The fnex whitepaper argues for increased portfolio diversification through alternative investments, like hedge funds and private equity, due to the rising correlation between stocks and bonds and the inadequacy of traditional 60/40 portfolios. With the prospect of longer retirements and significant downturns, many investors are turning to alternatives to enhance returns and reduce risks. The document highlights the growing acceptance of alternatives among institutional and retail investors, with a notable increase in allocations since the financial crisis.

1. A
Whitepaper
from
FNEX
Alternatives
&
Private
Investments
on
the
Rise...
1.7
trillion
reasons
to
consider
alternatives.
One
place
to
source
them.

2. 30
S.
Meridian
St.,
Suite
250
Indianapolis,
IN
46204
888.580.2588
www.FNEX.com
1 A
Whitepaper
from
FNEX
Does
your
portfolio
have
adequate
diversification?
The five-year bull market in equities has been breathtaking, with the Dow Jones
Industrial Average gaining more than 150% since the Great Recession. So, it’s
easy to forget that in the last 15 years investors in stocks have suffered two major
setbacks: a decline of 38% after the Internet Bubble collapsed in 2001, and an
even bigger crash of 54% following the start of the Financial Crisis in 2008. With
the DJIA again at record highs, is the time nearing for another major correction?
No one can predict the future with any accuracy, of course, but history teaches us
that since World War II, less than one third of bull markets have lasted longer
than five years.
Another concern is the fixed income markets, where the government and
companies sell bonds. The Federal Reserve has engineered a 30-year bond bull
market, with the aim more recently of stimulating the economy and avoiding
deflation. With short-term interest rates now near zero and the outlook for
inflation uncertain, at current levels the fixed income market offers little potential
reward and significant risk, according to
prominent asset managers.
Why should you be concerned about protecting
your portfolio? In the future, retirements will be
much longer than in the past and will have to be
financed primarily from savings. According to the
Social Security Administration, a man reaching
age 65 today can expect to live, on average, until
84. A woman will live approximately two years
more. Could your portfolio weather another
substantial downturn?
With so much uncertainty, many institutional
advisers and high-net-worth private investors have

3. A
Whitepaper
from
FNEX
30
S.
Meridian
St.,
Suite
250
Indianapolis,
IN
46204
888.580.2588
www.FNEX.com
2
been adding more diversity and protection to their portfolios with alternative
investments. While the name alternatives sometimes conjure up images of exotic,
risky investments, in fact the name simply means an alternative to stocks and
bonds. Most alternatives are designed to be less, not more risky than traditional
assets. Such investments can take many forms, but some of the most common are
hedge funds, private equity funds, real estate, managed futures and private
company stock.
In the past, traditional investment portfolios often used a mixture of 60% stocks
and 40% bonds because it had been observed that these two asset classes often
move in opposite directions. When stock prices were falling, for example, bonds
were usually headed up. So, owning bonds would protect your portfolio against
falling stock prices and vice versa. In the language of investment professionals,
stocks and bonds were uncorrelated.
But a strange thing happened during the 2008 Financial Crisis. Because of the
globalization of markets, stocks and bonds began to fall in lockstep. Ever since
then, these two asset classes have become more and more correlated — both
bonds and stocks rose in the first half of 2014, for example — so the old mix of
60/40 no longer offers the same portfolio protection it once did.
Even worse, when economists studied those 60/40 portfolios and looked at the
underlying risks involved, it turned out that 90% of the risk — the possibility of
losing money — was in the stock portion of the portfolio, far higher than the 60%
that the allocation to equities suggested. It became clear that something else was
needed.

4. A
Whitepaper
from
FNEX
30
S.
Meridian
St.,
Suite
250
Indianapolis,
IN
46204
888.580.2588
www.FNEX.com
3
The
Case
for
Alternatives/Private
Investment
The rationale for owning alternatives is relatively simple. Compared with stocks
and bonds, hedge funds, private equity funds, real estate, managed futures and
private company stock tend to be much more uncorrelated, meaning that they
move in different directions than equities and bonds and at different times.
Adding alternatives to a portfolio makes it possible to enhance returns while
reducing risk by increasing the overall diversification of assets.
Numerous academic studies have shown that portfolios with a higher degree of
diversification using uncorrelated assets tend to perform better over the long haul.
The idea is to maximize returns in up markets while reducing the risk of loss in
down markets. Of course, alternatives can also lose in those markets, but the
historical record shows a clear benefit to portfolio diversification.
For example, look at Exhibit 1, which shows the returns on various asset classes.
For the decade ending in 2013, private equity had an annual average return of
15.1% and hedge funds 5.8%, while the S&P 500 had an annual return of 7.4%
and Barclays Aggregate Bond Index returned 4.5%. For those concerned about
protecting their portfolios, it is useful to know that in the past decade and a half
one widely accepted measure of alternatives performance called the HFRI Fund
of Funds Composite Index has lost 4% or more in only two monthly periods,
while the global measure of equity performance known as the MSCI World Index
has been down 4% in 25 monthly periods.
What’s more, a large
number of academic
papers have
demonstrated that by
including alternatives
such as hedge funds
and managed futures
in a portfolio; it is possible to reduce the volatility of the entire portfolio.
Volatility is the rise and fall of stock prices and higher volatility frequently means

