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A Fiduciary Approach to Alternative Investments: Friend or Fad?

A Fiduciary Approach to Alternative Investments: Friend or Fad?
June 18
00:03 2019

History is replete with the carcasses of investment fads. Each “sure thing” has lured hapless investors onto the rocky shoals of financial ruin. Why have fads so easily tricked these poor souls? Because, at their respective initial stages, there’s not much difference between a terrific trend and a false fad. For someone tasked with protecting the best interest of investor, it’s critical to distinguish between a long-term investment trend and a short-term fad. How does a fiduciary do it?

The problem with separating fads from trends is that you usually don’t know for sure until it’s too late. The motive, however, is fairly easy to identify. “Chasing the highest returns,” says Len Hayduchok, CEO of Dedicated Financial Services in Hamilton, New Jersey. “You get into investments after they have taken a big run (Bitcoin and marijuana stocks are recent examples).”

The phenomenon of chasing fads is not new and dates back centuries. “Technology, oil MLPs, Bitcoin, every fad has its roots in economic reality,” says Holmes Osborne of Osborne Global Investors, Santa Monica, California. “Whether it be Dutch tulips or tech stocks in the 1990s, these investments made high profits and attracted many investors, only to create bubbles.”

For most, the combined “trend” of the internet and Y2K lead to the infamous tech bubble of the late 1990s. It turned out to be the fad of all fads and provides clues on how to identify fads. “The dot.com era was the most dramatic,” says Jeffrey A. Miller, President and Portfolio Manager of NewArc Investments, Inc.in Naperville, Illinois. “Companies changed business models to include the Internet. Others changed their name to include ‘.com’ and saw an immediate stock price spike. IPO’s exploded even when the companies had absolutely no record of earnings. Even price-to-sales ratios were astronomical, often exceeding 100.”

Beyond cryptocurrencies, ESG, and pot, there is one specific headline-grabbing investment that can help fiduciaries begin to determine how to tell the difference between a trend and a fad: alternative investments.

One can proactively define an alternative investment in general terms that most can agree on. “A good alternative is a sound investment that is uncorrelated to the overall market,” says Miller. “This can be a long/short approach, pairs trading, or shifting to the best factors or sectors.”

A fad, on the other hand, as mentioned, is easier to define in hindsight. William M. Francavilla of Barhamsville, Virginia, is a former director of wealth management at Legg Mason and author of The Madoffs Among Us, Combat the Scammers, Con Artists and Thieves Who Are Plotting to Steal Your Money. He says, “Whereas an alternative investment represents an element of convention such as real estate, venture capital, art and commodities, a fad is predicated on unproven speculation. Witness Bitcoin and Blockchain investments that offer spectacular short-term gain but may sell off just as rapidly.”

Unfortunately, a definition based solely on price action may not be practical, as it may apply to many different asset classes. “If an alternative investment is hot,” says Hayduchok, then it would be a fad—such as crypto currency like bitcoin. Tech stocks were a fad in the late 1990s but the chief investment vehicle was a stock, which is not an alternative investment.”

Perhaps, therefore, it may not make sense to attempt to distinguish between them. “They may be the same thing,” says Osborne. “They may make money for a while and then the cycle turns.”

Indeed, looking at price movements alone, it may be hard to tell the difference. You need to look beyond that. “Investment fads tend to follow a similar pattern, says Jonathan Seif, Founder of The ProFolio Group, LLC in New York City. “There’s a slow start of early adopters, followed by a quick acceleration once the public becomes aware, and an unjustified price increase, ultimately followed by a rapid sell-off once the first domino falls. Alternative investments tend to be far more cyclical and though they may have shifts in either direction, the merit of the investment generally does not change as rapidly as an investment fad.”

Perhaps, then, for all the warnings about past performance, it is the history that distinguishes the fad from a trend. In the best case, a trend is an example of “slow and steady wins the race.” In the worst case, a trend is simply a fad that keeps coming back.

It doesn’t mean you can’t score high rates of return investing in a fad. “With some luck you may make money,” says Osborne. “Some people get in and out at the right times.”

But is that a chance a fiduciary should take with someone else’s money? The answer is so obvious the question should not have to be asked.

“In general,” says Miller says, “the fads are inconsistent with sound retirement planning. If pursued at all, they should be in a side ‘fun account.’ The point is to meet your goals, not just having something to brag about at a cocktail party.”

A fiduciary knows this.

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary Solutions,  Hey! What’s My Number? How to Improve the Odds You Will Retire in ComfortFrom Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on TwitterFacebook, and LinkedIn.

 Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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