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FOR INVESTMENT PROFESSIONAL USE ONLY
RM2: An Alternative View of Risk ManagementHow to Minimize Risk and Maximize Returns With Alts
Agenda
I. The Risk Management ParadigmII. Are We Looking at Risk the Right Way?III. The Alternative R&RIV. Putting Alts to Work
2
The Risk Management Paradigm
3
The essence of investment management
is the management of risks,
not the management of returns.
-Benjamin Graham
“”
The Risk Management Paradigm
4
The essence of investment management
is the management of risks,
not the management of returns.
“”
So…How About those Returns?!?
5
Total Return
YTD 1 Year 3 Year
MSCI World Index 16.01 18.17 7.69
Russell 3000 Growth Index 20.43 21.87 12.65
NASDAQ 100 Index 23.99 24.08 15.26
Dow Jones Industrial Average Index 15.45 25.45 12.35
S&P 500 Index 14.24 18.61 10.81
Russell 2000 Index 10.94 20.74 12.18
MSCI EAFE Index 19.96 19.10 5.04
Russell Developed Europe Index LC 23.87 23.00 5.45
Russell Emerging Markets Index 26.92 21.64 5.33
Russell Emerging Europe Index SC 33.14 32.73 6.05
EURO STOXX 50 Index USD 25.23 29.21 4.15
As of September 30, 2017. Past performance is no guarantee of future results.
Lofty Valuations by Historical Standards
As of October 23, 2017
Shiller Cyclically Adjusted P/E Ratio
16.80
Long-Term Avg.
6
Risk Appetites are Up, Too
7
Because… Right?
8
Abnormally good or abnormally bad conditions do not last forever.
-Benjamin Graham
“ ”
An interest rate hike as low as 0.5% can take years of income from a client’s portfolio.
And…Interest Rates are Likely to Rise as Well
The above chart shows the effect of rising interest rates on a hypothetical $10,000 portfolio and how many years it may take to make up the loss.9
(Meaning Bonds May Not be a Safe Haven)
Source: Sukanto Chanda. Bloomberg Finance LP. DB Global Markets Research.10
The $8 Trillion Bubble17% of all Bonds Outstanding – roughly $8T out of $48T Trade at Negative Interest Rates
Global Debt Outstanding (Sovereign and Credit)
Bonds trading at negative interest rateBonds trading at positive interest rate
USDTrillion
USDTrillion
The Diminishing Real Return to CashThree-month T-Bill less inflation
Don’t Let Them Run to Cash Either
Source: Morningstar. Data from 7/31/1982 – 12/31/2016
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
1985 1990 1995 2000 2005 2010 2015
5-year trailing returns
3-year trailing returns
11
Are We There Yet?
12
What Lies Ahead…
13
Are We Looking at Risk the Right Way?
Question:
What is risk anyway?
15
Answer:
16
To clients, VOLATILITY feels like risk
But actually, the real risk is…
UN-anticipated LOSS
UN-protected LOSS
UN-recoverable LOSS
17
Because… Right?
18
The most fundamental constraint
is limited time.
-Gary Becker, economist
“ ”
Because… Right?
19
The most fundamental constraint
is limited time.“ ”
Reality Check?
20
11% Annually2 ½ Years 7% Annually
3 ½ Years
-20%
$300,000
$350,000
$400,000
$450,000
$500,000
$550,000
Peak 0 1 2 3 4 5 6 7 8Number of Years to Recover
A $500,000 Portfolio’s Recovery From 20% DeclineThose nearing retirement may not have time to rebound from significant losses.
Time = Money
The annual returns of 3%, 7% and 11% are hypothetical and used to demonstrate how long it may take to recover losses over time. The returns do not represent or predict the performance of any fund.
3% Annually8 Years
21
AKA: Why we do everything possible to limit losses
The Gain Required to Recover from a Loss
-1% -5% -10%-20%
-30%-40%
-50%-60%
1% 5% 11%2…
43%
67%
100%
150%
-100%
-50%
0%
50%
100%
150%
200%
Gain RequiredLoss Experienced
22
The Importance of Upside and Downside CaptureMinimizing the impact of market losses is equally as important, if not more, than capturing 100% of market gains
Past performance is not indicative of future results.
