends. These IDCs can be written off (deducted) in full in the first year of operation. in contrast, tangible drilling costs are associated with items that have some salvage value at the end of the program, such as drilling equipment. These types of tangible cost, instead of being immediately deductible, our deductible over several years. The deduction is taken as depreciation. In other words, each year, the asset is worth a little less, and that depreciated amount can now be deducted -Depletion allowances: these are tax deductions that compensate the program for the decreasing supply of oil or gas (or any other resource or mineral ) after it is taken out of the ground and sold 3. which oil and gas program would be best for a client? 1. A drilling program offers the greatest chance for capital appreciation but would not provide current income 2. an income program would be better suited for an investor who desires current cash flow, but it likely offers less capital appreciation potential 3. leasing programs: 1. These are created when DPP's purchase equipment leased to other businesses 2. This type of equipment can be as far ranging as jetliners or rail cars leased to airlines and railroads, trucks leased to shipping companies, or computers leased to any business in need of them 3. Investors receive income from lease payments, as well as a proportional share of write offs from operating expenses, interest expense, and depreciation of the actual equipment owned by the program 4. The primary investment objective of these programs is tax sheltered income (the income being sheltered by the write off's)

what are local government investment pools? (LGIP)

1. States establish local government investment pools (LGIP) to provide other government entities, such as cities, counties, school districts, or other state agencies, with a short term investment vehicle to invest funds 2.The LGIPs are generally formed as a trust in which municipalities can purchase shares or units in the LGIP investment portfolio 3. Not a money market fund, but they operate similar. For instance, an LGIP may be permitted to maintain a fixed $1 net asset value NAV - maintaining a stable NAV, similar to a money market mutual fund, facilitates liquidity and minimum price volatility 4. LGIP's are not required to register with the SEC and are not subject to the SEC's regulatory requirements, given that LGIP's fall within the governmental exemption, just as a municipal securities do -investment guidelines and oversight for LGIP's can vary from state to state 5. LGIP programs do have disclosure documents, generally include information statements, investment policy, and operating procedures -The information statement typically details the management fees associated with participation in the LGIP

what are the risks of ETNs? (exchange traded notes)

1. TAKE NOTE: The primary risk associated is default risk. liquidity risk is also a common concern. Even though they are called "exchange traded" , very few of them have ever actually been listed on an exchange 2. well the market price of an ETN, in theory, depends on the performance of the underlying index or benchmark, the ETN has an additional risk compared with an ETF; if the credit of the underwriting bank should falter, The note might lose value in the same way any other senior debt of the issuer would 3. additionally, there are limits to the size of ETN issues. This means, with limited availability, there are times when an ETN might trade at a premium to its inherent valuation. Investors purchasing at a premium could be subject to losses later depending on the value of the note at maturity

What is the tax treatment of DPP's?

1. The structure of the limited partnership allows for the investor to receive income that is sheltered from taxes 2. through the use of depreciation and depletion (depletion in natural resource programs such as oil and gas) create a deduction for tax purposes that is not an actual cost of the partnership 3. TAKE NOTE: income from an LP is called passive income and is added to ordinary income for tax purposes. Losses from an LP are called passive losses. Passive losses offset passive income only. However, if an LP generates tax credits, those may be used to offset income taxes directly; tax credits are not a type of income 4. EXAMPLE: revenue and costs for taxes - revenue: $300,000 -costs: -maintenance: $50,000 -loan interest: $70,000 -operations: $160,000 -depreciation: $50,000 ————————— -profit/loss: -$30,000 * note that depreciation is not an actual cost. To find the cash flow, add the depreciation back into the business results - profit/loss: -$30,000 -depreciation: $50,000 ————————- -Cash flow: $20,000

what are the three types of real estate investment trusts? (REIT)

1. a REIT is a company that manages a portfolio of real estate, mortgages, or both to earn profits for shareholders 2. REITs pool capital in a manner similar to that of an investment company but are not investment companies, neither open nor closed end. 3. shareholders receive dividends from investment income or capital gains distributions 1. REITs normally -Own commercial property (equity REITs) - own mortgages on commercial property (mortgage REITs) or - do both (hybrid REITs) 1.REITs are organized as trust in which investors buy shares or certificates of beneficial interest, either on stock exchanges or in the OTC market 2. under the guidelines of a subchapter M of the IRC, a REIT can avoid being taxed as a corporation by receiving 75% or more of its income from real estate and distributing 90% or more of its net investment income to its shareholders

what are exchange traded funds? (ETFs)

