Unregulated investments - worth the risk or a step too far? Laura Miller gauges opinion on the black sheep of the investment world.
Unregulated investments must have one of the worst reputations in financial services.
Examples that spring to mind certainly do not paint a very positive picture; Harlequin Property, Stirling Mortimer, Armadillo Energy, Arck – investors who put money into these off-piste schemes are all now struggling to get their cash back, and in many cases are chasing the advisers who recommended them.
The dangers associated with unregulated schemes are the reason the then-regulator, the Financial Services Authority, banned their promotion and marketing to retail investors earlier this year.
What should advisers make of the black sheep of investment?
Now they are only available to high net worth and 'sophisticated' investors. But is that enough?
Paraplanning service The Timebank director Damian Davies, who carries out research into all types of products, believes there is a place for unregulated investments in financial services, just not in the mainstream.
"There are different needs around. If you have a portfolio and know the risks and implications, you shouldn't rule unregulated investments out. Some advisers won't advise on unregulated schemes, but maybe they haven't met the right client."
He recommends clients segregate their portfolios where possible into a "core" part that can't be risked, and a "satellite" part that can.
"My frustration is when you hear advisers talk about unregulated schemes in a unilateral way, either they would never invest their clients in them or they always would – both are wrong," said Davies.
Anthony Catt compliance officer Tony Catt agrees.
"Unregulated investments often offer the opportunity of asset classes that are not available in regulated investments, he said.
Diversification is a key issue. Some of the investors who are now chasing their advisers for recommending unregulated schemes argue that, far from using them to diversify their portfolios, their advisers concentrated large chunks of cash, often from pensions, into these investments.
Conversations about the potential for losing money must be an integral part of clients' education about unregulated schemes, an area that needs more work, according to Davies.
"People are looking to make more than cash and the danger is some schemes sound so sexy, investors are blinded about the risk. It's far too easy for people not to appreciate that balance. That's why they need advisers."
Astute Wealth Management Chartered financial planner Andy McLaughlin believes more needs to be done to inform not just consumers but the adviser community as well.
He has come across clients with unregulated investments who didn't even know that they were unregulated, as well as an adviser who recommended the product arguing it was suitable simply because the client had assets of £5m.
"While they considered him to be suitable by virtue of his wealth, I would argue he wasn't sophisticated enough," said McLaughlin.
But is more information the answer at all? Should regulated advisers simply leave unregulated investment to other parts of the industry?
Opinion is split on this. Beaufort Planning partner Andrew Elson believes regulated advisers should only be able to advise on regulated products.
"Specialist qualifications should be needed to sell unregulated products, and regulated advisers may be best suited to refer to an expert in these areas," he said.
However, there is a flipside, which McLaughlin points out. "It is better we are in a position to educate clients about these investments rather than them going ‘underground'," he said.
Part of the problem with unregulated investments is that, if something goes wrong, investors are not covered by the Financial Services Compensation Scheme (FSCS) or Financial Ombudsman Service (FOS), unless – where the investment was advised upon – a failure in the advice process is detected. Should this change?
Perhaps unsurprisingly, given the FSCS and FOS are largely industry funded, most think not.
"Unregulated investments probably don't need to be included because they don't need the same level of protection – to invest in them clients must be prepared to lose that money," said Davies.
Catt, like many others, thinks there must be a boundary for what can be covered by the FSCS.
"I believe this should only include regulated products in the interests of treating those clients within the regulated environment fairly."
So investors aren't protected if they invest directly in unregulated products but what about advisers who recommend them? They can still be subject to claims if they don't dig deep into the investment beforehand.
"Due diligence should check as far along the chain of investment as possible," said Catt.
"Many funds provide details of custodians, market-makers, professionals such as accountants, solicitors, actuaries, counterparties etc. Checking the bona fides of all of these can be quite time consuming and sometimes difficult to truly verify [but are essential]."
What part in due diligence should the product literature play? "Take it with a pinch of salt," is Elson's advice.
"The dodgiest funds often have the glossiest literature and wonderful websites, " according to Catt. "The only thing advisers can do is to question the claims that are made with the fund managers and any other professionals mentioned in the literature."
All in all, unregulated products done right are a lot of work for an adviser who doesn't want a raft of costly complaints. Little wonder then that many choose to steer clear.
But for the right client, at the right time, and after extensive due diligence, a small speculative investment could be appropriate.
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