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liquid alternatives October 2016 citywireamericas.com

Bridging the gap

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A new approach to multi-asset investing In an environment of low expected returns and higher volatility, today’s investment process should go a step further. At Pioneer Investments, we believe in searching for effective diversification* by budgeting risk across multiple strategies is key to facing the new investment landscape and meeting emerging client needs. I. Macro Strategy

II. Macro Hedging

III. Satellite Strategies

IV. Selection Strategies

Our “View of the World”

Protection from Macro Strategy risks

Alpha Generation

Stable Yields above Cash Rates + Capital Preservation

For more information, please contact: US.Offshore@PioneerInvestments.com

*Diversification does not ensure a profit or protect against a loss. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. There can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested.


Contents/leader | liquid alternatives

Navigating the new normal michelle abrego deputy editor citywire americas

The so-called ‘new’ normal is looking decidedly old. The era of low rates and low returns has lasted far longer than anticipated as central bank easing has failed to spark the economic growth desired. The poor profits on offer look set to continue causing many investors to chase yield by conceding to more risk. In such an environment, the presence of liquid alternatives is welcome and their rise inevitable. However, these funds are still in their infancy and confusion still abounds about how best they should be used. To answer this question and more Citywire Americas gathered some of the top US offshore fund selectors, a product specialist and leading portfolio manager at a round table forum in New York. Our panel of experts discussed the rise of liquid alternatives, the myths which surround them, their qualities and how best they can be implemented in client portfolios as investors continue to navigate these challenging times.

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the debate

Flexible approches to fixed income

thirsting for liquid alternatives

A panel of experts offer their take on how to use alternatives

Pioneer’s Michael Temple takes us on a tour of alternative approaches to bonds

Liquid alts are fast becoming a mainstream asset, says Pioneer’s Hugh Prendergast

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liquid alternatives | biogrAPHIES

Joseph Raieta

Hans Abate

Michael Temple

Director of investment solutions Snowden Lane Partners

Head of portfolio management Americas EFG Asset Management

Director of credit research, US senior vice president Pioneer Investments

Joseph Raieta, CFA, joined Snowden Lane in 2015 as director of investment solutions and is responsible for Snowden Lane’s investment products and securities platform, trading and research. Previously, Raieta was senior director and head of product management at Icon Investment Group, where he managed key functions of a $5.5 billion, multi-product, alternative investments platform. Prior to that role, Raieta held investment team and capital raising roles at Icon Capital, BlackRock and AIG.

Hans Abate is head of portfolio management for EFG Asset Management covering Latin American markets. He offers a wide range of investment solutions for high-net-worth and institutional clients in the region. Prior to joining EFG in 2005, he was the head of investments for Dresdner Lateinamerika Financial Advisors, with responsibility for portfolio and risk management, product development and client advisory services. He also served as the fixed income strategist and adviser for Dresdner’s Latin American Bond fund.

Michael Temple is senior vice president of Pioneer Investment Management, the US investment division of Pioneer Investments, and director of credit research, US. He is responsible for oversight of Pioneer Investments’ US credit research department. Prior to joining Pioneer Investments in 2002, he was a portfolio manager at Boston Partners Asset Management, and was also a senior credit analyst at Putnam Investments. He was also a senior credit analyst at Duff & Phelps in Chicago, and the director of planning and investor relations for the Public Service Company of New Mexico.

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biographies | liquid alternatives

Hugh Prendergast

Christian Lee

Patrick St Denis

Head of strategic product & marketing Western Europe and international Pioneer Investments

Senior portfolio manager Itau Asset Management

Director of investments Spouting Rock

Hugh Prendergast leads the strategic product and marketing team for Western Europe and International at Pioneer Investments. He is responsible for managing the functions of marketing and product development and research. Prendergast has worked in the investment industry since 1995. Prior to his current role, he led the investment communication function in Pioneer Investments. Before joining Pioneer Investments in 2001, he worked as both a stockbroker to institutional clients and as a financial journalist.

Christian Lee joined Itau Asset Management in October 2011 as portfolio manager for the Itau Global Enhanced fund of hedge fund strategies along with customised hedge fund solutions for the bank’s ultra-high net worth clients. Prior to Itau, Christian cofounded the Alphanumeric Hedge Fund in 2005 and became partner at LyonRoss Capital (formerly Bassini Playfair & Wright, LLC). Lee spent over nine years at Credit Suisse where he was the lead a number of currency strategies.

