If you\u2019re investing in an instrument other than traditional stocks, bonds, or cash, then you\u2019re investing in an alternative. In the current low-interest rate environment, many retail investors are allocating a greater portion of their portfolio to alternatives in search of higher yield. It is also common for investors to believe that alternatives help contribute to a diversified portfolio and reduce volatility. Originally offered to institutional investors and sophisticated, high net worth individuals, alternatives come in many shapes and sizes. They include private placements, precious metals, managed futures, structured products, commodities, currency, and \u201calternative alternatives\u201d \u2013 just to name a few.<\/p>\n
Let\u2019s start by differentiating these from more traditional investments. Because alternatives frequently claim to have a low correlation with market indices, performance frequently depends more on manager skill than on market returns. Fees are often opaque and layered, and leverage may be used to magnify returns. One should also note that these investments can be highly illiquid. Their complexity explains their popularity among sellers, as complex products are often designed in favor of the issuer by having multiple layers of fees. In 2010, for the top five U.S. brokerage firms, alternatives generated $18 billion in fee revenues<\/em> (McKinsey & Company: The Mainstreaming of Alternative Investments).<\/p>\n According to Financial Industry Regulatory Authority (FINRA) rules, broker-dealers have an obligation to provide their clients with adequate disclosures and follow suitability rules. The disclosures include such details as liquidity, leverage, associated fees, and conflicts of interest. With regard to suitability, broker-dealers must consider the investor\u2019s age, risk tolerance, liquidity needs, financial and tax status, and other relevant characteristics (FINRA Rule 2111). Unfortunately, many broker-dealers have allocated a large portion of conservative investors\u2019 portfolios to alternatives. When broker-dealers, enticed by high commissions, take advantage of retirement savers and elderly clients, investors may be entitled to compensation for their losses.<\/p>\n