Morningstar Advisor - June/July 2013 - (Page 39)

sources estimated the marginal cost at around $80. Even expensive oil sources were highly profitable to extract. Oil fell to a low of $30 per barrel and remains well below that peak today. Exhibit 2 Performance of Higher vs. Lower Cyclicality for Infrastructure and Commodities Against Equities The Takeaways 140 Infrastructure Higher vs Lower Cyclicality We started this article by warning about the lure of diversification and how it can lead to paying high fees for investments billed as alternative that add little benefit to a standard portfolio of equities and government bonds. Here are some simple ways to avoid the pitfalls of alternative investing and tilt the odds in your favor. Equities Commodities Higher vs Lower Cyclicality Recession 1.0 120 0.8 100 80 0.6 60 0.4 40 0.2 20 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 First, limit your alternative investment portfolio Note: For infrastructure, higher cyclicality is proxied by UBS World Toll Roads Index total return USD, lower cyclicality by UBS Transmission and Distribution Index total return USD. For commodities, higher cyclicality is proxied by an average of returns from the S&P GSCI Industrial Metals to assets and strategies that behave Index total return and S&P GSCI Energy Index total return; lower cyclicality by an average of returns from the S&P GSCI Agriculture and Livestock differently from equities and bonds over a full Index total return and the S&P GSCI Precious Metals Index Total Return. Recession periods as estimated by the NBER market cycle. When possible, customize your alternative investments to reduce 1/31/00 5/31/018/31/0212/31/034/30/057/31/0611/30/073/31/096/30/1010/31/11 2/29/00 6/30/0110/31/022/29/045/31/058/31/0612/31/074/30/097/31/1011/30/11 3/31/00 7/31/0111/30/023/31/046/30/0510/31/062/29/085/31/098/31/1012/31/11 4/30/00 8/31/0112/31/02into 1/31/054/30/067/31/0711/30/083/31/106/30/1110/31/12 5/31/00 10/31/012/28/035/31/048/31/0512/31/064/30/087/31/0911/30/103/31/12 6/30/009/30/01 1/31/034/30/047/31/0511/30/063/31/086/30/0910/31/102/29/12 7/31/0011/30/013/31/036/30/0410/31/052/28/075/31/088/31/0912/31/104/30/12 8/31/00 32/28/025/31/038/31/0412/31/054/30/077/31/0811/30/093/31/116/30/12 10/31/00 3/31/026/30/0310/31/042/28/065/31/078/31/0812/31/094/30/117/31/12 9/30/00 1/31/02 7/31/0311/30/043/31/06 8/31/0712/31/084/30/107/31/1111/30/12 11/30/00 Net Flows 9/30/04 1/31/06 10/31/072/28/095/31/108/31/1112/31/12 12/31/004/30/02 8/31/0312/31/04 5/31/06 9/30/07 1/31/09 9/30/10 1/31/12 1/31/01 5/31/02 10/31/03Hedge 6/30/06 1/31/08 9/30/09 1/31/11 9/30/12 2/28/01 6/30/029/30/03 2/28/05 9/30/06 3/31/01 9/30/02 1/31/04 11/30/053/31/07 9/30/08 1/31/10 9/30/11 Exhibit12/31/014/30/037/31/049/30/05 1/31/07 6/30/0810/31/092/28/115/31/12 exposure to the economic cycle, as this is a key 12/31/994/30/017/31/0211/30/033/31/05Funds6/30/0710/31/082/28/105/31/118/31/12 driver of long-run equity returns. Hedge Fund Industry Net Flows ($U.S. billion) Second, be mindful of valuation and the amount of capital competing for opportunities. Large losses are more likely to follow when both reach extreme highs. Investors with long-term fixed allocations need to review their asset weights at least once a year and reduce target weights if these extreme conditions apply. Those with the capacity to dynamically adjust weights should be prepared to exit entire allocations. Admittedly, this requires a difficult, fundamental, valuationbased analysis that may not suit all investors, but the rewards are worth the effort. K Michael Coop is head of alternative investments and capital markets with Ibbotson Associates Australia. 200 150 100 Peak to trough change in price % Commodities Hedge Funds Intrastructure Equities 50 0 1998 –10 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: Hedge Fund Research, Inc. –20 Exhibit 4 Utility Sector Price/Earnings Ratio (Normalized) and Crude Oil Price –30 160 –40 120 –50 Oil Price U.S. Utilities PER Normalized 3.0 2.0 1.0 80 –60 40 0.0 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 –1.0 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 12/31/ 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Note: Oil price is proxied by West Texas Intermediate price, normalized. Utilities price/earnings ratio is based on the FactSet U.S. equity index price/earnings ratio. MorningstarAdvisor.com 39 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2013

Morningstar Advisor - June/July 2013
Contents
Contributors
Letter From the Editor
Not Your Values
How Do You Use Alternatives for Clients?
Working to Build a Niche
How to Put Buffett’s Investing Philosophy into Practice
Sophisticated Strategies for the Masses
Investments á la Carte
Investment Briefs
The Percentile Trap
Defense Firms Will Stay Aloft
Beware the Lure of Diversification
Using Alternatives in Practice
Managed Futures and Cash Rates
The World Is Getting Grayer
Waiting to Pull Up Anchor
The Price of Managing Volatility
Let’s Get Back to Basics
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Mutual Fund Urban Myths

Morningstar Advisor - June/July 2013