Real estate, private equity, private credit and other alternative investments can be challenging as estate assets.NicoElNino/iStockPhoto / Getty Images
As private assets become more common in investment portfolios, estate experts say these alternative investments create unique challenges for executors.
A multitude of private asset products are now available to Canadian investors as asset managers roll out investment funds targeting the retail market.
“The days of [alternative] products only being [sold through] offering memorandum to accredited investors are increasingly behind us,” says Stuart T. Smith, ScotiaMcLeod senior wealth advisor and portfolio manager with Smith Advisory Group in Toronto. “There are a lot of products that have found their way onto advisers’ shelves for them to talk to clients about.”
But private equity, private credit and other alternative investments can be challenging as estate assets, says Holly LeValliant, estate and trust consultant with the Davis Group at ScotiaMcLeod in Toronto.
“To start with, there is often a lack of liquidity,” she says.
Many beneficiaries rely on the disposition of estate holdings to cover taxes and other related costs, which can be difficult when those assets face liquidity constraints because of a lack of transparency, Ms. LeValliant says. “When you can’t sell a private asset, that can be a problem.”
While many new private asset funds are touted as “evergreen” and allow a percentage of the fund to be redeemed each month or quarter, the measures are far from infallible, Mr. Smith says.
He cites a recent experience with clients investing in private real estate income trusts that entered into the probate process with valuations that had become extremely challenging to arrive at.
“It is hard to quantify what a private real estate holding is worth until you sell it,” he says. “It’s one thing to have an appraisal done, but you don’t truly know what it’s worth until you go to sell it.”
Mr. Smith adds that beneficiaries may or may not have done “the proper planning to make sure that there is liquidity in the estate to pay things like probate and other final taxes, and can ensure they are able to wait for the estate to get settled.”
Consider estate consequences when building portfolios
As private assets become available to more investors, adoption is likely to increase, Ms. LeValliant says. “There’s a lot of pressure right now on advisers to do more than offer stocks and bonds strategies.”
But while many clients are looking to private asset allocations as a means to diversify their sources of return, Mr. Smith says, the estate challenges may be overlooked.
“From an advisory standpoint, we need to make sure we’re recommending stuff that’s matching risk tolerances, time horizons and general suitability,” he says. “These asset classes are not appropriate for all people.”
He says investors should look to something such as permanent life insurance to achieve the same outcome while providing a relatively immediate and guaranteed injection of liquidity at the outset of the probate process.
“It’s great to say you have a time horizon of 10 years, but that’s not always the case,” he says.
Andrew Feindel, portfolio manager and investment adviser with Richie Feindel Wealth Management at Richardson Wealth Ltd. in Toronto, says illiquidity alone shouldn’t deter investors from considering private holdings.
Wealth managers who include private equity in client portfolios can create liquidity for clients by affecting a “cross-book sale,” he says, or serving as an in-house market maker to transfer private assets between a client who wants to sell and another who wants to purchase those assets – “so long as [the investment] is suitable for that other client.”
There may also be buyback provisions offered by the private equity fund or issuer that allow for the sale of the position back to them, Mr. Feindel says, or the estate executor could pursue a sale on a secondary market.
However, both of those options often amount to proceeds that are less than the perceived book value. “You’re usually going to find a buyer, but it’s likely going to be at a discount,” he says.
The case for a corporate executor
Tanya Wilson, senior wealth adviser and portfolio manager with Gold Seal Financial Group at Wellington-Altus Private Wealth Inc. in Kelowna, B.C., says the disposition of private assets means a potentially very long time horizon for whoever is responsible for winding up the estate.
“It’s so important to choose the right person,” she says. “If you have illiquid assets that might carry a lock-up period spanning several years, you want to ensure you have an executor who will stand the test of time.”
Mr. Smith says it often makes sense for clients to seek professional help with the probate process – especially when confronted with illiquid assets that require appraisal.
“My view is, there is huge value in having a corporate executor assigned,” he says.
Professional executors are liable if they undervalue or otherwise fail to treat estate holdings adequately, Ms. LeValliant says.
“A professional trust company is held to a higher standard than a layperson,” she notes. “That’s a significant reason why people with high net worth turn to us. They don’t want that burden put on a family member or someone else.”
Editor’s note: A previous version of this article misidentified the ScotiaMcLeod wealth advisor and portfolio manager quoted in the story. He is Stuart T. Smith with Smith Advisory Group, not Stuart W.C. Smith with Smith Financial Management Team.