N-CSR 1 d501436dncsr.htm MADISON HARBOR BALANCED STRATEGIES INC. Madison Harbor Balanced Strategies Inc.
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM N-CSR

 

 

CERTIFIED SHAREHOLDER REPORT OF REGISTERED

MANAGEMENT INVESTMENT COMPANIES

Investment Company Act file number 811-21479

Madison Harbor Balanced Strategies, Inc.

(Exact name of registrant as specified in charter)

 

 

Madison Harbor Balanced Strategies, Inc.

125 Park Avenue, 25th Floor

New York, NY 10017

(Address of principal executive offices)

Madison Harbor Balanced Strategies, Inc.

Edward M. Casal, Chief Executive Officer

125 Park Avenue, 25th Floor

New York, NY 10017

(Name and address of agent for service)

Registrant’s telephone number, including area code: 1-212-380-5500

Date of fiscal year end: March 31, 2013

Date of reporting period: March 31, 2013

 

 

 


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Item 1. Reports to Shareholders.

The annual report to shareholders for the period ended March 31, 2013 is filed herewith.


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Managed by
LOGO

Madison Harbor Balanced Strategies, Inc.

Access to Private Real Estate Opportunities

 

LOGO

 


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Table of Contents

 

Letter to Shareholders

     1   

Your Portfolio

     3   

Consolidated Financial Statements

     6   

Report of Independent Registered Public Accounting Firm

     6   

Consolidated Statement of Assets and Liabilities

     7   

Consolidated Schedule of Investments

     8   

Consolidated Statement of Operations

     10   

Consolidated Statement of Changes in Net Assets

     11   

Consolidated Statement of Cash Flows

     12   

Consolidated Financial Highlights

     13   

Notes to Consolidated Financial Statements

     14   

Manager Highlights

     23   

Primary Strategies Implemented by Underlying Funds

     25   

Private Equity Funds and the J-Curve

     26   

Privacy Policy

     27   

Management Team and Independent Directors

     28   

This report is not authorized for use as an offer of sale or a solicitation of an offer to buy shares of Madison Harbor Balanced Strategies, Inc. (the “Fund”).

Past performance results shown in this report should not be considered a representation of future performance. Investment return and principal value of shares will fluctuate so that shares, if redeemed (see below), may be worth more or less than their original cost. The Fund’s shares are not traded on any securities exchange or any other market, and are subject to restrictions on transferability and resale. Shareholders do not have the right to require the Fund to repurchase or redeem their shares. The Fund may offer to repurchase Fund shares annually. Such repurchases, if any, will be subject to available liquidity and other restrictions, be consummated at a discount to the then net asset value per share, and will at no time exceed more than 5% of the Fund’s outstanding shares.

The views on the benefits and advantages of investing in real estate, as expressed herein, reflect the views and beliefs of the Adviser based on its experience in real estate investing. Many of the statements in this presentation are forward looking and contain significant risks and uncertainties. The opinions and views expressed herein are subject to change based on market and other conditions. Traditional investments are significantly different asset categories from that of real estate and thus the returns are significantly different, as are the characteristics of risk, liquidity and transparency.


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Letter to Shareholders

May 20, 2013

Dear Shareholders,

After a long winter, spring has arrived in New York, and similarly the long thaw after the global financial crisis of 2008 (GFC) seems to be ending in the US as a shaky recovery becomes more stable. After attending many of the underlying funds’ annual meetings, we are hearing positive anecdotes regarding the properties in our portfolio. In general, lease-up is occurring, even in secondary markets; sales of properties are occurring at decent valuations once a property is leased; and managers feel positively toward the prospects for their holdings. Since many of our managers have significant equity invested alongside us, they have personal alignment to ensure that values are maximized during this recovery period. Notwithstanding the good news within the portfolio and with regard to the ongoing recovery of the US economy, the fund remains vulnerable to international crises (political or economic) and to potential spikes in interest rates since low rates have helped fuel this recovery.

In comparison to previous recoveries, the pace of economic growth in the US has been slow, however the economy is now growing steadily. Unlike many other developed economies, US output is back above pre-financial crisis levels and on a clear upward trajectory. While the S&P 500 climbed 9.6% in the first quarter of 2013, US real estate remains relatively cheap. This could change as the recovery in commercial real estate moves from prime assets to higher-yielding secondary assets. Aviva Investors Research expects to see subdued but steady economic growth throughout this year, despite higher taxes and reductions in government spending. The US economy grew 2.2% in 2012, and the in-house view is for GDP growth of 1.6% this year. The equity market rally continues and the US Dollar Index, which tracks the currency against six of America’s biggest trading partners, is close to the highs seen in July 2012.

The ISM Purchasing Managers’ Index for March came in at 51.3, indicating a fourth consecutive month of expansion in US manufacturing. Although US unemployment remains stubbornly high at 7.6% and the March nonfarm payroll data disappointed, the latest reading of the Dow Jones Economic Sentiment Indicator in the US is close to its highest level since December 2007, which also suggests the US recovery is gaining traction. The housing market also continues to show signs of improvement. Average US home prices rose 8.1% in the 12 months to the end of January 2013, according to the S&P Case-Shiller Composite 20 Home Price Index.

The real estate occupier market fundamentals maintained their positive trend over the first quarter of 2013. According to the preliminary figures from PPR, vacancy rates sustained their downward movement across every sector with the warehouse sector seeing the largest inward movement of 20 basis points down to 8.2%. In terms of rents, the apartment, office and industrial warehouse sectors achieved positive growth in the first quarter but retail rents declined 0.2% year-on-year. We believe there is significant scope for sustained but steady improvement given the extent of declines experienced during the downturn.

The real estate investment market continues to look strong with the fourth quarter of last year delivering positive total returns of 2.5%, according to NCREIF. Nonetheless, the sales market continues to prefer stabilized assets over those with vacancy or other issues. The NCREIF NPI index, which represents unlevered stabilized core assets, recorded a total return of 10.5% for 2012 as a whole. Capitalization rates are still compressing across all sectors, albeit at a slowing pace. Relative pricing remains favorable with US real

 

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estate looking cheap relative to most other asset classes, suggesting further yield compression is possible, even for prime assets.

While lending conditions remain tight, the real estate debt market has shown considerable improvement over recent months. The latest Federal Reserve Senior Loan Officer Survey showed US banks had continued to ease their lending standards for commercial real estate.

Looking ahead, we expect the recovery to spread from core prime assets to good-quality secondary assets. We remain cautiously optimistic about the macro-economic and real estate market outlook, and expect real estate to deliver robust total returns over the next five years. This presents a positive environment for our fund managers to complete their business plans and harvest our investments.

Net Asset Value

The Fund’s March 31, 2013, net asset value was $701.70 per share, which represents a total return of +3.24% for the quarter, due in large part to strong returns for some of the larger funds in the portfolio, as discussed in more detail in the following Your Portfolio section of this report. The Fund’s return for its 2012/13 fiscal year was +6.48%. The Fund’s performance for the quarter outpaced the NCREIF Property Index, which returned 2.57%, but the Fund still trails the 10.52% return for the index over the past 12 months.1 The Fund’s annualized total return since inception is -3.63%, as adjusted for the reinvestment of distributions. The Fund’s current multiple (current NAV plus distributions paid since inception, divided by the offering price) is 0.75x.

Our investment philosophy and approach continue to be based on the use of fundamental research to identify a range of opportunities that we believe offer an attractive balance of risk and reward to assist our shareholders toward their long-term investing goals. We value our relationship with you as our investment partners and we stand ready to respond to any questions you may have.

Sincerely,

LOGO    LOGO
Edward M. Casal    Russell H. Bates
Chairman and    President
Chief Executive Officer   

 

 

1

National Council of Real Estate Investment Fiduciaries (NCREIF) Index (NPI) of a pool of private real estate investment properties.

 

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Your Portfolio *

Through March 31, 2013, the Fund has invested $43.7 million in its portfolio of private equity real estate funds, and these funds have returned $9.4 million in distributions, including $3.5 million in recallable capital. After adjusting for the recalled and recallable distributions, the Fund’s remaining commitment to the underlying funds is $1.9 million. The Fund’s liquid capital of $3.0 million remains invested primarily in short-duration government sponsored agency mortgage-backed securities, with the goal of capital preservation and moderate income production.

Consistent with the Fund’s standard practice, which is a function of the inherent quarterly lag in fund-of-funds reporting, this report is primarily based on valuations presented in our underlying funds’ Q4 2012 financial statements, which do not account for any Q1 2013 changes in value. In addition, US GAAP accounting rules require the Fund to adjust, when it deems necessary, each reported underlying fund valuation to our determination of fair market value. At March 31, 2013, our fair value adjustment came to -$1.2 million, which compares with an adjustment of -$1.0 million at December 31, 2012.

The table below provides a snapshot of the status of each of the underlying fund investments, including a “Current Multiple” figure which is computed simply as the Current Valuation plus Distributions Received, divided by Called Capital. These multiples provide a quick look at where each fund now stands, and range from 0.1x for Legacy II to 1.4x for Almanac IV. The portfolio’s overall multiple stands at 0.81x compared with 0.78x at the prior quarter-end.

Portfolio of Underlying Funds

March 31, 2013 (in US$ millions)

 

Underlying Fund

   Vintage
Year
     Committed
Capital
     Called
Capital
     Distributions
Received
     Current
Valuation
     Current
Multiple
    Remaining
Commitment
 

Barrow Street III

     2005       $ 4.4       $ 4.1       $ 0.8       $ 0.9         0.4   $ 0.3   

Exeter

     2007         5.0       $ 4.8         0.9         4.5         1.1     0.3   

Almanac IV

     2004         2.0       $ 2.1         1.4         1.5         1.4     —     

Guardian

     2004         1.5       $ 1.4         0.5         0.9         1.0     0.1   

Harrison Street I

     2006         5.3       $ 5.1         0.8         3.3         0.8     0.2   

Keystone II

     2005         2.5       $ 2.5         0.5         —           0.2     —     

Legacy Partners I

     2005         2.0       $ 2.0         0.2         1.3         0.8     —     

Legacy Partners II

     2006         2.8       $ 2.8         —           0.2         0.1     —     

Legg Mason II

     2005         1.5       $ 1.5         0.5         1.3         1.2     —     

Parmenter III

     2006         2.5       $ 2.7         0.2         1.6         0.7     —     

RREEF III

     2003         1.5       $ 1.5         0.2         0.6         0.5     —     

Thor II

     2007         5.0       $ 6.3         2.2         3.9         1.0     1.0   

Pearlmark II

     2004         1.5       $ 1.9         1.2         —           0.6     —     

Urban American II

     2007         5.0       $ 5.0         —           5.8         1.2     —     
     

 

 

    

 

 

    

 

 

    

 

 

      

 

 

 

Total

      $ 42.5       $ 43.7       $ 9.4       $ 25.8         0.81   $ 1.9   
     

 

 

    

 

 

    

 

 

    

 

 

      

 

 

 

 

 

* All information contained within the Your Portfolio section of this report is based on a combination of most recently available data, which, in some cases, is not current quarter data, and Adviser best estimates.

