Actively Connecting Investors with Alternative Opportunities


Using Alternatives in Portfolios

Senior Investment Strategist Esty Dwek explains how alternatives can reduce correlation and improve diversification.



Alternative investments include assets like property, private equity and managed futures. In the investment landscape of 2019, where interest rates are expected to keep rising, central banks are reducing their stimulus and market volatility is increasing, alternatives can provide a different perspective on markets, risk and investment returns.

Why include alternatives in an investment portfolio?

Alternative investments are becoming increasingly popular with financial advisers and wealth managers, with seven in ten saying they have become essential for portfolio diversification (Natixis Professional Fund Buyers Survey 2018). They can also provide de-correlation from equities and bonds, dampening the negative effects of market volatility, and have the potential to generate enhanced returns. Given the complex and challenging investment landscape in 2019, it’s easy to see why most investors are planning to allocate more to alternatives in both the short and long term (Prequin, 2018).

Diversification

Some alternative strategies have the potential to boost portfolio diversification, which can help to counteract the risk that poor performance by any single asset class or investment strategy might pose to a portfolio’s overall health. Many alternatives are designed to have a low correlation to stocks and bonds, meaning they seek to move independently of how these asset classes might behave in various market conditions.

Risk Management

Managing portfolio risk by seeking to act as a potential volatility buffer during episodes of market turbulence is another potential use of some types of alternative strategies. Some alternatives are designed to dampen the negative effects of market volatility if and when it occurs.

Return Enhancement

Amplifying portfolio returns or delivering returns beyond the benchmark are other potential abilities of alternative strategies. Some alternatives can seek additional returns by taking on more risk. The sophisticated techniques used by alternatives can magnify both a gain or a loss.

What types of alternative strategies are available?

Alternative investments can be either liquid or illiquid. The more illiquid, longer-term positions tend to have higher return prospects – but also the liquidity costs that go with it. Examples of illiquid alternatives include private equity and real estate, which generally impose limits on withdrawals. Essentially, liquid alternatives can be more readily exchanged or sold than illiquids. They tend to have more of an absolute return focus – exploiting arbitrage opportunities or focusing on relative value strategies –seeking to generate returns irrespective of the overall direction of markets. There’s a diverse range of alternative strategies available across the risk-return spectrum. These strategies can employ a number of additional tools that can help improve diversification, risk management and potential returns. These strategies include:

Short
Short Positions
Leverage
Leverage
Arbitrage
Relative Value
Illiquidity
Illiquidity
Complexity
Complexity
This means investors in alternatives can really hone in on the strategy that best suits their portfolio from a risk, return and diversification perspective. The table below provides an overview of some of the most popular alternative strategies and the affiliated investment managers with expertise in that area.

Managed Futures

Managed futures strategies typically focus on investing in listed bond, equity, commodity futures and currency markets, globally. Using future contracts, managers determine their positions based on expected profit potential. Market-neutral strategies look to profit from spreads and arbitrage created by mispricing. Trend-following strategies look to profit by going long (buying a holding) or short (borrowing a stock you don't own and selling it in the hope of repurchasing it at a lower price before returning to the stock lender) according to fundamentals or technical market signals. Systematic equity strategies, as the name suggests, use a suite of adaptive trading models that capture returns from trends within equity markets.

AEW    ArcticBlue

Global Macro

Global Macro strategies build portfolios around predictions of large-scale events on the individual country, region or global scale, implementing opportunistic investment strategies to capitalise on macroeconomic and geopolitical trends. They can take long (buying a holding) or short (borrowing a stock you don't own and selling it in the hope of repurchasing it at a lower price before returning to the stock lender) positions in multiple asset classes, with the ratio of holdings to each one based on their macro-economic projections. Portfolios are constructed at the asset-class level and can be based on a top-down view of global markets or they might use price-based and trend-following algorithms to help execute the fund's trades.

H2O    DNCA

Long-Short Equity

Long-short equity strategies invest in equities, as the name suggests, but they are considered alternatives as they seek to minimise market exposure while producing net gains. Long positions (essentially, buying a holding in a company stock) are those that are expected to increase in value. Short positions (borrowing a stock you don't own and selling it in the hope of repurchasing it at a lower price before returning to the stock lender) are those that are expected to decrease in value, which is sometimes referred to as ‘short selling’. These strategies can differ by geography, sector or investment philosophy and can have a broad or narrow scope.

