FYI: Cope & Paste 7/11/14: Kristian Grind: WSJ:
Choices Including Nontraded Real-Estate Investment Trusts and 'Liquid Alternative' Funds Have Numerous Risks
Regards,
Ted
Mutual funds that try to emulate hedge funds. Exchange-traded funds that use borrowed money to jack up their bets. Real-estate investment trusts that are hard to unload. Structured notes that look like conventional debt but can be far more risky, and "go anywhere" bond funds that are prone to trade safety for yield.
All these investments have at least one thing in common: They have seen their popularity soar recently as investors seek protection from perceived market dangers—or as fund companies market them heavily. They also are hard to understand, lack transparency, are expensive and don't have proven performance records.
In interviews, financial advisers, analysts and industry experts frequently said these investment types should be treated with extra caution by investors.
"Anything that is complicated is not something that the typical investor should buy," says Samuel Lee, an analyst at Chicago-based investment-research firm Morningstar MORN +0.44% who specializes in ETFs. "There are more opportunities for sophisticated players to take advantage of you."
To be sure, these investments can perform well and could have a place in a portfolio—albeit a small one—as long as they are used correctly. There are plenty of other risky investments marketed to individuals that aren't named here—foreign-exchange trading or options trading, for example.
Investors should ask several questions before they plunk down their money, says Robert Hockett, president and wealth manager at Atlanta-based Cambridge Wealth Counsel, which oversees $260 million in assets: Is it clear what the investment does? Does it come with high fees? Can you sell it easily? And does it have a proven record?
Here is what you need to know about the five investments—and some safer alternatives.
Liquid-Alternative Funds
"Liquid alternative" mutual funds typically employ hedge-fund-like strategies but don't come with the same restrictions. There isn't a high investment minimum, for example, and the funds aren't as difficult to exit as traditional hedge funds.
The category encompasses several different subsets, including so-called long-short funds—equity funds that hold long positions in some stocks while betting against others, and managed-futures funds, which bet on futures contracts. Other funds use leverage, or borrowed money, to ramp up their bets.
Liquid-alternative funds have skyrocketed in popularity, with investors pouring $40 billion into them in 2013, up from $14 billion the previous year, according to Morningstar. This year through June, they have taken in $14.6 billion.
Fund companies say they offer investors a chance to diversify their portfolio and capture at least some of the upside of stock returns in good markets while offering protection in down markets.
But skeptics say the strategies often are too complicated for the average investor to understand, and many are too new to have a proven track record. They also come with high fees: an average of 1.9% of total assets, or $190 per a $10,000 investment, compared with 1.2% for a typical actively managed stock mutual fund and 0.6% for a stock index fund, according to Morningstar.
"They have some ugly baggage and warts they carry," says Mark Balasa of Balasa Dinverno Foltz in Itasca, Ill., a wealth-management firm with $2.8 billion in assets under management. "Advisers are challenged to understand what they do, let alone investors."
Christopher Van Slyke, founder of WorthPointe, a wealth adviser in Austin, Texas, with $32
5 million of assets under management, says most of the funds he has seen pitched by investment firms don't have more than a six-month track record. He likens them to a "black box" because of their complex investment strategies.
Try instead: If you want some shelter from the risk of a bad decline in stocks, you could always keep more of your money in cash instead. It is safer and a lot cheaper.
Nontraded Real-Estate Investment Trusts
Nontraded real-estate investment trusts are similar to their public counterparts, which trade like stocks and allow investors to invest in an array of commercial properties.
Lately, nontraded REITs have been going gangbusters: In 2013, they raised $19.6 billion, up from $10.3 billion in 2012, according to Robert A. Stanger & Co., a Shrewsbury, N.J.-based investment bank that tracks the industry. Through June of this year, nontraded REITs have raised $8.8 billion.
Investors are attracted to them because of their high dividends—generally as much as 7% on invested capital versus 3% to 4% for publicly traded REITs, according to Green Street Advisors, a research firm in Newport Beach, Calif.
But nontraded REITs can be hard for investors to unload during a real-estate downturn, advisers say. The investments have become a concern of the Financial Industry Regulatory Authority, the industry's self-regulator. Because they are generally illiquid, their performance and value are difficult to understand and the cost is high, the agency has warned.
Disclosure is murkier than with publicly traded REITs. While nontraded REITs report their holdings quarterly, investors don't initially know more than the general asset class they are investing in when they buy in—what is known as a "blind pool."
What's more, say experts, because the REIT isn't trading publicly, it is hard to gauge its value until a liquidity event occurs, such as when the REIT is sold, merged or publicly listed, although the REITs typically use appraisals to report the share value after the offering closes.
Fees also are high, as much as 11% in initial sales charges to pay the retail broker, the dealer and the back-end costs of putting the REIT together, according to Stanger.
Nontraded REITs have a mixed track record. Of seven deals that were merged or sold in 2013, four are worth more now than the initial issuing price of the shares, according to Stanger. A $10 share in the Chambers Street REIT, for example, would now be worth $8.04, while a $10 investment in the Cole REIT would be worth $13.
56.
Try instead: Publicly traded REITs aren't nearly as risky and are far more transparent, and they can be a good diversifier in a portfolio, experts say. A mutual fund that holds a basket of commercial real-estate companies also can provide exposure to the market and is liquid, says Dave Homan of Willow Creek Wealth Management in Sebastopol, Calif.
The $24 billion Vanguard REIT ETF, VNQ +0.01% for example, whose holdings include property developers and REITs, has returned an average of 10.
5% over the past three years as of July 10, according to Morningstar. The ETF has an annual expense ratio of 0.1%, or $10 per $10,000 invested.
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http://online.wsj.com/news/interactive/INVESTOR0711?ref=SB10001424052702304642804580015090303169012
