The All-in-One Alternative? October 2013

Transcription

1 The All-in-One Alternative? October 2013 Rui de Figueiredo of Morgan Stanley Alternative Investment Partners says alternative investments should be more accessible to mainstream investors When you hear someone say alternative investing, at least a dozen different strategies may come to mind. That daunting complexity scares many suitable investors away from these valuable investments and can also cause many to misuse them, says Rui de Figueiredo, who oversees a group within Morgan Stanley s Alternative Investment Partners (AIP). The group is dedicated to managing customized, multi-asset alternative-investment portfolios on behalf of institutional and high-net-worth investors. It recently launched the AIP Dynamic Alternative Strategies Fund, a daily liquidity mutual fund that seeks to provide investors with a portfolio of alternative options that can complement more traditional holdings. In a recent discussion with Wealth Management s Tara Kalwarski, de Figueiredo explained why alternatives are a prominent feature of the investing landscape today. Tara Kalwarski: What is the chief focus of your research? Rui de Figueiredo: Helping investors enhance the efficiency of their portfolios through thoughtful asset allocation. Fundamentally, the purpose of asset allocation is to create portfolios that are efficient from a risk and return perspective. [With] traditional asset allocation, investors face a relatively limited set of investments that can be used to accomplish their objectives, whether they are conservative or aggressive. What we have done is recognize that this asset-allocation problem requires investors to look at a broader set of opportunities. That is why determining the proper role of alternatives within a portfolio has become so critical for both individuals and institutions. What alternatives provide is a wider range of risk and return types, allowing investors to access not only more attractive opportunities on a standalone basis but also a more diversified set of investments. That, in turn, allows investors to create a more robust portfolio. Ultimately, our goal is to find and manage high-quality investment strategies that are relatively uncorrelated with our clients traditional investments. Kalwarski: What are some of the challenges that must be addressed when seeking to determine the appropriate alternative exposure? de Figueiredo: Alongside the diversification and potential return-enhancement benefits, there are risks and challenges associated with alternative investments. Take hedge funds. One reason they are attractive is because of the active returns, or alpha, that the investment managers seek to generate. These returns are related to the investment strategies of the individual managers--how and when they enter certain markets, how they structure trades and how they decide which securities to buy and sell. In selecting a hedge fund, one needs to discern why the manager has a strong historical track record: Was [the manager] in the right place at the right time by luck? Or actually skillful? It is a challenge to come up with an approach to evaluate different types of risk and still make robust, forward-looking investment decisions that will add value to the portfolio. Another challenge is illiquidity. [Many] alternative investments are relatively illiquid. Private equity and private real estate are two examples and may not be appropriate for all investors. Since not all investors can take on illiquidity,

