What Are Non-Traded Equipment Leasing Funds?
Non-traded equipment leasing funds are another type of alternative investment. Like all alternative investments, these securities do not trade on any public securities exchanges. Rather, these companies are investment pools that purchase various types of equipment, e.g. mining or drilling equipment, ships, or even major office equipment. These funds then lease this equipment out to companies that require it for their business. These funds differ from publicly traded companies in multiple ways.
While publicly-traded companies have long-term goals and plans for operation, equipment leasing companies usually have a set length of time that is predetermined before its initial offering period. This is usually somewhere between seven and ten years. However, out of that length of time, only five years are actually dedicated to business operations. The rest of the time is dedicated to raising the necessary capital, purchasing the necessary equipment to begin operations, and then liquidating the company once the five years of operation have passed.
The Equipment Leasing Fund Prospectus and “Blind Pools”
Investors entering into these equipment leasing investment pools may not be aware just how risky they actually are. Unlike publicly-traded businesses that have detailed plans that lay out its inception and operation, equipment leasing companies may appear as if they just pop up overnight.
During its initial offering, the sponsor of the fund will provide investors with a prospectus. This is a document that details the overall business plan and the market for that business. However, most equipment leasing companies are what are known as “blind pools.” This means that there isn’t actually a set plan, and the prospectus is merely for show. In a “blind pool’ the fund’s sponsor uses the money raised during the initial offering to purchase whatever equipment they so choose.
If the prospectus was written with vague language, the sponsor is not required to purchase anything specific. While some equipment leasing company sponsors may choose what equipment to purchase based on what they feel is the best investment, there is nothing stopping them from making the decision based merely on the particular supplier, which could raise conflict of interest issues.
The Risks of Equipment Leasing Pools
There are considerable hurdles in building a successful operation that has a five year shelf life. While some businesses might find success in that period of time, it is most certainly not a common occurrence. Due to the nature of an equipment leasing fund’s business and the length of time set aside for operations, these companies almost set themselves up for failure. There are a lot of things that can go wrong in this time period, such as:
- There might be a much lower demand for the equipment the fund purchased than what was expected OR the equipment might malfunction or break in some manner. If either of these happen, then there is expensive equipment that this fund invested in doing nothing but sitting around and depreciating in value.
- There is also the possibility that lessees might default on their lease. Due to its short operation period, equipment leasing funds rely extra heavily on successful leases. A broken lease disqualifies the fund from months, or years, of revenue that the fund was counting on.
If any of these inherent risk factors become reality, it is then reflected in the investors’ distributions and the overall value of their shares.
Non-Traded Equipment Leasing Funds Are Incredibly Illiquid
In addition to these risk factors, equipment leasing funds are also incredibly illiquid
investments. Once the operation period for equipment leasing funds expire, the company will usually then begin its liquidation phase. However, investors are expected to maintain their shares until such time begins. This is because those managing the fund need to make sure they have the capital necessary to complete operations—especially if it is losing money in the ways described above.
Because of this, most equipment leasing funds will not buy back shares until the operations period has ceased and the liquidation phase has begun. Investors might be able to liquidate their shares early through limited secondary market companies; however, these companies often take advantage of investor desperation and will offer them much less than what they are told the shares are presently valued at.
It is the job of the securities broker to make sure they communicate every pertinent detail about an investment when pitching it to their customer. Securities brokers that allow their customers to invest into an equipment leasing fund without fully explaining the illiquid nature of the investment could face scrutiny for the misrepresentation or omission.
Brokers Take Advantage Of Investors By Recommending Risky Equipment Leasing Funds
One more crucial aspect about these investments that often goes undisclosed or misrepresented is the excessively high fees associated with them. Broker commissions for these products can be as high as 10 percent of the entire principal investment. This outrageous percentage is often the reason that equipment leasing funds are recommended to investors in the first place.
Securities brokers become motivated by these commissions to recommend these
investments to customers that are woefully unsuited for them. However, that is not all. This inordinately high commission is often compounded by other upfront fees that can sometimes come out to a total of 17 percent. That means an investor could lose close to 20% of their investment simply by investing into an equipment leasing fund. When a principal investment is lowered that substantially upfront, the possibility of the investor seeing any actual returns on their investment is near impossible.
While securities brokers might present these products to investors as safe and lucrative investments, nothing could actually be further from the truth. Alternative investments may be incredibly unsuitable for investors, and equipment leasing funds are no exception. While these products are generally unsuitable for most investors, this is especially true for investors with more conservative objectives and higher liquidity needs. Their unsuitability is a direct result of their inherent risk, illiquidity, and excessively high upfront fees that lower investors’ principal investments.