Hedge Funds, Expensive Beta, Low-Cost Alpha Replication is Better

Transcription

1 Hedge Funds, Expensive Beta, Low-Cost Alpha Replication is Better May 23, 2016 by Maneesh Shanbhag Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives. Hedge fund returns, like most strategies, are a combination of market risk (beta) and manager specific risk (alpha). Depending on an investor s goals with a hedge fund investment, high risk-adjusted return or diversification, replicating the hedge fund in order to avoid the detrimental effects of high fees is better than a direct investment. For investors seeking high risk-adjusted returns, or alpha, many top managers can be copied sufficiently well. This is because one only needs to know their largest positions with some timeliness (most managers provide more than enough of both with monthly and quarterly reporting). If one has high confidence that a top performing hedge fund manager will repeat their outperformance in the future, replicating the manager s portfolio should outperform their net-of-fee return. We review a formula that can be used to determine whether one can successfully replicate a manager. Alternative beta exposure, for diversification, is the other common reason for investing in hedge funds. Investors hope the beta from strategies such as trend-following and event-driven trading diversifies their stock and bond allocations even if their returns may be in line with these traditional asset classes. We show how to replicate many alternative betas using only a few publicly traded asset classes. This begs the question of whether alternative betas should be diversifying to stocks and bonds in the first place. We would argue not and, therefore, the only potential benefit of hedge fund investing in the first place is high alpha potential, which is extremely difficult to achieve. Mind your alphas and betas Following the dot-com collapse in equity prices, hedge funds were pitched as the solution to market volatility, sold as having the ability to generate high returns in any market environment and thus worthy of their 2 & 20 fee structure. After failing to deliver on this promise of high returns, the industry has pivoted, claiming hedge funds are a diversifier to traditional assets. This too has proven false. The chart below shows how a passive portfolio of stocks and bonds tracked the broad index of hedge funds with more than 80% correlation over the last decade. The hedge fund industry, with over $3 trillion under management, has become the market. Page 1, 2018 Advisor Perspectives, Inc. All rights reserved.

2 Hedge funds is the HFRI. Replication is 50% MSCI World, 20% Barclays US Treasury Index, 30% T- Bills. Source: Bloomberg. Data from Jan to Dec Hedge fund returns, like all strategies, can be separated into their component drivers of return: Total Return = Risk-Free Rate + Beta (buy and hold market risk) + Alpha (skill-based return) From the chart above we can see that a broad index of hedge funds delivers no skill-based return both portfolios earned 2.9% annualized over cash since January When we dissect how much of the hedge fund return is driven by beta risk versus alpha risk (tracking error), it is mostly beta, as illustrated in the pie chart below. While the 21% alpha risk may seem low to some since hedge funds are supposed to be all alpha, this number actually looks high to us. Page 2, 2018 Advisor Perspectives, Inc. All rights reserved.

3 Tracking error is HFRI minus Greenline s beta replication portfolio. Alpha is assumed to have 0 correlation to the beta replication in calculating the alpha risk share. Alpha risk on its own does not equate to outperformance as we can see; rather, it is often only the tracking error versus a selected passive benchmark. This serves as a reminder that beating markets is very difficult and few will achieve it over the long run. Those who over-diversify while paying high fees certainly are not likely to earn alpha and will, in turn, lag passive benchmarks by approximately their total fee. But this does not mean hedge funds should be completely disregarded. We separately discuss their beta and potential for alpha, and how we would go about replicating each piece more cost effectively. First a review of the characteristics of betas and alphas. There are two primary reasons to select an investment other than a passive index fund: 1. Higher risk-adjusted returns 2. Diversification potential Market risk, beta, like buying a passive equity index fund, should offer moderate risk-adjusted returns to compensate investors for taking risk, but no higher given the ease with which all investors can earn this return. If everyone could easily earn high returns, then we would all be rich. Most betas are also linked to similar risk factors, namely shifts in economic growth and inflation. With common risk factors, there is limited ability for diversification among betas. This logic should apply to alternative betas, as we will show. A single investment with both desirable characteristics, high return and diversification, can only be driven by skill, which we call true alpha. True alpha is determined by the skill, insight and disciplined process of a manager. By definition, skill is rare because markets are a zero sum game (and negative Page 3, 2018 Advisor Perspectives, Inc. All rights reserved.

