Alternative Investments - There is no Silver Bullet

Too Much Selling Products and Services, Over Helping Clients

One of the worst things about our industry is that too much of the industry isn't geared toward helping their clients, but rather to sell them products and services. Clients often believe that their advisors are acting in their best interest, which they should be doing, but some are biased and are selling them something to earn commissions off of the sale. One of the ways this deplorable behavior manifests itself is in product selections and investment recommendations.  Advisors often promote products which are new and exciting because they are more easy to sell, and not because they are the right investments for the client's portfolio.

On top of this, mutual fund companies and big banks design products to design products that reflect the most recent investing trends.  They promote new investment products as perfect solutions to investors problems. Because investors tend to have very short term memories, when they are presented with these new investing opportunities, they forget that no investment solution is perfect and they jump right in.  That's when the problems arise.

Proliferation of ETFs

In the past ten years we've seen this with the proliferation of ETFs and passive index funds. Don't get me wrong, some of these ETFs are genuinely good products which have added a lot of value, however many others were either completely unsuitable for retail investors (which of course didn't stop some advisors from selling them to their retail clients), or they were just bad products which didn't provide any value at all. This of course makes sense.  

Not Everyone Can be Above Average

In any area of product, there will be good products and there will be bad products. By definition, not everyone can be above average.  The trick is only buying the above average investments, and also making sure that the investments fit your individual goals.  Often the flavor of the month investment either won't be good for your individual portfolio, or in the case of things like mortgage backed securities in 2008, they won't be good for anyone.

The latest investment fad in the making is what we call Alternative Investments.  They are called alternative investments because they are meant to be 'alternatives' to traditional stocks and bonds.  For marketing purposes the investment industry has grouped together a wide range of non-traditional investments together and billed them as alternatives.  

These non-traditional investments include:

Real estate

Infrastructure Options and derivatives

Private equity

Commodities

Precious metals

Currencies

These investment categories have been less commonly used than stocks and bonds by retail investors in the past.  They are also alternatives because their prices tend to behave differently than those of stocks or bonds.  

For Example

Real estate and infrastructure is usually more resilient during recessions than stocks generally.  That's because their income streams are more locked in and are less likely to be affected by a recession than the average business.  Options and derivatives are used in hedge funds which can be completely uncorrelated to the stock market.  This means they can actually make money during market crashes. Precious metals also do well during times of turmoil as they are seen as a safe haven.  Some currencies like the USD and the Japanese Yen are also seen as safe havens. When you package all of these different alternatives together, you can get a nice complement to traditional stock and bond portfolios.  

Alternative Investments

However, like all investments, alternatives are not perfect. Alternative investments are often more costly to get into than traditional stocks or bonds. This means that they often can produce subpar investment results, even when their returns are only average.  The higher the fees and costs, the lower the returns generally.  This means that in order for alternatives to be justified, you often need to get a truly exceptional manager.  There are only so many exceptional managers to go around.  Higher fees are a motivation to create and sell these products. This will sometimes result in the creation of funds that are unsuitable to retail investors, but will still be sold to them.

Another problem that alternatives will eventually face is that they, like all investments, are not a silver bullet.  That means that inevitably they will face a period of underperformance at some point in time.  This isn't necessarily a problem with the investments themselves, it's more of a problem with investors' expectations. Nevertheless, when investors are sold on these investments, they rarely discuss what will happen when the investments go wrong.  That leads to big problems when those investors are counting on their alternatives to provide protection or income that they need to make their plan work. When the performance is less than their expectations, their plan falls apart. All is not lost however.  

There are some alternative investment funds that are very good investment opportunities. If used correctly they can be a nice complement to your portfolio.  However, retail investors should not underestimate the task of selecting the right alternative investment.  They are complicated products with a lot of moving parts to them. Properly selecting an alternative investment requires a lot of due diligence and expertise. So what is a retail investor to do, if these products are complex, and their advisor may not have their best interests at heart?

Fully Understanding the Investments You Make

Well, if you are investing on your own, you need to make doubly sure that you fully understand any investment you make.  You need to understand the advantages AND the disadvantages of these alternative investments and make sure you fully appreciate the risks involved. If you are relying on an advisor to advise you on these types of investments, you need to make sure to ask them how these alternative investments are going to help your portfolio and help your financial goals.  If your advisor can't explain that to you in plain language, it should be a red flag for you that the investment may not be in your best interests. Of course if you are unsure, you can always seek out a second opinion.

- Craig White, BA, LL.B., CIM

Craig White is an Investment Advisor at the award winning firm Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.