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Spring training for alternatives investors

Time to read: 3 min

As a big baseball fan and the father of a college baseball player, this is a joyous time of the year for me — it signals the return of baseball with the start of spring training. A primary goal of spring training is getting the players back to basics by focusing on the fundamentals of the game. By doing so, the players ensure they are ready to go when the season begins. In honor of spring training, I’d like to take investors back to the basics and fundamentals of alternative investments (or alts).

Alternative investments defined

Let’s start by defining what we mean by alternative investments. Invesco defines alternatives as investments other than publicly traded, long-only equities and fixed income. Based on this definition, investments that have any of the following characteristics would be defined as alternatives:

  • Investments that engage in “shorting” (i.e., seeking to profit from a decline in the value of an asset) such as global macro, market neutral and long/short equity strategies.
  • Investments in asset classes other than stocks and bonds, such as real estate, commodities, natural resources (i.e., timberland), infrastructure, and master limited partnerships.
  • Investments in illiquid and/or privately traded assets, such as private equity, venture capital, and private credit.

Alts for all – liquid strategies now available

Historically, alternative investments were only available to institutional and high-net-worth investors, but over the past decade several types have become available to individuals. Generally speaking, access to illiquid strategies such as private equity and direct real estate is still restricted, but liquid strategies such as REITs, global macro, long/short equity and several other traditional hedge fund approaches are available to individual investors through mutual funds.

Through the use of alternative investments, individual investors now have new and unique tools to help them achieve their goals. That said, alternatives can be confusing, and many investors struggle to understand the different types and strategies.

How can alternatives potentially help investors?

To use a baseball analogy, alternatives are like a good-hitting utility player — they can help both offensively and defensively. This dynamic can be seen in the chart below, which examines the historical performance of a portfolio of liquid alternatives compared to equities, fixed income, and a 60% equity/40% fixed income portfolio.

Example portfolio returns from August 1998 through December 20181

Source: Invesco. Past performance is not a guarantee of future results. Investments cannot be made directly into an index. Returns shown are annualized.

The ability to play offense is demonstrated by the fact that alternatives generated a compound annual return slightly above that of equities for the period shown. Similarly, the ability to play defense is illustrated through alternatives’ significantly lower volatility (as measured by standard deviation) and maximum decline compared to equities. To me, the biggest takeaway from the above chart is that while alternatives may enhance returns, their greatest contribution is potentially reducing risk within a portfolio by dampening volatility and decreasing maximum decline.

For investors, it is equally important to understand how alternatives have performed during different parts of the market cycle (see chart below1).

Source: Invesco. Past performance is not a guarantee of future results. Investments cannot be made directly into an index. Returns shown are annualized.

During bull market periods (tech bubble, debt run-up, post-crisis bull market), alternatives historically generated positive returns but lagged those of stocks. During the two bear market periods shown (bursting of the tech bubble and financial crisis), alternatives outperformed equities and the 60%/40% blend but trailed fixed income. In the first bear market period (tech bubble), alternatives generated a positive return, while in the other (financial crisis), the return was less negative than for equities.

My expectation for alt performance in 2019

When considering alternatives, I believe it is critical to understand the nature of returns during different parts of the market cycle. For nearly 20 years, the example alternative portfolio underperformed during periods of stock market strength but outperformed during periods of stock market weakness. Over the long term, this portfolio slightly outperformed equities, fixed income and a 60%/40% blend of the two. Of course, there is no guarantee this pattern will repeat itself, and history also suggests that long periods of market growth and low volatility could result in alternatives underperforming.

Given the strong equity performance over the past decade, holding alternatives has at times felt a little bit like being a fan of the New York Mets (e.g., disappointing and frustrating). That said, last year alternatives generally outperformed equities as traditional markets became more challenging and volatile.2

Looking ahead, I believe investors should consider preparing themselves for lower equity returns and elevated volatility. Given this outlook and the evidence presented today, investors may wish to consider the addition of alternative investments to their portfolios.

To learn more about Invesco and its alternative capabilities please visit our website at

1 Source: Invesco. Alternatives portfolio is represented by a portfolio consisting of: 20% Inflation-hedging assets; 20% Principal preservation strategies; 20% Portfolio diversification strategies; 20% Equity diversification strategies; 20% Fixed income diversification strategies. Traditional 60/40 portfolio is represented by 60% S&P 500 Index and 40% Bloomberg Barclays US Aggregate Bond Index. Equities are represented by the S&P 500. Fixed Income is represented by the Bloomberg Barclays US Aggregate Bond Index. 20% Inflation-hedging assets are represented by 15% FTSE NAREIT US Real Estate Index Series, All Equity REITs and 5% Bloomberg Commodity Index. The 15%/5% split reflects Invesco’s belief that investors tend to invest in strategies with which they are more familiar. 20% Principal preservation strategies are represented by the BarclayHedge Equity Market Neutral Index. 20% Portfolio diversification strategies are represented by 12% BarclayHedge Global Macro Index and 8% BarclayHedge Multi-Strategy Index. Multistrategy is underweighted in this example due to its potential overlap with global macro. 20% Equity diversification strategies are represented by the BarclayHedge Long/Short Index. 20% Fixed income diversification strategies are represented by the 20% BarclayHedge Fixed Income Arbitrage Index

2 In 2018, the Dow Jones Industrial Average returned -5.63% and the S&P 500 Index returned -6.24%, while the Credit Suisse Hedge Fund Index returned -3.19% and the Wilshire Liquid Alternative Index returned -4.25%.

