Our risk parity strategy seeks to help investors stay ready for virtually any type of economic environment by balancing its risks across stocks, bonds and commodities,¹ which typically behave differently during different parts of the market cycle. Maintaining a diversified allocation may help prevent one underperforming asset class from dominating the returns of the entire portfolio. But what happens when stocks, bonds and commodities all fall together, diminishing risk parity’s diversification benefits? We came very close to experiencing this situation in August, so in this blog, I look at what investors could expect if risk parity’s “worst-case scenario” came to fruition.

August 2015: Markets just missed a triple negative

First, let’s review what exactly happened in the markets in August. During that month, stocks fell by 6.62%, commodities fell by 0.92% and bonds barely ticked higher with a 0.13% gain.² With results like these, it’s not surprising for risk parity investors to wonder what would happen if all three asset classes fell in tandem.

How often have markets dropped together?

Now, let’s examine how often this type of scenario has occurred in the past. The chart below shows how often stocks, bonds and commodities were all negative and all positive from January 1973 to September 2015. Looking at the data on a monthly basis, all asset classes were negative 8.2% of the time — a relatively low figure. But as our time periods expanded to three months and then 12 months, the incidence of periods in which all three asset classes posted negative returns diminished dramatically.

When you look at the other side of the coin — periods when all three of the asset classes were up at the same time — you’ll see that these periods occurred at a much higher frequency than the “all negative” scenarios. And, the incidence of these “all positive” periods rose over time as well.

Taking a long-term view

Why is this significant for investors? These trends illustrate the long-term benefits of diversification that risk parity strategies seek to capture. The Invesco Global Asset Allocation team believes that for long-term investors, all-negative months could present an attractive entry point for investing in risk parity strategies, given the underlying asset classes’ tendency to return to a state of “normal behavior” over time (i.e., at least one asset class posts positive returns, re-introducing the diversification benefits).

What’s to come? Uncertainty

Historical analysis always begs the question of what we expect to happen in the future. The problem, of course, is that no one knows exactly what’s going to happen — and when — as we move forward. Markets are dynamic systems that are very hard to predict. Because the future is inherently unknowable, we believe one of the ways investors can temper that uncertainty is by spreading their risk across asset classes that have historically behaved differently through the shifting phases of the economic cycle.

• Commodities have historically performed well in inflation-driven markets.³
• Stocks have outperformed in times of low inflationary growth.⁴
• Government bonds may provide a measure of defense against recessionary/deflationary periods.

While we can’t predict the future with certainty, history shows us that most of the time, one or more of these asset classes has delivered positive returns, especially over longer time frames. Invesco Balanced-Risk Allocation Fund incorporates all three asset classes at all times. We believe this may help investors stay prepared for what’s to come.

• Each asset class exposure — stocks, bonds and commodities¹ — is built by considering the key drivers of return specific to that asset class.
• We combine these asset classes based on the amount of risk they may contribute to the portfolio. (Whereas other strategies, such as 60/40 portfolios, allocate a certain percent of capital to each asset class, regardless of their risk contribution.) We believe true diversification is key to limiting downside risk.
• Markets move in cycles, so the fund makes tactical adjustments to the portfolio, seeking to take advantage of these cycles, in an effort to make the portfolio more adaptive to the current environment.

To learn more about our team’s approach, read the previous blog, Risk parity: It’s about preparation, not predictions. You can also find more information on the fund page for Invesco Balanced-Risk Allocation Fund.

1 Under normal conditions, the strategy invests in derivatives and other financially-linked instruments whose performance is expected to correspond to US and international fixed income, equity and commodity markets. However, the performance of the asset classes cannot be guaranteed. The derivative investments and enhanced investment techniques (such as leverage) used by the portfolio are subject to greater risks than those associated with investing directly in securities or more traditional instruments.

2 Source: DataStream. Stocks represented by the MSCI World Index, bonds by the Barclays 10 Year Treasury Index and commodities by the S&P GSCI Commodity Index.

3 In the inflationary years of 1973 to 1981, commodities were the only asset class that provided meaningful returns above inflation. Commodities (S&P GSCI Index) returned 12.81%, inflation (Consumer Price Index) was 9.22%, T-Bills (Ibbotson U.S. 30-Day T-Bill Index) returned 8.23%, stocks (S&P 500 Index) returned 5.16%, corporate bonds (Ibbotson U.S. Long-Term Corporate Bond Index) returned 2.49% and long-term government bonds (Ibbotson U.S. Long-Term Government Bond Index) returned 2.49%. Sources: Morningstar; Bloomberg L.P., Lipper (commodities). ©2015 Morningstar Inc.; All rights reserved. The information contained herein is proprietary to Morningstar and/or its content providers. It may not be copied or distributed and is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

4 Stocks were the clear leaders in the low-inflationary growth periods of 1942 to 1965 and 1982 to 1999. From 1942 to 1965, stocks (S&P 500 Index) returned 15.70%, inflation (Consumer Price Index) was 3.06%, corporate bonds (Ibbotson U.S. Long-Term Corporate Bond Index) returned 2.45%, long-term government bonds (Ibbotson U.S. Long-Term Government Bond Index) returned 2.11% and T-Bills (Ibbotson U.S. 30-Day T-Bill Index) returned 1.70%. (The commodities index S&P GSCI was not yet incepted.) From 1982 to 1999, stocks (S&P 500 Index) returned 18.52%, corporate bonds (Ibbotson U.S. Long-Term Corporate Bond Index) returned 12.17%, long-term government bonds (Ibbotson U.S. Long-Term Government Bond Index) returned 12.08%, commodities (S&P GSCI Index) returned 9.00%, T-Bills (Ibbotson U.S. 30-Day T-Bill Index) returned 6.23% and inflation (Consumer Price Index) was 3.29%. Sources: Morningstar; Bloomberg L.P., Lipper (commodities).

Important information

Past performance is no guarantee of future results.

Diversification does not guarantee a profit or eliminate the risk of loss.

The MSCI World Index is an unmanaged index considered representative of stocks of developed countries.

The Barclays U.S. Treasury Bellwethers 10 Year Index is an unmanaged index considered representative of US Treasury bonds with maturities of 10 years.

The S&P GSCI Index is an unmanaged world production-weighted index composed of the principal physical commodities that are the subject of active, liquid futures markets.

The S&P 500 Index is an unmanaged index considered representative of the US stock market.

The CPI is a measure of change in consumer prices as determined by the US Bureau of Labor Statistics.

The Ibbotson U.S. Long-Term Government Bond Index is an unmanaged index representative of long-term US government bonds.

The Ibbotson U.S. 30-Day T-Bill Index is an unmanaged index representative of 30-day Treasury bills.

The Ibbotson U.S. Long-Term Corporate Bond Index is an unmanaged index representative of long-term US corporate bonds.

An investment cannot be made directly into an index.

