Salient Webinar Riskedbased Asset Allocation 91813 Final

For Institutional Use Only. Not For Further Distribution.
Risk-Based Asset Allocation & Portfolio Analysis

Salient Quantitative Research September 2013
Disclosure
This information is being provided to you by Salient Advisors, L.P., and is intended solely for educational purposes. No other distribution or use of these materials has been authorized. The opinions expressed in these materials represent the personal views of the investment professionals of Salient Advisors, L.P., and is based on their broad based investment knowledge, experience, research and analysis. It must be noted, however, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future results. Certain statements in this communication are forward-looking statements of Salient Advisors, L.P. The forward-looking statements and other views expressed herein are as of the date of this letter. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. The Adviser disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein. There can be no assurance that the Strategy will achieve its investment objectives. The value of any strategy will fluctuate with the value of the underlying securities. Please note that the returns in this presentation are the result of a hypothetical investment framework. This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Any offering or solicitation will be made only to eligible investors and pursuant to any applicable Private Placement Memorandum and other governing documents, all of which must be read in their entirety. There are special risks associated with an investment in commodities and futures, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Transactions in futures are speculative and carry a high degree of risk. Research and advisory services are provided by Salient Advisors, L.P., a wholly owned subsidiary of Salient Partners, L.P. and a Securities and Exchange Commission Registered Investment Adviser. Salient research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Commodity services provided through Salient Advisors, L.P. a Commodity Trading Advisor (CTA) and Commodity Pool Operator (CPO), registered with the Commodity Futures Trading Commission (CFTC) as a CTA and a CPO and a member of the National Futures Association (NFA). Salient recommends that investors independently evaluate particular investments and strategies, and encourage investors to seek the advice of a financial advisor. The appropriateness of a particular investment or strategy will depend on an investors individual circumstances and objectives. Salient is the trade name for Salient Partners, L.P., which together with its subsidiaries provides asset management and advisory services. Insurance products offered through Salient Insurance Agency, LLC (Texas license #1736192). Trust services provided by Salient Trust Co., LTA. Securities offered through Salient Capital, L.P., a registered broker-dealer and Member FINRA, SIPC. Each of Salient Insurance Agency, LLC, Salient Trust Co., LTA, and Salient Capital, L.P., is a subsidiary of Salient Partners, L.P. Please note that the returns presented in this paper are the result of a hypothetical investment framework. Backtested performance is NOT an indicator of future actual results and do the results above do NOT represent returns that any investor actually attained. Backtested results are calculated by the retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses. Certain assumptions have been made for modeling purposes and are unlikely to be realized. No representations and warranties are made as to the reasonableness of the assumptions. Changes in these assumptions may have a material impact on the backtested returns presented. This information is provided for illustrative purposes only. Backtested performance is developed with the benefit of hindsight and has inherent limitations. Specifically, backtested results do not reflect actual trading or the effect of material economic and market factors on the decision-making process. Since trades have not actually been executed, results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity, and may not reflect the impact that certain economic or market factors may have had on the decision-making process. Further, backtesting allows the security selection methodology to be adjusted until past returns are maximized. Actual performance may differ significantly from backtested performance. Backtested results are adjusted to reflect the reinvestment of dividends and other income. The above backtested results are do not include the effect of backtested transaction costs, management fees, performance fees or expenses, if applicable. No cash balance or cash flow is included in the calculation. 2013 Salient. All Rights Reserved.
Todays Presenters
Director of Quantitative Research, Portfolio Manager
Roberto M. Croce, Ph.D.
Director of External Managers, Portfolio Manager
Bill Enszer
Managing Director, Head of Sales and Intermediary Services
David Linton
Dollar Allocation Risk Allocation

Dollar Allocation
EM Debt, 1%
HY Bonds, 14%
Developed, 10%
Small Cap, 19% Treasuries, 25%
Growth, 12% Dividend/ Income, 6%
Value, 12%
For illustrative purposes only.

Risk Allocation
Other, 10%
Stocks, 90%
For illustrative purposes only.
Topics
Viewing portfolios in terms of risk
Beta vs. volatility terminology Using betas to understand managers Understanding risk Using risk as an input in portfolio construction Knowing current risk profile Convergence vs. Divergence Testing for Convergence and why it matters Using Divergence to build more robust Alternatives portfolios Application 1: examining investor current allocations Application 2: adding a Liquid Alternatives sleeve to investor portfolios
Considering downside risk in portfolio construction
Bringing it all together
Topics
Viewing Portfolios in Terms of Risk

