Most Alternative Investments Should Be Avoided

Working in investment management in Asia, we get asked all the time about investment strategies by our friends. Often, the question these days is about alternative investments, since many people are looking for something else besides their stock portfolio. Our advice is, “just don’t do it”!
We realise this simple announcement might need some explaining, since the case for an investment that doesn’t follow the stock market can seem like a good idea. We consider alternative investments to be a category of real assets outside the world of funds and direct stocks. Things such as wine, stamps, precious metals, diamonds, forestry plantations, art and collectibles are all alternative in our view.
Our negative advice puts us at odds with quite a few of our friends, but we aren’t writing this advice to make friends (or commissions). It also seems to fly in the face of the convincing stories and beautiful pictures and those wonderful graphs that go up towards the horizon, with barely a pause for breathe.
Practically all alternative investments sold by a broker ends in a loss
Not every investment ends in complete loss of capital, but the failure of programs and strategies that we have been pitched, and avoided, is so regular from what we can see, that your hit rate might be as low as 2 in 10. This makes the stock market look positively low risk. Not that you’ll ever see this risk reflected in the sales material of alternative investment salesmen. Even worse, we think that perhaps as many as one third of investment programmes are borderline fraudulent, if not a complete scam. Sometimes, it is difficult to tell the difference between the frauds and merely incompetence, but is that truly a useful distinction?
Why are alternative investments so risky?
Once you move outside market traded and regulated assets, like the stock and bond market, a lot of the protections in place vanish.
      • There are no custodian accounts built into the system to protect the investor from actions of the asset manager. Think about that for a second, there is nothing stopping your wine broker, loading up a case of your valuable wine in the back of his van and selling it and later telling you that it had been “lost or broken”. Of course, that can give him a bad reputation, but by that time, the fraud has happened, and, if done in a small way on enough people, the perpetrator has disappeared somewhere with his illicit gains.
      • The valuation methodologies on alternative investments can become divorced from reality, meaning you are most likely paying overinflated prices for assets. These methodologies often must be devised because trading happens so rarely (unlike stocks), but they can be abused, making it look like you have a profit when you actually don’t. Independent valuation experts are paid by the manager, so how independent are they truly? We have seen this happen to property funds like student accommodation funds for example, that while otherwise solid, ended up with problems unloading their assets that had overinflated prices and thus locked up their client’s assets for years whilst they waited for reality to catch up the model.
      • There are no protections in place against self-dealing. This is where your helpful broker buys from the market at a lower price and then sells to you for a higher price. For example, your wine broker might pick up a case of Chateau Lafite for $10,000 and then sell it to you for $14,000 USD. Would you ever know that your wine broker quietly pocketed $4,000 completely risk free? Later, the broker can just say, “demand isn’t that strong right now, so we suggest you hold for another two years while we charge you a management fee for crossing our fingers and hoping that the market bails out our poor deal”. Sounds like an awesome deal, right? Protections against this were put in place in securities markets more than 100 years ago, but they don’t exist in these alternative markets.
      • Fear the word ‘guarantee’ and you’ll avoid the worst of the worst. Whenever my partners and I hear the word ‘guarantee’ from an investment provider, we go running immediately. There is no better predictor of investment failure, in my opinion, than investment providers who use that word. Look for a company that is growing and making money now (think Facebook and not Tesla) and you are likely to do far better than looking for a safe haven that is anything but.
Don’t be the patsy
So, our simple rule of thumb is, if you are not already an expert in your preferred alternative asset class, then it should be avoided. If you need entry to the market via a broker (who might also call himself an IFA or financial adviser) because you don’t know enough, then you shouldn’t be playing the game.
Bill Longstreet is a partner with Shanghai based Caterer Goodman Partners, a primarily fee based financial advisory firm. For more tips on how to handle your savings, check out their blog,