How to Effectively Manage Risk Throughout a Market Cycle

Even as equity markets continue to make all-time highs, risk management remains one of the most important elements of the investment process. Coupled with the lasting impression of a former crisis -for today's investor, the Global Financial Crisis - investors often make the mis­take of treating all drawdowns in risk assets as a crisis-sized event.

While data shows that there is a significant equity market downturn every 7-8 years on aver­age, we often suffer from several smaller drawdowns in the interim that are not cycle-ending bear markets. Preparing portfolios to weather these intra-cycle corrections, which are relative­ly modest market downturns of higher frequency, can be key to keeping clients on track.

A tactical approach to portfolio management coupled with adequate diversification can pro­vide insulation from market fluctuations, while also offering risk mitigation in market draw­downs, return enhancement in strong markets, and a smoother ride overall.

Here are three considerations for building an "all-weather" risk management strategy:

1. Portfolio protection strategies are not one-size-fits all.

According to our research, 80% of equity market drawdowns greater than 5% are actually more intermediate in nature, ranging between 5% and 20%. During the large market corrections, when equities lose more than 20%, asset classes such as bonds, defensive commodities, and currencies have done the best job protecting investors.

However, there is no consistent pattern to protect investments during the smaller, intermediate downturns. For example, in periods where central banks are enacting tighter monetary policy, sovereign bond and equity prices could go down in tandem for some time, negating any diversification in an investor's portfolio.

Portfolio protection during intra-cycle corrections will be related to economic conditions, pol icy response, and market sentiment at that specific point in time. A sound tactical approach will improve an investor's probability of success in navigating periods of stress.

2. Going for cash may cost you. Diversify instead.

While the certainty of cash is appealing, especially during market corrections, investors often suffer the ill effects of being under-invested when markets bounce back after a downturn. Data shows that these intra-cycle downturns tend to happen fast and recover quickly, underscoring the importance of remaining invested. In our view, it's better to temper risk while staying fully invested and adequately diversified.

One key to helping investors weather the storm is to maintain the proper mix of assets accord­ing to the investor's risk tolerance and time horizon. This goes a long way towards mitigating portfolio volatility during periods of stress. Additionally, investors should have a portion of their allocation dedicated to a more tactical approach. Having the flexibility to tactically rotate, or even exit, market segments can add another layer of risk mitigation and help smooth out the ride over the long term.

3. Leverage the breadth of the ETF Universe.

ETFs provide a liquid and transparent vehicle to access global markets. With over 1,900 US listed ETFs spanning $3.8 trillion of assets under management, the investor now has unparal­leled flexibility to construct a low cost, well balanced portfolio.

The ETF marketplace offers a tremendous amount of tools to protect portfolios. This includes more traditional risk off asset classes such as core fixed income, commodities, and currencies, along with efficient access to a variety of defensive sectors. Additionally, ETF Sponsors have launched low-volatility equity ETFs designed to provide diversified exposure to lower volatili­ty US and international market segments.

Despite temptation to target risk management around only the largest market downturns, a well-rounded risk strategy will help you weather any storm. - Nasdaq

7 Ways to Invest With a Theme In Mind

Today's investors are interested in making a statement while earning a return.

Investors should stick to what they know best and avoid falling in love with the latest trends. (GETTY IMAGES)

Forget the investing style of your parents and grandparents. As times have changed, so have attitudes. Thematic investing is trending upward as more millennials and everyday investors look to change up their portfolio.

"It's a paradigm shift," says Peter Krull, president of Krull & Co., a socially and environmentally responsible investment firm in Asheville, North Carolina. "The new, younger millennial investors want to have a hand in picking what they are investing in and they want interactive tools. They want to be more intentional about their investment strategy. They want to be the change makers and they don't like the old school Wall Street way of doing things."

Although thematic investing has been around for a long time, it has traditionally been used as a tilt on one's portfolio, say for oil price fluctuations to actively manage a passive model with diversification while still being as low cost as possible, says Hardeep Walia, co-founder and CEO of Motif, an online investment broker in San Mateo, California, that offers investors the opportunity to create themes around stocks.

After the market crashed in 2008 many investors wanted to understand what they were investing in and began caring more about the types of investments, he says.

"If I were to buy a mutual fund and wanted exposure to technology, in general mutual fund companies don't necessarily tell me a lot about these products," says Walia, whose company creates indexes of up to 30 securities within each of its more than 250,000 motifs. "But if you know you've invested in a connected car or 3D printing, then all of sudden it's a very intuitive."

That has bred interest around investing in everything from robotics and female-led companies to high-yield dividends. It is more than just impact investing – investments made with a social or environmental focus.

"A lot of the rise is because of social media," says Kirsty Peev, a portfolio manager for Halpern Financial in Ashburn, Virginia. "We are all armchair activists. We can now make bold statements online. Companies are very smart and they see people wanting to make a statement with their investments so they've built a niche."

Here's how you can create theme-based investments.

Invest in what you know. Walia points to his father, a retired vascular surgeon who knew nothing about investing, but understood the nuances around a minimally invasive surgery-themed index fund.

"If you are starting to do thematic investing, start with something you understand," Walia says. "Everyone knows something about something."

Keep in mind your risk tolerance and time horizon, since a climate change themed fund may take longer to grow or investing in shale oil will be sensitive to market volatility, he says.

Pick a broad-based theme and stay diversified. Avoid being too heavily concentrated in one industry. Minimize investment risks by making sure you are not overweighting certain sectors in your portfolio while remaining properly diversified, says Matt Hylland, an investment advisor for Hylland Capital Management in Virginia Beach, Virginia.

"We all like to think that we can read the news and predict things," says Peev, who typically cautions against theme-based investing. "In reality, investors' predictive skills aren't very strong if you look at the history."

Instead, she recommends allocating less than 10 percent of your portfolio toward a particular sector or theme.

Look at themed-based exchange-traded funds. Consider creating value-based or dividend themed portfolios with less expensive companies. Vanguard Large Cap Value (ticker: VTV) ETF, which invests in large companies, and the Vanguard Small Cap Value (VBR), which invests in smaller companies, both trade at a cheap price compared to their net worth, Hylland says.

