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A Big Tax Break for Socially Responsible Investing

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Wealth Matters

A Big Tax Break for Socially Responsible Investing

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Steve Baird, chief executive of Baird & Warner, a Chicago real estate firm. Tax incentives intended to draw investors to so-called opportunity zones have pushed Mr. Baird to increase his investments in underserved communities.CreditCreditLyndon French for The New York Times

Steve Baird runs a Chicago real estate firm that is in its fifth generation. It’s a big operation that serves some of the nicest areas in the city and suburbs with brokerage, mortgage and title insurance services.

But in running a family-owned business, Mr. Baird said, he inherited his father’s interest in investing in underserved communities. And a recent clarification of a tax incentive for so-called opportunity zones — which are aimed at encouraging substantial investment in communities that need it — has caused him to step up his efforts in these areas.

“You’re going into an area that as a general rule hasn’t had any investment, and people don’t know about it,” said Mr. Baird, chief executive and president of Baird & Warner. “A normal investor doesn’t go into these areas and doesn’t understand the economic drivers. When you’re developing in downtown Chicago, you know all those things: demand, community, underwriting. These opportunity zones don’t have that or they’d have attracted investment.”

Generous incentives in the Trump tax cuts that Congress passed last year are meant to persuade people to work through those challenges. They include a reduction of the tax on capital gains that are used for the investment in the opportunity zone and then tax-free gains later from that investment.

Yet the incentives have made opportunity zones such a shiny tax break that investors need to be cautious. Anyone with considerable capital gains from other holdings, regardless of their source, is likely to be pitched on opportunity zones.

Substantial money is at stake. Investors can put any amount of capital gains into these opportunity zones, but many of the funds have minimums of $1 million.

A slew of banks, asset managers, advisers and funds are already setting their sights on opportunity zones. Soon, they will be tripping over one another to solicit wealthy investors. The investments could do a lot of good for the people living in the zones and earn investors a lot of money, or they could do little and enrich only the people running those funds.

Opportunity zones, pushed last year with bipartisan support, were created for a mix of urban, suburban and rural areas. They hark back to plans from the 1980s meant to steer capital into blighted neighborhoods.

These new investment vehicles differ from enterprise zones, which provide incentives like lower property taxes, corporate tax credits and other sweeteners for businesses moving to a designated area.

The structure of the investment is novel. The zones aim to entice people who, after years of increases in the value of their investments, have a lot of “embedded gains,” or taxes that would be owed if those holdings were sold.

Investors can put those profits into opportunity zone funds, which will invest in businesses and real estate in these designated areas. In return, the investors will get various tax breaks on both the investment they sold and the one they made in the opportunity zone.

If they maintain their investment for five years, they’ll get a 10 percent break on the capital gains tax they would owe today; if the investment lasts seven years, the reduction is 15 percent. When the investment in the opportunity zone hits 10 years, the gains on that investment are tax free.

Investing in these zones would seem like a win-win. But not all opportunity zones are the same, and the tax incentive could also keep investors from being sufficiently rigorous with their due diligence.

For starters, some of the zones are a stretch to qualify as neighborhoods in need of help. In Connecticut, South Norwalk, a bustling restaurants and arts area, is on the list. So are East Austin, Tex., where property taxes are rising quickly as property values soar, and Oakland, Calif., which is becoming San Francisco’s younger, hipper sibling.

There are investors who plan to focus on the edges of opportunity zones. Among them are Avy Stein, a co-founder of Cresset Capital Management, and Larry Levy, a real estate investor and a founder of Levy Family Partners, who have teamed up to raise a $500 million fund. Mr. Stein said one of the criteria is that the investments would need to have been worthy without the tax break.

“It makes sense to identify those areas where, with a substantial amount of capital, those communities can change,” Mr. Stein said. “It doesn’t make sense to put money into areas where the capital won’t come out.”

Still, an investment like that may not deliver the social return or have the wholesale community revitalization intended by opportunity zones. Investors moved by the social component of the zones will need to closely assess how and where funds are investing.

