Alternatives 2.0: Innovative Ways to Diversify Your Portfolio

¹  Source: Bloomberg, Morgan Stanley Wealth Management Global Investment Office, Private Equity Index Data: The Cambridge Associates Private Equity Index tracks the returns of a variety of private equity strategies, including buyout, control-oriented distressed, growth equity, energy, upstream energy and royalties, and venture capital. The data is updated quarterly using the Cambridge Associates Benchmark Calculator, with a lag of several months. Private equity returns are net to limited partners. Stocks are represented by the S&P 500 Total Return Index. Bonds are represented by Bloomberg US Aggregate. Alternatives Investment are composed of 16.6% Equity Hedge (HFRI Equity Hedge Index), 16.6% Equity Neutral (HFRI Equity Market Neutral Index), 33% Private Equity, and 33% Real Estate (National Council of Real Estate Investment Fiduciaries Property Index –NCREIF). Alternatives investments are not appropriate for all investors.

Definitions

For index, indicator and survey definitions referenced in this report please visit the following:

https://www.morganstanley.com/wealth-investmentsolutions/wmir-definitions

1940 Act Limitations

GIMA recognizes that both 1940 Act-registered open-end mutual funds that seek alternative-like exposure and traditional hedge funds seek investment returns that have lower correlation to traditional markets in an attempt to increase diversification in an overall portfolio.

Unlike traditional hedge funds, SEC registered open-end mutual funds that seek alternative-like exposure do not require investor pre-qualifications, enable efficient tax reporting, are subject to lower investment minimums and lower fees, provide portfolio transparency, daily liquidity, and are required to provide daily NAV pricing.

Because of 1940 Act limitations, mutual funds that seek alternative-like exposure generally must utilize a more limited investment universe and, therefore, will have relatively higher correlation with traditional market returns. Registered open-end funds are statutorily limited in their use of leverage, short sales and the use of derivative instruments.

Hedge funds typically charge an asset-based fee and a performance fee. Potential benefits to hedge funds include greater flexibility in terms of seeking enhanced returns through the use of leverage, exposure to less liquid investments, and the more flexible use of complex instruments such as derivatives.

As a result of these differences, performance for a mutual fund that seeks alternative-like exposure and its portfolio characteristics may vary from a traditional hedge fund that is seeking a similar investment objective.

Important Notice Regarding Complex Products – Please review

This fund utilizes non-traditional or complex investment strategies and/or derivatives.  Examples of these types of funds include those that utilize one or more of the below noted investment strategies or categories or which seek exposure to the following markets:

·          Commodities (e.g., agricultural, energy and metals), Currency, Precious Metals

·          Managed Futures

·          Leveraged, Inverse or Inverse Leveraged

·          Bear Market, Hedging, Long-Short Equity, Market Neutral

·          Real Estate

·          Volatility (seeking exposure to the CBOE VIX Index)

Please refer to the fund’s prospectus for additional information and descriptions of the specific non-traditional and complex strategies utilized by the fund.  Investors should carefully consider the fund’s investment objectives, detailed risk disclosures, charges and fees contained in the fund’s prospectus before investing.  Please review the prospectus carefully and discuss any questions you may have with your Financial Advisor.  You should also keep in mind that while mutual funds may at times utilize non-traditional investment options and strategies, they should not be equated with unregistered privately offered alternative investments.  Because of regulatory limitations, mutual funds that seek alternative-like investment exposure must utilize a more limited investment universe.  As a result, investment returns and portfolio characteristics of alternative mutual funds may vary from traditional hedge funds pursuing similar investment objectives.  They are also more likely to have relatively higher correlation with traditional market returns than privately offered alternative investments.  Moreover, traditional hedge funds have limited liquidity with long “lock-up” periods allowing them to pursue investment strategies without having to factor in the need to meet client redemptions.  On the other hand, mutual funds typically must meet daily client redemptions.  This differing liquidity profile can have a material impact on the investment returns generated by a mutual fund pursuing an alternative investing strategy compared with a traditional hedge fund pursuing the same strategy.  

