MainStreet Advisors Alternative Investments
Transcription
MainStreet Advisors Alternative Investments
MAINSTREET ADVISORS ALTERNATIVE INVESTMENTS Alternative Investments are financial securities that include: Commodities Hedge funds Real estate Private equity Alternative Investments are non-traditional portfolios, which may or may not include assets such as stocks, bonds, and cash. Alternative Investments may provide absolute or relative returns. Absolute returns may be achieved through the use of non-traditional strategies. Relative returns are measured in relation to a benchmark. Alternative Investments may provide opportunities for investors to hedge against inflation and/or a declining market. Investments in these assets can be made either directly or indirectly through individual securities, mutual funds, exchange traded funds, real estate investment trusts, or limited partnerships. In some cases investors for some securities must be accredited or able to absorb large downside risk and survive substantial loss. For individuals, accreditation is generally based on high personal wealth. Some of these investments require a substantial initial investment. Alternative Investments, regardless of the vehicle, possess high management fees. Furthermore, the regulation of some Alternative Investments is limited which increases the potential risk. Investors should weigh the costs and benefits before deciding to diversify their portfolios with Alternative Investments. Alternative Investments have low correlations to traditional investments which offer the opportunity to reduce the risk profile of a portfolio by increasing the overall diversification. Asset Class Correlation Coefficient1 US Treasury Bills 0.32 TIPS2-0.67 Intermediate US Bonds 0.14 International Bonds 0.19 International Stocks 0.61 Commodities-0.22 Private Equity 0.69 Venture Capital 0.36 Hedge Funds 0.61 Real Estate 0.20 US Inflation -0.19 1 2 Correlation Coefficients to Domestic Large Company Stocks TIPS since 1998 Source: Cambridge Associates, Dow Jones, AIG Commodity Index, Hedge Fund Research, Ibbotson Associates, National Association of Real Estate Investment Trusts (NAREIT), Standard & Poor’s, MainStreet Advisors Research 2007. [page 4 MainStreet Advisors Alternative Investments] Traditionally, stocks have been used to hedge portfolios against inflation even though domestic stocks are negatively correlated with inflation. TIPS, commodities, and US Treasury Bills are all positively correlated with inflation and thus tend to move in the same direction as inflation. Stocks perform well over long periods of time and do preserve purchasing power; however, these other asset classes hedge against inflation when stocks are not performing well. Adding uncorrelated (and positive-returning) assets to a portfolio of investments will reduce total portfolio risk. Alternative Investments which employ derivatives, shortsales or non-equity investments, tend to be uncorrelated with broad stock market indices. Including Alternative Investments in traditional portfolios of stocks and bonds shifts the opportunity set of risk/reward upward. This shift in the efficient frontier implies that for the same level of risk, historical portfolios earn more return. Alternatively, the shift implies that for the same level of return, historical portfolios assume less risk. Markets are unpredictable. The timing of returns within a series can have a dramatic impact on the end result. Reducing portfolio volatility can increase the probability of achieving an investment goal. $250,000 $215,892 $200,000 $189,726 +23% $150,000 +28% +18% $100,000 $100,000 Initial Investment +38% +8% +0% -2% -5% -8% -20% $50,000 Year 0 1 2 3 4 5 6 7 8 9 10 In this hypothetical example, each investment begins with $100,000. The lower volatility portfolio grows 8% per year. The higher volatility portfolio grows on average 8% per year but has a loss in year two that hinders performance for the balance of the years. The example is for illustrative purposes only and does not reflect average annual performance of any MainStreet Advisors portfolio or recommendation. Source: Putnam Research, 2005 [MainStreet Advisors Alternative Investments page 5] Commodities Commodities include: precious metals, sugar, cotton, coffee, natural gas, crude oil, refined products, livestock, grains, and industrial metals. Exposure to commodities may be obtained by making a direct or indirect investment. Most investors obtain exposure to commodities through indirect investment in mutual funds or exchange traded funds (ETFs). Over the last ten years, a period where both asset classes were down 30% of the time, an investment in the two asset class started and ended at the same amount. Over that time period the risk profile of the two asset classes is also consistent. Commodity data became readily available beginning in 1991. Since that time, commodities have earned an average annual return of 7.9%, compared to large company stocks which earned 11.1%. Over that time period, the standard deviation of both asset classes was similar, around 18%. The main difference in the return profiles of these two asset classes is that the beta of commodities over that period was 0.05. Furthermore, the correlation coefficient of commodities to large company stocks was -0.22. These