Invesco Balanced-Risk Allocation Fund risks:

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

There is a risk that the Federal Reserve Board (FRB) and central banks may raise the federal funds and equivalent foreign rates. This risk is heightened due to the potential “tapering” of the FRB’s quantitative easing program and other similar foreign central bank actions, which may expose fixed income investments to heightened volatility and reduced liquidity, particularly those with longer maturities. As a result, the value of the Fund’s investments and share price may decline. Changes in central bank policies could also increase shareholder redemptions, which may increase portfolio turnover and fund transaction costs.

An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

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.

The risks of investing in securities of foreign issuers, including emerging markets, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.

By investing in the subsidiary, the Fund is indirectly exposed to risks associated with the subsidiary’s investments, including derivatives and commodities. Because the Subsidiary is not registered under the Investment Company Act of 1940, as amended (1940 Act), the Fund, as the sole investor in the Subsidiary, will not have the protections offered to investors in U.S. registered investment companies.

Underlying investments may appreciate or decrease significantly in value over short periods of time and cause share values to experience significant volatility over short periods of time.

The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the Fund.

Michael McHugh, CFA

Client Portfolio Manager¹

Michael McHugh is a Client Portfolio Manager for Invesco’s Global Asset Allocation (GAA) team, which invests in stock, bond and commodity markets worldwide.

Mr. McHugh joined Invesco in 1998 as an Internal Wholesaler and was promoted to Regional Vice President in 2001. He joined the Product Strategy and Investment Services division in January 2005 as a senior research analyst and became a product manager the following year. Prior to joining the GAA team, he also co-authored the firm’s Rethinking Risk program.

Mr. McHugh began his career in the industry in 1996 as a financial advisor for American Express Financial Advisors Inc.

Mr. McHugh earned a BS degree in business information systems from Bellevue University. He is a CFA charterholder.

1 Not involved in managing assets of any fund.

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Active share, a tool for demonstrating how a fund’s portfolio differs from its respective benchmark, has been a common term among active investors over the last few years. Tracking error, which has a much longer history, is often regarded as another tool that does the same job. But the differences between the two measures affect how Invesco’s Global Opportunities investment team views their effectiveness and usefulness for investors.

Tracking error: Useful from returns perspective

Tracking error — the divergence between price behaviors of a portfolio and its benchmark — is a backward looking tool, using historical data to show the volatility of the fund’s returns versus that of its benchmark. It’s useful in demonstrating how closely a portfolio follows its benchmark from a returns perspective. However, it’s important to consider these two questions:

• What’s the benchmark? A fund with a low tracking error versus a volatile benchmark may not produce the return profile investors seek.

• Are upside and downside volatility equally important to investors? The most common method of assessing tracking error involves calculating the standard deviation of the fund and benchmark returns, which reflects both upside and downside volatility. In our experience, however, investors have been more concerned about the implications of downside volatility.

More importantly, as active investors, our team’s main reservation about tracking error is acceptance of the benchmark as the right reference point for measuring volatility and, by implication, risk. In contrast, the investment world doesn’t revolve around the benchmark for our fund managers. We define risk as the potential for permanent loss of capital, using maximum drawdown and downside volatility as indicators. And we often view volatility — at least in the short term — as an opportunity to exploit valuation anomalies in the stock market.

Active share: Looks at holdings and weightings

Active share is a much simpler calculation that provides a snapshot in time. It measures how different a portfolio is from its benchmark by comparing the fund’s holdings and their weightings with those of the benchmark. We believe active share provides a clearer picture of how active a fund manager is than drawing conclusions from standard deviation calculations.

In simple terms, a tracker fund that perfectly replicates its benchmark will have an active share of 0%, while an active fund that owns no constituents of its reference benchmark will have an active share of 100%. This measure is increasingly important, given the rise of passive investing and the need to differentiate between quasi-passive and genuinely active managers.

Origin of active share

The concept of active share was introduced in research by Martijn Cremers and Antti Petajisto, which indicated that portfolios with a high active share were, on average, likely to outperform their benchmarks, suggesting a positive correlation between performance and active share.¹ Additional research by Cremers and fellow economist Ankur Pareek² combined active share analysis with portfolio managers’ stock holding period, where long duration is defined as more than two years. The research shows clear outperformance, on average, of those strategies that combine high active share and long duration, or low turnover, of stocks. Of course, past performance does not guarantee future results.

Earlier this year, Invesco published a white paper examining the historical outperformance of active management, using active share as the measuring stick for active management.

Because high active share offers no performance guarantee, it’s possible to have a high active share portfolio that underperforms its benchmark. However, our team believes that to outperform a benchmark, portfolio construction needs to differ from the benchmark, and active share is a reliable, easy way of measuring this. So while active share doesn’t guarantee performance, we believe it’s a prerequisite — if you aren’t different, then you can’t hope to achieve a different result, good or bad.

By-product of investment philosophy

While we don’t explicitly target a high active share in the Invesco Global Opportunities strategy, it’s a by-product of our investment philosophy — concentrated and flexible investing that views risk as absolute, not relative. The result is an active share that is typically high, currently at 95%.

Put simply, to create an opportunity to deliver alpha for our investors, we believe the fund has to be meaningfully different from its benchmark. In addition, we see no evidence to suggest a direct link between the strategy’s tracking error and performance.

1 Source: “How active is your fund manager? A new measure that predicts performance,” Aug. 7, 2006.

2 Source: Patient Capital Outperformance: “The Investment Skill of High Active Share Managers Who Trade Infrequently,” Sept. 19, 2014.

Important information

Alpha refers to the excess returns of a fund relative to the return of a benchmark index.

Standard deviation measures a portfolio’s range of total returns and identifies the spread of a portfolio’s short-term fluctuations.

Drawdown is the largest cumulative percentage decline in net asset value as measured on a month-end basis.

Absolute return refers to the return an asset achieves over a certain period of time, without comparison to another measure or benchmark.

Rob Stabler

Product Director

Rob Stabler is a Product Director at Invesco Perpetual and is responsible for developing and delivering the investment message of the Global Equities team.

Mr. Stabler joined Invesco Perpetual in 2002 and spent 11 years working as regional sales manager within the Retail Sales team, developing and maintaining relationships across a range of wealth managers, IFA and fund-of-fund clients. He moved to his current position in 2013. Mr. Stabler began his career in financial services in 2000, working as an independent financial advisor.

Mr. Stabler earned a BA degree in politics and economics from Newcastle University. He also holds the Investment Management Certificate.

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As I travel across the country meeting with financial advisors and their clients, a common concern I hear voiced is “how can I position my portfolio for when the inevitable happens and interest rates start to rise?” In response, I state that certain types of alternative investments are well suited to help prepare portfolios for rising interest rates in the future, while also potentially adding value in the present.