The Language of Risk
The average amount by which a managers returns fluctuate around their average Technically: annualized standard deviation of returns The average amount by which a managers returns co-move with a benchmark
Volatility
Beta
Risk Contribution
The fraction of portfolio volatility due to a particular constituent, benchmark, or risk factor
Understanding Volatility
Volatility tells us the average size of returns without regard for the sign of those returns. Its a measure of riskiness.
20%
Monthly S&P 500 Returns
15% 10% 5% 0% -5% -10% -15% -20% 20%
Monthly Average: 0.65%
Absolute Value of S&P 500 Returns
15% 10% 5% 0% -5% -10% -15% -20% 2007 2008 2009 2010 2011 2012 2013
Monthly Average: 3.98%
Source: Salient Advisors, L.P., Bloomberg, September 2013. For illustrative purposes only. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index.
Understanding Beta
Fund-Specific Risk
15% 10% 5% 0% -5% -10% -15% -20% -20% y = 0.78x + 0.0027
Alpha: average manager returns in excess of benchmark
Beta: a measure of riskit tells us how much fund returns vary in response to changes in a risky benchmark. However, it is only a measure of relative risk, and tells us very little about absolute risk.
Example Fund Returns
-15%
-10%
-5%
0%
5%
10%
15%
Sample Benchmark Returns
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only. Past performance is not necessarily indicative of future results.
10
Understanding Beta
Beta Volatility
Monthly Returns
15% 10% 5% Return (%) 0% -5% -10% -15% -20% 2007 2008
Equal Betas to Different Benchmarks = Different Volatilities
Portfolio of Stocks w/ S&P 500 Beta = 1 Portfolio of Bonds w/ Barclays Agg Beta = 1 2009 2010 Year 2011 2012 2013
Source: Salient Advisors, L.P., Bloomberg, September 2013. For illustrative purposes only. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index.
11
Using Betas: Expressing Manager Styles

Express manager returns in terms of betas to common market risks.
In the process, re-state each managers returns as a function of market factors.

Sample Fund
: Manager Returns : Estimate of managers exposure-adjusted average performance : Estimate of managers exposure to Factor (where factors are market proxies like S&P 500 or the Continuous Commodity Index) : Manager-specific component of returns.
Bonds 0.00 Stocks 1.04 Commodities 0.01 US Dollar 0.00 High Yield Tilt 0.00 Value Tilt 0.41 Growth Tilt 0.00 Small Cap Tilt 0.15 Dev Ex US Tilt 0.00
= + 1 1 + 2 2 + +
Emerging Market Tilt 0.00
Long Only Stock Picker A 0.00%
Name of Fund
Alpha
Exposure to US Equity
Tilt toward value stock
Tilt toward small cap stocks
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only. No investment strategy can guarantee results.
12
Using Betas: Spotting Manager Style vs. Skill

Sample Fund Bonds 0.00 Stocks 1.04 Commodities 0.01 US Dollar 0.00 High Yield Tilt 0.00 Value Tilt 0.41 Growth Tilt 0.00 Small Cap Tilt 0.15 Dev Ex US Tilt 0.00 Emerging Market Tilt 0.00
Long Only Stock Picker A 0.00%
What appears to be outperformance...

$3.50 $3.00
Is actually just a value bias

Manager
$2.50
Manager
$3.00 $2.50
S&P 500
Russell 3K Value
US Dollars
$2.00 $1.50 $1.00 $0.50 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
US Dollars Year
$2.00
$1.50
$1.00
$0.50 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Year
Source: Salient Advisors, L.P., Bloomberg, 2003-2013. For illustrative purposes only. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index.
13
Using Betas to Understand Asset Classes

We believe Asset Classes are rarely as pure as investors may think.
High yield fixed income, for example, actually has a sizeable loading on equities. Many managers actually have a negative exposure on the US dollar (positive loading on foreign currencies) due to foreign holdings.
Sample Fund High Yield Credit Manager
0.00%
Bonds 0.00
Stocks 0.35
Commodities 0.08
US Dollar -0.13
High Yield Tilt 0.67
Value Tilt 0.00
Growth Tilt 0.00
Small Cap Tilt 0.00
Dev Ex US Tilt 0.10
Emerging Market Tilt 0.05
No loading on treasury bonds. Some high yield bond funds are contributing equity risk, not bond risk.
Manager likely has foreign credit exposure.
Source: Salient Advisors, L.P., Bloomberg, 2003-2013. For illustrative purposes only. No investment strategy can guarantee results.
14
Using Betas: Understanding Managers with Short Histories

What if a Funds inception date was 2010, but you wanted to understand how they would have faired in 2008?
Step 1: Calculate manager betas to common market benchmarks over period for which we have data Step 2: Multiply the resulting betas by the benchmark returns during the period of interest (2008) The results are shown to the right. This illustration models the Fund using data from 2010 onward then compares with actual returns in 2008
US Dollars $1.05 $1.00 $0.95 $0.90 $0.85 $0.80 $0.75 $0.70 $0.65 $0.60 Dec-07 Actual Model
Mar-08
Jun-08 Year
Sep-08
Dec-08
Mar-09
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only. No investment strategy can guarantee results.
15
Understanding Risk Contribution
Alpha Fund Specific Risk Betas to underlying factors or benchmarks Returns from underlying factors or benchmarks
No investment strategy can guarantee results.
16
Understanding Risk Contribution