4 sum after fees). True alpha can have much higher risk-adjusted returns than beta because of its rarity and also more diversification potential if it is driven by unique manager skill. Below we analyze how to separately replicate the alphas and betas embedded in hedge fund. Hedge fund alpha replication: A formulaic approach We have already explained why alpha is hard to earn and especially over long periods of time. Therefore, the word replication, implying easy or low cost, should not be consistent with the definition of alpha. Take this as fair warning as to the difficulty in outperforming by simply copying others. This being said, we should be able to create a logical framework for what strategies and managers we can copy and expect to increase the odds of earning higher risk-adjusted returns. The expectation with replicating a manager is simple: if they are good and we can copy them accurately, we should earn even higher returns than a direct investment with the manager by avoiding their high fees. In order to replicate a manager, we need transparency into their positions delivered in a timely manner. If we cannot get full transparency into a manager s holdings in real time, this does not mean we cannot closely replicate their performance. As long as one can replicate a large enough portion of their holdings so as to overcome the fee hurdle, then replication should be superior to investing directly with the manager. Through a thought experiment, we develop a logical framework that managers should be able to replicate successfully. We think there should be a trade-off between: 1. Fraction of portfolio that is transparent and fees paid as percentage of expected return For a manager earning 10% per year and charging a 2% management fee plus 20% on performance, their net of fees expected return is 6.4% (10% 2% management fee 20% x 8% of the remaining return = 6.4%). In this case, the investor keeps 64% of the gross return, which will vary with fee structure and expected return. If we cannot replicate a manager s entire portfolio, then how much is sufficient to at least match their net of fee alpha? If we assume all positions equally contribute to return, then we should only need to replicate enough of their portfolio to outperform their net of fee returns. If net of fees return is 64% of their gross return as in our example above, then we should have to replicate at least 64% of the portfolio. In practice, all positions are not equally weighted nor contribute equally to portfolio return. Furthermore a manager s highest conviction ideas get the largest weights and are also expected to earn proportionally more than the smaller positions. Mathematically, using the Herfindahl index, we can show that a 50 stock portfolio with half its weight in the largest 10 names is similar in diversification to a portfolio of 25 equally weighted stocks. Therefore we should be able to replicate less than 64% of the portfolio by at least a factor of 2 if most of our replication is of their highest conviction positions in this 50-stock portfolio example. Mathematically, we can say that, over time, replication should earn more than investing with the manager if: % of portfolio not replicated < % of return paid in fees Page 4, 2018 Advisor Perspectives, Inc. All rights reserved.

5 Furthermore, we can divide the % of portfolio not replicated by 2 for many managers given the likely concentration in their top ideas. 2. Time lag of position reporting divided by average holding period and fees paid as a percentage of expected return Since we cannot get immediately transparency into positions when a manager places a trade, how much lag in reporting positions still allows for successful replication? Said another way, with a given time lag when position data is reported relative to when a manager puts on their position, what is the maximum turnover a manager can have to allow for successful replication? To understand this, we show a thought experiment illustrating the trading of the perfect manager to arrive at an upper bound for turnover. The chart below shows what happens to the returns of a portfolio before, during and after the perfect manager holds it. The perfect manager initiates a position just as it begins making money and exits at the top. To further simplify, let s assume the portfolio makes its expected return at a linear rate over its holding period. This way, we can estimate the lost return from entering the same positions at a later time than the perfect manager. In this stylized example, we can see how much return is lost by implementing the manager s portfolio with a time lag. Assuming, again, the standard 2 & 20 fee for a manager earning 10% per year, as long as the time lag between the manager initiating a position and it being reported (and copied) is less than 36% (% of return paid in fees in the example above) of the manager s average holding period, then replication should outperform the net of fee returns. Said another way, if this manager had an average holding period of 12 months, as long as we can implement this portfolio less than 131 days of the manager doing so, then replication should outperform. In practice, we get transparency more frequently. With equity managers, they must report their positioning to the SEC within 45 days of each quarter-end. Managers of other strategies often give sufficient transparency into their top holdings in monthly reports and quarterly letters to also facilitate replication. Mathematically, with lag, we can say that replication should be successful when: Page 5, 2018 Advisor Perspectives, Inc. All rights reserved.