Specifically, I highlight four different types of alternatives for clients to consider:

• Senior loans (also known as bank loans, senior secured loans and/or leveraged loans) – Senior loans are loans made by banks to non-investment grade companies, commonly in relation to leveraged buyouts, mergers and acquisitions. The loans are called “senior” because they are contractually senior to other debt and equity, and are typically secured by collateral.

Given that the loans are made to non-investment grade companies, the yield associated with them tends to be higher than on investment grade corporate bonds.¹ For example, as of the end of May, senior loans were yielding 5.51% versus a yield of 2.99% on investment grade corporate bonds.²

Another key aspect of senior loans is that the interest rate paid is a floating rate that resets every 30 to 90 days.³ This means that in a rising interest rate environment, as long as the rate rises above a predetermined minimum level, the investor will receive increased payments from the borrower. Therefore, senior loans may potentially outperform other types of bonds in rising rate environments due to their floating rates.

Invesco offers three different senior loan investments strategies for individual investors: Two mutual funds, Invesco Floating Rate Fund with daily liquidity and Invesco Senior Loan Fund with monthly liquidity; and PowerShares Senior Loan Portfolio as an exchange-traded fund (ETF) option.

• Unconstrained bond funds – Unconstrained bond funds are funds in which the portfolio manager is given the flexibility to invest globally across all sectors of the fixed income markets. The manager also may use derivatives, leverage and shorting when implementing his or her strategy. Given the tools made available to the manager, unconstrained bond funds tend to have an absolute return orientation, meaning that they may seek to generate a positive return in any market environment.

In a rising interest environment, an unconstrained bond fund has the ability to take advantage of rising rates by utilizing a number of derivative strategies. One such strategy would be to short Treasury bond futures. Treasury bond futures mimic the returns of Treasuries, which are negatively impacted by rising rates. Therefore, by shorting Treasury futures you would gain when interest rates rise. Furthermore, such funds have the ability to avoid regions and sectors that they do not find attractive while focusing on the regions and sectors they believe offer the best potential for success. In general, investors should expect unconstrained bond funds to potentially outperform traditional bond funds in down bond markets, and to possibly underperform traditional bond funds in rising bond markets.

Invesco Unconstrained Bond Fund is a mutual fund available to individual investors. It seeks to provide a positive absolute return over a full market cycle.

• Market neutral funds – Market neutral funds seek to generate positive returns regardless of market environment by trading related stocks on a long and short basis. Such funds are designed to cushion a portfolio against broad market swings.

Although market neutral funds invest in equities, many of these funds are designed to reduce the volatility associated with their return. Therefore, investors who are interested in seeking lower volatility returns — but may be concerned about bonds’ exposure to interest rate risk — might consider market neutral funds as an option. That said, investors considering market neutral funds should be aware that such funds, unlike traditional bond funds, do not generate current yield, and that they can experience more severe declines than traditional bond funds.

For investors looking for a fund that is not subject to interest rate risk, and that seeks a positive return over a full market cycle while aiming to limit exposure to general risks associated with equity investing, market neutral funds such as Invesco Global Market Neutral Fund, might be an appealing option.

• Global macro funds – Global macro funds are funds that invest across the global markets in equities, fixed income, currencies and commodities on a long and short basis. As a result, these funds tend to be very opportunistic in their investment approach.

When interest rates begin to rise, the fallout is likely to be felt across the global markets. Given the markets traded and their opportunistic nature, global macro funds have the potential to thrive in a rising interest rate environment.

Invesco Global Targeted Returns Fund and Invesco Global Markets Strategy Fund are examples of global macro funds.

Read more blogs about alternative investing from Walter Davis.

1 This is due to the increased credit risk associated with non-investment grade companies relative to investment grade companies.

2 Source: Bloomberg L.P. as of May 31, 2015. Corporate bonds are represented by a subset of the Barclays US Aggregate Bond Index, and senior loans are represented by the S&P/LSTA Leveraged Loan Index.

3 Senior loans are usually priced relative to three-month LIBOR, with the lender receiving a fixed spread above the LIBOR rate. Therefore as LIBOR rises, the amount paid by the borrower increases. Importantly, most loans have a provision that establishes a minimum, or floor, for LIBOR. Typically the floor rate is around 1.00%. This helps protect the lender should LIBOR fall below 1.00%. Currently, the three-month LIBOR rate is approximately 0.28%. Due to the floor, LIBOR would need to rise above the 1.00% floor before the investor would receive the benefit of rising interest rates.

Important information

The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market.

The S&P/LSTA Leveraged Loan Index is a weekly total return index that tracks the current outstanding balance and spread over Libor for fully funded term loans.

An investment cannot be made in an index. Past performance cannot guarantee future results.

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.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Most senior loans are made to corporations with below investment-grade credit ratings and are subject to significant credit, valuation and liquidity risk. The value of the collateral securing a loan may not be sufficient to cover the amount owed, may be found invalid or may be used to pay other outstanding obligations of the borrower under applicable law. There is also the risk that the collateral may be difficult to liquidate, or that a majority of the collateral may be illiquid.

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.

Walter Davis

Alternatives Investment Strategist

As Alternatives Investment Strategist, Walter Davis serves as Invesco’s primary alternatives representative to retail, high net worth and institutional clients across the major broker dealers, wirehouses and RIAs. He is responsible for collaborating across Invesco’s alternative strategies to develop a cohesive alternatives education program for financial advisors and investors.

Prior to joining Invesco in 2014, Mr. Davis served as a managing director in Morgan Stanley’s Alternative Investments Department, and earlier as director of High Net Worth and Institutional Sales. Prior to Morgan Stanley, he worked at Chase Manhattan Bank in the Alternative Investments Department. He has worked in the industry since 1991.

Mr. Davis graduated cum laude with a BA in economics from the University of the South. He earned an MBA in finance and international business from Columbia Business School. He holds the Series 3, 7, 24 and 63 registrations.

The post Concerned about rising interest rates? Consider these four alternative investments appeared first on Expert Investment Views - Invesco US Blog.

The market downturn and ensuing volatility in the third quarter of 2015 is a timely reminder about the benefits of diversifying your portfolio with investment strategies that are expected to exhibit little-to-no correlation with the broad equity and bond markets.

Moreover, as the US enters the late innings of its current economic growth cycle, many professional and individual investors are expecting lower returns from equities going forward than they’ve enjoyed over the last few years. These lowered expectations are on top of concern about what will happen to investors’ bond holdings when today’s historically low interest rates eventually rise.

The Invesco Quantitative Strategies team believes one potential way to buffer the effects of market downturns, volatility and rising interest rates is to add market neutral equity strategies to traditional portfolios, as they potentially offer a unique approach to generating return regardless of the general movements of the equity and bond markets.

In this blog, I outline four of the top reasons to consider market neutral equity strategies:

1. They have very low levels of correlation to other asset classes

One of the ways investors attempt to manage and mitigate risk is by combining strategies that differ within and across asset classes to help diversify their return pattern over time. Using this approach, investors’ wealth creation is not tied to the fortunes of just one or a few investment options. Since market neutral strategies typically seek to eliminate exposure to the broader market, these strategies have also delivered attractively low levels of correlation, not only to the equity markets, but to other broad asset classes as well.

