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Be Careful With Those Alts, They’re Not At All the Same

July 22, 2015

In the current economic environment, after prolonged gains and record-low interest rates, many advisors are eager to diversify into alternative investments as a way to get exposure to products uncorrelated to stock and bond price changes. But advisors need to be aware of the inherent risks underlying alternatives, have a strategy to select the right products and managers, and be ready to monitor their investments regularly, Financial Advisor magazine writes.

A panel of experts at an event sponsored by Financial Advisor and Private Wealth magazines warned advisors to look for a number of red flags. To start with, advisors need to look beyond “style box” labels and understand risk parameters such as correlation with traditional asset products, the use of leverage, any directional bets within the strategy and more, Financial Advisor says. For that reason, liquid alts are a safer bet than hedge funds for first-time investors, as they are more transparent, Jeffrey Davis, chief investment officer at LMCG Investments, told the panel. But he warned advisors to watch out for “ephemeral liquidity” — liquidity that suddenly disappears.

Meanwhile, Jeffrey Sarti, copresident of Morton Capital, said advisors need to look at potential structural problems, such as liquidity mismatches with underlying assets, poor operational controls — including inadequate third-party monitoring — and, in particular, fee structures that encourage churning, reports the magazine. Sarti also said advisors need to look for managers who are themselves invested in their products, and even 10% may not be enough. “They have to feel pain in a nasty environment,” he said, as quoted in the magazine.

Furthermore, advisors need to do due diligence for each particular investment. Sarti said that when his firm is deciding on a real estate asset, they will actually visit the property, for example, according to Financial Advisor. And advisors need to be prepared to continue monitoring their investments for structural, economic and market changes, the magazine writes. Finally, advisors need to take into account the ease of access to portfolio managers — a major consideration, particularly for illiquid assets, other speakers on the panel pointed out.

By Alex Padalka
  • To read the Financial Advisor article cited in this story, click here.