statistics support that when stocks are up, commodities may be up or down and when stocks are down, commodities tend to be up. Despite similar risk and return profiles, commodities haven’t had as much upside potential and have had more downside risk. This point is further evidenced by the sharpe ratio of the two asset classes. Large company stocks have twice the sharpe ratio compared to commodities. Said another way, large company stocks provide twice the return per unit of risk compared to commodities. [page 6 MainStreet Advisors Alternative Investments] Our analysis of historical commodity returns supports that this asset class has negative correlations to portfolios of traditional stocks, provide attractive returns, hedge against inflation, and provide diversification benefits through superior returns when needed most. $100,000 Invested with Commodities vs. Large Company Stocks 250,000 200,000 150,000 100,000 50,000 Statistic 0 Standard Deviation20.0 Geometric Return9.0 Commodities S&P 500 17.3 5.9 Large Company Stock Commodities Source: Dow Jones, AIG Commodity Index, Standard & Poor’s, MainStreet Advisors Research 2006, Total Returns for the period 1998-2007 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Commodities vs. Large Company Stocks 50% 37.4% 40% 31.8% 30% 20% 10% 11.4% 7.9% 0% -10% Highest Return Average Return Lowest Return -20% -22.1% -30% -27.0% Large Company Stocks Commodities Source: Dow Jones AIG Commodity Index, Standard & Poor’s, MainStreet Advisors Research 2008, Total Returns for the period 1991-2007 [MainStreet Advisors Alternative Investments page 7] Hedge Funds Hedge funds provide investors with exposure to numerous strategies which can be summarized by these three categories: long/short, bear, and merger/arbitrage. Their name implies that these funds “hedge” risk. Hedging is a practice used in finance to reduce the risk associated with either rising or falling prices. Hedge funds may or may not hedge risk. Some funds, based on their strategy, may actually increase risk. Investors create hedge fund exposure by investing directly into a hedge manager or through publicly traded securities such as limited partnerships and mutual funds. Long/short Strategy “Buying long” involves purchasing a security such as a stock, bond, commodity, or currency, with the expectation that the asset will rise in value. “Buying short” involves just the opposite; purchasing a security with the expectation that the asset will fall in value. Long/short funds buy a portfolio of securities long that they feel will rise in value and sell a portfolio short that they feel will fall in value. Some long/ short funds employ a “market neutral” strategy where a fund matches its long positions with its short positions. A market neutral strategy is a lower risk approach to long/short where the fund attempts to make money, regardless of what the market is doing. Alternatively, a long/short fund may weight its long positions and short positions based on its market forecast, which may lead to higher risk. Bear Strategy A bear strategy invests in short selling and derivatives with the expectation that securities will move in the opposite direction of the index. Funds may use leverage to increase the extent to which it moves in relation to the index. For example, a fund may invest in a manner that moves one time, two times, or even more in the opposite direction than that of the index. Bear funds offer investors the ability to hedge their portfolio against a bear market, which dubs them “bear funds”. Merger/Arbitrage Strategy Merger/arbitrage funds look for opportunities or events that will lead to an increase in value of the underlying investments. These funds look for opportunities that include mergers, acquisitions, spin-offs, liquidations, tender offers, and leveraged buyouts. The performance of these funds indicates that sometimes the opportunities happen as predicted but sometimes the opportunities do not occur. The three distinct strategies perform differently in different market environments. These strategies may seek to perform when the underlying index is not performing or they may seek to perform regardless of how the market is performing. Of course, performance should be considered in the context of risk. The higher the risk that a fund takes, the higher the return the fund should be delivered. Hedge Fund data became readily available beginning in 1994. Since that time, hedge funds have earned an average annual return similar to that of large company stocks, 13.8% and 10.6% respectively. Over that time period, the standard deviation of hedge funds was about two-thirds that of large company stocks, 10.5% compared to 15.1%. Hedge funds which tend to own a portion of large company stocks have a beta and correlation coefficient, 0.37 and 0.61 respectively. These statistics support that stocks and hedge funds move similarly but hedge funds are less volatile. Over the last ten years, a period where large company stocks were down 30% of the time and hedge funds were down 10% of the time, an investment hedge funds provided superior results with lower volatility. As the chart indicates, hedge funds haven’t had as much upside potential or downside risk. This point is further evidenced by the sharpe ratio of the two asset classes. Hedge funds