Desperate to offer higher returns than can be had from conservative investments, the financial services industry has been pushing an asset class called “alternative investments” to individual investors. I am constantly contacted by vendors of these products and invited to participate in this “high commission high-return” arena. My question has always been: “Alternative to what; common sense and my client’s best interest?”

Enough time has gone by that many of these bright ideas have come full circle and proven to be disasters for investors. Recent articles have highlighted a few examples.



Monday, March 21, 2016, WSJ featured an article entitled “A HOT INVESTMENT IS LOSING ITS ALLURE”. Investors have poured $22 billion into funds called non-traded business development companies (BDC). These are packages of loans to small and medium size low quality companies.

Marketing materials promised steady dividends, yields as high as 8% and a haven from volatile markets according to fund documents and sales executives. One typical non traded BDC said in its disclosure document that its 10% up front sales load and 2% offering expenses mean that “only $88.00 of every $100.00 actually gets invested”. You would have to make a return of 14%-18% to just recover the fees.

So how have they performed? The performance figures that are available to the public only go through the end of third quarter 2015. They show a loss of 16% across the industry in the value of its assets versus the initial offering price to investors. No surprise then that investors pulled $47.3 million out of non-traded BDCs in the third quarter 2015, up from the $25.7 million they pulled out in the second quarter.

Wall Street continues to push these products, of course. Franklin Square Capital Partners the largest syndicator of these products, recently threw a fundraiser for Hillary Clinton featuring Jon Bon Jovi. Republican candidates have also been the beneficiaries of the Franklin largesse.



Another headline recently in the London Financial Times reads: “Smart Beta Is Not Quite As Clever As Billed.” Smart beta funds have been touted for the last few years as the latest new best thing.

Explaining a smart beta fund is like explaining air but I’ll give it a try. Beta is the academic term for the return you get from passively investing in an index. Smart beta comes up with a strategy to beat the index. As it turns out the strategies, which amount to identifying anomalies in the market, only work until everyone else notices the anomaly. It is similar to why asset allocation no longer works. Once everyone is allocating across all asset classes there is no longer any “play” in the strategy. So again, everyone wins but the investor.



Hedge funds are a continuum of high risk investment vehicles that typically charge higher fees than other money managers, historically 2% of assets under management and 20% of profits. There are usually high minimum investment amounts in excess of $1 million. Hedge funds have been especially popular with pension plans, insurance companies and endowment funds that are under pressure to meet distribution requirements that were put in place when interest rates and market returns were higher.

Over $3 trillion dollars has been pumped into these vehicles over the past decade but after six straight years of returns that have failed to match those of traditional stocks and bonds, the tide has turned.

In the first quarter 2016 the average fund lost 0.8% after fees. That follows a loss of 1.1% for the average fund in 2015.The average hedge fund investor has earned as cumulative 1% since the start of 2014 while taking inordinate risk. We have easily surpassed that in ultra safe investments.

For the first time since the data started to be tracked in 2001, endowments and foundations cut their contributions to hedge funds. A total of $15.3 billion was withdrawn in the first two months of 2016 alone.

At insurer AIG, first quarter operating income fell by 54% from a year earlier. The company blamed most of that decline on market losses which AIG chief Peter Hancock said were due to hedge funds.

Met Life reported a 19% decline in first quarter operating income partly due to alternative assets including private equity and hedge funds.



Investors will continue to believe that taking more risk somehow guarantees higher returns. The financial services and banking industries will continue to come up with ways to charge high fees on products that enable investors to do this. Unfortunately, the only thing that taking more risk guarantees is that you are taking more risk and probably paying dearly for the opportunity to do so.