Patrick St Denis joined Spouting Rock as director of investments in August 2015. Prior to joining Spouting Rock, he was responsible for manager research and investment analysis for Zurich Alternative Asset Management, an investment group within Zurich Insurance Company. He conducted manager research and investment due diligence as a member of the group’s investment team responsible for a $2 billion portfolio of hedge funds. Patrick began his finance career as an associate at UBS.

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liquid alternatives | THE DEBATE

Liquid alternatives: strategic solutions for uncertain times

With low interest rates and concerns about the global outlook, demand for liquid alternatives continues to rise as do the number of funds launched in the sector. Seven panelists shared their views on how liquid alternatives have evolved from a new player to a mainstay in their toolkits. If there was one point that all our investment experts shared, it was that although it’s still early days for this growing asset class, its attractiveness is only growing.

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How have liquid alternatives matured since rising to popularity after the 2008 financial crisis, and is this set to continue? Hugh Prendergast The outlook for liquid alternatives is that usage needs to grow. The forecast for beta returns are increasingly challenging for investors to meet some of their long-term objectives. For example, if you look at some large pension plans’ returns year to date they need to replace some of the shortfall from bond and equity returns enjoyed during a disinflationary trend and find other sources of return. As a result, the active part of the asset management industry is increasingly focusing on two things. One is outcome and outcomeoriented strategies aligning the objectives of how money is managed with the ultimate needs of the clients, rather than just relative returns to the market. Secondly, income and income replacement in many cases from new areas that were not necessarily traditionally thought of as income sources.

We see a great deal of investment flow going into liquid alternatives, and it is likely to be sustained as a result of the very low yield and low return environment that we’re facing.

Hans Abate Liquid alternatives are becoming an exciting tool that we have now as asset managers and with their recent and rapid growth, it resembles the early stages of when ETFs were introduced. It was something liquid, representative, it would add diversification and would help us on risk management. Liquid alternatives are improving the perception of hedge funds after the problems we had back in 2008. Indeed because now they are liquid, regulated and transparent they can be used easily and widely in most kinds of portfolios as building blocks. The beta years are probably going to be a diminishing factor ahead and we need to compensate returns in a low-yield environment. At best, we’re probably going to stick around here for a little while longer. So we need to look back on


the debate | liquid alternatives

alpha, we need to look back on something that can add value back to our portfolios. Certainly though, the liquid alternatives offering itself is a differentiator. I think the challenges as we all have in our businesses is really understanding what we own. We’re excited; I think these are the early stages.

Christian Lee I look at the liquid alternatives space with a healthy dose of skepticism. Some of the track records we’re seeing are three to four years old. We would like to see them mature to a bit longer. You want a track record that’s actually meaningful, like a decade or more. You want longevity and consistency in what these strategies claim to do.

Patrick St Denis When you look at the liquid alternatives space back when this

great asset growth happened in 2012/2013, I think you saw a lot of things thrown out there that were maybe labeled as liquid alternatives that didn’t necessarily tie that closely to what you might think of as traditional hedge fund strategies. I think what you’re seeing now though is a quality that’s starting to come more into line with private hedge funds.

Joseph Raieta We’re still in a world where these structures haven’t gone through the upheaval that we saw in 2008, and I think with that being the thesis for the creation somewhat and only having a three- or four-year track record on a lot of these products, there is reason for pause. A number of our advisers will look at world allocation funds, funds with very loose mandates, and say, ‘Okay, that’s not exactly an absolute return strategy, but it’s close enough and gives my

clients access to parts of the world that they may not get otherwise without jumping with both feet into liquid alternatives.’ Even with that said, I think we will start to go down the path of bringing more and more liquid alternatives into our client portfolios in a very measured way.

What types of liquid alternative strategies are you using and are they core holdings or more tactical plays? Hans Abate As we run discretionary portfolios we start with defining the end goal. What is it that we want to end up with? You pick and choose the right underline depending on the objective of the portfolio. We’ve been using uncorrelated strategies. For example, commodity trading advisor

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liquid alternatives | THE DEBATE

strategies have been a good place for us in the last two years. Fixed income arbitrage has helped a little bit as well, although we need to have a longer conviction [designated] period for that. Long/ short also has been a bit more of a directional strategy. Now, I think the caveat here is to be very careful. We love carry trades, for example, and we would love asset-backed securities (ABS), but ABS cannot be replicated as a liquid alternative, but they do complement with the fixed income arbitrage. That’s when you start getting a bit of a mix and match. We hold strategies depending in our conviction, but not necessarily within a full market cycle. For example, a managed future fund it’s great for the bull market, but it’s going to be awful in a bear market. It becomes also a tactical trade.