have twice the sharpe ratio than large company stocks. Said another way, hedge funds provide twice the return per unit of risk than large company stocks. Our analysis of historical hedge fund returns supports that this asset class has moderate correlations to portfolios of traditional stocks, provide attractive returns, hedge against inflation, and provide diversification benefits through superior returns when needed most. [page 8 MainStreet Advisors Alternative Investments] $100,000 Invested with Large Company Stocks vs. Hedge Funds 250,000 200,000 150,000 100,000 50,000 Statistic 0 Standard Deviation Geometric Return 1998 1999 2000 2001 2002 2003 2004 Hedge S&P 500 9.4% 9.9% 17.3% 5.9% 2005 2006 2007 Large Company Stock Hedge Funds Source: Hedge Fund Research, Standard & Poor’s, MainStreet Advisors Research 2008, Total Returns for the period 1998-2007 Large Company Stocks vs. Hedge Funds 50% 37.4% 40% 32.2% 30% 20% 10% 13.8% 10.5% 0% -1.5% Highest Return Average Return Lowest Return -10% -20% -22.1% -30% Large Company Stocks Hedge Funds Source: Hedge Fund Research, Standard & Poor’s, MainStreet Advisors Research 2008, Total Returns for the period 1994-2007 [MainStreet Advisors Alternative Investments page 9] Real Estate Real estate investments include: industrial/office, retail, residential, diversified, lodging/resorts, healthcare, self storage, and specialty. There are two ways to invest in real estate either directly or indirectly through a pooled investment company. Pooled investments such as Real Estate Investment Trusts (REITS), mutual funds, and limited partnerships provide diversification benefits and liquidity not found in direct investments. Real estate data became readily available beginning in 1978. Since that time, real estate has earned an average annual return of 12.0% compared to large company stocks which earned 13.0%. Over that time period, the standard deviation of real estate was similar to that of large company stocks, 17.0% compared to 15.1%. The beta of real estate over that period was 0.04. Furthermore, the correlation coefficient of real estate to large company stocks was 0.20. [page 10 MainStreet Advisors Alternative Investments] Over the last ten years, large company stocks and real estate were down 30% of the time. Consistent with similar risk and return profiles, real estate has had as much upside potential and downside risk. Our analysis of historical real estate performance, as measured by REITs, supports that this asset class has very low correlations to portfolios of traditional stocks and bonds, provide attractive returns, hedge against inflation, and provide diversification benefits through good returns when needed most. $100,000 Invested with Large Company Stocks vs. Real Estate $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 Statistic $50,000 Standard Deviation Geometric Return $0 1998 1999 2000 2001 2002 2003 2004 Real Estate S&P 500 21.0% 9.6% 17.3% 5.9% 2005 2006 Large Company Stock Real Estate Source: National Association of Real Estate Investment Trusts (NAREIT), Standard & Poor’s, MainStreet Advisors Research 2008, Total Returns for the period 1998-2007 2007 Large Company Stocks vs. Real Estate 50% 38.5% 37.4% 40% 30% 20% 10% 13.0% 12.0% 0% Highest Return Average Return Lowest Return -10% -20% -18.8% -22.1% -30% Large Company Stocks Real Estate Source: National Association of Real Estate Investment Trusts (NAREIT), Standard & Poor’s, Ibbotson Associates, MainStreet Advisors Research 2008, Total Returns for the period 1978-2007 [MainStreet Advisors Alternative Investments page 11] Private Equity Private equity investments are closed-end vehicles offered by specialized private equity managers. The assets invested are generally committed over a period of several years. Investments include: venture capital (financing new businesses) and buyouts (refinancing existing businesses). Private equity managers invest in privately held companies. Given the nature of these investments, the amount of information is limited and liquidity is very low. Investors may gain exposure to private equity through direct investment in the private equity fund or indirectly through publicly traded investment companies or exchange traded funds (ETFs). As the chart indicates private equity hasn’t had as much upside potential or downside risk. This point is further evidenced by the sharpe ratio of the two asset classes. Private equity has twice the sharpe ratio than large company stocks. Said another way, private equity provides twice the return per unit of risk than large company stocks. Private equity data became readily available beginning in 1987. Since that time, private equity has earned an average annual return similar to that of large company stocks,14.7% and 11.5% respectively. Over that time period, the standard deviation of private equity was about three-fourths that of large company stocks, 12.1% compared to 15.1%. Private equity which tends to own an equity position in smaller to mid sized companies have a beta and correlation coefficient of 0.48 and 0.69 respectively. These statistics support that stocks and private equity move similarly but private equity is less volatile. Over the last ten years, a period where large company stocks were down 30% of the time and private equity was down 20% of the time, an