For investors looking for dividend appreciation, Hylland recommends Vanguard Dividend Appreciation ETF (VIG), which invests in companies that have increased their dividends over the last 10 years, or Vanguard High Dividend Yield ETF (VYM), which invests in stocks that currently have a high yield.

Make sure to review the expense ratio. The lower the better, but aim for less than 0.3 percent, Hylland says.

Try a theme that minimizes volatility but still offers equity exposure. Many investors who pick themes are doing rule-based investing that focuses on low volatility via "smart beta."

"It's less trendy and sector chasing than most people think of theme investing," Peev says. "They'll take a particular index, say an emerging index, and instead of buying the whole index you buy only the stocks with the lowest volatility within that index."

Consider the future economy. Use what Krull calls the "what's the next economy" philosophy. Ask yourself what the economy will look like a decade from now.

Consider what companies may be providing energy and consumer goods. Look for companies that are doing innovative research and development that are open to trying new things.

"Companies that aren't afraid to make educated risks on new products and services have every chance," he says.

Avoid what's trending. "Five years ago we had clients who wanted to invest in gold, because everyone was talking about it," says Stuart Blair director of research for Canterbury Consulting in Newport Beach, California. "We counseled them not to make an unnatural tactical play because if you get caught up in the excitement it becomes a problem. Shortly after that gold dropped off and equity markets took off like a rocket ship."

Conversely, he says many investors are overlooking emerging markets which have slowed their growth, but are still growing at a rate far greater than the rest of the world.

"We aren't saying that this is the year emerging markets are going to do well," he says. "But we believe long-term the emerging markets are going to return more than U.S. and international developed markets."

Know that it is harder to exclude something than include it. Especially for investors who looking for socially responsible investing, it may take more work to create a customized equity-based portfolio.

Most socially responsible investing mutual funds are not going to exclude everything, such as animal testing and big pharma, as one of Krull's clients requested. It's not easy to hit those specifics, which means you have to look individual stock portfolios, he says.

Or if an investor is trying to remove guns from their portfolio, they may settle with eliminating gun manufacturers versus not buying any securities tied to guns since copper, which is used in bullets and a large part of the U.S. economy as well as emerging markets. - money.usnews

How to Make the Right Investment Decisions

When people get close to their retirement age, they concentrate more on saving enough money so that they can have an enjoyable and stress free retirement. To them, saving which was not an option suddenly is an option.

The truth is that saving your money does not guarantee that you will live a stress free life for the rest of your life after retiring. You are still going to be faced with different responsibilities, and before you know it, your savings are gone.

Chances are you will mismanage the money. Financial advisors usually say that retirees can still invest and reap good benefits. However, it is good you start earlier before you retire.

In any case, whether you are at your youthful age, about to retire or already retired, making smart investment decisions and getting the most out of them is dependent upon following professional advice and fees.

For you, the following are some useful tips and advice that will guarantee that you make the right and profitable investment decisions:

#1. Understand the risks involved in the investment plan.

Most people make the mistake of investing in a venture they know little or nothing about. They make these decisions based on the fact that they know someone who is doing well in such or because of its popularity.

These assumptions are don’t always work out well because they are assumptions until proven otherwise.

Usually, it is not what you are investing in that is bad but your lack of knowledge of how it works that makes you lose your money.

You need to try as much as possible to understand what you are investing in and how it works. Always consult a financial advisor when making investment decisions.

#2. Try not to focus on one risk

All investments are risky to a certain degree. This is especially true when you invest in the stock market. However, one thing you should know is that avoiding risks such as the stock market is a great risk on its own as it increases other type of risks.

These risks include longevity risk or the risk of outliving your money. Financial advisors say that retirees should consider short-term or certificates of deposit and other similar types of investment as being risk-free assets.

The reason is that when you invest in them, you may still have a guaranteed return of capital. These types of investments are the risks that are worth taking.

#3. Consider Investments that offers immediate annuities.

Annuities are reliable options if you want a guaranteed income payout. Investing in annuity qualifies you to get a monthly income in exchange for a large sum or payments over a series of years while you are alive.

Many types of annuities exist. They come with different features and can be expensive as well. Consider consulting a trusted financial adviser before you decide on which type of annuity to invest in.

With these tips and with the help of a professional financial advisor, you are guaranteed to make the right investment decision that will guarantee you a fun filled retirement. - huffingtonpost

Asian Funds Pile into Alternative Assets as Traditional Returns Slide

* As rates come down in Asia, bond yields tumble

* Investors increasingly buying alternative assets for yield

* Alternative assets bring liquidity, transparency risks

* 44 pct of Asian pension funds adopt higher-risk strategy -survey

* Investment environment expected to stay tough for years

By Nichola Saminather

SINGAPORE, Aug 17 As returns on traditional assets have nosedived or turned more volatile in Asia, conservative investors such as pension funds and insurers have been pouring cash into alternative investments that bring the yield they need, but at significantly higher risk.

Many countries in Asia only started to cut interest rates in 2015 or 2016, but they are now at or near record lows and expected to fall further; India, South Korea, Indonesia, Taiwan and Thailand are all likely to see rate cuts this year, according to economists at Nomura.

The resulting decline in bond yields has hit the region later than many other parts of the world, but is now forcing a strategy rethink for investors who need predictable income to match their fixed commitments.

Zurich Insurance's Asian division, for example, is considering investing in private debt including collateralised loan obligations and commercial real estate and infrastructure debt.

"We simply have to accept that returns going forward will be lower than what they have been historically," said Michael Vos, Asia-Pacific investment manager at Zurich. "There is no free lunch - if you want higher returns, you need to take more risk."

Risks include a dearth of buyers when you want to sell, a greater chance of loan defaults, and lower levels of disclosure about the underlying assets.

Credit Suisse said it, too, was increasing allocations to hedge funds and senior secured bank loans on behalf of Asian institutional clients.

Swiss private bank Union Bancaire Privee (UBP) said it was switching more of its high-net-worth clients' money from low-yielding bonds and volatile stocks into hedge funds, real estate debt and insurance-linked securities.

"There is no doubt that the risk/reward of equity and fixed income markets have deteriorated dramatically over the last six to 12 months," said Ted Holland, Hong Kong-based Asia-Pacific head of business development for UBP.

