What is a sophisticated investor?

“Sophisticated investor” is a legal term used to classify wealthy individual investors who do not require the protection of disclosure regimes. Investors must meet certain income and asset criteria to qualify for a Sophisticated Investor Certificate, which gives them access to exclusive rights in exchange for large capital investments.

Some investment promoters prefer to deal with fewer, larger clients; it means they are less tightly bound by regulations. For example, offers can be made to sophisticated investors without the need for a prospectus or product disclosure statement. This means they can invest in shares on general offer to the public, as well as exclusive “niche” assets that promise larger gains and smaller fees – although at a much higher risk.

Before making investments, a Sophisticated Investor Certificate must be produced, which has been issued within the past six months by a licensed accountant. The certificate shows that you fulfil at least one of the following:

• You have net assets of at least $2.5 million.
• Your gross annual income for each of the past two financial years was at least $250,000.
• You are investing at least $500,000 in the securities being offered.
• You have investments grossing at least $500,000 (not including property) in the same class of securities.

So why bother? A sophisticated investor can access exclusive offerings that are normally not available to individuals. “It enables individuals to access a whole range of alterative products,” says George Nikas, of Deutsche Bank Private Wealth Management.

Products in this category may include unlisted infrastructure funds and private equity funds, where offerings are made through private placements. These tend to be closed-end offerings (available only for a set time), such as some Macquarie infrastructure funds, and are normally aimed at wholesale investors because they set a high minimum threshold for investment.

A sophisticated investor may also have access to research reports that are more detailed than those available to retail investors, because “sophisticated” investors are treated as entities rather than individuals.

Nikas says many companies are now looking for sophisticated investors as a possible way of identifying a higher level of skill. “It comes down to a question of 'buyer, beware’,” he says, “and you wouldn’t want someone entering a risky investment without knowing what they’re doing.”

So does it matter if you never qualify as a sophisticated investor? Well some investments, including some hedge funds, will be beyond your reach, but you will also be protected from the risks inherent in these lightly regulated products.

There are some advantages to being a “non-sophisticated” investor, including the protection by strict regulations such as disclosure requirements and longer cooling-off periods. In September 2006, America's Amaranth Advisors made history by collapsing with a loss of $6.8 billion – the biggest hedge fund loss to date. No doubt some of the investors in that fund might have wished have they had never been quite so sophisticated.