This view of portfolio risk tells us what the primary drivers of portfolio volatility are. The results are often quite counter-intuitive.
By understanding the primary drivers of risk, the investor is able to grasp what will likely affect portfolio returns
$6
Dollar Allocation
Risk Allocation
$5
$4
US Dollars
$3
$2 Stocks Bonds 60/40
$1
$0
Year
Source: Salient Advisors, L.P., Bloomberg, January 1, 1990- August 31, 2003. For illustrative purposes only. Stocks are represented by the MSCI World Index. Bonds are represented by the Barclay US 10 Year. A 60/40 Portfolio is 60% MSCI World Index and 40% Barclay US 10 Year. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index.
17
Calculating Risk Contribution: The Basics

Its not as complicated as it seems
Portfolio of 2 assets with weights: 1 and 2 . The variance of the portfolio is then:

2 = =1 =1 ,
Risk Contribution from Asset 1 Where:

2 2 = 1 1,1 1 + 1 2 1,2 1 2 +
2 2 + 1 2 1,2 1 2 + 2 2,2 2
Risk Contribution from Asset 2
1 is weight of asset 1 1 is the volatility of asset 1 1,2 is the correlation between asset 1 and asset 2
Source: Salient Advisors, L.P., September 2013.
18
Using Risk as An Input

A traditional 60/40 Portfolio targets a specific dollar allocation and allows the risk allocation to float.
Bonds 4%
Traditional 60/40 Portfolio

Volatility: 10.1% Notional: 1.0x
Bonds 40%
Equities 60%
Equities 96%
A risk balanced investment process starts with a target risk allocation and then allows the dollar allocation to adjust to maintain the risk target.
Equities 17% Momentum 25% 25% Equities
Sample Risk Balanced Portfolio1

Volatility: 10.1% Notional: 1.7x
Momentum
40%
Commodities 13%
30%
Rates
Commodities
25%
25%
Rates
Data shown here represents the historical data of the indices selected to represent each asset class, as specified below.
Source: Salient Advisors, L.P., September 2013. 1 The asset allocation percentages have been rounded for illustrative purposes. Note: The Sample Risk Balanced Portfolio is constructed using the MSCI AC World Index (Equities), Continuous Commodity Index (Commodities), Barclays US Aggregate Long Treasury Index (Rates), Barclays US Corporate High Yield Index (Credit), and Barclay CTA Index (Momentum). For illustrative purposes only. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. Volatility is a mathematical measure of uncertainty or risk about the size of changes in a securitys value. A higher volatility means the fluctuations in value will be higher, while a lower volatility means those peaks and valleys will be smaller. Notional refers to the amount of money, or exposure, used to calculate payments. In other words, every dollar invested in this sample risk parity portfolio is exposed to $1.70 worth of assets.
19
Risk-Weighting Walkthrough
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only. No investment strategy can guarantee results. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. Indices used in table above: MSCI World Index, Continuous Commodity Index, Barclays Aggregate Bond Index, Barclay CTA Index.
20
Target Standard Deviation Weights Balanced Risk Contribution
For illustrative purposes only. Source: Salient Advisors, L.P., September 2013.
21
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only. No investment strategy can guarantee results. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. Indices used in table above: MSCI World Index, Continuous Commodity Index, Barclays Aggregate Bond Index, Barclay CTA Index.
22
Using Risk Contribution

A View of Diversification
Suppose a Financial Advisor constructed a diversified equity portfolio using 3 different equity managers.
Sample Fund Value Manager Growth Manager Small Cap Manager 0.00% 0.00% 0.00% Bonds 0.00 0.00 0.00 Stocks 1.01 0.92 1.12 Commodities -0.01 0.03 0.04 US Dollar -0.03 0.00 0.00 High Yield Tilt 0.03 0.05 0.08 Value Tilt 0.67 0.00 1.30 Growth Tilt -0.27 1.01 1.19 Small Cap Tilt 0.00 -0.06 0.48 Dev Ex US Emerging Tilt Market Tilt 0.00 0.00 0.00 0.02 0.02 0.02
What does the portfolios risk profile look like? How much does the investor benefit from the different equity styles?
23
Using Risk Contribution

Despite having several, very different line items, the portfolio is hardly diversified.
4.0%
96.0% Generic Stock Risk Style Risk and other Exposures
Nearly all of the portfolios risk is still driven by US Large Cap Stocks. Over time, there may be very little difference between the two portfolio return streams.
24
Volatility & Correlation Matter

Low Volatility + Low Correlation = Low Risk Contribution
25% 20% Volatility (%) 15% 10% 5% 0%
Bonds Stocks Commodities US Dollar High Yield Value Tilt Growth Tilt Small Cap Tilt Dev Ex US Tilt Emerging Market Tilt
Volatility
20% 15% 9% 5% 3% 4% 10% 6% 14%
7%
1.00 0.80 Correlation 0.60 0.40 0.20 0.00 -0.20 -0.40

