Compliance Considerations with Alternative Investments

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As investor interest in the market begins to rise with the market, so does their appetite for risk. Especially when most investors are trying to get back to even. Many investors listen to the noise form media, friends,and family members and eventually call their adviser. One of the pieces of noise I have been hearing is relative to alternative investing. 

At one time alternatives such as hedge funds and currencies were only for the very wealthy. Now you have mutual funds that will track a hedge fund index to products that bring down initial investment into a hedge fund to $100,000. Additionally there are funds and ETFs that utilize leverage. All these products may sound interesting and you have many tools that show how these product improve performance, but do not ignore the additional risk. 

As fiduciaries and from a compliance perspective, some steps you may wish to employ when considering these products include: 

  • Create a risk profile on a client. Although we all have profiles on our clients, it is a good idea to update the profile when considering these types of products.
  • Clearly disclose the risk that the client is taking when purchasing these products. 
  • Clearly disclose that some of these products have lockups of a year or two. I have seen many clients agree to these terms only to come back later and try to break the lockups. That process is very expensive.
  • Clearly disclose the fees that these products charge. Many clients do not understand the fees till they see the first statement. It would be a good idea to give them examples of fees.
  • Creating model portfolios with alternatives is great, but also show the downside risk.

In an up market clients get very excited about investing in high performing products. Just ensure they understand the risks involved.

Ash Bhatnagar, CFP®
President
RIA Independence Co.
Princeton, N.J.

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