Non-traditional investment options and strategies are often employed by a portfolio manager to further a fund’s investment objective and to help offset market risks.  However, these features may be complex, making it more difficult to understand the fund’s essential characteristics and risks, and how it will perform in different market environments and over various periods of time.  They may also expose the fund to increased volatility and unanticipated risks particularly when used in complex combinations and/or accompanied by the use of borrowing or “leverage.” 

Examples of non-traditional and complex investment options and strategies include the following.  Please keep in mind that the below list is not exhaustive.  Rather, it is a brief summary intended to focus your attention on some of the financial instruments, characteristics and special risk factors that may be associated with non-traditional mutual fund investments. 

Asset Class and Other Risk Considerations

Investing in the markets entails the risk of market volatility. The value of all types of investments, including stocks, mutual funds, exchange-traded funds (“ETFs”), closed-end funds, and unit investment trusts, may increase or decrease over varying time periods.

Past performance is not a guarantee of future results.

Investing in stocks, mutual funds and exchange-traded funds (“ETFs”) entails the risks of market volatility.  The value of all types of investments may increase or decrease over varying time periods. Besides the general risk of holding securities that may decline in value, closed-end funds may have additional risks related to declining market prices relative to net asset values (NAVs), active manager underperformance, and potential leverage. Some funds also invest in foreign securities, which may involve currency risk.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Alternative investments often are speculative and include a high degree of risk. Investors could lose all or a substantial amount of their investment. Alternative investments are appropriate only for eligible, long-term investors who are willing to forgo liquidity and put capital at risk for an indefinite period of time. They may be highly illiquid and can engage in leverage and other speculative practices that may increase the volatility and risk of loss. Alternative Investments typically have higher fees than traditional investments. Investors should carefully review and consider potential risks before investing. Certain of these risks may include but are not limited to:

• Loss of all or a substantial portion of the investment due to leveraging, short-selling, or other speculative practices;

• Lack of liquidity in that there may be no secondary market for a fund;

• Volatility of returns;

• Restrictions on transferring interests in a fund;

• Potential lack of diversification and resulting higher risk due to concentration of trading authority when a single advisor is utilized;

• Absence of information regarding valuations and pricing;

• Complex tax structures and delays in tax reporting;

• Less regulation and higher fees than mutual funds; and

• Risks associated with the operations, personnel, and processes of the manager.

Alternative/hedged strategies may use various investment strategies and techniques for both hedging and more speculative purposes such as short selling, leverage, derivatives and options, which can increase volatility and the risk of investment loss.  Alternative/hedged strategies are not appropriate for all investors.  A short sales strategy includes the risk of loss due to an increase in the market value of borrowed securities.  Such a strategy may be combined with purchasing long positions in an attempt to improve portfolio performance.  A short sales strategy may result in greater losses or lower positive returns than if the portfolio held only long positions, and the portfolio’s loss on a short sale is potentially unlimited.  The use of leverage can magnify the impact of adverse issuer, political, regulatory, market, or economic developments on a company.  A decrease in the credit quality of a highly leveraged company can lead to a significant decrease in the value of the company’s securities.  In a liquidation or bankruptcy, a company’s creditors take precedence over the company’s stockholders.

Hedge funds may involve a high degree of risk, often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager.

Bonds are subject to interest rate risk.  When interest rates rise, bond prices fall; generally the longer a bond’s maturity, the more sensitive it is to this risk.  Bonds may also be subject to call risk, which allows the issuer to retain the right to redeem the debt, fully or partially, before the scheduled maturity date.  Proceeds from sales prior to maturity may be more or less than originally invested due to changes in market conditions or changes in the credit quality of the issuer.

High yield bonds are subject to additional risks such as increased risk of default and greater volatility because of the lower credit quality of the issues.

Real estate investments: property values can fall due to environmental, economic or other reasons, and changes in interest rates can negatively impact the performance of real estate companies.