1. an exchange traded fund, considered an equity security, invest in a specific group of stocks and generally does so to mimic a particular index, such as the S&P 500 2. ETF trades like a stock on the floor of an exchange and, in regard to how it trades, is similar to a closed end investment company rather than an open end mutual fund 3. they are registered, however, as either an open end fund or as a UIT, but they are obviously different in many ways 1. because of the way they trade, an investor can take advantage of intraday price changes due to normal market forces, rather than just the underlying value of the stocks in the portfolio 2. ETFs can be purchased on margin and sold short 1. expenses tend to be lower than those of mutual funds, and the management fee is also low. 2. there is little trading activity required to keep the funds securities aligned with those in the index it is intended to track. this generally results in greater tax efficiency for the investor 1. Every time a person purchases or sells shares, there is a commission, and those charges can add up over time 2. ETF shares are not mutual fund shares but are registered as open end funds. It is common and that they are often compared to mutual fund shares

what are five important points to remember about REIT's?

1. an owner of REIT's holds an undivided interest in a pool of real estate investments 2. REITs may or may not be registered )public or private) with the SEC 3. REIT's may or may not be listed (trade) on exchanges 4. REIT's are not investment companies (open end or closed end) 5. REITs offer dividends and gains to investors but do not pass through losses like LPs, and therefore, are not considered DPP's

What are partnerships?

1. and unincorporated association of two or more individuals. Partnerships frequently open accounts necessary for business purposes 2. The partnership must complete a partnership agreement stating which of the partners can make transactions for the account 3.If the partnership opens a margin account, the partnership must disclose any investment limitations 4. An amended partnership agreement (similar to a corporate resolution) must be obtained each year if any changes have been made 5. partnerships are classified into two broad categories: general partnerships and limited partnerships 6. general partnership: all partners in the business have responsibility to manage the business -Ownership of a general partnership may be unequal, and specific responsibilities may be assigned to specific partners. The partnership agreement with detail the specifics of the partnership 7. all owners may be held liable for actions of the partnership; there is no liability protection 8. The business results of the partnership flow through to the partners for tax purposes proportional to their ownership interest 9. The partnership is a tax reporting entity (they report their business results) but not a tax paying entity (the owners would pay any taxes)

what are the disadvantages of ETFs when compared to open end mutual funds?

1. commissions: the purchase or sale of ETF shares is a commissionable transaction. The commissions paid can erode the low expense advantages of ETFs. this would have the greatest impact when trading in and out of ETF shares frequently or when investing smaller sums of money 2. over trading: given the ability to trade in and out of ETFs easily, the temptation to do so is possible. Excessive trading can eliminate the advantages associated with investing in a diverse portfolio and add to overall commissions being paid by the investor, further a rotating any of the other expense and operating cost advantages associated with ETFs 3. market influences on price: because ETFs trade on exchanges, share prices can be influenced by market forces such as supply and demand, like any other ETP. in this light, investors need to recognize that just as they might receive less than book value per share when selling corporate shares of stock, they may also receive less than NAV per share when selling ETF shares

what is a section 529 plan?

