A Guide to Alternative Investments

Transcription

1 Alternatives A Guide to Alternative Investments Alternative investments have been used by sophisticated institutional investors for decades to diversify their portfolios away from traditional stock and bond investments. They have the potential to provide new return sources that can help reduce volatility and protect portfolios during drawdowns and in periods of rising interest rates and inflation. Now these powerful investment vehicles are becoming available to a wider group of investors through retail mutual funds. In this paper, we ll outline how we view alternative investments, the different benefits they offer, and how different types of alternatives can be used in client portfolios. Not FDIC Insured May Lose Value Not Bank Guaranteed

2 OppenheimerFunds Alternative Assets and Strategies Alternative investments allow investors to expand their universe and diversify their portfolios beyond traditional stocks and bonds. They come in many shapes and sizes and have their own sets of risks, so it s important to understand how they work and what they could mean for a portfolio. We believe there are two types of alternatives appropriate for retail investors: Alternative assets give investors exposure to securities whose performance is not highly correlated with traditional stocks and bonds. Commodities, global real estate, precious metals and event-linked bonds are all examples of alternative assets. Some alternative assets are more volatile than others and tend to perform in line with their respective markets. They have the potential to provide attractive total returns while mitigating a portfolio s sensitivity to interest rates and inflation. Alternative strategies give investors exposure to managers who invest in stocks and bonds in non-traditional ways. Some of these are fun damental managers who seek to deliver performance based on different trading strategies long/short, market neutral and global macro, to name a few. Others take a systematic approach driven by quantitative models. There are times when fundamental and quantitative strategies will perform differently, so you can add diversification to your portfolio by owning both types. Alternative strategies have the potential to provide attractive absolute returns while mitigating the effects of volatility and unexpected drawdowns in the broad equity market. Alternative Assets Global Real Estate Invests in global commercial and residential real estate investment trusts. Master Limited Partnerships Invests in MLPs that are publicly traded on an exchange. Commodities Invests in agricultural, energy and other products that can be traded on a commodity exchange. Precious Metals Invests in metals commonly used in industrial processes. Event-Linked Bonds Invests in bonds whose interest and principal are based on the non-occurrence of certain events such as earthquakes and hurricanes. Alternative Strategies Long-Short Buys long equities expected to increase in value and sells short equities expected to decrease in value. Market Neutral Uses hedging strategies to create a portfolio that is relatively unaffected by specific market risks. Global Macro Takes long and short positions in equity, fixed income and futures markets based on economic and political views of various countries and macroeconomic principles. Managed Futures Uses futures contracts to diversify investments across a number of different investment styles and asset classes. Merger Arbitrage Creates value by buying and selling the stocks of companies that are potential merger candidates. Volatility Creates portfolios designed to profit from changes in market volatility. Currency Alpha Creates portfolios designed to profit from changes in global currencies. 2

3 The Right Way to Invest Alternative Solutions Different alternative investments are geared toward specific investment challenges. Investors have the potential to get protection from portfolio drawdowns with the help of alpha alternatives that seek total return with low volatility and low sensitivity to traditional asset classes. Income alternatives offer the potential to provide a source of income that is less sensitive to interest rates. Inflation alternatives are highly correlated 1 with inflation and offer the potential for real return. Alpha Alternatives Potential Protection from Drawdowns Long-Short Income Alternatives Potential Protection from Rising Rates Master Limited Partnerships Inflation Alternatives Potential Protection from Inflation Commodities Market Neutral Event-Linked Bonds Global Real Estate Global Macro Precious Metals Managed Futures Merger Arbitrage Volatility Currency Alpha 1. Correlation expresses the strength of the relationship between distribution of returns of two sets of data. The correlation coefficient is always between +1 (perfect positive correlation) and 1 (perfect negative correlation). A positive perfect correlation occurs when the two series being compared behave in exactly the same manner. 3