 

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Results reported by the underlying funds in Q4 2012 were mixed, with six funds reporting positive returns and eight with negative results, however strong performance from some of the larger funds more than offset the negative returns and the overall weighted average return for the quarter came in at +4.8%. This positive performance was offset in part by a slightly larger negative valuation adjustment for the quarter, but was still above 4% for the quarter.

Leading the way in Q4 was Urban American, at +24% reflecting year-end valuation updates on its portfolio which consists solely of New York City area workforce housing. Urban American is the largest holding in the Fund, at 22% of the portfolio of underlying funds, and the strong results are especially encouraging after several of its properties had been damaged in Super Storm Sandy. Thor Urban Property, the third largest position at 15%, was also up significantly at +23%, led by appreciation on its New York City retail assets and its downtown San Francisco office/retail building. Thor is another fund that only fully revalues its assets at year-end. Exeter, the Fund’s second largest position, at 17%, and an industrial fund, also reported a good quarter, at +4%. Of the funds that were down in Q4, Guardian was the weakest, at -32%, with year-end valuations on its DC area office portfolio reflecting the uncertain conditions in that region stemming from the sequester. Parmenter was also down, at -8%, as it faces persistent vacancy in its portfolio, and Barrow continues to struggle and was also -8% for the quarter. Another poor performer was Harrison Street, at -7%, and its impact was larger as it represents 13% of the portfolio of underlying funds.

During Q1 2013, the Fund received distributions from the underlying funds totaling $0.3 million, equal to 0.7% of the Fund’s capital commitments, with operating income from Exeter the largest component, followed by a distribution of income and realized proceeds from Almanac’s portfolio. Three other funds also made small distributions.

Just one small capital call was made in Q1 2013, by Guardian, of less than $0.1 million. Thor continues to account for the largest portion of the uncalled capital, at $1.0 million, part of which we expect will ultimately be used to pay down that fund’s subscription line financing facility which comes due in August 2013. The remaining $0.9 million in undrawn commitments is spread among Barrow, Exeter, Harrison, and Guardian, but these funds can only call capital to support existing investments and pay fund level costs.

 

LOGO

 

 

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We remain comfortable with the structure of the portfolio due to its diversification, both as originally allocated and at present as detailed in the charts on the previous page. The diversification figures are based on the current underlying fund portfolios as valued by the fund managers, based on the most recent available data.

The challenge of leasing up vacant space is the key risk facing the Fund’s portfolio at present, and for certain funds the risk is heightened due to refinancing and liquidity concerns. We continue to believe that the portfolio’s diversification as well as its defensive strategic composition will prove beneficial over time and that the Fund is positioned to benefit from a strengthening US economy and broader recovery in the commercial real estate market.

 

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Madison Harbor Balanced Strategies, Inc.

Consolidated Financial Statements

Report of Independent Registered Public Accounting Firm

To the Directors and Shareholders of

Madison Harbor Balanced Strategies, Inc.

We have audited the accompanying consolidated statement of assets and liabilities of Madison Harbor Balanced Strategies, Inc. and its subsidiary (the “Fund”), including the consolidated schedule of investments, as of March 31, 2013, and the related consolidated statements of operations and cash flow for the year then ended, the consolidated statements of changes in net assets for each of the years in the two-year period then ended, and the consolidated financial highlights for each of the years in the five-year period then ended. The consolidated financial statements and financial highlights are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial highlights based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of investments owned as of March 31, 2013, with management of the underlying investment funds and the custodian of the fixed income securities. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Madison Harbor Balanced Strategies, Inc. and its subsidiary as of March 31, 2013, and the results of their operations and their cash flows for the year then ended and the changes in their net assets and the financial highlights for each of the years in the two-year and five-year periods then ended, respectively, in conformity with accounting principles generally accepted in the United States of America.

EisnerAmper LLP

New York, New York

May 23, 2013

 

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Consolidated Statement of Assets and Liabilities

March 31, 2013

 

Assets

  

Investments at fair value (cost $38,402,111)

   $ 28,871,241   

Cash and cash equivalents

     220,422   

Accrued interest receivable

     7,596   

Prepaid expenses and other assets

     35,085   
  

 

 

 

Total Assets

     29,134,344   
  

 

 

 

Liabilities

  

Accrued expenses and other liabilities

     276,287   

Management fees payable

     87,697   

Due to affiliates

     500   
  

 

 

 

Total Liabilities

     364,484   
  

 

 

 

Net Assets

   $ 28,769,860   
  

 

 

 

Net Assets

  

Components of net assets:

  

Common Stock (par value $0.0001, 300,000 shares authorized, 41,000 shares issued and outstanding) and Paid-in capital

   $ 41,025,911   

Distributions in excess of net investment income

     (1,526,511

Accumulated net realized loss on investments

     (1,198,670

Accumulated net unrealized depreciation on investments

     (9,530,870
  

 

 

 

Net Assets

   $ 28,769,860   
  

 

 

 

Net Asset Value Per Share

   $ 701.70   
  

 

 

 

See accompanying notes to consolidated financial statements.

 

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Consolidated Schedule of Investments

March 31, 2013

 

Description

   Commitment  or
Principal
Amount
     Unfunded
Commitment
     Value      % of  Net
Assets
 

Private Equity Real Estate Funds (“Underlying Funds”)(1)

           

Urban American Real Estate Fund II, LP

   $ 5,000,000       $ —         $ 5,759,357         20.02

Exeter Industrial Value Fund, LP

     5,000,000         350,000         4,519,762         15.71

Thor Urban Property Fund II, Inc

     5,000,000         974,151         3,954,098         13.74

Harrison Street Real Estate Partners I, LP

     5,277,700         164,388         3,276,048         11.39

Parmenter Realty Fund III, LP

     2,500,000         —           1,591,266         5.53

Almanac Realty Securities IV, L.P

     2,000,000         —           1,525,435         5.30

Legg Mason Real Estate Capital II, Inc

     1,500,000         —           1,333,882         4.64

Legacy Partners Realty Fund I, LLC

     2,000,000         —           1,312,769         4.56

Barrow Street Real Estate Investment Fund III, LP

     4,400,000         302,275         896,317         3.12

Guardian Realty Fund II, LLC

     1,500,000         158,242         851,828         2.96

RREEF America REIT III, Inc. (2)

     1,500,000         —           591,528         2.06

Legacy Partners Realty Fund II, LLC

     2,800,000         —           234,797         0.82

Keystone Property Fund II, LP

     2,500,000         —           —           0.00
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Private Equity Real Estate Funds
(cost $35,325,820)

   $ 40,977,700       $ 1,949,056         25,847,087         89.85
        

 

 

    

 

 

 
  

 

 

    

 

 

       

Fixed Income Securities

           

FHLMC Series 4152, Class UD, Dated 01/01/13, 2.5%,
Due 01/15/43

   $ 296,226         —           288,611         1.00

FHLMC Series 3909, Class UA, Dated 08/01/11, 3.5%,
Due 08/15/25

     234,615         —           244,744         0.85

FHLMC Series 3852, Class CP, Dated 05/01/11, 4.5%,
Due 10/15/39

     215,085         —           223,613         0.78

FHLMC Series 4105, Class YB, Dated 09/01/12, 3.0%,
Due 05/15/42

     200,000         —           195,419         0.68

FHLMC Series 3972, Class AB, Dated 12/01/11, 3.5%,
Due 05/15/36

     79,229         —           81,182         0.28

FHLMC Series 4059, Class UA, Dated 06/01/12, 3.0%,
Due 11/15/41

     75,595         —           76,017         0.26

FHLMC Series 2979, Class MC, Dated 05/01/05, 5.0%,
Due 05/15/20

     17,063         —           18,371         0.06

FHLMC Series 2558, Class DE, Dated 01/01/03, 5.5%,
Due 09/15/32

     13,319         —           13,980         0.05

FHLMC Series 2727, Class PE, Dated 01/01/04, 4.5%,
Due 07/15/32

     13,390         —           13,780         0.05

FHLMC Series 2986, Class PE, Dated 06/01/05, 5.5%,
Due 10/15/33

     9,053         —           9,254         0.03

FHLMC Series 2931, Class DC, Dated 02/01/05, 4.0%,
Due 06/15/18

     6,726         —           6,766         0.02

FHLMC Series 3035, Class PA, Dated 09/01/05, 5.5%,
Due 09/15/35

     5,367         —           5,979         0.02

FHLMC Series 2780, Class JA, Dated 04/01/04, 4.5%,
Due 04/15/19

     3,841         —           3,974         0.01

FHLMC Series 2864, Class NA, Dated 09/01/04, 5.5%,
Due 01/15/31

     3,480         —           3,517         0.01

FHLMC Series 2994, Class ND, Dated 06/01/05, 5.0%,
Due 11/15/32

     1,213         —           1,217         0.00

FHLMC Series 2735, Class PG, Dated 01/01/04, 5.5%,
Due 09/15/32

     1,115         —           1,121         0.00

FNMA Series 2013-18, Class KD, Dated 02/01/13, 2.5%,
Due 03/25/33

     250,000         —           248,330         0.86

FNMA Series 2009-65, Class JY, Dated 08/01/09, 4.5%,
Due 09/25/39

     98,675         —           104,387         0.36

FNMA Series 2003-17, Class HC, Dated 02/01/03, 5.0%,
Due 03/25/18

     32,493         —           34,775         0.12

FNMA Series 2012-47, Class KL, Dated 04/01/12, 3.5%,
Due 04/25/42

     28,492         —           28,956         0.10

FNMA Series 2007-82, Class B, Dated 07/01/07, 5.0%,
Due 11/25/33

     25,473         —           25,930         0.09

FNMA Series 2008-74, Class B, Dated 08/01/08, 5.5%,
Due 09/25/38

     20,644         —           23,005         0.08

FNMA Series 2007-77, Class TC, Dated 07/01/07, 5.5%,
Due 09/25/34

     21,776         —           22,271         0.08

FNMA Series 1990-118, Class G, Dated 09/01/90, 6.0%,
Due 09/25/20

     12,191         —           13,147         0.05

FNMA Series 2004-88, Class HA, Dated 11/01/04, 6.5%,
Due 07/25/34

     11,448         —           12,155         0.04

 

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Consolidated Schedule of Investments

March 31, 2013

 

Description

   Commitment  or
Principal
Amount
     Unfunded
Commitment
     Value      % of  Net
Assets
 

Fixed Income Securities (continued)

           

