Many registered investment advisors and brokerage firms have increased their use of alternative investments for clients, many of whom are retired and lack the knowledge and sophistication to understand the complex investments, according to Liz Skinner’s InvestmentNews article entitled “Clients clamoring for alternative investments and advisers obliging.” But are alternative investments suitable for most investors? Similarly, are most investors provided with balanced disclosures of the risks that they are taking when they invest in alternative investments? Unfortunately, the answer to both questions appears to be no.
Alternative investments are highly complex investment and involve significant fees and risk of loss. They include venture capital investments, private equity, hedge funds, exchange-traded notes, limited partnerships, and structured products. While some advisors say they use alternative investments to stabilize and diversify their clients’ portfolios, these alternative investments, including structured notes, are being sold to elderly investors in large chunks (often 20% or more of their entire portfolio). Investors are routinely told that alternative investments offer higher returns in the short-term, but usually not told the true risks involved.
For example, one type of alternative investment, known as a reverse convertible, is structured a high-yield, zero-coupon bond linked to a reference asset, such as a stock. Reverse convertibles are often sold as relatively safe higher-yielding notes under names such as “Yield Optimization Notes.” Investors do not participate in any increase in value of the stock, however, and if the price of the stock is lower than a certain price at maturity, the investor does not receive his principal back in cash. Instead, he receives the linked stock, which is typically worth less than the amount invested, and possibly headed lower. This comes about as a result of a put option embedded in the structured note. The higher yield is really, in part, a premium payment by the issuer for the put option. Is that what the investors who were sold these structured notes expected? Hardly.
The MAT/ASTA municipal arbitrage hedge funds sold by Citigroup Fixed Income Alternatives provide another example of the risks of these products. The MAT/ASATA funds were sold to conservative investors as a low-risk, fixed income investment alternatives, but they were nothing of the kind. The funds imploded in early 2008 resulting in huge losses of between 71% and 97% to investors. The funds were based on a quantitative strategy that was difficult to understand, and was especially risky in volatile markets. The investment was far more risky than anyone let on to investors. As Barclays put it, fixed income arbitrage is really like “picking up nickels in front of a steamroller.”
Atlanta attorney J. Boyd Page observed: “The complexity of these alternative investments makes them very difficult for advisors and their clients to understand. They are fraught with risk, much of it not well understood by advisors and, therefore, not disclosed to investors. Advisors and their clients should carefully evaluate these products before recommending or investing in them. Unless they are looking for an investment that is like picking up nickels in front of a steamroller, most alternative investments should be avoided.”
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 45 occasions. Page Perry’s attorneys have extensive experience in representing investors in cases involving hedge funds, principal protected notes, reverse convertibles and other alternative investments. For further information, please contact us.