4 OppenheimerFunds Drawdowns Large drawdowns are the biggest threat to an investment portfolio. If your portfolio experiences a drawdown of 2%, you ll need 25% just to get back to even. And the deeper the drawdown, the more it takes to recover. Investors who experience deep drawdowns often abandon their carefully planned investment strategies at the worst possible time. Exhibit 1 Adding alpha alternatives to a traditional portfolio can help limit portfolio drawdowns. In this chart, we compare the drawdowns of three portfolios during three periods of financial stress. The portfolio of alpha alternatives (green) performed significantly better than an S&P 5 Index portfolio (gray) or a traditional 6/4 portfolio (black). Exhibit 2 What are alpha alternatives? Exhibit 1 The Deeper the Drawdown, the More Difficult the Recovery Growth levels required to achieve breakeven returns due to potential losses. 1% 5 5 Loss 1 11 Break-Even Return Managers that specialize in market neutral, currency and other similar strategies that have low sensitivity to stocks and bonds have tended to perform better in market crises, and offer the potential to mitigate volatility and the effects of unexpected broad market drawdowns. Source: OppenheimerFunds. Exhibit 2 Alpha Alternatives Have Outperformed Other Assets Annualized performance of three portfolios during periods of market stress, % Long-Term Capital Management (6/3/98 8/31/98) Tech Bubble (3/31/ 9/3/2) The Great Recession (1/31/7 2/27/9) S&P 5 6/4 Alpha Alternatives Sources: Standard & Poors, Hedge Fund Research Inc. and OppenheimerFunds. S&P 5 refers to the S&P 5 Index. 6/4 refers to a 6% allocation to the S&P 5 Index and a 4% allocation to the Barclays U.S. Aggregate Bond Index. Alpha alternatives are represented here by an equal combination of the HFR Equity Market Neutral Index, HFR Multi Strategy Index and the HFR Macro Currency Index. The indices shown are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any particular investment. See page 8 for index definitions. Past performance does not guarantee future results. 4

5 The Right Way to Invest Rising Interest Rates Rising rates can hurt traditional portfolios with fixed income assets. Even a 1% rise in interest rates can have a big impact on the prices of most conventional fixed income securities. Exhibit 3 Exhibit 3 Rising Rates Can Hurt Fixed Income Assets Price impact of a 1% rise in interest rates. % Adding an allocation of income alternatives can help diversify the fixed income portion of a portfolio, seeking to enhance returns and reducing its sensi tivity to interest rates. In this chart, we ve highlighted the performance of three portfolios during five 8.35 recent periods when the 1-Year Treasury yield rose 1 significantly. In all five periods, the portfolio of income alternatives performed significantly better than 1-Year Treasuries and the Barclays U.S. 15 Aggregate. Exhibit What are income alternatives? 2 Convertibles U.S. 5-yr. U.S. 1-yr. U.S. 3-yr. Barclays U.S. Agg U.S. High Yield Master Limited Partnerships, catastrophe bonds and other similar instruments have performed well during periods of rising rates, and offer the potential to decrease a portfolio s interest rate sensitivity. They have also become popular because they have the potential to deliver better income streams than traditional fixed income investments. Sources: Bloomberg, Hedge Fund Research Inc. and OppenheimerFunds as of 7/13/15. Convertibles is represented by the Barclays U.S. Convertible Bond Index. The U.S. 5-yr, U.S. 1-yr and U.S. 3-yr are represented by the most frequently traded on the run U.S. Treasury securities. Barclays U.S. Agg is represented by the Barclays U.S. Aggregate Bond Index. U.S. High Yield is represented by the Barclays U.S. Corporate High Yield Index. The indices shown are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any particular investment. See page 8 for index definitions. Past performance does not guarantee future results. Exhibit 4 Income Alternatives Have Outperformed Other Assets Annualized performance of three portfolios during periods of largest increases in 1-Year U.S. Treasury rates, % Sept 93 Nov 94* Sept 98 Jan May 3 June 6 Dec 8 Mar 1 July 12 Dec 13 1-Year U.S. Treasury Barclays U.S. Agg Income Alternatives Source: Bloomberg, as of 7/28/15. 1-Year U.S. Treasury is represented by the most frequently traded on the run U.S. Treasury securities. Barclays U.S. Agg is represented by the Barclays U.S. Aggregate Bond Index. Income alternatives are represented here by equal combinations of the Swiss Re Global Cat Bond Index, the Credit Suisse Leveraged Loan Index and the Alerian MLP Index. The indices shown are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any particular investment. See page 8 for index definitions. Past performance does not guarantee future results. 5

6 OppenheimerFunds Inflation Periods of high inflation can quickly erode the value of your retirement portfolio and cause stocks and bonds to underperform. Even modest inflation of 3% or 4% can reduce the purchasing power of your retirement assets by more than 5% over the course of a 25-year investment period. Exhibit 5 A traditional 6/4 portfolio is likely to suffer significant damage when inflation spikes. In the chart below, we compare real returns in two portfolios during the six most recent periods of high inflation. A portfolio of inflation alternatives delivered significantly higher real returns than the S&P 5 Index and the Barclays U.S. Aggregate Bond Index during four of the six periods. Exhibit 6 Exhibit 5 Inflation Erodes Living Standards Hypothetical value of $1, in 25 years based on different inflation rates. $1, 8, 6, 4, 2, 1, 77,782 6,346 46,697 36,4 27,739 21,291 What are inflation alternatives? % 1% 2% 3% 4% 5% 6% Commodities, global real estate and precious metals have historically provided protection for portfolios from inflation. Source: OppenheimerFunds, as of 7/28/15. Exhibit 6 Inflation Alternatives Have Outperformed Other Assets Annualized performance of three portfolios during periods of highest inflation, % (12.1% inflation) 1977 (6.7% inflation) 1978 (13.3% inflation) 199 (6.3% inflation) 2 (3.4% inflation) 27 (4.1% inflation) S&P 5 Barclays U.S. Agg Inflation Alternatives Sources: Bloomberg and Ned Davis Research Inc., as of 7/28/15. S&P 5 is represented by the S&P 5 Index. Barclays U.S. Agg is represented by the Barclays U.S. Aggregate Bond Index. Inflation alternatives are represented here by an equal combination of the S&P GSCI Commodities Index, the FTSE NAREIT U.S. Index and the S&P U.S. TIPS Index. U.S. TIPS total returns before 1997 were backfilled using data provided by Ned Davis Research, Inc. The indices shown are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any particular investment. See page 8 for index definitions. Past performance does not guarantee future results. 6

