Alternative Investments for Fiduciaries John Fidler Commonwealth Bank amp Trust Why Diversify Diversification is protection against ignorance It makes little sense if you know what you are doing ID: 782198
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Slide1
Who’s afraid of diversification?
Alternative Investments for FiduciariesJohn Fidler – Commonwealth Bank & Trust
Slide2Why Diversify?
“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
– Warren Buffett
Slide3FOMO...
HALF
of US mutual funds own AMZN (23% own NFLX)*
*As of 3/31/2018, percentages based on US equity mutual fund universe tracked by BAML
Slide4Why Diversify?
“Diversification is the only rational deployment of our ignorance.”
– Peter Bernstein
Slide5“I skate to where the puck is going, not where it has been.”
– Wayne Gretzky
Slide6What are Alternatives?
Catch-all category
Traditional Asset Managers:
Invest in stocks and bonds
Long only (no shorting)
Alternative Asset Managers:
Ability to invest in any asset classAbility to invest both long and short Potential use of leverage
Risk/return characteristic differ from traditional investments
Slide7Why Alternatives?
Investment alpha:
You can make money doing this
Informational alpha:
Access to world class investors
Diversification:
Returns can have low correlation to the rest of your portfolioLess risk, more return
Smaller drawdownsLower volatilityMore stable portfolios
Principal preservation
Source: JP Morgan Asset Management
Slide8What has worked in investing?
Source: Bloomberg. Indices shown: Reuters-CRB Index, Barclays Global Aggregate, EAFE Index, Credit Suisse Global Macro Index, Philadelphia Stock Exchange Gold & Silver Index, HFR Global Hedge Fund Index, Barclays High Yield Index, S&P 500 Index, HFR Equity Hedge Fund Index, Barclay CTA Index, HFR Merger Arbitrage Index, LPX50 Listed private Equity Index, Dow Jones Equity REIT Index, Russell 2000 Index.
8
Slide9Returns during market crises...
Crisis Periods: 1994 Surprise Fed Rate Hike (Feb-June 1994), 1998 LTCM Collapse (Jul/Aug 1998), Tech Bubble (March 2000-Sept 2002), 9/11 Attacks (Sept 2001), Global Financial Crisis (Oct 2007-March 2009). Source: Bloomberg
9
Slide10Universe of Alternative Strategies
Source: Hatteras Funds
Liquidity varies widely by strategy type
STRATEGY
ASSET
EXAMPLE
Global Macro
Managed Futures
Long/Short Equity
Market Neutral Equity
Short Selling
LEVEL
1
Active markets
Verifiable daily pricing
Stocks
Currencies
Commodities
REITs (public)
BDCs (public)
Merger Arb
Multi-Strategy
Relative Value
Fixed Income Arb
Long/Short Credit
LEVEL
2
No regular market pricing
Fair value based on OTC prices
Corporate bonds
Municipal bonds
Interest rate swaps
CMBS
Activist
Private
Equity Buyout
Distressed
Venture Capital
Private Real Estate
LEVEL
3
Non-exchange traded
Most unobservable
Private companies
Non-traded REITs/BDCs
Distressed
securities
More liquid
Less liquid
Slide11Debunking Myths
“Hedge funds” is not an asset class
A fund is a legal structure, not an investment strategy
Hedge funds are used to build a diversified portfolio, not to collectively beat an arbitrary benchmark in perpetuity
All managers are not created equal
Dispersion is bigger among alternative asset managers than traditional ones
Manager expertise and investor access matter
FeesDon’t look in someone else’s pocket: NET returns are what matters, not gross fees
That said, there’s rarely any reason to pay 2/20,
everything is negotiable
Slide12Manager Selection Matters
Source: JP Morgan
The case for indexing & ETFs in long-only:
Difference between best & worst traditional mutual fund managers is very small
The challenge of alts:
Difference between best and worst alternative asset manager is huge
The benefit of alts:
Even the median “Macro” manager adds value
Slide13Why Diversify?
Slide14“Diversification is the only free lunch in finance.”
– Harry Markowitz
Slide15Crisis Alpha
Source:
SocGen
, CSI, CB&T Estimates
Slide16Fiduciary Approach
Biggest diversification bang for allocation buck
Within alternatives, Commonwealth focuses primarily on
quant macro
and
managed futures
strategies, which inherently benefit and diversify traditional portfoliosCrisis Alpha
LiquidSystematic
Source:
SocGen
, CSI, CB&T Estimates
% of months SG CTA is positive when S&P is negative: 51%
Average SG CTA return in S&P down months: +0.5%
Average SG CTA return in 10% of worst S&P months: +1.9%
Slide17Impact of Fiduciary Structured Alpha on a Traditional Portfolio
Stats
Traditional
Portfolio
Enhanced
Portfolio
Impact of
Managed Futures
Annualized Return
6.5%
6.4%
Similar
returns (even during massive equity bull market)
Annualized Volatility
6.6%
5.4%
Less volatility
Largest Monthly Drawdown
7.2%
5.1%
Smaller drawdowns
Sharpe Ratio
0.99
1.20
Higher
risk-adjusted returns
Monthly data, January 2012 through June 2018, Investment Grade Bonds = Barclays Global Aggregate Total Return Index (Unhedged). US Large Cap stocks = S&P 500 Index. US Small Cap Stocks = Russell 2000 Index, Foreign Stocks = EAFE Index. Structured Alpha = Liquid Alpha CTF pro forma returns. December 2017 performance estimated through December 11. Sources: Bloomberg, CB&T Estimates
17
Slide18Managed Futures Value Proposition
Equity-like returns
Half the volatility of equities
Low historical correlation to equities, especially evident in market stress periods
Source:
Societe
Generale
, CSI
18
Slide19Structural Issues with Hedge Fund Investing
19
Structural Alpha: The Fiduciary Approach
High Fees
Cost Effective Structure
“Risky”
Liquidity
Transparency
Control
Inefficient
Limited Liability
Cash/Tax Efficient
Slide20Takeaways
1 – You can make money investing in alternatives
Source:
SocGen
, CSI
Slide21Takeaways
2 – Alternatives can make money when traditional asset classes are losing money
Source:
SocGen
, CSI,
Systematica
Slide22Takeaways
3 – Structure matters: Solutions exist for all investors to efficiently access these strategies
INVESTOR
TYPE
VEHICLE
SOLUTION
Non-QEP
Investor
Liquid Alts Mutual Fund
Many options, not many good ones
Revocable
or Irrevocable Trust
Fiduciary Common Trust Fund
Commonwealth only
CTF we are aware of
QEP
Investor
LP Fund
Many multi-manager
funds, not all structured by licensed fiduciaries
Slide23Questions?