FNMA Series 2003-22, Class KL, Dated 03/01/03, 5.5%,
Due 09/25/32

   $ 10,546         —         $ 11,142         0.04

FNMA Series 2003-71, Class UA, Dated 07/01/03, 4.0%,
Due 08/25/18

     3,947         —           4,144         0.01

FNMA Series 2003-46, Class DA, Dated 05/01/03, 5.0%,
Due 04/25/32

     3,931         —           4,011         0.01

FNMA Series 2003-33, Class AE, Dated 04/01/03, 4.5%,
Due 03/25/33

     1,537         —           1,608         0.01

FNMA Series 2003-37, Class QD, Dated 04/01/03, 5.0%,
Due 05/25/32

     1,068         —           1,072         0.00

FNMA Series 2004-91, Class A, Dated 11/01/04, 5.0%,
Due 11/25/32

     531         —           532         0.00

FNMA Pool Series 687044, Dated 01/01/03, 5.5%,
Due 01/01/18

     8,087         —           8,600         0.03

GNMA Series 2012-127, Class DC, Dated 10/01/12, 2.0%,
Due 08/16/42

     277,550         —           275,635         0.96

GNMA Series 2006-1, Class LA, Dated 01/01/06, 5.0%,
Due 06/20/35

     50,105         —           51,879         0.18

GNMA Series 2007-74, Class LB, Dated 11/01/07, 5.5%,
Due 02/20/28

     50,000         —           50,141         0.17

GNMA Series 2009-34, Class DA, Dated 05/01/09, 4.5%,
Due 03/20/34

     43,690         —           44,550         0.15

GNMA Series 2008-56, Class DL, Dated 06/01/08, 5.5%,
Due 09/20/37

     40,719         —           42,994         0.15

GNMA Series 2008-63, Class KH, Dated 07/01/08, 5.5%,
Due 02/20/37

     38,274         —           39,111         0.14

GNMA Series 2005-56, Class DB, Dated 07/01/05, 5.0%,
Due 08/20/33

     33,522         —           34,365         0.12

GNMA Series 2005-92, Class EC, Dated 12/01/05, 5.5%,
Due 03/20/34

     26,164         —           26,862         0.09

GNMA Series 2007-49, Class CD, Dated 08/01/07, 5.5%,
Due 11/20/32

     26,039         —           26,555         0.09

GNMA Series 2006-69, Class GE, Dated 12/01/06, 5.25%,
Due 02/20/33

     25,000         —           26,407         0.09

GNMA Series 2003-40, Class TD, Dated 05/01/03, 5.0%,
Due 03/20/33

     24,000         —           25,268         0.09

GNMA Series 2004-72, Class BA, Dated 09/01/04, 5.5%,
Due 02/20/33

     24,623         —           25,215         0.09

GNMA Series 2005-77, Class DA, Dated 10/01/05, 5.5%,
Due 02/17/33

     22,845         —           23,738         0.08

GNMA Series 2007-61, Class VN, Dated 10/01/07, 5.5%,
Due 02/20/28

     19,064         —           19,780         0.07

GNMA Series 2004-47, Class QD, Dated 06/01/04, 5.0%,
Due 08/16/33

     17,438         —           18,115         0.06

GNMA Series 2012-30, Class BC, Dated 03/01/12, 2.5%,
Due 08/20/40

     17,611         —           17,572         0.06

GNMA Series 2005-60, Class HC, Dated 09/01/05, 5.0%,
Due 05/20/32

     16,838         —           17,134         0.06

GNMA Series 2002-70, Class BL, Dated 10/01/02, 5.5%,
Due 07/20/32

     15,707         —           16,824         0.06

GNMA Series 2005-85, Class JN, Dated 11/01/05, 5.5%,
Due 10/16/32

     15,363         —           16,352         0.06

GNMA Series 2004-42, Class LE, Dated 06/01/04, 5.5%,
Due 07/20/33

     14,105         —           14,960         0.05

GNMA Series 2003-40, Class TA, Dated 05/01/03, 4.5%,
Due 03/20/33

     8,169         —           8,198         0.03

GNMA Series 2003-39, Class LM, Dated 05/01/03, 5.0%,
Due 05/20/32

     7,276         —           7,427         0.03

GNMA Series 1999-15, Class PC, Dated 05/01/99, 5.0%,
Due 04/16/29

     5,077         —           5,255         0.02

GNMA Series 2005-7, Class BA, Dated 02/01/05, 4.5%,
Due 07/20/32

     4,937         —           4,968         0.02

GNMA Series 2006-41, Class DB, Dated 08/01/06, 5.5%,
Due 11/16/31

     2,543         —           2,575         0.01

GNMA Pool Series 4460, Dated 06/01/09, 4.0%,
Due 06/20/39

     31,066         —           32,858         0.11

GNMA Pool Series 4736, Dated 07/01/10, 4.0%,
Due 07/20/40

     20,183         —           21,347         0.07

GNMA Pool Series 781092, Dated 10/01/99, 7.0%,
Due 10/15/14

     4,048         —           4,140         0.01

Morgan Stanley Liquid Asset Fund, Inc.

     392,319         —           392,319         1.36
  

 

 

       

 

 

    

 

 

 

Total Fixed Income Securities (cost $3,076,291)

   $ 2,980,431            3,024,154         10.46
  

 

 

       

 

 

    

 

 

 

Total Investments at Fair Value (cost $38,402,111)

         $ 28,871,241         100.31
        

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

(1) Investments in Underlying Funds are illiquid, exempt from registration under the Securities Act of 1933.
(2) A redemption request has been submitted for the investment in RREEF America REIT III, Inc., however that fund has indefinitely suspended redemptions.

 

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Consolidated Statement of Operations

For the Year ended March 31, 2013

 

Investment Income

  

Underlying Funds

   $ 835,874   

Interest

     154,639   
  

 

 

 

Total investment income

     990,513   
  

 

 

 

Expenses

  

Management fees

     508,338   

Professional fees

     174,000   

Administration fees

     172,000   

Insurance expenses

     46,884   

Board of Directors’ fees

     43,500   

Compliance

     36,000   

Printing expenses

     11,000   

Other expenses

     29,051   
  

 

 

 

Total operating expenses before reimbursement from Adviser

     1,020,773   

Reimbursement from Adviser

     (172,050
  

 

 

 

Net operating expenses

     848,723   
  

 

 

 

Net investment income

     141,790   

Net realized loss on investments

     (1,057,806

Net change in unrealized depreciation on investments

     2,666,114   
  

 

 

 

Net increase in net assets resulting from operations

   $ 1,750,098   
  

 

 

 

See accompanying notes to consolidated financial statements.

 

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Consolidated Statement of Changes in Net Assets

 

     Year ended
March 31,  2013
    Year ended
March 31, 2012
 

Increase (Decrease) in Net Assets Resulting from Operations:

    

Net investment income (loss)

   $ 141,790      $ (481,557

Net realized loss on investments

     (1,057,806     (106,150

Net change in unrealized depreciation on investments

     2,666,114        720,801   
  

 

 

   

 

 

 

Net increase in net assets resulting from operations

     1,750,098        133,094   
  

 

 

   

 

 

 

Net Assets, beginning of year

     27,019,762        26,886,668   
  

 

 

   

 

 

 

Net Assets, end of year

   $ 28,769,860      $ 27,019,762   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Consolidated Statement of Cash Flows

For the Year ended March 31, 2013

 

Cash Flows from Operating Activities:

  

Net increase in net assets resulting from operations

   $ 1,750,098   

Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by operating activities:

  

Net realized loss on investments

     1,057,806   

Net change in unrealized depreciation on investments

     (2,666,114

Increase/decrease in operating assets and liabilities

  

Purchases of investments owned

     (5,339,883

Proceeds from disposition of investments owned

     5,347,952   

Due from Underlying Funds

     22,912   

Accrued interest receivable

     (2,827

Prepaid expenses and other assets

     (1,606

Management fees payable

     (9,532

Due to affiliate

     500   

Accrued expenses and other liabilities

     17,503   
  

 

 

 

Net cash provided by operating activities

     176,809   
  

 

 

 

Net increase in cash and cash equivalents

     176,809   

Cash and cash equivalents at:

  

Beginning of year

     43,613   
  

 

 

 

End of year

   $ 220,422   
  

 

 

 

See accompanying notes to consolidated financial statements.

 

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Consolidated Financial Highlights

 

     For the Years ended March 31,  
     2013     2012     2011     2010     2009  

Per share data (for a share outstanding throughout the year) 1 :

          

Net asset value, beginning of year

   $ 659.02      $ 655.77      $ 634.18      $ 811.63      $ 1,019.00   

Net investment income (loss)

     3.46        (11.74     (10.09     (5.57     (5.52

Net realized gain (loss) on investments

     (25.80     (2.59     (4.34     (2.16     2.90   

Net change in unrealized appreciation (depreciation) on investments

     65.02        17.58        36.02        (169.72     (202.75
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total from operations

     42.68        3.25        21.59        (177.45     (205.37
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Return of capital distributions to shareholders

     —          —          —          —          (2.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total distributions to shareholders

     —          —          —          —          (2.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net asset value, end of year

   $ 701.70      $ 659.02      $ 655.77      $ 634.18      $ 811.63   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total return2

     6.48     0.49     3.40     (21.86 )%      (20.15 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net assets, end of year

   $ 28,769,860      $ 27,019,762      $ 26,886,668      $ 26,001,540      $ 33,317,334   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratios to average net assets3 :

          

Expenses, including expense reimbursement

     3.08     3.08     2.95     2.88     2.87

Expenses, excluding expense reimbursement

     3.71     3.70     3.71     3.65     3.62

Net investment income (loss)

     0.52     (1.76 )%      (1.52 )%      (0.77 )%      (0.58 )% 

Portfolio turnover rate

     19.58     18.10     31.18     58.14     46.57

See accompanying notes to consolidated financial statements.

 

1 

Per share calculations are based on average shares outstanding during the year.

2

Total return is calculated assuming a purchase of a share on the first day and a sale on the last day of each year reported and includes reinvestment of distributions. Past performance is not a guarantee of future results.

3

Ratios do not include expenses of Underlying Fund investments.

 

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Table of Contents

Notes to Consolidated Financial Statements

March 31, 2013

(1) Organization

Madison Harbor Balanced Strategies, Inc. (the “Fund”), is a Maryland corporation formed on December 16, 2003, and is registered under the Investment Company Act of 1940, as amended, as a closed-end, non-diversified, management investment company. The Fund commenced operations on January 28, 2005, and held its final closing on December 31, 2006 (the “Final Closing”). The Fund has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes. Pursuant to the Fund’s investment advisory agreement, dated April 28, 2008, Aviva Investor North America, Inc. (“Aviva Investors”), an Iowa corporation, serves as the adviser of the Fund (the “Adviser”). The Adviser is responsible for the day-to-day management and operation of the Fund. The Board of Directors (the “Board”) has overall responsibility for the management and supervision of the Fund. The investment objective of the Fund is to seek long-term capital appreciation as well as current return and to mitigate risk through diversification by investment in professionally managed real estate private equity funds (the “Underlying Funds”). The Fund’s investment period ended December 31, 2007, and the duration of the Fund, which was originally anticipated to be ten years from the Final Closing, is now anticipated to run through 2018.

