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The Case for Liquid Alternative Investments JUNE 2012 Jon Sundt, President & CEO, Altegris Allen Cheng, Chief Investment Officer, Altegris Advisors
The Case for Liquid Alternative Investments june 2012Jon Sundt, President & CeO, Altegris Allen Cheng, Chief Investment Officer, Altegris Advisors
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> At Altegris, we define liquid alternative invest-ments as mutual funds that may be suitable for a wide range of investors, and which provide access to best-of-breed alternative investment managers who can go long or short in various markets. While alternative investments have typically been geared toward institutional and high-net-worth investors, liquid alternatives enable a broader range of investors to take advantage of the historic strengths of hedge funds, while also benefiting from the attributes of mutual funds.
> Alternatives have been migrating to a broader investor base for some time, but that trend has gathered speed in the wake of the financial crisis. Investors are seeking out liquid alternatives that offer the potential for uncorrelated returns, lower volatility, and greater transparency and liquidity, while alternative investment managers are increas-ingly open to offering their strategies via more liquid vehicles, as they represent another potential avenue for asset growth and provide access to a new investor base.
> Some alternative investment strategies are better suited to a mutual fund structure than others. At Altegris, we believe that long/short equity, man-aged futures and global macro are particularly strong fits within a mutual fund framework.
> In Altegris’ view, long/short equity, managed futures and global macro should be included in a core alternatives allocation within a portfolio, and together offer the potential for lowering volatility and generating strong, non-correlated returns—providing both downside protection and enhanced performance potential in rising markets.
> In contrast to this core, some strategies that are compelling in a hedge fund format do not neces-sarily translate as well to mutual funds—due to a lack of liquidity or because they require levels of gross long and/or short exposure* beyond what is allowable in a mutual fund structure in order to generate appropriate risk-adjusted returns.
> With the universe of alternative investment manag-ers available via mutual funds expanding rapidly, it is becoming more of a challenge to identify premier investment talent. As such, we believe there are clear benefits from partnering with a firm such as Altegris that has built deep relationships with “the real deal”—top-flight, experienced alternative investment managers with the ability on a historical basis to deliver alpha—and can package their strategies in a liquid format for a range of advisors and their clients.
executive Summary
The recent financial crisis spurred investors to focus on liquid, non-correlated assets in their quest to better manage portfolio risk—while still seeking returns. It is no surprise, then, that increasing numbers of financial advisors and their clients have been considering liquid alternative investments to help meet this challenge.
* See glossary on page 23 for term definitions.
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> At Altegris, we believe that this elite level of talent is worth paying for—from a mutual fund investor’s standpoint, potentially higher fees for select liquid alternatives are appropriate in exchange for access to some of the best investment managers in the world.
> Particularly in light of recent history, we believe that it is critical for investors to maintain invest-ment flexibility and focus on strategies with the ability to perform in a variety of market condi-tions. Therefore, we suggest that investors build a diversified portfolio and position themselves to
take advantage of a range of market opportunities, including allocating to a mix of “convergent” and
“divergent” strategies available in liquid structures—with long/short equity, managed futures and global macro representing prominent examples of these two types of categories.
> By gaining exposure to premier alternative invest-ment managers, in a liquid format, investors can potentially enjoy the best of both worlds—the flexibility and convenience of mutual funds and the portfolio effects of alternative investments—in the pursuit of their long-term investment goals.
“Liquid alternatives enable a broader range of investors to take advantage of the historic strengths of hedge funds, while also benefiting from the attributes of mutual funds.”
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At Altegris, we define liquid alternative investments as mutual funds that may be suitable for a wide range of investors, and which provide access to best-of-breed alternative investment managers who can go long or short in various markets. While alternative investments have historically been the exclusive province of institutional and high-net-worth investors, liquid alternatives enable a broader range of investors to take advantage of their traditional strengths—including reduced portfolio volatility and asset-class correlations, as well as strong potential risk- adjusted returns.
At the same time, these investors benefit from the hallmarks of mutual funds, including a daily liquidity, low investment minimums, more flexible investor pre-qualifications and efficient 1099 tax reporting.
Alternatives have been migrating to a broader inves-tor base for some time, but this trend has gathered speed in the wake of the financial crisis. As illustrated in Figure 1, assets in alternative mutual funds have increased 128% since October 2008, to $99B as of March 2012, while the ratio of alternative mutual fund assets to total mutual fund assets has risen 35.7% during that same timeframe, according to Morningstar Direct.
The emergence of Liquid Alternative Investments
One of the principal legacies of the financial crisis that began in 2008 has been an increased focus on liquid, non-correlated assets, as investors seek to better manage risk in their portfolios—without giving up on performance. It is no surprise, then, that increasing numbers of financial advisors and their clients are turning to liquid alternative investments to help meet this challenge.
“ Liquid alternatives offer managers another avenue for asset growth at a point when competition has never been fiercer.”
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5
0
20
40
60
80
100
120
Jan-
06
Jul-0
6
Jan-
07
Jan-
08
Jan-
09
Jan-
10
Jan-
11
Jul-0
7
Jul-0
8
Jul-0
9
Jul-1
0
Jul-1
1
Jan-
12
Source: Morningstar Direct
Jan-
06
Jul-0
6
Jan-
07
Jul-0
7
Jan-
08
Jul-0
8
Jan-
09
Jul-0
9
Jan-
10
Jul-1
0
Jan-
11
Jul-1
1
Jan-
12 0.40%
0.50%
0.60%
0.70%
0.80%
0.90%
1.00%
1.10%
1.20%
1.30%
1.40%
Ratio of alteRnative Mutual funds assets / total Mutual fund assets
fiGuRe 1.
alteRnative Mutual fund assets ($ Billion)alternative mutual fund assets have surged on both an absolute level and relative to the broader mutual fund universe.
