FA AR ALTERNATIVE INCOME FUND *For professional investors only - Not for onwards distribution A MULTI STRATEGY APPROACH THAT YIELDS TO YOUR INCOME NEEDS OCTOBER 2012 DIVIDENDS AND COMPOUNDING: THE EIGhTH WONDER OF THE WORLD ARIA and ARIA Capital Management are trading names of Absolute Return Investment Advisers (ARIA) Ltd.
The Importance of Income There s no shortage of research to demonstrate how long-run returns are influenced by the reinvestment of dividends. 100,000,000 This is because the reinvestment of modest dividend amounts can soon grow to become a dominant part of the total return. 10,000,000 1,000,000 Inflation 2.2% pa Indeed, those stocks that are able to offer a consistent and rising level of dividend tend to strongly outperform during periods of flat stock market performance, and as a result of investor demand for income particularly when interest rates globally are at historically low levels. 100,000 10,000 1,000 Dividends 4.8% pa Capital Growth 2.2% pa The following chart breaks down total return into its known components, and shows the importance of income over the 1871-2006 long run. Dividends matter. Nominal Total Return Total Return Real Capital Growth 100 Source: Plexus Asset Management (based on data from Prof Robert Shiller and I-Net Bridge), 2008
Asset Class Universe POTENTIAL ASSET CLASS EXPOSURE Yielding Asset Classes Risk/Return Spectrum Lowest Risk/ Expected Return (within fixed income universe) Inflation-Linked Bonds (eg. TIPs) Global Government Bonds Senior Rated Loans Investment Grade Bonds High Yield Bonds Infrastructure Real Estate Convertibles and Mezzanine Debt At any one time, the Fund will seek to adjust its exposure to those asset classes offering the best risk adjusted returns. For example, currently whilst government bonds may not offer attractive yields when viewed from a historical perspective, given the Fund s capital preservation priorities, it may be advantageous to increased exposure to them during a flight to quality, as they are often considered safe havens when panic sets in. Equity income will constitute an important contributor to returns, typically focusing on large cap value orientated plays which have historically demonstrated increasing dividends. Energy Trusts Highest Preferred Shares Global Equities Source: Bloomberg, Global Government Bonds JP Morgan Global Government Bond Index, Convertibles Jefferies Active Convertible Index, Leveraged Loans S&P/LSTA Leveraged Loan Index, 1-10yr TIPS BarCap US Treasury Inflation Note 1-10yr Index, High Yield Bonds BarCap US HY index, Infrastructure Macquarie Global Infrastructure Index, REITs Dow Jones Composite REIT Index, Utilities Dow Jones Global Utilities Index.
Risk Reward spectrum 10-Year Total Return vs. Volatility (2001-2010) 12.00% 10.00% Infrastructure REITs ANNUALISED TOTAL RETURN 10 YRS 8.00%.00% 4.00% 1-10YR TIPS High Yield Bonds Convertibles Global Government Bonds Leveraged Loans MSCI world 2.00% Utilities Standard Credit Illiquid Assets 0.00% Equities 0.00%.00% 10.00% 1.00% 20.00% 2.00% ANNUALISED VOLATILITY 10YRS Source: Bloomberg, Global Government Bonds JP Morgan Global Government Bond Index, Convertibles Jefferies Active Convertible Index, Leveraged Loans S&P/LSTA Leveraged Loan Index, 1-10yr TIPS BarCap US Treasury Inflation Note 1-10yr Index, High Yield Bonds BarCap US HY index, Infrastructure Macquarie Global Infrastructure Index, REITs Dow Jones Composite REIT Index, Utilities Dow Jones Global Utilities Index. Past performance is not a guide to future returns.
THE HISTORY OF INTEREST RATES Interest rates are the dominant factor in determining the path of credit markets over the medium to long term over this timeframe, interest rates are almost certain to rise. Over the past10 years, quantitative easing by central banks has kept interest rates artificially low; as these easing programmes are reduced, interest rates should start to increase and normalise. Falling Rates A 30-Year Tailwind for Bond Returns Long-term treasury rates since 1871 (%) 1 12 9 One also needs to view the current interest rate environment in the context of long-term historical patterns. The following chart shows that current yields are near the interest rate lowest levels in 140 years, levels achieved at only one other time in the aftermath of the Great Depression. Whilst we view rate rises as unlikely, in the short term, rising rates will eventually hit prices of fixed income investments. Therefore, the ability to move to other yielding asset classes will be critical, particularly those that can perform against a backdrop of rising rates or inflationary pressures. 6 3 0 1880 1890 1900 1910 1920 1930 1940 190 1960 1970 1980 1990 2000 Oct 2010 Source: Robert Shiller long-term interest rate series through 1961, Federal Reserve 10-year constant maturity series beginning 1962, as at Oct. 2010 Past performance is not a guide to future returns.