AEW     AEW     AEW

Arbitrage & Absolute Return

Like other alternative investments, arbitrage and absolute return strategies include non-traditional assets and investment techniques. In essence, these strategies aim to deliver positive returns whatever the market does, rather than simply aiming to outperform a benchmark or reference index. Portfolios constructed using these strategies can be diversified across asset classes, geography and economic cycles, and managers pay special attention to the correlation between the different components of their portfolio.

seeyond     DNCA     H2O     ostrum

Real Estate

Real estate strategies invest in funds that buy or sell properties, which can include commercial or retail properties, or real estate debt. Some strategies look to provide a return from capital appreciation and income over the longer term, and to deliver, over time, outperformance of a benchmark or reference index. Others seek to better align the benefits of property as a real asset with, for example, the liabilities of pension savers. As with other tangible or ‘real’ assets, real estate is considered an illiquid alternative. The Illiquidity premium means it has the potential for higher returns than more liquid assets. It can typically provide downside protection – as illiquid asset pricing typically lags behind public market asset pricing – and it can offer portfolio diversification. What’s more, there are predictable cash flows with real estate, which can be inflation-linked for the duration of long-term contract. However, the relative ease of valuation and ability to transact, as well as the potential difficulty in find buyers and sellers, are all factors that contribute to the asset’s illiquidity.

AEW

Private Equity

Private equity (PE) strategies can invest directly in private companies or participate in leveraged (debt-assisted) and management buy-outs of publicly listed companies. They can also co-invest or partner with other market participants to enable a private company, or portfolio of companies, to grow or transform. In contrast with publicly listed companies, which often have multiple shareholders, PE managers work alongside the private company’s management team to enhance the running of the business. This can involve all areas of operation, from the top-line growth, efficiency savings, cash generation and procurement, to supply-chains, marketing and sales, improving reporting and human resources. Investments will typically be in companies or portfolios of companies in the smaller to middle market size, as opposed to larger cap companies – or indeed early-stage businesses, which typically require seed money and venture capital to grow. PE firms will typically look to hold investments for between four and seven years, at which time they will look to sell, or ‘exit’, their stake, either on the stock market, to a corporate buyer or to another investor.

flexstone

Private Debt

Private debt strategies invest in various types of loans and corporate bonds. Leveraged loans, for example, are one solution for institutional investors that allocated funds into government bonds more than a decade ago, when yields were attractive, and now wish to replace them as they mature. Other illiquid private debt strategies can also provide required yields and deliver a low risk, low volatility solution to long-term cashflow needs. These include investing in debt secured on real assets, like property and infrastructure.

mvcredit     ostrum     loomis

Infrastructure

Infrastructure strategies typically invest in ‘real assets’, like bridges, roads, airports and wind farms, but they can also invest in social development projects, which can include everything from hospitals to sustainable oceans. This can be through public private partnerships or core investments in regulated assets, through debt a variety of approaches within energy and utilities resources. As with other tangible or ‘real’ assets, infrastructure is considered an illiquid alternative. The Illiquidity premium means it has the potential for higher returns than more liquid assets. It can typically provide downside protection – as illiquid asset pricing typically lags behind public market asset pricing – and it can offer portfolio diversification. What’s more, there are predictable cash flows with infrastructure, which can be inflation-linked for the duration of long-term contract However, the relative ease of valuation and ability to transact, as well as the potential difficulty in find buyers and sellers, are all factors that contribute to the asset’s illiquidity.

ostrum     mirova     DNCA


Liquid Investments

Illiquid Investments

For information and insights related to illiquid investments and institutional solutions visit: https://www.im.natixis.com/en-institutional/topic/alternatives

Would you like more information?

Alternative investments involve unique risks that may be different than those associated with traditional investments, including illiquidity and the potential for amplified losses or gains. Investors should fully understand the risks associated with any investment prior to investing.

Diversification does not guarantee a profit or protect against a loss.

Managed Futures use derivatives, primarily futures and forward contracts, which generally have implied leverage (a small amount of money used to make an investment of greater economic value). Because of this characteristic, managed futures strategies may magnify any gains or losses experienced by the markets they are exposed to. Managed futures are highly speculative and are not suitable for all investors.

Commodity-related investments, including derivatives, may be affected by a number of factors including commodity prices, world events, import controls, and economic conditions and therefore may involve substantial risk of loss.

Hedge funds are unregistered private investment pools that are often illiquid and highly leveraged, and may engage in speculative investment practices. Hedge funds may be more volatile than investments in traditional securities and may not be suitable for all investors. Volatility management techniques may result in periods of loss and underperformance, may limit a portfolio’s ability to participate in rising markets and may increase transaction costs.

Real estate investing may be subject to risks including but not limited to declines in the value of real estate, risks related to general economic conditions, changes in the value of the underlying property owned by the trust, and defaults by borrowers.

Volatility management techniques may result in periods of loss and underperformance, may limit the Fund's ability to participate in rising markets and may increase transaction costs.

Short selling is speculative in nature and involves the risk of a theoretically unlimited increase in the market price of the security that can, in turn, result in an inability to cover the short position and a theoretically unlimited loss.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary.

Before investing, consider the fund’s investment objectives, risks, charges, and expenses. You may obtain a prospectus or a summary prospectus on our website containing this and other information. Read it carefully.

Arctic Blue Capital is an affiliate of H2O Asset Management.

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