Multi-Asset Alternatives:
Capturing Opportunities

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The Liquid Alternatives Landscape

Since the global financial crisis in 2008, investors have been searching for new ways to diversify their portfolios and create opportunities for better risk-adjusted returns. Liquid alternative mutual funds have emerged as a viable option, offering access to many of the same strategies used by hedge funds—which typically benefit from a broad, flexible investment mandate—in liquid, regulated mutual funds. 

Individual investors have been rapidly embracing the importance of alternatives in a well-constructed portfolio. According to Morningstar, assets in alternative mutual fund investments increased from $47 billion in 2007 to $294 billion at the end of 2015.1 

Recently, the clear frontrunner in the U.S. within the broad liquid alternatives universe has been funds classified with Morningstar’s U.S. Multialternative open-end category. For example, funds classified this way took in $17.6 billion in 2015, representing some of the strongest net flows of any category. Over the past nine years, the category has grown by leaps and bounds, from 25 funds and $6.3 billion in assets in 2007 to 157 funds and more than $55 billion in assets as of year- end 2015.2 

 

1Source: Morningstar Category AUM as of 12/31/2015. Excludes Trading categories within the Alternative US Category Grouping. Includes Nontraditional Bond category, which Morningstar groups under Taxable Bond. “Other” includes the following Morningstar alternative categories: Volatility, Multicurrency and Bear Market.

2Source: Morningstar, “Breaking Down the Multialternative Category,” http://www.morningstar.com/advisor/t/114413101/breaking-down-the- multialternative-category.htm. 

Volatility Can Be Destructive:

LOOK INTO ALTERNATIVES TO HELP SMOOTH OUT THE RIDE

It’s no secret that volatility can wreak havoc on portfolio returns. And as the chart below illustrates, falling equity prices in blue represented by the MSCI World TR Index can be closely correlated with spikes in volatility, represented by the CBOE Volatility Index (VIX). Even during periods of relatively low volatility, incremental spikes can have a negative—and potentially long-lasting—effect on returns.

While a traditional long-only strategy may have served your clients well in the past, it may be time to expand the opportunity set. Alternatives can be powerful portfolio diversifiers as they may generate returns that are uncorrelated with traditional asset classes. They also have the ability to implement hedging tools that may protect against sharp market downturns. 

 

THE RISE AND FALL OF EQUITIES IN RELATION TO MARKET VOLATILITY

THE RISE AND FALL OF EQUITIES IN RELATION TO MARKET VOLATILITY

Past market performance is no guarantee of future results. Index performance is not illustrative of any Dreyfus product or strategy. The CBOE Volatility Index (VIX) is a measure of market expectations of near-term stock price volatility. The MSCI World is a market capitalization-weighted index designed to provide a broad measure of equity-market performance throughout the developed world. An investor cannot invest directly in any index. 

 

 

Multialternative Category Casts a Broad Net

 

The Morningstar Multialternative category is broad, diverse and somewhat of a catch-all. The strategies in the category have the flexibility to invest in any asset class, including commodities or currencies. They also have the ability to utilize various alternative techniques such as holding short positions or using derivatives and options, although some strategies may not use these techniques at all. The majority of the funds in this category that choose to use alternative techniques do so to hedge against targeted risks.

With so many choices, it’s imperative that investors begin with a well-defined investment objective to help them narrow the field and identify the most appropriate funds for their portfolios. Whether investors are delving into alternatives for the first time, or enhancing an existing allocation, many multialternatives may offer built-in diversification along with the potential to mitigate portfolio volatility.

 

  • The use of derivative instruments, such as options, involves risks different from, or possibly greater than, the risks associated with investing directly in the underlying assets. A small investment in certain derivatives could have a potentially large impact on a fund’s performance.
  • Short sales, or selling a borrowed security, may involve substantial risk. If the security price depreciates, the short seller makes money. But if the security price rises, the short seller must pay for the higher price of the security when returning to the lender.

 

ALTERNATIVE TECHNIQUES CAN BE USED TO ENHANCE OR PROTECT PERFORMANCE 

 

OFFENSE GENERIC EXAMPLES DEFENSE GENERIC EXAMPLES

Shorting

Can make money when prices decline Shorting stocks, bonds, currency Can reduce beta exposure to help manage volatility

Long/short market neutral

Long biased equity hedge

Leverage

Can magnify gains (and loses) Futures can provide economic leverage to provide long or short exposures to assets Can reduce beta exposure to help control volatility Futures can provide economic leverage; using bonds to help offset equity downturns

Options

Can access upside with limited capital Call option on equity upside May provide downside protection Put options can limit equity or interest rate downside

 

  • There are two types of leverage: monetary leverage, as in short selling, can be risky because you potentially may need to pay back money you don’t have or never made on a trade. Economic leverage, on the other hand, does not require lending and therefore does not carry the same risks.