“How do you verify independently that the location where you’re investing is really low income?” asked John Wilson, head of research and corporate governance at Cornerstone Capital Group, a firm that specializes in socially responsible investments. “You want to put an added layer of diligence on this.”

Other nuances, both positive and negative, also need to be considered. For instance, the tax incentives work at full force only if the money put in is the capital gains from another investment. Those gains can be from just about anything — real estate, private equity, a business, public securities, even a house.

“The government wants to unlock money tied up in other investments,” said Craig Bernstein, a co-founder of OPZ Capital, a $500 million fund in Washington focused on opportunity zones. “It can be short- or long-term capital gains. But the only dollars you get the benefit from are capital gain dollars. It’s very confusing.”

Another consideration is the lockup period. For all intents and purposes, it’s 10 years. Real estate investments will probably pay distributions from the rents collected, but the bulk of the investment will be inaccessible for a decade.

Because opportunity zones are a new area of investment, no one has any experience to track.

“We can’t do any due diligence on these funds, per se,” said Chris Pegg, senior director of wealth planning for Wells Fargo Private Bank in San Diego. “Even when someone has a track record of putting together a fund, they’ve never been required to put together a fund so constrained by tax legislation.”

This may cause people to seek established firms or successful real estate investors. But as every prospectus says, past performance is not an indication of future returns.

Because most of these investments are going to be through funds, John D. Dadakis, a partner at the law firm Holland & Knight in New York, said he worried about the managers: “Are they going to do a good job or take all the money?”

There are other ways to get a tax break on real estate, by swapping one property for another through 1031 exchanges, which are named after that section of the tax code.

But what makes the opportunity zones attractive is that investors can take back the money they initially put into any investment, not just real estate, or even some portion of the gains and pay tax on it. With the traditional 1031 exchanges, the investor needs to swap real estate for real estate.

The biggest unknown may be how the final regulations will look. Guidance came out last month, and a public hearing is set for January, but there are still areas that are unclear, said Lesley P. Adamo, a lawyer at Lowenstein Sandler in New York.

For one, the ventures that funds invest in are supposed to do a certain amount of business in the opportunity zone, which is what makes real estate attractive. But there could be other options.

“A restaurant that is in an opportunity zone but delivers most of its food outside of it — that creates uncertainty,” Ms. Adamo said.

So does the requirement that an investment substantially improve the zone. Does that mean building something new, or rehabilitating an existing business?

“As a tax lawyer, you want to be really careful on how you advise your client,” Ms. Adamo said.

A decade from now, though, there will certainly be success stories. As Mr. Pegg pointed out, investing in the nicest building in, say, San Diego will produce predictable returns and keep your investment dollars safe. But that investment is not where the biggest returns are made.

“The real money has been made in areas that are economically distressed by the person who got into storage facilities or trailer park facilities early,” he said. “Those areas can have astronomical gains, but they require a lot of work.”

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Where the super wealthy are investing their money

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Ultra-wealthy investors aren’t bullish on the markets but they are well positioned to “weather the storm,” according to Michael Sonnenfeldt, founder of investment club Tiger 21.

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In the third quarter, Tiger 21 members moved more capital into real estate and private equity, according to its latest asset allocation report. The network, which is made up of more than 600 entrepreneurs from every industry, has $60 billion in assets.

Real estate accounts for 28 percent of its allocation, while 24 percent is in private equity.

“You want to be defensive, but in a low-risk environment you still have to take risk. So you are going to take risk where you have expertise: owning buildings, building small businesses,” Sonnenfeldt told CNBC’s “Power Lunch” on Thursday.

Members have also cut back on fixed income, only 9 percent of the club’s allocation, because of concerns about rising interest rates. It has 23 percent of its money in public equities, 5 percent in hedge funds and 10 percent in cash.

Sonnenfeldt said the members meet and try to figure out what is happening in the markets, businesses and the economy, and they’ve noted a shift from monetary policy to fiscal policy.

However, “normally when you have that shift, and the market always gets choppy when that happens, you don’t have a trillion-dollar deficit against wanting to have more infrastructure,” he added. “One or the other wins out. So when you add that and China … our members are concerned.”

