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Concerned About Rising Interest Rates? Consider These 4 Alternative Investments

Summary Certain types of alternative investments are well suited to help prepare portfolios for rising interest rates in the future, while also potentially adding value in the present. We highlight senior loan, unconstrained bond, market neutral and global macro strategies. Looking past traditional stocks and bonds may help prepare portfolios for a future rise in rates By Walter Davis, Alternatives Investment Strategist As I travel across the country meeting with financial advisors and their clients, a common concern I hear voiced is “how can I position my portfolio for when the inevitable happens and interest rates start to rise?” In response, I state that certain types of alternative investments are well suited to help prepare portfolios for rising interest rates in the future, while also potentially adding value in the present. Specifically, I highlight four different types of alternatives for clients to consider: Senior loans (also known as bank loans, senior secured loans and/or leveraged loans) – Senior loans are loans made by banks to non-investment grade companies, commonly in relation to leveraged buyouts, mergers and acquisitions. The loans are called “senior” because they are contractually senior to other debt and equity, and are typically secured by collateral. Given that the loans are made to non-investment grade companies, the yield associated with them tends to be higher than on investment grade corporate bonds. 1 For example, as of the end of May, senior loans were yielding 5.51% versus a yield of 2.99% on investment grade corporate bonds. 2 Another key aspect of senior loans is that the interest rate paid is a floating rate that resets every 30 to 90 days. 3 This means that in a rising interest rate environment, as long as the rate rises above a predetermined minimum level, the investor will receive increased payments from the borrower. Therefore, senior loans may potentially outperform other types of bonds in rising rate environments due to their floating rates. Unconstrained bond funds – Unconstrained bond funds are funds in which the portfolio manager is given the flexibility to invest globally across all sectors of the fixed income markets. The manager also may use derivatives, leverage and shorting when implementing his or her strategy. Given the tools made available to the manager, unconstrained bond funds tend to have an absolute return orientation, meaning that they may seek to generate a positive return in any market environment. In a rising interest environment, an unconstrained bond fund has the ability to take advantage of rising rates by utilizing a number of derivative strategies. One such strategy would be to short Treasury bond futures. Treasury bond futures mimic the returns of Treasuries, which are negatively impacted by rising rates. Therefore, by shorting Treasury futures you would gain when interest rates rise. Furthermore, such funds have the ability to avoid regions and sectors that they do not find attractive while focusing on the regions and sectors they believe offer the best potential for success. In general, investors should expect unconstrained bond funds to potentially outperform traditional bond funds in down bond markets, and to possibly underperform traditional bond funds in rising bond markets. Market neutral funds – Market neutral funds seek to generate positive returns regardless of market environment by trading related stocks on a long and short basis. Such funds are designed to cushion a portfolio against broad market swings. Although market neutral funds invest in equities, many of these funds are designed to generate returns that are bond like, both in terms of the level of return and the volatility associated with the return. That said, investors considering market neutral funds should be aware that such funds, unlike traditional bond funds, do not generate current yield, and that they can experience more severe declines than traditional bond funds. Global macro funds – Global macro funds are funds that invest across the global markets in equities, fixed income, currencies and commodities on a long and short basis. As a result, these funds tend to be very opportunistic in their investment approach. When interest rates begin to rise, the fallout is likely to be felt across the global markets. Given the markets traded and their opportunistic nature, global macro funds have the potential to thrive in a rising interest rate environment. Read more about alternative investing from Walter Davis. References This is due to the increased credit risk associated with non-investment grade companies relative to investment grade companies. Bloomberg L.P. as of May 31, 2015. Corporate bonds are represented by a subset of the Barclays US Aggregate Bond Index, and senior loans are represented by the S&P/LSTA Leveraged Loan Index. Senior loans are usually priced relative to three-month LIBOR, with the lender receiving a fixed spread above the LIBOR rate. Therefore as LIBOR rises, the amount paid by the borrower increases. Importantly, most loans have a provision that establishes a minimum, or floor, for LIBOR. Typically the floor rate is around 1.00%. This helps protect the lender should LIBOR fall below 1.00%. Currently, the three-month LIBOR rate is approximately 0.28%. Due to the floor, LIBOR would need to rise above the 1.00% floor before the investor would receive the benefit of rising interest rates. Important information The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market. The S&P/LSTA Leveraged Loan Index is a weekly total return index that tracks the current outstanding balance and spread over Libor for fully funded term loans. An investment cannot be made in an index. Past performance cannot guarantee future results. Alternative products typically hold more non-traditional investments and employ more complex trading strategies, including hedging and leveraging through derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate. You can lose money. Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested. Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Most senior loans are made to corporations with below investment-grade credit ratings and are subject to significant credit, valuation and liquidity risk. The value of the collateral securing a loan may not be sufficient to cover the amount owed, may be found invalid or may be used to pay other outstanding obligations of the borrower under applicable law. There is also the risk that the collateral may be difficult to liquidate, or that a majority of the collateral may be illiquid. Short sales may cause an investor to repurchase a security at a higher price, causing a loss. As there is no limit on how much the price of the security can increase, exposure to potential loss is unlimited. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Before investing, carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the products, visit invesco.com/fundprospectus for a prospectus/summary prospectus. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2015 Invesco Ltd. All rights reserved. Concerned About Rising Interest Rates? Consider These Four Alternative Investments by Invesco Blog