2 how do you match the many investment types with a very diverse set of investors? What we are essentially providing is a filter that allows investors to take the complex and heterogeneous world of alternatives and cull it to something that focuses on highquality investments in a well-balanced portfolio--a plug and play solution that allows investors to access [some of] the [potential] benefits of alternatives in a structured and thoughtful way. Kalwarski: How is the current economic and market environment shaping the positioning of the AIP Dynamic Alternative Strategies Fund? de Figueiredo: One of the interesting aspects of the investment world today is that we continue to be, in some sense, defined by the 2008 financial crisis. A few features of this recovery may explain why investors are so interested in alternatives. First, the path to recovery from a credit-driven crisis is one with significant deleveraging and adjustments. It s relatively slow and shallow. So things are getting better, but they're getting better at a very measured and inconsistent pace. There are bouts of volatility, partly driven by policy action but also driven by the uncertainty about exactly where the new equilibrium will be established. So investors are facing two aspects of the world that are very different from [what was] in the past: expecting potentially lower returns and increased periods of volatility. What that means is that investors cannot expect either the same level of absolute returns or the same risk-adjusted returns that we've had in the past. Although we view the market and economy as relatively resilient, the value of diversification is greater than ever before and the ability to effectively implement it is more difficult. People talk about how correlations move together in a crisis. But even post crisis we have observed a lack of stability in both volatilities and correlations. We launched the AIP Dynamic Alternative Strategies Fund in an effort to help investors manage these aspects of today s investment environment. Second, we believe investors may encounter risks that up until now have generally not been major concerns: interestrate risk and inflation risk. It is hard to imagine that interest rates will remain where they are today, three or four years from now. Short-term interest rates are at historically low levels globally. And we ve experienced a relatively benign inflation environment for over 20 years. Both of these are likely to change as the loose monetary policy, which has been pursued globally, is fully baked into the economy. Our approach is designed to help investors deal with these two problems by allowing investors to place part of their portfolio in [an] alternative [mutual fund], which may provide some resiliency to these trends in the future. Examples of investments currently in our portfolio along these lines include floating-rate bank loans--which [periodically reset] their nominal yields with higher interest rates or higher inflation--and commodities, which [historically have] moved positively in inflationary environments. Kalwarski: How does the AIP Dynamic Alternative Strategies Fund seek to provide investors with diversification? de Figueiredo: We employ a number of categories of assets that are not traditionally reflected in portfolios. Specifically, we group these into four categories: Pure Alpha, [those] generated through active trading strategies--and often seen in hedge funds--such as security-selection strategies; Expanded Credit, which are credit assets not represented in traditional fixed-income allocations, such as emergingmarket debt or bank loans; Real Assets, such as commodities or listed infrastructure, which are generally linked to inflation; and Discovery Assets, which are innovative asset classes that represent interesting opportunities such as frontier-[market] equity. Each of these tends to be less correlated with traditional assets and may be appealing complements to make portfolios more attractive both in terms of risk and return [potential]. Kalwarski: What are the biggest challenges when it comes to alternative investing? de Figueiredo: Alternatives come in many different flavors and formats, and being able to pick through the universe and build a portfolio can be a challenge. Morningstar's classifications of alternative [mutual funds], for example, include a broad swath of the alternative investment space. These may behave very differently from each other, and are, to be honest, highly varied in terms of quality as well. It may be difficult to understand which [alternatives] are solutions that follow a structured asset-allocation program and which are more specialized or narrow and may not help to diversify a portfolio or improve the risk-adjusted returns. 2

3 Furthermore, for many investors it can also be difficult to effectively monitor, manage and shift the allocations around without the appropriate resources. Take rebalancing as an example. In the traditional world, when you think about tactical asset allocation, it may be confined to fixed income and equity. When you move to alternatives, the range of options expands dramatically. Thus, it becomes very difficult to rebalance portfolios in response to changes in the market environment. Finally, there is the issue of cost. Costs in alternatives are highly varied. In some cases, when investors or advisors do not take a holistic approach, expenses can add up [to the point where] they actually undermine some of the value that a manager is seeking to add. At the AIP Dynamic Alternative Strategies Fund, we are focused on cost efficiency and have sought, wherever possible, to minimize expenses so investors can get [some of] the benefit of alternatives without the excess costs. de Figueiredo: In general, we have tried to create a portfolio that is relatively broad in terms of what categories it accesses. The AIP Dynamic Alternative Strategies Fund is a highly diversified portfolio allocated to a range of strategies; it targets a beta to the equity market of 0.35 or less. And so it should be a good diversifier. We believe that, where appropriate, it may be used as the core component of an investor s alternatives allocation, in much the same way that a broad-based equity fund or a core fixed-income fund is used to access traditional asset classes. Investors can then broaden out their alternatives portfolio as they gain more experience or have specific objectives or constraints that require additional satellite investments. Kalwarski: How does your product address some of these issues? de Figueiredo: First, we have been an investor for a long time in alternatives on a fiduciary basis for both institutional and high-net-worth clients. This means we have been able to start from the perspective of an investor first and foremost, allowing us to focus on a solution designed to achieve what investors are looking for. Hence, we are looking to offer a one-stop solution that provides diversity and delivers it in a package that complements traditional portfolios. Furthermore, our solution is completely open architecture. We source investments, wherever they are and from whoever provides them, based solely on their [perceived] quality. The other major benefit we provide is allowing investors to access new and interesting areas in the investment world. Much of the wealth that has been created in the economy over the last 30 years, both at the individual level and the aggregate macro level, is the result of innovation. It is produced by individuals or organizations scanning the world, looking for differentiated ideas that add value. We emulate that idea by filtering through the new ideas in the investment world on behalf of our clients, seeking to identify the ones that we believe have the potential to provide our clients with beneficial risk/return attributes. We refer to these new ideas as discovery assets. Kalwarski: What role does an alternative fund like this play in an overall portfolio? 3