"Finding 'low-risk' yield in this environment has been particularly difficult."

This rapid change in climate is demonstrated by GIC Pte, Singapore's biggest sovereign wealth fund.

Its portfolio return slowed to 3.7 percent per annum over the five years through March 2016, from 6.5 percent in the five years ended in March 2015, and it warned difficult investment conditions would persist for a decade.

A survey by State Street Global Investors in July found that 44 percent of 72 Asian pension funds, which must keep a steady income flowing to pensioners, are seeking higher-risk, higher-return strategies.

South Korea's National Pension Service, facing lower domestic bond yields than U.S. Treasuries, plans to increase its alternative holdings to 35 percent of assets by 2020 from 10.7 percent in 2015, and will begin investing in hedge funds this year.

It reported preliminary returns of 4.6 percent for 2015, down from 5.25 percent in 2014.

RISK TRADE-OFF

The trade-off in this hunt for yield is an increase in risks that require careful management.

Chief among them is a lack of liquidity. Many alternative investments, such as property or private equity, can't be readily turned to cash, so investors can't get their money out in a hurry. In a falling market, buyers for such assets become yet more scarce, exacerbating the falls.

They are also typically unlisted, so they are much less transparent than traditional investments, which are priced in real time on formal exchanges that typically demand more stringent governance and disclosure requirements.

"There are also not many reliable or accepted benchmarks out there, so how do you measure the performance of your portfolio versus the performance of the market?" said Beng-Eu Lim, Asia Pacific head of asset owner sector solutions at State Street.

If investors are stepping down the yield curve to instruments that don't carry an investment grade imprimatur from credit rating agencies, the risks of default are also higher.

Vos at Zurich acknowledges that investors in alternative assets need to take protective measures.

"When you take higher risk, it is important you have sufficient capital to absorb the extra volatility that comes with taking this additional risk so we are not forced sellers at the bottom of the market," he said.

But even private individuals are pouring into such investments.

Alternative investments made up 15 percent of Asian high-net-worth individuals' portfolios as of May 2016, almost double the level from three years ago, and are expected to rise further over the next year, according to market research firm East & Partners Asia.

UBP said some of its clients were raising their exposure to alternatives to as much as 50 percent of their portfolio, up from about 20 percent previously.

That flood of cash could ultimately defeat the investment rationale for yield-hungry investors.

"The weight of money coming into this sector can be overwhelming," State Street's Lim said. "As demand outstrips supply, that's going to raise the price and reduce expected returns." - Reuters

How to Make Sense of Investment Risk

Understanding different types of investment risk is key to financial success.

Most investors take risk as a given, but it's important to distinguish between various forms of business and market risk. Many retirees put all their assets in low-yielding investments they believe are "safe" -- which is to say investments where they're unlikely to lose principal. What they don't understand is that they are exposing themselves to other kinds of risk that are potentially more costly.

Business risk is associated with investing in a particular product, company or business sector. An example of assuming too much business risk is heavily investing in the common stock of your employer. Most experts recommend allocating no more than 10 percent of your investable assets in the company you work for.

Another illustration of business risk is the recent misfortunes of the fossil fuel industry.

For many years oil companies were very profitable because oil prices were high. Very few industry analysts anticipated the dramatic drop in oil prices that occurred in recent years, which has dried up profits and led to significant layoffs. The fact that many of these companies are well-managed and had excellent reputations did not prevent profitability from falling dramatically, with a similar effect on stock prices.

So you can see the importance of diversification across sectors.

Market risk, which is relevant to both domestic and international companies, relates to factors that that are systemic: They affect the overall economy or securities markets. These risks include:

Interest rate risk: According to FINRA, too many investors have a poor understanding of this. When interest rates increase, bonds fall in value, and vice versa. Even if you buy long-term Treasury bonds guaranteed by the U.S. government, they will fall in value when interest rates increase. Because of the unpredictable nature of interest rates, investors have to be cautious regarding the maturity dates of the bonds or bond funds in their portfolios. Anyone who expects to cash in their bonds in the short term should never be invested in long-term bonds.

Inflation risk: The general increase in prices of goods and services will reduce the value of money, thereby reducing your purchasing power if your investments earn less than the inflation rate. On an intermediate or long-term basis, you can't afford to have a significant part of your investments in short-term CDs, savings accounts and Treasury Bills paying less than 1 percent. In order to minimize inflation risk, you must have part of your portfolio in intermediate-term bond funds and/or common-stock index funds.

Currency risk: This is the risk associated with investments in companies or mutual funds with significant foreign investments. If the U.S. dollar increases in value relative to foreign currencies, the value of your investments in those countries will fall. The U.S. dollar is currently respected more than other currencies. Accordingly, investments abroad have associated risks.

Liquidity risk: This is the risk associated with the inability to buy or sell investments quickly for a fair price. For example, if you invest in stocks or bonds that have small capitalization and trade in the over-the-counter market, with large differences between the bid and ask prices, it is harder to realize profits.

In order for you to be a successful investor, you must understand associated risks. Distinguish between short-term and long-term objectives, and select your investments accordingly.

For long-term objectives, be willing to take steps to avoid inflation risk. Use a diversified portfolio, with a mix of common-stock index funds covering multiple sectors, as well as intermediate high-quality bond funds to minimize interest rate risk. - chicagotribune

Alternative Investments to Replace Bonds in Your Portfolio

The big drop in world markets after the United Kingdom's shocking vote to leave the European Union is only the latest reminder that investors need a variety of eggs in their portfolio baskets. Large caps, small caps, Asian stocks, European stocks, high-yield bonds, oil, copper--practically everything took a dive. The same happened in 2008. Not only did large-capitalization U.S. stocks lose 37% of their value, but real estate, commodities and foreign stocks tanked as well. Real diversification demands assets that don't move up and down in tandem.

You need a strategy for softening the impact of market setbacks. Using hedging strategies will usually produce slightly lower returns over the long run, but, in my view, the smoother ride you get in return is worth the cost. I would be happier with a 6% return year after year than a 25% gain one year and a 10% loss the next.