Important information

Blog header image: xjben/

The Dow Jones Industrial Average is a price-weighted index of the 30 largest, most widely held stocks traded on the New York Stock Exchange.

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

The Credit Suisse Hedge Fund Index is an asset-weighted hedge fund index and includes only funds, as opposed to separate accounts. The index uses the Credit Suisse Hedge Fund Database, which tracks approximately 9,000 funds and consists only of funds with a minimum of US$50 million under management, a 12-month track record, and audited financial statements. The index is calculated and rebalanced on a monthly basis and reflects performance net of all hedge fund component performance fees and expenses.

The Wilshire Liquid Alternative IndexSM measures the collective performance of the five Wilshire Liquid Alternative strategies that make up the Wilshire Liquid Alternative Universe. It is designed to provide a broad measure of the liquid alternative market.

The Bloomberg Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market.

The FTSE NAREIT All Equity REIT Index is an unmanaged index considered representative of US REITs.

The Bloomberg Commodity Index is a broadly diversified commodity price index.

The BarclayHedge Equity Market Neutral Index includes funds that attempt to exploit equity market inefficiencies and usually involves being simultaneously long and short matched equity portfolios of the same size within a country.

The BarclayHedge Global Macro Index includes funds that carry long and short positions in any of the world’s major capital or derivative markets.

The BarclayHedge Multi-Strategy Index includes funds that are characterized by their ability to dynamically allocate capital among strategies falling within several traditional hedge fund disciplines.

The BarclayHedge Long/Short Index includes funds that employ a directional strategy involving equity-oriented investing on both the long and short sides of the market.

The BarclayHedge Fixed Income Arbitrage Index includes funds that aim to profit from price anomalies between related interest rate securities.

Past performance is not a guarantee of future results.

A master limited partnership (MLP) is a publicly traded limited partnership in which the limited partner provides capital and receives periodic income distributions from the MLP’s cash flow and the general partner manages the MLP’s affairs and receives compensation linked to its performance.

Private equity strategies invest in companies that are not publicly quoted on a stock exchange.

Private credit strategies invest in debt instruments that are not publicly quoted on an exchange.

Macro strategies, which base investment decisions on macro views of various global markets, may take long and short positions within and across such asset classes as equities, fixed income and currencies.

Long positions are buying a security with the expectation that it will increase in value.

Net market exposure is the percentage difference between a fund’s long and short exposure.

Short positions/short selling is the sale of a security not owned by the seller, then buying later. The belief is that security prices will decline and the price paid to buy it back at will be lower than the price it was sold.

Long/short strategies (equity or credit) typically take both long and short positions to benefit from rising prices on the long side and declining prices on the short side.

Diversification does not guarantee a profit or eliminate the risk of loss.

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

Alternative investments can be less liquid and more volatile than traditional investments such as stocks and bonds, and often lack longer-term track records.

Alternative products typically hold more non-traditional investments and employ more complex trading strategies, including hedging and leveraging through derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate. You can lose money.

Short selling is a speculative investment and may require investors to meet margin requirements and repurchase the security at a higher price, causing a loss. As there is no limit on how much the price of the security can increase, loss potential is unlimited.

A real estate investment trust (REIT) is a company that owns (and typically operates) income-producing real estate or real estate-related assets.

Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.

Most master limited partnerships (MLPs) operate in the energy sector and are subject to the risks generally applicable to companies in that sector, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk. MLPs are also subject to the risk that regulatory or legislative changes could eliminate the tax benefits enjoyed by MLPs, which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the portfolio’s investments.

Although the characteristics of MLPs closely resemble a traditional limited partnership, a major difference is that MLPs may trade on a public exchange or in the over-the-counter market. Although this provides a certain amount of liquidity, MLP interests may be less liquid and subject to more abrupt or erratic price movements than conventional publicly traded securities. The risks of investing in an MLP are similar to those of investing in a partnership and include more flexible governance structures, which could result in less protection for investors than investments in a corporation. MLPs are generally considered interest-rate-sensitive investments. During periods of interest rate volatility, these investments may not provide attractive returns.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Walter Davis
Alternatives Investment Strategist

As Alternatives Investment Strategist, Walter Davis serves as Invesco’s primary alternatives representative to retail, high net worth and institutional clients across the major broker dealers, wirehouses and RIAs. He is responsible for collaborating across Invesco’s alternative strategies to develop a cohesive alternatives education program for financial advisors and investors.

Prior to joining Invesco in 2014, Mr. Davis served as a managing director in Morgan Stanley’s Alternative Investments Department, and earlier as director of High Net Worth and Institutional Sales. Prior to Morgan Stanley, he worked at Chase Manhattan Bank in the Alternative Investments Department. He has worked in the industry since 1991.

Mr. Davis graduated cum laude with a BA in economics from the University of the South. He earned an MBA in finance and international business from Columbia Business School. He holds the Series 3, 7, 24 and 63 registrations.

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