Patrick St Denis The way we’ve built our absolute return portfolio is based on our views of predictability, sustainable processes and return expectations, we tend to maintain a diversified portfolio allocated across equity long/short, event driven type strategies, systematic or managed futures as well as global macro and credit. We only do, or have historically only done, single-manager, single-strategy investments, but I think there are some really interesting products that have come out recently. Companies out there are putting some multimanager products together that give you some interesting exposure.

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Christian Lee For capital preservation or expected returns, our clients don’t necessarily need 800 to 1,000 basis points in annual returns. We need about 250 to 350 basis points, which I do believe is achievable through liquid alternatives because our clients, the majority of whom are based in Brazil, have a 14.25% nominal interest rate. Liquid alternatives do lend themselves to earn somewhere in that 250 and 350 basis point range for absolute returns. [They are expected to provide] very controlled volatility and drawdowns. From our perspective, there is an interesting opportunity set if you can come up with some creative products. From a Brazil perspective, if you take the Ibovespa Stock index for example, which is their benchmark equity index, the market cap is about $30 billion. That is only

‘From our perspective, there is an interesting opportunity set if you can come up with some creative products’ Christian Lee Itau Asset Management


the debate | liquid alternatives

about the size of a single small to medium-sized asset manager in the US or Europe. With a market cap that small, capacity is an issue. Therefore, liquid alternatives is a space we are carefully monitoring for solutions to our capacity constrained local markets.

Joseph Raieta

Our approach with liquid alternatives starts with a subset of clients for us. With our larger $10 million-plus relationships, we really do look at private structures to handle the alternative investments allocation of a portfolio. For those still substantial but smaller accounts you can achieve broad diversification, go through your checklist of non-correlated assets, of separate yield play or being able to manage your beta and do so at a lower investment level. Once you get into how to allocate or the strategies that we’re looking to manage within that bucket, then you’ve really got to take a deeper dive. You have to locate exactly what you’re buying and what the manager is actually doing what the manager say they’re doing.

Hugh Prendergast A lot of interest in liquid alternatives has focused on multi-strategy products. This is because of the function that investors are looking for from their liquid alternative selection. They want to build some asymmetry into their portfolio construction with maximum diversification* and minimum single strategy risk.

Investors are using liquid alternatives not to optimize returns, but to optimize probability.

Liquid alternatives include a broad bucket of strategies, but is there a place for products that sit between traditional asset classes and liquid alternatives? Michael Temple Our industry likes to throw things in boxes. Is it large-cap equity, small-cap equity? Is it alternative? Is it traditional long-only? We are bleeding a lot of stuff into various different boxes at Pioneer Investments right now. We are taking things from the hedge fund

space and transporting them into the long-only space. I run a multi-asset credit portfolio. I felt that at any given time those specific asset classes were hemmed in by the boxes that our industry has created. If we can get rid of the boxes and allow the various different asset classes to bleed into each other we can pick the best combination over time. We have also taken some of the tools in the hedge fund community and liquid alternatives space to help us alter correlations. This then helps us give a better outcome to our investors. I think one of the pitfalls that we, as investors, frequently fall into, is this idea of trying to create an investment strategy with low correlation or no correlation to financial markets.

* Diversification does not ensure a profit or protect against a loss.

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liquid alternatives | THE DEBATE

‘It’s not just a product set, it’s a mind-set. You can have this inside traditional mandates’ Hugh Prendergast Pioneer Investments

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It’s really low correlations to negative returns. At the end of the day, that’s what we’re trying to get investors’ brains wrapped around is: can we figure out a way to reduce the correlations to drawdowns? It is critical to wealth preservation and building wealth these days.

Hugh Prendergast On the one hand, we’re talking about liquid alternative products that make a claim of a particular outcome or an income, however the current investment environment is also forcing active managers to become more active. Therefore, one of the things that active managers can do is to introduce liquid alternative techniques into traditional mandates to optimize the probability of achieving the

client objective. The idea is that it’s not just a product set, it’s a mind-set. You can have this inside traditional mandates that are looking for alternative sources of return that were not traditionally applied in a long-only portfolio.

