Advisers face ‘high hurdle’ with alternatives

Financial advisers looking to invest their clients in alternative investment strategies have a hard job meeting their regulatory requirements for product suitability, a researcher says.

Friday, November 23rd 2012, 7:37AM 2 Comments

Morningstar has released a review of alternatives and concluded that they shouldn’t even be part of lower-risk (conservative or moderate) portfolios, given the “embedded risks and volatility” of these sorts of investments.

“For 'balanced' (50:50 growth/income split) portfolios, an alternatives allocation of up to a maximum of 10% could be used to provide additional diversification, and this should come entirely from the growth component,” Morningstar’s report said.

The research house said alternatives shouldn’t be considered an asset class due to the many types of strategies involved.

And it warned investors and advisers to be careful of the hype around some of these investments.

“Investment objectives stated in fund manager literature and marketing materials are not short on ambitious and attractive promises.

“Given the hefty price-tags and the role they are intended to play in a portfolio, it's essential to ensure that any proposed alternative investment is going to provide a truly different exposure, rather than overcharging for something that may be obtained cheaply through a traditional managed fund or exchange-traded fund.”

Morningstar head of research Chris Douglas said advisers have a number of challenges when it comes to assessing the suitability of alternatives, a “hugely broad universe” of investments ranging from equity arbitrage funds to art funds.

“A lot of alternative products don’t have a long track record; you don’t know how they are going to work in different conditions.”

Douglas said another problem for advisers is the complexity of some of these products.

“When you think about the suitability of any investment product a lot comes down to having an understanding of it such as where the assets are invested and what the fee structure is; a lot come with very high fees.

“Alternative investments have a high hurdle to overcome under the Financial Advisers Act.”

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Comments from our readers

On 23 November 2012 at 8:16 am Barry Read said:

The FAA hasn't put up a high hurdle in this regard, it is just stating minimum standards that I think any investor should/could/would expect from a professional who is picking where to invest their money.

On 23 November 2012 at 10:29 am Albert E said:

The FAA forces advisers to be more conservative in their recommendations as they are personally liable for the advice they give. I cannot see any justification for ever recommending "alternatives" to clients, even if the client has the most aggressive investment risk profile.

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