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In the wake of the crisis, investors are seeking out liquid alternatives that offer the potential for uncorre-lated returns, lower volatility, and increased transpar-ency and liquidity. For example, more than 71% of financial planners ranked correlation among their top five considerations in evaluating alternative invest-ments, followed by risk and liquidity, according to the Financial Planning Association’s 2011 Alternative Investments Survey, conducted in May 2011. Inves-tors in UCITS (a European investment product similar to US mutual funds) said in a survey published in November 2010 by Strategic Insight and Global Custodian magazine, Alternative and Hedge Fund UCITS in the Next Decade, that liquidity is the most important factor supporting the growth of alternative UCITS. In addition, institutional investors polled in a 2010 KPMG survey, Transformation: The Future of Alternative Investments, cited transparency as the primary challenge facing the alternative invest-ment industry.
At a time of rising investor demand, alternative investment managers are also becoming increasingly open to offering their strategies via more liquid vehicles as they seek to expand their businesses. Liquid alternatives offer managers another avenue for asset growth at a point when competition has never been fiercer—estimates peg the number of alternative investment managers operating globally at more than 5,000. In addition, mutual fund inves-tors represent a relatively untapped—and relatively
“sticky”—client base for alternative investment managers, as assets comprising a number of smaller allocations from advisors and individual high-net-worth investors can be more stable than a large block from a single institutional investor.
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Long/short equity typically entails a manager going long equities he or she expects to increase in value, while selling short equities he or she expects to decrease in value. Managed futures, in contrast, comprise a highly technical strategy in which manag-ers generally utilize proprietary, model-based trading systems to identify market trends and react to corresponding price movements in securities. Global macro is a fundamental strategy in which managers use macroeconomic data to predict price movements.
Despite the obvious differences in approach, these three strategies share key similarities. All generally focus on deep, actively traded markets primarily via centrally cleared instruments—publicly traded equi-ties from around the world, in the case of long/short equity; and global exchange-traded stock indices,
bonds, currencies and commodities for both managed futures and macro. All three have the flexibility to go long and short—thus providing managers with the ability to generate returns in a variety of market envi-ronments. In addition, all can effectively pursue their investment approaches within mutual fund regulatory constraints on leverage.
As a result, investors allocating to these strategies via liquid alternatives can enjoy some of the primary potential advantages of mutual funds—a high degree of transparency, the ability to quickly invest and redeem (thus aiding in actively rebalancing portfo-lios), and regulatory and board oversight—while also reaping the possible rewards of alternative investment exposure, including strong potential risk-adjusted returns and reduced volatility (See Figure 2).
The Best Strategies for Liquid Alts
Some alternative investment strategies are better suited to a mutual fund structure than others. At Altegris, we believe that long/short equity, managed futures and global macro are particularly strong fits within a mutual fund framework, and that these strategies should comprise a core allocation for any investor seeking a diversified exposure to alternative investments.
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fiGuRe 2.
PeRfoRMance taBle | January 1997 – March 2012Managed futures, global macro and equity long/short are favorable to traditional asset classes on a risk-return basis and are largely uncorrelated as well.
AnnualRate of Return
Annual Standard Deviation
WorstDrawdown
SharpeRatio
Managed Futures 6.72% 10.59% -13.24% 0.43
Global Macro 9.02% 6.11% -6.42% 1.04
Long/Short Equity 9.12% 9.89% -30.59% 0.68
US Stocks 6.18% 16.53% -50.95% 0.30
US Bonds 6.24% 3.55% -3.82% 1.03
coRRelation taBle | January 1997 – March 2012
Source: AltegrisPASt PerforMAnce iS not inDicAtive of future reSultS. the referenced indices are shown for general market comparisons and are not meant to represent any particular fund. An investor cannot invest directly in an index. Moreover, indices do not reflect com-missions or fees that may be charged to an investment product based on an index, which may materially affect the performance data presented. there is no guarantee an investment will achieve its objective, generate profits or avoid losses. Managed futures: Altegris 40 index®; long/Short equity: Hfri equity Hedge (total) index; Global Macro: Barclay Global Macro index; uS Stocks: S&P 500 tr index; uS Bonds: Barclay uS Aggregate composite Bond index. Standard deviation is a statistical measure of how consistent returns are over time; a lower standard deviation indicates historically less volatility. Drawdown measures the peak to valley loss relative to the peak for a stated time period. Sharpe ratio measures return in excess of the risk-free rate, per unit of risk, as measured by standard devia-tion. Date range based on common period of data availability for shown indices. See pages 24 and 25 for additional index definitions, descriptions, and risks.
Managed Futures
Global Macro
Long/Short Equity
US Stocks US Bonds
Managed Futures 1.00 0.52 -0.01 -0.16 0.24
Global Macro 0.52 1.00 0.72 0.45 0.17
Long/Short Equity -0.01 0.72 1.00 0.76 -0.02
US Stocks -0.16 0.45 0.76 1.00 -0.03
US Bonds 0.24 0.17 -0.02 -0.03 1.00
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Long/Short equity, Managed Futures and Global Macro: The Core of Alternative Investments
In Altegris’ view, long/short equity, managed futures and global macro should be included in a core alternatives allocation within a portfolio, and together offer the potential for lowering volatility and generating strong, non-correlated returns (See figure 3)—providing both down-side protection and enhanced performance potential in rising markets. Thus, the three strategies can combine to provide investors with one of the primary benefits of alternative investments: enhancing a portfolio’s ability to perform in a wide range of market conditions.
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fiGuRe 3.
alteRnatives in a PoRtfolioadding core alternative investments can potentially enhance a portfolio’s risk-return profile.