Source: Morningstar. Data from 7/1997-6/2017. Volatility as measured by standard deviation.
Introduce upside-down(side) thinking
23
The “Alternative” R&R
25
When advisors aren’t afraid to talk about
risk, investors aren’t afraid to make the
right decisions.- Riskalyze
“”
Alternatives Defined
26
Alternatives seek risk management
and rewards in a different way
than traditional stocks, bonds and cash.
Alternative investments are not just different to be different. They’re different to deliver diversification and give investors a real rate of return.
Alternative Investments
Trad
ition
al S
trat
egie
s
• Real Estate• Commodities (e.g., Gold)• Private Equity
• Stocks• Bonds• Currency
Trad
ition
al S
trat
egie
s
Traditional Investments
Alternative Investments
Alte
rnat
ive
Stra
tegi
es
• Managed Futures• Options Strategies
• Long/Short Equity• Long/Short Credit• Global Macro• Market Neutral
Traditional Investments
Alte
rnat
ive
Stra
tegi
es
27
Alternatives = Stocks, Bonds, Commodities and Currencies Managed or Packaged Differently
28
Three Things you can Potentially do with Alts
1. Offer New (Un-Correlated) Sources of Return
2. Help Stress-Proof Portfolios
3. Create a Smoother Investor Experience
Alternatives can Provide a Valuable Source of Additional ReturnSince 1994, alternatives have outperformed at least one element of an investor’s core* portfolio 74% of the time.
1 38 23 33 29 23 12 8 10 29 11 8 16 13 5 26 15 8 16 32 14 1 12
-3 22 22 26 9 21 5 4 3 15 10 5 14 7 -19 19 11 2 8 10 6 1 3
-4 18 4 10 0 -1 -9 -12 -22 4 4 2 4 5 -37 6 7 -3 4 -2 4 -1 1
’94 ’95 ’96 ’97 ’98 ‘99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ‘16
AlternativesStocksBonds
Annu
al R
etur
n (%
)1. Offer New (Un-Correlated) Opportunities for Returns
Past performance is not indicative of future results.
*Investor’s core is represented by stocks and bonds. Stocks are represented by the S&P 500 Index, Bonds by the Barclays Aggregate Bond Index and Alternatives by the Credit Suisse Hedge Fund Index. It is not possible to invest directly in an index.29
Average Alternative Outperformance During Challenging Periods for Stocks and BondsAlternatives can offer differentiated returns and an opportunity to outperform traditional assets when investors need it most.
2. Help Stress-Proof Portfolios
Past performance is not indicative of future results.
Source: Morningstar. Data from 12/31/1996-12/31/2016. Challenging periods for stocks and bonds are defined as equity bear markets and rising rate periods. Rising rate periods are the three largest during this time period and bear markets are the two largest during this time period. Alternatives are represented by the Credit Suisse Hedge Fund Index, stocks by the S&P 500 Index, and bonds by the Barclays Aggregate Bond Index. Data reflects average annualized outperformance of alternatives versus bonds during rising rate periods and stocks during bear markets. It is not possible to invest directly in an index.
15%
28%
0%
5%
10%
15%
20%
25%
30%
vs. Bonds During Rising Rates vs. Stocks During Bear Markets
30
Diversifying Sources of ReturnAlternatives have historically delivered more stability to investors over various market cycles.
$753,018
$556,860
$333,970
$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
$700,000
$800,000
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Gro
wth
of $
100,
000
StocksBondsAlternatives
3. Create a Smoother Investor Experience
Past performance is not indicative of future results.
