The latest Wall Street invention is selling funds that lock up investor's funds with high expense ratios. It is being framed as "the democratization of access to alternative strategies".
I have to laugh at Wall Street's constant creative ability to BS investors into crazy products that put investors at significant risk and make Wall Street lots of money.
While the idea has merit in some respects, it just depends on how much you trust the investment company and the portfolio manager. Warren Buffett had lockups in his early partnership and was very successful, but there are numerous examples of other lockups that investors lost huge amounts. It is sort like of being drugged where you can't move. You can see and hear someone fleecing you of all your possessions, but all you can do is watch.
As with all investments, there are positives and negatives to this product. Each investor must weight them out and make their own call as to which side outweighs the other.
Pluses
- Allowing fund investors to sell only a percentage of their holdings in a fund in a certain time period gives the portfolio manager flexibility in selecting investments. People switch funds like underwear now. This means the fund always has to have enough liquid assets (cash) and assets with high liquidity to meet mercurial investor redemptions.
- The fund manager can invest with a longer term focus in mind without having to have the "rug pulled out from him" with redemptions at the wrong time. Herd behavior is so pervasive in many aspects of our lives. A single small event can and does result in 180 degree turn of the crowd’s direction.
- Portfolio managers can invest in more risky assets which CAN have better returns. But, like the small print always says, there is no guarantee. The only thing that is guaranteed is the high fees the management company will be earning!
Minuses
- Expense ratios of 3% of assets per year. With the movement to index funds, many investors are paying expense ratios of less than 1/2 percent. The extra 2.5% will likely decimate returns over long periods. Ouch!
- If the fund fails to get the high returns they are seeking and actually gets very negative returns, the investor is stuck watching their investments go down, down, down....... as they wait and watch without being able to withdraw.
- The fund is investing in illiquid investments and by their very nature are hard to price since the market for the security isn't active. You are relying on the fund to price the asset each day. Do you think there will be a bias? LOL
- Many investments are illiquid. Why? Often because they are very risky. Lots of investments are becoming covenant light or covenant none. Covenants are great when you are in a bad situation. Without covenants, you just lose your money.
The salesman always paints a bright picture when selling risky stuff at high prices. They use your own behavioral biases to get you to jump. "It will only be available today!" "Everyone is getting in!" "It will be the opportunity of a lifetime!" "This is an opportunity for the small guy to participate in what the high net worth people are investing in!"
Often those salespeople are long gone when the Sh_t hits the fan. They have made their big bucks and have moved on. You are left watching your funds drop in front of your eyes and there is nothing you can do about it.
You make the call, but be sure you are well informed.