Bonds Stocks Commodities
Correlation to Equities
1.00 0.31 -0.32 -0.21 0.00 0.00 0.00 0.00 0.00 0.00
US Dollar
High Yield
Value Tilt
Growth Tilt Small Cap Tilt Dev Ex US Tilt
Emerging Market Tilt
Source: Salient Advisors, L.P., Bloomberg, September 2013. For illustrative purposes only. No investment strategy can guarantee results. Indices used above are as follows: Stocks: S&P 500 Total Return Index, Value: Russell 3000 Total Return Value Index, Growth: Russell 3000 Total Return Growth Index, Small Cap: Russell 2000 Total Return Index, Dev Ex US: MSCI World Index Daily Net TR Local, Emerging: MSCI Daily TR Net Emerging Markets Local, High Yield: Barclays US corporate High Yield Total Return Index Value Unhedged USD, Commodities: Continuous Commodity Index, Bonds: Barclays US 10Yr Note Futures Index, US Dollar: US Dollar Index Spot Rate
25
Topics
26
Downside Risk: When Correlations Go to One

Because many strategies behave differently in volatile periods, we think investors should consider downside risk separately.
Accounting for the degree to which correlations go to one in down markets typically helps address this challenge.
These differences are not captured in the prior analysis, which only looks at the long-run average behavior of managers relative to benchmarks. Because history is primarily made up of calm periods, the long-run average doesnt always do a good job capturing this asymmetry.
No investment strategy can guarantee results.
27
The Language of Downside Risk

Convergent Returns
Have high correlation to equities when equities are doing poorly Examples: stocks, private equity, high yield credit, real estate, relative value strategies, event driven strategies, etc.
Divergent Returns
Have negative correlation to equities when equities are doing poorly Examples: treasuries, value strategies, managed futures, global macro, etc.
For our purposes of this discussion, Convergence/Divergence will be measured as correlation to rises in volatility.
28
Determining if a Manager or Strategy is Divergent

Step 1: Line up manager returns next to the VIX Step 2: Use Excel formula to show return on days when VIX is increasing Step 3: Calculate correlation of strategy with rises in volatility
Correlations During Divergent Periods Manager 1 (0.35) Manager 2 0.22 Manager 3 (0.45) Manager 4 (0.80)
Divergent
Convergent
29
Determining if a Manager or Strategy is Divergent

Not All Hedge Funds are Equally Divergent
Correlation During Periods of Falling Volatility EQUITY Emerging Market CREDIT COM BONDS CURR Commodities ALTERNATIVES Event Driven HFs 0.49 0.38 0.59 0.62 0.57 0.46 0.44 0.30 Rel. Value HFs
Correlation During Periods of Rising Volatility
Stocks Value Growth Small Cap Dev Ex US Emerging Market High Yield Commodities Bonds US Dollar Macro HFs Rel. Value HFs Event Driven HFs 0.80 0.85 0.68 0.97 0.87 0.71 0.51 0.35
0.91 0.37 0.75 0.83 0.75 0.73 0.47 0.26
0.91 0.68 0.49 0.76 0.73 0.52 0.42 0.38
0.70 0.62 0.79 0.66 0.70 0.73 0.53 0.33
0.95 0.85 0.89 0.74 0.91 0.76 0.54 0.33
0.63 0.59 0.60 0.52 0.69 0.74 0.60 0.42
0.61 0.59 0.55 0.58 0.62 0.59 0.58 0.46
0.43 -0.35 -0.35 -0.03 0.48 0.43 -0.36 -0.38 -0.01 0.42 0.35 -0.33 -0.26 0.03 0.22 -0.35 -0.24 0.14 0.46 -0.45 -0.26 0.04 0.54 -0.32 -0.26 0.18 -0.20 -0.46 0.30 0.57 0.48 0.74 0.59 0.47 0.43 0.54 0.49 0.39
Macro HFs
High Yield
Dev Ex US
Small Cap
US Dollar
Growth
Stocks
Bonds
Value
The correlation between most asset classes rise during periods of rising volatility
0.24 -0.25 -0.32 -0.05 0.62
-0.14 0.06 -0.54 -0.35 -0.19 -0.15 -0.20 0.08 0.89 0.35 0.65 0.36 -0.53 0.61 -0.64 0.30 0.46 -0.39 0.15
-0.46 -0.53 -0.29 -0.51 -0.44 -0.48 -0.31 -0.81 -0.41 -0.03 0.22 -0.22 0.17 0.68 0.62 0.71 0.70 0.47 0.36 0.58 0.49 0.00 -0.11 0.07 0.75 0.76 0.76 0.76 0.79 0.84
Source: Salient Advisors, L.P., Bloomberg, 2000-2013. For illustrative purposes only. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. Indices used in table above: Stocks: S&P 500 Total Return Index, Value: Russell 3000 Total Return Value Index, Growth: Russell 3000 Total Return Growth Index, Small Cap: Russell 2000 Total Return Index, Dev Ex US: MSCI World Index Daily Net TR Local, Emerging: MSCI Daily TR Net Emerging Markets Local, High Yield: Barclays US corporate High Yield Total Return Index Value Unhedged USD, Commodities: Continuous Commodity Index, Bonds: Barclays US 10Yr Note Futures Index, US Dollar: US Dollar Index Spot Rate, Macro HFs: HFRI Macro (Total) Index, Rel. Value HFs: HFRI Relative Value (Total) Index, Event Driven HFs: HFRI Event-Driven (Total) Index
30
Why We Believe Convergence Matters