Source: Morningstar. Data from 1/1/1994-12/31/2016. Stocks are represented by the S&P 500 Index, Bonds by the Barclays Aggregate Bond Index and Alternatives by the Credit Suisse Hedge Fund Index. It is not possible to invest directly in an index.31
Source: WealthManagement.com Survey, 2016
22%
30%
42%30%
37%
47%
0%
10%
20%
30%
40%
50%
WirehouseAdvisor
IBD Advisor RIAs
10%
13% 13%13%
17% 17%
0%
5%
10%
15%
20%
WirehouseAdvisor
IBD Advisor RIAs
Advisors are planning to increase allocations to alts in client portfolios from an average of 13% today to nearly 17% in 2018.
Average % of clients with exposure to alts Average allocation to alts
Advisors Continue to Allocate to Alts
32
33
So What Could Go Wrong?
Investors Tend to Ditch Alts in Up Markets
Past performance is not indicative of future results.
Source: Morningstar. Data from 7/31/2008-12/31/2016. Stocks are represented by the S&P 500 Index, Bonds by the Barclays Aggregate Bond Index and Alternatives by the Credit Suisse Hedge Fund Index. Flows into Alternatives represents monthly flows into the Morningstar Long/Short Equity, Managed Futures, Market Neutral and Multialternative categories. It is not possible to invest directly in an index.
-$4
-$3
-$2
-$1
$0
$1
$2
$3
$4
$5
$6
$7
$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
$700,000
$800,000
2008 2009 2010 2011 2012 2013 2014 2015 2016
Net Monthly Flows (billions)
Grow
th o
f $10
0,000
Stocks
BondsAlternativesFlows into Alternatives
34
Help Clients Manage Emotions, Before They Take A TollInvestors who stayed the course may have been better off than those trying to time the market.
60/40 Portfolio
Portfolio with Alternatives
Monthly Net Flows (Morningstar Moderate Portfolio)
$164,846
$189,766
-12
-8
-4
0
4
8
12
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$140,000
$160,000
$180,000
$200,000
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Monthly N
et Flows ($ billions)
Gro
wth
of $
100,
000
“It’s off to the races!”
“Are we at the bottom yet? I’m going to cash.”
“I’ve missed out enough. I need to get back in the market.”
“U.S. Debt was downgraded by S&P? I can’t take another big loss. I’m out.”
“Looks like the market may continue to move higher. I’m getting back in.”
“The equity market just keeps going up. I don’t want to miss out. What could possibly happen?”
Don’t Let them Leave!
Past performance is not indicative of future results.
Hypothetical example is for illustrative purposes only. It is not possible to invest directly in an index. Source: Morningstar. Data from 6/30/2006-12/31/2016. The 60/40 Portfolio is represented by 60% S&P 500 Index and 40% Barclays Aggregate Bond Index. The Portfolio with Alternatives is represented by 37.5% S&P 500 Index, 32.5% Barclays Aggregate Bond Index, 15% Credit Suisse Long/Short Index and 15% Credit Suisse Multi-Strategy Index. The Morningstar Moderate Portfolio includes portfolios with 50-70% equity. The investor who allowed emotions to influence decision making moves to cash on 9/30/08 and back to 60/40 on 4/30/10 and again (to cash) on 7/31/11 and back to 60/40 on 1/31/13.
35
Putting Alts to Work
Real Return Forecasts
37
Capital Market Assumptions Summary
Provider As of Forecast Time Frame
US Equity
US LC Equity
US SC Equity
Intl Equity
EMEquity
Commod-ities
High Yield
Bank Loans
US Inv. Grade Debt
Intl Inv. GradeDebt
EM Debt
TIPS Cash Inflat-ion
GMO 7/31/17 7 yrs. -4.2% -2.8% -0.4% 2.7% -1.0% -2.7% 0.6% 0.1% 0.0%
Research Affiliates 7/31/17 10 yrs. 0.5% 0.3% 4.8% 6.6% 1.9% 1.3% 1.3% 0.4% 0.2% 2.0% 1.0% -0.5%
BlackRock 8/31/17 5 yrs. 1.9% 1.8% 3.1% 4.6% 0.5% 0.5% 1.3% -0.6% -0.8% 0.7% -0.1% -0.5% 2.25%
JPMorgan 1/31/17 10 yrs. 4.0% 4.8% 4.5% 7.0% 1.5% 3.5% 2.8% 0.8% -0.3% 3.3% 1.3% -0.3% 2.25%
AQR 1/31/17 7 yrs. 4.2% 4.6% 5.4% 3.0% 2.1% 0.7% -0.1% 0.0%
361 Capital 4/31/17 5 yrs. 3.7% 4.6% 6.8% 0.5% 0.9% 1.7% 0.3% -1.6% 2.3% 0.1% -0.1% 2.34%
Averages 3.9% 0.5% 1.0% 3.5% 5.5% 1.5% 1.6% 1.7% 0.1% -0.9% 1.8% 0.5% -0.2%
Source: GMO, Research Affiliates, BlackRock, JPMorgan, AQR, 361 Capital.