Flexible Asset Allocation: Correlation analysis At a point in the economic cycle where the economy and most financial assets are recovering, the opportunity in the credit space would generally be focused on securities which provide some of the upside of equities. Without being affected by rising interest rates examples would include convertible bonds and mezzanine debt (the coupon on mezzanine is typically LIBOR linked). Most investors fixed income exposures are there to provide a counterbalance to the risks and volatility of equities, so adding credit securities with a high correlation to equities may not be a desirable option. The FA AR Alternative Income Fund however seeks to provide an all terrain income orientated portfolio. Correlations Between Asset Classes over 10 Years (2001-2011) CORRELATION Global Government Bonds Utilities REITs Infrastructure Infrastructure REITs Utilities Global Government Bonds MSCI world Convertibles 1.00 0.68 0.93 0.31 0.89 0.88 1.00 0.8 0.17 0.71 0.8 1.00 0.32 0.80 0.80 1.00 0.09 0.41 1.00 0.86 1.00 TIPS BarCap Global Aggregate Leveraged Loans Convertibles MSCI world High Yield Bonds As shown in the table, the securities with negative correlations to government bonds are leveraged loans, since such loans LIBOR-linked interest rates benefits from rising rates at the same time that government bonds are negatively impacted. Leveraged Loans BarCap Global Aggregate TIPS High Yield Bonds 0.61 0.19 0.36 0.69 0.9 0.13 0.27 0.6 0.3 021 0.34 0.62-0.22 0.70 0.62 0.0 0.67-0.02 0.24 0.73 0. 0.3 0.49 0.72 1.00-0.03 0.18 0.82 1.00 0.77 0.16 1.00 0.3 1.00 Source: ARIA Capital Management, Bloomberg Please note data for TIPS, leveraged loans, convertibles are from inception that do not cover the whole period.
The Investment Case for Senior Loans Correlations with Inflation (since 1980) This table shows how senior loans have had the highest correlation with inflation The growing wealth of emerging markets has pushed up wages and the prices of commodities in those countries, thus increasing input costs for developed countries as well, contributing to the rising inflationary pressures we are currently witnessing. It s interesting to note how over the long term, equity markets do not seem to offer a good inflation hedge. ASSETS INFLATION Senior Loans 0.60 Commodities 0.46 Oil 0.46 TIPS -7 Year 0.4 LIBOR 0.34 Distressed Debt 0.32 Property 0.29 TIPS 7-10 Year 0.2 Hedge Funds 0.22 High Yield 0.18 REITs 0.06 S&P 00-0.02 Asset-Backed Securities -0.06 Timber -0.07 International Equities -0.11 Gold -0.12 Source: Credit Suisse AI - ISS team, March 2011
Shiller Valuations EQUITY MARKETS ARE STILL NOT CHEAP Tactically, we will move to asset classes when a favourable opportunity arises. Whilst equity markets are not particularly cheap on a long term basis, significant corrections can offer interesting opportunities to increase the Fund s exposure to equity income on a tactical basis. 4 40 3 30 1st quintile (most expensive) 2nd quintile 3rd quintile 4th quintile th quintile (cheapest) 2 20 1 10 31/01/1881 31/01/1901 31/01/1921 31/01/1941 31/01/1961 31/01/1981 31/01/2001 Source: SG Cross Asset Research, Robert Shiller, October 2010
Expected Returns ANNUALISED 10 YEAR REAL RETURNS, (1881-2010) BASED ON THE STARTING SHILLER PRICE TO EARNINGS RATIO The expected return of an asset class is driven primarily by the valuation it is bought at. 1 1.7% Equity market exposure toward higher yielding stocks, will likely be capped until valuations improve further. 2.3% 3 6.4% 4 7.2% 10.9% 0% 2% 4% 6% 8% 10% Source: SG Cross Asset Research, Robert Shiller, October 2010
Investment Process MULTI ASSET CLASS + ABSOLUTE RETURN INVESTING A DISCIPLINED INVESTMENT PROCESS CONTINUOUS MONITORING Eligible universe Equities, Government Bonds, Derivative Strategies, Senior Loans, Convertibles, REITS, Corporate bonds Strategic Asset Allocation InvesTment analysis & stock selection Risk budget VOLATILITY TARGET YIELD TARGET PORTFOLIO CONSTRUCTION CONTINUOUS MONITORING Risk management, including managing the volatility of the Fund s returns, is a priority. A macro currency overlay is another tool at our disposal. Exposing the Fund to high grade investment bonds, whilst varying its exposure to safe haven assets, should contribute to a lower volatility profile.
