Some advisors take a short-term approach to alternative products that are intended as long-term investments.bgwalker/iStockPhoto / Getty Images
Sign up for the Globe Advisor weekly newsletter for professional financial advisors on our sign-up page. Get exclusive investment industry news and insights, the week’s top headlines, and what you and your clients need to know. For more from Globe Advisor, visit our homepage.
More advisors are turning to alternative investments to broaden the options available for clients. But some advisors take a short-term approach to alternative products, according to a recent report from Investor Economics, an ISS Market Intelligence business.
Here are three big mistakes advisors make when integrating alternatives into traditional client portfolios:
1. Not looking beyond the rate of return
After the dismal performance of equities and bonds in 2022, many advisors looked to alternative investments to improve the overall performance of client portfolios. But some failed to read the fine print explaining how those enticing rates of return are achieved.
For example, private equity funds are meant to be held for the long term and there’s often a penalty for redeeming early, says Will Stevenson, senior research associate at Investor Economics. Furthermore, depending on the type of fund, the turnaround time to get the client’s money out can be a month or longer.
Many advisors put older clients in their 50s and 60s who may need their money sooner into private market funds. “That’s where some of the early redemptions come from,” he says.
“If you need access to the money right away, it’s not going fit within your portfolio,” Mr. Stevenson says. “You can’t just force a naturally illiquid investment strategy into a liquid fund structure and expect its return profile to mirror the original strategy perfectly.”
2. Not doing an in-depth fee analysis
Fees for alternatives tend to be higher because there’s less competition and more complex products, says Andrew Feindel, portfolio manager and investment advisor with Richie Feindel Wealth Management at Richardson Wealth Ltd. in Toronto.
Investors may also pay a performance fee if returns exceed a certain percentage. While some argue that gives portfolio managers an extra incentive to outperform, it also might be an incentive to take on more risk, Mr. Feindel notes.
He looks for high-water mark fees on alternatives, which cap how much will be charged, something that’s helpful in a down market. There are no performance fees until the high-water mark is reached.
“If you’re in a fund that declines 20 per cent and goes back up by 25 per cent or back to where it was, I don’t want to pay a performance fee on the recovery,” Mr. Feindel says. “That’s good for the fund manager, not necessarily good for the client.”
3. Not conducting overall due diligence
Some advisors listen to product pitches from eager wholesalers but don’t ask enough questions or do further research, says Colin White, portfolio manager at Verecan Capital Management Inc. in Dartmouth, N.S.
Mr. White has heard his share of presentations. His firm wants to introduce new asset classes for clients but not without clearly understanding what they’re all about. The complexity can be daunting.
“It’s just trying to figure out what’s real and what isn’t,” he says of his firm’s process regarding private markets. “It’s a very opaque space. It doesn’t have the same reporting requirements. We’re taking our time sifting through information because there are a lot of promises being made that just aren’t true.”
One he hears regularly is the concept of individuals gaining access to investments similar to those held in the Canada Pension Plan.
“Many pensions have positive net inflows of cash, so they’re perpetually in the growth phase and they have an infinite mortality,” Mr. White says. “An individual has neither of those things, so to say that somebody should be investing like a pension plan is just wrong.”
He has found the characteristics of the underlying investment matter for any product, even alternatives. “To say it’s all just one asset class isn’t accurate or fair.”
In that vein, when asked for second opinions on portfolios, Mr. Feindel notes many advisors put together what he calls “clustered client portfolios” in which the advisor favours similar versions of a product over and over again.
“They lack a diversified alternative strategy,” he says. “They’ll just have a lot of private credit, for example. So, I think there’s a bit of a familiarity bias that investors should look for.”
Mr. Feindel puts alternatives into different categories. Capital growth would be a fund that strives to outperform the S&P/TSX Composite Index or the S&P 500, for example. He considers private equity under that category.
But he classifies real estate and private credit, for which the goal is to derive consistent income, as income growth. Volatility management, he says, is about protecting capital and making sure clients don’t lose money.
For more from Globe Advisor, visit our homepage.
