Most Financial Advisers Don’t Understand Alternative Investments According To John Hancock Survey


Given the array of exotic alternative investments being sold to the public, it’s logical that many investors often don’t understand what they are buying. What is even scarier is that it is likely their professional investment adviser doesn’t understand the alternative investment either. Investment advisers ? 75 percent of them ? admit they do not understand alternative investments. Notwithstanding their puzzlement, 50 percent of advisers said they intend to increase their use of them in their clients’ accounts this year. They could use some help, however, because of alternative investments are so confusing. (“Alternatives spur anxiety,” InvestmentNews).

Investor attorney J. Boyd Page of Page Perry observed “This is a very problematic situation. How can financial advisers recommend an investment in good faith if they don’t understand it? Similarly, how can financial advisers explain the investment to their client when they don’t the risks.”

“There’re too many different types of alternatives out there, and it makes it confusing for advisers,” Bob Boyda, John Hancock’s head of global asset allocation, was quoted as saying. That is true as far as it goes, but it does not go far enough. It is not just the bewildering number of alternatives out there that is confusing to investment advisers. Alternative investments are intrinsically confusing. They lack transparency and are almost impossible for an outsider evaluate.

To understand whether an alternative investment is suitable, an investment adviser needs to be able to evaluate the range of possible outcomes and their likelihood of occurrence. But manager track records and performance statistics are often unavailable or misleading. ?Prospectuses and marketing materials often list boiler-plate risks but rarely address the likelihood of the specific risks associated with the investment. Thus the answers to simple questions such as “What’s the worst possible outcome?” and “How likely is that?” are simply not available to advisers.

In order to answer basic questions like: “How does the investment work, what are the fees, and is the investment a good deal?” the adviser or his firm must be able to conduct due diligence. Most advisers lack the background, time and ability to interview and investigate managers and promoters, evaluate strategies, methods and fees, make appropriate comparisons to other investments, and reach appropriate conclusions. The fees are embedded and not transparent.

REITs, hedge funds and private equities frequently involve transactions by and among people with interests that conflict with the investors. Examples may include asset acquisitions that were not done at arms-length and were made at inflated prices based on inflated appraisals. Hedge funds give managers virtually unlimited discretion and provide little or no verifiable information to outsiders about what the fund is doing.

Many alternative investments use complex derivatives, which are virtually impossible for ordinary advisers to evaluate. Derivatives generate nonlinear (kinked) outcomes and abnormal (skewed) distributions. To determine whether an option is fairly priced, one would have to be able to do the Black-Sholes mathematical computations that earned a Nobel prize.

Investment advisers pretending to advise investors about alternative investments is like the blind leading the blind ? except that advisers who sell alternative investments stand to receive outsized commissions for selling them.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.