When it comes to investing in public stocks, the wealthy turned to names such as Apple, Amazon, Facebook and Berkshire Hathaway.

While tech has taken a beating lately, Sonnenfeldt said tech stocks are “unique because of their scalability.” Amazon, which fell into bear market territory earlier this week, is still up 37 percent year to date. Apple, which also tumbled into a bear market on Wednesday, is up more than 12 percent so far this year.

Sonnenfeldt called Apple “rock solid” and said of Amazon, “Where else can you get a shopping center on a desk? It’s still the best place to do it.”

However, he conceded that Facebook is now facing some headwinds thanks to recent hits to its reputation and the possibility of regulation. On Wednesday, The New York Times released a bombshell report that detailed how the company avoided and deflected blame around its handling of Russian interference in the U.S. election and other problems.

When it comes to Tiger 21’s favorite sector, health care is the “gift that keeps on giving,” Sonnenfeldt said.

“If you cure cancer, in good times and in bad, you’re going to have a winner,” he said.

Plus, there is “huge wealth” in the U.S. and people will pay to improve the quality of their lives, he said.

— CNBC’s Stefanie Kratter contributed to this report.


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The Blue Economy: How Impact Investing Can Help It Grow

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The world’s oceans provide food security to 3 billion people who rely on fish as their primary source of protein. However, their livelihoods are under threat as 90% of the global fisheries are being fished at above their maximum sustainable levels. Asia will face the maximum adverse impact of that overfishing, as it accounts for 84% of all people employed in the fisheries and agriculture sector worldwide. Globally, the push for the so-called “blue economy” or sustainable use of oceans aims to protect economic activity worth $3 billion-$5 billion annually that coasts and oceans support.

There is help at hand from impact investors, who can sustain their investment commitments because they use strategies that earn them returns while achieving social impact. Two prominent impact investors in this space are the Partnerships and Environmental Management for the Seas of East Asia (PEMSEA), based in Quezon City, Philippines; and the Meloy Fund for Sustainable Community Fisheries of the nonprofit Rare group in Arlington, Va., which helps communities adopt sustainable behaviors towards their natural environment and resources.

Founded more than 40 years ago, Rare sees its role as promoting “behavior change,” where it helps local communities “adopt sustainable behaviors that enable them to benefit from the protection of nature,” said Dale Galvin, managing director of Rare and managing partner of Meloy Fund. Its chief tool is a methodology called the Pride Campaign, “which helps communities figure out what they feel pride in, in their backyard,” he added. “We look at that as an emotional hook for promoting behavior change.”

Galvin had spent half his career in top management roles in private sector banking and consulting, but a desire “to create value and stop more value-destroying activities” drew him to impact investing and Rare. “It was a way for me to connect my former business experience with the developing world,” he said.

At PEMSEA, the effort is “to foster and sustain healthy coasts and oceans across Southeast Asia through integrated management solutions and partnerships,” said Aimee Gonzales, its executive director. It works on driving policy development at the national level, and implementation of those policies at the local level. It emphasizes an “integrated coastal management” approach where it focuses not just on sustainable fish production, but also on sustainable ecosystem habitats.

Galvin and Gonzales shared insights about impact investing with Knowledge@Wharton for its podcast series “From Back Street to Wall Street.” The series is being produced in partnership with Impact Investment Exchange (IIX), a Singapore-based organization that serves as a bridge between investors and development goals in Asia. (Listen to this episode using the player at the top of this page. You can find links to the other episodes in the series here.)

Why a Dedicated Fund

At Rare, Galvin saw the need for dedicated vehicles like the Meloy Fund in his previous role as chief operating officer, where he led “Fish Forever,” a global coastal fisheries reform recovery program. In its attempts to scale that program, the organization realized that it needed to tap not just donors, but also private investors and governments. It worked on models around sustainable fisheries that showed positive returns for investors, in addition to protecting the livelihoods of the people that depend on those fisheries and poverty alleviation, he said.