The Factor-Based Story Behind Successful Growth Funds

Summary Most large cap stock active fund managers underperformed their benchmarks in the 15 years to December 2014. Active large growth funds performed much better than large value funds vis-à-vis benchmarks. Virtually all of actively managed growth funds’ outperformance can be explained by quantitative multi-factor analysis. Americans have invested trillions of dollars in actively managed mutual funds in the hope of beating an index such as the S&P 500 or the Russell 1000 Growth. At Gerstein Fisher, we believe that markets tend to do a pretty good job of pricing risk and that most investors are better off “buying the market” (via an index fund) than trying to beat it. But we also think that there’s a better way to invest in equities than through either purely passive indexing or traditional active management. I’ll get to that method shortly after sharing summary results of a multi-step fund performance study that we recently conducted. Active Funds and Benchmarks We analyzed two Morningstar categories of funds, large cap growth and large cap value, from January 1, 1990 to December 31, 2014. During this 15-year period, 37% of the growth funds and 42% of the value funds disappeared-liquidated, merged, etc. We studied this aspect to eliminate survivorship bias in the study; obviously, funds that are shuttered by managers tend to be the poor performers. In the next step, we measured how many of the surviving funds outperformed their benchmarks during the 15-year time frame. Of the large cap growth survivors, 67.5% beat their benchmark (Russell 1000 Growth), while just 49% of the living value funds beat their bogey (Russell 1000 Value). All told, 42% of the large cap growth funds that existed in January 1990 beat their benchmark, compared to only 28% of large cap value funds. Moreover, the average outperformance for active growth was 2.14 percentage points per year vs. just 1.17 points for the active value funds. Two conclusions we can draw from this research are that 1) It is very difficult for professional portfolio managers to outperform an index, and 2) Growth appears to be the investing style that quite consistently performs best among actively managed funds. In fact, neither of these conclusions is either particularly new or surprising, as past research by Gerstein Fisher and others has amply demonstrated. See, for example, ” In Mutual Funds, is Active vs. Passive the Right Question? ” Explaining Outperformance But here is where the research gets really interesting. We conducted an extensive statistical analysis of the large cap growth funds that outperformed. We drilled down and studied whether quantifiable company characteristics, or “factors”, could be used to explain the outperformance. We honed in on just four factors– size, value, momentum and profitability-to measure the extent to which excess exposure (relative to the Russell 1000 Growth Index) to these factors could explain outperformance. I’ll digress very briefly to explain the theory and evolution of multi-factor investing. In 1976, Steve Ross published a landmark paper on Arbitrage Pricing Theory, which explained that security returns are best explained by more than one factor.* Since then, academics have identified dozens of quantifiable variables, such as momentum, that impact stock returns. In effect, even stocks from different industries that share similar such characteristics should generate similar returns. The Exhibit below illustrates the premiums over a 40-year period for the four factors we used to analyze the active growth funds. Note, for instance, that investors were historically rewarded with a 3-point premium (per year) for investing in more profitable companies and 3.5 points for being in smaller companies. (click to enlarge) Now back to our study. When we accounted for the momentum, size, value and profitability factors, we found that only 1.6% of the managers actually outperformed the benchmark (after adjusting for positive tilts to these four factors), or generated positive alpha (i.e., excess return of a fund relative to its benchmark). Another way of stating this is that 98.4% of the outperformers had higher factor exposure than the benchmark. For example, 95% of these winners had a positive tilt to value (relative to the Russell 1000 Growth Index) and 64% had higher-than-index exposure to smaller companies. Given this evidence that outperformance of active growth managers is almost entirely explained through their (witting or unwitting) excess exposure to certain factors, the next question is whether there is a rigorous, methodical, quantitative way to target certain factor exposures in order to outperform the index over extended time periods. We believe that there is-the Multi-Factor® quantitative investing style that underpins our three equity mutual funds. In the coming weeks, I plan to write a series of articles to elaborate on the principles and applications of multi-factor investing. In advance of that, I invite you to read a short piece we recently published on this investment strategy: ” What is a Multi-Factor Investment Approach? ” Conclusion Active fund managers have great difficulty beating passive indexes over long time periods. Actively managed growth funds perform well relative to benchmarks compared to value funds, but nearly all of the growth funds’ outperformance can be explained quantitatively by multi-factor analysis. *Finance students will recognize the factor-premium formula for portfolio return–+β11 +β22 +… … + β n n + –where portfolio return is described as the sum of the risk-free rate, factor exposures, and alpha. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Will FedEx’s Q4 Spell More Trouble For Transport ETFs?

