Alternative Investments: A Custodian Speaks

By Amy McIIwain, President, Financial Social Media on Monday, November 26th, 2012

Alternative investments are hot enough that RIAs, broker dealers, family offices and others are feeling the pressure when it comes to picking the right vehicle and incorporating it into their reporting systems.

Since the custodian is at the center of so many of the accounting issues that alternatives present, I reached out to PENSCO Trust Company CEO Kelly Rodriques to get his advice for those looking to add these assets to their platforms.

Naturally, any expansion of your investment universe will require formal due diligence.

Kelly notes that where these relatively exotic vehicles are concerned, it is even more crucial than ever that an advisor ensures that they ultimately complement the investor’s investment plan, including time horizon and risk tolerance.

Separation of due diligence from the ongoing task of managing the portfolio helps a lot here, he says.

“More and more we see a division of responsibilities for the various aspects of nontraditional investing, including asset custody and administrative duties.”

And that’s what regulators want to see where anything from private REITs to direct holdings of non-traded equity is on the table.

“This separation of duties safeguards against fraudulent practices and provides appropriate controls,” he explains. “SEC input and guidelines are enabling investors to better understand the details of alternative investments and how and why they are performing.”

From due diligence to reporting


Once an alternative investment vehicle has been selected, the challenge shifts to keeping current on how much it is worth on the open market at any given time. Needless to say, lack of transparency is often cited as a reason for not investing in alternative investments.

“Asking up front about external audits, valuation frequencies and how they are done is very important in setting expectations and learning about the controls in place,” Kelly tells me.

“Failure to understand these details is a leading indicator of potential problems later.  And in the case of qualified investments, such as IRAs that fall under IRS regulations, it’s even more important.”

Some large financial service firms that do not focus on these critical facets of compliance have been forced to resign from client accounts.

This has had spillover effects on the investors themselves, forcing them to find another custodian or realize a taxable distribution of a qualified investment — which can lead to a larger tax liability and an early withdrawal penalty tax.

Where we go from here

Looking ahead to trends in reporting on alternative investments in 2013, custody of alternative asset funds is of increasing concern to sponsors and their clients. 

Kelly says that “some of the unfortunate problems of the past were a result of a sponsor trying to do everything, maintaining control of the asset and reporting on all facets of it.”

This lack of specialization in the custody of alternative assets created an opening for fraud or error, he says.

Especially in the wake of Bernard Madoff’s fraud and the subsequent collapse of several exotic securities — not to mention the brokerage firms that sold them — regulators and investors alike now demand to see evidence of an independent custodian.

Successful custodians are opening up their books in far greater detail than ever before.

“Custodians are providing more transparency into fund activities and more timely information to clients,” Kelly says.

“Greater visibility into alternative assets is happening routinely via online account access and as more information is incorporated into portfolio accounting systems.” 

Of course, transparency in itself is not the solution to anyone’s regulatory or fiduciary concerns where alternative assets are concerned.

At best, having more information from the custodian only generates more data for advisors to monitor, analyze and store. And the more alternative assets you work with, the more custodians you probably need to track.

Ultimately, consolidating all this key account data into a unified, expandable platform is the key to bringing these in-demand asset classes into your clients’ investment platform.

Automating the way custodians can feed you the data allows you to check transaction information and valuations on even the most exotic instruments on the market today, on demand and on the fly.

Passing that access on to your clients makes them feel safer about alternative and conventional investments alike.

When your alternatives are beating the mainstream asset classes, they probably won’t complain unless the results truly look too good to be true. But should one falter, absolute transparency can help keep fleeting disappointment from turning into a post-Madoff panic.

Kelly Rodrigues is CEO of PENSCO Trust Company, the nation’s most sophisticated alternative asset custodian, providing financial institutions, individual investors and financial advisors with comprehensive solutions delivered with outstanding service.

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