Investors are being sold more and more alternative investments and large broker-dealers are ramping up to supply that demand, according to the Wall Street Journal (“Alternatives Get a Boost”). The trouble is that most investors do not fully understand these products and their brokerage firm advisers do not fairly explain the risks and problems associated with them, because that would counter-productive to their sales efforts.
What are they selling? Merrill Lynch’s sales of private (Reg D) offerings have risen rose 70% this year, according to the article. There are many more varieties of alternative investments, such as private equity funds, hedge funds, variable products and structured products. What they have in common is that they are generally illiquid, complex, costly, leveraged, opaque and have a high degree of risk.
Oftentimes investors are told that alternative investments are good diversification tools ? i.e., that they are not highly correlated with the stock market. But that is not necessarily true. In market crashes, hedge funds that were sold as uncorrelated were actually highly correlated with swooning stocks.
One thing is certain. The role of brokerage advisers is primarily one of sales. Their compensation is tied to the revenue they generate, and sales are not made by disclosing problems and risks with a prospective investment.
Investors should be very skeptical of sales pitches for alternative investment products. Understanding these products takes a background and requires tools that most investors and brokerage firm advisers do not have.
Anyone considering an alternative investment should read “The Only Guide to Alternative Investments You’ll Ever Need ? The Good, the Flawed, the Bad and the Ugly,” by Larry E. Swedroe and Jared Kizer, which puts most alternative investments in the flawed, bad and ugly categories, and concludes that? “historical evidence demonstrates that once viewed on a risk adjusted basis, the average hedge fund has a hard time keeping pace with Treasury bill returns.”
Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.