Christian Lee There is what we would call lower-hanging fruit in the alternative space. For example, an actively managed large-cap equity strategy offered as liquid alternative may be a satisfactory solution for investors seeking some outperformance over long-only options. If the liquid alternative can offer superior downside protection, the compounding effect from lower drawdown volatility can be very valuable for investors.


the debate | liquid alternatives

How can alternative instruments improve positioning and diversification of a portfolio? Michael Temple I think one of the great benefits in my career has been to work with a number of liquid alternative managers within my own organization to get their perspective on markets. It’s created what I would call a more multi-dimensional approach to thinking about traditional long-only types of endeavors. In the sense that you can begin to hedge your bets. In the case of credit, you can begin to say, ‘I can create a multi-scenario economic analysis and then a multi-scenario analysis for an individual company’s ability to repay its obligations.’ There are ways that you can essentially help protect yourself from the downside if you’re wrong and so the mind frame of a liquid alternatives manager is really critical at this stage in the cycle. Everyone’s talked about a low-return environment from here until when we get the great reset – whether or not we get one any time soon – is to essentially begin to build what I would describe as almost investment airbags into each of the components of your long-only or traditional portfolio.

depends on their approach in deciding what percentage of that bucket is going to be an alternatives versus long-only, and really illustrating that to clients to show them how you’re shifting that risk return profile of that bucket or of their overall portfolio.

Hugh Prendergast You have to think about what does risk mean to the investor? A typical way that we as an industry measure risk is around volatility. Is risk volatility? Is risk drawdown? Is risk liquidity or diversification or is it ultimately really around the risk of not meeting the investor’s objective? Ultimately real risk is the risk of not meeting the investment objective. I think the role of liquid alternatives in a client portfolio is about increasing the probability of reaching your objective with, I think Michael put it well, the use of investment airbags.

What is your due diligence process right now? How are you analyzing these types of instruments? Hans Abate It is the same criteria as selecting an offshore hedge fund, on which we have to perform comprehensive due diligence. Assessment of funds must be forward looking. Along with the business side or really deep down in the investment strategy, I think the operational due-diligence side is what matters the most. From that you can dive into the structure, the corporate governance, and the operation side. It’s very important to see what they’re trading, what the procedure and processes are. We think one of the highest risks that we have in Ucits is the liquidity mismatch. So yes, the fund is quite liquid, but are the underlying securities liquid enough or not?

Patrick St Denis It can start with a strategic asset allocation with your client. Some people just look at equity or some people will start in the absolute return bucket. Different advisors approach it in different ways. It really just

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S P O N S O R E D S TAT E M E N T

AIMING FOR TRUE ALPHA WITH LIQUID ALTERNATIVE STRATEGIES The Absolute Return Portfolio Management team is a dedicated team of investment professionals with diverse specialisations and extensive experience, across several market cycles. The team has an average of 17 years’ investment experience and has a proven record, for an average of 11 years, in absolute return investing.

DAVIDE CATALDO Head of Absolute Return Multi-Strategy -23 Years’ Industry Experience & 23 Years with Pioneer Investments

What are Liquid Alternatives? Liquid Alternatives seek to generate returns which are less reliant on the direction of bond or equity markets, while aiming to mitigate the downside and supress portfolio volatility. These investment products are viewed as having little or no return correlation with traditional assets and the majority are categorised as absolute return products, since their returns are generally calculated on an absolute basis rather than relative to the returns of traditional investments. Although Liquid Alternatives combine nontraditional strategies into a regulated *Diversification does not ensure a profit or protect against a loss.

mutual fund structure, they generally offer daily or weekly liquidity. The growth of Liquid Alternatives can largely be viewed as a reaction to the losses investors endured from non-regulated investments during the Global Financial Crisis. That said, regulated nontraditional UCITS strategies have been steadily growing as investors seek comfort in the fact that these are more tightly regulated vehicles. UCITS regulations have strict guidelines on transparency, liquidity, leverage and risk management.

