Looking beyond stocks and bonds to help you prepare for what's next. Anshul Sharma, Head of Alternative Investment Strategy for the Chief Investment Office with Merrill, discusses the Chief Investment Office’s outlook for the economy, how Alternative Investments should be a part of your overall investment strategy, especially during challenging times, and some practical ideas to possibly consider.
Project Title: Merrill AI New Normal Seminar: Prerecorded & Animated Date: September 3, 2020 Version #: Final Agency/Production Company: thINK Total Run Time: 22:20 MAP#: 3146310 Audio Script Anshul Sharma: Thank you for joining us to talk about how you can weather volatile markets with confidence. My name is Anshul Sharma, Head of Alternative Investment Strategy for the Chief Investment Office for Merrill and Bank of America Private Bank. As we all face unprecedented times, I want you to know that we are here to help in any way we can. Helping you take stock of your finances and make thoughtful decisions about your investments is why we are here today. Over the next 20 to 30 minutes, we’ll talk about how the coronavirus is impacting the markets and potentially, your finances. We’ll share our Chief Investment Office’s outlook for the economy. We’ll explore how alternative investments may be able to help you prepare for what’s next and last, we’ll offer you some practical ideas that you may want to consider in evaluating your current approach. [Important information shown on screen: The investments discussed have varying degrees of risk, and there is always the potential of losing money when you invest in securities, and future prospects may not be realized. When considering the appropriateness of mutual funds or alternative investments, please be aware that there are significant differences between these investments which will cause their investment portfolios, performance, tax treatment and other factors to differ. These differences include the types, availability and diversity of securities that can be purchased, economies of scale, regulations and other factors applicable to their management. Bank of America, Merrill, their affiliates, and advisors do not provide legal, tax, or accounting advice. Clients should consult their legal and/or tax advisors before making any financial decisions. Alternative investments are speculative and involve a high degree of risk. There generally are no readily available secondary markets, none are expected to develop and there may be restrictions on transferring fund investments. Alternative investments may engage in leverage that can increase risk of loss, performance may be volatile and funds may have high fees and expenses that reduce returns. Alternative investments are not in the best interest of all investors. Investors may lose all or a portion of the capital invested. Hedge funds can result in higher return potential but also higher loss potential. It is required that any prospective investor must meet certain qualifications and acknowledge they understand the risks associated with investing in hedge funds. An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage, and short sales which can magnify potential losses or gains. Restrictions exist on the ability to redeem units in a hedge fund. Hedge funds are speculative and involve a high degree of risk. Investments in private equity involve a high degree of risk and therefore should only be undertaken by qualified investors whose financial resources are sufficient to enable them to assume these pg. 2 risks and to bear the loss of all or part of their investment. Investments in private equity include significant risks not otherwise present in public market investments. Furthermore, private equity investors are afforded less regulatory protections than investors in registered public securities. There may be conflicts of interest relating to a mutual fund(s) or an alternative investment product(s) and its service providers, including Bank of America Corporation, and its affiliates, who are engaged in businesses and have clear interests other than that of managing, distributing and otherwise providing services to the mutual fund or alternative investment. These activities and interests include potential multiple advisory, transactional and financial and other interests in securities and instruments that may be purchased or sold by the mutual fund or alternative investment, or in other investment vehicles that may purchase or sell such securities and instruments. These are considerations of which investors in the mutual fund or alternative investment should be aware. Investors should bear in mind that the global financial markets are subject to periods of extraordinary disruption and distress. During the financial crisis of 2008–2009, many private investment funds incurred significant or even total losses, suspended redemptions, or otherwise severely restricted investor liquidity, including increasing the notice period required for redemptions, instituting gates on the percentage of fund interests that could be redeemed in any given period and creating side pockets and special-purpose vehicles to hold illiquid securities as they are liquidated. Other funds may take similar steps in the future to prevent forced liquidation of their portfolios into a distressed market. In addition, investment funds implementing alternative investment strategies are subject to the risk of ruin and may become illiquid under a variety of circumstances, irrespective of general market condition. Certain information contained in this document constitutes forward looking statements, opinions, or beliefs. Due to various risks and uncertainties, actual events