Esoteric Investments
Daniel Kiernan, director of Intelligent Partnership, offers a good due diligence process to undertake for assessing the opportunities for esoteric investments in this article published yesterday in Professional Adviser.
In our previous article we highlighted that there is a case for including esoteric investments in client portfolios where suitable as they can be good diversifiers that offer the prospect of uncorrelated, above market returns.
And since the market crash of 2008, rather than seeing a flight to safety – into strong defensive stocks – we have actually seen something of a flight to esoteric alternatives as investors look for less volatile sources of growth and look to ‘real’ assets to combat the impact of inflation.
However, it is important to assess which esoteric investments are viable opportunities as they are often in the non-regulated space – and therefore we have to sort the wheat from the chaff before even considering them for clients.
So here I will outline some of the key considerations to bear in mind when assessing esoteric investment opportunities.
Once again, by esoteric investment I am not referring to any form of collective investment scheme – be it regulated or unregulated. I am referring to directly held assets, non-regulated investments into farmland, forestry, gold and other precious metals, property and other tangible assets.
What’s different?
When assessing non-regulated investments, it is important to proceed with extreme caution as neither the product providers nor the distributors are regulated and scrutinised by the FSA. This means there are three key differences with regulated products that must be kept in mind:
- Unlike regulated products, you cannot rely upon the marketing material and will have to test the veracity of the claims the product providers make – although they are still bound by the rules of trading standards and the misrepresentation act so they are committing an offence if their claims are too outlandish.
- There is no recourse to the FSA, FSO or FSCS for investors in the event of a dispute or investment failure. You will need to be very clear on this throughout your conversations with your clients.
- You will need to verify that the investment is a genuine opportunity and not a scam or ill-thought out get-rich-quick scheme by focusing on exactly where the money goes, what price is being paid for the asset and how investors own the asset.
These are three significant differences, but once you have dealt with these the assessment process is much the same as for regulated products – does the investment case make sense, are the management team competent, does the business model stack up, is it suitable for clients’ investment objectives?
And of course both regulated and non-regulated investments can still underperform or fail and turn out to be poor investment decisions.
The due diligence process
Everybody’s due diligence procedures will be slightly different, but the stages you need to go through might look something like the table on the next page.
Avoiding the chaff
Non-regulated product providers’ materials can be very heavy on the benefits and very light on the risks of the investment.
They often make a very good macro case – after all it is easy to make a general argument for biofuels or farmland – but they can be much less clear on how exactly they intend to make money and pay investors.
The word guaranteed is overused in this sector as well – unless the funds to pay the returns are held in escrow or there is an insurance policy underwriting them, then providers should not be using the word guaranteed. Thorough due diligence is the answer here.
The better quality products will have plenty of documented information, will be open and transparent, will positively respond to any requests for further details and will have commissioned independent research reports to evidence and support their claims. A lack of evidence, specifics or track record is a warning sign.
It is also wise to drill into the legals and the structure to get comfortable with how the asset is owned and how the purchase price has been reached. One of the key benefits of directly held investments is that they represent ownership of something tangible that still has a value even if the operator goes bust – so it is key that the investor really does have ownership and that they paid a fair price for the asset.
In short, it is important to be able to come to an informed opinion on the investment and establish if:
- It is a genuine business looking for capital;
- An ill-thought out pipe dream;
- Something that has just been designed to collect investors’ money and do little else.
Who can help?
As mentioned above, good product providers should be able to supply a lot of the information that will be needed, including independent research they have commissioned. Anybody else in the value chain should also have undertaken due diligence and be prepared to share it.
Trustworthy distributors of esoteric investments will act as a quality filter and only bring worthwhile investments to market and should also be able to provide due diligence. Finally, there are independent companies with background and expertise in esoteric investments that you can outsource due diligence to.
So although assessing the correct esoteric investments may look like a very big task to begin with, by working through the right channels it can be very easy to find good products that are suitable.
The wheat
There is a strong appeal for directly held esoteric investments – uncorrelated, diversified returns are tempting and ownership of something tangible feels very secure – this kind of investing can really engage people.
Thorough, documented assessment of these opportunities means you can sort out the wheat from the chaff and have some strong alternative investment opportunities in your kitbag for certain interested clients.
Article Published IFA Online