6 Reporting lag / Holding Period < % of return paid in fees Similarly as with the fraction of the portfolio we replicate, we can divide by a factor of 2 the Reporting lag / Holding Period to remove some conservatism because markets do not behave linearly nor do managers consistently catch the tops and bottoms of trades. We can now combine the fraction of portfolio factor and reporting lag factor to estimate whether replication for a given manager should be successful or not with the following formula: [ % of portfolio not replicated + Reporting lag / Holding Period ] / 2 < % of return paid in fees Next, we look at a few examples of actual managers we have replicated and how our formula applies in each case. We do not disclose the individual manager names, but the studies are based on real managers and their actual returns and holdings information. Hedge fund alpha replication: Manager replication examples We start with a large, well-known activist investor, whom we will call Manager 1 because this style of investing generally translates into concentrated portfolios of a few positions with long holding periods. From their 13F fillings, Manager 1 usually holds positions with typically 80% of their capital in their top 10 holdings. Furthermore, as activists they tend to have long holding periods of at least 3 years. Let us assume that all of their holdings are in U.S. companies, which are reported in SEC 13F filings with a 45 day lag after the end of each quarter. For a portfolio like this, we should be able to replicate 100% of their portfolio with a short lag relative to their average holding period. For our example, we assume their fee is 2 & 20 with an expected return of 15%. Applying our formula: % of portfolio not replicated = 0% Reporting lag / Holding Period = 45 days / 3 years or 1095 days = 4.1% % of return paid in fees = 2% management fee + [20% x (15%-2% mgmt fee)] = 2.6% performance fee = 4.6% / 15% = 30.7% 0%/ %/2 = 2.1% < 30.7% YES, replication should outperform Our formula suggests we should be able to handily outperform Manager 1 s net of fee returns through replication. The chart below compares our replication results to their gross and net of fee returns over the last 5 years. Our replication strategy is to exactly copy their 13F filings on the day they are released (45 day lag). As expected for a manager with long holding periods, our replication strategy would have roughly matched their gross returns and saved the investor over 5% in fees per annum. Page 6, 2018 Advisor Perspectives, Inc. All rights reserved.

7 Activist funds are well suited for replication since they are primarily long-only and long term holders of equities. Below we analyze another manager who has been successful over the past decade using a different approach. Manager 2 is large long/short manager for whom their largest position until mid 2015 was Valeant Pharmaceuticals. Manager 2 also offers a long-only fund, which is what we attempt to replicate. This manager has a growth and quality bias, some international exposure (we assume 20% on average) and nearly 100% annual turnover in their portfolio. For the sake of example, we assume their fee structure is lower than for the average hedge fund, at 1% + 20% of returns above the S&P 500. We assume their expected outperformance is 5% annually. Applying our formula for Manager 2 gives:source: Bloomberg, Greenline Partners analysis. Data from Nov 2010 to Aug There is a potential for loss, as well as gain that is not reflected in the hypothetical information portrayed. The hypothetical performance results shown do not represent the results of actual trading using client assets but were achieved by means of the retroactive application of a model designed with the benefit of hindsight. Investors should carefully review the additional information presented by Greenline Partners as part of any hypothetical comparison. % of portfolio not replicated = 20% (non US positions not reported to SEC) Reporting lag / Holding Period = 45 days / 365 days = 12.3% % of return paid in fees = 1% management fee + [20% x (5%-1%)] = 0.8% performance fee = 1.8% / 10% = 18% 20%/ %/2 = 16.2% < 18% YES, but barely. Replication may produce similar results to manager net of fees Our formula suggests that our replication should roughly match Manager 2 s net of fee results. This is in part driven by their lower effective fee than for the average hedge fund. Keep in mind that our formula is meant to serve as a conservative estimate while in reality many managers that do not meet our criteria should still be replicable. As we can see in the chart below, our replication of Manager 2 matches their net of fee returns in spite of them having high turnover and a significant book of Page 7, 2018 Advisor Perspectives, Inc. All rights reserved.