Managing Risk without Sacrificing Returns
38
Efficient Frontier 5-year forward-looking estimates
0
1
2
3
4
5
6
7
8
9
0 2 4 6 8 10 12 14 16 18
Expe
cted
Ret
urn
(%)
Expected Volatility (Standard Deviation %)
Aggressive
Moderate
Conservative
60/40
86% Equities0% Bonds0% Cash14% Alternatives49% Equities
11% Bonds2% Cash38% Alternatives
18% Equities24% Bonds22% Cash36% Alternatives
60% Equities40% Bonds
Returns Standard Deviation Average Worst Case Scenario
Aggressive Portfolio 8.5% 16.5% 24.3%Moderate Portfolio 7.2% 10.8% 14.6%Conservative Portfolio 5.2% 5.4% 5.7%60/40 Portfolio 5.3% 9.3% 13.6%
Allocations for Sample Portfolios on The Efficient Frontier
39
Name US EquityIntl Dev Equity EM Equity Commodities High Yield Bank Loans US IG Debt TIPS Intl IG Debt EM Debt Cash
Long/Short Equity
Long/Short Credit
Global Macro
Managed Futures (Trend + CounterTrend)
Equity Market Neutral Total
Aggressive 12.9 56.3 16.8 2.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.6 0.0 1.6 8.1 0.0 100.0Moderate 13.0 22.2 14.3 1.8 0.0 6.5 2.0 0.0 0.0 2.8 1.6 8.7 0.0 7.2 20.0 0.0 100.0Conservative 3.8 3.9 10.3 0.0 0.0 6.9 16.1 0.0 0.0 1.2 21.6 9.0 0.0 7.4 19.8 0.0 100.060/40 60.0 0.0 0.0 0.0 0.0 0.0 40.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 100.0
361 Global Managed Futures Strategy Fund361 Global Long/Short Equity Fund
Portfolio Diversifier
Managed Futures funds often invest across multiple asset classes and have the ability to go long and short, which can produce low correlations to equities and can reduce overall portfolio risk.
361 Global Managed Futures Strategy Fund (AGFZX)
• Positive ReturnsReturned 7.74% over rolling 12-months with annualized return of 4.33% since inception (vs. -5.59% and 0.73% for the Managed Futures category respectively) with avg. net market exposure of 26% over that time frame.
• Portfolio DiversificationFund’s correlation to global equities, as measured by MSCI World Index has been 0.13 from the first full month of operation following the Fund’s inception.
• Positive Alpha GenerationFund has generated alpha of 3.18% since the Fund’s inception based on monthly returns.
3Q17 YTD 1 Year 3 Year Since Inception (2/12/14)
AGFZX – Class I 3.06% 6.81% 7.74% 5.02% 4.50%
Citigroup 3 Mo T-Bill Index 0.26% 0.56% 0.64% 0.29% 0.24%
Morningstar Managed Futures Category 0.62% -2.01% -5.33% -0.30% 1.29%
Annual Expense Ratio: AGFZX: Net 1.87% / Gross 2.27%
Includes dividend and interest expense on short sales, acquired fund fees and expenses. When excluded, the net with limitation expense ratio is: AGFZX 1.99%†Returns shown over one year are annualized. Returns include the reinvestment of dividends and income. † Reflects a contractual expense limitation in place. The Adviser has contractually agreed to maintain the total annual fund operating expenses at stated levels, exclusive of certain expenses such as acquired fund expenses and dividend and interest expenses on short sales until 2/28/2018. See Prospectus for additional details.
