Alternative investment: opportunity or stupidity?

Alternative investment: opportunity or stupidity?
25 October 2011

PRUDENT investment management is the most important contributor to building and preserving wealth, so it’s important to get it right.

Until recently, I was  an adviser in the UK where the general (quality) consensus is moving away from the latest fad offerings dreamed up by investment management companies back to the standard assets classes that have always been on offer.

This begs the question: are alternative investments a sound opportunity or speculative stupidity?

The basics

There are four main asset classes available to investors: equities (stocks and shares), fixed interest (such as government gilts and bonds), property and cash.

Each of these asset classes has different risk characteristics and relative attractiveness during different stages of the economic cycle. It is universally accepted that holding the right mix of assets at the right time is by far the biggest determinant of portfolio performance. If only it were that simple.

Wider universe

Having become an ‘offshore’ IFA operating outside the scope of the British Financial Services Authority, I am now bombarded with different offerings from life companies and investment houses.

Some of them sound extremely attractive and many are quite topical – tapping into current themes such as the environment and clean energy – but it’s unlikely you would get them in such a highly regulated market as the UK.

But is this a bad thing? There is no doubt that offshore investors have access to a much wider universe of funds and investments than UK-based retail investors. I think it is also fair to say that offshore investors expect a higher rate of return than UK investors and, in general, are prepared to take a few more risks (if risk is properly explained in the first place).

Scams abound

That said, there is the real risk that these funds will blow up in your face. There have been some very high profile cases of investments that have turned out to be complete shams. Did advisers and investors actually understand what was going on inside these investments?

If you invest in the four assets classes previously mentioned, you can achieve huge diversification and relatively low ‘scam’ risk.

Four top tips

So what should you do? Here are four top tips...

1. Go for liquid assets

Long-only equity only funds invest in actual shares as do vanilla fixed interest and property funds – meaning that these funds are backed by genuine, liquid assets.

Bar the occasional business going under, you are not really at risk of the fund blowing up in your face. Property funds can impose a moratorium on removing investment in certain circumstances, but this is to be expected from a less liquid asset. Essentially, you know what you are buying. With many of the alternative investments on the market it is a very different story.

2. Understand your investments

Some alternative funds invest in things such as American life assurance contracts, futures, commodities, recycling, clean energy development – all things which could make decent returns and some which do offer genuinely non-correlated diversification (the Holy Grail in investment terms), but are less well understood by advisers, let alone their clients.

The old adage goes “if you don’t understand something, don’t invest in it”. When it comes to more exciting investments on offer, it’s also said that “if it sounds too good to be true, it probably is”.

This is sound advice and has been repeatedly shown to be worth following over the years. Yet there are many investments on offer in the UAE that I would challenge most people to explain succinctly.

3. Ignore the hard sell

The other thing that concerns me is the way individual investments are punted. Investors need diversified portfolios that fit in with their overall plan and objectives.

Appealing to people’s greed factor and punting the ‘next big thing’ (a prime example right now being gold) is reckless.

Why is it that ‘experts’ are always telling you what and when to buy, but nobody ever tells you when to sell? It’s because they get paid when you buy and they get nothing when you sell.

4. Be a little risky

There is a compelling case for sticking to ‘boring’ investments: you know what you are buying and there is plenty of scope for diversification and returns.

However, if you want to invest in some of the more esoteric investments on offer in the offshore markets, go in with your eyes open and accept that, along with the usual risks you take on board when investing, you are heading off the beaten path and there is an increased capacity for things to go wrong.

As such, only allocate small parts of your portfolio to single investments or funds and don’t fall for all the hype and pile into ‘the next big thing’.

Pic credit: Master isolated images/ FreeDigitalPhotos.net

Are you an alternative investor, or do you prefer to stick with traditional investments? Tell cashy...

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Chartered financial planner
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