Real Asset Funds What Are They and Should I Use Them? 2003 2014 Multnomah Group, Inc. All Rights Reserved.
Scott Cameron, CFA Scott is the Chief Investment Officer for the Multnomah Group and a Founding Principal of the firm. In that role, Scott leads Multnomah Group s Investment Committee, is responsible for the development of the firm s investment research methodology, and conducts investment manager due diligence. Scott also consults with plan sponsors on investment menu design, investment manager selection, fiduciary governance, and vendor fees/services. Prior to founding the Multnomah Group, Scott was an investment consultant with a national retirement services firm. Scott is a member of the CFA Institute, the CFA Society of Portland, the Investment Management Consultants Association, and the Portland Chapter of the Western Pension & Benefits Council. Scott holds a B.S in Management from Purdue University. 2
Agenda What Are Real Assets? Why The Current Interest in Real Assets? Asset Class Overview Product Overview Investment Manager Due Diligence 3
What Are Real Assets? Definition Physical or tangible assets that have value, due to their substance and properties. Real assets include precious metals, commodities, real estate, agricultural land and oil. They are appropriate for inclusion in most diversified portfolios - with their proportion dependent on the investor's risk tolerance and preferences - because of their relatively low correlation with financial assets, such as stocks and bonds. They are particularly well-suited for inflationary times, because of their tendency to outperform financial assets during such periods. Other Meanings Real in an investing context means inflation-adjusted Real Asset funds are designed to invest in financial assets (i.e. stocks/bonds, etc.) that are backed by real assets and/or provide positive inflation-adjusted returns Definition Source: Investopedia 4
Why The Current Interest in Real Assets 1. Changing Focus of Retirement Plan Objectives 2. Recognition That Financial Asset Correlations Have Increased 3. Concerns About the Impact of Fiscal and Monetary Policy 5
Changing Dynamics in Retirement Plans Traditional Model To maximize the accumulation of assets by retirement Asset class coverage with an emphasis on stocks to generate highest expected return Nominal investment returns relative to benchmarks and peer groups Volatility of returns Retirement Plan Objective Investment Menu Design Success Measures Risk Management New Model To replace current income In retirement Objective driven with a greater diversity of asset class exposure Income replacement rates Income replacement shortfall 6
Increased Correlations Among Financial Assets 1.00 Rolling 60 Month Correlations to the S&P 500 Index 0.90 0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00 Dec-82 Sep-83 Jun-84 Mar-85 Dec-85 Sep-86 Jun-87 Mar-88 Dec-88 Sep-89 Jun-90 Mar-91 Dec-91 Sep-92 Jun-93 Mar-94 Dec-94 Sep-95 Jun-96 Mar-97 Dec-97 Sep-98 Jun-99 Mar-00 Dec-00 Sep-01 Jun-02 Mar-03 Dec-03 Sep-04 Jun-05 Mar-06 Dec-06 Sep-07 Jun-08 Mar-09 Dec-09 Sep-10 Jun-11 Mar-12 Dec-12 Sep-13 Jun-14 Source: MPI Stylus Russell 2000 Index MSCI EAFE USD 7
Expansionary Monetary Policy (Low Rates) 25.00 Effective Federal Funds Rate 20.00 15.00 10.00 5.00 0.00 8
Expansionary Monetary Policy (Quantitative Easing) $5,000,000 Federal Reserve Bank Total Assets Total Assets ($MM) $4,500,000 $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 Source: Federal Reserve Bank of St. Louis 9
Expanding Government Debt Levels $20,000,000 Total Federal Public Debt $18,000,000 $16,000,000 $14,000,000 Debt ($MM) $12,000,000 $10,000,000 $8,000,000 $6,000,000 $4,000,000 $2,000,000 $0 Source: Federal Reserve Bank of St. Louis 10
Low Current Inflation Relative to History 25.00 Historical Inflation (CPI) 20.00 15.00 CPI % 10.00 5.00 0.00 Historical Average (3.5%) -5.00-10.00-15.00 1925 2014 Source: Federal Reserve Bank of St. Louis Consumer Price Index Average 11
Asset Classes Treasury Inflation Protected Securities (TIPS) Commodities Natural Resource Stocks Utilities/Infrastructure Real Estate Gold Floating Rate Debt Currencies Master Limited Partnerships 12
Product Overview At least 10 different investment management firms have launched real asset funds since 2010 The funds generally include some, but not all of the asset classes discussed previously There is no consensus on what asset classes should be included in the products Decisions generally align with the existing capabilities of the investment manager Lack of consensus on peer group Morningstar categorizes the funds as Moderate Allocation, World Allocation, Conservative Allocation and Tactical Allocation Lack of consensus on benchmark indices Either use a custom blended index or a single index that doesn t really match the portfolio 13
Investment Manager Due Diligence Investment Management Firm Capabilities Asset Class Selection Costs Portfolio Management 14
