Although the traditional combination of stocks, bonds and cash can provide most investors with satisfactory investment returns over time, an alternative class of investments exists for affluent and institutional investors. These alternative investments can provide an additional measure of diversification and tax benefits not available in traditional avenues. Consequently, financial planners who understand and offer this type of investment are in a much better position to land larger and more profitable clients and accounts.

What Are Alternative Investments?
This unique class of investments does not fall into a single larger class, such as debt or equities, but can be either one or the other. This investment class can satisfy many investment objectives such as speculation, avoiding taxes or reducing overall volatility. Alternative investments can include any of the following, as well as many other specialized investment vehicles generally tailored for high net-worth investors:

  • Individual or managed derivatives
  • Oil and gas ventures
  • Hedge funds
  • Tax shelters
  • Commercial equipment-leasing programs

Navigating Restrictions And Regulations
Financial planners who are registered representatives (RRs) face somewhat different issues than those who are registered investment advisors (RIAs). RRs are limited to selecting alternative investments that their broker-dealers have approved, while RIAs have relatively few restrictions to contend with when choosing an alternative vehicle. RRs with clients who want an alternative investment, but don't have such investments approved by the broker-dealer, only have one course of action available. The representative must submit the investment to the broker-dealer's compliance department for approval, and hope that:

  • The compliance department decides to approve the investment, and
  • The entire process doesn't take so long that the RR loses the sale.

RRs are also subject to the rules set forth by their broker-dealers regarding alternative investments, such as what type of client the reps will allow to invest in these alternatives. Getting around these internal regulations can often be very difficult, and usually they must get permission from either the compliance department head, president or vice-president of the company to do so. Brokers who cannot get approval for an alternative-investment trade for a particular client are therefore generally powerless to effect the transaction.

Although RIAs do not have the same restrictions as RRs, they are bound as fiduciaries to select the best possible investment for their clients and must assume sole liability if their choice goes awry. But the only real logistical limitation that RIAs face when choosing alternative investments is whether the specific investment being used can be offered on a fee-based platform. If it cannot, the advisor must either become licensed to sell securities and become appointed with a broker-dealer that offers the security, or find a different investment alternative.

A possible trend that can emerge from this dilemma is broker-dealers allowing their RRs to act as RIAs in alternative investments only. This allows the broker-dealer to retain its representatives while satisfying the clients' alternative-investment needs.

Evaluating Available Options
RRs who have clients that want alternative investments should ask about their broker-dealer's policy on this matter. Many RRs might have to face the choice of either settling for a different, perhaps less appropriate, alternative investment for their clients or finding a new broker-dealer that will accommodate them. This is more likely to be an issue for brokers who work at major wire house firms, as many of the independent broker-dealers often provide a much more comprehensive array of alternative investments to choose from.

RIAs must weigh for themselves the potential profit and liability of offering alternative investments. For example, an RIA could have several clients who would benefit from a specific type of alternative investment, such as a working interest in an oil and gas project. A single lease that has been carefully researched could provide a substantial profit source for both the RIA and the clients - and with only a reasonable amount of liability for both.

However, the potential commission or other fee that is charged must always be weighed against any possible consequences that could fall upon the RIA if the investment does not perform as expected. In many cases, this type of decision defies simple mathematical analysis; RIAs must employ common sense and careful due diligence in evaluating the risks inherent in the investment. RIAs must also acquire any licenses that are required to effect the transaction, such as a life insurance license for life-settlement cases.

Offering your clients alternative investments comes with its own set of risks and rewards. RIAs, in particular, should make a careful evaluation of all pertinent factors before entering into this type of transaction. However, a properly executed transaction of this type can provide clients with a measure of both profit and diversification that cannot be matched by traditional investment avenues, as well as possible substantial tax benefits. RRs who are just beginning to explore this subject should consult their broker-dealers for more information.

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