* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download Alternatives Special Report
Survey
Document related concepts
Mark-to-market accounting wikipedia , lookup
Special-purpose acquisition company wikipedia , lookup
Early history of private equity wikipedia , lookup
Stock trader wikipedia , lookup
Private equity in the 2000s wikipedia , lookup
Environmental, social and corporate governance wikipedia , lookup
Private equity wikipedia , lookup
History of investment banking in the United States wikipedia , lookup
Investment banking wikipedia , lookup
Money market fund wikipedia , lookup
Interbank lending market wikipedia , lookup
Fund governance wikipedia , lookup
Private equity secondary market wikipedia , lookup
Mutual fund wikipedia , lookup
Socially responsible investing wikipedia , lookup
Transcript
WEALTH MANAGEMENT INVESTMENT RESOURCES MARCH 23, 2017 Alternatives Special Report Wealth Management Investment Resources ALPER DAGLIOGLU Managing Director Morgan Stanley Wealth Management [email protected] DANIEL MACCARRONE Executive Director Morgan Stanley Wealth Management [email protected] ADAM S. LIEBMAN Executive Director Morgan Stanley Wealth Management [email protected] A Positive Set-Up for Hedge Funds As with most of active management, investor sentiment toward hedge funds has been poor in recent years. We believe disappointing performance has kept some investors on the sidelines despite their growing uneasiness with traditional equity and fixed income investments so late in the economic cycle. Despite a challenging 2016 for hedge funds, we did see an improvement in performance as the year progressed and have seen better results year-todate. Unfortunately, the structural headwinds such as heightened competition we discussed in “Hedge Funds–Is Bad News Good News?” (Alternatives Special Report, June 14, 2016) have not changed dramatically. However, some of the cyclical challenges are abating and should provide more opportunities for skilled managers. After a long period of accommodative global monetary policy and scant fiscal stimulus, the market environment has shifted. As a result of these changes, asset correlations are falling and dispersion in securities is increasing, creating a positive backdrop for 2017. Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance. Please refer to important information, disclosures and qualifications at the end of this material. ALTERNATIVES SPECIAL REPORT MARCH 23, 2017 Recent Performance Despite some of the challenges for hedge funds in 2016, categories such as event driven and distressed credit were able to take advantage of the rebound in the energy and materials sectors and corporate merger-and-acquisition (M&A) activity. Equity long/short and global macro generated, in aggregate, mixed returns. The past year can be marked by three distinct periods, and in each case, many funds struggled with positioning. Most of the drawdown occurred during the first quarter as the market sold off into mid-February, largely driven by the collapse in oil prices. The market rallied strongly later in the quarter, leaving many funds poorly positioned from exposure and sector standpoints. A similar pattern emerged after the Brexit referendum in June and the US election in the fourth quarter. Managers who were positioned correctly or were nimble enough to capture the ensuing rallies after the initial sell-offs were in the minority. In sum, it did not pay to have insurance or hedge against perceived negative outcomes for risk assets. Despite the challenging year, we saw an improvement in hedge fund performance after the first-quarter. We’ve seen evidence of alpha generation as the outlook for hedge fund strategies has improved leading up to and following the US presidential election. Current-year performance began on a positive note, affirming the view that a more favorable market set-up can set the stage for better performance. As can be seen in Exhibit 1, there was a significant difference in performance between top-performing and bottom-performing hedge funds in 2016. Both manager and strategy selection were big contributors to this divergence, which was 12.59% for the year. Despite mixed performance in aggregate, there were plenty of managers who produced solid absolute and risk-adjusted returns when benchmarked more appropriately to core fixed income or Exhibit 1: Difference Between Top- and Bottom-Performing Hedge Funds Was Wide in 2016 HFRI Fund Weighted Composite One-Year Three-Year Five-Year Return (%) Sharpe Ratio Return (%) Sharpe Ratio Return (%) Sharpe Ratio 25th Percentile 11.63 1.33 6.92 0.82 9.74 1.09 50th Percentile 4.99 0.57 3.41 0.34 6.23 0.65 75th Percentile -0.97 -0.13 0.28 0.00 3.08 0.30 Top vs. Bottom Quartile 12.59 1.46 6.64 0.82 6.66 0.79 60% equity/40% fixed income portfolios. While the S&P 500 Index ended the year up 11.96%, the MSCI All Country World ex USA Index was up only 5.01% and bonds posted muted gains with the Bloomberg Barclays US Aggregate Bond Index up just 2.65%. In contrast, hedge fund returns as measured by the 50th percentile of the HFRI Fund Weighted Composite was up 4.99% for 2016. Favorable Economic and Policy Backdrop A number of current economic and policy crosswinds should favor security selection, and to some extent, market timing. Managers should be better positioned, given the changing macroeconomic landscape and a pickup in GDP growth, interest rates and inflation. These anticipated or realized developments have recently led to increased dispersion in securities. They may also