8 international positions. Finally, we will review one more manager to show replicating a partial portfolio. Below we review a $20ln long/short global manager, Manager 3. Manager 3 has a growth bias with high turnover (near 100%) and some international exposure. Historically, based on their 13F fillings, Manager 3 has held around 50% of their capital in the top 10 holdings. Hence we compare replicating only the top 10 versus their full portfolio. Let us again assume a 2 & 20 fee structure and 15% expected return. Applying our formula to Manager 3 for a full replication versus only for their Top 10 positions:source: Bloomberg, Greenline Partners analysis. Data from Nov 2010 to Mar There is a potential for loss, as well as gain that is not reflected in the hypothetical information portrayed. The hypothetical performance results shown do not represent the results of actual trading using client assets but were achieved by means of the retroactive application of a model designed with the benefit of hindsight. Investors should carefully review the additional information presented by Greenline Partners as part of any hypothetical comparison. Top 10 only replication: % of portfolio not replicated = 50% (50% held outside of top 10 positions, remaining assumed to be U.S. only for simplicity) Reporting lag / Holding Period = 45 days / 365 days = 12.3% % of return paid in fees = 4.6% / 15% = 30.7% 50%/ %/2 = 31.2% < 30.7% NO, but close. Replication may produce results close to manager net of fees Full portfolio replication: % of portfolio not replicated = 20% (only international positions excluded) Page 8, 2018 Advisor Perspectives, Inc. All rights reserved.

9 Reporting lag / Holding Period = 45 days / 365 days = 12.3% % of return paid in fees = 4.6% / 15% = 30.7% 20%/ %/2 = 16.2% < 30.7% YES, replication should outperform The chart below shows that Manager 3 can be successfully replicated using either the top 10 positions or the full portfolio, both of which historically outperformed their net of fee returns. The table below of Manager 3 s net returns shows that either replication would have consistently outperformed. Source: Bloomberg, Greenline Partners analysis. Data from Jan 2009 to Dec There is a potential for loss, as well as gain that is not reflected in the hypothetical information portrayed. The hypothetical performance results shown do not represent the results of actual trading using client assets but were achieved by means of the retroactive application of a model designed with the benefit of hindsight. Investors should carefully review the additional information presented by Greenline Partners as part of any hypothetical comparison. In this example, we can see how the high conviction positions drive effectively all of the returns for Manager 3. We expect this to be similar for many good managers. While our formula is not meant to be precise, it can be used to inform replication strategy. For example, with Manager 3, our replication formula suggests that it should be more reliable to go with full portfolio replication on a forward looking basis as it provides a greater margin of safety. Our formula is purposely conservative but allows one to make educated assumptions around how transparency and portfolio turnover factor into which hedge funds we should be able to replicate successfully. For this analysis we have only looked at equity managers because of the ease of obtaining their Page 9, 2018 Advisor Perspectives, Inc. All rights reserved.

10 holdings information through public fillings. One can also replicate managers of other asset classes including fixed income, futures and OTC derivatives, given periodic transparency into their holdings. A token direct investment with the purpose of receiving position reporting would be sufficient to then replicate and outperform the manager net of fees. Beyond just return, the other benefits of replication over direct investment are: 1. Daily liquidity (no lock ups, gates, etc.) 2. Control 3. Full transparency 4. Tax efficiency if relevant (e.g., incorporate tax loss harvesting) There are pitfalls to replication as well that one should be aware of before embarking in this direction, which we discuss next. Shortcomings with hedge fund alpha replication The benefits of replicating hedge funds versus investing in them directly are the higher returns that result from significantly lowering fees. Beyond the performance of their portfolio, we think there are potential benefits from investing directly with a talented manager: 1. Understanding why you own what you own 2. Learning from the manager s research, which could benefit your broader portfolio First, we have all heard the investing advice to know what you own. We think hedge fund replication is no exception to this rule. With any good manager, there will inevitably be periods of underperformance between periods of outperformance. Our discipline to stick with a manager will be tested during the period of underperformance, and one needs to deeply understand their investment process, its risks and signs that it is broken in order to make a quality decision about when to stop replicating. This decision may be made more confidently with direct access to the manager. Second, having access to a manager should be educational and drive learnings in your thinking that can benefit your broader portfolio. If not, the manager is likely not one of the best in their field. The hope is these learnings are applicable to your broader portfolio, which could yield a benefit worth far more than the fees paid on a token direct investment. Note that to capture these portfolio level benefits, one needs to be highly engaged with this top manager, which likely means only having a few such deep relationships. Note that both of these potential shortcomings with replicating a manager versus investing directly can be overcome by making a minimum investment or buying a curated list from a consultant to gain access to the transparency, research and thought process and then replicating their strategy at the appropriate size. Hedge fund beta replication Switching gears to the beta side of hedge fund replication. Beta is simply the market return anyone can Page 10, 2018 Advisor Perspectives, Inc. All rights reserved.