or results may differ materially from such forward looking statements, opinions, or beliefs. Merrill offers a broad range of brokerage, investment advisory (including financial planning) and other services. There are important differences between brokerage and investment advisory services, including the type of advice and assistance provided, the fees charged, and the rights and obligations of the parties. It is important to understand the differences, particularly when determining which service or services to select. For more information about these services and their differences, speak with your advisor. Some or all alternative investment programs may not be in the best interest of certain investors. No assurance can be given that any alternative investment’s investment objectives will be achieved. Many alternative investment products are sold pursuant to exemptions from regulation and, for example, may not be subject to the same regulatory requirements as mutual funds. In addition to certain general risks each product will be subject to its own specific risks, including strategy and market risk. Certain alternative investments require tax reports on Schedule K-1 to be prepared and filed. As a result, investors will likely be required to obtain extensions for filing federal, state, and local income tax returns each year. This material is provided for information purposes only and does not constitute an offer to purchase any security or investment or a solicitation of investment advice. An offer of interests in any particular investment can only be made pursuant to the relevant private placement memorandum, pg. 3 which contains important information concerning risk factors, performance and other material aspects of the investment and must be carefully read before any decision to invest is made. This material is provided for informational purposes only by the Investment Solutions Group (ISG) Alternative Investments group and is not a publication of BofA Global Research. The views expressed are those of ISG, are developed in consultation with the ISG Chief Investment Office (CIO) and are subject to change. While some of the information contained in this primer may draw upon research by BofA Global Research, this material is neither reviewed nor approved by BofA Global Research. All sector and asset allocation recommendations must be considered in the context of an individual investor's goals, time horizon, liquidity needs and risk tolerance. Not all recommendations will be in the best interest of all investors. Investing involves risk, including the possible loss of principal. Past performance is no guarantee of future results. All recommendations must be considered in the context of an individual investor’s goals, time horizon, liquidity needs and risk tolerance. Not all recommendations will be in the best interest of all investors. Investment products and services may be available through a relationship with Merrill Lynch Wealth Management or Bank of America Private Bank. Merrill Lynch Wealth Management makes available products and services offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated (also referred to as “MLPF&S” or Merrill) which is a registered broker-dealer, registered investment adviser, and a wholly owned subsidiary of Bank of America Corporation (“BofA Corp.”). Certain Bank of America Private Bank associates are registered representatives with MLPF&S and may assist you with investment products and services provided through MLPF&S and other nonbank investment affiliates. Bank of America Private Bank is a division of Bank of America, N.A., Member FDIC, and a wholly owned subsidiary of BofA Corp. The Fund’s investment manager and its affiliates may be subject to certain U.S. banking laws and to regulation by the Federal Reserve Board. Such banking laws, rules, regulations and guidelines, and the interpretation and administration thereof by the staff of the applicable regulatory agencies, restrict the transactions by the Fund, as well as the transactions between the Fund’s investment manager and its affiliates and the Fund. Investment products: Are Not FDIC Insured, Are Not Bank Guaranteed, May Lose Value © 2020 Bank of America Corporation. All rights reserved.] Before we dive in, first and foremost, we hope that you and your family are safe and staying healthy in these uncertain times. Coronavirus has impacted nearly every aspect of our lives and is having a significant impact on people across the country. Beyond its immediate health impact, coronavirus has caused stress in our health system, dramatic drops in spending and economic activity as people stayed home to help stem the spread of the virus and massive increases in unemployment due to the extended shutdowns. People remain focused on their health and wellbeing of their families and loved ones and keeping everyone safe from harm. They have taken on new responsibilities as teachers and caregivers on top of their regular day-to-day responsibilities. The pandemic’s effects on the economy and the markets are compounded by simmering trade tensions and the oil price shock that started just as the virus began to take hold in Europe and pg. 4 America. All these factors are still causing uncertainty and spilling over into people’s finances even those who have relatively secure employment and finances are concerned. This is where we can help. We don’t yet know the ultimate impact of the virus but we are confident that in time, we’ll all get through this. We’re sharing our thoughts today to make sure you have the information and advice you need to navigate these challenging times and be prepared for when things get back to normal. Despite the