lead to higher volatility, which, while has yet to occur, may bode well for certain hedge fund managers who are able to capitalize on these shifts. Markets are currently facing several economic and policy outcomes that favor active management and hedging. As we move into the later phases of the economic cycle, risk management should play a greater role in manager outperformance. During the past several years, passive strategies have been rewarded on an absolute and risk-adjusted basis primarily because there have been limited periods of decline, particularly in US equity markets. The potential for significant fiscal stimulus including tax reform, repatriation and infrastructure spending can help drive company fundamentals creating relative winners and losers for long/short strategies. Also, a tighter monetary policy could impact a variety of assets classes globally as the suppression of volatility comes to an end. For instance, global macro managers who seek to profit from shifts in interest rates have struggled in recent years given the lack of rate volatility. Notably, the recent moves in interest rates and currencies have provided more opportunities for managers. Cyclical Headwinds Abate As we mark the eighth-anniversary of the equity bull market, history tells the next eight years are unlikely to be same as the last. The stock market’s recovery since the global financial crisis has been one that can be measured by above-average returns coupled with below-average volatility. This low-volatility environment brought with it few deep or prolonged market pullbacks, limiting opportunities for hedge funds. The utilization of various risk management techniques or hedging during this relatively calm period has hurt the performance for active managers. We believe the active versus passive investment debate is in fact partially a cyclical one. In the recently published “The Case for Active Source: Hedge Fund Research, GIMA as of Dec. 31, 2016 Please refer to important information, disclosures and qualifications at the end of this material. 2 ALTERNATIVES SPECIAL REPORT MARCH 23, 2017 Exhibit 2: Periods of Superior Risk-Adjusted Returns for Passive Benchmarks Are Not Unprecedented—Recall 1983-1988 and 1995-2000 3 Active Outperforms: 17 consecutive interest rate hikes from 2004 to 2007 Active Outperforms: Interest rate at a then-record low of 5% 2 50% Active Outperforms: Financial crisis of 2007-2008 40 30 20 1 10 0 0 - 10 -1 - 20 Active Outperforms: Collapse of the tech bubble, early 2000s recession and 9/11 -2 - 30 Sharpe Ratio of a US 60% Stocks/40% Bonds Portfolio (left axis) Percentage of Large-Core Managers Outperforming vs. Long-Term Average (right axis) - 40 Recession -3 1983 - 50 1986 1988 1991 1993 1996 1998 2001 2003 2006 2008 2011 2013 2016 Note: The Sharpe ratio is calculated by subtracting the risk-free rate—such as that of the three-month US Treasury bill—from the rate of for a portfolio and dividing the result by the standard deviation of the portfolio. Standard deviation, a proxy for volatility, is a measure of the dispersion of a set of data from its mean. Source: Morgan Stanley Wealth Management GIC, Bloomberg as of Dec. 30, 2016 Management” (GIC Wealth Management Perspective, Jan. 11, 2017) the percentage of large-cap core equity managers outperforming has often moved along with the economic cycle, with outperformance occurring late in the market cycle as evidenced in the early 2000’s and leading up to and during the financial crisis in 2008 (see Exhibit 2). The prospect of higher interest rates and inflation in the US has grown in recent months. That means buying assets simply for yield regardless of valuation, which worked for many years, has become a riskier strategy. The consequences of higher rates will most clearly be felt in the bond market, where returns are expected to be muted across most sectors. Furthermore, the prospect of higher rates and divergent global monetary policy should lift market volatility and dispersion across asset classes, some of which we have already begun to see. Global monetary policy since the financial crisis has tended to raise correlations and reduce volatility, presenting challenges for strategies that focus on bottom-up fundamental investing. Should volatility rise toward historical levels (see Exhibit 3, page 4), opportunities for hedge funds are apt to improve as the ability to protect on the downside and capitalize on security-level dispersion should increase. Recently, cross-asset correlations have fallen sharply, which tends to be more common later in market cycles (see Exhibit 4, page 4). This should bode well for strategies like global macro and multi-strategy funds which typically allocate across asset classes and regions. Fees are another oft-cited headwind. During the past several years, investors have scrutinized fund fees given low returns combined with the adoption of better analytical tools such as factor analysis to help identify how much returns came from the managers’ value added (alpha) versus market gains (beta). While fees are always important, weak performance made investors even more cost-sensitive. In fact, during the past 12 months, hedge fund managers have begun to soften their attitudes toward fee reductions—and industrywide, fees are coming down. Anecdotal evidence from managers and other allocators suggest that there are a reasonable percentage of large hedge fund investors paying “below headline” fees. Undoubtedly, many hedge funds are capitulating on fees lest they face investor redemptions. According to Hedge Fund Research (HFR), in 2016 total industry assets increased 4.1% to $3.02 trillion, a gain driven by positive performance. However, HFR also cited total industry outflows of $70.1 billion. While outflows only represented just over 2% of industry assets, it was the largest outflow from the industry since 2009. We believe this pressure on hedge funds will enable investors to allocate to Please refer to important information, disclosures and qualifications at the end of this material. 