11 earn through a simple and easily replicable strategy. Anyone can buy an S&P 500 index fund to achieve equity market returns without any skill. And those who follow this approach in a disciplined manner through up and down markets tend to outperform most other investors. Simple and easily replicable rules also apply to other strategies such as value investing (e.g. buy low P/E stocks) and alternatives such as merger arbitrage (e.g., naively buy the acquiree and short the acquirer). As we have discussed in previous papers (most recently Bond-like Stocks, and Stock-like Bonds, Dec. 2015), we believe most asset class betas can be replicated using a combination of the primary asset classes: equities, interest rates and commodities. This is because each of these asset classes respond uniquely to shifts in growth and inflation, the primary risk factors and together can replicate any exposure to these risk factors. If we can fundamentally understand the biases embedded in a strategy, then we should be able to find a replicating mix of primary asset classes to closely match it. Hedge fund beta is no exception. We start with a simple example, long/short equity managers. We can infer from the long/short equity return stream that in aggregate these managers are net long ~50% (e.g., long 100%, short 50% of their capital). Therefore, our simple replication strategy is long 30% S&P % Russell 2000 Value Index to give us the target equity exposure with a value tilt since hedge funds tend to systematically favor value over growth investing. As you can see in the chart below, the replication tracks the Hedge Fund Research index of long/short managers with over 90% correlation. Source: HFRI, Bloomberg, Greenline Partners analysis As a second strategy, distressed debt is seen as a potentially diversifying exposure in addition to offering the potential for high returns due to its illiquid and idiosyncratic nature. First, we do not believe illiquidity on its own means an asset should be diversifying. Private equity is not diversifying to equities as it is just owning illiquid businesses. Distressed debt can be thought of as lower quality than junk bonds or having an even more equity like nature than junk. Therefore, we replicate the asset as part equity risk and part high yield bonds. This simple two asset class replication is 81% correlated to the universe of distressed debt hedge funds. Furthermore, this shows that distressed debt is mostly just equity risk and hence should not be diversifying to public equities. Page 11, 2018 Advisor Perspectives, Inc. All rights reserved.

12 Source: HFRI, Bloomberg, Greenline Partners analysis We look at one more class of hedge fund strategies, event driven investing. Event driven strategies attempt to take advantage of pricing inefficiencies after corporate events such as mergers, spinoffs and bankruptcies. For example, one could replicate merger arbitrage funds by going long the stock of all acquirees and shorting the stock of acquirers. Another proxy for such corporate events is the performance of convertible debt. This type of debt should deliver equity upside if certain conditions for convertibility materialize (exit from bankruptcy, improving balance sheet, etc.) otherwise a payout with a debt-like profile. The downside risk on convertibles is much more equity like than the name would suggest since not meeting the specified financial conditions can trigger a negative credit event, including bankruptcy. We replicate event driven hedge funds with a delevered exposure to the Barclays US Convertible Bond index. The resulting replication has an almost 90% correlation with event driven hedge funds. Source: HFRI, Bloomberg, Greenline Partners analysis Page 12, 2018 Advisor Perspectives, Inc. All rights reserved.

13 If we look across the replication charts above, we can see two things: First, they all zig and zag together, implying a similar equity-like risk embedded in all of these strategies. And second, our passive replications have performed better over the last decade in spite of the selection bias in hedge fund indices, as hedge fund assets have grown and the relevant asset classes have become more efficient. In spite of the fancy strategy names, there is no fundamental diversification across these strategies and no easy alpha available. Above are just a few examples of how we would replicate hedge fund beta. We have also included more examples of hedge fund strategy replications in the Appendix of this paper. Given the ease with which we can replicate hedge fund beta using liquid, public market asset classes, it should come as no surprise that there are already ETFs that attempt to replicate hedge fund beta. One example is Index IQ s Hedge Multi-Strategy tracker (ticker: QAI). This fund had 116 holdings across at least a dozen asset classes and styles as of January 31, 2016 and uses a statistically driven process to match the beta exposures in the HFR Fund Weighted Composite Index. The result of their unnecessarily complex replication methodology is shown in the chart below. The results do not track the HFRI as well as our simple global stocks and Treasuries replication. Simple replication is 50% MSCI World ETF (ticker: URTH), 20% US Treasury ETF (ticker: GOVT), 30% 3 Month US T-Bills backfilled with index data prior to ETF inception in Feb Source: Bloomberg, Greenline Partners analysis. Data from Mar 2009 to Dec Aside from reinforcing the K.I.S.S. (keep it simple, stupid) rule, the take away is that most hedge fund beta can be simply replicated using 1-2 public market asset classes and, therefore, should not be diversifying to the traditional asset classes that we use to replicate them. We will let you draw your own conclusions as to the usefulness of hedge fund beta in a portfolio. Page 13, 2018 Advisor Perspectives, Inc. All rights reserved.