‘True alpha is not generated from single trades. It is the result of a carefully built portfolio of multiple, independent strategies.’ Including Liquid Alternatives in a Portfolio The returns and diversification* benefits previously provided by bonds are likely to be unsustainable going forward; hence, we have seen an over-reliance on the growth of equities. Including liquid alternative strategies in a portfolio could help investors manage risk, by capturing some

of the market upside potential and limiting the market downside – aiming to provide investor protection at crisis points. Nontraditional mutual funds can use approaches and investment techniques that may not be utilised in traditional equity and fixed income investing, potentially leading to asymmetric returns (where the upside potential is greater than the downside risk). Alternative managers are able to adjust market exposure by utilising long and short investments, which can potentially preserve capital and generate returns. Asset Allocation in Today’s Environment The days of a traditional 60/40 split between equities and bonds being considered the optimal portfolio could well be behind us. Maintaining this allocation may not produce the steady returns that investors have come to expect. This poses a need to look at differentiated ways of generating returns. Efficiently integrating Liquid Alternatives can allow for enhanced diversification via potential alpha-driven returns and low correlations to the broader markets. When examining a 20-year period, adding a 20% allocation to alternatives within various traditional portfolios would have improved the risk-adjusted returns. Given the lack of extensive history, the chart below is a proxy showing how an allocation to


S P O N S O R E D S TAT E M E N T

alternatives (in this case hedge funds) would have benefitted a portfolio over a 20 –year period. A rethinking of traditional approaches to portfolio allocation is needed. Liquid Alternatives can be viewed as a complement to traditional asset allocation, rather than an opportunistic allocation to alternatives. A 20% alternative allocation could be built from existing allocations without altering the proportional balance (e.g. Long/Short Equity can be allocated from existing Equity exposure and Long/Short Credit can be allocated from existing Bond). Embracing this new way of investing

alongside their existing allocations may be necessary to achieve investors’ investment objectives. What Makes a Good Liquid Alternatives Manager? Simply put, experience is paramount. A combination of top-down and bottom-up idea generation appears to be an optimal approach. From a top-down perspective, three things would influence strategic allocation – a manager’s macroeconomic view, how individual strategies move in and out of focus and the subsequent level of risk the manager is looking to take within a portfolio. From a bottom-up perspective, some managers would aim to explore various investment opportunities

globally without setting a target on geographical allocations. Investment ideas could be selected on the basis of many factors including (but not limited to) manager strategy and approach, experience, risk management, operational strength, inter-manager correlation and market correlation, return objectives, and subject to understanding operational issues. The cyclicality and structural shifts in strategies and on market expectations i.e., whether heading for a widening spread environment or a tightening in liquidity and the combination of qualitative insight and quantitative tools can allow managers to pursue an aggressive return target.

Adding Alternatives to a Traditional Asset Allocation Mix May Improve Risk-Adjusted Returns

ANNUALISED RETURN

Adding 20% Allocation to Alternatives Within Various Traditional Portfolios Over a 20-Year Period 40% Global Equity 60% Global Equity 40% Global Bonds 20% Global Bonds 7.5% 20% Global Equity 20% Alternatives 20% Alternatives 60% Global Bonds 7.0% 20% Alternatives 6.5% 6.0% 30% Global Equity 70% Global Bonds

5.5%

70% Global Equity 30% Global Bonds

50% Global Equity 50% Global Bonds

5.0% 4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

STANDARD DEVIATION does not guarantee future results. This chart is for illustrative purposes only and is not meant to represent the performance of any particular investment. Indices used: Alternatives - HFRI Fund Weighted Composite Index; Global Bonds - Barclays Capital Global Aggregate Bond Total Return Index; Global equities - MSCI World Local Price Index. Past performance does not guarantee and is not indicative of future results.

Important Information: Source of the MSCI data: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or redisseminatedin any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an“as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages. ( www.mscibarra.com) Unless otherwise stated all information and views expressed are those of Pioneer Investments as at August 2016. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This article is for informational purposes, and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security, product, service or investment. The opinions expressed in this article do not constitute investment advice and independent advice should be sought where appropriate. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies.


liquid alternatives | THE DEBATE

Patrick St Denis It’s taking that extra step and actually demanding time with the portfolio manager. Just making sure to spend that time with the portfolio manager to understand their philosophy and ask questions around risk management and how they approach a drawdown in their portfolio, how they might react, what their views are in the market. Also, that the great thing about liquid alternatives is daily performance. You can see what’s happening every day. I like to think that I’m very rarely shocked by a fund’s performance based on what’s happening in the market that day, but when that starts to happen, that’s when you have to get a little bit concerned or that’s part of that monitoring process, that ongoing process.