172% Total Return 197%
10% Ann. Standard Deviation 7%
-31% Worst Drawdown -22%
5.60 Reward/Risk Ratio 9.13
Common Period*
+25%
+3.53
+3%
+9%
Traditional Portfolio
60%US Stocks
40%Bonds 38%
USStocks
32%Bonds
10%LSE
10%MF
10%GM
Traditional Portfolio + Alternatives
Source: Altegris*January 1997 – March 2012. the referenced indices are shown for general market comparisons and are not meant to represent any particular fund. the above is not intended, and should not be construed, as asset allocation advice. there is no guarantee that any investment product will achieve its objectives, generate profits or avoid losses. PASt PerforMAnce iS not inDicAtive of future reSultS. An investor cannot invest directly in an index. Moreover, indices do not reflect commissions or fees that may be charged to an investment product based on the index, which may materially affect the performance data presented. Standard deviation is a statistical measure of how consistent returns are over time; a lower standard deviation indicates historically less volatility. Drawdown measures the peak to valley loss relative to the peak for a stated time period. inDiceS: uS Bonds: uS Aggregate Bond index; uS Stocks: S&P 500 total return index; long/Short equity (lSe): Hfri equity Hedge (total) index; Managed futures (Mf): Altegris 40 index (started July 2000; data available back to 1990); Global Macro (GM): Barclay Global Macro index. risk/reward ratio = total return/Worst Drawdown. Date range based on common period of data availability for shown indices. See pages 24 and 25 for additional index definitions, descriptions and risks.
“ even in the context of liquid alternative investments, it is important to keep in mind that the potential benefits of these strategies are typically realized over a long-term time horizon.”
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fiGuRe 4.
Mutual funds / PRivate fundsMutual funds and private funds offer different—but potentially complementary—characteristics for investors.
Source: Altegris for illustrative purposes only. there is no guarantee that any investment product will achieve its objectives, generate profits or avoid losses.
Mutual Funds Private Funds
Liquidity> Daily Liquidity> Daily final NAV pricing
> Typically monthly/quarterly liquidity> Typically monthly final NAV pricing
Taxes > Form 1099 reporting > Form K-1 reporting
Availability> Available to most investors, subject to
investment suitability> Available to accredited and higher,
subject to investment suitability
Access> Automated subscription and processes
(NSCC)> Manual subscription and redemption
processes with advanced notice required
While liquid alternative investments can deliver more transparency and liquidity than typically offered by hedge funds accessible via private placement (See Figure 4), the two types of vehicles are not mutually exclusive within a well-diversified portfolio. For inves-tors with the appropriate levels of investable capital for whom alternative investments are suitable, allo-cating sufficiently to liquid alternatives can free them
up to simultaneously pursue less-liquid strategies of-fering higher risk—and potentially higher returns—by virtue of their longer investment horizons. As a result, liquid alternatives and private placement alternative investments can work in tandem to position a portfo-lio to generate potentially strong risk-adjusted returns in both up and down markets.
Even in the context of liquid alternative investments, it is important to keep in mind that the potential benefits of these strategies are typically realized over a long-term time horizon. For example, a quick glance at a chart of monthly managed futures performance shows a significant amount of “red,” representing negative monthly returns. Yet, out of the last 22 full years for which data is available, managed futures had just three down calendar years, with average an-nual returns of 8.5% over that time period
(See Figure 5). Investors should therefore expect managed futures—as well as other strategies, such as long/short equity or global macro—to have periods of underperformance relative to other asset classes. However, knowing that past performance is not necessarily indicative of future results, we believe that, historically, these strategies have proven their worth over the long term, and that patient investors will be best positioned to maximize the attributes of these approaches.
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Source: AltegrisPASt PerforMAnce iS not neceSSArilY inDicAtive of future reSultS. An investor cannot invest directly in an index. Moreover, indices do not reflect commissions or fees that may be charged to an investment product based on the index, which may materially affect the performance data presented. indices: Managed futures: Altegris 40 index® (started July 2000; data available back to 1990). time frame: January 1990 – March 2012.
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year
2012 0.32% 0.41% -2.28% -1.57%
2011 -1.37% 1.70% -1.53% 3.90% -3.65% -2.60% 3.59% -0.20% -0.06% -3.96% 0.30% 0.96% -3.23%
2010 -2.49% 0.94% 3.97% 1.54% -2.42% 0.38% -1.29% 4.14% 1.82% 3.88% -3.54% 4.29% 11.33%
2009 -0.65% -0.05% -2.77% -3.27% 1.38% -2.66% -0.11% 0.33% 2.38% -2.56% 4.03% -4.00% -7.98%
2008 1.82% 5.69% -0.44% -1.15% 2.06% 2.67% -4.59% -2.67% 0.21% 5.15% 3.67% 2.57% 15.47%
2007 1.71% -3.75% -2.34% 4.20% 3.57% 2.89% -3.09% -3.73% 4.67% 4.31% -0.65% -0.23% 7.18%
2006 1.91% -1.78% 2.68% 2.44% -2.65% -1.37% -1.48% 1.12% -1.06% 1.10% 2.45% 3.38% 6.70%
2005 -4.20% 0.69% -0.56% -2.45% 3.09% 3.41% 0.06% 0.54% 1.54% 0.16% 4.29% -1.81% 4.51%
2004 0.96% 5.64% -0.98% -6.22% -1.59% -3.30% -1.14% -0.69% 1.35% 3.42% 5.41% 0.33% 2.57%
2003 6.13% 5.97% -5.72% 1.47% 5.87% -2.51% -2.26% 0.94% -0.46% 2.25% -0.30% 4.33% 15.99%
2002 -1.20% -2.82% -0.29% -2.36% 2.59% 8.84% 5.34% 2.41% 4.61% -5.18% -2.76% 6.09% 15.22%
2001 1.04% 0.95% 6.48% -6.16% 0.03% -1.10% 0.22% 2.99% 3.08% 4.32% -7.77% 2.11% 5.39%
2000 0.91% -1.12% -2.48% -1.51% 1.37% -1.55% -1.76% 2.06% -1.74% 2.09% 6.26% 8.23% 10.63%
1999 -2.89% 1.87% -0.81% 3.07% -1.66% 2.60% -0.78% 0.60% 0.35% -4.42% 1.94% 1.29% 0.87%
1998 0.63% -0.78% 1.17% -3.97% 2.54% 0.12% 0.21% 7.93% 4.47% -0.40% -1.83% 2.35% 12.61%
1997 3.91% 2.39% -0.11% -2.34% -1.66% 1.16% 6.98% -4.76% 1.26% -0.62% 1.40% 2.68% 10.22%
1996 3.12% -6.01% 0.57% 5.22% -2.36% 1.02% -2.58% -0.35% 4.49% 8.10% 7.05% -2.28% 16.04%
1995 -2.70% 3.66% 8.23% 1.79% 1.13% -2.16% -1.96% 1.24% -2.50% 0.10% 1.68% 4.49% 13.16%
1994 -4.14% -2.27% 1.59% -1.33% 2.24% 4.71% -3.13% -3.79% 1.31% -0.05% 1.40% -1.73% -5.46%
1993 -0.85% 7.61% -0.55% 4.60% 0.10% 1.43% 4.87% -1.14% -1.25% -0.70% -1.69% 1.81% 14.66%
1992 -8.16% -3.79% -0.08% -3.72% 1.08% 6.67% 7.16% 5.36% -2.43% -0.26% 1.63% -1.42% 0.89%
1991 -5.44% 0.30% 6.90% -1.65% -1.10% 2.69% -4.55% -1.01% 5.45% -2.65% 1.02% 16.01% 15.12%
1990 4.27% 2.11% 3.71% 3.72% -6.53% 2.68% 10.36% 8.00% 3.37% 3.02% -0.39% -1.31% 37.15%
Positive Negative
fiGuRe 5.
