From the May 2008 issue of Investment Advisor • Subscribe!

Tangible Diversification

In the stock and bond markets, Larry Nakamura is as passive as they come, but when it comes to real estate, that's another story entirely

For an active investor, the turmoil on the world's stock exchanges that we've seen in recent months can produce a kind of virtual motion sickness. For the advisors of such clients, times like these can involve a great deal of hand holding, the fielding of anxious phone calls, and constant reassurances that the markets go in cycles and should eventually stabilize again. Larry Nakamura, president of Torrey Capital in San Diego, a fee-only RIA firm with about $25 million in reportable assets under management, on the other hand says that he really hasn't heard much from his clients about what's been happening on Wall Street.

Nakamura has worked to make sure that his clients understand the importance of diversification and staying committed to a long-term asset allocation strategy. He looks at each client's portfolio quarterly but only reallocates as needed. "If any position is out of its asset allocation by more than 5% to 10%, we'll reallocate that portfolio," he says. "If new cash comes in, we'd prefer to use that to fix the allocation, versus starting to sell things to get back to the model. We really make a conscious effort to minimize the tax impact."

When it comes to traditional investments in stocks and bonds, Nakamura is firmly committed to a passive strategy. For most client portfolios he relies primarily on DFA funds, citing their low cost, coupled with an impressive track record. "For a client's core portfolio we firmly believe that indexing or some form of passive asset allocation is probably the best strategy for most people," he says. Nakamura was a principal in a trading firm early in his career and says he saw peers build accounts with tens of thousands of dollars into multimillion dollar accounts in a year's span, only to end up giving it all back. "Were these guys great traders? Yeah, but they didn't hold on to it," he says with a bit of a laugh. "That happens to most people, even those who are only trading on a limited basis. We really believe that staying with a consistent asset allocation that uses proven methods is the best approach for most."

Torrey Capital also uses ETFs on occasion for clients who want exposure to a specific sector. "On the fixed-income side, we will use a Vanguard product or ladder an individual bond portfolio for clients as needed," he says, "but we primarily recommend to clients that the majority of their portfolio be some sort of allocation using passive asset allocation funds or passive asset class funds."

The need for structured fixed-income products isn't as pronounced among Nakamura's clients as it is for many advisors. The majority of his clients have extensive real estate portfolios, as do Nakamura and his wife.

"They understand the values of diversification and going into the stock market and its risks and rewards," he says of his clients. "A lot of them have a tendency to make real estate investments because they seem to be safe. They're tangible. You can feel them and touch them. If all hell breaks loose you can still go live in one of your properties," he adds with a laugh. "You can't do that with your stock certificates."

Ties That Bind

Both Nakamura and his wife come from families that have long been involved in the California real estate market. His clients come primarily from friends and family and an interest in real estate is one of their common bonds.

Sometimes Nakamura will put together a deal with a group of clients to acquire a commercial property or he may broker client participation in deals brought to him by others. "We don't get compensated for that," he says. "We're sharing the investment opportunity with our clients because we know they have a propensity to invest in real estate and if we like the deal, we're happy to show it to our clients as well."

On occasion, clients will move money out of investment accounts that Nakamura manages in order to take advantage of a real estate opportunity, and that's all right with him, especially if it meets the client's long-term goals. "We're buying real estate for income, not for speculation or appreciation. We get that, but the main focus is the fixed-income aspect of it, the generation of cash flow from these properties," he explains. This is especially true with "clients who are a little skittish about the stock and bond markets," and who have had some success in real estate and feel they understand it much better.

While for the neophyte real estate investor this could be a pretty scary time, Nakamura thinks it's a great time, but only if you know what you're doing. "I guess you could say I'm an opportunist," he admits. "I look on the opportunity side and don't focus on all the doom and gloom that Wall Street and the media tend to focus on. We're concerned, we're cautious, but at the same time we are seeing some of the best deals that we've seen in a long time and a lot of people that I speak to in the industry say the same thing. The environment has tightened up, the banks have tightened up, and there are a lot of good projects out there that need funds. If you play your cards right, you can get a lot of projects at a substantial discount right now."

