|Gary D. Halbert|
President & CEO
Printer Friendly Version
Email this to a friend
’ALTERNATIVE INVESTMENTS’ – WHAT ARE THEY? – PART I
Introduction – A
Look At So-Called “Alternative Investments”
With the stock market coming off
of a wrenching 3-year bear market and analysts warning of real estate and
bond “bubbles,” the most common question I receive from people is where can
they invest their money to make a reasonable return with manageable risk.
Many of these investors have turned to so-called
“Alternative Investments” in an effort to rebuild their
In this issue of
Forecasts & Trends E-Letter, I will begin a multi-part
discussion of Alternative Investments. I will generally define what they
are, how they are sold, and to whom, and some of the pros and cons of adding
these investments to your portfolio.
If you are not familiar with
such investments as “hedge funds” or “private equity funds” or “managed
futures funds” and other different investment options, then this series on
Alternative Investments, is must reading
for anyone considering such additions to their portfolio.
Like my multi-part series in
Jan-Feb-Mar on the “Mutual Fund Merry
Go-Round,” this will be another series of hopefully very
educational articles on the Alternative Investment marketplace, including a
detailed discussion on “hedge funds”
which have become increasingly popular among sophisticated investors in recent
Even if you don’t need the
information today, you will have it for future reference. As with my
earlier “Mutual Fund” series, I
am waiving my copyright, and you may share this information with others
(with proper credit given, please).
Defining What Are
One of the biggest challenges
for this article was coming up with a concise definition of an Alternative
Investment. And to what are these newer investment vehicles an
alternative? Some ultra conservative investors would consider stocks and
mutual funds to be alternative investments when compared to fixed-income
investments such as certificates of deposit or fixed annuities.
On the other end of the
spectrum, very sophisticated investors may not consider many of the
investments that I will discuss to be Alternative Investments, since they
deal with them all the time. After poring over volumes of materials on this
subject, the best definition of Alternative Investments I can come up with
is “investments that, either due to their
complexity or structure, are not generally suitable to the public” -
meaning in this case, the average investor.
Complexity is typically a
limiting factor when considering Alternative Investments, as I will discuss
below. Structure refers to how the investment is offered. Many Alternative
Investments are sold in the form of “private
placements” which are generally available only to wealthy
My List Of So-Called
My basic list of Alternative
Investments would include: options, futures,
straddles, leaps, precious metals (bullion or shares) or other
such investments that require a detailed knowledge of the applicable
instruments and markets to have a chance to be successful.
In addition to these, I would
also consider the following as Alternative Investments:
hedge funds, managed futures funds, private equity offerings, currency funds,
direct participation programs (limited partnerships), and other funds that
Because the term Alternative
Investments encompasses such a wide variety of offerings, I must limit my
discussion of the various types to a few major categories. If I tried to
discuss each and every conceivable type of Alternative Investment, this
series of E-Letters would stretch to book-length proportions.
In the weeks ahead (not every
week, mind you) I will focus on those Alternative Investments that I see
getting the most attention from investors, including hedge funds, managed
futures funds, private equity and others.
In this issue, however, I will concentrate on things you should generally know
about ALL types of Alternative Investments.
A Few Overall Precautions
With any type of
investment, it is important to know all of the risks before committing your
hard-earned dollars. As a general rule, Alternative Investments
carry all of the standard investor requirements and risks of traditional
equity and bond investments. In addition, there are specific requirements
and risks associated with Alternative Investments that you should be aware
of. Here are some key points to consider.
1. As I stated
above, most Alternative Investments are not available to everyone. Many
Alternative Investments are private offerings available only to
“sophisticated investors.” In general, to be sophisticated you must qualify
as an “accredited investor”
as defined by SEC guidelines. To meet these guidelines, in general terms,
you must have net worth of at least $1
million in assets, or have income over $200,000 per year (last
two years and expectation of same this year), or both. There are even some
offerings that require you to have over $5 million in assets to qualify.