14 Conclusion Prior to the 1970s, active stock and bond management was the only way to buy a diversified portfolio of securities. Net of fees, the average manager underperformed the S&P 500 and most of their returns were driven by the market, not their skill. The invention of the index fund in 1972 gave investors a low cost way to earn the market return. Hedge funds have reached a similar point in their lifecycle where it has become well known that the industry as a whole does not outperform market averages. Hedge fund replication is the same innovation as index funds were over 40 years ago. Like with index funds, a thoughtful replication of a manager should outperform net of their fees. In general, we do not recommend investing in hedge fund strategies. Paying the high fees involved ignores the extremely competitive nature of capital markets and how this puts the odds of earning adequate returns against you. Replicating a manager or strategy, as a starting point to avoid high fees, is a way to put the odds back in your favor. Maneesh Shanbhag is co-founder of Greenline Partners and is responsible for the investment process. Greenline Partners is an asset management and advisory firm focused on constructing unlevered, cost and tax-efficient portfolios across multiple asset classes. We work with a range of investors including foundations, endowments, family offices and wealth advisors as both an investment manager and advisor. The firm was founded by alumni of Bridgewater Associates, who served on the firm s investment team and acted as lead advisors on asset allocation, liability management, risk budgeting and manager selection for leading institutional investors including pension funds, endowments, foundations and family offices. Greenline Partners is headquartered in New York, NY with offices in Seattle, WA. For more information, please visit or info@glinepartners.com. Appendix: Hedge fund beta replication strategies We analyzed various hedge fund strategies based on the data published by Hedge Fund Research, Inc (HFRI). The results of replicating each strategy with simple combinations of one or two cheaply available market risk premia is shown below. Note that most hedge fund indices have a selection bias that boosts their reported return and has been documented in academic papers but is outside the scope of this paper. In spite of this, our replications using public market indices outperform most hedge fund indices over the past decade. All data is from January 2000 to December 2015, obtained from Bloomberg. 1. HFRI Fund Weighted Composite Replicated using 50% delevered S&P 500 with 87% correlation. Page 14, 2018 Advisor Perspectives, Inc. All rights reserved.

15 2. HFRI Equity Market Neutral funds: Replicated using a mix of 20% long Russell 2000 Value and short 5% S&P 500 with 67% correlation. 3. HFRI Equity Fundamental Value funds: Replicated using 50% delevered Russell 2000 Value with 95% correlation. Page 15, 2018 Advisor Perspectives, Inc. All rights reserved.

16 4. HFRI Equity Sector Energy/Materials Funds: Replicated using a mix of 60% Energy sector/20% Materials sector/20% cash allocation with 80% correlation. 5. HFRI Equity Sector Technology/Healthcare funds: Replicated using 50% Technology sector with 95% correlation. 6. HFRI Equity Short Bias funds: Replicated with a 100% short S&P 500 position with 85% Page 16, 2018 Advisor Perspectives, Inc. All rights reserved.

17 correlation. 7. HFRI Global Macro funds: Replicated using a mix of 25% Commodity futures + 25% Currency carry (long high yield currencies/short low yielding currencies) with 46% correlation. 8. HFRI Macro Commodities funds: Replicated using a mix of 35% Commodity futures overlayed with a 6-month moving average trend following strategy with 73% correlation. Page 17, 2018 Advisor Perspectives, Inc. All rights reserved.

18 9. HFRI Macro Currency funds: Replicated using a 50% de-risked exposure to the US Dollar trend following index based on a 6-month moving average, with 41% correlation. 10. HFRI Fixed Income Relative Value funds: Replicated using a mix of 65% High Yield debt/35% cash with 90% correlation. Page 18, 2018 Advisor Perspectives, Inc. All rights reserved.