MontHlY ManaGed futuRes RetuRns | January 1990 – March 2012short-term fluctuations have not dampened managed futures’ strong long-term performance.
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In contrast to core strategies such as long/short equity, managed futures and global macro, some strategies that are compelling in a hedge fund format do not necessarily translate as well to mutual funds.
For example, some are not sufficiently liquid. Indeed, the lack of liquidity is a fundamental driver of investment returns for these strategies. This group includes virtually all forms of distressed securities investing, certain structured credit approaches and activist/special-situation strategies. However, while these strategies can provide challenges within a liquid mutual fund structure, they remain more nimble
than investments such as physical private real estate, private equity, venture capital, timber and other hard assets, and infrastructure when considering them within a portfolio context (See Figure 6).
Leverage is another key factor in evaluating whether an alternative investment strategy fits within a mutual fund format. Strategies such as relative value and sta-tistical arbitrage, for example, can produce attractive risk-adjusted returns, yet they require leverage levels beyond what is allowable in a mutual fund structure in order to be effectively implemented.
PrivateReal
Estate
PrivateEquity
Distressed Securities
Fixed Income Arbitrage
Credit Long/Short
EventDriven
Multi-strategy
Multi-strategy
Commodity Long/Short
Equity Long/Short
Global Macro
Managed Futures
Liquidity of assets in the portfolio
Inve
stor
abi
lity
tow
ithd
raw
ass
ets
Sources: citi Perspectives: the liquidity crisis & its impact on the Hedge fund industry, July 2010; Altegrisfor illustrative purposes only.
fiGuRe 6.
alteRnative investMent liquiditYManaged futures, global macro and long/short equity are the most liquid of the principal alternative investment strategies.
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“Investors realize the full benefits of liquid alternatives only when they work with top-flight, experienced alternative investment managers with a robust infrastructure behind them, and the demonstrated ability to deliver alpha in a variety of markets.”
At Altegris, we believe that investors realize the full benefits of liquid alternatives only when they work with “the real deal”: top-flight, experienced alterna-tive investment managers with a robust infrastructure behind them, and the demonstrated ability to deliver alpha in a variety of market environments. Figure 7 illustrates the degree to which the best managers can outperform relative to average managers within
a particular alternative investment strategy—in this case, long/short equity. In addition, this performance dispersion highlights the fact that, unlike traditional investments whose performance is typically mea-sured relative to benchmarks, the absolute returns of alternative investments are driven by manager skill—and thus manager selection is particularly important.
“The Real Deal”
With the universe of alternative investment managers available via mutual funds expanding rapidly—on top of the 5,000-plus hedge funds already in operation—it is becoming more of a challenge for investors to identify and access the most talented investment profes-sionals. As such, we believe there are clear benefits from partnering with a firm such as Altegris that has built deep relationships with premier alternative investment managers around the world, and can secure opportunities to invest with these managers and package their strategies in a liquid format for a range of advisors and their clients.
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-20%
0%
20%
40%
60%
80%
100%
2007 2008 2009 2010 2011
17.1%
32.1%
-19.6% -7.8%
11.5%
42.8%
10.9%
82.4%
29.6%
6.5%
Average Return: Average Long/Short Equity Managers
Average Return: Highest 25% Performing Long/Short Equity Managers
fiGuRe 7.
aveRaGe lonG/sHoRt equitY ManaGeR RetuRns | January 2007 – december 2011over the past five years, the highest performing long/short equity managers on a calendar year basis have provided a substantial return premium over the strategy’s average managers.
Source: AltegrisPASt PerforMAnce iS not neceSSArilY inDicAtive of future reSultS. An investor cannot invest directly in an index. Moreover, indices do not reflect commissions or fees that may be charged to an investment product based on the index, which may materially af-fect the performance data presented. Data from screen of Hfri database. criteria: established managers whose strategy was “equity Hedge.” “established” defined as those with firm-wide assets greater than $50M, a track record that started prior to January 2007, who reported data through December 2011 (1043 managers).