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For example, if you look at Third Avenue Credit Fund last year, on days when the credit market was having good days, they were still losing money and so that was a tell-tale sign to us that they were just getting hit with redemptions and having to force sell and incur losses. It could be quantitative, qualitative analysis, say an equity long/short manager, for example, we like to break down their long attribution, short attribution, look at their stock spread, look at the alpha that they generate year over year relative to a benchmark and doing that work, but the monitoring aspect especially is a monthly practice for us. Look at what their assets are, how they change month over month because you don’t want to be the last one [trying to redeem].

Can you share any red flags that you might have come across that would make you question a manager or fund? Christian Lee With the ongoing evolution of our industry − especially after the 2008 crisis − we have now what we can call boiler plate red flags to watch out for. For example, who is the fund’s auditor? If their office is in a strip mall out in Long Island, NY you’re likely to have a serious problem. As Hans rightly pointed out, asset/liability mismatches and fund size per strategy are also an ongoing concern. Namely, can a strategy contain asset liability mismatches as assets increase? On the qualitative side, one needs to monitor continuity within an investment team. Frequent


the debate | liquid alternatives

turnover can be a tell-tale sign of organizational problems. Ask yourself how the organization failed to keep key persons. These are a few relevant due diligence points to consider whether you’re evaluating a hedge fund or liquid alternative.

Patrick St Denis A portfolio manager who doesn’t really know his book that well or can’t really give you all the stats on top positions, that’s a cause for concern. You need to look at the portfolio and see how crowded positions and how liquid those positions are. Who else is in those positions? How differentiated they are? Then the thing that I’ve found to be a little quirky in shifting over to the alternative Ucits space or the 40 Act space is sometimes a couple of weird combinations of multi-strategies that some fund management companies have come up with where there might be two really different types of strategies that are combined into one fund. Until you really get into the conversation and talk about what their strategy is, it’s sometimes not that clear. I might just add one more thing where we’re talking about turnover and sustainability of a fund there are – I’m guessing – three-quarters of the actual funds probably, are under $200 million or even $100 million and understanding what that breakeven point is and really getting a feel for what their commitment is to the strategy in this fund. But even if the liquidity is not a concern for the portfolio, but you’re doing all this work and you don’t want a fund to close on you in a

couple of months after so many resources to the research process.

Joseph Raieta Tying the last two points together, with third-party service providers you need as much visibility as you can get. If they are getting close to break even, you can tell if there’s corners being cut as far as how they’re allocating cost and then you press that up against what their fees are and get a really good understanding of the profitability of the fund itself. That lets you know how things are being managed from a business perspective, which alternately, if you are going to come up against a situation where you do unexpectedly have a manager leave or some sort of close that has nothing to do with the actual terms of the fund, those are situations that I think you get some visibility earlier by understanding who the service providers are.

What triggered your usage of liquid alternatives and how has that evolved? How do you think it will continue to develop? Patrick St Denis We bought into outsource a CIO type mandate, which got us looking at more of a strategic asset allocation and got us looking at liquid alternatives as an alternative to alternatives. That’s what got us interested back in 2012 and we thought there was a pretty interesting opportunity as hedge fund allocators and due-diligence folks to get ahead of it and we ourselves just decides to build a proprietary database to maintain all of our research and we do that with any assets that we look at. So we think it’s a pretty interesting way to get really valuable exposure and again, it’s just us and the market

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liquid alternatives | THE DEBATE

communicating, I guess us trying to figure out who the best is or who can benefit from liquid alternatives the most and I’m not sure that even the market itself has figured that out yet. Institutions have been slow, endowments are doing a little bit, retail investors. I’ve heard some big banks quote statistics that just about 1% of their retail clients are in alternatives and liquid alts. So yes, I think that’s our way forward, to figure out where it works best and I think we’re all trying to figure that out.

Hans Abate The key point is looking ahead. We need to look at what are the components of our portfolio that we need not necessarily today, but

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down the line. We are seeking long-term returns and capital preservation. So it’s a natural fit and today’s financial environment calls for that. In our current economic and financial environment where returns are hard to find it’s vital to turn to and seek high professional talent. Where is the talent and how can we deploy that specific talent in portfolios tactically? Where is it that it’s going to fit and what’s going to fit and when do we take it in and take it out? So that’s where the tactical part comes in. Organically, as well as with new customers. We have new clients also adding in as well so, our positions are increasing as we go along.