“You can’t invest in a sector like oceans or fisheries and expect to make a real difference outside of the company you’re investing in, unless you’re connecting that to the management of the natural resource.” –Dale Galvin

The Meloy Fund invests in fishing and seafood-related enterprises, and focuses on Indonesia and the Philippines. The two countries account for 4.3 million small-scale fisheries, 21 million hectares of critical marine habitat, $4 billion in latent value in small-scale fisheries and 4 million tons of fish. “That is the most bio-diverse area in the world,” said Galvin. He noted that as part of the Coral Triangle, which includes the waters of Malaysia and Papua New Guinea, the area has about 25,000 islands and 400 million people, some of whom are the poorest in the world. “It is the most important place to work, if you care about coral reefs and mangroves and coastal fishing.”

In order to scale its operations, the Meloy Fund has begun collaborating more and more with governments, in addition to communities, urging them to adopt sustainable ways of managing their natural resources. Within that, coastal fishing is a critical area of focus, “because it is the intersection of food, climate, biodiversity and natural resources,” Galvin said. “It has been an undermanaged, under-appreciated part of the environment for a long time.”

Justifying the Investments

Rare aims to develop solutions to advance sustainable fisheries that are replicable globally. Galvin said Rare shapes its work by asking itself questions like: How do we help coastal fisheries recover? How do we create the right management approach, and then replicate that on a national and then a global scale?

Galvin said Rare explored some critical questions before it could justify the need for the Meloy Fund, such as: Will companies, businesses and other organizations in that supply chain respond to opportunities to source local, sustainable seafood? Will they see the business necessity of that? In addition, will fishers, on the other hand, respond to the opportunities to change behaviors in response to economic and social incentives?

“When we figured out that the answers to those questions were ‘yes,’ we knew that we should launch a fund to begin to demonstrate that effect,” said Galvin.

At last count, the Meloy Fund had raised $22 million from various investors to support its work in protecting coastal marine fisheries, the latest of which is the Dutch development bank FMO. Its budget for next year is $30 million. Galvin explained what made it possible for the fund to attract those investors: “You can’t invest in a sector like oceans or fisheries and expect to make a real difference outside of the company you’re investing in, unless you’re connecting that to the management of the natural resource.”

The fund plans to use those monies to make 10 to 15 investments of between $1 million and $2 million each, in businesses across the fishing industry, including fish processors, retailers and others in the supply chain. It attempts to stretch the impact of its investments through blended financing, which is a mix of donor funds and private capital.

In measuring the impact of its investments, the Meloy Fund has access to data generated by Rare’s coastal fishery recovery program, said Galvin. That data tracks how communities are doing in terms of income stability, climate resilience, and other aspects like fish biomass and reef health, he added.

Investing in ‘Behavior Change’

Galvin explained that to entice businesses to change the ways in which they source their fish, the communities involved agree to their behaviors, and the government is actively involved in managing the fisheries. The fund achieves those objectives by collaborating with NGOs and governments in managing the supply chains in fisheries. “We catalyze the government to do its part, and NGOs to do their part.”

“We look at that as an emotional hook for promoting behavior change.” –Dale Galvin

The “behavior change” that Rare pushes for is critical to get all actors on board, Galvin said.

“If I’m a fisher and I decide, ‘well, I want to change my behavior. I want to catch only the right-sized fish with the right gear in the right places — that doesn’t necessarily change my destiny if everybody else in my community doesn’t do that. If everybody comes in and catches the same thing – whatever they want, as fast as they can – then I don’t benefit at all. Therefore, the behaviors have to be social norms. Those behaviors might be agreeing to where they fish, agreeing to how they fish, agreeing to how they manage and count fish, and how much they can fish every year – and who can fish and who can’t.”

Help with Transition

The transition to that ideal world is not easy, and necessarily involves a phase where the impacted fishers need to have alternative livelihoods. “Often in the short-term, you’re going to have this dip – we call it the J-curve,” he said. The solution to tide over that transitory phase captures the essence of the work done by the Meloy Fund, he added. “[It is about] creating more value per catch – higher premiums, lower costs, reducing waste, improving the coal chain and so on. Through interactions with business, we can help those fishers receive more money per hour or per kilo of fish. That helps them make that transition.” Many fishers also pursue alternative livelihoods, such as in food processing or aquaculture, he added.