1. is specific type of education savings account available to investors 2. The plan allows money to be use for qualified expenses for K -12 and post secondary education 3. qualified expenses include tuition at an elementary or secondary public, private, or religious school for up to $10,000 per year 4. because they are state sponsored, they are defined as a municipal fund security 5. The sale of these plans must be accompanied or preceded by an official statement or offering circular (similar to a prospectus) in the same way other municipal security sales would be TAKE NOTE: The $10,000 spending limit does not apply to post secondary (after high school) education - A $10,000 a year limit on college costs would not be enough to cover costs of most colleges, but is sufficient for most pre-college (K - 12) education 1. any adult can open a 529 plan for a future college student, the donor does not have to be related to the student ( an adults student may also contribute to her own 529 plan) 2. with a 529 plan, the donor can invest a lump sum or make periodic payments 3. when the student is ready for college, the donor withdrawals the amount needed to pay for qualified education expenses (tuition, room and board, and books) 4. withdrawals for non-qualified expenses will be subject to taxes on any gains and a 10% penalty on the gains Contributions: 1. Contributions, which are considered gifts under federal tax law, are made with after-tax dollars, and earnings accumulate on a tax deferred basis 2. withdrawals are tax free at the federal level if they are used for qualified education expenses 3. most states permit tax free withdrawal's as long as the donor has opened an in-state plan 4. in addition, some states allow contributions to in-state plans to be tax deductible, therefore, if one of your customers wishes to open an out-of-state plan, you must advise the customer that certain tax advantages may not be available to out-of-state donors 1. if a beneficiary does not need the funds for school, there are no tax consequences if the donor changes the designated beneficiary to a family member of the original beneficiary EXAMPLE: if the original beneficiary chooses to not attend college, the donor can transfer the funds from that child's 529 plan into a siblings plan without penalty - also, if the current beneficiary receives a scholarship, the donor may withdraw the equivalent value from the plan without penalty. Income taxes on the gains would still apply

what are the guidelines regarding limited partnerships sales and dissolutions?

1. lPs may be sold through private placements or public offerings 2.If sold privately: investors receive a private placement memorandum for disclosure -generally, such private placements involve a small group of limited partners, each contributing a large sum of money -these investors must be accredited investors (meeting income and net worth criteria) and must have substantial investment experience 3. The general public generally does not meet the above description 4. In a public offering: LPs are sold by prospectus for disclosure 5. in a public offering distribution, a large number of limited partners each making a relatively small capital contribution ($1000-$5000) is more likely because they do not need to be accredited investors 1. generally, LPs are liquidated on a predetermined date specified in the partnership agreement 2. Early shut down may occur if the partnership sells or disposes of its assets or if a decision is made to dissolve the partnership by the limited partners holding a majority interest 3. when dissolution occurs, the GPs must settle accounts in the following order: -secured lenders -other creditors - Limited partners- First, for their claims to shares of profits and then for their claims to a return of contributed capital - GPs

What are the risks to limited partners?

1. liquidity: there is effectively no secondary market for limited partnership interests. any transfer of interest in an LPN requires permission of the general partner. An investor in a limited partnership should assume she will own the program until it ends 2. audit/recapture of tax benefits: If the IRS disallows a prior tax benefit, The consequences flow through to the limited partners. If an audit resulted in the depreciation deduction being disallowed, the limited partners would find themselves having the extra profit/ loss of income for that tax year. -The IRS will likely impose taxes and penalties for the under reporting of income plus interest on the unpaid taxes. The limited partners would have to pay for the problem. Remember, the LP is a tax reporting, but not a tax paying entity

What are other relevant points regarding section 529 plans?

1. overall contribution levels can vary from state to state 2. assets in the account remain under the donors control, even after the student becomes of legal age 3. there are no income limitations on making contributions to a 529 plan 4. plans allow for monthly payments if desired by the account owner 5. Account balances left unused may be transferred to a related beneficiary 6. rollovers are permitted from one states plan to another state plan, but no more than once every 12 months

what are the two basic types of 529 plans?

1. prepaid tuition plans for state residents : - allow resident donors to lock in current tuition rates by paying now for future education costs -inflation hedge:yes -outpace inflation: no -School/system: specific 2. savings plans for residents and nonresidents: - This is the more popular option, and it allows donors to save money to be used later for education expenses -inflation hedge: maybe, depends on performance - outpace inflation: maybe, depends on performance - School/system: any

what are the advantages of ETFs when compared with open end mutual funds?

1. pricing and ease of trading: because individual ETF shares are traded on exchanges, they can be bought or sold any time during the trading day at the price they are currently trading at as opposed to mutual funds, which use forward pricing and are generally priced once at the end of the trading day 2. margin: ETFs can be bought and sold short on margin like other ETP's. Mutual funds cannot be bought on margin, nor can they be sold short 3. operating costs: ETFs traditionally have operating costs and expenses that are lower than most mutual funds 4. tax efficiency: ETF scan and sometimes do you distribute capital gains to shareholders like mutual funds do you, but this is rare. Understanding that these capital gains distributions are not likely, there are no further tax consequences with ETF shares until investors sell their shares. This may be the single greatest advantage associated with ETFs

what are public and private REIT's? (Real estate investment trust)