The transportation sector has given an ugly performance this year in spite of a strengthening economy, better job conditions and cheap fuel. The major culprit is the strong dollar, which is eroding the profitability of big transporters. The rough trading is expected to continue for the sector in the months ahead, especially after a disappointing fourth quarter 2015 earnings report from bellwether FedEx (NYSE: FDX ). The courier company lagged our estimates on revenues and earnings and guided lower, dampening investors’ mood. However, the numbers were better than the year-ago quarters. Q4 FedEx Results in Detail Earnings per share climbed 4.7% year over year to $2.66 but missed the Zacks Consensus Estimate by four cents. Revenues rose 2.5% year over year to $12.1 billion but fell shy of our estimate of $12.39 billion owing to negative currency translation and lower fuel surcharges. FedEx’s ongoing three-year cost cutting measures in the FedEx Express unit, which started in late 2012, are largely paying off and are expected to continue doing so in the coming quarters. This profit-improvement plan will continue to boost revenue and profitability. However, a strong dollar and lower fuel surcharges will likely keep on hurting the company’s profitability in fiscal 2016. As a result, the second largest U.S. package delivery company provided fiscal 2016 earnings per share guidance of $10.60-$11.10, the midpoint of which is below the Zacks Consensus Estimate of $10.90. Investors should note that FedEx is in the process of acquiring the Dutch parcel-delivery company TNT Express ( OTCPK:TNTEY ) for €4.4 billion ($4.8 billion). The buyout is expected to close in the first half of calendar year 2016. The acquisition, pending European regulatory approvals, would bolster its global footprint, particularly in the European markets with many untapped nations like the UK and France. The deal would create the third-largest delivery company in Europe after United Parcel Service (NYSE: UPS ) and Deutsche Post ( OTCPK:DPSGY ). Hence, the transaction will give a big boost to the company’s competitive position and future growth story. That being said, FedEX has a solid Growth Style Score of ‘A’ with some flavor of value as it also has a Value Style Score of ‘B’. Further, the stock has a favorable Zacks Rank #3 (Hold) and a solid industry Rank in the top 43% at the time of writing. Market Impact FDX shares dropped as much as 3.3% in yesterday’s trading session following disappointing results on elevated volumes of nearly 2.5 times than the average. This represents the biggest one-day fall so far this year. Given this, many investors may want to tap the beaten down price of FDX by considering either of the following ETFs: iShares Transportation Average ETF (NYSEARCA: IYT ) The ETF tracks the Dow Jones Transportation Average Index, giving investors exposure to the small basket of 20 securities. Out of these, FedEx occupies the top position in the basket with 13.5% of assets. Within the transportation sector, railroad takes the top spot with 46.8% share in the basket while air freight and logistics (30.1%), and airlines (15.2%) round off the top three. The fund has accumulated nearly $870 million in AUM while it sees good trading volume of around 438,000 shares a day. It charges 43 bps in fees per year from investors and lost 0.3% on the day following the earnings results. The product is down 8.3% in the year-to-date time frame and has a Zacks ETF Rank of 3 or ‘Hold’ rating with a High risk outlook. SPDR S&P Transportation ETF (NYSEARCA: XTN ) This fund follows the S&P Transportation Select Industry Index and uses almost an equal weight methodology for each security. Holding 50 stocks with AUM of $399.2 million, FedEx takes the fourth spot with a 2.7% share in the basket. The product is heavily exposed to trucking which accounts for 36.2% of total assets while airlines make up for another one-fourth share. Airfreight & logistics, and railroads account for 22.7% and 11% share, respectively. The fund charges 35 bps in fees per year from investors and trades in a moderate volume of about 83,000 shares a day. XTN was down 0.6% at the close after FedEx earnings were released and 8.5% so far in the year. The fund has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a High risk outlook. Original Post