 

Three Mutilalternative Strategies to Consider

At BNY Mellon, we offer three multialternative strategies that span the risk continuum, offering investors opportunities to diversify their traditional equity and fixed income allocations while seeking to manage their overall portfolio risk. 

RETURN/RISK ILLUSTRATION

RETURN/RISK ILLUSTRATIONFor illustrative purposes only. All investments have risk and may lose value.

Fund Comparison

 

BNY Mellon Absolute Insight Multi-Strategy Fund (MAJIX)

This fund follows a multi-strategy approach by investing in absolute return strategies that have historically exhibited a low correlation to each other.

Dreyfus Global Real Return Fund
(DRRIX)

The fund seeks total return (consisting of capital appreciation and income).

Dynamic Total Return Fund
(AVGRX)

The fund seeks total return.

Potential Characteristics

Absolute return, low volatility vs. traditional asset classes, diversification

Absolute return, growth, diversification, capital preservation

Total return, growth with downside mitigation, directional global macro

Approach

Low correlations, high diversification

BNY Mellon Absolute Insight Multi-Strategy Fund follows a multi-strategy approach by investing in absolute-return strategies that have historically exhibited a low correlation to each other, each managed by a specialist team across a different investment universe. This approach gains access to a large number of uncorrelated investment ideas in seeking to achieve a high level of built-in diversification. The strategies are combined with an aim of giving the portfolio stability, diversification, and upside capture. 

A low-volatility, global multi-asset investment approach

Newton implements time-tested, fundamental, research-driven security selection to build its managed portfolios. The fund is structured around a stable core of predominantly traditional return-seeking assets (equities, corporate debt, infrastructure, renewables and convertibles), and an insulating layer of ‘stabilizing’ assets (such as gold, government bonds, currency hedging, cash and equity index options or futures) aiming to dampen volatility, mitigate downside risk, and preserve capital.

Tactical allocation and tail risk tools

The fund actively shifts exposures among asset classes including stocks, bonds, cash, currency and commodity allocations to pursue global equity-like total returns with lower volatility than the broad global equity market over a market cycle. Within a single asset class exposure, the strategy typically employs long and short positions based on the relative attractiveness of individual markets. The fund employs a benchmark agnostic investment approach.

Management Expertise 

A unique team approach

The fund invests across a range of absolute-return strategies managed by specialist equity, fixed income, currency and multi-asset teams with oversight provided by a senior investment committee. More than 30 managers are supported by over 100 investment professionals who contribute their skills and expertise to the fund and its underlying strategies.

A globally minded multi-asset manager

Newton has nearly 40 years of experience in multi-asset investing and believes no company or economy should be considered in isolation. This holistic view can help form a better understanding of the overall risk exposures of the portfolio and has been an integral part of the absolute- return strategy Newton has managed firmwide for more than 12 years. 

Multi-asset pioneers

Mellon Capital has three decades of experience in managing multi-asset strategies based on their research-focused, fundamentals-based systematic investment approach, committed to continuous innovation. The core portfolio management team is supported by over 40 investment professionals.

 

No investment strategy or risk management technique can guarantee success in any market environment.

Breaking With Tradition: Alternatives Offer a New Way Forward 

 

Alternatives have moved closer to the mainstream as investors see the need to find new ways to diversify their portfolios, mitigate risk, and manage volatility. Liquid alternatives may offer opportunities to achieve these goals by investing beyond traditional long-only stock and bond investments. The following list offers tips for evaluating liquid alternative strategies: 

Liquid Alternative Strategy List

Understand the Alternative Strategy’s Objective 

 

  • Match intended alternatives and their roles to investment objectives.
  • Understand the risk and return potential limitations.

  • Recognize in which environments the strategy may thrive or be challenged.

  • Since it is not managed to a benchmark, be mindful not to compare it to one, especially during short-term time periods.

  • Review risk and return.

  • Review performance along with measures of risk (standard deviation) and risk-adjusted returns (Sharpe ratio). 