We think that with highly Convergent strategies, beta exposures rarely fully reflect downside risk. This is especially true for multi-asset portfolios, like Hedge Funds.
Sample Fund Macro HFs Rel. Value HFs Event Driven HFs
0.00% -0.01% 0.00%
Bonds
Stocks
Commodities US Dollar
High Yield Tilt
Value Tilt
Growth Tilt
Small Cap Tilt
Dev Ex US Tilt
Emerging Market Tilt
0.15 -0.07 -0.04
-0.02 0.02 0.13
0.13 0.05 0.06
0.00 0.00 0.02
-0.07 0.30 0.14
0.00 0.43 0.36
0.10 0.48 0.55
0.00 -0.14 -0.09
-0.09 0.03 0.08
0.11 0.02 0.03
Oct 2008 Return
-1.3%
-16.8%
-18.3%
7.8%
-13.8%
0.5%
-1.8%
-2.3%
-2.9%
-12.2% Total
Macro HFs Rel. Value HFs Event Driven HFs
-0.21% 0.10% 0.05%
0.30% -0.41% -2.14%
-2.46% -0.97% -1.15%
0.00% 0.00% 0.13%
0.96% -4.20% -1.92%
0.00% 0.22% 0.18%
-0.17% -0.85% -0.96%
0.00% 0.32% 0.20%
0.26% -0.10% -0.24%
-1.29% -0.25% -0.38%
-2.6% -6.1% -6.2%
October 2008 Performance

Macro HFs Predicted Actual
Rel. Value HFs -6.1% -14.1%
Event Driven HFs -6.2% -7.5%
-2.6% -1.7%
31
Topics
32
Bringing It All Together

Examining Sample Investor Current Allocations Alternatives Portfolio
Step 1: Identify primary drivers of current portfolio risk Step 2: Construct a more balanced portfolio Step 3: Identify the merits of a specific Alternatives portfolio Step 4: Examine which new allocations would be best
33
Sample Traditional Investor Portfolio

Dollar Allocation
HY Bonds, 14% Developed, 10%
Asset Class
Fund Type
Developed Small Cap
Fund % Asset Class % 10.0% 19.4% 12.3% 12.3% 5.9% 0.0% 25.0% 1.0% 14.0% 100.0% 0.0% 26.0% 14.0% 100.0% 60.0%
EM Debt, 1%
Equity
Growth Value Dividend / Income
Small Cap, 19%
Commodities Commodities Bonds Credit Total

Treasuries EM Debt HY Bonds
Treasuries, 25%
Growth, 12%
Dividend / Income, 6%
Value, 12%
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only.
34
Factor Analysis by Fund

Sample Fund R2 0.05% 0.03% Bonds -0.15 0.46 0.36 -0.31 -0.04 -0.22 0.00 1.04 -0.07 Stocks 0.89 0.39 0.00 1.09 1.08 0.73 0.69 0.00 0.33 Commodities 0.07 0.19 1.13 0.04 0.02 0.10 0.13 -0.02 0.11 US Dollar -0.43 -0.12 -0.28 0.00 0.00 0.00 -0.07 0.00 0.00 High Yield Tilt 0.10 0.44 0.29 0.09 0.00 0.00 0.00 0.00 0.90 Value Tilt 0.91 0.00 0.00 0.00 -0.12 0.00 0.94 0.00 0.00 Growth Tilt 0.31 0.00 0.00 0.00 0.90 0.00 0.00 0.00 0.00 Small Cap Tilt 0.00 0.08 0.00 0.83 0.00 0.00 -0.15 0.00 0.00 Dev Ex US Tilt 0.79 0.00 0.00 0.16 0.00 1.58 0.00 0.00 0.00 Emerging Market Tilt 0.19 0.19 0.00 0.00 0.00 0.00 0.09 0.00 0.00 Developed Equity Fund 0.97 EM Debt Fund Commodities Fund Small Cap Fund Growth Fund Value Fund 0.74
0.86 -0.43% 0.99 0.99 0.07% 0.02%
0.80 -0.20% 0.15% 0.09%
Dividend / Income Fund 0.93 Treasury Fund HY Bond Fund 0.96
0.90 -0.15%
High R2 indicates that the betas provide a predictive representation of the Fund.
35
Portfolio Risk Contribution Factor Level

