An investment portfolio can benefit from having an allocation to alternative assets, but care must be taken when selecting them because some are riskier than others.
With so many alternative assets now available through Oeics and investment trusts, no longer are these the preserve of the wealthy. However, an FSA crackdown on unregulated schemes (Ucis) means some alternative assets are not appropriate for retail investors, so recognising what is allowed and what is not is imperative. Here’s our quick guide to the things to consider when recommending these investments.
1. Assess the client’s investment needs. Whether or not an investment portfolio will hold alternatives, and which type, depends on a client’s objectives. Do they need the income from commercial property or infrastructure funds? Do they want the capital growth from private equity? Such questions can be answered by finding out if the client needs to meet certain objectives and whether or not this additional exposure will help to achieve it.
2. Measure appetite for risk and capacity for loss. Alternatives can be a double-edged sword. On the one hand, they can mitigate losses because they behave in a different manner to traditional equities and have a low correlation to them. But private equity and hedge funds are often considered riskier, so it is important to make sure they are appropriate for the client’s particular circumstances.
3. Research, research, research. In the universe of alternative assets, it is even more important to ensure the fund selected is the right fit for the portfolio. This requires thorough research, perhaps more so than mainstream equities. For example, some listed private equity and hedge funds get high ratings from wealth managers and are widely considered to be strong holdings, but this is not true for the entire sector.
4. Be realistic. Just because something is an alternative investment does not mean it is a magic bullet that will always provide brilliant returns. They are alternatives because they have a low correlation to equities, not because their potential returns are any better.
5. Beware of unregulated investments. Some alternative assets fall under unregulated collective investment scheme (Ucis) rules, such as wine funds, classic cars, carbon credits and others. Under FSA rules, anything that is not regulated and falls under Ucis rules cannot be promoted to retail clients. While there is nothing that can stop a person investing in a wine fund, a financial adviser cannot provide any advice related to it.
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