3 ALTERNATIVES SPECIAL REPORT MARCH 23, 2017 Exhibit 3: Volatility May Continue to Rise, Creating Potential Mispricings some of the most successful funds that have previously been closed to new capital. We continue to have conversations with managers who are more open to lower fees and we expect this trend to continue in the near future. The primary value proposition of most hedge funds should be to deliver some portion of their returns based on skill or “alpha” and provide diversification benefits to a client’s overall portfolio. We believe this will become more attainable in a lower-fee structure combined with a more favorable market environment. 0.50 % 47.4% Percent of Days With VIX Above 20 0.45 39.2% 0.40 0.35 0.30 Manager Selection and Current Themes 0.25 0.20 16.7% 16.7% 2015 2016 0.15 0.10 4.4% 0.05 1.2% 0.00 Past 20 Past 10 Years Years 2013 2014 Source: Bloomberg, Morgan Stanley Wealth Management GIC as of Dec. 31, 2016 Exhibit 4: Cross-Asset Correlation Has Plummeted in Recent Months Morgan Stanley Global Cross-Asset & Regional Index 50 % 45 40 35 30 25 20 15 2003 2005 2007 2009 2011 2013 2015 2017 Source: Bloomberg, Morgan Stanley Research as of March 6, 2017 Although the backdrop of active management has improved, valuations indicate there may be fewer large and apparent undervalued opportunities in traditional equity markets (see Exhibit 5, see page 5). In fixed income, yields remain low and spreads are generally on the tight side. This suggests lower returns from traditional stock and bond portfolios as the Global Investment Committee’s seven-year market forecast calls for lower returns and more normalized levels of volatility than we have seen in the 2009-2016 period. We believe this set-up is positive for manager skill or alpha to be a more significant driver of returns, a situation that favors hedge funds. One of the challenges investors face in manager selection is that when a manager running a strategy outperforms, new investors tend to pile in. On the other hand, when a strategy is out of favor or the manager underperforms, investors leave. This isn’t true just for hedge funds, but for all active management. However, as we have witnessed through the years, investors often have less patience with underperforming hedge funds that charge higher fees and provide less liquidity. We believe this is one of the reasons that has exacerbated the weaker performance of many funds of hedge funds. It is rare that hedge fund managers increase their assets under management when they are underperforming. However, we do believe in mean reversion in asset-class returns or the beta to a strategy. Additionally, for talented managers, we believe there is oftenmean reversion, too. In fact this was evident from 2015 to 2016 when certain factors and strategies fell out of favor but rebounded in a relatively short period of time. This too is happening in early 2017. While we would not simply advocate for a “buy low, sell high” approach to picking hedge funds and can’t exactly time when mean reversion will occur, we also would not dismiss the notion that entry points matter. Buying asset class or manager performance purely on momentum can prove costly if you buy after the easy money has been made. Previous studies have demonstrated that the best-performing managers over the longterm (10 years) often spend considerable time in the bottom half or Please refer to important information, disclosures and qualifications at the end of this material. 4 ALTERNATIVES SPECIAL REPORT MARCH 23, 2017 Exhibit 5: Higher Valuation Means Fewer Opportunities in Traditional Equity the Global Investment Committee’s market outlook (see Exhibit 6). In each of these areas, we cite specific strategies that we believe can succeed given the market environment. Each of these respective themes focuses on achieving targeted investment objectives with specific alternative investment strategies. This means it is not just general strategies, but specific managers that can help achieve a desired objective. For instance, under “Portfolio Diversifiers With Low Correlation,” the investment objective is to beat core fixed income with a similar level of risk. The benchmark here would be the Bloomberg Barclays US Aggregate Bond Index which has a 2.57% yield to worse (as of Feb. 28,) annualized volatility of 4.07% since 1984 and a duration of about six. Here we are recommending certain relative-value and trading-oriented hedge fund strategies with a similar low volatility (4% to 6%) and low correlation to equities (less than 0.3). We believe certain alternative investment managers can provide viable alternatives to fixed income where risk and correlation levels are similar—and still offer superior returns. In the Strike Zone Source: Bloomberg, Morgan Stanley Wealth Management GIC as of Dec. 30, 2016 quartile of performance rankings when viewed in rolling threeyear periods. (Joel Greenblatt, “The Big Secret For the Small Investor, How Expense Ratios and Star Ratings Predict Success,” Morningstar Fund Spy, Aug. 