If things go back to the way they were pre-global financial crisis, will there still be a need for liquid alternatives? Hugh Prendergast I think there would still be a need for liquid alternatives. People will still want to have asymmetry towards negative returns. I think there’s still a strong argument for people using liquid alternatives as a way to choose what risks they want to be exposed to and which they don’t. Therefore, where they have high conviction, a long investment will always, always, always have a role. The entire industry cannot become alternative simultaneously and everybody wins. By definition that will not work. So therefore, there’s no


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death of long-only investing. It’s a matter of what’s the right proportion for clients in terms of their expectations, of how much should be sourced from lower correlated or uncorrelated sources of return versus the more standard ways of investing. Again, where I see the industry going as a whole again, retail maybe the last to join in this, is that ultimately, the role of liquid alts for the mutual fund industry will have a weight of about 20% of the total. It may take us another five years to get there, but I think liquid alternatives have a role.

Patrick St Denis I hope to see some growth [in this space]. Being selfish and wanting a few more tools in my tool box. As a portfolio manager, there’s still some sector specific long-short funds or I’d love a better selection of true global macro strategies, which is a very liquid hedge fund strategy and could easily translate into a liquid alt fund.

Are there any macro-economic developments that could endanger strategies that use alternative components?

encouraged by central banks that to a large degree have created a very low yield environment. Naturally, individual institutional investors will tend to migrate towards this asset class and I think frankly, the challenge of the liquid alternatives asset class is to provide both meaningfully low correlations and reasonable return for their investor’s expectations. My fear is that we will see what we saw this when the unconstrained bond fund category was launched several years ago. It was launched in reaction to concerns about rising rates in the US, and everyone was just like, ‘Get me out of that whole duration issue.’ The category ended up being woefully behind in terms of their expectations. They do not deliver. [My fear is that] the migration from the hedge fund community really doesn’t deliver. The inability to actually go into illiquid assets will limit returns. So the challenge is for the liquid alt space to deliver and manage the expectations of the clients.

‘My fear is that we will see what we saw this when the unconstrained bond fund category was launched several years ago’ Michael Temple Pioneer Investments

Michael Temple

Endowments and other regulatory bodies that have been essentially charged with providing investors a 7% to 7.5% return in order to meet liabilities are going to be woefully underfunded here and they’re going to have real challenges. Individual investors are going to have challenges generating enough income from their assets, in order to comfortably live. So it’s an entire society-wide challenge that we’re faced with, given assets inflation

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liquid alternatives | THE interview

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the interview | liquid alternatives

Strength and flexibility Fixed income’s role has shifted and Pioneer portfolio manager Michael Temple speaks to Rob St George about how alternative tactics can help investors get reacquainted with bonds Portfolio construction used to be simpler: an allocation to equities for growth and an allocation to bonds for protection. A look back at long-run investment returns could appear to validate the continued appeal of that approach, but any complacency prompted by past performance would be a mistake. What has changed is the starting point: bond yields are at record lows. The Barclays Global Aggregate index has a yield to worst of just 1.24%, while around 40% of the government bond market offers negative yields. ‘We’re really in an environment right now where central banks have compressed yields and spreads dramatically,’ said Michael Temple, portfolio manager and director of credit research, US, at Pioneer Investments. ‘If you look out over the past 50 years, I don’t think we have been in an environment where the returns that fixed-income investors can expect from the asset class have been so low.’ So if investors can no longer rely upon a broad exposure to bonds for a stable income stream and low or negative correlation to

equities, what should they do? For Temple, the answer is not to change their expectations of the role of fixed income in a portfolio, but to change their approach to bonds so that their expectations can still be met. ‘The conclusion we have reached is that fixed income ends up having to use different tools, tools that we can get from the liquid alternative or hedge-fund universe, to provide the lower correlations that have historically been a natural attribute of fixed income,’ he explained. For an unconstrained bond manager, such tools do exist. Temple cited using options, currencies, and insurance-linked securities as some of the non-traditional instruments at his disposal for these purposes. ‘The way we have approached the challenge is to recognize that there are still pockets where we can find some very interesting opportunities,’ he stated. ‘However, we are also very cognizant that we don’t want to take extreme risk in order to achieve what historically would have been viewed as an average or even mediocre return.’ One way in which Temple manages risk is through scenario-based techniques that establish ‘safety nets’ in his portfolio. ‘When there is confusion about the macroeconomic environment, it is even more critical that we look at multiple different scenarios,’