The traditional wisdom for hedging a portfolio is to buy bonds to temper the ups and downs of stocks as well as provide consistent income. Medium- and long-term Treasury securities, with maturities ranging from, say, seven to 15 years, have thrown off interest of about 5% annually over the past century, with no risk of default. So a portfolio with half of its assets in Treasuries and half in a diversified bundle of U.S. stocks has produced long-term returns averaging about 7.5% annually. Even better, in no 10-year period over the past 90 years has such a portfolio ever lost money, according to Morningstar.

Investors, however, face two big hurdles: Bonds today are not paying 5% interest, and U.S. stocks seem unlikely to match their long-term average return of 10% per year. The 10-year Treasury is yielding 1.49%. If you believe stocks will return a few percentage points per year less than they have in the past, a 50-50 portfolio will, on average, return less than 6% a year.

There is, however, another solution. You can substitute alternative investments for some of your bond holdings. An alternative is an asset class that moves out of sync with the stock market. One popular example is gold. On June 24, the day the outcome of the U.K. vote to leave the EU became known, SPDR Gold Shares ( GLD , $126), an exchange-traded product that tracks the price of the commodity, rose 4.9%, while SPDR S&P 500 ETF ( SPY , $209), which tracks Standard & Poor's 500-stock index, fell 3.6%. In 2008, when the S&P 500 ETF plunged 36.8%, the Gold fund gained 5.0%. In 2013, when the stock market ETF soared 32.2%, the Gold fund sank 28.1%. (Prices are as of June 30.)

Gold and stocks sometimes move together--as in 2009, 2010 and 2012--but, generally, they orbit different planets. Although I'm not a fan of gold, it is clear its meanderings aren't determined by the same forces that move stock prices.

Shift to neutral

Another example of an alternative investment is the market-neutral fund , whose manager tries to take market risk out of the picture by constructing a portfolio that balances long and short positions. Longs are simply traditional stock purchases, made in the hope that prices will rise. When you go short, you borrow a stock from someone else, sell it immediately, and then hope it declines in value so you can buy it back and return it when it's worth less--and pocket the difference.

In a market-neutral fund, a manager may go long with one stock and short with another one in the same sector, making a profit if the long does better than the short. For example, a manager might decide that Coca-Cola ( KO ) is superior to Pepsico ( PEP ). She buys $1 million worth of Coke stock and shorts $1 million worth of Pepsi stock. Over a year, let's say that the overall market is up, and Coke rises by 20%, but Pepsi increases by just 5%. The fund makes a $200,000 profit on Coke stock and suffers a $50,000 loss on Pepsi stock, for a net gain of $150,000, not including dividends. What if the overall market falls? The fund can still make money as long as Coke outpaces Pepsi. Say that Coke declines by 10% but Pepsi drops by 25%; then the fund will lose $100,000 on Coke but make $250,000 on Pepsi, for a net gain of $150,000.

Market-neutral strategies are typically the province of highly paid hedge-fund managers. Some of the best public mutual funds in this sector require lofty minimum investments and charge high fees. Vanguard charges just 0.25% a year for its Market Neutral Fund ( VMNFX ), the lowest fee of any mutual fund in the category, but it requires an initial minimum investment of $250,000. (The 0.25% figure excludes extra costs involved in selling short.)

Otherwise, the pickings in this category are slim. Among no-load funds with reasonable minimums, the best by far is TFS Market Neutral ( TFSMX ), which requires a minimum investment of $5,000 and has an expense ratio of 1.9% (excluding short-selling-related fees). Over the past 10 years, the fund, which focuses on small-cap stocks, has returned 3.9% annualized. Since 2008, the fund's calendar-year returns have ranged from -7% to 17%, suggesting relatively low volatility, the hallmark of a good market-neutral fund. By contrast, the range for SPDR S&P 500 ETF was -37% to 32%.

Also consider the approach of the Merger ( MERFX ) and Arbitrage ( ARBFX ) funds to alternative investing. Each buys shares of already-announced takeover and merger targets, with the goal of capturing the last few percentage points of appreciation between the post-announcement share price and the price at which the deal is consummated. The result is modest, bond-like performance that is utterly divorced from the overall stock market and that exhibits little volatility. In 2008, the annus horribilis for stocks, Merger was down 2.3%; Arbitrage fell 0.6%.

Finally, you can invest in companies whose business is relatively isolated from the economy as a whole. One prime example is reinsurance. Property-and-casualty insurers don't want to bear the entire risk of shelling out payments after a catastrophic event, such as a huge hurricane, so they buy their own insurance from reinsurers. The performance of such companies depends, in large part, on the frequency of major natural disasters--events unrelated to the stock market.

Warren Buffett is a longtime fan of the business. His company, Berkshire Hathaway ( BRK.B , $145), owns Gen Re, one of the largest reinsurers. Berkshire is broadly diversified, with holdings that range from jewelry retailing to banking to consumer goods. But, with the exception of 2008, Berkshire's annual returns have diverged nicely from those of the S&P 500 over the past decade.

Rules for Alternatives

Alternative funds have been one of the fastest-growing segments of the mutual fund industry in recent years. “Alt funds,” as they are commonly referred to, seek to provide attractive absolute and relative long-term returns, typically with lower risk than stock funds. They can offer diversification to traditional stock and bond portfolios.

When one considers the current rock-bottom bond yields, high stock valuations and the market’s recent volatility, it’s not difficult to understand alt funds’ appeal.

But some alternative mutual funds have fallen short. Their proliferation has increased the choices, making the research process even more important in selecting a solid fund for your clients.

For over a decade, our firm has invested in alternative strategies, including alternative mutual funds, for our clients. We have reviewed scores of these funds over that time period. Here are 10 rules to consider when researching them:

1. Begin With The End In Mind.

There are many varieties of alternative investment. The first step in evaluating an alternative mutual fund is determining what you are trying to accomplish. What level of risk, return and correlation to stock and bond markets are you looking for? Are you looking for a low-risk bond surrogate, a more growth-oriented (and thus riskier) strategy, or something in between? If you are adding alternatives to a traditional stock and bond portfolio, what asset classes are you reducing to make room for the new strategy? Knowing may help you determine the characteristics of the alternative investment you’re looking for. Alternative investment strategies sometimes promise to deliver “stock-like returns with bond-like risk,” but things that sound too good to be true usually are.

