Advance with Alternative Investments Diversification when you need it All charts are for illustrative purposes and not intended to be representative of any specific investment vehicle. Please refer to the Appendix on back cover for definitions of benchmarks displayed. Past performance is not indicative of future results. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, the information should not be construed as advice designed to meet the particular investment needs of any investor. Advance with Alternative Investments 1 Expand your investment toolkit Of all the lessons learned from the 2008 market dislocation, one of the most lasting realizations is that our tolerance for risk may actually be lower than we previously imagined. Yet as markets have recovered through the years that have followed, we may have also learned that some risk may be required to achieve the returns we seek. Therefore, taking steps to accept risk — and consequently manage it — may be a priority for you. Portfolio diversification is one way to compared to a volatile benchmark, an and/or difficult to value, and some may hedge against risks associated with investment can both recover faster and have limited regulatory oversight. individual securities. For example, equity grow quicker. Conversely, non-correlated and fixed income investors spread risk assets may not perform as well as the Which solution is right for your by owning stocks from diverse sectors broader equity market during extended goals? and geographies, and by purchasing bull markets, where they may only capture Alternative investments come in bonds from different issuers with a portion of the equity market upside. several shapes and sizes. Depending different credit ratings and maturities. on your specific needs and financial But when broad price swings remain It is certainly true that alternative circumstances, one may be more commonplace for stocks, and bonds and investments come with important appropriate than another. The purpose cash seem stuck in a low interest rate considerations to understand before of this brochure is to provide a brief environment, alternative investments investing. For example, not all strategies overview of some of the most common may offer a solution to protect against are alike or serve the same purpose. types of alternative investments and these types of systemic risks. Some strategies may use leverage or those that are offered at RBC Wealth other complex financial structures that Management: hedge funds, private RBC Wealth Management defines involve risk, some may be more illiquid equity, and real assets. alternative investments simply as any investment outside of publicly traded, long-only, stocks, bonds, or cash. Though Alternative investment strategies alternative investments are commonly perceived to carry an undue amount of Hedge Funds Private Equity Real Assets risk, alternative investments may actually Convertible Arbitrage Buyout Commodities lower certain types of risk exposure by Distressed Direct Lending Energy taking advantage of what are often called Equity Long/Short Mezzanine Infrastructure “non-correlated asset classes.” This term is used for alternative investments because Fixed Income Arbitrage Venture Capital Real Estate their performance is less likely to correlate Global Macro Timber with the performance of the broader Managed Futures stock, bond, and cash markets. As non- Market Neutral correlated assets, alternative investments Merger Arbitrage can help portfolio volatility attributable to equity markets as well as help improve overall returns. By losing less value This chart provides examples of investment strategies employed by alternative asset managers. 2 RBC Wealth Management Hedge funds Potential to diversify beyond traditional long-only investing Definition We define hedge funds as investment strategies that have access to a broader mandate than just equities, bonds, and cash. Some examples of the types of strategies available to hedge fund managers include shorting, the use of leverage, the use of derivative securities, and the ability to invest in instruments that do not offer daily liquidity. This broader approach provides hedge fund managers the opportunity to generate differentiated sources of return, increased portfolio diversification, and enhanced risk-adjusted returns. Features and benefits Differentiated sources of return Hedge funds include differentiated sources of return, allowing for reduced volatility which has resulted in returns that have been historically more consistent than the S&P 500 over time. From 1990 to 2015, hedge funds were able to provide more consistent returns than equity markets, as represented by the S&P 500, by capturing 50% of the equity market upside and 25% of its downside. By limiting the downside market participation, hedge funds not only provided notable out performance over equities, but did so with much less volatility. This performance result is possible because most hedge funds have access to strategies