As shown in Figure 1, from January 1997 to August 2015, market neutral strategies had only a 0.18 correlation to equities and a 0.04 correlation to bonds. Market neutral also had low correlation to another popular asset class, commodities, as well as to other segments of the fixed income market, such as leveraged loans and high yield. As investors seek to diversify their holdings in order to lower overall volatility, we believe market neutral strategies should be considered as a way to achieve that goal.

Sources: Invesco and StyleADVISOR. (January 1997 – August 2015) BarclayHedge Alternative Investment Database. Past performance is not a guarantee of future results. Investments cannot be made directly into an index.

2. They may offer lower levels of total volatility

Another way to potentially mitigate risk across an investment lineup is to include strategies that may offer lower levels of total volatility (variation in portfolio returns). Even if these strategies were perfectly correlated with other investments, their potentially lower total volatility profile could help lower the overall average volatility of the full lineup. Market neutral strategies also may be appealing to investors from this total volatility perspective, as their volatility has tended to be less than the broader equity markets, and in some cases, similar to broad fixed income indexes (see Figure 2). Furthermore, since market neutral returns are expected to be independent of the broader equity market, a spike in market-level volatility may not necessarily mean a spike in market neutral volatility.

Sources: Invesco and StyleADVISOR. (January 1997 – August 2015). BarclayHedge Alternative Investment Database. Past performance is not a guarantee of future results. Investments cannot be made directly into an index.

3. They have a history of attractive downside protection during extreme market stress

Another often-cited potential benefit of market neutral is that the strategies may offer investors a way to mitigate severe losses during a sharp equity market sell-off. Because these strategies typically have beta exposure to the market that hovers around zero, a big drop (or surge) in equities should not influence the performance of the strategy. This contrasts sharply with traditional, benchmark-centric strategies, which typically have very high levels of market exposure and tend to vary similarly to the broader market.

Sources: Invesco and StyleADVISOR. January 1997 – August 2015. BarclayHedge Alternative Investment Database. Past performance is not a guarantee of future results. Investments cannot be made directly into an index.

4. They can provide an opportunity for higher returns in a rising interest rate environment.

We believe an increase in the federal funds rate from the US Federal Reserve is inevitable; at this point it’s simply a matter of when and by how much. For market neutral equity strategies, a rise in interest rates – specifically short-term interest rates — can potentially provide a boost to returns. This occurs when market neutral equity strategies short a stock and receive proceeds from that sale. Those proceeds typically earn a rate of return tied to the prevailing short-term interest rate, such as the fed funds rate. When that rate increases, so does the interest earned by market neutral equity strategies on their short sale proceeds

Key takeaway

We believe a market neutral equity strategy is a valuable complement to a traditional portfolio of stocks and bonds, as well as an excellent diversification tool that enables investors to pursue increased returns from assets that respond differently to changing market conditions. Such characteristics may be important to today’s investors given the recent market downturn, volatility and expectation of rising interest rates.

Important information

Beta is a measure of risk representing how a security is expected to respond to general market movements.

Correlation is the degree to which two investments have historically moved in relation to each other.

Volatility measures the amount of fluctuation in the price of a security or portfolio over time.

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

The S&P/LSTA US Leveraged Loan 100 Index is representative of the performance of the largest facilities in the leveraged loan market.

The S&P GSCI Index is an unmanaged world production-weighted index composed of the principal physical commodities that are the subject of active, liquid futures markets.

The BofA Merrill Lynch US High Yield Index tracks the performance of US dollar-denominated, below-investment-grade corporate debt publicly issued in the US domestic market.

BarclayHedge Alternative Investment Database is a computerized database that tracks and analyzes the performance of approximately 6800 hedge fund and managed futures investment programs worldwide. BarclayHedge has created and regularly updates 18 proprietary hedge fund indices and 10 managed futures indices. BarclayHedge indexes reflect performance of hedge funds, not of retail investment strategies, and are used for illustrative purposes only solely as points of reference in evaluating alternative investment strategies. Please note: BarclayHedge is not affiliated with Barclays Bank or any of its affiliated entities. Performance for funds included in the BarclayHedge indices is reported underlying fees in net of fees.

About risk

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Most senior loans are made to corporations with below investment-grade credit ratings and are subject to significant credit, valuation and liquidity risk. The value of the collateral securing a loan may not be sufficient to cover the amount owed, may be found invalid or may be used to pay other outstanding obligations of the borrower under applicable law. There is also the risk that the collateral may be difficult to liquidate, or that a majority of the collateral may be illiquid.

Junk bonds involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.

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 the fund 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, the fund’s exposure is unlimited.

Kenneth Masse, CFA

Client Portfolio Manager¹

Ken Masse is a Client Portfolio Manager for Invesco Quantitative Strategies (IQS).

Mr. Masse entered the industry in 1992 and joined Invesco in 2008. Previously, he was an equity portfolio manager, head of Portfolio Construction & Implementation and a structured investments portfolio manager for PanAgora Asset Management.

Mr. Masse earned a bachelor’s degree in finance from Bentley University and a master’s degree in finance from Boston College. He holds the Series 6, 7 and 79 registrations and is a CFA charterholder.

1 Not involved in managing assets of any fund.

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Divergence in economic growth and monetary policy around the world has led to an increasingly volatile market environment in 2015. Specifically, while the United States (US) and the United Kingdom (UK) have been preparing to raise interest rates from rock-bottom levels, Europe and Japan have continued to employ quantitative easing measures. China also stepped up monetary easing policies during the year through several interest rate cuts and a surprise devaluation of its currency.

What is important to know about our team’s investment process is that we take a two- to three-year view of the world, which helps us avoid some of the short-term noise in the markets, looking across asset classes, currencies, geographies and sectors to identify good long-term ideas¹ wherever they may be. Going forward, we believe the following themes will likely prevail over the next two to three years:

Low, but positive, global economic growth

• We believe that structural economic growth will remain subdued on a global basis. However, regional differences could continue, with inventory and capital expenditure concerns acting as a potential drag on consumption-led US growth, and the economic slowdown in China posing a potential risk to Europe’s cyclical recovery.

Interest rates to remain low

• At the beginning of 2015, we acknowledged that interest rates could start to rise in the US and the UK, and that impacted our appetite for having duration in the portfolio. Given the modest economic outlook, we expect interest rates to remain low over the next few years even if rates do tentatively start to rise in the US and UK. We believe the outstanding question is whether the monetary policies that are driving these changes will be effective in sustaining a healthy economic recovery.

Low inflation to continue globally

• We expect low inflation to continue globally, exacerbated by ongoing competitive currency devaluation. We believe underlying inflation will remain low in the face of structural factors, such as debt overhang, and that implied inflation priced into forward interest rates will remain high.

