The Enemy of Prudent

Tom Kostigen at Financial Advisor magazine is at it again.  His premise: clients want to invest in "private equity investments in the emerging markets that have potential to do good and provide good returns."  The problem is, "advisors don’t know how to sell these investments."  The author claims that the problem is that advisors don't know how to get paid.  I beg to differ.  Fee only and fee and commission advisors can easily get paid under a fee structure based on hourly or AUM structures.  The overwhelming majority of advisors to clients with an interest in this arena operate under one of these compensation structures.

No, the biggest obstacle to overcome is the risk and due diligence necessary to vet this (or any) investment.  The regulatory environment is such that disappointing performance is grounds for seeking legal recourse.  Recommending an investment with an objective expressed in terms other than risk and return is exposing one's self to unnecessary risk of litigation. And the illiquidity and lack of transparency that are characteristics of private equity and their funds exacerbates that risk.

Now the industry is moving toward a fiduciary standard for all advisors, raising the expectations of clients, and the risks to advisors.  How can an investment objective of "doing good" be measured, in the face of requiring that all actions be taken in the best interest of the client?  Isn't forgoing some portion of a market return in order to achieve some societal goal, a failure against such a fiduciary standard?

By and large, the impact investments I have reviewed do not qualify as prudent investments.  Either they rely on subsidized operations, or require a reduced cost of capital.  Usually, they are inefficient solutions to problems that are being resolved on a more rational basis, but at a slower pace that desired.  That is a recipe for disappointed capital.