Alternative investment products require more education and transparency rather than a regulatory crackdown, as investors turn to them to boost portfolio returns, proponents say.
Last week, SEC Commissioner Luis Aguilar
called for a stronger agency focus on complex products, which often embed derivatives and use leverage, because they are increasingly being sold to retail investors.
But alternatives provide crucial diversity to portfolios, especially on days such as April 17, when the stock market plummeted, said William Kelly, chief executive of the Chartered Alternative Investment Analyst Association.
“The emphasis seems to be too much on the risk side,” Mr. Kelly said. “It can't be all about rinsing out the bad actors.”
Instead, he'd like to see a greater industry effort to inform investors about the risks they're taking with alternatives, such as equity-indexed annuities, leveraged and inverse exchange-traded funds, principal protected notes and alternative funds.
“Education has to be moving at a faster pace,” Mr. Kelly said. “It's all about education and making sure the end consumer understands what they're buying and how it fits into their portfolio.”
Alternatives generally have high fees and low liquidity. Mr. Aguilar said investor advocates have questioned whether there's enough disclosure about risks associated with alts.
“These concerns are valid and deeply troubling,” Mr. Aguilar said. He called for the SEC to extend to all complex securities the agency's initiative to strengthen disclosures about structured notes. He also said the SEC should partner with state regulators and the Financial Industry Regulatory Authority Inc. in a crackdown.
But regulators tend to focus on the negative, whereas investors can benefit from the diversity alternatives add to portfolios, according to Joe Halpern, chief executive of Exceed Investments.
“They're not all bad,” he said. “There are a lot of positive characteristics to a lot of alternative investments. But everyone needs to be thoughtful about the process of making them available to the masses.”
Using listed and cleared products “will add a level of transparency and competition to any vehicle out there,” Mr. Halpern said. His firm is working with NASDAQ on offerings based on that index.
Investors are enticed by complex products because they're trying to find higher returns in a low-interest-rate environment — and that's where danger lurks, Mr. Aguilar said.
“These investments can be very opaque and complex for retail investors,” Mr. Aguilar said in prepared remarks last week to the North American Securities Administrators Association. “Yield-starved investors become easy prey for fraudulent schemes that are cloaked as investments in complex securities.”
But the market is booming. The amount of assets in alternative mutual funds grew from $76 billion at the end of 2009 to more than $311 billion at the end of 2014.
“A lot of investors are speaking with their wallets,” Mr. Halpern said.
The key to making sure they're protected as demand grows is for investment advisers and brokers to explain the “value proposition” of the beta that alternatives can bring to an asset allocation, Mr. Kelly said.
“That helps sell an end solution as opposed to just pushing another product into the portfolio,” he said.