Despite the multiple line items in the investors other asset allocation, the portfolio is largely undiversified and dominated by equity risk.
Bonds, -1% Commodites, 6% Credit, 3% Other, 3%
Stocks, 90%
36
Fund Risk Contribution
The EM Debt Fund looks a lot like domestic stocks and high yield. Could we be gaining that exposure more cheaply elsewhere?
The Value Fund looks more like the S&P. Maybe we should find a better fit.
The Dividend & Income Fund looks a lot like value stocks, which is consistent with what you would expect.
37
Constructing A More Balanced Portfolio

Less Equities Required than Investors May Think
Dollar Allocation
Developed, 8% HY Bonds, 20% Small Cap, 5% Growth, 2% Value, 2% Dividend / Income, 8% Credit, 10%
Risk Allocation
Other, 9%
Stocks, 54% Commodities, 10% Treasuries, 30%
Commodites, 25% EM Debt, 15% Bonds, 2%
38
A Balanced Portfolio May Reduce Drawdown
Return 7.2% 6.9%
Vol 11.2% 8.5%
Ret/Risk Max Drawdown 0.64 -36.9% 0.81 -26.3%
For illustrative purposes only. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. Source: Salient Advisors, L.P., September 2013.
39
Bringing It All Together

Adding a Liquid Alternatives Sleeve to Investor Portfolios
Liquid Alternatives should avoid:
High cost most 2/20 structures are unnecessary Inefficient offerings can be replicated with traditional beta and are really equities in drag Highly Convergent exposures performs poorly in volatile periods
Use prior techniques to assess managers on a level that goes beyond their Fact Cards
Analyze their risk level, and how it will affect the rest of portfolio Assess returns during volatile periods Reconstruct longer histories to include stressful markets
40
Adding Breadth
Liquid Alternatives typically exhibit low correlation to traditional asset classes
EQUITY Dividend / Income COM BONDS CREDIT Relative Value ALTERNATIVES
Commodities
Event Driven
Developed
Developed Small Cap Growth Value Dividend / Income Commodities Treasuries EM Debt HY Bonds Relative Value Event Driven L/S Equity Trend Alt Beta Risk Parity
0.92 0.93 0.85 0.93 0.52 -0.28 0.72 0.70 0.72 0.86 0.93 -0.04 0.21 0.48
0.92 0.93 0.94 0.94 0.79 0.80 0.90 0.91 0.48 0.54 -0.34 -0.32 0.66 0.67 0.72 0.74 0.68 0.73 0.82 0.83 0.86 0.88 0.14 0.11 0.29 0.22 0.41 0.45
0.85 0.93 0.52 -0.28 0.79 0.90 0.48 -0.34 0.80 0.91 0.54 -0.32 0.80 0.52 -0.31 0.80 0.53 -0.27 0.52 0.53 0.07 -0.31 -0.27 0.07 0.71 0.56 0.63 0.08 0.72 0.53 0.49 -0.23 0.77 0.60 0.61 -0.26 0.81 0.66 0.54 -0.37 0.83 0.67 0.61 -0.37 0.00 0.01 0.20 0.04 0.18 0.21 0.23 0.00 0.33 0.42 0.65 0.37
0.72 0.66 0.67 0.71 0.56 0.63 0.08 0.68 0.72 0.71 0.70 -0.02 0.21 0.51
0.70 0.72 0.74 0.72 0.53 0.49 -0.23 0.68 0.78 0.76 0.65 -0.12 0.11 0.36
0.72 0.68 0.73 0.77 0.60 0.61 -0.26 0.72 0.78 0.81 0.75 0.04 0.22 0.41
0.86 0.82 0.83 0.81 0.66 0.54 -0.37 0.71 0.76 0.81 0.91 0.03 0.23 0.43
0.93 -0.04 0.21 0.48 0.86 0.14 0.29 0.41 0.88 0.11 0.22 0.45 0.83 0.00 0.18 0.33 0.67 0.01 0.21 0.42 0.61 0.20 0.23 0.65 -0.37 0.04 0.00 0.37 0.70 -0.02 0.21 0.51 0.65 -0.12 0.11 0.36 0.75 0.04 0.22 0.41 0.91 0.03 0.23 0.43 0.07 0.24 0.46 0.07 0.54 0.37 0.24 0.54 0.38 0.46 0.37 0.38
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only. Past performance is not a guarantee of future results. Proxies used in the correlation chart are as follows: Developed: Vanguard Global Equity Fund, Small Cap: Vanguard Small-Cap ETF, Growth: Vanguard Growth ETF, Value: UBAM - Neuberger Berman US Equity Value, Dividend/Income: BlackRock Equity Dividend Fund, Commodities: PIMCO Commodity Real Return Strategy Fund, Treasuries: iShares 7-10 Year Treasury Bond ETF, EM Bonds: Franklin Templeton Investment Funds - Templeton Emerging Markets Bond Fund, HY Bonds: BlackRock Global Funds - US Dollar High Yield Bond Fund, L/S Equity: HFRI Equity Hedge (Total) Index, Trend: Salient Trend Index, Alt Beta: Salient Alternative Beta Index, Risk Parity: Salient Risk Parity V15 Index
Risk Parity
Treasuries
L/S Equity
Small Cap
HY Bonds
EM Debt
Alt Beta
Growth
Trend
Value
41
Factor Analysis by Fund: Alternatives