performance and investment profile suitability* of FA AR ALTERNATIVE INCOME Strongly rising stock prices OR Strongly falling stock prices Likely to Underperform stock markets Potential to Outperform May be suitable for investors With a long-term investment time horizon Seeking a quarterly income Looking for some long-term growth potential Comfortable with the risks associated with an equity based investment. Not suitable for investors Requiring capital security Looking for short-term returns Uncomfortable with the level of risk associated with equity based investment Looking for a fixed quarterly income. * Please note the above is a general view of the Fund and its suitability. Each potential investors suitability is dependant on the investors personal circumstances.
CONCLUSION more money has been lost reaching for yield than at the point of a gun Ray DeVoe, Legg Mason We believe that investors need to rebalance their portfolios away from securities with high duration risk arising due to the potential for increasing interest rates and inflation in the overall economy. At times, the Fund may wish to benefit from the equity upside from the economic recovery, in which case they should target convertibles. Ray DeVoe of Legg Mason Wood Walker said after the bond market meltdown in 1994 that more money has been lost reaching for yield than at the point of a gun. Investor s search for higher yields and higher returns often leads them to take a disproportionate amount of risk and causes them to lose money when a safer, lower return is available. The Fund aims to provide safer return while managing risk. in summary SECURITY BENEFITS DRAWBACKS WHEN TO INVEST TIPS (inflation linked treasury) Government Bonds Senior Loans Inflation-linked, governmentbacked credit rating Government-backed credit rating, low default rates Interest rate protection, same credit rating as high yield but higher up the capital structure Low yields, which declines further when inflation declines Low yields Lower yields, callable at par at any time In declining interest rate or rising inflation rate environments When interest rates peak, recessionary environments Before interest rate increases High Yield Bonds High return when prices are stable Higher default risk, lower recovery rates on defaults Before periods of fast dropping default rates and during periods of fast growth Convertibles and Mezzanine Equity option, mezzanine has interest rate protection Lower recovery rate when defaulted, expensive for borrowers so limited depth of market Before periods of growth and inflation Source: Dexion Capital, March 2011
Appendix 1: EXAMPLE Asset Allocation 2. 20 Cash 10 Global High Yield Floating Rate Notes 1 Emerging market debt % % 1% 20% % Cash (20.00%) Floating Rate Notes (.00%) Global High Yield (.00%) Emerging Market Debt (1.00%) Index linked bonds (.00%) Covertibles (.00%) 1 Index linked bonds % % Government Bonds (.00%) Corporate Bonds (10.00%) 1 Convertibles 10% 1% Asset backed lending (.00%) Master limited partnerships ( MLPs ) (.00%) 1 Government Bonds % % % Real estate investment trusts ( REITs ) (.00%) Global Listed Equities (1.00%) 10 Corporate Bonds 2. Traditional preferred stocks Asset backed lending Source: ARIA Capital Management. Note: Data reflects target allocations within the Fund and is not a guarantee of future allocations. 2. Master limited partnerships ( MLPs ) 7. Real estate investment trusts ( REITs ) 10 1 Global Listed equities 0 10 20 30 40 Example Strategic Allocation Example of how allocation may change due to active management
Appendix 2: Fund Specifics Investment universe Broad. All asset classes can be considered, both traditional and alternative including: fixed income, equity income, senior loans, real estate, convertibles and mezzanine, real estate investment trusts, cash instruments and derivatives. Income.0% 6.%* Regular Quarterly Income A diversified portfolio with the flexibility to move between asset classes: Flexibility to consider a wide range of yielding asset classes. Returns delivered through dynamic tactical asset allocation and manager/asset selection. Derivatives may be used for efficient portfolio management, as well as for meeting the investment objective of the Fund. A strong track record in delivering attractive risk-adjusted returns Multi Strategy Income fund able to perform well in all conditions. Risk Target Volatility of portfolio of high quality global corporate bonds AMC 1.% Benchmark 1 month LIBOR +2% Legal Structure Currency Share Classes Segregated portfolio of FA SPC Sterling US Dollar and GBP. Accumulation and Distribution. Performance Fee Pricing Custodian Domicile 20% over high watermark Fortnightly EFG Switzerland Cayman Islands