19 11. HFRI Emerging Market funds: Replicated using 50% delevered MSCI Emerging Market equities index with 96% correlation. DISCLOSURES: The information contained herein is the property of Greenline Partners, LLC and is circulated for information and educational purposes only. There is no consideration given for the specific investment needs, objectives or tolerances of any of the recipients. Additionally, Greenline's actual investment positions may, and often will, vary from its conclusions discussed herein based upon any number of factors, such as client investment restrictions, portfolio rebalancing and transaction costs, among others. Reasonable people may disagree about a variety of factors discussed in this document, including, but not limited to, key macroeconomic factors, the types of investments expected to perform well during periods in which certain key economic factors are dominant, risk factors and various assumptions used. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This report is not an offer to sell or the solicitation of an offer to buy the securities or instruments mentioned. HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS: Hypothetical or simulated results are subject to inherent limitations and do not represent actual trading or the costs associated with managing a portfolio. The hypothetical or simulated results shown have been achieved through the retroactive application of a back-tested model designed with the benefit of hindsight. Unless otherwise indicated, results shown are gross of fees, include the reinvestment of interest, gains and losses, and do not take into account the reduction of any management fees, costs, commissions, or other expenses that may be associated with the implementation of a portfolio. The individuals involved in the preparation of this document receive compensation based on a variety of factors, including individual and firm performance. Additional information about Greenline Partners, LLC, including fees charged, is located in Greenline s Form ADV, which is accessible at Greenline s CRD Number is Page 19, 2018 Advisor Perspectives, Inc. All rights reserved.

20 Past performance is not a guarantee of future results. Forward-Looking Statements and Opinion: Certain statements contained in this presentation may be forward-looking statements that, by their nature, involve a number of risks, uncertainties and assumptions that could cause actual results or events to differ materially, potentially in an adverse manner, from those expressed or implied herein. Forward-looking statements contained in this presentation that reference past trends or activities should not be taken as a representation that such trends or activities will necessarily continue in the future. Greenline Partners undertakes no obligation to update or revise any forward looking statements, whether as a result of new information, future events or otherwise. Opinions offered herein constitute the judgment of Greenline Partners, as of the date of this presentation, and are subject to change. You should not place undue reliance on forward-looking statements or opinions, as each is based on assumptions, all of which are difficult to predict and many of which are beyond the control of Greenline Partners. Greenline Partners believes that the information provided herein is reliable; however, it does not warrant its accuracy or completeness. Information presented herein (including market data and statistical information) has been obtained from various sources which Greenline Partners, LLC considers to be reliable including but not limited to the Federal Reserve, International Monetary Fund, National Bureau of Economic Research, Organization for Economic Co-operation and Development, United Nations, US Department of Commerce, World Bureau of Metal Statistics as well as information companies such as BBA Libor Limited, Bloomberg Finance, L.P., Global Financial Data, Inc., Hedge Fund Research Inc., Markit Economics Limited, Moody's Analytics, Inc., MSCI, Standard and Poor's, and Thomson Reuters. However, Greenline Partners, LLC makes no representation as to, and accepts no responsibility or liability whatsoever for, the accuracy or completeness of such information. Greenline Partners, LLC has no obligation to provide recipients hereof with updates or changes to such data. All projections, valuations and statistical analyses are provided to assist the recipient in the evaluation of the matters described herein. They may be based on subjective assessments and assumptions and may use one among alternative methodologies that produce different results and, to the extent that they are based on historical information, they should not be relied upon as an accurate prediction of future performance. This material is not intended to represent a comprehensive overview of any law, rule or regulation and does not constitute investment, legal, or tax advice. You should exercise discretion before relying on the statements and information contained herein because such statements and information do not take into consideration the particular circumstances or needs of any specific client. Accordingly, Greenline Partners, LLC makes no representation or warranty as to the accuracy of the information contained herein and shall have no liability, howsoever arising to the maximum extent permitted by law, for any loss or damage, direct or indirect, arising from the use of this information by you or any third party relying on this presentation. The information contained in this document is current as of the date shown. Greenline Partners has no obligation to provide the recipient of this document with updated information or analysis contained herein. Additional information regarding the analysis shown is available upon request, except where the Page 20, 2018 Advisor Perspectives, Inc. All rights reserved.

21 proprietary nature precludes such dissemination. This material is furnished on a confidential basis only for the use of the intended recipient and only for discussion purposes, may be amended and/or supplemented without notice, and may not be relied upon for the purposes of entering into any transaction. No part of this document or its subject matter may be reproduced, disseminated, or disclosed without the prior written approval of Greenline Partners, LLC. Page 21, 2018 Advisor Perspectives, Inc. All rights reserved.