An “article” in a leading Canadian financial daily last week urged investors to consider alternative investments such as hedge funds, private debt funds, factoring funds, etc in order to achieve solid investment returns without taking on high risk. Once the privilege of the ultra-rich, such investment opportunities are now becoming increasingly available to a larger swath of the investing public. In this environment of low interest rates and peak stock market levels, surely these alternative investments are just what investors need, right? Wrong.
To begin with, the article was a blatant sales pitch. It was actually hard to believe it wasn’t labelled as a sponsored article or advertisement. The author must have paid for it to be placed otherwise it was one of the worst cases of irresponsible financial editorship we’ve seen in a long time. It reads exactly how these investment products are pitched to investors: “high stable income, lower volatility, enhanced returns – both helpful and in fact necessary in this low yield environment”.
The problem with many alternative investment products and with the way they are sold is that they contain risks that people find it very difficult to understand and price. These risks are ignored or brushed over during a sales pitch and buried in the fine print of any Risk Acknowledgement an investor might be required to sign before writing the cheque.
In its most general sense, risk should be defined as the chance you might not achieve the outcome you desire. From a financial planning perspective it’s not having enough money to support your life goals. Investing should be done in a way that balances return and risk such that these attributes are as aligned as possible with your goals. Here are some helpful tips to avoid having your investments fail to deliver:
- Avoid having all your eggs in one basket – diversification is one of the most sensible risk management strategies.
- Avoid structured investment products – it’s unlikely the person selling them to you understands how they’ll perform in adverse market conditions.
- Avoid locking in – lack of liquidity might prevent you from selling an investment when you need the money.
- Beware of credit risk – a fixed income return is only as sure as the guarantor
- Avoid high costs – one of the surest ways to keep more of your savings is to avoid high cost, high commission products – many complex products are unduly risky in order to extract profit for the product manufacturer.
Investing in broadly diversified, liquid, low cost investment funds should keep you out of trouble for the most part. Alternative investments are often recognizable because they have just the opposite characteristics – undiversified, illiquid, high cost. These products are sold based on possibilities rather than probabilities – sure it’s possible to achieve high returns but at what risk? Too often the risks are glossed over. So beware the (wo)man bearing low risk stable returns.