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Passive investments require active monitoring

Welcome back! 👋

LP investments are passive, right?

They are, but they're also not.

Today I will explore why there are a lot of benefits to keeping up to date with your LP investments.

This is particularly important if your distributions have been paused or you have a sense that your investment might be distressed.

Hopefully you’ll appreciate this (half) joke by the end of today’s articleLet’s dive in:

So first, I know what you’re thinking already - “why does monitoring matter, I’m not a decision maker anyway!”

I will address this first (#1 below) and present 4 other benefits to active monitoring of LP investments:

1. You can influence GP decisions & strategy

• While LPs are generally passive and it’s true that they lack decision making abilities, they can still have significant influence over the GP’s decision making and strategy

• While you (as LP) hope that the GP allocates a “fair” amount of time to your particular investment, the reality is that there are always competing priorities (staffing, other investments that might be more challenging or have pressing needs, personal matters, etc) and it can certainly be the case that your property needs some extra attention

• I advise on many cases day to day where there are ~no other LPs who are actively holding the GP accountable, making any LP who’s both knowledge & informed even more critical to the investment success

• By asking questions, voicing concerns, and providing constructive feedback, you can influence the decisions and strategies implemented by the GP

• This proactive engagement can lead to improved management and potentially turn around a struggling investment - remember that the GP is not all knowing and people (including GPs) make mistakes!

• To be clear: I am not talking about micromanagement here, I am simply saying you should be reading your updates, keeping the GP accountable for any prior promises (which would certainly include the original plan presented in the investment deck), and asking any questions as the investment progresses

• In Minimum Viable Reporting Package, I write about why I think it’s super important to compare monthly or quarterly results to the original financials. If this isn’t presented to you as an LP, you should have your own spreadsheet to keep track!

2. You might catch misrepresentation or fraud

• If you have a sense that something is not going according to plan, this is the ultimate time to pay attention (ideally you would’ve caught it early, but it’s almost never too late)

• By staying informed and scrutinizing the investment closely, you increase your chances of catching any discrepancies or fraudulent activities early

• While this is a complex and relatively rare issue (there’s a big difference between fraud and an investment that’s under performing), identifying misrepresentation or fraud promptly can potentially lead to recovering some or all of your investment through legal routes

If you have a sense that something is not going according to plan, this is the ultimate time to pay attention

3. You will learn from any mistakes and be able to use those lessons in other investments

• Investments don't always work out as planned, and understanding why is essential for future success … and the sooner you learn, the better!

• While this may not offer immediate financial relief, it equips you with the knowledge to avoid similar pitfalls in the future

• This is particularly important for anyone who’s making repeat LP investments (especially with the same exact GP)

• More generally, learning from mistakes is a natural process of investing, so the more engaged you are the better of an investor you’ll become over the years as you accumulate each marginal lesson

4. Your realizations might have practical financial and life implications

• Knowing the current status of your investment (i.e. I invested $500,000, but how much is it worth today and how much will I get back) is crucial for setting realistic expectations about your financial future

• For example, in the event of expected losses that are material to your overall net worth or needs, this knowledge might necessitate adjustments such as returning to work or seeking part-time roles to supplement your income - you do not want to be surprised by this when the GP sends you a foreclosure notice, trust me!

• So, in summary, being aware of your investment’s standing helps you make informed decisions about your financial planning

5. You might have a tax bill coming up that you're not considering

• Poor performing investments can have significant tax implications (i.e. a surprise bill!) due to depreciation recapture, as I talked about in Hidden risks of tax benefits in syndications and Losing it all in foreclosure

While it’s true that passive investments aren’t active in the sense that the GP is doing all the work, it still pays to pay attention as an LP. Taking a proactive approach can make a significant difference in the success of your investment and your overall financial well-being.

As always, would love to hear any questions or comments and wishing you a wonderful weekend ahead.

I advise LPs on existing and potential positions and write articles here weekly on what I see in the marketplace that could help you invest better. You can find me on LinkedIn or Twitter.

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