In the 4th quarter, Alternative Investment ("Alternatives") returns were for the most part directionally the same as in the 3rd quarter with commodities being a notable exception by switching from negative to positive. The magnitude of returns were, however, generally more muted. Year-to-date, ten of 11 categories had positive returns, though short biased was essentially flat for the year. The performance themes in the quarter were fairly clear cut. Equity beta (event driven, volatility arbitrage, hedged equity), credit (distressed, credit arbitrage), and inflation hedging exposures (commodities) did well, while low/negative beta (equity market neutral, macro, managed futures, short bias) and interest rate sensitive exposures (real estate) struggled. As in the 3rd quarter, returns mostly aligned with the rank order correlation to the S&P 500, with real estate and commodities being exceptions. Real assets (commodities and real estate), which had both done very well in the first half of the year, diverged dramatically in the second half of the year due to their differing interest rate sensitivities amidst a rising rate outlook in the United States. Commodities rallied sharply during the fourth quarter, while real estate headed further into negative territory. Managed Futures continued its elegiac performance posting near bottom returns for the quarter and the poorest returns for the entire year. Managed futures, commodities, and macro have historically shown low correlations to stocks and bonds; thus, they serve as potentially strong portfolio diversifiers. Strategies such as credit arbitrage, event driven, hedged equity, et al., which have higher correlations with equities, provide attractive risk/return profiles through lower volatility. These characteristics may allow investors to broaden their investment choices and create more efficient portfolios. Correlations using monthly returns over the past two years shows these historic relationships remain intact.
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