speed and severity of the recession and employment levels, there are signs of encouragement. The Federal Reserve has been swift to enact stimulus measures to facilitate liquidity and provide reassurances to the markets. Congressional legislation and White House efforts to support individuals, small businesses and industries have been expensive and are ongoing and unemployment claims having risen dramatically early on are now starting to slowly taper. Our Chief Investment Office feels that the market will continue to take cues from health data including a significant increase in testing overall, greater availability of medical supplies as well as promise for treatment and a potential vaccine. We believe the second quarter will likely be considered the most challenging period of the year in terms of corporate earnings and overall productivity. We are already seeing a turn in key economic data. Given improving health data in many areas within the United States, a cautious reopening of the economy has begun and could accelerate in the coming months and produce better-than-expected results in the third quarter. Assuming a limited impact of a second wave of coronavirus infections or other external shocks, the green shoots of momentum and productivity should appear throughout the third quarter and fourth quarter in our view. The most powerful tool you have for weathering current market conditions is maintaining discipline. Regardless of market conditions, there are some investing basics that you should keep in mind. For most of you, investing is a long-term pursuit. You’re investing for needs 5, 10, even 20 years down the road. Long-term goals are best served by taking a long-term approach to investing and staying invested, so, don’t abandon the markets during short-term bouts of volatility. On the topic of goals, always remember why you are investing. Quarter-over-quarter performance matters but the real measure of how you are doing is how you are progressing towards your goals. It is through this lens, one that takes into account not just performance but also risk over the long-term that we evaluate your progress. Also, remember the basics. Historically, establishing an asset allocation that is aligned with your goals, diversifying your holdings within your allocation and rebalancing regularly have been the best way to achieve superior risk-adjusted returns over the long run. And finally, you want to be on the lookout for opportunities. Even in volatile or declining markets, there are opportunities for tactical investments, strategic rebalancing and tax loss harvesting that may better position your portfolio for the future. As you think about how you want to prepare for the new normal, you may also want to consider how alternative investments like hedge funds, private equity and real assets may complement your traditional investments and help you better prepare for the new normal. So, what do we mean when we say “alternative investments?” Alternative investments are strategies that may complement traditional stock and bond investments by employing investment pg. 5 strategies and techniques typically not found in traditional investments and exposing you to a broader range of markets and securities. There are three main types of alternative investments that you may want to consider. Hedge funds are strategies that engage in a wide range of investments and trading techniques not available to traditional asset managers such as investing in less liquid markets, taking on concentrations and using leveraged derivatives and short-selling to help generate the terms. Adding hedge funds to a portfolio can assist with capital preservation and provide you with differentiated returns. Private equity investments invest in companies and other assets outside public markets and seek to capitalize in areas of growth, restructuring or capital needs. Private equity managers aim to improve the operations of the companies they invest and create value for investors. Historically, private equity has outperformed public equity offering investors a premium for the additional risks associated with investing in the private markets. Real assets include a wide range of securities comprising both actively and passively-managed investments in precious metals, commodities, real estate, infrastructure, agricultural land and natural resources. Investments in real estate often act as additional diversifiers from stocks and bonds and can serve as a hedge against inflation. It’s important to note that alternative investments are generally less liquid than traditional investments as many strategies within the alternatives complex typically require longer periods of time for returns to materialize and therefore, require investors to be able to withstand greater illiquidity risks. Additionally, alternative investments typically offer less transparency and charge higher fees including incentive fees when compared to traditional investments. Because each client is unique, we offer alternative investment solutions through a wide variety of structures tailored to your liquidity needs and risk tolerance. The right investment or combination of investments will depend on these factors and should be looked at in the context of your larger financial picture and goals. One example of how alternatives can help portfolios is through risk mitigation, particularly during times of stress. Here you see a chart that compares the performance of the S&P 500 against that of Hedge Fund Research Inc’s fund weighted composite index which represents a diversified basket of hedge fund strategies. And what we find is that during the last 10 significant market drawdowns since 2011, hedge