This document is intended for advisors to support the assessment of investment suitability for investors. Investors are expected to consult their advisor to determine suitability for their investment objectives and portfolio. Please read the offering documents before investing. Source of data is Bloomberg, and Ontario Teachers’ Pension Plan[1], unless otherwise indicated. The information contained herein is derived from sources which are believed to be reliable and every effort has been made to ensure the accuracy of its contents.
Publication Date: December 1st 2022
This month’s blog is brief. From the largest pensions to the most traditional bank platforms, investors are increasingly embracing alternative investments[2].
The question is, why?
We believe two reasons often come to the forefront:
Diversification
Potential Returns Enhancement
In our view 2022 has demonstrated that many portfolios have little or inconsequential amounts of the above. While some forward-thinking investors such as Ontario Teachers' Pension Plan (OTPP) have long moved away from a traditional 60/40 portfolio and successfully navigated this new inflationary regime (OTPP announced first half 2022 performance of 1.2%), many investors are experiencing double digit negative returns (60/40 MSCI ACWI/Barclay’s Agg portfolio down -14.1% through November 30th)[3].
If Diversification and returns enhancement indeed are the motivations to embrace alternatives, we may recommend investors think hard about what they're invested in, how much, and why.
Importantly, investors should consider what may work in this inflationary environment versus what may have worked in the Quantitative Easing (QE) driven, Zero Interest Rate Policy (ZIRP) environment of the 2010s.
1 - Diversification – Not All Alternatives Are The Same
Many investors, particularly those at traditional bank platforms with portfolio constraints, have used their “alternative” allocation for investments in private equity, infrastructure, and traditional hedge funds. As demonstrated in Table 1 below, these generally have a high correlation to equities (S&P 500) and accordingly provide nominal diversification benefit.
Table 1: The correlation of most alternatives to the S&P 500 is high.
Term Jan 1st 2006 to Oct 31st 2022. Source: Auspice Investment Operations & Bloomberg. Infrastructure: S&P Global Infrastructure Index (SPGTIND). Global Hedge Funds: HFRX Global Hedge Fund Index (HFRXGL). Global Real Estate: FTSE EPRA/NAREIT Global Real Estate Index (RUGL). Emerging Markets: MSCI EM Emerging Markets Net Return USD (MSCI EM NET). Private Equity: S&P Listed Private Equity (SPLPEQTR). Hedge Equity: HFRX Equity Hedge Index (HFRXEH). High Yield: S&P 500 High Yield Corporate Bond Index (SP5HYBIT). EAFE: MSCI EAFE Net Return USD (MSCI EAFE NET). Merger Arbitrage: HFRX Merger Arb Index (HFRXMA). Credit Arbitrage: HFRX Credit Arb (HFRXCRED). Macro Multi Strat: HFRX Macros Multi Strat (HFRXMMS). MLP: S&P MLP Index (SPMLP). Passive Commodity: S&P GSCI Total Return Index (GSCI TR). Active Commodity: Auspice Broad Commodity Excess Return Index (ABCERI). CTA Trend Followers: BTOP 50 Index. The performance of Auspice Broad Commodity Index prior to 9/30/2010 represents index data simulated prior to third party publishing as calculated by the NYSE. You cannot invest directly into an index. This is a hypothetical example, for illustrative purposes only.
2 – Potential Returns Enhancement – Consider the Macro Environment
Many alternatives and traditional investments such as bonds and real estate provided attractive returns in the previous QE / ZIRP decade in which cash was cheap (interest rates near zero globally[4]).
It may be prudent for investors to revisit long term asset class allocation given the inflationary environment that we are currently in. Consider Table 2 below.
Table 2: The real total returns of assets through eight US inflationary regimes, as well as the annualized return during inflationary, non-inflationary, and all periods
Source: The Best Strategies for Inflationary Times, March 29th 2021.