To satisfy the requirements, you
must be prepared to share your personal
financial information with the sponsor of most Alternative
Investments, since that sponsor is responsible for making sure that
offerings are made only to those who qualify as accredited investors and
that the investment is suitable for you. If you don’t like sharing
information about your personal finances, then Alternative Investments are
probably not for you.
Alternative Investments are usually suitable only for wealthy investors, the
minimums required to invest in many of these programs can be considerable.
It is very common to see the required minimum investment be $100,000-$250,000,
with many requiring investments of $1 million or more, and some at $5
million or more.
Private offerings are also
usually limited as to the number of investors they can take. In many cases,
only 100 investors can invest in any one of these private offerings (funds),
so by the time you learn of an Alternative Investment, it may be fully
3. If you do
qualify as an “accredited investor,” there is a presumption (right or wrong)
that you are better able to discern between good and bad investments than
the average investor. Therefore, private
offerings have less regulatory scrutiny than public offerings.
That means that you will need to read the Private Offering Memorandum
(prospectus) and other offering materials very carefully and ask lots of
questions if there is something you don’t understand. It is also imperative
that you check out the background of the sponsor of any private offering you
As this is written, the SEC and
other securities regulators are looking at regulating certain types of
Alternative Investments more closely to both reduce the chances of fraud and
limit access to these investments to those who are truly suitable for the
risks they carry.
Alternative Investments have fees that are much higher than those related to
stocks, bonds and mutual funds. It is not
uncommon for a hedge fund or other alternatives to charge a 1-2% annual
management fee, plus 20% (or more) of the trading profits. As a
result, there are two important things (among others) to remember in
relation to Alternative Investment fees.
First, it is important that
you analyze “fee-adjusted numbers,” meaning that the
past performance record is calculated “net” of all fees and expenses. To
determine whether you are looking at performance net of all fees and
expenses, you will generally have to review the fine print disclosures
accompanying the marketing material.
Second, don’t let the fee
structures, alone, make your decision. Today, many investors
make a decision on a mutual fund based primarily on its fee structure. The
financial media has gone a long way to help this idea along by praising
low-fee funds and demonizing those that charge more. However, what really
matters at the end of the day is how much money you have in your pocket.
Some alternative asset strategies can produce higher net returns than
comparable low-fee alternatives.
5. As mentioned
above, some Alternative Investments that are private offerings are regulated
more loosely than traditional securities. However, there are some
Alternative Investments that are not regulated at
all by the SEC or NASD. This class of Alternative Investments
includes, among others, “viatical settlements” and “senior life
settlements,” which both involve buying existing life insurance policies on
sick or older persons at a discount and waiting until they die. (Sounds
pretty morbid, doesn’t it?)
The subject of viatical and
senior life settlements is large enough for an entire E-Letter on its own.
While some states have attempted to regulate these types of products through
their insurance departments, these types of investments are still mostly
considered private property transactions, with limited regulatory oversight
in many cases. Therefore, the term
“caveat emptor” (buyer beware) gains even greater
6. Many Alternative
Investments are very illiquid. Many hedge funds and other
alternative investment funds have very restrictive policies for getting your
money out. Some only allow redemptions once a year, or twice a year or
quarterly. There is no market for these securities, so you must understand
the illiquidity issues going in and consider such investments only for the
Generally speaking, no single type of Alternative Investment should amount to
more than 10 to 15% of your overall portfolio. Most legitimate
investment sponsors will recognize the need to limit your exposure to these
riskier investments to a small part of your overall portfolio. As discussed
above, most will ask many questions about your personal financial
situation. However, there are others who would recommend that you put your
whole life savings into these investments.
Resist that advice!
8. Even though
some Alternative Investments, especially some hedge funds, can show a
history of positive returns with very low losing periods (including no
annual losses), I do not consider any Alternative
Investment to be compatible with a truly conservative investment strategy.