1. public: REIT's that are registered with the SEC, therefore subject to all disclosure requirements 2. private: these REIT's are not registered with the SEC. Non-registered REIT's are not subject to the same disclosure requirements as public REITs and therefore, are subject to greater risk 3. exchange-traded or listed REITs: these REIT's are traded on a stock exchange 4. for those that are not listed on an exchange and trade instead of in the OTC market, unique risks exist. many non-listed REIT's are difficult to price and have far less liquidity versus a listed product

What are hedge funds? What are the suitability and risk issues of investing in a hedge fund?

1. some private investment companies can be what are known as hedge funds. 2. Hedge funds are often organized as limited partnerships and are sold as private placements 3. Hedge funds investments are pooled and professionally managed, but hedge funds have more flexibility in the investment strategies employed 4. while hedging is the practice of attempting to limit risk, most hedge funds specify generating higher returns as their primary investment objective 5. in attempting to achieve these returns, they tend to shoulder a substantial amount of risk 6. hedge funds are typically aggressively managed and often construct portfolios of high risk investments 7. hedge funds use advanced and sometimes complicated investment strategies 8.some of the more common strategies employed by hedge funds are: 1. highly leveraged portfolio's (borrowing to purchase securities) 2. The use of short positions (selling securities the portfolio does not own) 3. The utilization of derivative products such as options and futures 4. currency speculation 5. commodity speculation and 6. The investment in politically unstable international markets 9. Most hedge funds are organized as private investment partnerships, allowing them to limit the number of investors or require large initial or minimum investments if they so desire 10. some also require that investors maintain the investment for a minimum length of time (ex 1 year) and to that extent they can be considered illiquid 11. these minimum holding requirements are known as lock up provisions

what are achieving a better life experience (ABLE) accounts?

1. tax advantage savings accounts for individuals with disabilities and their families 2. they were created as a result of the passage of the ABLE act of 2014 3. The beneficiary of the account is the account owner, and income earned by the accounts is not taxed 4. The ABLE act limits eligibility to individuals with significant disabilities where the age of onset of the disability occurred before turning age 26. One could be over the age of 26, but as long as the onset of the disability occurred before age 26, one is eligible to establish an ABLE account 5. if an individual meets the age/onset criteria and is also receiving benefits either through Social Security insurance (SSI) and/ or social Security disability insurance (SSDI), he is automatically eligible to establish an ABLE account 6. only one ABLE account per person is allowed 7. contributions to these accounts, which can be made by any person, including the account beneficiary, as well as family and friends, must be made using after-tax dollars and is not tax-deductible for purposes of federal income taxes 8. some states, however, do allow income tax deductions for contributions made to an ABLE account 9. contributions by all participating individuals are limited to a specified dollar amount per year, which may be adjusted periodically to account for inflation

what are limited partnerships? (LP) what are its two types of partners?

1. this is the most common type of DPP in the securities industry 2. LP are investment opportunities that permit the economic consequences of a business to flow or pass through to investors 3. The businesses themselves are not taxpaying entities 4. these programs pass through to investors a share in the income, gains, losses, deductions, and tax credits of a business entity 5. The investors (partners) would then have the responsibility to report individually to the IRS 6. The greatest disadvantage to limited partners is the lack of liquidity in the partnership interest 7. The secondary market for LP interests is extremely limited; investors who wish to sell their interests frequently cannot locate buyers (i.e.- interest in the business is not freely transferable) 8. an LP involves two types of partners: the general partner and a limited partner 9. an LP must have at least one of each 10. property in these partnerships is usually held in the form of a tenants in common (TIC) , which provides limited liability and no management responsibilities to the limited partners

what are direct participation programs? DPP

1. unique forms of business that raise money to invest in real estate, oil and gas, equipment leasing, and other similar business ventures 2. DPP are not taxed directly as a corporation would be; instead, the income or losses are passed directly through to the owners of the partnership-the investors 3. The investors are then individually responsible for satisfy any tax consequences 4. there is virtually no secondary market for an investor to divest interest in a DPP, and in this regard, DPP are considered highly illiquid - on the point of liquidity alone, they are not suitable for many investors