Summary
Consider that Ontario Teachers’ Pension Plans (OTPP) had just 9% of their portfolio in public equity and 22% in fixed income as of June 30th 2022. OTPP delivered an impressive +1.2% return in the first half of 2022, far superior to the traditional portfolio (60% MSCI ACWI / 40% Barclay’s Agg) result of -16.3%[5]. Notably OTPP had 12% of the entire portfolio in commodities, 7% in absolute return, and 5% in a separate inflation hedge portfolio.
“Our diversified portfolio performed well and as designed, delivering positive returns despite a highly inflationary environment that saw losses in most major stock and bond indices. We saw positive returns in our inflation-sensitive, infrastructure and absolute return strategies asset classes, which were partially offset by losses in public equities, venture growth and credit,”
“The fund has benefited from our deliberate efforts over the last 12 months to tilt the asset mix towards those that perform well in inflationary environments, particularly commodities and infrastructure.”
-Ziad Hindo, OTPP Chief Investment Officer. (See here for article).
References
[1] https://www.otpp.com/en-ca/about-us/news-and-insights/2022/ontario-teachers--delivers-positive-return-in-first-half-of-2022/
[2] https://advisor.visualcapitalist.com/the-projected-growth-of-alternative-assets/
[3] Source: Auspice Investment Operations and Bloomberg. See index definitions at end. You cannot invest directly in an index.
[4] https://fortune.com/2022/10/13/low-inflation-interest-rates-aberration-economic-regime-change-bank-of-america/
[5] Source: Auspice Investment Operations and Bloomberg. See index definitions at end. You cannot invest directly in an index.
Disclaimers Below
IMPORTANT DEFINITIONS, DISCLAIMERS AND NOTES
1. The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe. Price Return data is used (not including dividends).
2. The MSCI ACWI Index (MSCI ACWI), MSCI’s flagship global equity index, is designed to represent performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 24 emerging markets. As of May 2022, it covers more than 2,933 constituents across 11 sectors and approximately 85% of the free float-adjusted market capitalization in each market.
3. The Barclay’s Aggregate Bond Index (Barclay’s Agg), is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in for measuring the performance of the US bond market.
4. The S&P Goldman Sachs Commodity Excess Return Index (GSCI TR), is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The GSCI Total Return (“TR”) Index includes the return on cash collateral.
5. The Auspice Broad Commodity strategy combines opportunistic commodity exposure with capital preservation. Returns for Auspice Broad Commodity Excess Return Index or “ABCERI” represent returns calculated and published by the NYSE. ABCERI index calculated and published by NYSE since Sep. 2010. Returns prior as published by the NYSE are considered hypothetical. The index does not have commissions, management/incentive fees or operating expenses. The Auspice Broad Commodity Excess Return (“ER”) Index does not include the return on cash collateral.
6. The S&P Global Infrastructure Index (SPGTIND) is designed to track 75 companies from around the world chosen to represent the listed infrastructure industry while maintaining liquidity and tradability.
7. The HFRX Global Hedge Fund Index (HFRXGL) is designed to be representative of the overall composition of the hedge fund universe. It is comprised of all eligible hedge fund strategies, including but not limited to convertible arbitrage, distressed securities, equity hedge, equity market neutral, event driven, macro, merger arbitrage, and relative value arbitrage. The strategies are asset weighted based on the distribution of assets in the hedge fund industry.
8. The FTSE EPRA/NAREIT Global Real Estate Index (RUGL) is a free-float adjusted, market capitalization-weighted index designed to track the performance of listed real estate companies in both developed and emerging countries worldwide. Constituents of the Index are screened on liquidity, size and revenue.
9. The MSCI EM Emerging Markets Net Return USD (MSCI EM NET) captures large and mid cap representation across 24 Emerging Markets (EM) countries. With 1,386 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country
10. The S&P Listed Private Equity (SPLPEQTR) comprises the leading listed private equity companies that meet specific size, liquidity, exposure, and activity requirements. The index is designed to provide tradable exposure to the leading publicly-listed companies that are active in the private equity space.
