Calls for 'average' IFAs to avoid complex funds of hedge funds

Advisers lacking specialist investment expertise should be “discouraged” from recommending funds of hedge funds and other alternative investments, despite the FSA unblocking access for retail clients.

Investment experts argue the regulator should enforce additional levels of qualifications on advisers seeking to recommend the products.

They welcome widening the scope of investments products available, but argue most consumers lack both the "experience and risk tolerance" to invest in them.

The FSA last week unveiled a new regime allowing retail consumers to invest in Funds of Alternative Investment Funds (FAIFs), but warned advisers they must understand the products before making a recommendation.

Under the new regime, FAIF managers can wait 185 days before paying redemptions, but they must explain redemption procedures clearly to investors.

Although it says due diligence on both the funds and their underlying investments must be carried out by the FAIF manager, the FSA minds advisers to be aware of the vetting process and consider whether it was adequate.

It adds advisers should think about how the FAIF is likely to perform in different market conditions, how diversified the portfolio is, its tax treatment, as well as any constraints in the manager's choice of underlying investments.

However, investment experts say generalist IFAs should boast additional levels of qualification before being allowed to offer them to clients.

Frank Dolan, investment director at Novatis Asset Management, says he is unsure whether the "average" IFA can cope with the additional complexities and the implied need to undertake extra due diligence.

"There will obviously be some, perhaps specialist, IFAs who can recommend the funds but I would hope the FSA discourages the average adviser, whether independent or restricted, by insisting they have an additional level of 'qualification' - and perhaps even experience - before being allowed to offer them to clients."

Nicholas Manterfield, an investment adviser at Manchester-based Brookfield Financial Planning, adds: "I would be very careful as to the type of adviser who can sell these products and the type of client they are recommended to. They do have a place as a diversifier but they can be extremely volatile."

In its consultation paper on retail access to FAIFs, the FSA says the fact some vehicles can rise in falling markets and vice versa could prove "counterintuitive" to consumers. Dolan says this should act as warning enough for most advisers to steer clear.

Martin Bamford, managing director at Informed Choice, anticipates a trickle of client interest in FAIFs as a result of the FSA's regime, but says there will be little need to recommend them simply for diversification purposes.

"There will be some interest - there always is when something previously exclusive comes to the market - but that is not a reason to automatically invest in them," he says.

"I am not sure we will see a need for them from a risk versus reward perspective. I am not sure clients will need to invest in expensive and opaque hedge fund management in order to get the results they are looking for."

Andrew Merricks, head of investments at Skerritt Consultants, adds: "FAIFs have this aura about being quite exotic and exciting but they employ so many different strategies and, in my experience, the returns are no greater than cash."