1st August 2014

Unregulated investments: risk versus reward

Unregulated Collective Investment Schemes (“UCIS”) have been dominating the financial headlines over the past two years whilst the Financial Conduct Authority (FCA) has grappled with the lengthy process of ensuring that retail investors do not fall foul of inappropriate advice regarding such schemes.

The result of the FCA’s review is a complete ban on the promotion of UCIS and “close substitute pooled schemes” to the vast majority of retail investors in the U.K. and the introduction of a new regulatory framework governing the operation and promotion of such products.

Under the new regulatory framework, investments such as these can only be promoted to sophisticated or high-net worth investors, or to authorised professional advisers..

Non-Mainstream Pooled Investments

UCIS and close substitute pooled schemes – which are collectively known as Non-Mainstream Pooled Investments (“NMPI’s”) – cover everything from syndicated commercial property and unit trusts set up for tax-exempt investors, to investments in fine wine and forestry / timber; all which are viewed as alternative investments. These types of investment have traditionally been perceived as riskier due to the complex nature of some of their fund structures and the fact that many of the schemes have been highly geared and illiquid in nature; however, that is not the case for every type of UCIS.

The FCA’s review of these types of product has been brought about by a large number of retail investors having lost significant sums of money because they did not fully understand the nature and operation of the schemes in which they were encouraged to invest. In many cases investors had not benefitted from appropriate advice on the suitability of such investments, particularly having regard to their personal circumstances and investment expertise.

However, the FCA has also recognised that some of these schemes do have significant benefits for certain investors, hence the arrangement whereby investors can declare themselves sophisticated investors or high-net worth individuals, thereby enabling them to continue taking advantage of alternative investments.

Alternative Investments

When it launched 5 years ago, Rougemont Estates recognised the importance of being an FCA regulated company and it dedicated significant time and resource to becoming appropriately regulated.
Whilst the new statutory regulations may seem like a major headache to many, they are welcomed by Rougemont as they deliver a long awaited legal obligation on all promoters of such products to provide a uniform high level of transparency in their dealings with investors.

Therefore, there is now a regulatory as well as moral obligation on business operating in this sector to ensure that investors know just exactly what it is they are investing in, what the benefits and risks are of the investment, what return they will receive and when, and what fees the promoter of the product is making from the investment.

Despite these new changes syndicated commercial property investments are still viewed as a riskier alternative asset investment and whilst Rougemont is regulated by the FCA, their actual investment promotions are not; this means that investors may not be protected by either the Financial Ombudsman Service (FOS) or the Financial Services Compensation Scheme (FSCS).

However, with an investment in tenanted commercial property investors always retain the value of the land and buildings. Clearly, the main risk is that the tenant becomes insolvent and defaults on its lease obligations; therefore, careful assessment of the tenant’s covenant strength combined with detailed due diligence into the terms of the lease and a rigorous appraisal of the quality of the building itself, its geographical location and its potential for alternative uses are all considered prior to an opportunity being promoted.

Syndicated Commercial Property and liquidity

A major benefit of investing in syndicated commercial property is the freedom for investors to participate in a wide range of well researched, high quality, tenanted properties. Investors can choose to have their commercial property exposure in just one, or a range of diverse property classes and tenants, whilst at all times retaining ownership of their specific pro – rata share of the actual property itself. Syndicated commercial property provides an investor, wanting to invest in commercial property as part of a balanced investment portfolio, the opportunity to do so at levels of financial investment that would not normally deliver exposure to such high quality properties and tenants.

One clear downside with such investments is liquidity and in the case of Rougemont, other than within its client base, there is no established secondary market for the investment. Accordingly, investors have to be prepared to consider such investments as illiquid and be held as a medium to long term investment. However, it is worth noting that when clients have sought to liquidate their investment Rougemont has, to date, never failed to secure a sale of the holding on a client’s behalf. The process is benchmarked against an annual independent valuation and the transaction typically takes two/three weeks.

An alternative to syndicated commercial property is an investment in an established regulated real estate fund, where there is no direct ownership of the asset and all investment and management decisions are made by the fund managers. These investments are viewed as having a much higher degree of liquidity, with investors normally being able to disinvest at will; however, this is not always proven to be the case. In the early stages of the recession, Aviva prohibited investors from exiting their fund while they battled to meet the scale of investor redemptions and seeking to avoid being faced with having to sell off commercial property below their market value to repay investors.

Co-investors

A further benefit of the UCIS promotion rules is the knowledge that your fellow investors will be like-minded individuals. By only promoting to sophisticated or high-net worth investors, you can be reasonably confident that your co-investors will have the necessary experience to participate in making informed commercial decisions regarding the future management of the asset.

Syndicated commercial property investments, promoted and operated by FCA regulated companies, allow investors the freedom to invest in and own their dedicated percentage of a well tenanted quality commercial property, delivering regular quarterly returns with the potential for capital growth.

The FCA recognises this and by now formally establishing a new regulatory framework, advisors and investors can take comfort in the knowledge that every aspect of the business and its promotions are both transparent and ethical.

Unregulated investments are riskier but the rewards can be greater and, most importantly, investors retain control.