2. Don’t Skip The Basics.

Your research on alternative investments should include all of the due diligence you would normally conduct on traditional investment managers. That means evaluating a manager’s “four P’s”: its people, process, philosophy and performance. Quantitative data such as performance is available in mutual fund databases. The management firm’s investment presentation, shareholder reports and commentaries from recent years should offer insight on its people, investment process and philosophy. After you read these documents, a phone interview with the portfolio manager can help you understand his or her thinking. Finally, face time with key members of the investment team during on-site visits will be very useful in helping you assess the qualitative aspects of the manager.

3. More Complicated Strategies Take More Time To Research.

Alternative mutual funds are often more complicated than traditional stock and bond mutual funds. As fiduciaries, we are responsible for thoroughly investigating and researching the investments we recommend to our clients. For example, we followed managed futures strategies for years before investing in a fund for our clients. We wanted to take extra time to really understand how the investment worked. It should go without saying, but if you don’t have a good understanding of a strategy, you shouldn’t recommend it to your clients.

4. Ask What Could Go Wrong.

Risk is often thought of as volatility or the standard deviation of returns. When evaluating alternative investments, advisors should seek to gain a deeper understanding of the risks the strategy is taking and what could go wrong. We want to uncover hidden risks that may not show up in the investments’ historical standard deviation. The risk section of a fund’s prospectus can provide you with clues for investigating the risk of a strategy. For example, does the strategy employ leverage, use derivatives, invest in illiquid securities or use counterparties? What are the risks related to each? Other questions we often ask: What is a perfect storm for this strategy? How much could the strategy lose in that scenario? What risks does the portfolio manager believe are the most significant? In which environments is the strategy expected to do well—and in which will it likely do poorly?

5. Compare Apples To Apples.

It would be silly to compare a small-cap value fund with an emerging markets equity fund or compare a high-yield bond fund with a municipal bond fund. So it’s important to remember that alternatives also cover a wide range of similarly diverse strategies. Morningstar currently breaks the alternative universe into more than a dozen categories including long/short equity, bear market funds and market neutral funds. When researching alt funds, it’s important to compare those that follow similar strategies. Even within categories, the strategies can vary greatly in their approach.

6. Past Performance Is No Guarantee, But Still Nice To Have.

Past performance is no guarantee of future returns, but it is helpful to see how a fund has performed in the past. Because so many alternative mutual funds have come out in recent years, many don’t have a five-year or even a three-year track record. Some funds with shorter track records offer historical performance from either a similar institutional strategy or back-tested data. But a strategy in a mutual fund may be very different from an institutional strategy because there are limits on illiquid investments, limits on leverage and diversification requirements, to name just a few potential differences. It’s important to understand the differences before you can determine whether the institutional track record is applicable to the fund strategy. Also, it is good to confirm that the performance data is actual live data and not back-tested data. Back-tested data always looks good! If the institutional strategy is very similar to the fund’s, you can be comfortable analyzing it.

7. Consider Market Cycle Performance In Standard Time Periods.

In addition to looking at performance over the standard one-, three- and five-year time periods, it is important, especially with alternative strategies, to review how funds perform during different parts of the market cycle. We like to review performance from the peak of the market to the trough, from the trough to the peak, and over the full market cycle. Standard one-, three- and five-year time frames may all take place during a bull market, giving you only half the story.

8. Consider Risk-Adjusted Performance.

Within alternatives, more so than in traditional stocks and bonds, strategies may be run with more or less risk, and you need to account for that when comparing strategies. For example, one long/short equity strategy may typically be 40% net long and another 20%. Using risk-adjusted performance measures such as the Sharpe ratio is helpful when comparing managers with different risk characteristics.

9. Consider The Correlation To Stock And Bond Markets.

Part of the appeal of alternative investments is the diversification they offer apart from traditional stock and bond markets. But it’s important to consider how correlated each alternative investment is to those markets and how much diversification it will provide to the portfolio. Those correlations may change over time as well. For example, managed futures strategies may have a positive correlation to stocks during bull markets and a negative one during bear markets.

10. Don’t Forget Taxes And Expenses.

Alternative mutual funds are often less tax-efficient and often have higher expenses than traditional stock and bond mutual funds. It may make sense to buy an alternative fund in a tax-deferred account, but if the fund will be in a taxable account, evaluate the after-tax returns. When you review expenses, remember that some alternative mutual funds are funds of funds and have two layers of management fees. Funds that short stocks as part of their investment strategy will have to pay short interest and dividend expenses in addition to management fees. When considering alternative mutual funds, review the components of the expenses to understand them and look for lower fee options that are less of a hurdle for a manager to overcome.

Now that they are seven years into a bull market facing extremely low bond yields, investors’ attraction to alternative mutual funds would be understandable. However, the proliferation of these funds in recent years makes thorough research and due diligence by advisors and investors even more important if they are to select strategies that will be a good fit for them.

No Break for Worst Asian Currency as Clouds Gather Over Malaysia

The bad news just doesn’t stop for Asia’s worst-performing currency.

Already reeling from a renewed slump in oil prices and a political scandal that just won’t go away, the Malaysian ringgit is now facing the prospect of another cut in interest rates. It’s the region’s biggest loser in the past month and analysts still see scope for it to drop more than 2 percent by year-end.

The currency’s slide highlights all is not well as the nation’s economy heads for its worst performance this decade. Crude oil’s plunge to a four-month low this week undermines the finances of net oil exporter Malaysia, while the appeal of its relatively high bond yields is being tempered by the scandals surrounding a troubled state investment fund. Rabobank Group and UBS Group AG both predict Bank Negara Malaysia will add to its first rate cut in seven years in coming months.

Another rate reduction “will be a further negative for the currency because one of the things that’s attractive about it is it’s got a relatively high yield,” said Michael Every, head of financial markets research at Rabobank in Hong Kong. “They’ve been extremely stable on the interest-rate front up until the last cut. If we get another one, it will get the market thinking: ‘What do they know that we don’t?’”

July’s easing was a “pre-emptive move” and there are no current plans to adjust rates again over the next few meetings, although policy makers will look at data to see what is needed, central bank Governor Muhammad Ibrahim told the official Bernama news agency in an interview published July 14. Malaysia is able to absorb external shocks should the global economy deteriorate, Muhammad told Bernama.