On April 19, 2006, the Fund formed a wholly-owned subsidiary, Madison Harbor Balanced Strategies Taxable REIT Subsidiary, Inc. (“MHBS-TRS”). Unlike the income earned from other investments in which the Fund owns an interest, income earned by the investments of a taxable REIT subsidiary is not attributable to the Fund for the purposes of certain REIT qualification tests, and this income does not maintain its character when distributed from the taxable REIT subsidiary to the Fund as a dividend. As a result, income that might not be qualifying income for purposes of the income tests applicable to REITs could be earned by a taxable REIT subsidiary without affecting the REIT status of its Fund. The Fund may employ one or more taxable REIT subsidiaries through which to invest in Underlying Funds or other assets, the ownership of which might adversely affect the Fund’s qualification under the REIT rules if such assets were held directly. As of March 31, 2013, the Fund’s investment in Barrow Street Real Estate Investment Fund III and a portion of its investment in Harrison Street Real Estate Partners I, LP were held by MHBS-TRS.

(2) Summary of Significant Accounting Policies

 

  (a) Basis of Presentation

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).

 

  (b) Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Adviser to make estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses in the financial statements. The Adviser believes that the estimates utilized in preparing the Fund’s financial statements are reasonable and prudent; however, actual results could differ from these estimates.

 

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  (c) Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Madison Harbor Balanced Strategies, Inc. and its wholly-owned subsidiary, MHBS-TRS. MHBS-TRS is 100% owned and controlled by the Fund. All material intercompany transactions and account balances have been eliminated in consolidation.

 

  (d) Valuation

FAIR VALUE MEASUREMENT – DEFINITION AND HIERARCHY

The Fund provides disclosures about investments that are measured and reported at fair value using a fair value hierarchy, which prioritizes and ranks the level of market price observability used in measuring investments at fair value. Market price observability is impacted by a number of factors, including the type of investment, the characteristics specific to the investment, and the state of the marketplace (including the existence and transparency of transactions between market participants). Investments with readily available actively quoted prices, or for which fair value can be measured from actively quoted prices in an orderly market, will generally have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Investments measured and reported at fair value are classified and disclosed in one of the following categories based on inputs:

 

   

Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities that the Fund has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment. Examples of assets utilizing Level 1 inputs are: most U.S. Government securities and money market securities.

 

   

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Examples of assets utilizing Level 2 inputs are: certain U.S. agency securities and collateralized mortgage obligations.

 

   

Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement. Examples of assets utilizing Level 3 inputs are: private equity real estate funds.

The availability of observable inputs can vary from product to product and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Fund in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

 

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Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Fund’s own assumptions are set to reflect those that market participants would use in pricing the asset at the measurement date. The Fund uses prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or Level 2 to Level 3.

Money Market Securities. Money market securities are valued using quoted market prices. Valuation adjustments are not applied. Accordingly, the Fund’s investments in money market securities are categorized in Level 1 of the fair value hierarchy.

U.S. Agency Securities. U.S. agency securities include collateralized mortgage obligations and are generally valued using quoted market prices or are benchmarked thereto. Accordingly, the Fund’s investments in U.S. agency securities are categorized in Level 2 of the fair value hierarchy.

Investments in Private Equity Real Estate Funds. The Fund’s investments in private equity real estate funds take the form of direct private investments in such entities. The transaction price is used as the best estimate of fair value at inception. Thereafter, valuation is based on an assessment of each underlying investment, incorporating valuations that consider the evaluation of financing and sale transactions with third parties, expected cash flows and market-based information, including comparable company transactions, performance multiples and changes in market outlook, among other factors. These nonpublic investments are included in Level 3 of the fair value hierarchy because they trade infrequently, and, therefore, the fair value is unobservable.

The Fund’s net asset value per share is determined by the Board at the end of each calendar quarter. Because of the inherent uncertainty of valuations, the fair value of investments as determined by the Board may differ significantly from the values that would have been used had a ready market for those investments existed, and the differences could be material.

In determining fair value, the Board uses a multi-step valuation process each quarter, as described below.

 

  (i) The first step of the process is a review and analysis conducted by the Adviser of the reported net asset value of each of the Underlying Funds. This includes a review of the Underlying Fund’s latest financial statements and an analysis of its real estate portfolio and the methodologies and assumptions, including discount rates and exit cap rates (the ratio of projected net operating income to terminal sales price), used by each Underlying Fund in the valuation of the portfolio. Since the Underlying Funds generally do not issue their financial statements until 60 to 90 days after quarter-end and the Fund seeks to issue its net asset value within 30 days of quarter-end, the Adviser by necessity generally relies on prior quarter financial information.  

 

  (ii) The results of this review and analysis are compiled by the Adviser and consideration is given to subsequent events at each Underlying Fund level and within the real estate markets in which they invest, and to events and conditions in the broader real estate market and economy.  

 

16


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  (iii) The Adviser then calculates a discount rate for each Underlying Fund using external data including market interest rates at the current quarter-end and lending spreads for specific real estate property types, and an estimated cost of equity rate based on the specific Underlying Fund portfolio. The Adviser also reviews the exit cap rate and other assumptions used by each Underlying Fund. A fair value is then determined for each Underlying Fund based on the Adviser’s internally derived discount rate and exit cap rates.

 

  (iv) The results of this analysis are detailed in a Valuation Memorandum which is reviewed and, subject to any revisions, approved at a meeting of the Valuation Committee.

 

  (v) The Valuation Committee then provides a recommendation to the full Board for their review and approval.

The following table provides quantitative information related to the significant unobservable inputs for Level 3 investments carried at fair value at March 31, 2013:

 

     Fair Value      Unobservable
Inputs
   Range

Private Equity Real Estate Funds

   $ 25,847,087       Discount Rates    6.88%  -  25.00%
      Exit Cap Rates    5.73%  -  9.00%
      Cost of Equity Rates    13.00%  -  25.00%

Changes in discount rates, exit cap rates or cost of equity rates, each in isolation, may change the fair value of our Private Equity Real Estate investments. Generally, an increase in discount rates and cost of equity may result in a decrease in the fair value of Private Equity Real Estate investments.

 

  (e) Income and Expense Recognition

Dividend and interest income is recognized on the accrual basis. Income from Underlying Funds is recognized as declared and distributed by the Underlying Funds. Investment transactions are accounted for on a trade date basis.

The Fund is responsible for and pays all fees and expenses incurred. Such expenses include, but are not limited to, the Adviser’s management fee, fees paid to the Fund’s administrator and custodian, legal fees, accounting fees and audit expenses, the fees and expenses of directors, directors’ and officers’ insurance, travel expenses incurred on the Fund’s behalf, and organizational and offering costs of the Fund.

In the event that the expenses of the Fund in any particular fiscal year of operations, excluding the Adviser’s management fees, offering costs, taxes and extraordinary items, and any expenses for MHBS-TRS, exceed 1.00% of the Fund’s average month-end net asset value for the fiscal year (the “Expense Reimbursement Methodology”), the Adviser will reimburse the Fund for any such expenses incurred above that amount (the “Expense Reimbursement”). The Fund notes that its private placement memorandum stated that “in the event that [the Fund’s] total ongoing operating expenses in any particular fiscal year of operations, excluding management fees, exceed 1.00% of [the Fund’s]

 

17


Table of Contents

net asset value as determined at the end of that fiscal year, the Adviser will reimburse the Fund for any such expenses incurred above 1.00% of [the Fund’s] net asset value,” (the “Stated Methodology”). In fact, the Stated Methodology was never employed, and the Expense Reimbursement Methodology has historically benefitted the Fund’s shareholders, compared with the amount that would have been reimbursed to the Fund under the Stated Methodology. The Fund believes that the Expense Reimbursement Methodology represents the industry standard for fee reimbursements of this nature. However, when the value of the net assets of the Fund is declining, as it had been in the market environment in 2009 and 2010, the Expense Reimbursement Methodology would be less beneficial to Fund shareholders than the Stated Methodology.

The total expenses of the Fund, excluding management fees, offering costs, taxes, expenses of the Fund’s taxable REIT subsidiary and extraordinary items, for the year ended March 31, 2013, amounted to $447,259, and the Expense Reimbursement for such period amounted to $172,050.

 

  (f) Income Taxes

The Fund has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), commencing with the taxable year ended December 31, 2005. To qualify as a REIT, the Fund must meet a number of organizational and operational requirements, including a requirement that it currently distribute at least 90% of its adjusted taxable income to its shareholders. The Fund believes that it has been organized and has operated in a manner that will allow it to qualify for taxation as a REIT under the Code commencing with the taxable year ended December 31, 2005 and thereafter and it is management’s intention to adhere to these requirements and maintain the Fund’s REIT status.

As a REIT, the Fund will generally not be subject to corporate level federal income tax on taxable income it currently distributes to its shareholders. If the Fund fails to qualify as a REIT in any taxable year, it will be subject to federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and may not be able to qualify as a REIT for the subsequent four taxable years. Even if the Fund qualifies for taxation as a REIT, the Fund may be subject to certain state and local income and excise taxes on its income and property, and to federal income and excise taxes on its undistributed income.

For the tax year ended December 31, 2012, MHBS-TRS incurred a net operating loss (“NOL”) for federal income tax purposes of approximately $218,000 which is available for carry forward through 2032. The difference between the tax loss and the financial statement net loss of MHBS-TRS of approximately $64,000 mainly relates to the timing of the recognition of realized losses for tax purposes. As of December 31, 2012, the cumulative NOL is approximately $2,227,000 which expires through 2032. For the tax years ended December 31, 2006 through 2012, MHBS-TRS has recorded a full valuation allowance against the deferred tax asset relating to the cumulative NOL to the extent that the cumulative NOL exceeds the unrealized gains on investments, if any. The total valuation allowance at December 31, 2012, was approximately $779,000, including $76,000 recorded in 2012.

The Fund evaluates tax positions taken or expected to be taken in the course of preparing the Fund’s tax returns to determine whether the tax positions are “more likely than not” of being sustained by the applicable tax authority. Tax positions deemed to meet the “more likely than not” threshold would be recorded as a tax benefit or expense in the current year. Management has analyzed the Fund’s tax positions taken on federal and state income tax returns for all open tax years (2009 and later) and has concluded that as of March 31, 2013, no provision for income tax would be required in the Fund’s

 

18


Table of Contents

financial statements. The Fund’s federal and state income and federal excise tax returns for tax years for which the applicable statutes of limitations have not expired are subject to examination by the Internal Revenue Service and state departments of revenue. Interest and penalties on uncertain tax positions, should any be taken, will be classified as interest and other expense, respectively.

 

  (g) Distributions to Shareholders

Distributions to shareholders are recorded on the declaration date.