Temple commented. He therefore models different possibilities and their implications: What is happening in the manufacturing sector? What does that mean for inflation? What impact will that have on the trajectory of interest rates? ‘The reason you do all this is because you want to be able to optimize the investments within your portfolio that collectively, among all these different scenarios, do a better job than anything else,’ Temple said. ‘Part of the reason why we need to consider multiple environments is because the probability distribution of these outcomes has been so distorted by what central banks are doing. It used to be that you could with a fairly high conviction level say, “Given the economic environment, we need to be growth oriented. We need to worry about inflation and we need to think about focusing on the asset classes that are going to do well in that scenario.” Now, with this long fat tail on either side in terms of the distribution of potential macroeconomic outcomes, you need to think about this much more dynamically.’ The views expressed are those of Pioneer Investments as at September 7, 2016 and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected.

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Routes to returns Concerns over the outlook for long-term returns from equities and bonds, combined with a rise in volatility, have investors searching for new sources of returns. Robert St George talks to Pioneer’s Hugh Prendergast about why liquid alternatives is fast becoming a mainstream asset class Facing a world in which returns are lower at the same time that volatility and correlations are higher, investors could be forgiven for needing a drink. A different sort of liquid solution may serve them better, though. In early September, the International Monetary Fund observed that 2016 was likely to be the fifth consecutive year in which global economic growth was below its long-term average of 3.7%. That slump could easily continue next year, the organization added. In such an environment, it is difficult for investors to rely on broad financial markets for stable, sustainable returns. It is, moreover, becoming harder for investors to construct robust portfolios using traditional tools as volatility and correlations between asset classes both spike. With volatility, the problem is as much with its sudden savageness as with any long-term trends. For example, the Chicago Board

Options Exchange Volatility Index – or VIX – had sat below 14 for a two-month period between July and September. But then in the middle of that month it leapt to almost 18. There had been a similar surge in June: after months in a range between 14 and 16, VIX soared to nearly 26. Traditionally safe harbors in such storms are providing less portfolio protection too. Credit Suisse’s cross-market contagion indicator, which tracks the relationship between asset classes, shows that equities, bonds, currencies and commodities are influencing each other at a higher rate so far this year than at any time since the measure was created in 2008. ‘In a world where the outlook for investment returns is low and risk relative to the return available looks high, investors have to think less about getting exposure to markets and more about what their ultimate investment objective is,’ argued Hugh Prendergast, head of strategic product and marketing, Western Europe and international, at Pioneer Investments. As an example of a priority objective, Prendergast highlighted the importance of minimizing drawdown. Mathematically, a 50% loss in a portfolio – and, for comparison, the maximum drawdown in the MSCI World index between 2007 and 2009 was 57% – requires a 100% recovery to break even. In a low-growth environment, the time it takes to make that break-even return is far longer than

has historically been the case. ‘You have to think about a solution that will ultimately maximize the probability of reaching your investment objective as your primary aim, and less about trying to maximize returns,’ Prendergast remarked. Employing liquid alternative strategies rather than beta-only products can assist investors in this regard. ‘A liquid alternative fund can help investors maximize their investment objectives through the inclusion of non-traditional or uncorrelated sources of return,’ said Prendergast. ‘They are therefore less susceptible to what is happening in the market.’ The liquid alternative structure, however, spans a wide variety of approaches so investors must be discerning in choosing the optimal solution for their objectives. ‘If an investor is looking to select a liquid alternative manager, it is not always the highest-performing product that is the best,’ noted Prendergast. ‘It is the one that has the highest probability of delivering the desired goal. The liquid alternative manager should be using strategies that are not correlated to other parts of a traditional portfolio, but doing so within a strict adherence to the mandate and without bringing in other sources of risk.’ The views expressed are those of Pioneer Investments as at September 7, 2016 and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected.

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Pursuing alpha in a low return world Explore Liquid Alternatives with Pioneer Investments As investors look for non-traditional strategies, liquid alternatives target new sources of return and may help to: → Increase return potential → Enhance diversification* → Mitigate risk and the effects of drawdown in difficult markets

For more information, please contact: US.Offshore@PioneerInvestments.com

*Diversification does not ensure a profit or protect against a loss. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. There can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested.

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