funds outperformed stocks underscoring their importance to portfolios and down-markets. The most recent example of this was during the pandemic in the first quarter of this year, on the right-hand side of the chart, where stocks were down 20% and hedge funds were down only 11%. Private equity may also offer important benefits to portfolios during times of stress. This chart illustrates the internal rate of return for individual private equity vintages from 1994 to 2016. Though the return varies year-over-year, interestingly, some of the best-performing vintages are the ones that closed during or shortly after recessionary periods denoted by the shaded regions on the chart which correspond to the correction following the tech bubble in 2001 and the Global Financial Crisis in 2008. Intuitively, this makes sense that private equity managers are able to deploy capital to take advantage of opportunities that come about from dislocations, market volatility and often favorable entry points but also apparent from this chart is the variability between vintages. This, to us, further underscores the importance of diversification between asset classes and within asset classes when building an investment portfolio. pg. 6 So, Alternative investments can help during times like these but they also play an important role during normal times. The world of alternatives is diverse and comprise of many types of strategies – strategies that can help achieve a number of different goals and address many common investor concerns. For instance, if you’re looking for yield as a primary goal, particularly important in today’s low interest rate environment, to us, you should consider defensive strategies. Strategies like these seek relative stability of returns and/or enhanced income. If you are concerned about rising market volatility, diversifying alternative investment strategies may help protect your portfolio since they seek to diversify holdings so that performance is generally not dependent on market direction. These strategies may also offer potential hedging benefit against inflation. And, if you are wondering how you can continue to generate compelling returns, growth-oriented strategies may be able to deliver capital appreciation with a focus on differentiated returns. While these strategies may come with higher risk and greater market exposure, they may also offer you the potential for higher long-term growth. These three outcomes are also not mutually exclusive. They can be used in combination within your portfolio and the right mix will depend upon your goals, your risk tolerance and your time horizon in addition to other factors. Each alternative strategy performs differently throughout the business cycle and it’s important for us to understand that so that we can best utilize these strategies and manage our expectations. The relative performance of different alternative investment strategies will depend on larger economic factors and where we are in the business cycle. For instance, in an expanding economy shown on the left-hand side, strategies that have a more direct link to economic conditions such as venture capital and strategies that focus on mergers and acquisitions may offer favorable riskadjusted performance. As the economy contracts, strategies that invest in distressed assets and those that look for relative value may offer better performance and in an economy that is recovering from a downturn, equity long-short strategies may be the best performers. The fact these strategies perform so differently from one another underscores the importance of diversification when allocating to alternatives. While the Chief Investment Office believes that the strategic long-term mindset is a prerequisite for alternative investors, knowing at what point in the cycle these strategies tend to benefit most allows you to incorporate an element of opportunistic thinking into your portfolio. Depending on your goals and budget financial situation, we believe there are two ways to integrate alternatives into your portfolio. The first is to build an allocation that is diversified across the different alternative strategies. For this approach, we would leverage multi-strategy funds, fund of funds vehicles or combined individual single-strategy funds to achieve a diversified allocation within hedge funds, private equity and real assets. If you are looking to complement your traditional stock and bond investments to help you achieve a specific outcome, be it differentiated yield, growth or diversifying exposures or to take advantage of individual opportunities in the market, a targeted approach may need a better choice. A combination of single-strategy funds may be structured to help you achieve your specific objectives and it’s important to remember that diversification is still advised. You and your financial advisor should work together to evaluate your situation and what you were trying to achieve to determine which approach or combination of approaches is most appropriate for you. pg. 7 How you approach allocating to alternatives will depend on your goals and larger financial situation including things like your risk tolerance, your need for liquidity and other factors and it’s through this combination of factors that we can determine what the right allocation to alternative is for you. As an example, here you see the Chief Investment Office’s strategic asset allocation guidance for a moderate risk profile with low tax sensitivity. Notice how the portfolio is diversified across stocks, bonds and alternative investments such as hedge funds, private equity and real assets. Also, note that in addition to being diversified by asset