 

  (h) Cash and Cash Equivalents

The Fund considers cash in banks, obligations of the U.S. Government, commercial paper and deposits with financial institutions with maturities of three months or less when acquired and that can be liquidated without prior notice or penalty, to be cash and cash equivalents.

The Fund currently maintains its cash balances with SEI Private Trust Company. The Fund has not experienced any losses on such accounts and does not believe it is exposed to any significant risk on cash and cash equivalents. From time to time, the Fund may, during the course of operations, maintain cash balances with financial institutions in excess of federally insured limits.

 

  (i) Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-04 – Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS (“ASU 2011-04”). ASU 2011-04 clarifies the application of some requirements for measuring fair value and requires additional disclosure for fair value measurements. The disclosure requirements are expanded to include for fair value measurements categorized in Level 3 of the fair value hierarchy: 1) a quantitative disclosure of the unobservable inputs and assumptions used in the measurement; 2) a description of the valuation processes in place; and 3) a narrative description of the sensitivity of the fair value to changes in unobservable inputs and interrelationships between those inputs. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011, for public entities. The Fund adopted this standard on April 1, 2012. The Fund has determined that implementation of this standard had no material impact on its process for measuring fair values, financial position or results of operations.

(3) Capital Share Transactions

As of March 31, 2013, 300,000 shares of $0.0001 par value common stock were authorized.

Shares of the Fund’s common stock were initially sold at a price of $1,000 per share. The Fund’s shares are not traded on any securities exchange, are not expected to trade on any other market, and are subject to restrictions on transferability and resale. Shareholders do not have the right to require the Fund to repurchase or redeem their shares. The Fund may, from time to time after the one-year anniversary of the Final Closing, offer to repurchase Fund shares annually, on terms established by the Board. Such repurchases, if any, will be subject to available liquidity and other restrictions, be consummated at a discount to the then net asset value, and will at no time exceed more than 5% of the Fund’s outstanding shares. The Fund did not make a tender offer during the year ended March 31, 2013.

 

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The Adviser may pay, from its own resources, compensation to certain distributors of the Fund’s shares in connection with the servicing of investors. This amount is currently anticipated to range between 0.325% and 0.650% of net asset value annually.

As of March 31, 2013, affiliates of the Adviser owned approximately 0.1% of the shares of the Fund.

(4) Investments

As of March 31, 2013, the Fund had committed an aggregate of $42,455,700 to 14 Underlying Funds, of which 13 Underlying Funds with commitments totaling $40,977,700 remain in the portfolio. As of December 31, 2012, Underlying Fund Pearlmark Mezzanine Realty Partners II, LP was liquidated. With the exception of one Underlying Fund, redemptions are not permitted and liquidity is available only to the extent that the Underlying Funds make distributions. Underlying Fund RREEF America III REIT, Inc. does permit redemptions but has indefinitely suspended redemptions. As of March 31, 2013, the unfunded commitment to Underlying Funds was $1,949,056.

Cost of investments in, and distributions received from, Underlying Funds, for the year ended March 31, 2013, were $2,143,012 and $1,402,893, respectively. Distributions received from Underlying Funds included recallable return of capital of $396,916 and non-recallable return of capital of $1,005,977. The cost of purchases, and the proceeds from sales and repayments, of fixed-income securities were $3,196,871 and $3,945,059, respectively, for the year ended March 31, 2013. At March 31, 2013, the original cost of investments for federal income tax purposes was substantially the same as the cost for financial reporting purposes. At March 31, 2013, net unrealized appreciation (depreciation) on investments in Underlying Funds was ($9,478,733) (gross unrealized appreciation of $1,345,971 and gross unrealized depreciation of ($10,824,704) and net unrealized appreciation (depreciation) on fixed-income securities was ($52,137) (gross unrealized appreciation of $5,162 and gross unrealized depreciation of ($57,299).

FAIR VALUE MEASUREMENTS

The Fund’s assets recorded at fair value have been categorized based upon a fair value hierarchy. See Note 2 for a discussion of the Fund’s policies regarding this hierarchy.

The following fair value hierarchy tables present information about the Fund’s assets measured at fair value on a recurring basis as of March 31, 2013:

Assets Measured at Fair Value on a Recurring Basis as of March 31, 2013

 

     Quoted Prices in
Active Markets
for Identical
Assets
     Significant Other
Observable
Inputs
     Significant Other
Unobservable
Inputs
     Balance as of
March 31,
2013
 
     (Level 1)      (Level 2)      (Level 3)         

Fixed Income Securities:

           

Money Market Fund

   $ 392,319       $ —         $ —         $ 392,319   

U.S. Agency Securities

     —           2,631,835         —           2,631,835   

Private Equity Real Estate Funds

     —           —           25,847,087         25,847,087   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 392,319       $ 2,631,835       $ 25,847,087       $ 28,871,241   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

20


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Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis for year ended March 31, 2013

 

     Beginning
Balance
     Realized  Gains
(Losses)1
    Unrealized
Gains
(Losses)1
     Total Realized
and Unrealized
Gains

(Losses)1
     Purchase,
Sales, Other
Settlements
and
Issuances, Net2
     Ending
Balance
 

Private Equity Real Estate Funds

   $ 23,276,952       $ (945,217   $ 2,775,233       $ 1,830,016       $ 740,119       $ 25,847,087   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

1

Realized and unrealized gains(losses) are included in net realized gains(losses) on investments and net changes in unrealized appreciation(depreciation) on investments in the consolidated statement of operations.

2

Excludes $835,874 of investment income included in the consolidated statement of operations.

The total change in unrealized appreciation (depreciation) included in the statement of operations attributed to Level 3 investments still held at March 31, 2013, was $1,827,448.

During the year ended March 31, 2013, there were no transfers between Level 1 and Level 2 assets and liabilities and no significant changes to the Fund’s fair valuation methodologies.

(5) Investment Advisory Fees

Pursuant to the investment advisory agreement between the Fund and the Adviser, the Adviser is entitled to receive, on a quarterly basis, in advance, a management fee at an annualized rate equal to 2.00% of the net asset value of the Fund comprised of Underlying Fund investments, and 1.00% of the net asset value of the Fund comprised of proceeds of offerings and distributions that have not been invested in Underlying Funds (the “Managed Account”). Gross management fees for the year ended March 31, 2013, were equal to 1.85% of the Fund’s average net assets, and the effective management fee rate, net of the Expense Reimbursement, was an annualized 1.22%.

(6) Administration Agreement

SEI Investments Global Funds Services (the “Administrator”) provides certain administration, accounting and investor services for the Fund. In consideration for such services, the Fund pays the Administrator a monthly fee based on month-end net assets at an annual rate of up to 0.10%, subject to certain fee minimums, and will reimburse the Administrator for certain out-of-pocket expenses. For the year ended March 31, 2013, the Fund incurred Administration fees of $172,000, which equates to the minimum fee.

(7) Distributions to Shareholders

For the years ended March 31, 2013 and 2012, the Fund had no distributable earnings and declared no distributions, and at the end of each of these periods the Fund had no undistributed ordinary income.

Dividends from net investment income and distributions from net realized capital gains are determined in accordance with U.S. federal income tax regulations, which may differ from those amounts determined under GAAP. The primary reasons that differences may exist between the Fund’s tax-basis versus GAAP-basis net investment income are: (1) certain GAAP-basis amounts recognizable for tax purposes in different tax years; (2) certain GAAP-basis offering cost expenses not recognizable for tax purposes; and (3) differing tax and GAAP year ends (December 31, and March 31, respectively). These differences are temporary in nature.

 

21


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(8) Subsequent Events

Subsequent to March 31, 2013, the following distributions were received from, and contributions made to, Underlying Funds:

 

Underlying Fund

   Transaction      Amount     

Date

Exeter Industrial Value Fund, LP

     Distribution       $ 110,644       April 19, 2013

Almanac Realty Securities IV, LP

     Distribution         16,648       April 29, 2013

RREEF America REIT III, Inc.

     Distribution         17,881       April 30, 2013

Harrison Street Real Estate Partners I, LP

     Distribution         210,238       May 8, 2013

Exeter Industrial Value Fund, LP

     Distribution         700,280       May 14, 2013

Thor Urban Property Fund II, LP

     Contribution         222,833       May 15, 2013

 

22


Table of Contents

Manager Highlights

We have committed to invest in fourteen Underlying Funds with leading investment managers.

 

     Fund Size      Strategy    Investment
Type
     ($
millions)
     Value
Added
   Opportunistic    Equity    Debt

Barrow Street Real Estate Investment Fund III – Focuses on middle-market ($5 to $25 million of equity or mezzanine debt) opportunities that typically are too small for larger opportunity funds and yet too big for local operators. Barrow Street pursues strategies that include: unique commercial and residential development opportunities; redevelopment and distressed investments; cyclical repositioning and leasing of existing commercial properties.

   $ 372      

 

¡

        

 

¡

Exeter Industrial Value Fund – A value-add fund focusing on industrial and flex properties in the Eastern U.S. The fund will implement a lease-up, development or redevelopment strategy in alternative markets to overheated primary markets, such as the Northeast I-81 corridor over the congested I-95 corridor; affordable Southeast (Nashville, Memphis, Louisville, Tampa and Orlando) market over Chicago, Indianapolis, Dallas, Atlanta or Miami; and the growing eastern port markets (Charleston, Norfolk, Jacksonville and Savannah) benefiting from the overspill from the west coast ports.

   $ 350         

 

¡

     

 

¡

Almanac Realty Securities IV – Makes entity level investments in operating company platforms that utilize value-added strategies. The fund provides real estate operating companies with growth capital, financing expertise and hands-on management experience in order to increase the value of the underlying company. (Formerly Five Arrows.)

   $ 445               

Guardian Realty Fund II – Acquires Class B/B+ commercial office buildings within the Washington D.C. metropolitan area. The fund targets assets with high potential for value enhancement through repositioning, re-tenanting, refurbishing and intensive hands-on asset management. Target assets are in highly desirable locations and at least 80% leased to high quality tenants with below market rents.

   $ 114               

 

¡

Harrison Street Real Estate Partners I – An opportunistic allocator fund investing in student housing, senior housing, medical office buildings, self-storage and parking. The fund will create exclusive joint ventures with local operating partners, streamlining deal flow and providing flexible capital and capital market expertise. Harrison Street has a team with experience investing in these niche sectors as well as the ability to thoroughly screen best- in-class partners, structure exclusive joint venture partnerships and provide capital market expertise to the partners.

   $ 209               

 

¡

Keystone Property Fund II – Acquires underperforming Class C/D properties at significant market discounts and transforms them through extensive redevelopment into Class B+/A office buildings. The renovations are typically done while tenants are still in place in order to maintain positive current cash flow.

