Good [morning, afternoon, evening]. I m [name] with [firm]. Today, we will talk about alternative investments.

Transcription

1 Good [morning, afternoon, evening]. I m [name] with [firm]. Today, we will talk about alternative investments. Historic economist Benjamin Graham famously said, The essence of investment management is the management of risk, not the management of returns. And this has never been more true than it is with the volatile markets of today. Throughout our discussion today, you will begin to understand the importance of managing risk as it relates to the performance and overall outcome of investing. Moreover, you will see how the use of alternatives, also referred to as non-traditional investments and investment strategies, can help manage risk which may lead to stronger outcomes. 1

2 Our goal today is to help you gain a better understanding of the types of alternative investments available, how they can help you solve challenges, and smart ways to allocate to them. 2

3 So, what are alternatives anyway? 3

4 In truth, the term Alternatives is used to mean two very different things. The first are alternative asset classes like commodities, real estate, currency, and interest rates, or basically any asset class that falls outside the traditional asset classes of stocks, bonds, and cash. The second are alternative strategies. Alternative strategies can invest in traditional and alternative asset classes and can use alternative tools intended to enhance profits. Of course, alternative tools that are meant to magnify profits can also magnify losses and add risks. 4

5 Alternatives provide many benefits to investors. While alternative strategies can introduce new risks, alternative investments have historically provided less volatility than more traditional investments. In fact, they were originally designed to reduce risk. Alternatives also have the potential to enhance performance and to perform in many different market environments. They typically have lower correlations to traditional asset classes, which means they react differently than traditional investments to market events. This can help minimize loss during volatile times. For example, if an event occurs that causes traditional investments to have a sharp decrease in performance, alternative investments with low correlation to traditional investments would not experience the same sharp decrease. In addition, alternatives can help provide wider diversification at both the asset class and strategy levels which can spread your risk across more options to help enable more steady performance. As a result, alternatives can help: Minimize volatility across market cycles. Achieve a higher level of diversification. Potentially enhance returns by managing the downside. Preserve wealth over time. 5

6 Currently, there are many different types of alternative strategies and more are continually being created. While all alternatives offer the potential to reduce risk and enhance returns, the primary objective of a given fundmay be more focused on one objective than another. We find that alternatives generally fall into three main categories: Risk reducers Return enhancers Diversifiers Based on your investing goals, you can choose alternatives from one or more of these categories. 6

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8 As this chart of investment returns over the last 20 years illustrates, markets are becoming increasingly volatile. Volatility refers to the amount of uncertainty or risk about the size of changes in an investment s value. A higher volatility means that the value can change dramatically over a short time period in either direction. A lower volatility means that the value does not change dramatically in a short period of time, but can change at a steady pace over a longer period of time. Volatility is not simply due to financial crises, but also to political turmoil, significant weather events, and more. These more significant market events are known as tail events. Tail events represent an investment s most extreme up or down performance periods. These types of events typically exceed peoples expectations for magnitude of gains or losses and often are longer than people expect. In the 2000s, or what s known as the Lost Decade, there were two significant market downturns: the 2001 recession and the 2008 Financial Crisis. These events taught investors many uncomfortable lessons about volatility. Not only is it destructive, but it can also be difficult to recover from. Consider that: Volatility is a constant, but spikes periodically. Volatility can be highly destructive to investment values. Higher volatility may be becoming more persistent. 8

9 As a result of all this volatility, investor perception of risk has changed. While risk has traditionally meant volatility and the prospect of loss, today it is much more than this. To investors, risk is now the possibility they will not reach their goals. The last decade has demonstrated to them: The importance of absolute outcomes, or superior returns. The significance of capital preservation, or not losing their initial investment. The need for liquidity, or the ability to quickly convert invested assets into cash. And, the importance of net performance, or performance reduced by fees and taxes they must pay. 9

10 Now, let s take a look at some typical investments. Here we have U.S. stocks, international stocks and bonds 20-year historical returns. We also show alternatives strategies. Looking at the chart in detail you can see a few things. Alternative investments offer similar returns to stocks with less than half of the volatility, so they can help investors protect their portfolios from downside risk. And, due to the powerful impact compounding can have on a portfolio value, downside protection may actually be more critical to portfolio values than upside potential. 10