He gives as an example a local mortgage broker who is buying homes from the bank at 50 cents on the dollar and then finding a buyer. "We financed him in the beginning of January for a single family home here in San Diego and he just closed escrow last week [the end of March] and we've received our money back, plus interest. On an annualized rate, it works out to around 22%. We were protected in that if this guy fails to sell the house, we just foreclose on it and take it back or we force him to sell the property. At the price he paid for it, it would sell in a heartbeat, even in this environment."

In the current credit environment, Nakamura is pretty confident that the number of such private financing deals will only grow. "The banks only can lend a certain way, with certain guidelines and parameters," he says. "Middle tier builders who don't have a mainstream to Wall Street or to the bond market where they can readily finance their projects, these guys use these private funds and hard-money lenders to do their deals. [That is happening] in this environment even more so because the banks are so tight right now with their underwriting standards." (Nakamura also runs a private mortgage pool available to clients through a separate company, Torrey Capital Mortgage Fund; see sidebar.)

The Advisor's Role

Professional management is really what Nakamura's millionaire-next-door clients are looking for when they sign on. "They had small businesses or were high-level executives who did very well for themselves--saved, did the right things--and are now at a point in their lives where they don't want to handle it themselves, or they've worked with somebody and want someone to take over and bring things together in one place," he explains. "That's what we offer."

The posted client minimum is $250,000, although Nakamura's ideal target is really twice that. The firm is compensated solely through fees which can be computed on an hourly basis, on a contract basis with a flat fee retainer, or as a percentage of assets under management. "It's really driven by the client, what the client is looking for, and what the relationship is," he explains. "Sometimes if the portfolio is of substantial means and they want us to manage the whole thing and do all the other planning too, we'll say, okay, let's just come up with a reasonable fee. We give them the choice."

For the most part he says that his clients are pretty sophisticated about investing. Many have traditionally handled all aspects of their financial life themselves and tend to be familiar with the ins and outs of investing in real estate, "but there's always something that they don't quite understand," Nakamura says. "They can't see all the pieces to the puzzle. They might only see one piece, so we help them see all the pieces by pointing out the things they should really be paying attention to...You really need to look at everything collectively," he argues, "before you can make an informed decision."

How He Got Here

Like many young people, when he was in college, Larry Nakamura wasn't in the ideal position to make an informed decision about his future. He was majoring in business at the University of California at Los Angeles and working in a pizzeria owned by the family of a friend. While browsing through a book of job postings at the career counseling office he saw listed an internship with Shearson Lehman Brothers.

That line of work really wasn't for him, but luckily his boss saw some potential and teamed him with a broker, John Brady, who had just left the firm to start a boutique investment bank whose niche was taking public micro-cap companies, with capitalizations between $2.5 million and $10 million.

"I learned a lot about the business from the investment banking side," says Nakamura. "We underwrote IPOs and I got a good education on how the Street really works."

He eventually left that firm and with three partners started a trading firm in Newport Beach, California. "This was in the late '90s when the Internet craze/tech bubble was just forming and everybody was a day trader. We grew that firm to where we ended up with about 25 traders and were trading, on a good day, probably 10 million shares a day just from our office."

At this point he was bitten pretty hard by the entrepreneurial bug, as were his partners, and together they launched a software development firm, Nexa Technology. "We wanted to develop a new product for the industry because we were having some frustrations with the software platform that we were using. What we did was design and develop one of the first true multilingual direct access trading platforms in the world." A few years later Nexa was purchased by Penson Worldwide in Dallas. Its software program is still in use in seven different countries.

After that successful venture, Nakamura moved to San Diego and worked for 2 1/2 years as chief compliance officer for Dunham and Associates, helping to launch 13 mutual funds and a number of private offerings, before deciding to become his own boss again in 2003.

"I wanted to create a boutique firm that specialized in highly servicing the needs of our clients--keep it small, with a personal touch. That's what we're in the process of doing."


Managing Editor Robert F. Keane can be reached at bkeane@investmentadvisor.com.

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