7 The Right Way to Invest How to Use Alternatives in Client Portfolios The risks associated with alternatives are different from the risks of traditional investments. The performance of alpha alternatives will vary with manager skill and market conditions. The performance of income alternatives will be influenced by conditions in the credit market. The performance of inflation alternatives tend to vary with commodity prices and the real estate market. Exhibit 7 Exhibit 7 Alternatives Can Enhance a Portfolio s Risk/Return Profile Investors can create different risk/return profiles by funding alternative investments from equity or fixed income assets. Funded Proportionately Funded from Fixed Income Before you invest in alternative mutual funds, you should make sure they offer true diversification and are not closely correlated with the equity or fixed income markets. Potential Return Funded from Equities Balanced Portfolio You can invest in funds that hold a single alternative asset or in funds that offer a diversified portfolio of alternatives assets. We believe that most traditional 6/4 portfolios can be enhanced with a 1% or 15% allocation to alternative investments. Your approach to funding this allocation should be based on your financial goals. By funding the allocation from your fixed income portfolio, you can potentially increase return and add more risk. By funding it from your equity portfolio, you can reduce risk along with potential returns. By funding it proportionately from both equities and fixed income, you can increase return potential while reducing risk. All of these approaches have the potential to make your portfolio more efficient. Risk Source: OppenheimerFunds proprietary research of potential return and risk of a 6/4 portfolio, comprised of 6% S&P 5, 4% Barclays Aggregate, with a 3% allocation to a Multi-Alternatives Benchmark. Multi-Alternatives Benchmark is comprised of the following: 5% HFRX RV: Multi-Strategy, 5% Bloomberg Commodity Index Total Return, 5% LMMA Gold Price PM USD, 5% FTSE EPRA/NAREIT Global Index TR USD, 1% Alerian MLP Index, 1% CS Leveraged Loan Index, 15% Swiss Re Global Cat Bond Performance Index Total Return. 7