Negative betas on stocks indicates a diversifying asset in the area where the portfolio needs it the most.
Fund
Relative Value Event-Driven Long Short Equity Trend Alt Beta Risk Parity
0.38% 0.35% 0.18% 2.05% 2.60% 0.63%
Bonds
Stocks
Commodities
Currencies
High Yield Tilt
Value Tilt
Growth Tilt
Small Cap Tilt Dev Ex US Tilt
Emerging MarketTilt
0.00 -0.12 -0.12 0.00 0.00 1.19
0.12 0.27 0.36 -0.30 0.00 0.33
0.10 0.09 0.13 0.27 0.22 0.45
0.00 0.00 -0.10 0.00 0.36 0.00
0.23 0.19 0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00 0.45 0.00
0.00 0.00 0.21 0.00 0.00 0.00
0.00 0.13 0.19 0.00 0.24 0.00
0.22 0.18 0.40 0.00 0.00 0.00
0.00 0.08 0.12 0.00 0.28 0.41
High alpha indicates that theres a strong constant premium over the exposures expressed by the betas.
42
Fund Risk Contribution

Liquid Alternatives
120% Bonds 100% Stocks Commodities US Dollar High Yield Value Growth Small Cap Dev Ex US Emerging Market Other
Risk Contribution (%)
80%
60%
40%
20%
0% Relative Value Event Driven L/S Equity Trend Alt Beta Risk Parity
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. Note that an investor cannot invest directly in the Index. Trend: Salient Trend Index, Alt Beta: Salient Alternative Beta Index, Risk Parity: Salient Risk Parity V15+ Index
43
Consider Alternatives through a Lens of Convergence

Correlation to Equities During Rising Volatility
1.00 0.80 0.60 0.40 Correlation 0.20 0.00 -0.20 -0.40 -0.60 -0.80
HFRI Relative Value (Total) Index HFRI Event-Driven (Total) Index HFRI Equity Hedged Trend Alt Beta Risk Parity
0.80
0.87
0.90
0.87
-0.33 -0.54
For illustrative purposes only. Source: Salient Advisors, L.P., Bloomberg, September 2013.
44
Consider Alternatives with Meaningful Volatility

Volatility
25%
20%
20%
Volatility (%)
15%
15%
15%
10% 7% 5% 4%
9%
0%
HFRI Relative Value (Total) Index
HFRI Event-Driven (Total) Index
HFRI Equity Hedged
Trend
Alt Beta
Risk Parity
For illustrative purposes only. Source: Salient Advisors, L.P., Bloomberg, September 2013.
45
Adding Liquid Alternatives to a Well-Balanced Portfolio

Dollar Allocation
Developed, 3% Small Cap, 2% RP, 10% Growth, 2% Value, 2% Dividend / Income, 2% Commodities, 5% Other, 29% Stocks, 29%
Risk Allocation
Alt Beta, 10%
Trend, 10% Credit, 4% Treasuries, 35% EM Bonds, 4%
HY Bonds, 15%
Bonds, 11%
Commodities, 27%
46
Adding the Right Liquid Alts May Enhance Potential Returns

Reduced Drawdown, Increased Potential Return
Return 7.2% 12.5%
Vol Ret/Risk Max Drawdown 11.2% 0.64 -36.9% 7.1% 1.75 -11.5%
Source: Salient Advisors, L.P., September 2013. For illustrative purposes only. Past performance is not a guarantee of future results.
47
Salient Mutual Fund Platform

