Danger, risk

SEC Issues Risk Alert on Alternative Investments

Danger, risk

At Index Fund Advisors, we have never advised our clients to engage with alternative investments such as hedge funds, private equity funds, or funds of private funds. A recent alert from the Securities and Exchange Commission (SEC) reinforces our stance. The alert addresses the due diligence processes among advisors who do advocate alternative investments.  One problem with the whole due diligence process is that there is no central clearinghouse of information such as Morningstar that would readily allow comparisons among alternative investments. For example, while an investor can easily learn how much cash drag his equity fund currently has, there is no reliable way to do that for a hedge fund. Even more importantly, there is no way to see how much leverage is currently employed. Advisors who use alternative investments are completely at the mercy of the investment providers.

The SEC alert noted certain deficiencies that were found in audited investment advisory firms that use alternative investments such as:

  • Omitting alternative investment due diligence policies and procedures from their annual reviews
  • Providing potentially misleading information in marketing materials about the scope and depth of due diligence conducted
  • Having due diligence practices that differed from those described in the advisers’ disclosures to clients.

All of this is highly reminiscent of the Fairfield Greenwich Group, which was implicated in Bernie Madoff’s Ponzi scheme. Their Website was filled with all kinds of flowery language about how they “employ a significantly higher level of due diligence work than typically performed by most fund of funds and consulting firms.” As it turns out, they were nothing more than a feeder fund to Madoff. Their claims of due diligence were utterly meaningless.

Anyone who has spent some time on our Website knows that we believe that virtually any investor can be matched with a risk-appropriate portfolio using only index funds of global equities and fixed income. It is our opinion that alternative investments are simply not needed. As far as how investors in alternatives have performed, we know from Simon Lack that hedge fund investors as a group have gotten the same return as they would have had from Treasury Bills. An investment advisor who claims to have expertise in alternative investments should be given an extra degree of scrutiny. One basic problem is that there are so many different kinds of hedge funds that it would stretch credulity for someone to be an expert in all of them, and hedge funds are just one category of alternative investments.

If you need assistance in finding a portfolio of index funds that is right for you, please give us a call at 888-643-3133.