Past returns shown do not guarantee future results. Current performance may be lower or higher. Call 888-736-1227 for latest month-end returns. Return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than original cost.41
Risk Reducer
Long/Short Equity funds have the flexibility to not only buy stocks that they believe will appreciate, but to short stocks that they believe will decline in value, which increases the potential sources of alpha and reduces downside risk.
361 Global Long/Short Equity Fund (AGAZX)
• Growth while Managing Downside RiskHas returned 115% of the MSCI World Index with 71% of the volatility, while only capturing 35% of the drawdown*
• Top Quartile RankingRanked 13th of 221 funds in the Morningstar Long/Short Equity category surpassing 94% of its peers**
• Positive Alpha GenerationHas had 65% of the return comprised of alpha**
3Q17 YTD 1 Year 3 Year Since Inception (2/12/14)
AGAZX – Class I 4.74% 12.38% 11.72% 8.86% 8.74%
MSCI World Index 4.84% 16.01% 18.17% 7.69% 7.57%
Morningstar Long/Short Equity Category 2.55% 6.97% 8.68% 2.64% 2.66%
Annual Expense Ratio: AGAZX: Net 2.27% / Gross 2.22%Includes dividend and interest expense on short sales, acquired fund fees and expenses. When excluded, the net with limitation expense ratio is: AGAZX 1.69%† Returns shown over one year are annualized.
† Reflects a contractual expense limitation in place. The Adviser has contractually agreed to maintain the total annual fund operating expenses at stated levels, exclusive of certain expenses such as acquired fund expenses and dividend and interest expenses on short sales until 2/28/2018. See Prospectus for additional details.
*Data is from 2/1/2014 to 9/30/2017 which represents the Fund’s first full month of operation. The Fund's inception date is 1/6/2014. Statistics calculated using monthly return data relative to the MSCI World Index.**Morningstar quartile rankings from 1/1/2015 to 9/30/2017 due to Morningstar not recognizing the predecessor account.
Past returns shown do not guarantee future results. Current performance may be lower or higher. Call 888-736-1227 for latest month-end returns. Return and principal value will fluctuate so that shares, when redeemed, may be worth more or less than original cost.42
Disclosure
43
Alternative investing – Special Considerations
Investors considering investing in alternatives (“alts”) should be aware of the unique characteristics and risks of these investments. Alternative mutual funds may hold non-traditional investments and employ more complex trading strategies than traditional mutual funds.
Alternative funds might invest in assets such as foreign securities, commodities, futures, small-cap companies, high yield bonds (also known as junk bonds), exchange-traded products and other non-traditional type products as compared to traditional stocks, bonds and cash. Funds that invest in these types of assets may be subject to higher risks, more volatility and less liquidity.
These funds also may employ complex strategies, including hedging and leveraging through derivatives and short selling including but not limited to:
Short selling Risk - The potential loss from a short sale is theoretically unlimited since the appreciation of the underlying asset also is theoretically unlimited.
Derivative Risk - Derivatives include instruments and contracts that are based on and valued in relation to one or more underlying securities, financial benchmarks, indices, or other reference obligations or measures of value. Major types of derivatives include futures, options, swaps and forward contracts. Depending on how the Fund uses derivatives and the relationship between the market value of the derivative and the underlying instrument, the use of derivatives could increase or decrease the Fund’s exposure to the risks of the underlying instrument. Using derivatives can have a leveraging effect and increase fund volatility.
Leveraging Risk - Certain Fund transactions, including entering into futures contracts and taking short positions in financial instruments, may give rise to a form of leverage. Leverage can magnify the effects of changes in the value of the Fund’s investments and make the Fund more volatile
Investors should fully understand the strategies and be able to bear the risks of any alternative mutual fund they are considering and how it might fit into their overall portfolio before investing. Further information can be found in the Fund’s prospectus.
All investing involves risk including the possible loss of principal.