“Those in the traditional fishing sector are now beginning to understand that if they don’t start to transition, they’re going to be out of luck,” he said. “Many times they need capital to help them make that transition, to build new facilities, and working capital to begin to explore new markets – that’s our pipeline.”

Galvin hoped Rare’s work would help attract “hundreds of millions of dollars and more countries” to its cause, and ultimately bring about the change envisaged under the World Bank’s Sustainable Development Goals (SDGs). In many ways, the SDGs are interconnected, he said. “You can’t fix life below water without working towards zero hunger, no poverty and gender equality,” he added. “And because of that, you have the opportunity for lots and lots of capital to flow in to fix these problems. Millennials are going to ensure that their money is invested in companies that do the right things. So the momentum is in the right place.”

Charting the Blue Economy’s Course

At PEMSEA, the broad backdrop for its work is the so-called “blue economy,” the catchphrase to represent the environmentally and socially sustainable use of marine resources, while generating sustainable economic benefits and fostering inclusive growth. Its goals are not restricted to merely fish catch, or in increasing volumes of fish caught. It extends to the whole realm of marine planning, including eco-tourism, ecosystem management and restoration, and the shipping and maritime industries.

“One main thing that would help is empowering the small scale fisheries and giving them a voice at the table.” –Aimee Gonzales

PEMSEA helps fisher folk organize themselves through co-managing schemes. It earmarks protected areas where they are encouraged to become “stewards” of their own patch of fishing coastal communities and coastal lands. About 90% of fishers in Asia, for example, are small-scale fishers, and half of them are women, Gonzales said. Part of PEMSEA’s work is in helping them organize themselves and making them aware of their rights, she added.

“One main thing that would help is empowering the small scale fisheries and giving them a voice at the table,” said Gonzales. “More often than not, their concerns are lumped with the concerns of the large fishing fleets.”

A PEMSEA project in China on pollution reduction and waste management along the Xiamen waterfront has become “a model for ecological and economic success,” PEMSEA claims on its website. The project has provided increased access to the beach and seas for leisure and tourism, cleaner lakes and bays for residents, a venue for industries and a home for rich biodiversity, it states. In addition, the investment has generated a net benefit of RMB 64 million ($10 million) annually for the community.

In another project in Danang, Vietnam, it helped the community strengthen its resilience to increasing impacts from floods, typhoons and coastal erosion. Its integrated coastal management approach included boosting natural buffers against storm surges, improved forecasting and early warning and recovery systems, and the construction of shelters and houses to withstand typhoon damage.

Funding Challenges

PEMSEA helps provide micro financing to help fishers supplement their livelihoods and income. In projects where it wants to achieve higher scale, it uses blended financing and public-private partnerships, Gonzales said.

Coastal conservation projects could have large capital requirements that are beyond the reach of individual funds, and they necessarily have to tap governments and institutional investors. “This is the challenge that PEMSEA is tackling at the moment,” said Gonzales. PEMSEA is putting together an ocean investment financing facility to support “high-quality investable deals,” she added. It calls for actions on several fronts, such as project sourcing, project development, and alignment of private capital with government and owner-funding initiatives.

To be sure, PEMSEA faces challenges in attracting investors to its social impact initiatives. Some of them are around the rights of small-scale fishers to pursue sustainable use of fish resources, and in determining science-based sustainable harvesting levels that can justify investments, Gonzales said. “These are some of the pre-conditions for investors to come and invest in these fisheries projects.”

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How To Invest Better -Why The Best Investments Are Boring

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Thumbs Up to the 4 Tips to help get the best investment returns. (Forbes Royalty Free)

We just had a wild ride on the stock market with the Dow losing more points in just two days than we’ve seen in quite some time. This big two-day loss prompted me to share four basic tips that many people ignore. With these four pillars of investing success, it’s nearly impossible to lose money in the stock market. That’s assuming you give them enough time to work.

