Increased Risks in Bonds and Equities
Against a backdrop of an aging bull market, historically low bond yields, the unwinding of unprecedented Fed intervention, investors are asking themselves about alternatives they can incorporate into their portfolio to potentially help provide consistent returns and lower correlation to the market.
Source: Bloomberg L.P., as of Sept. 30, 2014
US Aggregate Bonds are represented by the Barclays US Aggregate Index. Yield is represented by Yield To Worst. Risk is represented by modified adjusted duration.. Past performance is not indicative of future results.
The Importance of Preserving Assets
The financial crisis reminded investors of an important financial truism. The bigger the portfolio drawdown, the more it takes to make up for lost ground. By mitigating the magnitude of drawdowns, investors may be more likely to have the emotional wherewithal to stick to their financial plan. By reducing the volatility of returns, the likelihood of achieving long-term goals may increase.
Incorporating Alternatives into an Investment Portfolio
The case for utilizing uncorrelated strategies to build well diversified portfolios is well supported by academic literature.1 While balanced growth can be pursued with a traditional 60/40 approach, it may be further enhanced by implementing an allocation to alternatives whose strategy supports volatility management. As seen in the illustration below, as the allocation to alternatives increased, returns increased while volatility declined, which resulted in improved sharpe ratios. The uncorrelated nature of alternatives also mitigated the magnitude of the maximum drawdown.
1 Sources: Thomas Schneeweis, "Alternative Investments in the Institutional Portfolio," updated Summer 2000; CME Group "Managed Futures: Portfolio Diversification Opportunities, Potential for enhanced returns and lowered overall volatility," August 2012
The concept behind the PowerShares Multi-Strategy Alternative Portfolio is simple - allocate across alternative risk premia index strategies based upon historical index volatility trends with the objective of generating a positive total return with low correlation to the broader securities market.
Currently, the Benchmark consists of five Indexes. Each Index was developed by Morgan Stanley & Co., LLC (Benchmark Agent) and has live history. According to the allocation rules as defined by the Benchmark, the Fund uses a risk-weighted method by allocating notional exposure to each Index based on a weighting equal to the inverse of its trailing 12 month volatility, with the most volatile Indexes receiving the lowest weights.
As illustrated below, the Morgan Stanley Volatility Term Premium Index has three times the volatility of the other four Indexes, and thus is allocated only 8% of the Benchmark's weight. The Benchmark's historical allocation to any Index has ranged from 5% to 30%, and may limit an allocation to any Index to 30% of the Benchmark. The weightings are rebalanced quarterly.
|Index||Benchmark Weight |
as of Nov. 11, 2014
| 12-Month |
|MS Enhanced Forward Rate Bias USD||27%||3.47%|
|MS US Target Equity Alpha||24%||3.87%|
|MS Enhanced Currency Carry Optimized||21%||4.34%|
|MS SmartInvest Alpha||20%||4.68%|
|MS Volatility Term Premium||8%||11.96%|
Sources: Morgan Stanley, Bloomberg L.P., Weights as of Sept. 30, 2014. 12 month volatility measured by the annualized standard deviation of returns from Sept. 30, 2013 to Sept. 30, 2014.
The PowerShares Multi-Strategy Alternative Portfolio is an actively managed ETF that seeks a positive total return with low correlation to the broader securities market. LALT accesses non-traditional risk premia through the implementation of a multi-strategy investment approach that invests across asset classes in equities, currencies, interest rates and equity volatility markets.
About the Fund's Investment Approach
- A multi-strategy investment approach across asset classes seeks to lower a traditional investment portfolio's risk profile
- The use of long and short techniques designed to provide flexibility in down markets
- Rules-based alternative beta strategy offered at a lower cost than a hedge-fund strategy1
- Intraday liquidity & transparency1
- No K-1; issues 1099
- 0.96% total expense ratio2
About the Benchmark
The Morgan Stanley Multi-Strategy Alternative Index (the Benchmark) was developed by the Sales & Trading Division of the Institutional Securities Group of Morgan Stanley and includes a combination of quantitative, rules-based strategies (Benchmark Strategies) aimed to capture non-traditional risk premia across equities, rates, currencies and volatility markets. The Benchmark Strategies may be categorized into three types: Quantitative/Stylistic Strategies, Volatility Risk Premium Strategies and Carry Strategies. Currently, the Benchmark consists of five Indexes. Each Index was developed by Morgan Stanley & Co. LLC (the Benchmark Agent) and has live history.
The Benchmark is designed to offer attractive investment characteristics including:
- Low correlation - Each Index underlying the Benchmark has low to negative correlation relative to equities, bonds and one another.3
- Low volatility - Four of the five indexes underlying the Benchmark have had considerably lower volatility than stocks.3
- Reduced drawdown - The Indexes underlying the Benchmark had significantly better drawdown characteristics than stocks.
1 Since ordinary brokerage commissions apply for each buy and sell transaction, frequent trading activity may increase the cost of ETFs. ETFs disclose their full portfolio holdings daily. Shares are not individually redeemable and owners of the shares may acquire those shares from the Fund and tender those shares for redemption to the Fund in Creation Unit aggregations only, typically consisting of 50,000 shares.
2 As stated in the Fund's prospectus, the PowerShares Multi-Strategy Alternative Portfolio has a gross expense ratio of 1.00%. However, the Adviser has contractually agreed to waive fees and/or pay certain Fund expenses through at least Aug. 31, 2015 which resulted in the total net operating expense of 0.96%. The Fund also includes Acquired Fund Fees and Expenses of 0.05%.
3 Source: Bloomberg L.P. from March 31, 2007 to Sept. 30, 2014