Active Managers Are Meeting Diverse Challenges

Alternative investment (“alternatives”) managers seek to meet the challenge of developing new approaches to investment selection and risk management. Alternatives may be generally defined as investments beyond traditional stocks and bonds.

Instead of following the direction of stock and bond markets, many alternatives managers seek growth, value and other objectives - in places and ways others may overlook. These next-generation strategies are designed to move independently, with low correlation to familiar indexes of stocks and bonds.

This provides individual investors with access to a selection of innovative investment opportunities. Alternatives are also offered in a variety of structures, including mutual funds, hedge funds, closed-end funds and master limited partnerships (MLPs).

 

Non-traditional asset classes


Strategies that offer exposure to asset classes other than traditional equities and fixed income.

Non-traditional investment strategies


Flexible strategies that seek returns from a broad range of instruments and markets and utilize investment techniques such as shorting and hedging.

Limited-liquidity assets


Strategies that offer access to limited-liquidity investments such as private equity and private debt, which historically have been unavailable to most individual investors.

 

Investors are using alternatives to moderate risks

Adding even a small portion of alternatives to a traditional investment portfolio has the potential to enhance its risk profile, for three reasons:

  • Alternative managers utilize a broader range of investment techniques, with a wider menu of strategies. This can increase portfolio exposures and overall diversification.
  • Alternatives do not respond to the same influences as traditional investments, and they may move in different cycles, producing low-correlating returns.
  • Alternatives may be actively managed to pursue “off-the-path” opportunities, including low-volatility strategies.
     
Alternatives pursue a variety of objectives

The investment objectives of alternative managers may include:

  • Broadening holdings beyond traditional asset classes
  • Achieving greater portfolio diversification
  • Reducing stock exposure to market price volatility
  • Managing bond exposure to interest rates
  • Helping investors plan for rising inflation
  • Increasing investors’ access to strategies with limited liquidity
  • Actively managing assets tactically or strategically over economic cycles
     
Alternatives participate in proven styles

The first alternative investments were hedge funds. While hedge funds remain attractive to institutions and wealthy individuals, a new wave of “liquid alternatives” is expanding access to all types of investors. The liquid alternatives are available in familiar structures, such as mutual funds and closed-end funds. They may pursue hedge fund-like styles and strategies, including those defined below.

Convertible arbitrage — The manager seeks to profit from spreads between a convertible security and the common stock of the same company.

Equity hedge — The manager participates in equities on both the long and short side, and may strategically or tactically change the net exposure — i.e., the balance of longs and shorts — in response to perceived opportunities, economic cycles, market indicators or fundamental research.

Equity market neutral — The manager maintains a portfolio of balanced long and short stocks, so as to keep net exposure near zero — i.e., there is very little or no exposure to the market’s general direction.

Fixed income relative value — The manager looks for opportunities to capture opportunities in bonds that are mispriced relative to others, often by evaluating yield differences (“spreads”) between bonds based on their duration or credit quality.

Event driven — The manager specializes in evaluating and arbitraging specific asset classes (such as convertible securities or distressed debt) or events (such as mergers). Managers often balance long and short positions, seeking to capture event-driven opportunities.

Global macro — The manager creates a portfolio diversified broadly among global asset classes including equities, fixed income, commodities, currencies and other asset classes. The portfolio may be strategically adjusted to capture economic trends or timely opportunities.

Long/short equity — The manager buys (“goes long”) the most attractive stocks identified by research and sells (“goes short”) the least attractive. The goal is to generate returns by capturing alpha through manager expertise in stock selection.

Merger arbitrage — The manager buys stock of a target company and shorts stock of an acquiring company (or vice versa) to capture transaction premiums.

Multi-strategy — A fund combines different alternative styles in an attempt to diversify risks and reduce overall volatility. The included strategies may seek different sources of returns.
 

Alternatives offered in different investment structures

Mutual funds — The "open-end investment company" structure is widely used and very familiar to most investors. It offers daily valuation and redemptions. Regulations require most mutual funds to be diversified. Mutual funds also offer a choice among share classes and shareholder services, such as automatic reinvestment of distributions. Liquidity is high.

Closed-end funds — These investment companies differ from open-end funds in several ways: They offer a fixed number of shares during an initial public offering, and then trade on an exchange based on investor demand for shares, similar to stocks. They provide the convenience of intraday trading along with enhanced liquidity and transparency. Closed-end funds may trade at a premium, a price above net asset value (NAV), or a discount, a price below NAV. Liquidity is high.

Fund of hedge funds (FOHFs) — FOHFs specialize in evaluating and selecting portfolios of hedge funds. They aim to increase diversification by mixing hedge fund managers and styles. A top-level (overlay) manager dynamically adjusts the mix of managers to increase active value. Some FOHFs are registered securities, while others are offered as private placements. Liquidity is limited.

3(c)7 Fund — This is a hedge fund or FOHF that is limited to U.S. qualified purchasers. These funds must limit the number of investors to 499, to be privately offered and not subject to registration with the Securities and Exchange Commission. Liquidity is limited.


Related Literature

IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. Please see each product’s web page for specific details regarding investment objective, risks, performance and other important information. Review this information carefully before you make any investment decision.

Carefully consider a fund’s investment objectives, risks, charges and expenses before investing. Please view the prospectus or summary prospectus for this and other information. Read it carefully.

FINANCIAL ADVISORS: Please note that not all share classes may be available for sale at your firm. Please call the Legg Mason Sales Desk 1-800-822-5544 or your Legg Mason Sales contact for more information.

Alternative hedge strategies involve investments that employ aggressive investment strategies and carry substantial risk. They may not be suitable for all investors.