Brent crude’s 13 percent slump this quarter is exacerbating Malaysia’s woes. Sliding energy prices have eroded export earnings and rising costs are curbing business investment. Economic growth slowed to the least in more than six years in the first quarter, and analysts project it will ease to 4.2 percent for the year as a whole, the least since 2009.

The outlook for the currency is linked to oil prices as Malaysia derives 20 percent of its revenue from energy-related sources. The nation loses 450 million ringgit in annual income for every $1 decline in oil, the prime minister said in April.

Lagging Behind

The ringgit has dropped 1.3 percent in the past month, underperforming its regional peers which all recorded gains except for the Philippine peso and Indonesia’s rupiah. The currency traded at 4.051 per dollar as of 7:56 a.m. in London on Thursday. It was as strong as 3.142 in August 2014, when oil was still above $100 a barrel.

The ringgit will weaken to 4.10 per dollar by the end of September and 4.15 by year-end, according to the median estimates of analysts surveyed by Bloomberg. Rabobank is more bearish, predicting 4.15 by Sept. 30 and 4.30 by the end of December, Every said.

Bank Negara unexpectedly cut its benchmark interest rate by a quarter point to 3 percent on July 13 to bolster growth, and analysts say pressure is building for another move.

UBS projects the central bank will make another quarter-point rate cut by early next year and the ringgit will weaken to 4.40 per dollar by the end of December in anticipation. Three-year bonds yield five basis points less than the central bank rate, signaling investors see a chance for further easing.

‘Common Problem’

“Malaysian export growth continues to be weak, a common problem among emerging-market economies, and the current-account surplus is expected to narrow further, which could put pressure on the currency when portfolio inflows slow,” said Maximillian Lin, a currency strategist at UBS in Singapore.

Sentiment toward the economy has soured as global probes into 1Malaysia Development Bhd. gathered pace, raising the stakes in a scandal which has dogged Prime Minister Najib Razak for more than a year.

1MDB is at the center of a controversy involving accusations of embezzlement and money laundering. It defaulted on a $1.75 billion bond in April amid a dispute with the co-guarantor as to who was liable for the payment.

U.S. prosecutors said on July 20 they’re looking to recover more than $1 billion in assets they contend were siphoned from 1MDB, whose advisory board Najib chaired until recently. The Monetary Authority of Singapore announced a day later it had seized S$240 million ($179 million) in assets from individuals linked to alleged fraud at the fund. Najib and 1MDB have both denied wrongdoing.

‘Fairly Benign’

Not everyone is bearish.

JPMorgan Chase & Co. predicts the ringgit will stay between 3.90 and 4.10 per dollar in the second half as Malaysia’s relatively high bond yields attract investors. That scenario would only be threatened if the Federal Reserve were to raise interest rates at the same time as Bank Negara cuts them, its foreign-exchange analysts say.

“If the Fed outlook was fairly benign it’s not likely that another rate cut would hurt ringgit sentiment all that much,” said Jonathan Cavenagh, head of Asia emerging-market currency strategy at JPMorgan Chase in Singapore. “Outright yields are still quite high, particularly compared to the major developed markets. Hence we would expect limited downside in the ringgit.”

While Malaysian bonds offer the second-highest interest payments in Southeast Asia after Indonesia’s, they are losing their allure. The yield on the benchmark 10-year security dropped to 3.62 percent on Thursday, from as high as 4.45 percent in August 2015.

“High foreign participation in the local currency bond market — we estimate 34 percent of outstanding Malaysian government securities are owned by foreigners — makes the ringgit very sensitive to the Fed outlook and to domestic political developments,” UBS’s Lin said. - Bloomberg

Why hold alternative investments?

IN the world of serious portfolio investing, the BIG 3 asset classes are equities, fixed income and cash. There are also two outlier asset types: investment real estate and alternative investments, or alts, which round off the full set of five asset classes the world’s savviest investors use to construct their wealth accumulation vessels. 

In recent weeks, I have written on the roles of cash, fixed income, equities and investment real estate within a portfolio. Today, we complete our set by looking at alts. 

Alts is a convenient catch-all category for six asset segments or asset subclasses used by wealthy investors to a modest extent. According to the 2016 World Wealth Report (2016 WWR) published by Capgemini in late June, earlier this year, the world’s wealthiest people sank 15.7 per cent of their investment wealth in alts. The alts asset class comprises half a dozen asset segments — hedge funds, structured products, private equity, derivatives, foreign currency and commodities. 

Despite being very different from one another, the six asset segments have one striking similarity: they have low correlations with the other four more widely-used asset classes — cash, fixed income, equities and investment real estate. (Note: Low and ideally negative correlations mean the prices of different assets do not move in tandem.) 

Here is a rundown of the six segments comprising alts: 

HEDGE funds are absolute return investment vehicles that attempt to generate positive nominal returns in all investment environments by taking both long (buy first, then sell) and short (sell first, then buy) investment positions. They are often deemed high risk and are not readily available in Malaysia. Purveyors of hedge funds, though, abound in more sophisticated financial centres, including Singapore and Hong Kong. 

STRUCTURED products are hybrid offerings comprising a primary investment like a zero coupon bond and a riskier growth investment, such as a derivative (see derivatives below for an explanation), which can tie up capital for several years, namely the structured term or tenure. (My biggest complaint about structured products is not with their risk, but with the irritating, frustrating, widespread incorrect use of the word “tenor” for “tenure” (see www.usingenglish.com/forum/threads/27292-Tenor-vs-Tenure). 

My linguistic pedantry aside, structured products can be far riskier than numerous naive retail investors are led to believe. They come in two flavours: structured deposits, which are relatively safer than their racier, riskier cousins, structured investments. 

PRIVATE EQUITY are ownership stakes in private companies that are not (yet) listed on a stock exchange. Such stakes can be ideal wealth generators for sophisticated investors, who have both deep know-how and vast financial muscle. They require the know-how to assess the long-term prospects of various private companies and the muscle to invest in several private equity positions to spread their risk and raise the likelihood of enjoying at least one or two gushers within their extensive set of private ownership positions. 