9, 2010). GIMA recently published several 2017 Alternative Investment Themes which we would characterize as opportunities currently presenting themselves within the hedge fund landscape based on Baseball Hall-of-Famer Ted Williams was known for waiting for just the right pitch before he would swing. The same can be said for the current market backdrop for hedge funds and for active management in general. We believe market dynamics favor certain alternative strategies over traditional investments using an outcomes-oriented approach to manager selection and portfolio construction. However, discipline and proper execution will be necessary to produce even if the set-up is just right. Exhibit 6: Current Opportunities in Hedge Funds Portfolio Diversifiers with Low Correlation Managing Global Volatility Rising Rates and Spread Widening Increase in Dispersion & Corporate Activity Reliable Income Market Environment Bond yields remain historically low, prospect of rising interest rates, weaker absolute and riskadjusted returns from core fixed income Volatility remains below historical averages, later in the economic cycle and cross-asset correlations have been falling Normalization of interest rates is likely to hurt longerduration assets and create additional fixed income volatility Correlations have been falling with diverging monetary and fiscal policy. M&A deal volume remains elevated Commercial real estate fundamentals remain stable with a favorable economic backdrop as evidenced by capital flows and vacancies Investment Opportunities Relative-value, trading-oriented strategies that have a low volatility of 4% to 6% and low correlation to equities, less than 0.30, as an alternative to core fixed income Global macro and managed futures typically work better during volatility spikes and trending markets across asset classes Structured credit funds can offer attractive yields with lower duration and event-driven outcomes that are less dependent on the market Equity long/short managers with differentiated positioning and event-driven/activist funds that can capitalize on corporate activity Nontraded real estate funds offer access to commercial real estate with reliable income of 5% to 6% and lower volatility versus publicly traded REITs Source: Morgan Stanley Wealth Management GIMA Please refer to important information, disclosures and qualifications at the end of this material. 5 ALTERNATIVES SPECIAL REPORT Glossary ALPHA This measures the difference between a portfolio’s actual returns and its expected performance, given its level of risk as measured by Beta. A positive Alpha figure indicates the portfolio has performed better than its Beta would predict. A negative Alpha indicates the portfolio’s underperformance given the expectations established by the Beta. The accuracy of the Alpha is therefore dependent on the accuracy of the Beta. Alpha is often viewed as a measurement of the value added or subtracted by a portfolio’s manager. BETA This measures a portfolio’s volatility relative to its benchmark. A portfolio with a Beta higher than 1.0 has historically been more volatile than the benchmark, while a portfolio with a Beta lower than 1.0 has been less volatile. CORRELATION This is statistical measure of how two securities move in relation to each other. This measure is often converted into what is known as correlation coefficient, which ranges between -1 and +1. Perfect positive correlation (a correlation coefficient of +1) implies that as one security moves, either up or down, the other security will move in lockstep, in the same direction. Alternatively, perfect negative correlation means that if one security moves in either direction the security that is perfectly negatively correlated will move in the opposite direction. If the correlation is 0, the movements of the securities are said to have no correlation; they are completely random. A correlation greater than 0.8 is generally described as strong, whereas a correlation less than 0.5 is generally described as weak. DRAWDOWN This term refers to the largest cumulative percentage decline in net asset value or the percentage decline from the highest value or net asset value (peak) to the lowest value net asset value (trough) after the peak. SHARPE RATIO This statistic measures a portfolio’s rate of return based on the risk it assumed and is often referred to as its risk-adjusted performance. Using standard deviation and returns in excess of the returns MARCH 23, 2017 of T-bills, it determines reward per unit of risk. This measurement can help determine if the portfolio is reaching its goal of increasing returns while managing risk. Index Definitions BLOOMBERG BARCLAYS US AGGREGATE BOND INDEX This This index tracks US-dollar-denominated investment grade fixed rate bonds. These include US Treasuries, US -government-related, securitized and corporate securities. HFRI FUND WEIGHTED COMPOSITE INDEX This is a global, equalweighted index of over 2,000 single-manager funds that report to the HFR database. Constituent funds report monthly net of all fees performance in US dollar and have a minimum of $50 million under management or a 12month track record of active performance. The HFRI Fund Weighted Composite Index does not include funds of hedge funds. MORGAN STANLEY GLOBAL CROSS-ASSET AND REGIONAL INDEX This index is an average of regional correlations and cross-asset correlations with components from equity, credit, rates and foreign exchange assets. MSCI ALL COUNTRY WORLD INDEX EX USA This is a free-float-adjusted, market-capitalization-weighted index that is designed to measure equity market performance in the global developed and emerging markets outside the US.. S&P 500 INDEX This capitalization-weighted index includes a representative sample of 500 leading companies in leading industries in the US economy. VIX This is a trademarked symbol for the Chicago Board Options Exchange Market Volatility Index, a measure of the implied volatility of the S&P 500 index options. Please refer to important information, disclosures and qualifications at the end of this material. 