class, this approach incorporates diversification within the asset classes as illustrated in the pie charts on the right. The exact composition of your alternative investment holdings should be determined after evaluating your goals and investor profile and will likely consist of a blend of different hedge fund strategies including equity hedge, event-driven, relative value and global macro, different private equity holdings that combine buyout, venture, real estate, credit and special situations investments and real assets which include precious metals, commodities and real estate. The Chief Investment Office and our alternative investments team continue to monitor the investment landscape in search of opportunities that we believe could benefit our clients. These insights drive our near to midterm asset allocation recommendations and are made available to our clients to help guide their investment decisions. In the current environment, our team sees opportunity in the following areas of the alternative investments complex. Within hedge funds, we see a favorable opportunity set for equity hedge strategies given the impact of coronavirus and the resulting economic fallout on many different industries. We believe that continued uncertainty on the macro front and widening dispersion between earnings estimates will likely contribute to a larger gap between top and bottom performing equities and as such, skilled stock pickers stand to benefit. Within private markets, we see opportunities for special situation strategies that we think could benefit from pockets of dislocation resulting from the coronavirus pandemic and secular shifts across sectors due to new and disruptive technologies. Given the recent market drawdown and resulting valuation compression, we expect that savvy managers will deploy dry powder opportunistically to buyout and distressed areas of the market via direct and through secondary investments. As per usual and even more important in markets like these, we recommend that investors plan a disciplined multiyear commitment strategy that builds portfolio diversity among different managers, styles, geographies and vintages. It goes without saying that quality matters when searching for and ultimately, selecting the most appropriate investments for your portfolio but nowhere is this thought more fundamental than in the world of alternative investments and that’s because the differences or dispersion between fund managers and alternatives is meaningfully wider than it is in traditional investments. These thoughts show the range of returns for US stock mutual funds, hedge funds and private equity funds. What’s immediately apparent is that the range of returns between top and bottom performing managers in hedge funds and private equity are meaningfully wider than in stocks. To us, the takeaway here is that the opportunity cost of having a lower tier manager in your portfolio is much greater in alternative investment than it is in stocks. This is largely due to the fact that alternative investment managers typically generate a larger share of their returns from active decisions and proprietary investment strategies rather than broad market exposure like traditional pg. 8 asset managers. Now, while past performance is not an indicator of future results, our team continues to believe that the importance of careful sourcing and due diligence cannot be overstated when contemplating investment and alternatives especially since individual manager performance will likely be a larger driver of your experience in alternatives than it would be in the traditional area of your portfolio. With that in mind, the Chief Investment Office leverages a robust due diligence capability that is built on qualitative and quantitative research, proven fundamentals and localized insights to offer you best-in-class alternative investment options. Through its rigorous process, our team of 26 due diligence professionals seeks out talented managers and innovative investment strategies with a focus on two distinct areas. First is investment due diligence where we evaluate all managers and funds on a consideration using qualitative and quantitative criteria. Sourcing, where we look for fund managers from proprietary and industry sources, initial due diligence where we evaluate each strategy’s people, philosophy and process through a comprehensive investment review including an initial screening of the fund manager’s materials and performance, qualitative review of strategy, research process, team portfolio construction and risk management during onsite visits and conference calls and qualitative and quantitative review of performance and risk factors. Then each strategy undergoes business due diligence where we examine operational and business risks including document review, onsite visits and background checks. That covered sourcing and initial due diligence but left out the most important part of our job, monitoring existing investments where we regularly assess the investment merits and ensure the fund is of the same caliber or better than when we first brought them onto the platform. The goal of our process is to ensure that you and your advisor can choose from the best opportunities available from standalone to single-strategy funds to diversified alternative portfolio offerings. We have been at the forefront of alternative investing for over 30 years and our experience has helped us build a leading alternative investment platform that can better serve you and your investing needs. We currently help clients like you manage over $59 billion in alternative assets with a team of over 100 dedicated professionals, one of the largest in the