These products should only be considered by investors willing to take on
higher risks with the potential for higher rewards.
9. Finally, the
standard rule of investing still applies: If it
sounds too good to be true, it probably is.
Adversity Breeds Marketing
With interest rates at the
lowest level in over 40 years, and the stock market gaining but still very
risky, Alternative Investments are growing in popularity among sophisticated
investors. As noted above, many of these investments are only available
through private offerings. As such, they are not allowed to advertise these
Unfortunately, there are
unscrupulous investment sponsors who are very actively promoting bogus
investments in an effort to attract investors who are scared of the stock
market but frustrated with low interest earnings. Others may promote
legitimate investments, but might overstate the potential benefits or
understate the risks of the alternative strategies.
Most vulnerable are those
investors who are retired and trying to live off of the income generated by
their investments. With interest on CDs and other fixed-rate investments so
low, seniors are looking into alternatives to maintain their standard of
living. In addition to this group are investors who lost huge amounts of
money in the stock market when the tech bubble burst. Many of these
investors are looking for a way to make up for all of their losses.
Investment scam artists consider groups of investors like this to be “ripe
for the picking.”
January 21, 2003 E-Letter
, I discussed the increase in investment scams and how to avoid them. You can
view that issue by
CLICKING HERE. In addition to what I said in January, I would like to
provide the following list of telltale signs of investment fraud from the
1. Be wary of promises of
quick profits, offers to share “inside” information, and pressure to invest
before you have an opportunity to investigate.
2. Be careful of promoters
who use “aliases.” Pseudonyms are common, especially on the Internet, and
some salespeople will to try to hide their true identity. Look for other
promotions by the same person.
3. Words like “guarantee,”
“high return,” or “as safe as a C.D.” or “limited offer,” may be a red flag.
No financial investment is “risk free” and a high rate of return means
4. Watch out for offshore
scams and investment opportunities in other countries. When you send your
money abroad, and something goes wrong, it's more difficult to find out what
happened and to locate your money.
Balancing Opportunity And
From reading the cautions in
this article, you may think that I am against the use of Alternative
Investments. Nothing could be further
from the truth. My company has sponsored a number of Alternative
Investments over the years. However, as with any investment, Alternative
Investments must be consistent with an investor’s overall financial goals
and risk tolerance.
Determining whether Alternative
Investments are suitable for you may or may not be something you feel
comfortable doing for yourself. Most investors would be well advised to
seek out the services of a qualified Investment Advisor to help evaluate any
Alternative Investment that they are considering, especially if this
opportunity came your way as a result of a telemarketing call or Internet
e-mail or chatroom.
ProFutures Investments, is active in helping investors determine
whether various investments are suitable for them. You can call
1-800-348-3601 and talk to any of my Investor Representatives and
they can help you out. If you insist on someone closer to your local area,
you can find a qualified Financial Planner by going to the
Financial Planning Association website (
www.fpanet.org) and clicking on “Find A Planner.”
There are Alternative
Investments that offer good opportunities to participate in different
markets and different investment strategies which are not available to the
general investing public. But it is important to keep in mind that while
these alternatives may offer higher return potential, they also involve
special risk factors that must be taken into consideration.
Above all, you MUST understand the risk factors and your own tolerance for
that type of investment.
Most of my clients are high net
worth, sophisticated accredited investors. As such, I advise them to
consider Alternative Investments as a part of their asset allocation and
active management strategies. Just as no single stock sector always has the
highest performance, no single Alternative Investment outperforms the market
and its peers all the time. As always,
diversification is the key to a successful portfolio.
In the next installment of this
Alternative Investment series (in the next couple of weeks), I will discuss
hedge funds in detail – one of the most popular and fastest growing
investment areas in recent years. If you have heard about hedge funds, but
weren’t sure just what they are, I will attempt to enlighten you (pros and
cons) with the next issue in this series.