Alternative investments can be described as any investment that is not a traditional stock or bond. Wall Street firms have created a wide variety of alternative investments to sell to investors. These alternative investments are manufactured in a variety of ways and each major Wall Street firm has its own proprietary investments. These complex investments are frequently sold by investment banks as an alternative to investing in the stock market or as a complex hedging strategy which allows an investor to hedge his risks against the stock market. However, these investment products frequently have significant fees and costs paid to themselves and affiliated companies. Alternative investments are now considered a core asset by most financial institutions and represent a significant percentage of Wall Street’s revenues.
Investors have grown disappointed in returns realized from traditional portfolios invested in traditional buy-hold asset allocation strategies. Traditional investing is considered to be any investment strategy which involves maintaining “long” positions in stocks, bonds and cash. Traditional investment portfolios hold varying proportions in these asset classes based on historical returns and volatility designed to maximize returns for a specified level of risk. This type of portfolio construction method across the traditional asset classes of stock, bonds and cash result in investment returns “relative” to the overall securities markets.
Alternative investments have been available to sophisticated investors, such as large pension funds, foundations and trusts. Retail investors are being targeted by Wall Street firms to invest in alternative investments packaged in familiar investment vehicles, including private placements, mutual funds, market-linked notes and ETFs. The alternative investment universe is comprised of investments in:
- Real Estate;
- Private Equity/Venture Capital;
- Market-Linked Notes;
- Commodities; and
- Hedge Funds.
Alternative investments can have certain investment characteristics, including:
- low correlation with traditional investments;
- greater diversification;
- potential for greater returns over time;
- limited performance histories;
- long term investment time horizon;
- non-traded, limited liquidity; and
- limited downside in volatile markets.
The primary rationale for investing a portion of an investor’s portfolio in alternative investments is to generate portfolio returns with greater returns on a risk-adjusted basis. The supposed low to negative correlation of alternative investments to traditional investments provides superior results for an investment portfolio during “down markets” which smooth portfolio returns over time. Professional money managers caution investors cannot “market-time” when to invest in alternative investments which Wall Street firms argue makes alternative investments a permanent part of an asset allocation strategy.
Alternative Investments are frequently complex and multi-faceted which provide greater investment opportunity in the face of many obstacles which retail investors must weigh against the potential benefits, including:
- lack of transparency;
- lack of suitable performance benchmarks;
- inherent conflicts of interest;
- higher fees and commissions;
- illiquid, non-traded investments;
- less securities industry regulation;
- non-transferable interests; and
- long term, investment time horizon.
Alternative investments benefits can be described in technical terms, but there are serious concerns about the suitability of these types of investments for retail investors. Retail investor liquidity concerns make investments suitable only when there is a long enough investment time horizon over multiple market cycles. In many instances, alternative investments are not traded or uncertain pricing makes it difficult to ascertain actual performance measurements. In addition, portfolio construction methods used by traditional asset allocation models are unable to accurately predict portfolio returns when alternative investments are added because their prices are not measurable with limited price histories making risk/return assumptions tenuous leaving financial advisor unable conduct adequate due diligence required for making suitable investment recommendations.
It is important to determine what percentage of your investment portfolio should be invested in Alternative Investments based on your investment objectives, risk tolerances and investment time horizon.
Investors are advised to seek competent financial, tax and legal advice concerning the decisions they make with their investments. Klayman & Toskes, P.A. can provide you with a free consultation concerning any securities industry violations related to the handling of your investments accounts by a full-service brokerage firm or registered investment advisor.
Information contained on this webpage is for educational purposes only
and should not be considered legal advice.
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