DERIVATIVES are securities that are essentially gambles. The fluctuating price of a derivative is based on (or literally “derived” from) the intermediate price movements of an underlying asset, such as a stock or index (like the KLCI or S&P 500) or a commodity. Each derivative is a contract between two or more parties. The contract’s settlement value hinges on the price of the primary underlying asset. 

FOREIGN currency. As Malaysians, our base currency is the ringgit. Since ours is a minor currency within the global scheme of things, sophisticated investors sometimes take long positions in currencies they think will strengthen and short positions in currencies they suspect will weaken. The foreign currency or foreign exchange (forex) market is the world’s largest! Worldwide, the most traded currencies are the greenback, or US dollars, the euro, yen, British pound and Swiss franc. 

COMMODITIES are real, tangible assets. In Scott Frush’s book Commodities Demystified, he explains: “Commodities... represent the food we eat, the fuel we use to power our automobiles, the metal we utili(s)e to make (jewellery) and the lumber we use to build our homes. Without commodities, our civili(s)ation would not exist today.” - NST

How To Prepare For The Coming Stock Market Crash

Economists are cautioned to predict what or when, but never both. While not an economist, I’ll heed this advice and predict what. The stock market will crash in dramatic fashion.

It’s inescapable. Central banks have driven rates into the ground. According to the WSJ, there is more than $11 trillion of debt with negative yields.

Lower yields in turn drive up asset prices. Stocks seem to break new highs on a regular basis. There’s talk of real estate bubbles forming again. It’s not surprising. With cash earning nothing, investors move their liquidity to other assets (e.g., dividend paying stocks) for yield.

Eventually the music will stop and investors will head for the exits. While I don’t know when it will happen or what will be the final straw that sets panic in motion, a significant correction will occur.

Here are several ways to prepare your portfolio for the inevitable.

1. Recognize Bear Markets are a Reality

In his book The Road Less Traveled, M. Scott Peck observed that life is difficult. But he didn’t stop there:

Life is difficult. This is a great truth, one of the greatest truths. It is a great truth because once we truly see this truth, we transcend it. Once we truly know that life is difficult-once we truly understand and accept it-then life is no longer difficult. Because once it is accepted, the fact that life is difficult no longer matters.

One can apply this to investing. Stock markets crash from time to time. If we recognize this in good times, we prepare ourselves for the difficult times.

The timing of a market correction is sometimes surprising. The crash of 1987 comes to mind. But the fact of a down market should never take us by surprise.

2. Check Your Asset Allocation

It’s been said that the more you sweat in peace, the less you bleed in war. The same is true with investing. It’s during a bull market that we should ensure that our asset allocation is both realistic and aligned with our financial objectives. The goal is to have in place an investment plan that we can stick with during a down market.

Here the primary focus is on the stock and bond allocations. This critical decision drives long-term returns and volatility more than any other asset allocation decision. The worst time to make significant changes to an investment plan is when equities are in free-fall. For those with at least 10 years left before retirement, an asset allocation of at least 70% in stocks is ideal. As you near retirement, the stock allocation often goes down. Even in retirement, however, keeping at least 50% in stocks is usually a good idea. Remember that at age 65, retirees are still planning on a 30 year retirement.

3. Examine Each Fund

Beyond asset allocation, we should examine each individual mutual fund or ETF we own. This is particularly true if you invest in actively managed mutual funds. A combination of high expense ratios and a falling market often cause people to sell actively managed funds at the wrong time. In fact, studies have found that investors in index funds were more likely to stick to their investment plan in difficult times then those who invest in actively managed funds.

4. Follow the 5-Year Rule

A good rule of thumb is not to invest any money in the stock market that you’ll need over the next five years. This is particularly important for those who are in retirement and relying on their investments for daily expenses. The goal here is to avoid a situation where you have to sell stocks during a bear market in order to meet living expenses.

This rule is difficult to follow today given the extremely low yields in the bond market. But given the relatively high prices of equities, it’s an important rule to follow. With at least 5-years worth of expenses out of the market, an investor is more likely to weather a bear market knowing their immediate needs are taken care of.

5. Stay Out of Debt

This last factor may surprise some because it has nothing to do with investing directly. It’s here that we take a holistic approach to our finances. You’ve probably worked through a questionnaire from a brokerage firm that’s designed to assess your appetite for volatility. These questionnaires tend ask questions such as what you will do if the stock market falls by 20%.  What these questionnaires fail to address is the amount of debt that you have.

Why is that important?  In my experience, those with little debt relative to their income and assets are more likely to weather a bear market. In contrast, those with a lot of debt relative to their income and assets are in a less stable financial position and more likely to flee the market in fear.

I put the question of how to prepare for a stock market crash to the Dough Roller Facebook community. There were many helpful responses. One member named Ryan offered sage advice:

My two cents would be that there isn’t any preparation (in terms of moving money) that needs to be done if you have already chosen your investment strategy. You simply have to ride out the lows to get to the highs. The market can’t be timed (let alone twice) so don’t try to sell at the top then buy at the low. Market crashes are part of the cycle and are unavoidable. That said, I think psychologically is where people could benefit from preparation. Simply educating yourself on market cycles and reading literary works (The Simple Path to Wealth by JL Collins) of much smarter people will keep your emotions in check better during a downturn than if you didn’t take these proactive steps.

The key is to prepare now for a falling market. In my case, I assume that the value of my portfolio will be cut in half during the next bear market. While that is extreme, it follows the old adage, prepare for the worst and hope for the best. - Forbes

Forecasts show Brexit weighing on Asia -- Malaysia in particular

MASASHI UEHARA, principal economist, and KENGO TAHARA, senior economist, Japan Center for Economic Research

TOKYO -- The U.K.'s decision to leave the European Union has cast uncertainty over key Asian economies, new Japan Center for Economic Research forecasts show.

The center on Wednesday published its fourth short-term outlook for five Asian markets: China, Indonesia, Thailand, Malaysia and the Philippines. Though the Brexit vote has had little immediate impact on these countries' stock prices and exchange rates, the decision is expected to depress growth through trade and the financial markets as the withdrawal approaches.

This year, China's economy is expected to continue decelerating, following the slowdown in 2015. The four major Association of Southeast Asian Nations economies are projected to tread water around their 2015 gross domestic product growth rates, with China holding them back.

