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Get a piece of the ship?
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February 6, 1998: 6:12 p.m. ET
Equipment investments offer cash flow, but investors need to be wary
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NEW YORK (CNNfn) - Stock prices are jumping up and down. Bond yields are being squeezed. And growth rates are in doubt. Can you find investment tranquillity in owning a piece of a ship, plane, oil rig or rail car?
Apparently some investors think so. Stock market volatility and questions about future growth rates are pushing them toward a little-noticed investment vehicle: equipment partnership funds.
"A lot of people are interested in using this type of fund now. They are looking for hard-asset driven investments," said John Scarcella, senior vice president of Atel Securities Corp. in San Francisco. He said his fund, one of the few equipment funds available to the public, has seen $65 million in new business come its way in the fourth quarter.
Another equipment investment syndicate, Icon Securities Inc., also based in San Francisco, has seen a surge of interest as well.
"We're getting a ripple effect from what's been going on in markets over the past few months," said Allen Hirsch, president of Icon Securities. "People now are waking up to the fact that while they may have had a great return in the bull market, it may be ebbing. People are getting more careful, funds are moving elsewhere and we're a small beneficiary of that."
Through equipment investment funds, investors pool money to buy assets like cargo ships, offshore oil drilling platforms, marine cargo containers, railroad freight cars, earth moving equipment, grain combines and airplanes. Those assets are then leased to various companies over extended periods of time. The returns from the leases are subsequently divided up among the investors, as is any money from a final sale of the assets. The fund administrator gets a cut either in the form of a fee or a percentage of the overall return or both.
But there are some pitfalls. Returns depend on how well the assets are deployed in specific industries. And equipment fund investments come in the form of limited partnerships, which can sometimes put investors at the mercy of a general partner. In some well-publicized cases in the late 1980s the partner took advantage of investors, which has given them a certain negative stigma.
"About eight to 10 years ago they got a bad rap, and in my opinion deservedly so," said Joel Bernstein, an attorney with Goodkind Labaton Rudoff & Sucharow, a law firm that represents investors in limited partnership cases.
Some history
Equipment funds came into the investment scene during the late 1970s and 1980s. They were sold as ways to take advantage of certain high-growth industrial markets.
For example, several funds specialized in marine container investments hoping to take advantage of booming overseas trade. As those funds acquired enough funds for sizeable equipment purchases, however, they stopped offering shares to the public market.
"It was an excellent way to raise capital," said Jim Hoelter, president of Textainer Equipment Management. "But now, as we've grown, we have access to more traditional capital markets."
Today, equipment funds tend to include a range of equipment types, instead of focusing on one sector.
"Ours is a very diversified fund ranging from small ticket items like office equipment to big ticket items like ships and airplanes," explained Hirsch of Icon. "We've pooled into the same fund to get the maximum diversification."
How they work
Investors buy into equipment funds through limited partnership arrangements that cover a certain number of unit shares in the fund. Icon, for example, offers $100 unit shares. Also funds require a minimum investment, usually $2,500 for an individual investment account. The partnerships can be purchased through most brokers or directly from the companies themselves.
Money raised through selling partnerships is used purchase equipment. Different funds sometimes follow different strategies in this area. Atel, for example, concentrates on leasing 75 percent its equipment portfolio to companies with high credit ratings. It also buys equipment with a high resale value.
"We try to minimize the credit risk and the residual risk," said Scarcella.
Icon, on the other hand, works on buying out existing leases. Smaller private placement funds -- funds that only sell partnerships to accredited investors -- tend to concentrate only on a few large assets.
"Our goal is to really limit the size of our fund so that we can be selective about the investments we make without the pressure of having to keep large sums of money invested," said Steve Harwood, president of Cypress Leasing Corp. in San Francisco. (In case you are wondering, San Francisco tends to be recognized as the North American hub for the equipment leasing business.)
What they offer
Equipment fund returns vary, depending on the mix of assets. Atel and Cypress, for example, say their funds are currently on track to make a return of 10-11 percent in the coming year. Icon's Hirsch said he would be disappointed if his fund didn't return 14-15 percent this year.
In addition, the funds -- because they represent equipment ownership -- use depreciation gains on various assets to shield a percentage of the return from taxes for a few years, depending on the life of the assets involved.
"This is primarily a cash-flow deal," explained Scarcella. "Sure, there are some tax advantages, but people are primarily doing this to get the cash stream ... some use it to supplement their dollar-cost averaging in mutual funds." The regular payments from the equipment fund can get automatically forwarded to other investment accounts, he said. "This can be an ideal investment to make up a small portion of someone's portfolio."
"Our fund is ideal for someone four to five years away from retirement and currently in a high-income tax bracket," said Hirsch. "It gives them cash flow for about four years with very little tax effect. Then, when the depreciation runs out, it comes at a time when they've retired and fallen into a lower tax bracket anyway."
Also, returns from equipment funds are insulated from various market trends, promoters point out.
"Equipment leasing is driven by factors different from those that drive stocks," Harwood said. "And as inflation goes up, equipment leasing values go up. When inflation goes up, bond markets tend to fall."
Pitfalls
Equipment funds have a set life, usually determined by the useful life of the equipment the fund is investing in. An investor, therefore, needs to be prepared to stick with the fund for the long haul. Also, the fund shares tend to be illiquid. Some institutions may be willing to buy shares, but only at a discount.
"It's not a very efficient secondary market," Scarcella warned.
Also, equipment fund performance lies totally in the hands of the manager or general partner, who makes the investment decisions, negotiates the leases, and arranges the final sale of the assets when they are at the end of their useful life.
"When talking about equipment, it's important to look at what kind of equipment the fund will be buying," said Bernstein. "It may be the kind of equipment with a long life that doesn't become obsolete over time. An airplane, for example, lasts over the long term and has a good resale value, but computer equipment may have a shorter useful term."
And, if the general partner is unscrupulous, sweetheart deals can be cut that may benefit the general partner at the expense of the investors. For example, assets could be sold to a company in which the general partner has an interest at a greatly reduced price, hurting the final return to investors.
So investors need to look carefully at the manager's track record with other funds, the demand for the type of equipment being purchased by the fund, and the resale value of the equipment.
"It's important to look at the all the fees the general partner is going to be charging over the life of the fund," Bernstein suggested. He said he has represented clients who had most of their partnership investments eaten up by management fees.
"Like anything," Bernstein advised, "you got to use some common sense."
-- by staff writer Allen Wastler
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