11 Todemonstrate the significance of protecting a portfolio from volatility, let s take a look at two very different portfolios over the same five-year period. These portfolios each began with investments of $500,000, and both averaged 10% returns, but Portfolio A ended up worth nearly $33,000 more than Portfolio B even though Portfolio B had higher upswings. Why is this? Because of the volatility in the pattern of returns. Portfolio B had larger upswings, but larger downturns as well. And while this example uses relatively small losses, consider tail events like the one in 2008, where many investors lost 40% or more. It would take an investor nearly 12 years at a four percent rate to recover. And, even if an investor earns 10 percent per year after a downturn like that, it would still take more than five years to get back into positive territory. Consider what would have happened to an investor who lost 40% and was taking retirement distributions as well. For a retiree, or even a pre-retiree, it may not be possible to recover from that type of drop. 11

12 So how do alternative investments help minimize volatility in a portfolio? To help explain this, let s explore an investment term known as correlation. Correlation is a measure of how two investments move in relation to one another.two investments with low correlation to one another react differently to market events, whereas two investments with high correlation to one another react similarly to market events. Simply put, a portfolio that contains investments with low correlation to one another is positioned to perform more consistently because when market events occur, the investments react differently, which can minimize the overall volatility experienced by the portfolio. Because alternatives exhibit low correlation to traditional investments, including alternative investments and alternative strategies in your portfolio can provide diversification that offsets the risks inherent to traditional investments and investment strategies. 12

13 Anotherreason to consider alternatives is their historically consistent outcomes. As you can see in this chart, alternatives (represented by the HFRI Blended Index second bar from the top) have delivered a much tighter distribution of returns over the same time periods as most traditional strategies, providing less volatility and less downside risk. Even when we take a closer look at bonds, as represented by the Barclays Capital U.S. Aggregate Index (the top bar on the chart), you can see that alternatives offer far better return potential with far less risk than any stock indices. When you also consider the lower correlation of alternatives as well, it becomes evident that adding alternative strategies may help to solve a number of investment challenges and may be extremely appropriate if you are retired or are saving for retirement. 13

14 Let s also explore the power of compounding as a favorable characteristic of alternatives. Consider that: downside volatility has a greater impact on portfolio value than upside returns, and alternatives have historically delivered similar returns to stocks with half the volatility. Using hypotheticalreturns of less volatile alternative investments, this chart shows the differencealternatives can make over time by charting returns of the S&P 500 over the past 30 years. Whenyour portfolio doesn t lose as much value, it doesn t have to gain more than the difference to break even. See here the difference in the ending value is 35%, with a portfolio that doesn t have as much volatility. 14

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16 Due to their unique benefits, investment in liquid alternatives is on the rise. As you can see by this chart, an increasing number of individual investors have been selecting them. Consider that the number of liquid alternatives has grown from 42 to more than 400 in the past 10 years. At the same time, individual investments have grown from $11 billion to nearly $180 billion. 16

17 Traditionally, alternative investments were only available to ultra-high-networth or institutional investors. Most alternative strategies like hedge funds have extremely high minimums, high performance fees, and complex tax reporting. Additionally, they are typically not transparent, so investors rarely know what they own. They do not provide daily liquidity and may only enable quarterly or annual redemptions. Additionally, these strategies rarely limit the use of alternative tools and they re not often subject to formal regulations. Mutual funds and other traditional investments, on the other hand, offer daily redemptions, complete transparency, low investment minimums, simple reporting, are subject to formal regulations, and typically limit the use of alternative tools. Liquid alternatives, however, have brought alternative strategies to individual investors. Alternative strategies within the mutual fund vehicle, liquid alternatives provide investors with the best of both worlds by enabling them to access alternative strategies with all the benefits of typical mutual funds. They provide liquidity, low minimums, no performance fees, and a focus on absolute returns. They allow use of alternative tools -with limits designedto protect the investor. They are subject to formal regulations and typically provide the protections of the Investment Company Act of

18 And, regardless of your risk tolerance, adding alternatives to your portfolio may help improve your portfolio s risk and return characteristics significantly reducing volatility, minimizing the downside, and smoothing out returns. For example, allocating 20% to alternatives could reduce the risk within your portfolio, but not sacrifice that much return. 18

19 In conclusion, I d like to reiterate the important role alternatives can play in solving the investing challenges you may be experiencing in today s volatile market environment, helping: Reduce the potential for large losses Achieve a higher level of diversification Preserve wealth over time, with more possibility for more consistent returns 19

20 Thank you for joining me today. I ll be happy to take any questions at this time. 20

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