Malaysia looks likely to feel the biggest effects from Brexit and the Chinese slowdown, with its real GDP growth rate falling to 4.1%.

Under the circumstances, Asian countries are expected to step up monetary easing, including interest rate cuts.

China's waning momentum

JCER projects China's real GDP growth rate in 2016 will slow to 6.5%, down 0.4 of a point from last year's 6.9%. The country is coming off its worst economic performance since 1990, in the wake of the Tiananmen Square crackdown the previous year. Real estate investment has underpinned growth in the first half of 2016, but sluggish capital investment -- long a main engine for China -- will hinder the economy. Last year's boost of the financial sector are bound to wear off this year.

In 2017, China's growth rate is projected to slow to 6.0%, with the European economy also taking a hit from Brexit.

In June 2016, Chinese private-sector investment lost momentum and its year-on-year growth fell to nearly zero. Meanwhile, investment by state-owned enterprises increased rapidly, sustaining overall investment growth. Investment in the real estate sector expanded in large coastal cities, and housing prices appreciated strongly. Corporate debt is swelling, mainly in the steel, shipbuilding and property sectors.

Since the global financial crisis hit in 2008, China has accumulated a great deal of corporate debt, with the ratio reaching 170% of GDP in the fourth quarter of 2015. That is above the level of Japan during the economic bubble years.

Looking ahead, China is facing reduced investment, an increase in defaults and depreciation of the yuan. The ratio of nonperforming loans is officially less than 2%, but the ratio of debts bearing interest greater than companies' profits is over 15%, according to the International Monetary Fund. The central government still has deep pockets, but it is important to monitor the risk of defaults fueling credit anxiety.

Malaysian risks

The 2016 growth rate for the four ASEAN countries remains at 4.6%, on a par with the 2015 figure. Weaker growth in Malaysia, compared with 2015, and a sluggish Thai economy should be offset by strong growth in Indonesia and the Philippines. Indonesia is seeing healthy domestic consumption, and expectations for the Philippines are rising now that this year's presidential election has come and gone.

Flat aggregate growth is expected in 2017, at 4.6%, due to China's slowdown and Brexit.

Malaysia is in for a pinch: The 4.1% annual growth projected for 2016 and 2017 is down from a relatively high 5.0% last year. The projected rate would be the lowest since 2009, when the global crisis sent the figure plunging to minus 1.5%.

Malaysia heavily depends on exports, which account for about 70% of its GDP. The ratio of exports to the U.K. and other EU countries as a percentage of GDP is just below 7% -- the highest among the four major ASEAN countries surveyed. Out of the four, Malaysia also has the most credit from British banks and makes the most direct investment in the U.K. This is why it is the most exposed to Brexit.

The Southeast Asian country's dependence on exports to China is also relatively high.

Since the introduction of a goods and services tax in April 2015, Malaysia's consumption has turned sluggish as well. The large household debt load means a quick consumption recovery is unlikely. Budget austerity will also weigh on investment.

Delayed U.S. rate hikes and the rise in crude oil prices will help to stem the ringgit's depreciation -- making a generally positive impact on Malaysia's fiscal balance and corporate earnings. But if the ringgit were to rapidly strengthen against the dollar, it would hamper already slowing exports.

Political risk must also be taken into account. Prime Minister Najib Razak remains shrouded in suspicion over a graft scandal dogging state-owned investment company 1MDB. 

Turning to Thailand, exports under the military regime are slumping amid China's slowdown. The consumption recovery appears shaky. And private-sector investment is stagnating.

In 2015, Thailand mustered 2.8% growth, and the figure is expected to increase only slightly, to 3.0%, in 2016. The projection factors in a net export increase, since imports are shrinking more than exports. The Thai economy relies heavily on exports, with China accounting for a significant portion. Tourism is another key contributor, and a recent decrease in Chinese arrivals bodes ill for service exports. Chinese travelers make up just under 30% of total visitors to Thailand. 

In Thailand, too, political risk is increasing ahead of a national referendum in August on a new draft constitution. The growth rate for 2017, when a general election is expected, is projected at 2.9%.

Relatively high growth can be expected in Indonesia and the Philippines, which are less dependent on external demand. Both countries are less susceptible to the influence of China and Brexit. In Indonesia, domestic demand, such as private consumption, is expanding steadily. As President Joko Widodo's government has become more stable, there is hope that deregulation will proceed smoothly, boosting growth.

Indonesia's growth forecast for 2016 is 4.9%, up 0.1 of a point from 2015, with another uptick to 5.0% expected in 2017. The actual rate of 4.8% in 2015 was the first below 5% since the collapse of Lehman Brothers in 2008.

The Philippine economy is expected to expand under the new administration of President Rodrigo Duterte, who took office at the end of June. Robust domestic demand is seen supporting consumption growth. This year, the economy is projected to grow 6.4%, up 0.5 of a point from 2015.

The government intends to accelerate infrastructure investment, and Duterte's other economic plans -- such as measures to attract foreign investment -- are worth watching. Growth is projected to remain brisk, at 6.4%, in 2017.

Stimulus ahead

In these uncertain times, many Asian countries have already executed monetary stimulus measures, such as interest rate cuts, and they are likely to strengthen those measures in the near future. Malaysia cut its policy interest rate by 0.25 of a point, to 3%, for the first time in about seven years on July 13 -- a few weeks after the Brexit referendum. Malaysia is expected to trim the rate further in the second quarter of 2017, but there is a chance it will do so again within 2016.

Indonesia reduced interest rates four times in 2015, and a further cut to 5% is expected in the fourth quarter of 2016. Thailand is seen making a cut to 1.25% in the fourth quarter of 2016, after reductions in both March and April last year. China is also expected to carry out a cut of 0.25 of a point, to 4.1%, in the fourth quarter of 2016. China lowered its key rate five times in 2015.

Last year, Asian countries faced currency depreciation in anticipation of higher interest rates in the U.S. That is not the case in 2016. In addition to currency stability, inflation rates are within the scope of official expectations. As a result, central banks are now well-positioned to cut rates.

Only the Philippines is expected to carry out a rate hike in the fourth quarter of 2016, to ward off higher inflation and prevent the economy from overheating. - Nikkei Asia Review