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