The Demystification of Alternative Investments

The past four years have been anything but kind to those of us trying to identify an investment vehicle delivering a reasonable rate of return on our hard earned money. More often than not people are asking where they should invest their money. All the while demanding that the investment vehicle recommended is fairly conservative, safe, liquid, stable, and with manageable risk. – OK, that rules out your reasonable rate of return. And don’t think that it’s going to get any easier over the next several years. The global financial markets remain frothy – like a winter’s Starbucks Caramel Brulée Latte. Remember when we were much younger and Mom bought us Mr. Bubbles? Well, Mr. Market has had a field day with Mr. Real Estate Bubble, Mr. Bond Bubble, Mr. European Community Bubble, and the likes. Since I subscribe to the reversion to the mean philosophy, and I know that the financial intermediation we all experience is more times than not less than acceptable, I never respond to that question in a casual or general manner. Why, because we all have different financial goals and objectives. Still this could make the case for the qualified retail investor to try and seek higher returns by turning to Alternative Investments in the hopes of re-building their nest egg.

Most financial professionals would agree that it’s not easy to concisely describe Alternative Investments. A friend of mine working at one of the large Mutual Fund companies refers to them as “private investments that have less than transparent legal structure than many traditional investments.” In most cases these are investments that are not suitable for the average investor due to their complexity. Since most Alternative Investments (AI’s) are sold as “Private Placements,” they are generally only available to wealthy and experienced investors. I would consider them as any investment that isn’t usually part and parcel of a traditional or conventional portfolio. The thinking behind investing in AI’s is generally to allow for greater diversification, especially when considering those investments aren’t closely correlated with the more traditional investments. Correlation as a factor in the construction of diversified asset allocation portfolios has taken a beating since 2008, but in my book it’s still relevant. I also tend to look more closely at the risk vs. reward tradeoff involved with one’s investment decisions and asset allocation plan. Take note, be careful when reading a prospectus and comparing nominal dollar returns as compared to those that are inflation adjusted. The bottom line is that an Alternative Investment’s expected risk characteristics will usually differ from those of traditional investments. That’s why many investment managers will employ AI’s as an investment strategy to try and produce higher returns within a given investment universe.

Take special note – practically all AI’s are privy to more flexible regulation. Most are not regulated by the SEC or FINRA, and AI Managers are not required to guarantee these investments provide liquidity or diversification. Your Financial Planner should advise you that only those individuals with a net worth of at least $1 million, and a minimum annual personal income of at least $200,000, can invest in these types of investments. The aforementioned is really the only guideline(s) set forth by the SEC.

Alternative Investments include the following:

• hedge funds
• partnership vehicles (limited partnerships) – including private equity, private debt, R.E., oil, gas, timber
• managed futures funds
• private equity offerings
• commodities i.e., precious metals
• currency funds
• and other funds that use derivatives including options, straddles, and leaps

Unless you meet the SEC’s definition of a wealthy investor, and are sophisticated enough to understand the risks involved, AI’s are not for you. Even if you qualify, there are many questions that you need to ask both yourself and your financial planner. We’re all going to have to learn to live with the levels of volatility and below average returns we’ve been experiencing these last few years. One needs to have a plan, and that plan will help to provide the roadmap with directions on how to achieve your financial goals and objectives. A Financial Planner will help you to develop, implement and monitor your plan – it should be comforting to know that a financial professional with a high level of fiduciary responsibility is putting your best interests ahead of their own - there really is no other alternative.

Author’s Note: Please consult with your CFP®, CPA and/or Estate/Tax/Eldercare Attorney when discussing your financial needs and developing the appropriate personal/business financial plan.

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John Politi is Executive Director of the Jewelers for Veterans Foundation, a 501(c)(3) Non-Profit, dedicated to connecting US Military Veterans with training & employment in the jewelry industry – www.jewelersforveterans.org. He holds an MBA in Financial Management, MBA-Advanced Certificate in Health Care Management, Series 65 (Investment Advisor Representative), and successfully completed the required CFP® Financial Planning Educational Program. John would enjoy receiving your feedback and/or questions in regard to your Financial Planning activities, especially, Defined Contribution Programs (401K), 403b, 457, and Pre/Post Retirement Planning – both personal and business. He enjoys active membership with the Financial Planning Association-Greater Hudson Valley, NY, serving on their Pro Bono Committee, as well being a member of ACHE, Healthcare Leaders of NY Chapter, and the 24KT Club of New York. John welcomes your input and can be contacted at, , or telephone 212.600.2475.