   $ 111               

 

¡

Legacy Partners Realty Fund I – Invests in office properties in western markets, primarily Southern California, the San Francisco Bay area, Denver and Seattle, seeking to acquire properties which have suffered from lack of demand due to the decline in technology investment or which are in need of substantial renovation. The management team at Legacy is the former west coast unit of the Lincoln Property Company.

   $ 332         

 

¡

     

 

¡

 

23


Table of Contents

Manager Highlights

(Continued)

 

     Target
Fund Size
     Strategy    Investment
Type
     ($
millions)
     Value
Added
   Opportunistic    Equity    Debt

Legacy Partners Realty Fund II –This is the second in a series of office property funds sponsored by Legacy. The strategy for fund II is equivalent to fund I, as described above.

   $ 457               

 

¡

Legg Mason Real Estate Capital II – Makes short-term loans to real estate operators that seek significant improvements to their propertiesperformance as a result of capital improvements, re- leasing, improved management and re-positioning. This is the fourth real estate debt fund managed by this team. This fund targets the West, Southwest, Southeast and Mid-Atlantic markets.

   $ 455         

 

¡

  

 

¡

  

Parmenter Realty Fund III – A Miami-based real estate investment company with a history of successful value-add investing in office buildings across the southeast and southwestern regions of the U.S. The Manager makes research driven acquisitions in the office sector and selective acquisitions in the condo/multifamily sector.

   $ 246         

 

¡

     

 

¡

RREEF America REIT III – An open-ended fund that makes equity investments in value added real estate ventures nationwide. The funds activities include direct acquisitions, physical improvements, market re-positionings, active management and sales of well-located apartment, industrial, retail and office properties in major metropolitan markets. The fund also invests in new speculative development projects.

   $ 2,097         

 

¡

     

 

¡

Thor Urban Property Fund II – A value-added and opportunistic operator fund focused on investing in retail and mixed-use assets in urban inner city markets throughout the U.S. including Chicago, Philadelphia, Baltimore, Washington D.C., Los Angeles, Houston, Atlanta, South Florida and Puerto Rico, with an emphasis in New York City. Thor possesses a unique combination of significant experience in urban retail markets as both an investor and operator, and as a retailer. Thor’s investment strategy is built upon a combination of inner city supply and demand imbalance, compelling demographic growth trends and Thor’s knowledge of the intricacies of the urban retail environment. Thor will acquire existing assets to implement rehabilitation and repositioning strategies, and development and redevelopment retail and mixed-use properties in urban locations.

   $ 596               

 

¡

Pearlmark Mezzanine Realty Partners II Utilizes the network of Pearlmark (formerly Transwestern) to source and analyze subordinated loans to borrowers who pursue stabilized and value added investments in real estate on a nationwide basis. Fund liquidated in 2012.

   $ 300         

 

¡

  

 

¡

  

Urban American Real Estate Fund II – Urban American focuses on workforce housing in urban neighborhoods primarily across the New York City metropolitan area. Their strategy is built upon the direct relationship between capital expenditures and permissible rental increases in rent regulated apartments, where increases in rents can be achieved through investment in unit and common area upgrades. Urban American is able to identify single asset and portfolio investments by understanding the required capital improvement and maintenance for each property and by leveraging its strong reputation in local communities for improving the quality of available housing.

   $ 171         

 

¡

     

 

¡

 

24


Table of Contents

Primary Strategies Implemented by Underlying Funds

 

     Barrow III    Exeter
Industrial
   Almanac IV    Guardian II    Harrison
Street
   Keystone II    Legacy I    Legacy II    Legg
Mason II
   Parmenter III    RREEF III    Thor
Urban II
   Pearlmark II    Urban
American II

Investment Strategy

                                         

Core Plus

            ü                              

Value-Add

   ü    ü    ü    ü       ü    ü    ü       ü    ü    ü       ü

Opportunistic

   ü             ü    ü                   ü      

Mezzanine

                           ü             ü   

Footprint

                                         

Regional

      ü       ü       ü    ü    ü       ü             ü

National

   ü       ü       ü             ü       ü    ü    ü   

Property Types

                                         

Office

   ü       ü    ü       ü    ü    ü    ü    ü    ü       ü   

Retail

         ü                         ü    ü    ü   

Multi-Family

   ü                         ü       ü       ü    ü

Industrial

      ü    ü          ü       ü    ü       ü         

Hotel/Resort

   ü       ü                   ü             ü   

Research & Development

                     ü    ü                  

Land

                                 ü         

Specialty

         ü       ü             ü       ü         

Contribution to Value

                                         

Operator / Active Management

      ü       ü       ü    ü    ü       ü    ü    ü       ü

Allocator of Capital

   ü       ü       ü                   ü         

Lender

                           ü             ü   

Aggressive Leasing

      ü       ü    ü    ü    ü    ü       ü    ü    ü       ü

Minor Cosmetic Upgrades

      ü       ü    ü    ü    ü    ü       ü    ü    ü       ü

Redevelopment

   ü    ü          ü    ü    ü    ü       ü    ü    ü      

Development

   ü    ü          ü          ü             ü      

Operating Company Investing

         ü                                 

For-Sale Strategies

   ü                                     ü   

External Opportunity Drivers

                                         

Industry Consolidation

            ü          ü    ü                  

Market Timing

      ü                ü    ü       ü       ü      

Replacement Costs

   ü    ü       ü    ü    ü    ü    ü       ü    ü    ü       ü

Inadequate Capitalization

   ü    ü    ü       ü             ü          ü    ü    ü

Asset Level Distress

   ü    ü             ü    ü    ü       ü    ü    ü       ü

Market Level Distress

                     ü    ü          ü         

 

25


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Private Equity Funds and the J-Curve

The private equity Underlying Funds in which we invest will likely experience operating losses in the early years of their operations–as they call capital from investors and begin to build their respective portfolios. Therefore, until they fully execute their strategies, it may take several years for the Underlying Funds to appreciate (or depreciate) in value. As such, our proportionate allocated share of these operating losses will likely result in a decline in the recorded values of our Underlying Fund investments in the early years of the Fund’s life. This phenomenon, known as the “J-Curve”, is typical of private equity investing.

In making our investments in Underlying Funds, we have made the judgment that, as the Underlying Funds fulfill their investment programs, gains will be realized in the later years of their operations that will more than offset the earlier operating losses, thus resulting in long-term positive annualized total returns. However, there can be no assurance that such judgments will prove correct and, more generally, there can be no assurance regarding the future performance of any investment in an Underlying Fund.

In the hypothetical illustration below, please observe that the return for a typical Underlying Fund, and by extension the effect on our Fund, is negative in the early years but projected to “turn the corner” and reach positive levels in later years. It is important to note that investing in private equity is a long term pursuit. Again, although future performance is never guaranteed, we strongly believe that investors with patience will ultimately be rewarded.

J-Curve Phenomenon–Hypothetical Illustration

 

LOGO

 

 

26


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Privacy Policy

This privacy statement is issued by Madison Harbor Balanced Strategies, Inc. We consider privacy to be fundamental to our client relationships and adhere to the policies and practices described below to protect current and former clients’ nonpublic personal information.

We do not disclose nonpublic personal information about our clients or former clients to third parties other than as described in this notice. We never sell client lists or individual client information. Internal policies and procedures are in place to protect confidentiality, while allowing client needs to be served. Only individuals who need to do so in carrying out their job responsibilities may access client information. We maintain physical, electronic and procedural safeguards that comply with federal and state standards to protect confidentiality. These safeguards extend to all forms of interaction with us, including the Internet.

In the normal course of business, clients give us nonpublic personal information on applications and other forms, and through transactions with us or our affiliates. We collect information about our clients (such as name, address, birth date, social security number, educational and professional background, assets and income) and their transactions with us (such as investments, performance and account balances). To be able to serve our clients, the information we collect is shared with our affiliates and to third parties that perform various services for us, such as transfer agents, lawyers, accountants, custodians and broker-dealers. This includes identification information (e.g., name and address), transaction and experience information (e.g., account balance), and other information necessary to accomplish customer transactions. In addition, the information we collect may be shared with affiliates, with financial institutions with which we have joint marketing agreements, or with other parties as permitted or required by law. Depending on where you live, state or local law may provide you with additional protections and may require that we send you additional notices. If any law requires that we obtain permission before we share your information, we will do so. Finally, we may be required by domestic or foreign laws to disclose certain information about our clients to tax or other authorities.

Any organization receiving client information may only use it for the purpose designated by Madison Harbor Balanced Strategies, Inc. or its affiliates.

 

27


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Management Team and Independent Directors1

Senior Management Team

Edward M. Casal, 55, Chief Executive Officer, Chief Investment Officer and Chairman of the Board of Directors of the Fund. Mr. Casal is also the Chief Investment Officer of the Global Real Estate Multi-Manager Group at Aviva Investors. Mr. Casal has over 25 years of broad experience in real estate and corporate finance at Madison Harbor Capital, UBS, Dillon, Read & Co. and Goldman, Sachs & Co. In his career, he has been actively involved in over $20 billion of real estate investments including equity, debt, joint venture and merger and acquisition transactions. Mr. Casal is a Director of Parkway Properties, Inc.

Russell H. Bates, 46, President. Mr. Bates also serves as Portfolio Manager and on the Global Investment Committee of the Global Real Estate Multi-Manager Group at Aviva Investors. Mr. Bates has over 15 years of experience in business and law, most recently with Madison Harbor Capital, and as a real estate investment banker at UBS and Friedman Billings Ramsey, and as an attorney with the U.S. Securities and Exchange Commission. Mr. Bates also served as Senior Investment Officer of FBR Asset Investment Corp., where he managed its real estate mezzanine lending program and had portfolio responsibility for its mortgage loan holdings. Mr. Bates is a member of the Pension Real Estate Association, the Urban Land Institute and the International Council of Shopping Centers.

Independent Directors of the Fund

Cydney C. Donnell, 53, is an Executive Professor, Associate Department Head-Finance Department and Director of Real Estate Programs at the Mays Business School at Texas A&M University. She formerly served as a Managing Director at European Investors/Ell Realty Securities, Inc. where she managed real estate securities on behalf of U.S. pension funds, foundations, endowments and high net worth clients. Ms. Donnell is a Board member of American Campus Communities Inc., Pebblebrook Hotel Trust, and the Employees Retirement System of Texas. Ms. Donnell is Chair of the Fund’s Valuation Committee and also serves on the Audit and Nominating & Compensation Committees.

Stanley R. Perla, CPA, 69, has over 40 years of public and private real estate audit and accounting experience, including a 35 year career at Ernst & Young, the last 25 of which as Partner. He served as Ernst & Young’s national director of real estate accounting, as well as on Ernst & Young’s national accounting and auditing committee. Most recently Mr. Perla was Managing Partner at Cornerstone Accounting Group, a public accounting firm specializing in real estate and prior to that he served as Director of Internal Audit at Vornado Realty Trust. He is a Director and Chair of the Audit Committee at American Realty Capital Fund V and American Realty Capital Real Estate Income Fund, and a Director of GTJ REIT, Inc. Mr. Perla is Chair of the Fund’s Audit Committee and also serves on the Valuation and Nominating & Compensation Committees.