In order to facilitate these opportunities for investors, an advisor should possess the expertise in alternatives to blend top-down viewpoints with bottom-up analysis to identify the most compelling market op-portunities for clients and the best-of-breed managers within each strategy. A detailed assessment and multilayered due diligence process for each manager is also essential before an investment is approved. An advisor must then be able to provide an entrée to managers who are often capacity constrained or have historically provided limited access to non-institutional investors. Once strategies are implemented within a multi-manager portfolio, the advisor should utilize advanced return analysis and risk profiles to actively manage and rebalance the portfolio. Finally, the advi-sor should have the resources to perform an ongoing evaluation of each manager in the portfolio—including constant investment review and risk monitoring. This blend of alternatives background, investment skills and analytical resources is rare among investment advisors, based on our experience, and is a key rationale for partnering with a firm such as Altegris.
For mutual fund investors more accustomed to low-cost, index-based products, the higher fee levels often associated with exposure to liquid alternatives can be an issue. At Altegris, we believe that true talent is worth paying for—from a mutual fund investor’s standpoint, potentially higher fees are appropriate in exchange for access to some of the best investment talent in the world: an elite group of managers within the alternative investment universe with a history of consistently generating strong risk-adjusted returns in both up and down markets, supported by institutional-quality infrastructure.
Whether in private placement or mutual fund for-mat, the best managers can be more expensive for investors to engage directly—if they are open to new investors at all. Regardless of the vehicle, the best managers are in a position to be able to command higher fees—if they can deliver consistently strong risk-adjusted returns, those fees represent a wise investment, in our view.
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Figure 8 shows the extent to which a higher-fee investment can compound assets relative to a low-fee vehicle. Within Morningstar’s managed futures category, many passive strategies—which generally feature lower fees than their actively managed coun-terparts—track the Diversified Trends Indicator (DTI) Index, which can go both long and short depending on whether prices are above or below their seven-month moving average. In our example, we compare the compound growth of an initial $1,000 investment in the DTI with an identical allocation to the Altegris 40, an asset-weighted index that comprises the 40 largest managers in the managed futures space. Managers report their returns net of both perfor-mance fees (typically around 20%) and management fees (around 2%) for inclusion in the Altegris 40
Index. As such, the substantial 73% difference in the compound of the allocation to that index vs. an investment in the DTI since July 2000 underscores the notion that higher fees can be worthwhile in the service of better returns.
Certainly, passive exposures via indices, such as in exchange-traded funds (ETFs), represent a viable—and popular—option for investors seeking more liquid access to alternatives. However, Altegris believes that actively managed mutual funds have the ability to best capture the risk-return attributes of core alternative investment strategies such as long/short equity, managed futures and global macro due to their nimbleness and flexible investment opportunity sets.
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GRowtH of $1000 | July 2000 – March 2012Higher fees in context: actively managed futures have significantly outperformed low-fee index funds on a historical basis.
Source: Morningstar Direct, AltegrisPASt PerforMAnce iS not neceSSArilY inDicAtive of future reSultS. An investor cannot invest directly in an index. Moreover, indices do not reflect commissions or fees that may be charged to an investment product based on the index, which may materially af-fect the performance data presented. the Altegris 40 index was started in July 2000; data is available back to 1990. See pages 24 and 25 for additional index definitions, descriptions, and risks.
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While it’s difficult to draw up a macroeconomic fore-cast for the next few years, volatility in the markets is a factor that will always exist to some extent regardless. As a result, we believe it is important for portfolios to incorporate investments that are able to not only withstand times of increased market volatility, but potentially profit from them as well—and man-aged futures within our alternatives core may be one
such investment (See Figure 9). Managed futures have historically performed well in a wide variety of market conditions, including when expected volatil-ity is high or simply shifting. The ability of managed futures to perform despite market volatility may, therefore, be beneficial to those seeking to counter market uncertainty.
Preparing for the Markets’ next Phase
Particularly in light of recent history, we believe that it is critical for investors in formulating their long-term plans to maintain investment flexibility and focus on strategies with the ability to perform in a variety of market conditions. At the same time, we also believe that the ability to go long and short in various asset classes is a key driver for extended investment success.
“We believe that the ability—and skill—to go both long and short is crucial for delivering strong risk-adjusted returns in up and down markets.”
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Decrease in expected volatility Increase in expected volatility
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annualized Rate of RetuRn at vaRious viX levels | January 1990 – March 2012Managed futures have delivered consistently strong historical performance across different levels of market volatility. on average, since 1990 managed futures have delivered a return of 13% when the viX, an index that measures market volatility, is 40% or higher than its historic average. in contrast, us stocks have lost an average of 24% at the same viX levels.
Source: Bloomberg, Altegristhe annualized return of an investment is only one measure of performance. Performance should never be the sole consideration when making an investment decision. there is no guarantee that any investment will achieve its objectives, generate profits or avoid losses. PASt PerforMAnce iS not neceSSArilY inDicAtive of future reSultS. An investor cannot invest directly in an index. Moreover, indices do not reflect commission or fees that may be charged to an investment product based on the index, which may materially affect the performance data presented. inDiceS: uS Stocks: S&P 500 total return index; Managed futures: Altegris 40 index (started July 2000; data available back to 1990); int’l Stocks: Morgan Stanley capital international, inc. eAfe net index; commodities: S&P GSci total return index; reits: ftSe nAreit composite total return index; viX index. Date range based on common period of data availability for shown indices. See pages 24 and 25 for additional index definitions, descriptions and risks.
Beyond preparing for continued volatility, we believe that investors should endeavor to build a diversified portfolio and position themselves to take advantage of a range of market opportunities by allocating to a mix of so-called “convergent” and “divergent” strate-gies that are available in liquid structures—a topic that Altegris plans to examine in greater detail in an upcoming white paper.
Convergent strategies are based on the idea that the intrinsic value of securities and asset classes can be measured using fundamental data. By analyzing this
data, a convergent manager can express an opinion on whether a security is over-/undervalued, believing that the price will “converge” to its intrinsic value over time. Long/short equity is a prominent example of a convergent strategy.