I hate to be the bearer of bad news but great investing is boring. I mean like really boring. Of course, I’m talking about the opposite of the latest stock that is all the rage or Cryptocurrency, like Bitcoin. Is it still trading at $20,000? No, I didn’t think so. While achieving financial security may not be the most exciting thing in the world, it sure feels good.  Saving money may not be sexy. As far as investing goes the more boring the better.

Reduce your Investing Stress

Investing is stressful and researching the internet for investing advice may only add to that stress. With some many points of view when it comes to investments, it’s hard to know which advice is the best for your unique situation. To potentially ease some of this tension, I’m going to share four basic pillars of investing success that I think anyone can follow. With these four steps, it will be nearly impossible not to achieve financial freedom provided you save enough and give your investment enough time to grow.

The Four Boring Pillars of Investing Success

Following these four tips will help you invest better. They may be boring, but they will leave you a lot more time to enjoy life with your family and friends.

  • Invest on a regular basis – If you set up automatic contributions into your investments, you will buy more shares when prices are low and buy less shares when prices are high. More importantly, you will continue to buy investments when the sky seems to be falling. Do you know how amazing your returns would have been if you had just kept putting money into your 401(k), each paycheck, through the financial crisis? People like me did it, and boy let me tell you the numbers look great. Setting up automatic contributions means you don’t have to think about it. It also helps to ensure you continue putting money in when times get scary.

This is often called dollar-cost averaging. It doesn’t eliminate investing risk, but it sure increases the odds of you reaching your financial goals. It should also help lower your stress level when investing.

  • Have a diversified portfolio – Don’t put all your eggs in one basket. If you consistently invest into a single company and they go bankrupt, you may get killed financially. Diversification won’t eliminate volatility in your investment portfolio, but it basically eliminates the possibility that your money will go to zero. I guess it is possible that every company in the S&P 500 could go bankrupt in a single day. If that happened, we would have bigger issues to deal with than your nominal investment returns.

You may think a company is amazing because the stock price has been skyrocketing. However, owning stock in only one company (no matter how fabulous you think it is) greatly raises your risk of losing all of your money. If you aren’t diversified, you are likely speculating rather than investing.

You may also enjoy: The Rich Person Roth- For the Most Tax Free Income 

  • Rebalance automatically – Typically, this is done once a year. Most of the time you can set this up to happen automatically at some regular interval, like annually. If you never rebalance and the stock market goes up, you will end up with a riskier portfolio than what you originally set up. This could leave you getting hit harder if the stock market eventually takes a dip. On average, the market has a 10% dip about once per year. That shouldn’t be a cause for concern but rather something to be aware of.

Conversely, if the market goes down for a bit, you could end up with a portfolio that is more conservative than is appropriate for you. Additionally, you could miss out on gains that come when the market rebounds. Rebalancing resets the portfolio to the risk level you started with.   It also helps you buy low and sell high over time.

  • Leave it all alone – Even if there was a way to pick the perfect investment portfolio, guaranteed to get amazing returns, you would see someone screwing it up. Historically, the S&P has earned around 11% percent, per year, over the long run. The average investor typically ends up getting something like 1/3 of that return over time, according to the DALBAR studies. The study is released every year, but the results seems to be similar year in and year out. Whether the market is going up or going down, some people make the dumbest financial moves. Those decisions kill their financial returns even if they were lucky enough to pick the best investment options available at that time.

Bottom line, set up pillars one through three. Have them work automatically and let them do their thing.

Investing success is much more about avoiding big mistakes than being a stock-picking savant.  Which is lucky for you, since I don’t think stock-picking savants exist. Avoiding investing mistakes is something we can all do well, with a little help.

As RuPaul says “Dont F&ck it up!” (Photo by Santiago Felipe/Getty Images)

For extra credit, talk with an independent fiduciary financial planner to determine how much needs to be invested each month, and where, to reach your personal financial goals. A financial planner, like myself, can also help to hold you accountable to pillars one through three over time, and follow the fourth. To quote RuPaul, “Don’t f&ck it up”.

Related: 10 Retirement Accounts You Need to Know About

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