11. The HFRX Equity Hedge Index (HFRXEH) The HFRX Equity Hedge Index measures the performance of the hedge fund market. Equity hedge strategies maintain positions both long and short in primarily equity and equity derivative securities. Strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios.
12. The S&P 500 High Yield Corporate Bond Index (SP5HYBIT), a subindex of the S&P 500 Bond Index, seeks to measure the performance of U.S. corporate debt issued by constituents in the S&P 500 with a high-yield rating. The S&P 500 Bond Index is designed to be a corporate-bond counterpart to the S&P 500, which is widely regarded as the best single gauge of large-cap U.S. equities.
13. The MSCI EAFE Net Return USD (MSCI EAFE NET) is an equity index which captures large and mid cap representation across 21 Developed Markets countries around the world, excluding the US and Canada. With 799 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.
14. The HFRX Merger Arb Index (HFRXMA) consists of strategies which employ an investment process primarily focused on opportunities in equity and equity related instruments of companies which are currently engaged in a corporate transaction. Merger Arbitrage involves primarily announced transactions, typically with limited or no exposure to situations which pre-, post-date or situations in which no formal announcement is expected to occur.
15. The HFRX Credit Arb (HFRXCRED)consists of strategies that employ an investment process designed to isolate attractive opportunities in corporate fixed income securities; these include both senior and subordinated claims as well as bank debt and other outstanding obligations, structuring positions with little of no broad credit market exposure.
16. The HFRX Macros Multi Strat (HFRXMMS) consists of strategies which employ components of both Discretionary and Systematic Macro strategies, but neither exclusively both. Strategies frequently contain proprietary trading influences, and in some cases contain distinct, identifiable sub-strategies, such as equity hedge or equity market neutral, or in some cases a number of sub-strategies are blended together without the capacity for portfolio level disaggregation.
17. The S&P MLP Index (SPMLP) provides investors with exposure to the leading partnerships that trade on the NYSE and NASDAQ. The index includes both master limited partnerships (MLPs) and publicly traded limited liability companies (LLCs), which have a similar legal structure to MLPs and share the same tax benefits.
18. The BTOP50 CTA (BTOP 50) seeks to replicate the overall composition of the managed futures industry with regard to trading style and overall market exposure. The BTOP50 employs a top-down approach in selecting its constituents. The largest investable trading advisor programs, as measured by assets under management, are selected for inclusion in the BTOP50. In each calendar year the selected trading advisors represent, in aggregate, no less than 50% of the investable assets of the Barclay CTA Universe.
Futures trading is speculative and is not suitable for all customers. Past results are not necessarily indicative of future results. This document is for information purposes only and should not be construed as an offer, recommendation or solicitation to conclude a transaction and should not be treated as giving investment advice. Auspice Capital Advisors Ltd. makes no representation or warranty relating to any information herein, which is derived from independent sources. No securities regulatory authority has expressed an opinion about the securities offered herein and it is an offence to claim otherwise. Please read the offering documents before investing.
Certain statements in this document are forward- looking statements, including those identified by the expressions “anticipate”, “believe”, “plan”, “estimate”, “expect”, “intend”, “target”, “seek”, “will” and similar expressions to the extent they relate to the Fund and the Manager. Forward- looking statements are not historical facts but reflect the current expectations of the Fund and the Manager regarding future results or events. Such forward-looking statements reflect the Fund’s and the Manager’s current beliefs and are based on information currently available to them. Forward-looking statements are made with assumptions and involve significant risks and uncertainties. Although the forward-looking statements contained in this document are based upon assumptions that the Fund and the Manager believe to be reasonable, none of the Fund or the Manager can assure investors that actual results will be consistent with these forward-looking statements. As a result, readers are cautioned not to place undue reliance on these statements as a number of factors could cause actual results or events to differ materially from current expectations.
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