Select opportunities in risk assets

• We believe that select opportunities exist in risk assets, but current equity valuations must be navigated with care as earnings trends show differences between regions. Within fixed income, the search for yield appears to be distorting valuations, although US corporate bonds look, in our view, more fairly priced.

Higher levels of market volatility to persist

• Volatility has risen in 2015, but we believe that divergent economic policy globally, as well as non-market forces such as political interference, could underpin persistently higher levels of absolute volatility over the coming years.

Given this two- to three-year outlook of the market, in the shorter-term we believe that 2016 could potentially bring with it some significant changes across financial markets. The beginning of a rate-tightening cycle could lead to a very different landscape for investing, as compared to the past few years which were defined by very loose monetary policy. This is important for a multi-asset portfolio like ours. For example, if interest rates rise, bonds may not provide the diversification² investors need.

Another general theme, which extends through 2016 and beyond, is the use of different policy tools around the world. Ongoing competitive currency devaluation is a theme that may dominate across Asia in particular as economies fight for their share of global trade. In this environment, taking views on individual countries rather than broad-based regions makes sense as individual countries are responding to global economic pressures in very different ways, in our view. As policy and economic factors diverge across regions, this typically underpins higher asset class volatility than we have experienced over the past few years.

Learn more about Invesco Global Targeted Returns Fund.

Important information

1 The opinions of the ideas expressed are those of Invesco Multi-Asset Team and are based on current market conditions which are subject to change without notice. These opinions may differ from those of other investment professionals.

2 Diversification does not guarantee a profit or eliminate the risk of loss.

Volatility measures the amount of fluctuation in the price of a security or portfolio.

About risk

There is a risk that the Federal Reserve Board (FRB) and central banks may raise the federal funds and equivalent foreign rates. This risk is heightened due to the potential “tapering” of the FRB’s quantitative easing program and other similar foreign central bank actions, which may expose fixed income investments to heightened volatility and reduced liquidity, particularly those with longer maturities. As a result, the value of the Fund’s investments and share price may decline. Changes in central bank policies could also increase shareholder redemptions, which may increase portfolio turnover and fund transaction costs.

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. These risks are greater for the Fund than most other funds because its investment strategy is implemented primarily through derivatives rather than direct investments in more traditional securities.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The Fund is subject to the risks of the underlying funds. Market fluctuations may change the target weightings in the underlying funds and certain factors may cause the Fund to withdraw its investments therein at a disadvantageous time.

Leverage created from borrowing or certain types of transactions or instruments may impair liquidity, cause positions to be liquidated at an unfavorable time, lose more than the amount invested, or increase volatility.

The Fund is non-diversified and may experience greater volatility than a more diversified investment.

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 Fund may invest in derivatives either directly or, in certain instances, indirectly through Invesco Cayman Commodity Fund VII Ltd., a wholly owned subsidiary of the Fund organized under the laws of the Cayman Islands (Subsidiary). Because the Subsidiary is not registered under the Investment Company Act of 1940, as amended (1940 Act), the Fund, as the sole investor in the Subsidiary, will not have the protections offered to investors in U.S. registered investment companies.

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

Debt securities are affected by changing interest rates and changes in their effective maturities and credit quality.

Underlying investments may appreciate or decrease significantly in value over short periods of time and cause share values to experience significant volatility over short periods of time.

The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the Fund.

David Millar

Head of Multi Asset, Invesco Perpetual

David Millar is head of the Multi Asset team for Invesco Perpetual. Mr. Millar joined Invesco in January 2013 and is based in Henley-on-Thames, outside of London.

After commencing his investment career with Scottish Widows in 1989, where he qualified as an actuary, Mr. Millar joined the Fixed Interest team at Scottish Widows Investment Partnership in 1996, becoming head of Bond Strategy and chair of the Bond Policy group. In 2008, he joined Standard Life Investments as an investment director of the Multi Asset investing team. He was one of the portfolio managers on their absolute return fund and was chair of their Bond Investment group.

Mr. Millar earned a BSc (Hons) degree in mathematical statistics from the University of Cape Town and is a Fellow of the Institute and Faculty of Actuaries.

Invesco Perpetual is a business name of Invesco Asset Management Limited (IAML), an investment adviser. Invesco Distributors, Inc., Invesco Advisers, Inc. and IAML are each indirect, wholly owned subsidiaries of Invesco Ltd.

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The past year witnessed a significant spike in volatility as the health of the global economy faced uncertainty. Global markets struggled with concerns over growth and stability in China, emerging market weakness and currency devaluation, recession in Japan and the continued need for inflation-targeting policy in Europe. And while the US economy appeared to be the relative picture of health, the equity markets continued to focus on decisions by the Federal Reserve Board (the Fed) and depressed commodity prices.

Even with these macroeconomic cross currents, favorable underlying strength of commercial real estate and infrastructure fundamentals continued throughout calendar 2015. Returns for real estate equities were consistent yet below the broader indices, while returns for master limited partnership (MLP) and infrastructure equities were dramatically lower.

What might 2016 have in store?

• The tempered macroeconomic growth environment, manageable levels of new commercial construction and the “lower for longer” interest rate outlook currently embraced by many forecasters should provide a fairly supportive environment for both commercial real estate and infrastructure, in our view.  For many of the companies in which we invest, underlying cash flows remain stable-to-growing. However, share prices and investor sentiment were anything but stable in 2015. The year may bring another dose of share price volatility in spite of healthy company operating performance.
• The Fed’s pace and timing of additional tightening of monetary policy will likely impact asset prices. History shows that investors typically overreact to interest rate increases and reduce exposure to income-related investments including US real estate investment trusts (REITs). This volatility has traditionally paved the way for US REITs to outperform in the year following the initial market reaction.
• Additional stimulus by the European Central Bank and the People’s Bank of China is likely to result in a stabilization of economic growth, albeit at lower levels than in recent history. This would have the greatest impact on our global real estate and global infrastructure portfolios.
• Growing capital needs within the public sector may increasingly result in the privatization of large scale infrastructure projects, such as the redevelopment of New York’s LaGuardia airport or the infrastructure concession programs in Sao Paulo, Brazil, and throughout Japan.
• The 2015 budget cuts by energy companies should continue to slow US oil production, and inventories should fall in 2016, helping to stabilize the oil price environment. This could bode well for MLPs, which have been battered despite their traditionally low correlation to commodity prices and the contractual nature of their cash flows.
• Geopolitical events remain top of news and are extremely difficult to forecast for either their occurrence or their impact on global capital markets and investment returns.

Taking advantage of volatility

With so many macro cross currents in mind, where do we see opportunity? We believe investors should:

1. Remain focused and committed to their long-term strategic asset allocation. If the market over-reacts to short-term events, rebalancing portfolios may help take advantage of such movements.
2. Examine the types of investments that may improve portfolio diversification.  Companies that own commercial real estate and infrastructure assets typically offer long-term stable cash flows and have historically paid attractive dividends that outpace inflation.  Many of these long-term contractual cash flows in which we invest are insulated from short-term economic bumps in the road.