industry. And, we have invested in this capability for one reason, to help you turn your plans into action. Our alternative platform offers you strategies for many goals and market environments that can help you preserve capital, reduce portfolio volatility, increase return potential and potentially enhance income. We also offer widely-recognized alternative investment solutions that we can access as one of the largest players in the alternative investments space. This means we can facilitate access to a broad array of asset managers including some exclusively available to our clients while also maintaining our highly selective due diligence process. And, last but certainly not least, we offer a seamless investment experience that is fully digitized with streamlined execution reporting and tax support to make it easy to use alternative investments in your portfolio. So, what should you consider doing now? First, remember you’re not alone. We’re here to help. Your advisor can answer your questions and offer you guidance and insight to help you make sense of the markets. We are here to offer you advice so you can make informed decisions about your finances and maintain investment discipline. This checklist is a handy reminder of the things pg. 9 we can do together, steps that will help you maintain confidence in your investment strategy and to help you stay on track toward achieving your long-term goals. And it all begins with a conversation. Your advisor is always available to answer your questions, provide you our perspective and offer advice so, don’t hesitate to reach out to them. I’ve said it a lot during this presentation but it’s important to focus on your goals and your plan. Your goals are why you invest and are the foundation of everything we do. And if you want to learn more about alternative investments, schedule a time to discuss what you’ve learned today with your advisor to have an open discussion about how you can invest towards your goals. Thank you for taking the time to join me today and thank you for being a Merrill client. Index descriptions S&P 500 Index, widely regarded as the best single gauge of the U.S. equities market, includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Although the index focuses on the large-cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. The HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 1,400 single-manager funds that report to HFR Database. Constituent funds report monthly net of all fees performance in US Dollar and have a minimum of $50 Million under management or a twelve (12) month track record of active performance. The HFRI Fund Weighted Composite Index does not include Funds of Hedge Funds. Past performance not indicative of future results. The hedge fund indices and other indices shown are provided for illustrative purposes only. Hedge fund indices do not represent benchmarks or proxies for the return of any particular investable hedge fund product. The hedge fund universe from which the components of the indices are selected is based on funds which have continued to report results for a minimum period of time. This prerequisite for fund selection interjects a significant element of "survivor bias" into the reported levels of the indices, as generally only successful funds will continue to report for the required period, so that the funds from which the statistical analysis or the performance of the indices to date is derived necessarily tend to have been successful. There can, however, be no assurance that such funds will continue to be successful in the future. Merrill assumes no responsibility for any of the foregoing index performance information, which has been provided by the index sponsor. Neither Merrill nor the index sponsor can verify the validity or accuracy of the self-reported returns of the managers used to calculate the index returns. Merrill does not guarantee the accuracy of the index returns and does not recommend any investment or other decision based on the results presented. Any index shown is not intended to imply that an investment in any program fund is comparable to the returns, volatility or investment in the securities represented by such an index or that an underlying funds seeks to replicate or correlate with such index. The performance and tax consequences of an investment in the securities represented by an index and of an investment in any program fund may be, and in many cases are likely to be, materially different as the composition of the index may not reflect the manner in which the fund or portfolio is constructed in relation to expected returns, fund or portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change over time. Index returns reflect reinvestment of dividends and do not reflect the pg. 10 effect of advisory fees. The indices referred to herein do not reflect the performance of any account or fund managed by Merrill or its affiliates, or of any other specific fund or account, are unmanaged and do not reflect the deduction of any management or performance fees or expenses. Indices are used for illustrative purposes only, are unmanaged and are not available for direct investment.
Some or all alternative investment programs may not be in the best interest of certain investors. No assurance can be given that any alternative investment’s investment objectives will be achieved.
The Chief Investment Office, which provides investment strategies, due diligence, portfolio construction guidance and wealth management solutions for Global Wealth & Investment Management ("GWIM") clients, is part of the Investment Solutions Group (“ISG”) of GWIM, a division of Bank of America Corporation (“BofA Corp.”).