Chasing the Yield in Alternative Investments Can Prove Risky

In recent years, retail investors have been pouring money into alternative investments by the droves. From 2008 to 2009, that money more than doubled to $712 billion from $312 billion, according to McKinsey & Company. For many investors, the allure of these alternative products – which include non-traded real estate investment trusts (REITs) and private placements – is often the promise of higher returns and supposed immunity to the volatility of stock markets.

As reported Feb. 10 by the New York Times, the phenomenon of investors’ actively moving their money in pursuit of higher interest rates – also known as chasing yield – is being felt throughout the economy. Jeremy C. Stein, a Federal Reserve governor, expressed concern in a recent speech that investors desperate for yield could be creating a bubble in widely available investments like junk bonds.

Take the case of Mary Beck, a furniture business consultant in Pasadena, Calif. In 2008, when stock investments in her husband’s IRA began to decline rapidly, the couple moved $470,000 of their money into a new product recommended by their broker.

The offering – part ownership in a fleet of luxury cars – was unfamiliar to the Becks. But because the broker making the pitch had been around for years, they ultimately decided it was a solid investment.

“We knew that 12% wasn’t realistic, but 7% seemed realistic,” Mrs. Beck said in the New York Times article. “To us, it was a very conservative way to ensure that we’d increase our savings.”

That was until they stopped receiving interest payments. The Becks later lost their money when the venture went bankrupt in 2012. Now the couple is rethinking their retirement and planning to work longer.

Gary Spiegel, 54, also was featured in the New York Times story. A woodworker by trade in upstate New York, Spiegel was persuaded to buy into three private placements after he grew tired of the volatile stock market and withdrew all of his money in March 2010. Much of that money, $100,000, went into a company that was supposed to produce a bilingual television show, “Hacienda Heights,” while paying a 10% interest rate.

“The banks weren’t giving interest, and I was getting turned off by stocks,” Spiegel said in the NYT story.

Spiegel ended up losing $318,000. He settled a legal dispute with his broker this month, just before an arbitration hearing.

Like private placements, non-traded REITs also have become an increasingly popular alternative investment for retail investors like the Becks and Spiegel. These same REITs are what landed LPL Financial in trouble recently with Massachusetts regulators.

The outstanding amount of non-traded REITs reached $65 billion last year, up from $43 billion in 2009, according to Direct Investments Spectrum. In addition to the Massachusetts case against LPL Financial, the Financial Industry Regulatory Authority  (FINRA) fined David Lerner Associates $14 million over issues with non-traded REITs last October.

The bottom line: Investors who want to take speculative bets on complex investment products that, until a few years ago were pitched only to the most sophisticated investors, may be wise to think long and hard before doing so.