6 ALTERNATIVES SPECIAL REPORT MARCH 23, 2017 IMPORTANT DISCLOSURES The sole purpose of this material is to inform, and it in no way is intended to be an offer or solicitation to purchase or sell any security, other investment or service, or to attract any funds or deposits. Investments mentioned may not be suitable for all clients. Any product discussed herein may be purchased only after a client has carefully reviewed the offering memorandum and executed the subscription documents. Morgan Stanley Wealth Management has not considered the actual or desired investment objectives, goals, strategies, guidelines, or factual circumstances of any investor in any fund(s). Before making any investment, each investor should carefully consider the risks associated with the investment, as discussed in the applicable offering memorandum, and make a determination based upon their own particular circumstances, that the investment is consistent with their investment objectives and risk tolerance. Alternative investments often are speculative and include a high degree of risk. Investors could lose all or a substantial amount of their investment. Alternative investments are suitable only for eligible, long-term investors who are willing to forgo liquidity and put capital at risk for an indefinite period of time. They may be highly illiquid and can engage in leverage and other speculative practices that may increase the volatility and risk of loss. Alternative Investments typically have higher fees than traditional investments. Investors should carefully review and consider potential risks before investing. Alternative investments involve complex tax structures, tax inefficient investing, and delays in distributing important tax information. Individual funds have specific risks related to their investment programs that will vary from fund to fund. Clients should consult their own tax and legal advisors as Morgan Stanley Wealth Management does not provide tax or legal advice. Past performance is no guarantee of future results. Actual results may vary. Diversification does not assure a profit or protect against loss in a declining market. All expressions of opinion are subject to change without notice and are not intended to be a forecast of future events or results. Further, opinions expressed herein may differ from the opinions expressed by Morgan Stanley Wealth Management and/or other businesses/affiliates of Morgan Stanley Wealth Management. This is not a "research report" as defined by FINRA Rule 2241 and was not prepared by the Research Departments of Morgan Stanley Smith Barney LLC or Morgan Stanley & Co. LLC or its affiliates. Certain information contained herein may constitute forward-looking statements. Due to various risks and uncertainties, actual events, results or the performance of a fund may differ materially from those reflected or contemplated in such forward-looking statements. Clients should carefully consider the investment objectives, risks, charges, and expenses of a fund before investing. Indices are unmanaged and investors cannot directly invest in them. Composite index results are shown for illustrative purposes and do not represent the performance of a specific investment. While the HFRI indices are frequently used, they have limitations (some of which are typical of other widely used indices). These limitations include survivorship bias (the returns of the indices may not be representative of all the hedge funds in the universe because of the tendency of lower performing funds to leave the index); heterogeneity (not all hedge funds are alike or comparable to one another, and the index may not accurately reflect the performance of a described style); and limited data (many hedge funds do not report to indices, and the index may omit funds, the inclusion of which might significantly affect the performance shown. The HFRI indices are based on information self-reported by hedge fund managers that decide on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, L.L.C. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indices may not be complete or accurate representations of the hedge fund universe, and may be biased in several ways. Interests in alternative investment products are offered pursuant to the terms of the applicable offering memorandum, are distributed by Morgan Stanley Smith Barney LLC and certain of its affiliates, and (1) are not FDIC-insured, (2) are not deposits or other obligations of Morgan Stanley or any of its affiliates, (3) are not guaranteed by Morgan Stanley and its affiliates, and (4) involve investment risks, including possible loss of principal. Morgan Stanley Smith Barney LLC is a registered broker-dealer, not a bank. SIPC insurance does not apply to precious metals, other commodities, or traditional alternative investments. © 2017 Morgan Stanley Smith Barney LLC. Member SIPC. Please refer to important information, disclosures and qualifications at the end of this material. 7