  • Look at risk and return stats over trailing and rolling time periods— as well as periods when you would expect the strategy to thrive or be challenged.
  • Take a look at the ratio of the strategy’s up months to down months.
  • Dive deeper into drawdown and recovery.
  • Assess the most challenging time periods for the strategy: Did it perform in line with expectations? How long did it take to recover?
  • Determine whether your portfolio would have fared better with or without the strategy over a full market cycle. 

 

Standard deviation is applied to the annual rate of return of an investment to measure the investment’s volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.

The Sharpe ratio uses standard deviation to measure a fund’s risk-adjusted returns. The higher a fund’s Sharpe ratio, the better the fund’s returns have been relative to the risk it has taken on.

A drawdown is the peak-to-trough decline during a specific recorded period of an investment, fund or commodity. A drawdown is usually quoted as the percentage between the peak and the subsequent trough.

BNY MELLON ABSOLUTE INSIGHT MULTI-STRATEGY FUND (MAJIX)

DREYFUS GLOBAL REAL RETURN FUND (DRRIX)

DYNAMIC TOTAL RETURN FUND (AVGRX)

Potential Characteristics

Absolute return, low volatility vs. traditional asset classes, diversification

Absolute return, growth, diversification, capital preservation

Total return, growth with downside mitigation, Directional global macro, downside mitigation

Inception Date

12/4/2015 (MAJIX)
5/11/2005 (Strategy Inception)

5/12/2010 (DRRIX)
4/1/2004 (Strategy Inception)

5/2/2006 (AVGRX)

Fund Type

Absolute Return (capital preservation) Absolute Return (capital preservation) Total Return (volatility-managed growth)

Performance Goal

Positive returns over rolling 12-month periods Seeks positive absolute return over a full market cycle “Equity-like” returns with less risk over a market cycle

Volatility (Standard Deviation) Target

Seeks less volatility than major equity markets Annualized volatility between global stocks and global bonds Risk range of 7%-10% standard deviation over a full market cycle

Mutual Fund Categories

Morningstar: Multialternative Lipper: Alternative Multi-Strategy Morningstar: Multialternative Lipper: Alternative Multi-Strategy Morningstar: Multialternative Lipper: Alternative Global Macro

Invests Globally?

Yes Yes Yes

Multi-Asset?

Yes Yes Yes

Invests in Emerging Markets?

Yes Yes Yes

Expected Sources of Return

  • Market–neutral stock selection (long/ short)
  • Currency selection (long/short relative to fully hedged USD position)
  • Market-neutral bond selection (long/ short)
  • Asset-class selection (long/short)
  • Strong stock selection: all positions are conviction-based without reference to any index; corporate bonds and convertibles
  • Asset type flexibility: the portfolio shifts tactically in accordance with Newton’s views on the investment world, in order to identify areas of both risk and opportunity
  • Emphasis on capital preservation: managing risk to offer investors the potential for attractive long-term total returns
  • Dynamic asset allocation (long/short)
  • Country selection/index level (long/short)
  • Commodity selection
  • Currency selection (long/short relative to fully hedged USD position)

Primary Portfolio Risk Management Techniques

  • Built-in diversification potential through uncorrelated absolute return sleeves
  • Risk limits on gross and net exposure, beta and modified duration within each underlying sleeve
  • Scenario analysis and stress- testing
  • Targeted hedging to isolate expected alpha sources
  • Emphasis on capital preservation with equity upside participation
  • Security selection through proprietary research and investment themes
  • Portfolio construction using a single portfolio approach
  • Portfolio guidelines with volatility between bonds and equity, with maximum 5% in any corporate issuer and maximum 20% in any sector
  • Portfolio construction emphasizes diversification across asset classes, and individual risk positions, overlaid with liquidity considerations
  • Four pillars of downside risk management: volatility management, macro environment, tail risk hedging, stress-testing and scenario analysis

Derivative Use

Return generation and risk hedging (capital loss and currency)
  • Exchange-traded derivatives are used for three main purposes: capital protection, volatility reduction and synthetic exposure
  • The fund does not short individual securities or employ leverage. Daily liquidity and valuation is critical
  • Puts and/or short futures on major equity indices and currency forwards compromise main derivative use for capital protection and FX risk
  • Primarily utilizes exchange-traded futures and currency forwards for return-generating and risk-hedging purposes
  • Efficient and cost-effective implementation
  • Highly liquid instruments

Potential Ways to Implement

Bond complement or replacement
  • Defensive equity complement
  • Fixed income complement
  • “World allocation” complement
  • Conservative equity complement
  • “World allocation”
  • Core “alternative” global macro position

 

Asset allocation and diversification cannot assure a profit or protect against loss.