8 Index Definitions The 1-Year U.S. Treasury Yield is generally considered to be a barometer for long-term interest rates. The Alerian MLP Index is a composite of the 5 most prominent energy Master Limited Partnerships (MLPs). The Barclays U.S. Aggregate Bond Index is an index of U.S. Government and corporate bonds that includes reinvestment of dividends. The Barclays High Yield Bond Index covers the universe of fixed rate, non-investment-grade debt. The Barclays U.S. Convertible Bond Index represents the market of U.S. convertible bonds with outstanding issue sizes greater than $5 million. Convertible bonds are bonds that can be exchanged, at the option of the holder, for a specific number of shares of the issuer s preferred stock or common stock. The Barclays U.S. Corporate High Yield Index measures the USD-denominated, high yield, fixed rate corporate bond market. The Bloomberg Commodity Index Total Return (formerly the Dow Jones-UBS Commodity Index Total Return) is designed to provide diversified commodity exposure by combining the returns of futures contracts on a diversified basket of physical commodities and the returns on cash collateral invested in 13-week (3-month) U.S. Treasury Bills. The index relies primarily on liquidity data and dollar-adjusted production data in determining the relative quantities of included commodities. The Credit Suisse Leveraged Loan Index is a composite index of senior loan returns representing an unleveraged investment in senior loans that is broadly based across the spectrum of senior bank loans and includes reinvestment of income (to represent real assets). The FTSE EPRA/NAREIT Global Real Estate Index is composed of property company constituents that trade on several global exchanges and are designed to represent general trends in eligible listed real estate stocks worldwide. The FTSE National Association of Real Estate Investment Trusts (NAREIT) Equity REITS Index is an index consisting of certain companies that own and operate income-producing real estate that have 75% or more of their respective gross invested assets in the equity or mortgage debt of commercial properties. The HFRI Equity Market Neutral Index employs sophisticated quantitative techniques of analyzing price data to ascertain information about future price movement and relationships between select securities for purchase and sale. These can include both Factor-based and Statistical Arbitrage/ Trading strategies. In many, but not all cases, portfolios are constructed to be neutral to one or multiple variables, such as broader equity markets in dollar or beta terms, and leverage is frequently employed to enhance the return profile of the positions identified. Equity Market Neutral Strategies typically maintain characteristic net equity market exposure no greater than 1% long or short. The HFRI RV Multi-Strategy Index employs an investment thesis predicated on realization of a spread between related yield instruments in which one or multiple components of the spread contains a fixed income, derivative, equity, real estate, MLP or combination of these or other instruments. The HFRX Macro Currency Index includes both discretionary and systematic currency strategies. Systematic currency strategies have investment processes typically as a function of mathematical, algorithmic and technical models, with little or no influence of individuals over the portfolio positioning. Discretionary currency strategies are reliant on the fundamental evaluation of market data, relationships and influences as they pertain primarily to currency markets including positions in global foreign exchange markets, both listed and unlisted, and as interpreted by an individual or group of individuals who make decisions on portfolio positions; strategies employ an investment process most heavily influenced by top-down analysis of macroeconomic variables. The S&P 5 Index is a market capitalization weighted index of the 5 largest domestic U.S. stocks. The Swiss Re Cat Bond Index is constructed to track the total return for U.S.-dollar-denominated catastrophe bonds. The S&P GSCI Commodities Index is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully collateralized basis with full reinvestment. The S&P U.S. TIPS Index is a broad, comprehensive market value-weighted index that seeks to measure U.S. TIPS market performance. TIPS are inflation-protected securities that provide exposure to the U.S. Treasury market, while also diminishing inflation risk. The principal of a TIPS is adjusted for inflation, as measured by the Consumer Price Index. Indices are unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any Oppenheimer fund. Past performance does not guarantee future results. Alternative asset classes may be volatile and are subject to liquidity risk. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, regulatory and geopolitical risks. Emerging and developing market investments may be especially volatile. Eurozone investments may be subject to volatility and liquidity issues. Investments in securities of growth companies may be volatile. Mid-sized company stock is typically more volatile than that of larger company stock. It may take a substantial period of time to realize a gain on an investment in a mid-sized company, if any gain is realized at all. Bonds are exposed to credit and interest rate risks (when interest rates rise, bond/fund prices generally fall). Commodity-linked investments are speculative and have substantial risks, including the loss of principal. Event-linked securities are fixed income securities for which the return of principal and interest payment is contingent on the non-occurrence of a trigger event that leads to physical or economic loss. If the trigger event occurs prior to maturity, a fund may lose all or a portion of its principal and additional interest. Inflation-indexed debt securities are subject to the risks associated with investments in fixed income securities. Risks associated with rising interest rates are heightened given that rates in the U.S. are at or near historical lows. When interest rates rise, bond prices generally fall, and a fund s share prices can fall. Investing in MLPs involves additional risks as compared to the risks of investing in common stock, including risks related to cash flow, dilution and voting rights. Funds investments are concentrated in the energy infrastructure industry with an emphasis on securities issued by MLPs, which may increase volatility. Energy infrastructure companies are subject to risks specific to the industry such as fluctuations in commodity prices, reduced volumes of natural gas or other energy commodities, environmental hazards, changes in the macroeconomic or the regulatory environment or extreme weather. MLPs may trade less frequently than larger companies due to their smaller capitalizations which may result in erratic price movement or difficulty in buying or selling. Additional management fees and other expenses are associated with investing in MLP funds. Senior loans are typically lower rated and may be illiquid investments (which may not have a ready market). Funds may invest without limit in belowinvestment-grade securities. Funds may invest a variable amount in debt rated below B. Diversification does not guarantee profit or protect against loss. Visit Us oppenheimerfunds.com Call Us Follow Us Shares of Oppenheimer funds are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency, and involve investment risks, including the possible loss of the principal amount invested. This material is provided for general and educational purposes only, and is not intended to provide legal, tax or investment advice, or for use to avoid penalties that may be imposed under U.S. federal tax laws. Contact your attorney or other advisor regarding your specific legal, investment or tax situation. Before investing in any of the Oppenheimer funds, investors should carefully consider a fund s investment objectives, risks, charges and expenses. Fund prospectuses and summary prospectuses contain this and other information about the funds, and may be obtained by asking your financial advisor, visiting oppenheimerfunds.com or calling 1 8 CALL OPP ( ). Read prospectuses and summary prospectuses carefully before investing. Oppenheimer funds are distributed by OppenheimerFunds Distributor, Inc. 225 Liberty Street, New York, NY OppenheimerFunds Distributor, Inc. All rights reserved. JK July 3, 215