Leland R. Speed, 80, serves as a Director and Chairman of the Board of New York Stock Exchange listed real estate investment trust EastGroup Properties, Inc. He was previously a Director and Chairman of the Board of Parkway Properties, Inc., and served as Executive Director of the Mississippi Development Authority. Mr. Speed serves on the Fund’s Audit and Nominating & Compensation Committees.

 

 

1 

All directors of the Fund have served since the Fund’s inception, with the exception of Mr. Speed, who has served since October 2004. Mr. Casal does not hold any directorships other than noted above. Additional information regarding the directors and officers of the Fund may be found in the Fund’s most recently filed Form N-CSR, which is available on the Commission’s website at http://www.sec.gov, and may be reviewed and copied at the Commission’s Public Reference Room in Washington, DC. Information on the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330.

 

28


Table of Contents

 

LOGO

Madison Harbor Balanced Strategies, Inc.

125 Park Avenue, 25th Floor

New York, NY 10017

For more information,

please call 212.380.5500

A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to portfolio securities, as well as information relating to how the Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30, is available (i) without charge, upon request, by calling 1-212-380-5500; and (ii) on the Commission’s website at http://www.sec.gov. However, since the Fund’s strategy consists of investing in real estate private equity funds (“Underlying Funds”), for which voting rights will be limited, the Fund will likely have few opportunities, if any, to vote proxies.


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Item 2. Code of Ethics.

The Registrant has adopted a code of ethics that applies to the Registrant’s Chief Executive Officer and Chief Financial Officer. For the calendar year ended December 31, 2012 and the Registrant’s fiscal year ended March 31, 2013, there were no amendments to a provision of its code of ethics, nor were there any waivers granted from a provision of the code of ethics. A copy of its code of ethics is filed with this Form N-CSR under Item 12(a)(1).

 

Item 3. Audit Committee Financial Expert.

(a)(1) The Registrant’s Board of Directors has determined that the Registrant has at least one audit committee financial expert serving on the audit committee.

(a)(2) The audit committee financial expert is Stanley Perla, who is “independent” for purposes of Item 3 of Form N-CSR.

 

Item 4. Principal Accountant Fees and Services.

 

(a) Audit Fees: The aggregate fees billed for professional services rendered by EisnerAmper LLP (“EisnerAmper”), the Registrant’s independent registered public accounting firm for the fiscal years ended March 31, 2013 and 2012 for services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for the fiscal years ended March 31, 2013 and 2012 were $76,000 and $72,000, respectively.

 

(b) Audit-Related Fees: The aggregate fees billed for assurance and related services rendered by EisnerAmper that are reasonably related to the performance of the audit of the Registrant’s financial statements and not reported under paragraph (a) of this Item 4 in the fiscal years ended March 31, 2013 and 2012 were $0 and $0, respectively.

 

(c) Tax Fees: The aggregate fees billed for professional services by EisnerAmper for tax compliance, tax advice and tax planning in the fiscal years ended March 31, 2013 and 2012 were $62,000 and $65,000, respectively.

 

(d) All Other Fees: No such fees were billed to the Registrant by EisnerAmper in the fiscal years ended March 31, 2013 and 2012.

(e)(1) It is the policy of the Audit Committee to pre-approve all auditing services and permitted non-audit services (including fees and terms thereof) to be performed for the Registrant by its independent registered public accounting firm, subject to the de minimis exceptions for non-audit services described in Section 10A(i)(B) of the Securities Exchange Act of 1934 (the “Exchange Act”). The Audit Committee may form and delegate authority to subcommittees consisting of one or more independent members when appropriate, including the authority to grant pre-approvals of audit and permitted non-audit services, provided that decisions of such subcommittee to grant pre-approvals shall be presented to the full Audit Committee at each of its next scheduled meetings.


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(e)(2) Percentage of fees billed applicable to non-audit services pursuant to waiver of pre-approval requirement were as follows:

 

     Fiscal Year 2013     Fiscal Year 2012  

Audit-Related Fees

     0     0

Tax Fees

     0     0

All Other Fees

     0     0

 

(f) Not applicable. The percentage of hours expended on EisnerAmper’s engagement to audit the Registrant’s financial statements for the most recent fiscal year attributed to work performed by persons other than EisnerAmper’s full-time, permanent employees was not greater than 50 percent.

 

(g) The aggregate non-audit fees and services billed by EisnerAmper for the fiscal years ended March 31, 2013 and March 31, 2012 were $0 and $0, respectively.

 

(h) Not applicable. No non-audit services were provided to the Registrant’s investment adviser nor any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the Registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X.

 

Item 5. Audit Committee of Listed Registrants.

Not applicable as the Registrant is not a listed issuer as defined in Rule 10A-3 under the Securities Exchange Act of 1934.

 

Item 6. Schedule of Investments.

A schedule of investments in securities of unaffiliated issuers, as of the close of the reporting period, is included as part of the annual report to shareholders filed under Item 1 of this form N-CSR.

 

Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies.

The Registrant has delegated the voting of proxies relating to its voting securities to its investment adviser, Aviva Investors North America, Inc. (“AINA” or the “Adviser”). However, since the Registrant’s strategy consists of investing in real estate private equity funds, for which voting rights will be limited, there will likely be few, if any, opportunities to vote proxies on behalf of the Registrant. The Proxy Voting Policies and Procedures of the Adviser (“Proxy Voting Polices”) are as follows:

Aviva Investors North America, Inc.

Proxy Voting Policies and Procedures

Policy

AINA is responsible for exercising voting authority over client portfolio securities consistent with the client’s best interests, which is viewed as making a judgment as to what voting decision (including a decision not to vote) is reasonably likely to maximize total return to the client. In the management of fixed income portfolios, the receipt and voting of proxies occurs less frequently than for equity portfolios; e.g., in the instance of restructuring debt resulting in the issuance of equity. AINA’s policy and practice is to receive and vote client proxies, disclose and mitigate conflicts of interest, make the policy available upon client request, respond to client inquiries regarding the voting of proxies and maintain appropriate records.


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Background

SEC-registered investment advisers who exercise voting authority over client securities, are required by Rule 206(4)-6 of the Advisers Act to (a) adopt and implement written policies and procedures that are reasonably designed to ensure that client securities are voted in the best interests of clients, which must include how an adviser addresses material conflicts that may arise between an adviser’s interests and those of its clients; (b) disclose to clients how they may obtain information from the adviser with respect to the voting of proxies for their securities; (c) describe to clients a summary of the adviser‘s proxy voting policies and procedures and, upon request, furnish a copy to its clients; and (d) maintain certain records relating to the adviser’s proxy voting activities when the adviser does have proxy voting authority.

Responsibility

The Trading Officer has the responsibility for the implementation and adherence to the policy.

Cross Border Mandates

Participating Affiliates shall comply with this policy with respect to US clients. PA Compliance shall provide certifications of their compliance upon request of the CCO.

Procedures

General Handling of Proxy Materials - Proxy materials should be directed to the investment area responsible for managing accounts holding the security; e.g., proxies for registered fixed income securities should be directed to Fixed Income Management, proxies for unregistered securities should be directed to Private Fixed Income Management, proxies for high yield securities should be directed to High Yield Management, proxies for money market funds should be directed to Treasury Management / Business Planning. Employees should promptly forward all proxy materials received to the appropriate investment area.

Disclosures - AINA will include a concise summary of its proxy voting process in its Form ADV, Part 2 (known as the Client Brochure effective 3/31/12) explaining how clients may obtain information about how their proxies were voted and how to obtain a copy of the policy.

Client Requests for Information - Client requests for the policy should be forwarded to the CCO; client requests for information about how AINA voted their proxies should be forwarded to the Client Relationship Manager. The CCO or Client Relationship Manager (or designee), as appropriate, is responsible for responding to such requests in writing and providing the policy or requested information.

Third-Party Proxy Services - AINA may retain a third-party service provider to provide proxy recommendations or guidelines, to cast votes, to respond to client requests for the policy or voting information, and to keep and maintain records required under the policy.

Voting Procedures and Guidelines

Portfolio managers within each responsible investment area are to vote (or to refrain from voting) proxies for accounts they manage in a manner consistent with the policy, the accounts’ investment management agreements, and any written instructions from the clients.

Portfolio managers are to notify the CCO of his or her votes, contrary to AINA’s general guidelines, votes on non-routine matters and instances where the portfolio manager refrains from voting.

Absent special circumstances or client instructions, AINA typically votes proxies according to the following general guidelines:

 

 

we consider the opinion of management on the issues to be voted;


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we evaluate the effects of our vote on management, on shareholder value, and on the issuer’s business and business practices;

 

 

we vote with management on routine corporate housekeeping proposals, such as election of directors and selection of auditors; and

 

 

we vote against proposals that entrench management or board members, diminish shareholder rights, reduce the proportionate share of current shareholdings, or result in unequal voting rights.

The following matters will be evaluated on a case-by-case basis, and AINA will vote on these matters in the best economic interests of its clients: preemptive rights offerings; staggered boards (where they do not exist already); new classes of shares having different voting rights; “poison pills”; and “golden parachutes.”

AINA may refrain from voting client proxies when: the securities are no longer held in the account; the voting materials are not received in sufficient time to allow proper analysis or an informed vote by the voting deadline; it determines the cost of voting will likely exceed the expected potential benefit to the accounts; the securities have been loaned pursuant to the account’s securities lending arrangement and are unavailable to vote; or the securities are of a de minimus amount (as determined by the Proxy Committee).

Each portfolio manager must notify the CCO by email or in writing of the manager’s intention to vote a proxy contrary to AINA’s general guidelines or not to vote a proxy, and must not vote or take other action until instructed by the CCO. The CCO may resolve the matter or may convene the Proxy Committee to instruct the portfolio manager how to proceed.

Conflicts of Interest

Each portfolio manager is responsible for identifying, prior to each proxy vote, material, actual or potential conflicts between the interests of AINA, its affiliates, or employees and the interests of the accounts for which the manager will vote, including conflicts arising from:

 

 

Existing or prospective client or other relationships involving the issuer or the executive officers of the issuer;

 

 

A significant business, personal, or financial interest of the designated portfolio manager in the outcome of the vote;

 

 

Undue influence upon the designated portfolio manager, whether exerted by an internal or external party (such as agents of the issuer).

Any portfolio manager or other employees with any concern or doubt about whether a conflict (or potential conflict) of interest exists with respect to any proxy solicitation must inform the CCO promptly before taking action or voting the proxy.

If a material actual or potential conflict of interest is identified with respect to a proxy vote, the designated portfolio managers responsible for voting on behalf of accounts affected by the conflict must each notify the CCO by email of the details of the conflict, and must not vote or take other action until instructed by the CCO. The CCO may resolve the matter or may convene the Proxy Committee to instruct the designated portfolio managers how to proceed. The CCO will report conflict resolution to the Operational Risk Committee.

