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ADISA Video: Compliant Use of Alternative Investments

The DI Wire’s publisher, Damon Elder, interviewed Mike Kell, senior vice president at iCapital, to discuss the compliant use of alternative investments. Kell begins with an emphasis on the importance of having a foundational understanding of alternative investments and recommends that financial advisors understand what alternative investments are, why they should consider them, what the different structures and strategies are and how they fit into a portfolio before considering them.

Video Transcript

Damon Elder   00:10

Welcome to another edition of Focus on Alternatives hosted by ADISA, the Alternative and Direct Investment Securities Association. I’m Damon Elder, publisher of The DI Wire.com and I’m joined today by Mike Kell, senior vice president with iCapital. So, Mike thanks for joining us today and we’re going to discuss something that’s right in your wheelhouse. Which is kind of the complex nature of alternatives and the compliance considerations the financial professionals really have to take into consideration when they’re going to advise their clients in regard to investment in alternatives.

So, alternatives are considered complex investment products. So, what are and there are just a host of different compliance regulations and considerations that financial professionals really need to take into account. From your perspective what’s really the most significant one or the one they really need to pay the most attention to?

Mike Kell   00:58

Well, there’s certainly a number of them we’ll we’ll touch on a few of them here today. But I would say one of them is probably the most simplistic but often overlooked and that’s the concept of of truly understanding having a foundational understanding of alternative investments. And ultimately what that starts with is really understanding what alternative investments are, why you might consider them for your clients what the different structures and strategies are and then ultimately understanding how they fit a portfolio from an asset allocation perspective. Once you have a foundational understanding of alternative investments then it’s very important to understand the fund or funds that you’re considering for investing on behalf of your clients. No two funds are identical even those with the same structure strategy or asset class so it’s very important to understand the nuances of each individual fund that you’re considering for investing on behalf of your clients.

Damon Elder   01:45

Mike, so once the financial professional really has that keen understanding of an alternative investment or multiple alternative investments, and you know how they are kind of kind of fit into an investor’s portfolio. You know what are some of the obligations that they maintain before actually allocating to one of those investments?

Mike Kell   02:01

I think there’s really two more that come to mind. Once they have that foundational understanding of alternative investments and they understand that the products themselves, it really comes to to to two things one is the considering reasonable alternatives for each of the funds. Now specific to reasonable alternatives whether you are an advisor under the fiduciary rule, or whether you’re registered representative under regulation best interest. That the obligations are similar, and that being it and it makes sense that before you invest in a particular fund on behalf of your client it’s prudent to make sure that you consider reasonable alternatives to ensure that that particular fund that you do choose is in the best interest of your client. Now as we think about initial due diligence obligations it’s very important to verify the details of a fund as well as a history of that manager before you actually invest in that fund, so that you can have the best chance of positive outcomes.

Damon Elder   02:57

Great Mike, so you know once the financial professional understands the product the complexity of it, they’ve done they’ve reviewed reasonable alternatives for their client, and they’ve done their initial due diligence. You know what are some of the other obligations that they still entail to and and have to consider from an ongoing perspective through the their ongoing consultation of their clients?

Mike Kell   03:20

I think that that’s exactly the point, that the fact that these are truly illiquid investments they go for a long time. And just because you make the sell on day one or the recommendation on day one your obligation doesn’t stop. You have an obligation to continue monitoring that from an ongoing perspective and that’s the likes of whether it’s monthly performance reports, whether it’s updates to the offering documents, understanding the underlying investments that are being purchased, looking at things like style drift et cetera. And ultimately what you have to do is you have to justify the whole recommendation, so it is a liquid you might not be able to to get out of the investment even if you if you don’t think that it’s still favorable, but you still are justifying the whole recommendation. So, remember if you’re a registered Rep that received upfront compensation or even maybe a trail commission going forward or you’re an investment advisor continually charge a fee for service, you have to prove the fact that you’re earning that fee. And part of earning that fee is conducting that ongoing diligence throughout the life of the fund even if you cannot redeem it because it is a liquid in nature.

Damon Elder   04:26

Well that that brings up a good point Mike, because you know keep seeing these reports in these studies and these surveys that are constantly saying that RIA’s and other investment advisors are looking to allocate more to alts. And yet I don’t think we’ve the industry has really been seeing a huge uptick in RIA’s bringing their clients into also you know why is that or am I wrong?

Mike Kell   04:48

Well, I think historically that might have been more accurate. I do think recently you have seen a shift over the past handful of years that more of the allocation to alternative investments are actually shifting from the predominant registered representative at IBD’s going to the RIA’s and the wires and large banks etcetera.

Damon Elder   05:07

So, Mike we’ve talked a bit about you know the complex nature of this whole alternative investment space you know, and we could spend hours talking about it but, is there any one final topic you want to touch on before we wrap up?

Mike Kell   05:18

I would just say really two things, number one is documentation. We we say it all the time it it seems like a a small hurdle, but it is something that that goes by the wayside all too often. All of these obligations that we discussed it all has to be documented, why… because typically even during a routine regulatory exam this is something that’s going to come up years down the road. You’re not going to remember all of this wonderful thing that you did to support their recommendation. So, document everything that you do so that during a routine regulatory exam you have the information at your fingertips.

Secondly it is this is a very laborious process, there are ample service providers that are happy and help every step of the way. One key point is that the obligation falls on you as the financial professional so you cannot shift that obligation completely you can use service providers to help you fulfill those obligations but remember the key point there is you cannot shift that obligation in its entirety.

Damon Elder   06:15

Well, I mean I think many people understand that the financial services industry is probably the most heavily regulated one in the country and certainly you got to dot your i’s and cross your t’s to keep yourself out of trouble make sure you do your job properly.

So, Mike thanks so much for joining us today. and thank you for joining us for another episode of focus on alternatives hosted by ADISA.

For more information on alternative investments please visit adisa.org and of course feel free to visit The DI Wire.com for your Daily News thanks so much

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