4 Investors should carefully consider the investment objectives and risks as well as charges and expenses of a mutual fund before investing. To obtain a prospectus, contact your Financial Advisor or visit the fund company s website. The prospectus contains this and other information about the mutual fund. Read the prospectus carefully before investing. The fund s ability to achieve its investment objective depends on the ability of the underlying funds to achieve their investment objectives. There can be no assurance that the underlying funds or the fund will achieve their investment objectives. The cost of this type of investment may be higher than a mutual fund that invests in stocks and bonds only. You should also be aware that some mutual funds employ non-traditional or complex investment strategies and/or derivatives. Examples of these types of funds include those that utilize one or more of the below noted investment strategies or categories or which seek exposure to the following markets: Commodities (e.g., agricultural, energy and metals), Currency, Precious Metals Managed Futures Leveraged, Inverse or Inverse Leveraged Bear Market, Hedging, Long-Short Equity, Market Neutral Real Estate Volatility (seeking exposure to the CBOE VIX Index) Non-traditional investment options and strategies are often employed by a portfolio manager to further a fund s investment objective and to help offset market risks. However, these features may be complex, making it more difficult to understand the fund s essential characteristics and risks, and how it will perform in different market environments and over various periods of time. They may also expose the fund to increased volatility and unanticipated risks particularly when used in complex combinations and/or accompanied by the use of borrowing or leverage. The fund s prospectus will contain information and descriptions of any non-traditional and complex strategies utilized by the fund. Both 1940 Act-registered open-end mutual funds that seek alternative-like exposure and hedge funds seek investment returns that have lower correlation to traditional markets in an attempt to increase diversification in an overall portfolio. Unlike hedge funds, 1940 Act registered open-end mutual funds that seek alternative-like exposure do not require investor pre-qualifications, enable efficient tax reporting, are subject to lower investment minimums and lower fees, provide portfolio transparency, daily liquidity, and are required to provide daily NAV pricing. Because of 1940 Act limitations, mutual funds that seek alternative-like exposure generally must utilize a more limited investment universe and, therefore, will have relatively higher correlation with traditional market returns. Registered open-end funds are statutorily limited in their use of leverage, short sales and the use of derivative instruments. Hedge funds typically charge an asset-based fee and a performance fee. Potential benefits to hedge funds include greater flexibility in terms of seeking enhanced returns through the use of leverage, exposure to less liquid investments, and the more flexible use of complex instruments such as derivatives. As a result of these differences, performance for a mutual fund that seeks alternative-like exposure and its portfolio characteristics may vary from a hedge fund that is seeking a similar investment objective. Diversification and asset allocation do not assure a profit or protect against loss in declining financial markets. Equity Securities prices may fluctuate in response to specific situations for each company, industry, market conditions, and general economic environment. Companies paying dividends can reduce or cut payouts at any time. International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economics. The views and opinions expressed herein do not necessarily reflect those of Morgan Stanley. The information and figures contained herein has been obtained from sources outside of Morgan Stanley and Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of Morgan Stanley. Morgan Stanley is not responsible for the information, data contained in this document. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results. The material has been prepared for informational or illustrative purposes only and is not an offer or recommendation to buy, hold or sell or a solicitation of any offer to buy or sell any security, sector or other financial instrument, or to participate in any trading strategy. It has been prepared without regard to the individual financial circumstances and objectives of individual investors. Any securities discussed in this report may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. There is no guarantee that the security transactions or holdings discussed will be profitable. This material is not a product of Morgan Stanley & Co. LLC or CitiGroup Global Markets Inc.'s Research Departments or a research report, but it may refer to material from a research analyst or a research report. The material may also refer to the opinions of independent third party sources who are neither employees nor affiliated with Morgan Stanley. Opinions expressed by a third party source are solely his/her own and do not necessarily reflect those of Morgan Stanley. Furthermore, this material contains forward-looking statements and there can be no guarantee that they will come to pass. They are current as of the date of content and are subject to change without notice.

5 Any historical data discussed represents past performance and does not guarantee comparable future results. Indices are unmanaged and not available for direct investment. Tracking No PS / Morgan Stanley Smith Barney LLC. Member SIPC