Proxy Committee

AINA has established the Proxy Committee to determine how to resolve matters referred to it by the CCO and to assist with review of the policy and operation of these procedures.

 

 

The Proxy Committee is comprised of the following members: Chief Compliance Officer or designee, the Trading Officer, the senior officer of each of the responsible investment areas or designees (Note: only the senior officer or designee of the responsible investment areas affected by a conflict must participate in any meeting), the Vice President of Operations or designee, and any other person identified by the CCO with respect to any particular matter.


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The Proxy Committee may act upon the majority decision (but not less than two) of the members participating in any meeting (which may be held by telephone, email, or other means that the Committee deems appropriate). Any member may schedule a meeting of the Proxy Committee upon notice to the other members.

 

 

At least annually, the CCO will convene a meeting of the Proxy Committee to review the firm’s proxy voting activities, the adequacy and effectiveness of the policy, and any recommendations for changes. The CCO or Proxy Committee may amend the policy at any time, subject to AINA’s obligation to act in its clients’ best interests.

Recordkeeping

Trade Operations will retain records in accordance with the SEC’s five-year retention requirement including: the policy and any amendments, proxy materials (provided, AINA may rely on records maintained through EDGAR); a record of each vote that AINA casts (and any decisions to refrain from voting); any document created that was material to making a decision how to vote or that memorializes that decision; records reflecting the resolution of conflicts of interest; and client requests for the policy or proxy voting information, and the firm’s responses.

 

Item 8. Portfolio Managers of Closed-End Management Investment Companies.

Pursuant to an investment advisory agreement, dated April 28, 2008, AINA serves as the investment adviser to the Registrant. Madison Harbor Capital Management, LLC (“MHCM”) had previously served as the Registrant’s investment adviser from its inception on January 28, 2005. On April 9, 2008, AINA acquired the assets of Madison Harbor Capital, LLC, (“Madison Harbor”) the parent company of MHCM. On April 28, 2008, at an in-person meeting, the Registrant’s Board, including a majority of the directors who were not interested persons of the Registrant as defined under the Investment Company Act of 1940, approved a new investment advisory agreement with AINA (the “New Advisory Agreement”) that contained substantially the same terms and conditions as the prior agreement with MHCM, subject to shareholder approval. The Registrant held a special meeting of shareholders on November 25, 2008, during which the New Advisory Agreement was approved.

In accordance with the terms of the New Advisory Agreement, AINA, through its Investment Committee, is authorized to make all decisions with respect to investments, divestitures, changes in investment strategy, and utilization of leverage. Investment Committee decisions shall be unanimously approved by the members of the Investment Committee. The Investment Committee is currently comprised of Edward M. Casal and Russell H. Bates.

In December 2012, AINA’s parent, Aviva plc, announced that it had entered into an agreement to sell its U.S. insurance business, Aviva USA, to a third-party buyer. The Fund’s investment advisor, AINA, is a wholly owned subsidiary of Aviva USA and will be included in the sale, however the business of managing the Fund will not be sold and Aviva has formed a new SEC Registered Investment Advisor, Aviva Investors Americas, LLC, which will manage the Fund once the sale is consummated. At that time the individuals responsible for performing investment advisory services will be transferred from AINA to AIA. When the transfer is complete, AIA will mirror AINA’s former operation in terms of personnel, structure and management. The Fund’s Board has approved the transfer of the Fund’s investment advisory agreement to AIA.

Edward M. Casal, Chairman, Chief Executive Officer, and Chief Investment Officer of the Registrant, 55, is Chief Investment Officer of the Global Real Estate Multi-Manager Group of Aviva Investors (“Aviva”), an affiliate of the Adviser. Mr. Casal has over 25 years of experience in domestic and international corporate finance and real estate investment banking. Mr. Casal has advised public and private real estate clients and their Boards with regard to transactions with an aggregate value in excess of $20 billion. Mr. Casal has originated and transacted both entity-level and real estate property-level transactions including equity and debt financings, secondary real estate transfers, acquisitions, dispositions and mergers, review of corporate strategic alternatives, unsolicited tender offers, spin-offs, split-offs, restructurings, valuations, lease negotiations and fairness opinions.

Mr. Casal was a founder of Madison Harbor and joined AINA when it acquired the assets of Madison


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Harbor in April 2008. Prior to founding Madison Harbor in 2003, Mr. Casal spent 18 years at UBS Investment Bank, beginning with one of its predecessor companies, Dillon, Read & Co. Inc. From 1985 to 1991, Mr. Casal advised domestic and international clients with regard to a wide range of real estate investment opportunities including joint venture assignments on behalf of institutional investors, restructuring of lease transactions, property sales and acquisitions. From 1992 until the merger with UBS in 1997, he directed the firm’s real estate advisory, financing and agency activity in North America primarily focused on real estate transactions for corporations and merger and acquisition transactions for public and private real estate companies. From 1997 to 2001, Mr. Casal served as Executive Director of the UBS Warburg global real estate investment banking team primarily responsible for new business origination and led all of the firm’s real estate strategic advisory and M&A assignments in North America. Mr. Casal began his Wall Street career at Goldman, Sachs & Co. where he served in the municipal finance, equity research and real estate departments and his principal investing career with Alan Patricoff Associates, a venture capital firm.

Mr. Casal is a graduate of Tulane University (where he received the Wall Street Journal award for excellence in Finance) and has an MBA from the Harvard Graduate School of Business. He is a member of the Urban Land Institute and the International Council of Shopping Centers.

Russell H. Bates, President and Secretary of the Registrant, 46, is a Portfolio Manager of the Global Real Estate Multi-Manager Group of Aviva Investors, an affiliate of the Adviser. Mr. Bates has over 15 years of experience in business and law, most recently as a commercial real estate investment banker. Assignments have included over $4 billion in equity and debt financings, mergers, spin-offs, restructurings, valuations and fairness opinions.

Mr. Bates was a founder of Madison Harbor and joined AINA when it acquired the assets of Madison Harbor in April 2008. Prior to founding Madison Harbor in 2003, Mr. Bates was a Director with UBS Investment Bank in its global real estate investment banking group where he was primarily responsible for execution of banking, underwriting, advisory and associated products and services within the real estate, lodging, gaming and leisure sectors. While there he represented clients on numerous public merger transactions including an international hostile takeover, asset sales, private joint venture transactions, and preferred equity capital raising. Prior to joining UBS, he served as a Vice President of Real Estate Investment Banking at Friedman Billings Ramsey where he completed numerous initial public offerings and follow-on offerings for equity and mortgage real estate investment trusts (REITs). Concurrently, he served as Senior Investment Officer for FBR Asset Investment Corporation, a REIT that made mezzanine loans as well as bridge equity investments in private real estate companies prior to an IPO. In this capacity, he originated and managed the mezzanine lending program, evaluated potential investments for its investment committee and had portfolio responsibility for its mortgage loan holdings.

Prior to his investment banking career, Mr. Bates was an attorney with the US Securities and Exchange Commission with its Division of Corporation Finance focusing on Real Estate and Securitization transactions. In addition, Mr. Bates spent four years with PepsiCo, Inc. as a manager focusing on acquisition integration.

Mr. Bates is a graduate of Baylor University and the Southern Methodist University School of Law and is a member of the Urban Land Institute, the International Council of Shopping Centers and the State Bar of Maryland.

***

Portfolio managers of the Adviser beneficially own equity securities of the Registrant as follows:

 

Edward M. Casal    $10,001 - $50,000
Russell H. Bates    $10,001 - $50,000

Employees of the Adviser serve as the portfolio managers of the Registrant. The compensation paid to such individuals consists of a base salary and discretionary bonus, as well as deferred compensation and retirement benefits, and this compensation is reviewed annually by the executive committee of Aviva Investors. Investment performance, including that of the Registrant, is one of several factors on which this compensation is based, but there is not a direct link between compensation and the Registrant’s performance.


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The portfolio managers employed by the Adviser manage the following accounts in addition to the Registrant

 

     Registered  Investment
Companies
     Other Pooled
Investment Vehicles
     Other
Accounts
 
     # of Accounts    Assets$(000)      # of Accounts    Assets$(000)      # of Accounts    Assets$(000)  

Edward M. Casal

   0    $ —         1    $ 100,725       0    $ —     

Russell H. Bates

   0    $ —         1    $ 38,736       0    $ —     

Conflicts of Interest

The Adviser and its affiliates and employees may engage in a broad spectrum of activities, including sponsoring and managing investment funds, engaging in broker-dealer activities, and other activities. In the ordinary course of business, these institutions or individuals may engage in activities when their interests or the interests of their clients may conflict with the interests of the Registrant and the Registrant’s investors.

Allocation of Management Time and Services

The Registrant does not have its own employees and relies upon the Adviser and its affiliates for management of the Registrant and its assets. Conflicts of interest may arise in allocating management time, services or functions between the Registrant and other entities for which the Adviser and its affiliates may provide similar services. The officers and employees of the Adviser devote such time to the Registrant’s affairs as they, in their sole discretion, determine to be necessary for the conduct of the Registrant’s business.

 

Item 9. Purchases of Equity Securities by Closed-End Management Company and Affiliated Purchasers.

Not applicable. Neither the Registrant nor any “affiliated purchasers”, as defined in Rule 10b-18(a)(3) under the Exchange Act, purchased any shares of the Registrant that are registered by the Registrant pursuant to Section 12 of the Exchange Act.

 

Item 10. Submission of Matters to a Vote of Security Holders.

Not applicable.

 

Item 11. Controls and Procedures.

(a) The certifying officers, whose certifications are included herewith, have evaluated the Registrant’s disclosure controls and procedures within 90 days of the filing date of this report. In their opinion, based on their evaluation, the Registrant’s disclosure controls and procedures are adequately designed, and are operating effectively to ensure, that information required to be disclosed by the Registrant in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

(b) There were no significant changes in the Registrant’s internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Registrant’s internal control over financial reporting.

 

Items 12. Exhibits.

(a)(1) Code of Ethics attached hereto.


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(a)(2) Separate certification for each of the principal executive officer and the principal financial officer of the Registrant as required by Rule 30a-2(a) under the Investment Company Act of 1940, as amended (the “1940 Act”), are filed herewith.

(b) Officer certifications, as required by Rule 30a-2(b) under the 1940 Act, are filed herewith.


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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

     Madison Harbor Balanced Strategies, Inc.
    

/s/    Edward M. Casal

     Edward M. Casal
     Chief Executive Officer

Date: June 7, 2013

Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

    

/s/    Edward M. Casal

     Edward M. Casal
     Chief Executive Officer

Date: June 7, 2013

 

    

/s/    Michael Fortier

     Michael Fortier
     Chief Financial Officer

Date: June 7, 2013