Divergent strategies, in contrast, aim to profit when fundamental valuations are ignored by the market. These strategies—of which managed futures is a prime example—seek to identify and exploit serial price movement (trends and momentum) that reflect changing market themes and investor sentiment.
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Global macro is a strategy that could fall under either category, depending on the market environment. Macro managers may anticipate market dislocations and position their portfolios for “divergence,” or they may identify mispriced markets and position their portfolios for “convergence.”
In fact, global macro’s flexibility is further under-scored by the fact that the strategy has historically exhibited strong performance in bear markets— particularly relative to equities. Figure 10 illustrates how global macro managers as a group have demon-strated significant “crisis alpha”—the ability to make profits in periods when long-only strategies have experienced substantial losses.
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GloBal MacRo RetuRn / s&P 500 RetuRn | January 1997 – March 2012Global macro has produced positive returns during four of the five worst quarters for the s&P since January 1997.
Source: Altegris PASt PerforMAnce iS not inDicAtive of future reSultS. An investor cannot invest directly in an index. Moreover, indices do not reflect commissions or fees that may be charged to an investment product based on the index, which may materially affect the performance data presented. Global Macro: Barclay Global Macro index; uS Stocks: S&P 500 total return index. Date range based on common period of data availability for shown indices. See pages 24 and 25 for additional index definitions, descriptions and risks.
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fiGuRe 11.
saMPle lonG/sHoRt equitY PoRtfolio eXPosuResa hedged long/short portfolio with low net exposure may be less vulnerable to market swings than one that is 100% net long.
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Source: AltegrisShort: selling an asset/security that may have been borrowed from a third party with the intention of buying back at a later date. Short positions profit from a decline in price. if a short position increases in price, covering the short position at a higher price may result in a loss. long: buying an asset/security that gives partial ownership to the buyer of the position. long positions profit from an increase in price. there is no guarantee that any investment product will achieve its objectives, generate profits or avoid losses. the success of an investment is dependent upon the ability of a long/short equity manager to identify profitable investment opportunities and successfully trade. the identification of attractive trading opportunities is difficult, requires skill and involves a significant degree of uncertainty. See the glossary on page 23 for term definitions.
Amid changing economic conditions, we believe that the ability—and skill—to go both long and short is crucial for delivering strong risk-adjusted returns in up and down markets. Strategies that include long and short exposures can be highly flexible, and managers can adjust those exposures to a variety of market conditions.
In long/short equity, for example, higher net long ex-posures (where long exposure is significantly greater than short exposure) will generally correspond with periods of increased bullishness in the strategy, while
lower net exposures would typically indicate a more bearish outlook and/or cautious positioning.
We believe that this ability to adapt exposures on both the long and the short sides of portfolios provides an edge over traditional long-only portfolios, where the manager might rely on stock-picking abilities and market beta. That is, a long/short portfolio can be adjusted to hedge against swings in the market, whereas a portfolio that is 100% net long (high beta) is vulnerable to such swings (See Figure 11).
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GRowtH of $1000 | January 1997 – March 2012investors can potentially benefit from a long-term approach to core alternative investments.
Source: Morningstar Direct, AltegrisPASt PerforMAnce iS not neceSSArilY inDicAtive of future reSultS. An investor cannot invest directly in an index. Moreover, indices do not reflect commissions or fees that may be charged to an investment product based on the index, which may materially af-fect the performance data presented. Date range based on common period of data availability for shown indices. See pages 24 and 25 for additional index definitions, descriptions and risks.
Additional alpha may be generated by a manager’s ability to successfully pick securities on both the long and the short sides. As a result, the best managers not only use shorting as a hedging mechanism, but also as an opportunistic means of delivering alpha in a range of environments. This further underscores the appeal of experienced alternative managers who have a history of successfully identifying securities on both the long and short sides, and simultaneously managing the delicate balance between those two books—as opposed to managers transitioning from the long-only world who might be astute at identify-ing undervalued securities but have not yet proven that they possess the skills to efficiently oversee a short portfolio.
In the context of a long-term investment strategy, long/short equity, managed futures and global macro are all designed to do well in a wide range of short-term market conditions. As liquid, opportunistic, non-correlated investments, these strategies can potentially allow an investor to weather an array of short-term conditions in order to achieve his or her longer-term risk-adjusted return objectives, as illustrated by the compound growth of a $1,000 investment in Figure 12.
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By gaining exposure to premier alternative investment managers, in a liquid, mutual fund format, investors can infuse their portfolios with more flexibility, reduce correlations to stocks and bonds and improve their potential risk-return profiles. Altegris believes that,
through the use of liquid alternatives, investors can potentially enjoy the best of both worlds—mutual funds and alternative investments—as they pursue their long-term investments goals.
Conclusion
Alternative investments and mutual funds have historically existed in separate realms—where high-net-worth and institutional investors have been the beneficiaries of access to the former, and a broader range of investors have taken advantage of the strengths of the latter. However, recent years have seen a blurring of the lines between the two worlds—and that shift has gathered momentum in the wake of the financial crisis.
For more information and perspectives on alternatives, please visit altegrisacademy.com or contact your alternatives consultant at Altegris Investments (800) 828-5225.
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Glossary
Alpha: measures the non-systematic return which cannot be attributed to the market. It shows the difference between a fund’s actual return and its expected return, given its level of systematic (or market) risk (as measured by beta). A positive alpha indicates that the fund has performed better than its beta would predict. Alpha is widely viewed as a measure of the value added or lost by a fund manager.
Beta: A measure of volatility that reflects the tendency of a security’s returns and how it responds to swings in the markets. A beta of 1 indicates that the security’s price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security’s price will be more volatile than the market.
Drawdown: a drawdown is any losing period during an investment time frame. It is calculated by taking the peak-to-valley loss relative to the peak for a stated time period. The figure is expressed as a percentage.