Salient Risk Parity Fund Salient Trend Fund Salient Alternative Beta Fund
SRPAX | SRPCX | SRPFX SPTAX | SPTCX | SPTIX SABAX | SABCX | SABFX
Salient MLP & Energy Infrastructure Fund II SMAPX | SMFPX | SMLPX Salient Global Equity Fund
SGEAX | SGECX | SGEIX
For further information, contact our Sales Desk at 800-994-0755 or visit www.salientfunds.com
48
Index Glossary
Barclays Aggregate Bond Index - a U.S. Aggregate index that covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities. The index includes government securities, mortgage-backed securities, asset-backed securities and corporate securities all with a maturity of greater than one year. This index is subject to interest rate risk (as interest rates rise bond prices usually fall), the risk of issuer default, and inflation risk. Barclay CTA Index - is a leading industry benchmark of representative performance of commodity trading advisors. There are currently 582 programs included in the calculation of the Barclay CTA Index for the year 2013, which is unweighted and rebalanced at the beginning of each year. This index is non-diversified and therefore may be more volatile than the S&P 500 Index. Barclays U.S. Corporate High Yield Index - an index of U.S. below investment grade bonds. Continuous Commodity Index - made up of 17 commodities whose futures trade on U.S. Exchanges. The index is a broad measure of overall commodity price trends. There are six component groups: Energy, Grains, Industrials, Precious Metals, Livestock and Softs. Equal weighting is used for both arithmetic averaging of an individual commodity months and for geometric averaging of the 17 commodity averages. This index is subject to commodity price risk. 60/40 Portfolio represented by 60% MSCI World Index and 40% Barclay 10 US Year Treasury Index. MSCI World Index - a stock market index of 1,500 'world' stocks. It is maintained by MSCI Inc., formerly Morgan Stanley Capital International, and is often used as a common benchmark for 'world' or 'global' stock funds. MSCI Emerging Market Equity covers over 800 securities across 21 emerging markets and represents approximately 13% of world market cap. Russell 3000 Growth Index - measures the performance of the broad growth segment of the U.S. equity universe. It includes those Russell 3000 Index companies with higher price-to-book ratios and higher forecasted growth values. Russell 3000 Value Index - measures the performance of the broad value segment of U.S. equity value universe. It includes those Russell 3000 Index companies with lower price-to-book ratios and lower forecasted growth values. Russell 2000 - measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. S&P 500 Index - an unmanaged, capitalization weighted index comprising publicly traded common stocks issued by companies in various industries. The S&P 500 Index is widely recognized as the leading broad-based measurement of changes in conditions of the U.S. equities market. This index can be affected by general market or economic conditions. VIX - The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge." HFRI Equity Hedge (Total) Index Investment managers who maintain positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. HFRI Relative Value Index Investment managers who maintain positions in which the investment these is predicated on realization of a valuation discrepancy in the relationship between multiple securities. HFRI Event Driven Index Investment managers who maintain positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments. US Dollar Index Spot Rate - is a geometrically-averaged calculation of six currencies weighted against the U.S. dollar.
49
4265 San Felipe, 8th Floor Houston, Texas 77027 Phone: 713.993.4675 Fax: 713.993.4698 salientpartners.com

Salient Webinar Riskedbased Asset Allocation 91813 Final

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Salient Webinar Riskedbased Asset Allocation 91813 Final

Uploaded by

Copyright:

Available Formats

For Institutional Use Only. Not For Further Distribution.

Risk-Based Asset Allocation & Portfolio Analysis

For Institutional Use Only. Not For Further Distribution.

For Institutional Use Only. Not For Further Distribution.

Director of Quantitative Research, Portfolio Manager

Roberto M. Croce, Ph.D.

Director of External Managers, Portfolio Manager

Managing Director, Head of Sales and Intermediary Services

For Institutional Use Only. Not For Further Distribution.

Dollar Allocation Risk Allocation

Small Cap, 19% Treasuries, 25%

Growth, 12% Dividend/ Income, 6%

For illustrative purposes only.

For Institutional Use Only. Not For Further Distribution.

Dollar Allocation Risk Allocation

For illustrative purposes only.

For Institutional Use Only. Not For Further Distribution.

Considering downside risk in portfolio construction

Bringing it all together

For Institutional Use Only. Not For Further Distribution.

Considering downside risk in portfolio construction

Bringing it all together

For Institutional Use Only. Not For Further Distribution.

Viewing Portfolios in Terms of Risk

For Institutional Use Only. Not For Further Distribution.

Monthly S&P 500 Returns

15% 10% 5% 0% -5% -10% -15% -20% 20%

Monthly Average: 0.65%

Absolute Value of S&P 500 Returns

Monthly Average: 3.98%

For Institutional Use Only. Not For Further Distribution.

15% 10% 5% 0% -5% -10% -15% -20% -20% y = 0.78x + 0.0027

Alpha: average manager returns in excess of benchmark

Example Fund Returns

Sample Benchmark Returns

For Institutional Use Only. Not For Further Distribution.

Equal Betas to Different Benchmarks = Different Volatilities

For Institutional Use Only. Not For Further Distribution.

Using Betas: Expressing Manager Styles

Emerging Market Tilt 0.00

Long Only Stock Picker A 0.00%

Tilt toward value stock

Tilt toward small cap stocks

For Institutional Use Only. Not For Further Distribution.

Using Betas: Spotting Manager Style vs. Skill

Long Only Stock Picker A 0.00%

What appears to be outperformance...

Is actually just a value bias

For Institutional Use Only. Not For Further Distribution.

Using Betas to Understand Asset Classes

Sample Fund High Yield Credit Manager

High Yield Tilt 0.67

Value Tilt 0.00

Growth Tilt 0.00

Small Cap Tilt 0.00

Dev Ex US Tilt 0.10

Emerging Market Tilt 0.05

Manager likely has foreign credit exposure.

For Institutional Use Only. Not For Further Distribution.

Using Betas: Understanding Managers with Short Histories

For Institutional Use Only. Not For Further Distribution.

Understanding Risk Contribution

No investment strategy can guarantee results.