RISK WARNINGS The target yield expected is not guaranteed and may change any time without notice. Telephone calls are recorded to ensure compliance with our legal and regulatory obligations and internal policies. The information in this document is based on our understanding of law and regulation at the time of print and is subject to change. The value of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. Please note that bond funds may not behave like direct investments in the underlying bonds themselves. By investing in bond funds the certainty of a fixed income for a fixed period with a fixed return of capital are lost. Investments in smaller companies may involve a higher degree of risk as small cap markets tend to be much more volatile than their larger capitalisation counterparts. Investments may be concentrated in any one country, sector or issuer. The Fund may have a significant exposure to high yield bonds, emerging market bonds or non investment grade or unrated bonds at any time. Non investment grade bonds may increase the risk to capital. ARIA and ARIA Capital Management are trading names of Absolute Return Investment Advisers (ARIA) Ltd. Issued by Absolute Return Investment Advisers (ARIA) Ltd which is authorised and regulated by the Financial Services Authority. Investment is subject to documentation (Prospectus, Simplified Prospectus and Terms and Conditions), copies of which can be obtained from ARIA, 4 Duke Street, Richmond, Surrey TW91HP Derivatives may be used to achieve Fund objectives and allocations may vary significantly over time. The yield or the capital value of the Fund (or both) can fluctuate and investors may not get back their original investment. In the case of a new Fund, there is a risk that if the anticipated size of the Fund is not achieved, the proportion of charges and expenses allocated to the investment may be higher and the value of the investment consequently reduced. Please note that investments in foreign markets are subject to special currency, political, and economic risks. Exchange rates may cause the value of underlying overseas investments to go down or up. Investments in emerging markets may be more volatile than other markets and the risk to capital is therefore greater. Also, the economic and political situations may be more volatile than in established economies and these may adversely influence the value of investments made.
DISCLAIMER This document is intended only for professional investors and financial advisers. This document is not directed at or intended for the use of retail clients. The material on these pages is provided for information purposes only; it is not an invitation to invest. Income from investments may fluctuate and investors may not recoup the amount originally invested. Please refer to the relevant Fund Offering documents and/or the terms and conditions for any services offered for detailed information. Please seek relevant professional advice before making any investment decision. Past performance is not a guide to future returns. This document contains forward-looking statements concerning the financial condition, results of operations and businesses of ARIA Capital Management. Such statements, expressed or implied, are based on management s current expectations and assumptions, which may change without notice, and are no guarantee of future results, performance or events. In the United Kingdom Hedge Funds are classed as unregulated collective investment schemes, the promotion of which is restricted by Section 238 of the Financial Services and Markets 2000 (the Act ). Shares may not be offered or sold in the United Kingdom other than to investors of a kind described in the Financial Services and Markets Act 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2001, namely: firms authorised to carry on investment business under the Act; and institutional and other investors who have experience of alternative, unregulated investments such as hedge funds. This document does not constitute an offer or solicitation to sell shares in any of the funds or provide any investment services mentioned, by anyone in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it is unlawful to make such offer or solicitation. Persons interested in acquiring funds should inform themselves as to (i) the legal requirements in the countries of their nationality, residence, ordinary residence or domicile; (ii) any foreign exchange controls; and (iii) any relevant tax consequences In addition the funds has not been registered under the United States Securities Act 1933 or the Investment Company Act 1940 and is not available for subscription by US investors. Absolute Return Investment Advisers (ARIA) Limited is authorised and regulated by the Financial Services Authority in the UK, with Firm Reference number 277. A Limited Company registered in England and Wales No: 7091239. ARIA and ARIA Capital Management are trading names of Absolute Return Investment Advisers (ARIA) Limited. ARIA 113/2012