Investors should consider the investment objectives, risks, charges and expenses of a mutual fund carefully before investing. To obtain a prospectus, or a summary prospectus, if available, that constraints this and other information about the fund, investors should contact their financial advisor or visit dreyfus.com. Investors should be advised to read the prospectus carefully before investing.

Main Risks

Equities are subject to market, market sector, market liquidity, issuer, and investment style risks to varying degrees. Bonds are subject to interest rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. Investing in foreign denominated and/or domiciled securities involves special risks, including changes in currency exchange rates, political, economic, and social instability, limited company information, differing auditing and legal standards, and less market liquidity.  These risks generally are greater with emerging market countries.

Currencies are can decline in value relative to a local currency, or, in the case of hedged positions, the local currency will decline relative to the currency being hedged.  These risks may increase fund volatility.

Short sales involve selling a security the portfolio does not own in anticipation that the security’s price will decline.  Short sales may involve risk and leverage, and expose the portfolio to the risk that it will be required to buy the security sold short at a time when the security has appreciated in value, thus resulting in a loss.

Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors.

Derivatives and commodity-linked derivatives involve risks different from, or possibly greater than, the risks associated with investing directly in the underlying assets.  Derivatives can be highly volatile, illiquid, and difficult to value and there is the risk that changes in the value of a derivative held by the portfolio will not correlate with the underlying instruments or the portfolio’s other investments. Commodity-linked derivative instruments may involve additional costs and risks such as commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments.

The CBOE Volatility Index (VIX) is a measure of market expectations of near-term stock price volatility.

The MSCI World is a market capitalization-weighted index designed to provide a broad measure of equity-market performance throughout the developed world. An investor cannot invest directly in any index.

Standard deviation is applied to the annual rate of return of an investment to measure the investment’s volatility.

Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility. The Sharpe ratio uses standard deviation to measure a fund’s risk-adjusted returns. The higher a fund’s Sharpe ratio, the better the fund’s returns have been relative to the risk it has taken on. A drawdown is the peak-to-trough decline during a specific recorded period of an investment, fund or commodity.  A drawdown is usually quoted as the percentage between the peak and the subsequent trough.

Investment advisory services in North America are provided through four different investment advisers registered with the Securities and Exchange Commission (SEC), using the brand Insight Investment: Cutwater Asset Management Corp. (CAMC), Cutwater Investor Services Corp. (CISC), Pareto New York LLC (PNY) and Pareto Investment Management Limited (PIML).

The North American investment advisers are associated with other global investment managers that also (individually and collectively) use the corporate brand Insight Investment and may be referred to as “Insight” or “Insight Investment.” CISC and CAMC are owned by BNY Mellon and operated by Insight. The sub-investment adviser for the BNY Mellon Absolute Insight Multi-Strategy Fund is PIML, an affiliate of The Dreyfus Corporation.

“Newton” and/or the “Newton Investment Management” brand refers to the following group of affiliated companies: Newton Investment Management Limited, Newton Investment Management (North America) Limited (NIMNA Ltd) and Newton Investment Management (North America) LLC (NIMNA LLC). NIMNA LLC personnel are supervised persons of NIMNA Ltd and NIMNA LLC does not provide investment advice, all of which is conducted by NIMNA Ltd. NIMNA LLC and NIMNA Ltd are the only Newton companies to offer services in the U.S. Newton is a wholly owned subsidiary of the Bank of New York Mellon Corporation.

Mellon Capital Management Corporation (“Mellon Capital”) is an investment adviser registered with the Securities and Exchange Commission (“SEC”) under the Investment Advisers Act of 1940. Mellon Capital is a wholly-owned indirect subsidiary of BNY Mellon. The firm is defined as Mellon Capital and includes assets managed as dual officers of BNY Mellon and as dual employees of The Dreyfus Corporation.

This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular investment. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. The Dreyfus Corporation, Newton, Mellon Capital, Insight, and MBSC Securities Corporation are subsidiaries of BNY Mellon. 


©2016 MBSC Securities Corporation, distributor, 225 Liberty St, 19th Fl., New York, NY 10286.

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