that can hedge their market exposure — although it is important to note that not all hedge funds hedge. It is also important to note that in strong equity market environments, hedge fund strategies are likely to underperform on a relative basis. For example in 2013, the S&P 500 was up 32% while hedge funds, as represented by the HFRI Fund Weighted Composite Index, were up just 9%. Advance with Alternative Investments 3 Growth of $1MM, 1990-2015 14 12 n HFRI Fund Weighted Composite Index n 10 S&P 500 8 -21.4% -1.5% In $MM 6 4 -50.9% -38.7% 2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Using HFRI Fund Weighted Composite Index as a proxy for hedge funds and the S&P 500 for equity markets, the above chart shows the potential for hedge funds to outperform equity markets on a cumulative basis. (Source: Zephyr Analytics) Portfolio diversification Hedge funds can provide diversification benefits through reduced correlation. The investment management industry has always highlighted the importance of portfolio diversification. Over time, the definition of “portfolio diversifiers” has evolved. Over the past few decades, diversifying by region, sector, market cap, maturity, and coupon has largely been sufficient for equities and bonds. However, over time, this has proven not to be enough for some investors. As a result, alternative strategies have been considered as an option to help achieve those same intended diversification objectives. Portfolio diversification from 1990-2015 20% Improved Returns Lower VolatilityLower Drawdown 15% 8.52% 9.19% 9.0% 10% 6.72% 5% Max Drawdown 0% -5% Return Standard Deviation -10% -15% -20% -25% -30% -25.17% -35% -31.44% n Portfolio A Balanced (No Alternatives) 40% Bonds, 60% U.S. Equity n Portfolio B Balanced (With Alternatives) 40% Bonds, 35% U.S. Equity, 10% Diversified Hedge Funds, 10% Private Equity, 5% Real Estate Using the HFRI Fund Weighted Composite Index as a proxy for hedge funds, the S&P 500 as a proxy for equity markets, the Barclays US Aggregate as a proxy for bonds, the Cambridge Private Equity Index as a proxy for private equity, and the National Association of Real Estate Investment Trusts (NAREIT) All Equity Index for real estate, the above chart shows that allocating a portion of your portfolio to alternative investments may help reduce the overall volatility of your portfolio and create the potential for greater wealth creation and preservation over time. (Source: Zephyr Analytics) 4 RBC Wealth Management Enhanced risk adjusted returns Historically, hedge funds have preserved value relatively well in down markets when compared to traditional equities. Hedge funds have typically shown over time that they can mitigate downside participation during market dislocations, including the bursting tech bubble in the early 2000’s and again in the recent financial crisis of 2008. In 2008 for example, equity markets, as represented by the S&P 500, were down 37% while hedge funds, represented by the HFRI Fund Weighted Composite Index, were down 19%. Likewise from April to December 2001, the S&P 500 was down 15%, while hedge funds, represented by the HFRI Fund Weighted Composite Index, were up about 5%. Downside protection during market dislocations 10% 0% -10% -20% -30% -40% -50% Russia default; Tech bubble Recession 9/11 terrorist Corporate Iraq war Credit crisis LTCM blow up bursts concerns attacks Fraud Dec. '02 - Jun. '08 - Aug. 1998 Apr. - Dec. '01 Fed. - Aug. '01 Sept. '01 Mar. - Sept. '02 Feb. '03 Mar. '09 n HFRI Fund Weighted Composite Index n S&P 500 Using the HFRI Fund Weighted Composite Index as a proxy for hedge funds, and the S&P500 as a proxy for equity markets, the above charts shows that hedge funds have tended to decline less than the equity markets in periods of severe equity market stress. By providing downside protection, hedge funds may reduce the recovery time from drawdowns and may provide portfolio growth opportunities more quickly. (Source: Zephyr Analytics) Fund of Hedge Funds Fund of hedge funds provide a vehicle for investing in multiple hedge fund strategies and managers, and provide investors with an additional layer of due diligence, monitoring, and risk management. While there are diversification benefits of this structure, an additional layer of fees is often charged. Advance with Alternative Investments 5 Private Equity Potential to enhance returns through an illiquidity premium Definition Private equity funds attempt to achieve enhanced risk-adjusted returns relative to public stock markets. Private equity funds utilize strategies such as acquiring private companies and adding value by improving operational efficiency to enhance margins, or by adjusting corporate strategy to drive growth. Since private equity funds take a long-term view on their investments, they are less liquid investments; however, they have demonstrated the ability to capture an illiquidity premium because of this long-term investment view. The typical holding period for private equity is 10 years or more.