If investors remain committed to strategic objectives and fundamental decisions during 2016, there is a good chance that market volatility can work in their favor.

Read more in our 2016 Investment Outlook series.

Important information

Diversification does not guarantee a profit or eliminate the risk of loss.

Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.

Investment in infrastructure-related companies may be subject to high interest costs in connection with capital construction programs, costs associated with environmental and other regulations, the effects of economic slowdown and surplus capacity, the effects of energy conservation policies, governmental regulation and other factors.

Most MLPs operate in the energy sector and are subject to the risks generally applicable to companies in that sector, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk. MLPs are also subject the risk that regulatory or legislative changes could eliminate the tax benefits enjoyed by MLPs which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the portfolio’s investments.

Joe Rodriguez

Managing Director

Head of Global Real Estate Securities

Invesco Real Estate

In addition to portfolio management, Mr. Rodriguez is a managing director and the head of real estate securities for Invesco Real Estate, where he oversees all phases of the unit, including securities research and administration.

Mr. Rodriguez began his investment career in 1983 and joined Invesco Real Estate, the Dallas-based investment management affiliate of Invesco Institutional (N.A.), Inc., in 1990. He has served on the editorial board for the Financial Times Stock Exchange National Association of Real Estate Investment Trusts (FTSE NAREIT), as well as the editorial board of the Institutional Real Estate Securities newsletter. He is a member of the National Association of Business Economists, American Real Estate Society and the Institute of Certified Financial Planners. He has also served as adjunct professor of economics at The University of Texas at Dallas.

In addition, Mr. Rodriguez was a contributing author to Real Estate Investment Trusts: Structure Analysis and Strategy, published by McGraw-Hill. He made contributions as editor and author to several industry publications, and has been featured as a real estate expert by both financial industry print and television media such as CNBC and Bloomberg News.

Mr. Rodriguez earned a Bachelor of Business Administration degree in economics and finance as well as an MBA in finance from Baylor University.

Whenever I meet with advisors and clients, I emphasize the importance of looking through the windshield when investing, rather than looking into the rearview mirror. In other words, invest in anticipation of what might happen in the future — not in reaction to what has happened in the past. To see why this is important, let’s examine what the view looks like from the driver’s seat today.

Looking in the rearview mirror: above-average equity returns and low risk

Given where we are today, investors who look in the rearview mirror see a wonderful period for US equities post-financial crisis. As the table and chart below illustrate, over the past five years, US equities have generated returns well above their long-term historical average. Furthermore, these returns have been achieved with relatively low levels of risk (as measured by standard deviation).

The past five years have been marked by high returns and low volatility for stocks

Source: Lipper, Inc. Data through Nov. 30, 2015. Stocks represented by the S&P 500 Index. An investment cannot be made directly in an index. Past performance is no guarantee of future results.

Looking through the windshield: a possibility of below-average returns

While many stock investors have benefitted tremendously over the past five years, firms like Morgan Stanley have begun to warn investors to “prepare for an era of below-average returns.”¹ While no one knows what the future holds for equities, I believe it’s prudent for investors to prepare for a normalization of equity returns and volatility (i.e., for equity returns to decline from current levels, and for volatility to increase from current levels — performing more in line with their long-term historical averages.)

Preparing for change in the markets

How can investors prepare for this scenario? I believe that alternative investments will prove helpful to investors, especially as equity returns normalize. As the chart² below demonstrates, over the long term, alternative investments have historically delivered equity-like returns with lower levels of volatility and maximum decline.

The period represented is January 1997 through June 2015. Past performance is not a guarantee of future results.

While the above chart is helpful for examining alternatives over the long term, many investors’ experience with alternatives has been limited to the post-financial crisis period, a time in which equities have outperformed alternatives. As a result, many investors ask why they should consider alternatives when they’ve been able to generate strong equity returns with relatively low levels of risk over the past few years.

Looking at the historical performance of alternatives during bull and bear market cycles (see chart² below), it is clear that alternatives have historically lagged stocks during bull market periods and outperformed stocks during bear market periods. As investors consider how to position their portfolios for the future, they need to consider whether the recent period of strong equity returns and low equity volatility will continue or whether equity returns and volatility will normalize.

The period represented is January 1997 through June 2015. Past performance is not a guarantee of future results.

What’s your view?

For an investor who looks in the rearview mirror and believes the recent period of equity performance will continue, it may be preferable to avoid alternative investments and focus on equities. But for investors who look through the windshield and see the need to prepare for the possibility of declining equity returns and increasing equity volatility, I believe alternative investments should be considered for inclusion in their portfolios.

For more information about alternatives

• To learn more about Invesco’s alternative strategies, please visit invesco.com/alternatives.
• You can also read previous blogs from Walter Davis, and ask Walter your questions about alternatives with our Ask the Expert feature.
• And, learn why it’s time to say goodbye 60/40 and to consider alternatives as more of your core.

Important information

1 Bloomberg Business, “Morgan Stanley: Get Ready for a Period of Low Returns in the Market”, Nov. 30, 2015.

2 Source: StyleAdvisor. Alternatives portfolio represented by a portfolio comprising allocations to each of the following alternatives categories:

• Inflation-hedging assets, represented by 15% FTSE NAREIT All Equity REIT Index and 5% Bloomberg Commodity Index. The 15%/5% split reflects Invesco’s belief that investors tend to invest in strategies with which they are more familiar.
• Principal preservation strategies, represented by 20% BarclayHedge Equity Market Neutral Index.
• Portfolio diversification strategies, represented by 12.5% BarclayHedge Global Macro Index and 7.5% BarclayHedge Multi-Strategy Index. Multistrategy is underweighted in this example due to its potential overlap with global macro.
• Equity diversification strategies, represented by 20% BarclayHedge Long/Short Index.
• Fixed income diversification strategies, represented by 10% CS Leveraged Loan Index and 10% BarclayHedge Fixed Income Arbitrage Index.

The performance of individual alternative investments will differ from that of the index.

Equities represented by S&P 500 Index. Fixed income represented by Barclays US Aggregate Bond Index. Traditional 60/40 Portfolio represented by 60% S&P 500 Index and 40% Barclays US Aggregate Bond Index. An investment cannot be made directly in an index. Index returns do not reflect any fees or expenses. Past performance is not a guarantee of future results.

The Bloomberg Commodity Index is a broadly diversified commodity price index.

The Credit Suisse Leveraged Loan Index represents tradable, senior-secured, US-dollar-denominated, noninvestment-grade loans

The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market.