investment in private equity provides superior results with lower volatility. Our analysis of historical private equity performance supports that this asset class has moderate correlation to portfolios of traditional stocks and bonds, provide attractive returns, and provide diversification benefits through superior returns when needed most. [page 12 MainStreet Advisors Alternative Investments] $100,000 Invested with Large Company Stocks vs. Private Equity $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 Statistic $50,000 Standard Deviation Geometric Return $0 Private Equity S&P 500 15.4% 14.2% 17.3% 5.9% Large Company Stock Private Equity Source: Cambridge Associates, Standard & Poor’s, MainStreet Advisors Research 2008, Total Returns for the period 1998-2007 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Large Company Stocks vs. Private Equity 50% 37.4% 40% 32.3% 30% 20% 10% 14.7% 11.5% 0% -10% -11.1% -20% -22.1% -30% Large Company Stocks Private Equity Highest Return Average Return Lowest Return Source: Cambridge Associates, Standard & Poor’s, Ibbotson Associates, MainStreet Advisors Research 2008,Total Returns for the period1987-2007 [MainStreet Advisors Alternative Investments page 13] Analysis of each alternative investment has led to the conclusion that adding each independently brings diversification benefits to a traditional portfolio. The chart illustrates the value of the 100S Portfolio (100% domestic large company stocks), the 50S/50B Portfolio (50% domestic large company stocks and 50% domestic intermediate term bonds), and the Efficient Balanced Portfolio (36% domestic intermediate term bonds, 35% domestic large company stocks, 5% foreign stocks, 5% domestic small company stocks, 5% domestic mid sized company stocks, 5% hedge funds, 3% private equity, 3% commodities, and 3% real estate). The chart illustrates that over the last ten years, a period where large company stocks were down 30% of the time, an investment in the Efficient Balanced Portfolio produced better results with lower volatility. Just adding domestic intermediate term bonds reduced the volatility and increased the return over the 100S Portfolio. [page 14 MainStreet Advisors Alternative Investments] The Efficient Balanced Portfolio didn’t have the same upside potential or downside risk. In 2003, domestic large company stocks were up 28.7% while the Efficient Balanced Portfolio was up only 20.3%. However, the portfolio captured value when domestic large company stocks were falling. In 2002, domestic large company stocks fell 22.1% while the Efficient Balanced Portfolio fell just 4.5%. Over the ten year period, the portfolios generated the following results: 100S Portfolio Standard Deviation Geometric Return 17.3% 5.9% 50S/50B Portfolio 7.8% 6.3% Efficient Balanced Portfolio 8.3% 7.5% Including Alternative Investments in traditional portfolios of stocks and bonds shifts the opportunity set of risk/ reward upward. This shift in the efficient frontier implies that for the same level of risk, historical portfolios earn more return. Alternatively, the shift implies that for the same level of return, historical portfolios assumed less risk. $100,000 Invested in 100S Portfolio vs. 50S/50B vs. Efficient Balanced Portfolio $250,000 $200,000 $150,000 100S Portfolio 50S/50B Portfolio Efficient Balanced Portfolio $100,000 Source: Dow Jones AIG Commodity Index, CSFB/Tremont Hedge Fund Index, National Association of Real Estate Investment Trust (NAREIT), Cambridge Associates, Ibbotson Associates, MainStreet Advisors Research 2008, Total Returns for the period 1998-2007, 50S/50B Portfolio and Efficient Balanced Portfolio rebalanced annually $50,000 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 [MainStreet Advisors Alternative Investments page 15] The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. This presentation is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon the client’s investment objectives. The portfolio risk management process and the process of building efficient portfolios includes an effort to monitor and manage risk, but should not be confused with and does not imply low or no risk. Traditional and Efficient Portfolio Statistics include various indices that are unmanaged and are a common measure of performance of their respective asset classes. The indices are not available for direct investment. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed, and a loss of principal may occur. Investing for short periods may make losses more likely. The opinions expressed are those of MainStreet Advisors. This information is subject to change at any time, based on market and other conditions. The information presented has been obtained with care from sources believed to be Reliable, but is not guaranteed. Member and/or officers may have material ownership interest in investment mentioned. Any investments purchased or sold are not deposit accounts and are not endorsed by or insured by the Federal Deposit Insurance Corporation (FDIC), are not obligations of the Bank, are not guaranteed by the Bank or any other entity and involve investment risk, including possible loss of principal. MainStreet Advisors and “Bank” are independently owned and operated. MAINSTREET ADVISORS 120 N LASALLE, 33RD FLR CHICAGO, IL 60602 312.223.0270 MAINSTREETADV.COM