Splashy news headlines have led some clients, and more than a few financial professionals, to believe the sweeping generalization that retail alternative investments are inherently bad. While story after story paints the picture of crooked brokers foisting mega risky products on unsuspecting investors—who invariably experience huge losses—these depictions are at odds with reality.
For one, there is nothing intrinsically wrong with advisors including alternatives as part of their toolkit to serve clients, whether it’s direct participation programs, non-traded real estate investment trusts, business development companies or a wide range of other products. For qualified investors, alternatives complement more traditional holdings and can play a valuable role in helping them achieve their long-term objectives.
Secondly, when there’s been advisor wrongdoing in this slice of the industry, it’s been the exception, not the rule. Yes, broker-dealers have paid hefty settlements related to alternatives in the past, but a great number of those came after firms decided it would be less costly to settle unsubstantiated misconduct claims than to spend years defending them against overly zealous plaintiff’s attorneys.
Despite the noise that sometimes surrounds alternative investments, if firms adhere to rigorous due diligence and suitability processes, there is no reason to shy away from them.
Due Diligence And Suitability
Many considerations go into properly vetting a product, but perhaps the most basic is whether a market exists for an offering. In other words, does the product make sense on its own merit and are others likely to invest in it as well? If not, the sponsor could be forced to unwind the program prematurely, which will result in clients losing a portion of their principal.
Assess the business behind the product as though you plan to form your own business in that arena. Is it properly capitalized? Are enough subject matter experts on staff in each department? Does the product function as described and exhibit favorable investment performance? What’s the fee structure and is it reasonable? These criteria apply across the board, from holdings in energy exploration companies to senior living facilities.
The answers will help winnow down the number of products worth considering. Just as a good college accepts a small percentage of applicants, a good broker-dealer is equally selective about which alternatives it makes available to advisors. From there, a firm can begin to investigate other aspects of a sponsor’s past, from its regulatory history to the performance track record of senior executives.
When a firm has high standards and a long history of vetting alternatives, it can typically spot, almost from the beginning, when a solution won’t be able to pass muster or be a good fit for its advisors. That makes it easier to invest in due diligence on those products most likely to complement their platforms.
For example, sometimes broker-dealers load up on a particular class of commercial office properties in an effort to achieve product diversity. It perhaps makes more sense, however, to concentrate instead on providing access to only the three top providers. That will create a reasonable level of variety, preserve firm resources, and give advisors what they need to serve clients best.