BarclayHedge indexes reflect performance of hedge funds, not of retail investment strategies, and are used for illustrative purposes only solely as points of reference in evaluating alternative investment strategies. The BarclayHedge Equity Market Neutral Index includes funds that attempt to exploit equity market inefficiencies and usually involves being simultaneously long and short matched equity portfolios of the same size within a country. The BarclayHedge Global Macro Index includes funds that carry long and short positions in any of the world’s major capital or derivative markets. The BarclayHedge Multi Strategy Index includes funds that are characterized by their ability to dynamically allocate capital among strategies falling within several traditional hedge fund disciplines. The BarclayHedge Long/Short Index includes funds that employ a directional strategy involving equity-oriented investing on both the long and short sides of the market.

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

The FTSE NAREIT All Equity REITs Index is an unmanaged index considered representative of US REITs.

The return/risk ratio is a measure of return in terms of risk measured by the standard deviation for a specific time period.

Standard deviation measures a portfolio’s range of total returns and identifies the spread of a portfolio’s short-term fluctuations.

Hedge funds are typically aggressively managed portfolios of investments for high net worth investors that use advanced investment strategies such as leverage, long, short and derivative positions with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). Hedge fund managers have less restriction on their investment methodologies than mutual fund managers, and hedge funds are less regulated and therefore offer less investor protection than mutual funds. Mutual funds are more transparent with regard to disclosure of underlying holdings and have lower fees than hedge funds.

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.

Stock and other equity securities values fluctuate in response to activities specific to the company as well as general market, economic and political conditions.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Walter Davis

Alternatives Investment Strategist

As Alternatives Investment Strategist, Walter Davis serves as Invesco’s primary alternatives representative to retail, high net worth and institutional clients across the major broker dealers, wirehouses and RIAs. He is responsible for collaborating across Invesco’s alternative strategies to develop a cohesive alternatives education program for financial advisors and investors.

Prior to joining Invesco in 2014, Mr. Davis served as a managing director in Morgan Stanley’s Alternative Investments Department, and earlier as director of High Net Worth and Institutional Sales. Prior to Morgan Stanley, he worked at Chase Manhattan Bank in the Alternative Investments Department. He has worked in the industry since 1991.

Mr. Davis graduated cum laude with a BA in economics from the University of the South. He earned an MBA in finance and international business from Columbia Business School. He holds the Series 3, 7, 24 and 63 registrations.

When you set a goal, are you hoping to achieve that goal? Or simply to make an average effort? Of course you want to meet your goals. Yet in investing, many people measure success against average market benchmarks, which may or may not help you meet your financial goals. Below, I discuss three ways to help you invest with your goals — not benchmarks — in mind.

1. Find your recipe

Our family kitchen boasts a variety of cookbooks for different cuisines, including American, Italian and French. Whatever their origin, the recipes require a mix of ingredients that, when combined and sequenced properly, result in a delicious outcome. But it’s also important to account for personal taste. For example, our son likes hot sauce on his scrambled eggs, while my wife and I prefer just a little salt and pepper. All three of us are getting protein, but his comes with a greater chance of heartburn, in our opinion. On the other hand, he thinks we’re boring.

Likewise, a properly designed portfolio has a variety of ingredients, which can be tailored to suit individual tastes. As I explained in my previous blog, “Endowment empowerment” for your portfolio, the basic ingredients for creating highly diversified portfolios include:

• Equities, including US, foreign, emerging markets and private equity.
• Fixed income, including corporate, government and foreign.
• Preferred or convertible securities.
• Alternative assets, such as real estate, commodities, infrastructure, precious metals and master limited partnerships.
• Alternative strategies, such as market neutral funds, that can further diversify a portfolio.

Your financial advisor can help you determine which strategies are right for you, and in what amounts. As investors get closer to their retirement years, advisors generally recommend a gradual shift toward risk reduction: Same basic ingredients, but reallocated to different percentages — and hold the hot sauce on the eggs.

2. Have conviction in your approach

There’s been a lot of debate among investors over the benefits of “active” funds, with investments that are chosen by portfolio managers, and “passive” funds, which are designed to track indexes. At Invesco, we believe this debate misses the point — we believe well-constructed portfolios can include both styles of investing. But again, no matter if you choose an active manager or an index-based strategy, we believe the ultimate objective shouldn’t be to settle for an average benchmark — it should be about achieving goals. You can read more about Invesco’s high-conviction approach to active and index-based strategies.

3. Be patient, but not passive

Even if passive investments are included in your investment mix, that doesn’t mean you should be passive about your portfolio. I believe investors should take an active approach to the allocation process — including regularly reviewing your portfolio with your advisor, rebalancing holdings to maintain your ideal allocation, and replacing “stale ingredients” that no longer fit your goals.

Keep in mind, however, that there’s a difference between “active” and “reactive.” In volatile markets, it can be tempting to react to every rise and fall in your portfolio, and switch out investments as soon as they start to underperform. However, markets move in cycles, and sometimes this year’s underperformers can be next year’s outperformers. That’s where patience comes in.

How can you maintain the proper balance? Your financial advisor can help you design, implement and maintain an individualized investment plan that applies these principles to your specific goals to potentially help you achieve the retirement you envision.

Talk to your advisor

Markets will always fluctuate, and no one can predict the future with 100% accuracy. But I believe that with a well-diversified investment mix, a high-conviction approach to investing, and an active but patient strategy for reviewing and rebalancing your portfolio, you can potentially generate the type of income and gains necessary to meet your retirement goals.

Investors with adequate exposure to equity and fixed income may want to talk to their advisors about additional ingredients that could help diversify their portfolios. Invesco Unit Trusts offers many choices to explore, including:

• Preferred securities, such as Preferred Opportunity Portfolio (PFOP).
• Alternative investments, such as Alternatives Allocation Portfolio (ALTS), American Infrastructure Growth Portfolio (INFA), Real Assets Growth & Income Portfolio (REAL) and MLP & Income Portfolio (MLPI).
• Diversifying strategies, such as Defensive Equity & Income Portfolio (DFEN), High Income Allocation Portfolio (HIAP) and Inflation Hedge Portfolio (HEDG).

Important information

Diversification does not guarantee a profit or eliminate the risk of loss.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Private equity strategies invest in companies that are not publicly quoted on a stock exchange.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Preferred stock is class of ownership in a corporation that has a higher claim on its assets and earnings than common stock.

A convertible security is an investment that can be changed into another form, such as convertible bonds that can be changed into common stock.

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.

A master limited partnership (MLP) is a publicly traded limited partnership in which the limited partner provides capital and receives periodic income distributions from the MLP’s cash flow and the general partner manages the MLP’s affairs and receives compensation linked to its performance.

Market neutral strategies use offsetting long and short stock positions in an attempt to limit nonstock-specific risk.

Investors considering high-conviction strategies should be aware of the unique characteristics and additional risks. This does not constitute a recommendation of the suitability of any investment strategy for a particular investor.