Hedge Funds of Funds and many funds of funds are private investment vehicles restricted to certain qualified private and institutional investors. They are often speculative and include a high degree of risk. Investors can lose all or a substantial amount of their investment. They may be highly illiquid, can engage in leverage and other speculative practices that may increase volatility and the risk of loss, and may be subject to large investment minimums and initial lockups. They involve complex tax structures, tax-inefficient investing and delays in distributing important tax information. Categorically, hedge funds and funds of funds have higher fees and expenses than traditional investments, and such fees and expenses can lower the returns achieved by investors . Funds of funds have an additional layer of fees over and above hedge fund fees that will offset returns.

The risks associated with purchasing BDC securities include, but are not limited to portfolio company credit and investment risk, leverage risk, market and valuation risk, price volatility risk, liquidity risk, capital markets risk, interest rate risk, dependence on key personnel, and structural and regulatory risk.

Investors should carefully consider the investment objectives, risks, charges and expenses of a mutual fund or closed end fund before investing. The prospectus contains this and other information about the mutual fund or closed end fund. To obtain a prospectus, contact your Financial Advisor or visit the mutual fund or closed end fund company’s website. Please read the prospectus carefully before investing.

Important Disclosures

Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.  Past performance is not necessarily a guide to future performance. Please refer to important information, disclosures and qualifications at the end of this material.

The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors.  Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this material.

This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument.  That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter.  We have no obligation to tell you when information herein may change.  We make no representation or warranty with respect to the accuracy or completeness of this material.  Morgan Stanley Wealth Management has no obligation to provide updated information on the securities/instruments mentioned herein.

As a diversified global financial services firm, Morgan Stanley Wealth Management engages in a broad spectrum of activities including financial advisory services, investment management activities, sponsoring and managing private investment funds, engaging in broker-dealer transactions and principal securities, commodities and foreign exchange transactions, research publication, and other activities. In the ordinary course of its business, Morgan Stanley Wealth Management therefore engages in activities where Morgan Stanley Wealth Management’s interests may conflict with the interests of its clients, including the private investment funds it manages. Morgan Stanley Wealth Management can give no assurance that conflicts of interest will be resolved in favor of its clients or any such fund.

The securities/instruments discussed in this material may not be appropriate for all investors.  The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.  Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors.  Estimates of future performance are based on assumptions that may not be realized.  Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates.  Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events.  Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. 

This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material.

Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice.  Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.

All expressions of opinion are subject to change without notice and are not intended to be a forecast of future events or results. Further, opinions expressed herein may differ from the opinions expressed by Morgan Stanley Wealth Management and/or other businesses/affiliates of Morgan Stanley Wealth Management.

This is not a "research report" as defined by FINRA Rule 2241 or FINRA Rule 2242 and was not prepared by the research departments of Morgan Stanley & Co. LLC, Morgan Stanley Smith Barney LLC, or its affiliates.

Certain information contained herein may constitute forward-looking statements. Due to various risks and uncertainties, actual events, results or the performance of a fund may differ materially from those reflected or contemplated in such forward-looking statements.

Indices are unmanaged and investors cannot directly invest in them. Index results are shown for illustrative purposes and do not represent the performance of a specific investment.

Past performance is no guarantee of future results. Actual results may vary. Diversification does not assure a profit or protect against loss in a declining market.

Alternative investments involve complex tax structures, tax inefficient investing, and delays in distributing important tax information. Clients should consult their own tax and legal advisors as Morgan Stanley Wealth Management does not provide tax or legal advice.

Investments in Private Credit funds are offered pursuant to the terms of the applicable offering memorandum, may be distributed by Morgan Stanley Smith Barney LLC and certain of its affiliates, and (1) are not FDIC-insured, (2) are not deposits or other obligations of Morgan Stanley or any of its affiliates, (3) are not guaranteed by Morgan Stanley and its affiliates, and (4) involve investment risks, including possible loss of principal. Morgan Stanley Smith Barney LLC is a registered broker-dealer, not a bank.

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