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Let Your Clients Buy the Farm and Manage the Risk

By Grace Williams

Financial Advisor IQ logo

The market’s euphoric run-up has investors jittery, but is it time for clients to take money out of the market and invest instead in some real estate or a friend’s bakery?

According to survey results released by PENSCO Trust Company, of 684 clients that custody their retirement assets in self-directed individual retirement accounts, 63% said they either had increased or planned to increase their allocation to alternatives due to market volatility, up from last year.

Because this class of investment allows clients to steer the ship, the ability to control the investment more and to choose what they invest in could prove fruitful or fatal. And PENSCO noted that investors want to diversify their portfolios and invest where they have personal expertise and knowledge.

“Folks are always looking for alternatives to help with diversification,” says Patrick Hughes, president of PENSCO, in an interview with FA-IQ. “Their reaction to market volatility is increasing their interest in, or allocation to, alternatives to deal with it.”

Avoiding the swampland swindle

The big question, then, is where can advisors direct their clients? The number one place survey respondents gave top bidding to was the real estate market, with 53% saying they were likely to shift their alternative investments there.

But while it’s desirable outside of an IRA, real estate in an IRA is a less-desirable strategy, according to Josh Jalinski, a financial advisor and president of Toms River, N.J.-based Jalinski Advisory Group, a firm with $300 million in assets under advisement. To Jalinski the problem, primarily, is that keeping real estate in an IRA strips the investment of its beneficial write-offs. Instead, “If [they’re] owning it in an IRA, own it with a publicly-traded REIT in different sectors, such as apartment complexes,” said Jalinski.

Similarly, Phil McDonald, director of fixed income and alternatives for Glastonbury, Conn.-based Symmetry Partners, which has $7 billion in assets under management and advisement, cautions investors and advisors alike to ponder a safety-first approach.

“We think there are pretty good solutions out there in the traded and mutual funds space,” he says. “With non-traded [alternatives], the primary concern is lack of liquidity for the average retail investor. That can be quite a concern.”

According to the survey, clients were interested in parking their finances in other alternative spaces as well. Private equity received high marks with 26% saying they would look to invest there. Notes and peer-to-peer lending rounded out the top spots.

Fidgety investors will always feel the urge to rebalance and shop around for alternatives. The good news is that 40% of survey respondents sought advice from their advisor about alternative opportunities. And many advisors think there’s a way to satisfy the client’s interest in alternatives.

McDonald recommends anywhere from 10%-25% of an overall portfolio parked in alternatives, while Jalinski advises a cap of 30% in this arena.

“If it’s too small, it’s not going to enable anything,” says McDonald. “But if it’s too large, it’s not wise [and] leaving opportunity on the table for most investors.”

Before turning your clients down flat, or putting their assets into alternatives that don’t pan out, Jalinski suggests considering safer, less-sexy routes to round out the client’s portfolio. For example, cash-value life insurance, which gained in down times and up.

“We’re seeing alternatives in life insurance as a comparative alternative to fixed income,” he says.

Hughes believes doing a little homework ahead of time can also help ease the pain when clients come calling with potentially obscure and hard-to-research alternative investments such as a friend’s small business.

“I can imagine advisors becoming more cautious about more unique investment opportunities they could present to the client,” says Hughes. “Advisors want to have the story primarily around diversification, unique stories of capital appreciation or income generation.”


To read this article on Financial Advisor IQ, click here.