Exposure: the proportion of money invested in a particular type of security and/or market sector or industry. usually expressed as a percentage of total portfolio holdings.
Long: buying an asset/security that gives partial ownership to the buyer of the position. Long positions profit from an increase in price.
Sector: group of businesess that share similar characteristics or a related product of service (e.g., energy, consumer, financials, technology).
Short: selling an asset/security that may have been borrowed from a third party with the intention of buying back at a later date. Short positions profit from a decline in price. If a short position increases in price, covering the short position at a higher price may result in a loss.
Standard deviation: a statistical measure of how consistent returns are over time; a lower standard deviation indicates historically less volatility.
Style: the primary strategy or philosophy used by an investor or money manager to select individual securities.
VAMI: value added monthly index. A graph that shows the compounded growth of a $1,000 investment on a monthly basis.
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Index Definitions
An investor cannot invest directly in an index. Moreover, indices do not reflect commissions or fees that may be charged to an invest-ment product based on the index, which may materially affect the performance data presented. the referenced indices are shown for general market comparisons and are not meant to represent any particular investment.
Commodities. The S&P GSCI Total Return Index measures a fully collateralized commodity futures investment and currently includes 24 commodity nearby futures contracts.
Int’l Stocks. The MSCI eAFe Index is a capitalization-weighted index widely accepted as a benchmark of non-uS stocks compiled by Morgan Stanley. It represents an aggregate of 21 individual country indices that collectively represent many of the major markets of the world.
Long/Short Equity. The HFRI equity Hedge (Total) Index tracks funds that maintain positions both long and short in primarily equity derivative securities. equity hedge managers would typically maintain at least 50% exposure, and may in some cases be entirely invested in, equities—both long and short. HFRI equity Hedge (Total) is a fund weighted index and reflects monthly returns, net of all fees, of funds that have at least $50 million under management or been actively trading for at least twelve months.
Managed Futures. The Altegris 40 Index® tracks the performance of the 40 leading managed futures programs, by ending monthly equity (assets) for the previous month, as reported to Altegris by the over 500 managed futures programs that report performance to Altegris’ proprietary database. The Altegris 40 index represents the dollar-weighted average performance of those 40 constituent programs. The Index started in july 2000; data is available back to 1990.
REITs. The FTSe nAReIT Composite Total Return Index includes both price and income returns of all publicly traded ReITs (equity, mortgage and hybrid). The Index began on December 31, 1971 with a base value of 100.
US Bonds. The Barclays Capital u.S. Aggregate Index represents securities that are SeC-registered, taxable, and dollar denominated. The index covers the u.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. These specific indices include the Government/Credit Index, Government Index, Treasury Index, Agency Index and Credit Index.
US Stocks. The S&P 500 Total Return Index is the total return version of S&P 500 index. The S&P 500 index is unmanaged and is generally representative of certain portions of the u.S. equity markets. For the S&P 500 Total Return Index, dividends are reinvested on a daily basis and the base date for the index is january 4, 1988. All regular cash dividends are assumed reinvested in the S&P 500 index on the ex-date. Special cash dividends trigger a price adjustment in the price return index.
VIX. Chicago Board Options exchange Volatility Index, commonly known as the VIX, measures implied near-term volatility of S&P 500 index option prices.
Global Macro. The Barclay Global Macro Index tracks the performance of ~175 global macro programs, by ending monthly values, net of fees, as reported to Barclay Hedge.
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Representative Index Characteristics Key Risks
Commodities S&P GSCI Total Return Index
24 principal physical com-modities that are the subject of active, liquid futures markets
Market risk. Prices may decline.Derivative risk. May be subject to higher volatility.Leverage risk. Volatility and risk of loss may magnify with use of leverage.
International Stocks
MSCI EAFE Index 1,000+ stocks from 20+ devel-oped markets in Europe and the Pacific Rim
Stock market risk. Stock prices may decline.Country / regional risk. World events may adversely affect values.Currency risk. Unfavorable exchange rates may occur.
Long/Short Equity
HFRI Equity Hedge (Total) Index
Variety of investment processes that maintain at least 50% exposure to equities—both long and short
Stock market risk. Stock prices may decline.Industry risk. Adverse sector performance may cause declines.Leverage risk. Volatility and risk of loss may magnify with use of leverage.
Managed Futures
Altegris 40 Index® 40 top AUM managed futures programs, monthly, as reported to Altegris
Market risk. Prices may decline.Leverage risk. Volatility and risk of loss may magnify with use of leverage.Country / regional risk. World events mayadversely affect values.
REITs FTSE NAREIT Composite Total Return Index
Publicly traded US real estate investment trusts (REITs)
Stock market risk. Stock prices may decline.Industry risk. Adverse real estate may cause declines.Interest rate risk. Prices may decline if rates rise.
US Bonds Barclays Capital US
Aggregate Index
Wide spectrum of taxable, investment-grade US fixed income
Interest rate risk. Bond prices will decline if rates rise.Credit risk. Bond issuer may not pay.Income risk. Income may decline.
US Stocks S&P 500 Total Return (TR) Index
500 US stocks
Weighted towards large capitalizations
Stock market risk. Stock prices may decline.
Global Macro Barclay Global Macro Index
~175 global macro programs by monthly values as reported to Barclay.
Market risk. Prices may decline.Leverage risk. Volatility and risk of loss may magnify with use of leverage.Country / regional risk. World events mayadversely affect values.
Index Descriptions And Risks
Characteristics Key Risks
S&P Diversified Trends Indicator Composite of 24 liquid futures evenly weighted between finan-cial and physical commodities
Market risk. Prices may decline.Leverage risk. Volatility and risk of loss may magnify with use of leverage.Country / regional risk. World events may adversely affect values.
Indicator Definition, Description and Risk
S&P Diversified Trends Indicator. The S&P DTI is a composite of 24 highly liquid futures grouped into 14 sectors, evenly weighted between financial and physical commodities.