5. A
Whitepaper
from
FNEX
30
S.
Meridian
St.,
Suite
250
Indianapolis,
IN
46204
888.580.2588
www.FNEX.com
4
an increased risk of loss. Since the financial crisis, double-digit ups and downs in
the DJIA have become a much more frequent occurrence.
That combination — better risk-adjusted returns — has attracted institutional
investors to alternative investments in recent years. Some of the greatest
advocates for using alternatives have been the endowments of major universities
such as Harvard, Yale and Stanford. And it’s clear why: Yale has experienced a
20-year record of 13.5% average annual returns thanks largely to its nearly 70%
exposure to alternative investments.
Pension
funds
increase
allocations.
Even institutions with much shorter time horizons have gravitated to alternatives
because of their better risk/return profile. For example, pension funds, which have
the lowest risk tolerance of any institutional investor because they have to pay out
pensions every year, had only 5% of their assets allocated to alternatives in 1995,
but by 2013 had reserved 19% of their funds for alternatives, according to a recent
global study.
Because of these benefits, many high-net-worth
retail investors are now including a 15-
20% allocation to a basket of alternative
investments in their portfolios.
Some investors worry that alternatives are by
definition risky because fund managers can
use borrowed money, a process called
leverage and can make bets against the
market, a process called shorting. In addition,
a few prominent hedge fund managers have
been in the headlines lately for making
controversial comments about their investments. But a good analogy for the
alternatives market is to the airlines industry: air disasters regrettably make
occasional headlines, but most people continue to fly because there is

6. A
Whitepaper
from
FNEX
30
S.
Meridian
St.,
Suite
250
Indianapolis,
IN
46204
888.580.2588
www.FNEX.com
5
overwhelming evidence that air travel is the safest form of transport available,
beating cars and trains. The same is true for alternatives: despite the media
coverage, most funds are conservatively managed to reduce risk, not increase it.
Accredited
Investors:
Who
qualifies?
Because most alternative investments are exempt from the registration
requirements of the Securities and Exchange Commission, the SEC has adopted
rules limiting ownership of these unregistered securities to what are termed
“accredited investors.” There are two ways an investor can qualify as accredited:
1. They must have earned income above $200,000 (or $300,000 together with a
spouse) in each of the past two years, and expect to have similar income in the
current year, or 2. Have a net worth over $1 million, with or without a spouse and
not including their principal residence.
Many alternative investments are offered
in the form of partnerships, with the
investment manager known as the
general partner, who manages and
markets the fund, and the investors
known as the limited partners. Because
they are partnerships, many alternative
investments are not considered as liquid
as stocks and bonds because the money
invested can be withdrawn only at certain
times of the year. This makes alternatives
ideal for long-term investing strategies
such as planning for your retirement. As part of this tradeoff, investors expect and
often reap higher rewards for the illiquidity of their investments compared to
traditional asset classes.

7. A
Whitepaper
from
FNEX
30
S.
Meridian
St.,
Suite
250
Indianapolis,
IN
46204
888.580.2588
www.FNEX.com
6
Here is a brief guide to what is available on the market:
Hedge funds: As the name implies, these funds were originally designed to
“hedge” or lower risk by taking short positions against the market. There are now
hundreds of different hedge funds available using many different strategies to
make a profit. Some of the most
prominent are long/short funds, which
still bet against the market to limit
risk; global macro funds, which can
invest anywhere in the world their
managers see a profit potential;
market neutral funds, which try to
capture differences in prices among
related securities like stocks and
bonds; event driven funds, which seek
to profit from such things as mergers
and bankruptcies and distressed credit
funds, which try to identify such
things as mispriced bonds and loans.
Private Equity: These partnerships are run by a financial sponsor who often uses
leverage to buy a majority stake in a mature but faltering company, takes it
private, and improves the management of the company in hopes of either selling it
to another firm or floating its shares on the stock market for a large profit.
Managed Futures: These are accounts managed by professional money
managers who invest the funds typically in futures contracts in commodities,
equities, interest rates or currencies. They can buy contracts that reflect either
long or short positions. The accounts often use what is called notional funding,
allowing an investor to put up only 25-50% of the amount to be invested.
Private Company Stock: These private placements allow a limited number of
investors to buy non-public shares in a private company that is not registered with
the SEC. These tend to be smaller companies than those listed on exchanges and

8. A
Whitepaper
from
FNEX
30
S.
Meridian
St.,
Suite
250
Indianapolis,
IN
46204
888.580.2588
www.FNEX.com
7
have a greater potential to return profits. But these shares can be highly illiquid
and investments are generally for the very long term.
One thing these assets all have in common is that they tend to be uncorrelated
with traditional stock and bond investments. Thanks to their uncorrelated nature
and excellent risk/return profiles, alternative investments are gaining ground not
only with institutional investors, but with many retail investors as well. A recent
report from market analyst McKinsey said that alternative investments by retail
customers are growing at 5% a year and are expected to reach $13 trillion in 2015,
double the amount retail customers invested in alternatives in 2005. “Growth is
expected to continue, fueled by increasing allocations by institutional investors
and the movement of alternatives into the retail investment mainsteam,”
McKinsey said.
DISCLAIMER NOTICE: This communication is for informational purposes only and nothing
herein should be construed as a solicitation, recommendation or an offer to buy or sell any
securities or product. FNEX is not a broker-dealer or a registered investment advisor and does not
originate any securities. FNEX does not advise or consult any member on the merits of any
investment or securities offering. The information contained herein has been obtained from
sources believed to be reliable, but FNEX, LLC does not guarantee accuracy or completeness.
FNEX 2014 © All rights reserved.