Advisors recommending alternative investments to higher-wealth clients are thinking outside the box about how to generate higher returns. While some alternatives certainly can, and do generate better returns than are available in the equity markets, they are not without risk or other limitations. A prudent advisor should leverage third-party due diligence resources before determining whether the investment is a good match for an individual client.
Investors are attracted to alternatives, like non-traded REITs for example, because they have generated yields that are significantly higher than the equity markets during the past few years. Despite the limited liquidity inherent in some alternative products, investors find the tradeoff for higher yield to be worth tying up funds for over a five-to-seven year period. Such investors with sufficient capital and an appropriate risk profile want to work with advisors who will guide them into the alternatives market so they can participate in these yields.
Knowledge Increases Your Credibility
The better informed you are about alternatives, by going the extra mile on due diligence, the more likely it is that you’ll attract high-wealth clients. You’ll be adding extra value to your services by recommending quality investments that earn a greater return for your clients. Here are our recommendations for 7 important due diligence steps you can take to retain your best clients and attract new ones. Your unique knowledge of alternative products is your marketing power.
Here are Your Top 7 Considerations
- Ask the tough questions about the sponsor and the manager’s financial commitment to the investment program. Sponsors and executives who are personally invested in the success of the project are highly motivated to ensure that it will succeed. If the sponsor isn’t invested, perhaps this is a sign that your client shouldn’t be either.
- If possible, set up in-person meetings with the sponsor’s principals or managers. It’s often easier to gauge the truthfulness of data in the offering when the direct source of the information is across the table from you. You’ll also get a better understanding of the cost structure, liquidity terms and the risks for each alternative.
- Use third party data reports from reputable services like FactRight, even if there is a fee. These services do the hard work of digging deeper into due diligence so you don’t have to. Third party services are experts at finding and confirming the information on alternative investments. You’ll be able to confidently recommend—or not—a specific investment to your clients.
- Talk to other financial advisors who have worked with the sponsor or product in the past. They have first-hand knowledge of the way the sponsor works and how accurately the sponsor presents its performance. Put little stock in the literature supplied by the sponsors. This material is intended to present the project in the best possible light with the most optimistic outcome. That said, track record is paramount. In looking at prior performance, has the sponsor done what it said it would do? If performance has faltered, how did the sponsor or its principals step up to limit losses for its investors?
- Expect that the vetting process will take time. As with everything else, there will always be another “can’t pass up” opportunity. Don’t rush through due diligence because if you do, inevitably, you will miss something.
- Consider your sources. Take the time to thoroughly vet the source of the information and how the source draws conclusions. As noted already, be wary of any sponsor-provided promotional materials. Give them the weight and credibility that they probably deserve—low and highly biased.
- Due diligence is ongoing. Always be on the lookout for material changes that could affect a client’s investments.
Provide Unique and Valuable Service
One bad investment recommendation can utterly destroy even the strongest client relationships. That’s what this whole, due diligence exercise really comes down to—preserving and developing trusting relationships.
When you invest in your own knowledge, you invest in your client’s satisfaction and trust. You’re offering a credible service that puts you a step ahead of other advisors. Put the right people on your team to support your research efforts and make good, solid recommendations to clients. It’s you and your clients who benefit over the long term.
There is no clear guidance from the SEC about its expectations for advisors in the event of a compliance audit and no industry-wide standard about what to include in a due diligence review of alternatives. Incorporating the suggestions above, at a minimum, should help you cover some of the common concerns investors may have and secure their trust in your guidance.