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Risks and Important Considerations
Altegris Advisors LLC is an SEC-registered investment adviser that advises alternative strategy mutual funds that may pursue investment returns through a combination of managed futures, macro, equity long short, fixed income and/or other investment strategies.
MUTUAL FUNDS INVOLVE RISK INCLUDING POSSIBLE LOSS OF PRINCIPAL.
As with all mutual funds, there is the risk that you could lose money through your investment in the fund. no fund is intended to be a complete investment program. Many factors affect a fund’s net asset value and performance and there can be no assurance that any fund will achieve its investment objectives.
Alternative investment mutual funds are subject to certain risks including, but not limited to, non-diversification risk, which means that a fund may invest in fewer securities at any one time than a diversified fund and the fund’s performance may be more sensitive to any single economic, business, political or regulatory occurrence. factors such as domestic and foreign economic growth and market condi-tions, interest rate levels and political events affect the securities and derivatives markets. When the value of the fund’s investments goes down, your investment in a fund decreases in value and you could lose money.
An investment in derivatives, such as futures and options contracts, involves additional risks that a fund would not be subject to if it invested directly in the securities and commodities underlying those derivatives. the fund may experience losses that exceed losses experienced by funds that do not use futures contracts and options. long options positions may expire worthless. Although futures contracts are generally liquid instruments, under certain market conditions there may not always be a liquid secondary market. trading restrictions or limitations may be imposed by an exchange, and government regulations may restrict trading in futures contracts and options. over-the-counter transactions are subject to little, if any, regulation and may be subject to the risk of counterparty default.
When a fund invests in fixed income securities or derivatives, the value of your investment in the fund will fluctuate with changes in interest rates. in general, the market price of debt securities with longer maturities will increase or decrease more in response to changes in interest rates than shorter-term securities. other risk factors include credit risk (the debtor may default) and prepayment risk (the debtor may pay its obligation early, reducing the amount of interest payments). “High yield” or “junk” bonds present greater credit risk than bonds of higher quality, as well as heightened liquidity risk and risk of default.
foreign investing involves risks not typically associated with uS investments, including adverse fluctuations in foreign currency values, adverse political, social and economic developments, less liquidity, greater volatility, less developed or less efficient trading markets, political instability and differing auditing and legal standards. these risks are magnified in emerging markets.
Alternative investment mutual funds may also engage in short selling and short position derivative activities, which involve significant financial risk. Positions in shorted securities and derivatives are speculative and more risky than “long” positions (purchases) because the cost of the replacement security or derivative is unknown. therefore, the potential loss on an uncovered short is unlimited, whereas the potential loss on long positions is limited to the original purchase price. You should be aware that any strategy that includes sell-ing securities short could suffer significant losses. Shorting will also result in higher transaction costs (such as interest and dividends), which reduces a fund’s return, and may result in higher taxes. the use of leverage by a fund, such as borrowing money to purchase securities or the use of options, will cause the fund to incur additional expenses and magnify the fund’s gains or loss.
the investment expertise of the portfolio manager may prove to be inaccurate and may not produce the desired results. the manager’s judgments about the attractiveness, value and potential appreciation or depreciation of a particular security in which the fund invests may prove to be inaccurate and may not produce the desired results.
If used in connection with the sale or promotion of an investment company product, this material must be preceded or accompanied by a prospectus for the respective product.
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About Altegris
Altegris searches the world to find what we believe are the best alternative investments. Our suite of private funds, actively managed mutual funds and managed accounts provides an efficient solution for financial pro-fessionals and individuals seeking to improve portfolio diversification.
With one of the leading research and investment groups focused solely on alternatives, Altegris follows a disciplined process for identifying, evaluating, selecting and monitoring investment talent across a spectrum of alternative strategies including managed futures, global macro, long/short equity, event-driven and others.
Veteran experts in the art and science of alternatives, Altegris guides investors through the complex and often opaque universe of alternative investing. Alternatives are in our DNA. Our very name, Altegris, highlights our singular focus on alternatives, the highest standards of integrity and a process that constantly seeks to mini-mize investor risk while maximizing potential returns.
The Altegris Companies, wholly owned subsidiaries of Genworth Financial, Inc., include Altegris Investments, Altegris Advisors, Altegris Funds and Altegris Clearing Solutions. Altegris currently has approximately $3.36 billion in client assets, and provides clearing services to $774 million in institutional client assets.*
* Altegris and its affiliates are subsidiaries of Genworth financial, inc. and are affiliated with Genworth financial Wealth Management, inc., and include: (1) Altegris Advisors, llc, an Sec registered investment adviser; (2) Altegris investments, inc., an Sec-registered broker-dealer and finrA member; (3) Altegris Portfolio Management, inc. (dba Altegris funds), a cftc-registered commodity pool operator, nfA member and Sec-registered investment adviser; and (4) Altegris clearing Solutions, llc, a cftc-registered futures intro-ducing broker and commodity trading advisor and nfA member. the Altegris companies and their affiliates have a financial interest in the products they sponsor, advise and/or recommend, as applicable. Depending on the investment, the Altegris companies and their affiliates and employees may receive sales commissions, a portion of management or incentive fees, investment advisory fees, 12b-1 fees or similar payment for distribution, a portion of commodity futures trading commissions, margin interest and other futures-related charges, fee revenue and/or advisory consulting fees. Genworth financial, inc. (nYSe: GnW) is a leading fortune 500 insurance holding company dedicated to helping people secure their financial lives, families and futures. Genworth has leadership positions in offerings that assist consumers in protecting themselves, investing for the future and planning for retirement—including life insurance, long-term care insurance, financial protection coverages and independent advisor-based wealth management—and mortgage insurance that helps consumers achieve home ownership while assisting lenders in managing their risk and capital.
ALTegrIS ADVISOrS888.524.9441www.altegrisadvisors.com
Printed June 2012405183_052512
