Understanding Alternative Investments (DBC)

From Invesco: Most will agree that one of the least enjoyable summer traditions is summer school. I got a vivid reminder of this the other day when I put my youngest son on the bus for his summer classes, then had flashbacks to my own summer before 9th grade when I did the same thing. But while summer school is not particularly fun (at any age), it can be extremely valuable.

In my experience, summer school gave me a preview of material I needed to know for the upcoming year and allowed me to catch up on any previously covered material that was difficult to master. Regardless of the reason for our summer “sentence,” we all emerged from summer school smarter and better prepared for the upcoming year.

With this in mind, I thought I would use this summer to write a series of blogs covering the basics of alternative investments. My hope is the series will provide an opportunity for people to become more familiar and comfortable with this topic and be more informed investors as we head into the second half of 2017.

What are alternative investments?

While there is no one definitive definition, Invesco defines alternatives as investments other than publicly traded, long-only equities and fixed income. Based on our definition, the alternatives category would include investments with any of the following characteristics:

  • Investments that engage in “shorting” (i.e., seeking to profit from a decline in the value of an asset), such as global macro, market neutral and long/short equity strategies
  • Investments in asset classes other than stocks and bonds, such as commodities, natural resources (e.g., timberland, crude oil), infrastructure, master limited partnerships (MLPs) and real estate
  • Investments in illiquid and/or privately traded assets such as private equity, venture capital and private credit

Liquid vs. illiquid investments

At a high level, Invesco divides the universe of alternatives between liquid and illiquid alternatives.

  • Liquid alternatives predominantly invest in underlying instruments that are frequently traded and regularly priced, providing investors the ability to redeem their investments on a regular basis. Alternative mutual funds fall into this category, and are available to everyday investors. Traditional hedge funds are another example, but these are typically only available to high net worth investors (with a net worth over $5 million) and institutional investors (such as pension plans, foundations, endowments).
  • Illiquid alternatives predominantly invest in underlying instruments that are privately traded, priced on a periodic basis (often quarterly) and require a long holding period (typically several years) during which investors have little to no ability to redeem their positions. Private equity, venture capital, direct real estate, private credit, direct infrastructure and natural resources are examples of illiquid alternatives. Illiquid alternatives are only available to institutional investors and high net worth individuals.

Alternative asset classes vs. alternative investment strategies

Invesco further divides the universe of alternatives between alternative asset classes and alternative investment strategies:

  • Alternative asset classes are investments in asset classes other than stocks and bonds, such as real estate, commodities, natural resources, infrastructure and MLPs. Individuals can access these asset classes through mutual funds. The performance of these investments is often driven by the underlying performance of the asset class as a whole. Investors frequently invest in alternative asset classes in an attempt to hedge against inflation, achieve equity-like returns and to receive attractive levels of current income.
  • Alternative investment strategies are investments in which the fund manager is given increased flexibility with how to invest. The manager is often able to trade across multiple markets and asset classes such as stocks, bonds, currencies and commodities and may have the ability to short markets. The ability to short has the potential to significantly impact the return stream of these investments, as shorting gives these strategies the potential to generate positive returns in a falling market environment. It’s important to note that in rising markets short positions are exposed to unlimited loss potential.

Additionally, alternative investment strategies often use derivatives such as futures, forwards, options and swaps in order to potentially improve portfolio diversification, hedge market risks, help protect on the downside and efficiently establish market exposure.

Because of these characteristics, the performance of an investment in an alternative investment strategy is highly dependent on the skill of the underlying manager (rather than the general direction of a certain market), and performance across managers can vary greatly.

Common hedge fund strategies such as global macro, long/short equity, market neutral, managed futures and unconstrained fixed income are all examples of alternative strategies. Individuals can typically access these strategies through mutual funds to diversify their portfolios, potentially limit volatility during falling market environments, or add an investment with the potential to generate positive returns in both rising and falling markets.

What’s next?

Now that we’ve reviewed what alternatives are, the next blog will focus on why one should consider investing in alternatives. In the meantime, to learn more about Invesco and our alternative investment options please visit our website at www.invesco.com/alternatives.

Important information

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.

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 PowerShares DB Com Indx Trckng FundETF (NYSE:DBC) was unchanged in premarket trading Thursday. Year-to-date, DBC has declined -5.56%, versus a 11.63% rise in the benchmark S&P 500 index during the same period.

DBC currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #37 of 130 ETFs in the Commodity ETFs category.

This article is brought to you courtesy of Invesco.