Investment Manager Firm Capabilities Real asset funds shift responsibilities to the fund manager from the participant Asset allocation is the responsibility of the fund manager Security selection is the responsibility of the fund manager Transitioning responsibility to the fund manager requires plan sponsor to gain deeper understanding of the investment management firm Firm stability Experience Commitment People Process Resources 15
Firm Evaluation Criteria How stable is the organization? What experience does the firm have in managing real asset portfolios? Commitment Does the firm have a dedicated staff for managing the real asset funds? Is this a core asset class of the firm? Have the products shown sufficient traction in the market to ensure long-term viability? Does the fund manager demonstrate thought leadership within the real asset universe? People What experience do the portfolio managers have with real asset funds? How long have they been managing these products? Do they have any other responsibilities within the firm? Process Do they have a process for evaluating changes to the portfolios? Have they managed investment products before? Do they have a defined process for managing cash flows? How do they handle rebalancing? 16
Asset Class Considerations Which asset classes are included in the funds? How did the fund manager determine which asset classes would be suitable for inclusion within the funds? What modeling was done to determine the appropriate mix of asset classes? Did the fund manager utilize capital market assumptions in their modeling? Historical data? Forecasted data? What impact do the fund manager s investment products play in determining asset classes? Were asset classes excluded because the manager lacked a product? Were asset classes included solely because a manager has a product in that class? How frequently does the fund manager review the asset class structure of the funds? Have there been any recent changes in the asset classes utilized by the funds? Are they evaluating any future changes to the asset class lineup? 17
Proprietary vs Open Architecture Proprietary Investment Management All of the underlying portfolios are managed by the fund manager May create perceived conflicts between the fund investors and the fund manager May expose investors to highly correlated alphas Open-Architecture Investment Management Fund manager utilizes outside portfolio managers to handle the security level portfolio management responsibilities Not very common Adds an additional level of fees to the funds Open-architecture is not a guarantee of higher performance Hybrid Strategies Sub-advised portfolios Fund manager utilizes sub-advisers for a portion of the portfolio 18
Ongoing Monitoring Methodology Has anything in our initial analysis changed? Is the fund behaving consistent with expectations given the market environment? Are the portfolio managers adding value? How do these products compare to alternatives in the market? 19
Conclusion Real asset funds are designed to provide attractive real returns by investing in a combination of real assets and financial assets that are positively correlated to inflation The use of these types of funds may be attractive within a defined contribution context because of the objective-based approach is simpler for participants to use There is no consistency in the design or construction of these funds with different investment managers A lack of a homogenous peer group or generally-accepted benchmark index makes selection and evaluation more complex Plan sponsors wishing to utilize these funds need to commit to greater oversight of these products 20
Disclosures Multnomah Group, Inc. is an Oregon corporation and SEC registered investment adviser. Investment performance and returns are based on historical information and are not a guarantee of future performance. Investing contains risk. Some asset classes involve significantly higher risk because of the nature of the investments and the low liquidity/high volatility of the securities. Any information and materials contained herein or on our website are provided for general informational purposes only and are not intended to be comprehensive for any particular subject. Multnomah Group utilizes information from third party sources believed to be reliable but not guaranteed, and as a result, information is provided to you "as is." We do not represent, guarantee, or provide any warranties (either express or implied) regarding the completeness, accuracy, or currency of information or its suitability for any particular purpose. Multnomah Group shall not be liable to you or any third party resulting from any use or misuse of information provided. Receipt of information or materials provided herein or on our website does not create an adviser-client relationship between Multnomah Group and you. Multnomah Group does not provide tax or legal advice or opinions. You should consult with your own tax or legal adviser for advice about your specific situation. 21