There is no assurance the trust will achieve its investment objective. An investment in this unit investment trust is subject to market risk, which is the possibility that the market values of securities owned by the trust will decline and that the value of trust units may therefore be less than what you paid for them. This trust is unmanaged and its portfolio is not intended to change during the trust’s life except in limited circumstances. Accordingly, you can lose money investing in this trust. The trust should be considered as part of a long-term investment strategy and you should consider your ability to pursue it by investing in successive trusts, if available. You will realize tax consequences associated with investing from one series to the next.

Jack Tierney

Head of Product Development, Management and Investment Research

Invesco Unit Trusts

Mr. Tierney joined Invesco in 2010. Prior to joining the firm, he performed the same role for Van Kampen Unit Trusts since 2003. During his tenure with Van Kampen, he held positions within Van Kampen Consulting, business development, marketing services, mutual fund product management, and distribution, having started as a wholesaler with Van Kampen Merritt in 1984.

Prior to Van Kampen, Mr. Tierney spent four years with Merrill Lynch in Chicago as a financial advisor. He began his career as a high school business teacher and basketball coach in the Chicago suburbs. Mr. Tierney earned a Bachelor of Science degree in Marketing and a Master of Science degree in Business Education from Northern Illinois University.

I discussed in a recent blog post how it might be prudent for investors to brace for the normalization of equity returns and risk – that is, when equity returns decline from recently high levels, risk increases from recently low levels, and they both perform more in line with their long-term historical averages.

Right after that blog posted, we experienced a sharp equity sell-off and a spike in volatility.

As the equity market normalizes, I believe alternative investments can be helpful to investors. That’s because alternatives have a history of outperforming equities during periods of stock market weakness, as the chart below demonstrates.

The period represented is January 1997 through June 2015. Past performance is not a guarantee of future results.

Invesco believes that to reach their goals, investors should make alternatives a core part of their portfolios. But which alternatives? In times like these, I believe investors should consider the following strategies as a way to potentially reduce the effects of equity volatility in their portfolio.

Market neutral strategies – Market neutral funds trade related equities¹ on a long and short basis — to the point where the fund has close to a zero beta² and close to zero net market exposure. With market neutral strategies, the key to generating a positive return is security selection — that is, determining which equities to go long on and which to go short.

Given their lack of beta and net market exposure, market neutral funds tend to be insulated against market swings, have the potential to generate positive returns in all market environments and typically produce returns that have low correlation to stocks and bonds. Furthermore, market neutral funds tend to generate modest returns with low volatility, similar to the historical risk-return profile of bonds.

Investment ideas – I believe advisors seeking to insulate their clients’ portfolios against heightened volatility should consider market neutral funds. Invesco Global Market Neutral Fund is an example of typical market neutral fund, while Invesco All Cap Market Neutral Fund is an example of a more aggressive version (i.e., it seeks higher returns with higher risk).

Global investing and trading strategies – Global investing and trading strategies invest opportunistically on a long and short basis across the global equity, fixed income, currency and commodity markets. Global macro and managed futures are the two most common examples of this strategy. These funds have the ability to trade opportunistically, selecting which markets they want, and don’t want, to participate in. Furthermore, because these funds have the ability to invest on both a long and short basis, they have the potential to achieve profits in both rising and falling market environments. Both global macro and managed futures funds have historically done well during periods of heightened market volatility and have historically generated returns with low correlation to stocks and bonds.

Investment ideas – Advisors should consider this strategy if they are looking to add investments to their clients’ portfolios that have the ability to benefit from heightened volatility, can opportunistically trade the global markets and have the potential to profit in both rising and falling markets. Invesco Global Targeted Returns Fund and Invesco Global Markets Strategy Fund are examples of global macro funds.

Long/short equity – Long/short equity funds combine both long and short equity positions in a portfolio, while typically being net long to stocks. As a result, these funds have a positive beta to stocks, and their performance tends to directionally follow the equity market. In general, such funds would be expected to underperform stocks during a rising equity market (due to losses on the fund’s short equity positions), and outperform stocks during a falling equity market (due to gains on the fund’s short equity positions).

Two key differentiators across long/short equity funds are how they implement their short positions and their typical net exposure to the market. For example, some funds use indexes for their shorts, while some will short stocks they think will decline in value. A manager with expertise in shorting can potentially add considerable value by playing offense with the short portion of the portfolio. That’s because those managers seek to generate positive returns from their short positions rather than using shorts solely for hedging purposes. The level of net market exposure can vary greatly from manager to manager, and is something that an advisor should understand before investing.

Investment ideas – Advisors concerned about the direction of the equity market should consider replacing some of their long-only equity exposure with exposure to long/short equity. By doing so, advisors can help their clients maintain net long exposure to the equity markets, while gaining potential downside protection. Invesco Long/Short Equity Fund and Invesco Macro Long/Short Fund are examples of long/short funds.

For more information about alternatives

• To learn more about Invesco’s alternative strategies, please visit invesco.com/alternatives.
• You can also read previous blogs from Walter Davis, and ask Walter your questions about alternatives with our Ask the Expert feature.
• And, learn why it’s time to say goodbye 60/40 and to consider alternatives as more of your core.

Important information

1 Stocks are related if they are driven by the same fundamental factors, for example, two stocks from the same industry

2 Beta is a measure of the volatility of an equity in comparison to the equity market as a whole

Diversification does not guarantee a profit or eliminate the risk of loss.

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.

Alternative investment products, including hedge funds and private equity, involve a high degree of risk, often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. There is often no secondary market for an investor’s interest in alternative investments, and none is expected to develop. There may be restrictions on transferring interests in any alternative investment.

Walter Davis

Alternatives Investment Strategist

As Alternatives Investment Strategist, Walter Davis serves as Invesco’s primary alternatives representative to retail, high net worth and institutional clients across the major broker dealers, wirehouses and RIAs. He is responsible for collaborating across Invesco’s alternative strategies to develop a cohesive alternatives education program for financial advisors and investors.

Prior to joining Invesco in 2014, Mr. Davis served as a managing director in Morgan Stanley’s Alternative Investments Department, and earlier as director of High Net Worth and Institutional Sales. Prior to Morgan Stanley, he worked at Chase Manhattan Bank in the Alternative Investments Department. He has worked in the industry since 1991.

Mr. Davis graduated cum laude with a BA in economics from the University of the South. He earned an MBA in finance and international business from Columbia Business School. He holds the Series 3, 7, 24 and 63 registrations.

The Invesco Global Asset Allocation team doesn’t consider double-digit declines in equity markets to be normal.  However, we do see three “typical” characteristics that have returned to the markets over the last few months — characteristics that we believe bode well for a global asset allocation approach.

1. Diversification is in demand again.  Historically, owning a wide set of assets has, on balance, been a smart strategy in both good times and bad. But the last few years – like the late ’90s dot.com era – have largely been an environment where US stocks have consistently outperformed and diversification has detracted from returns.  Recent months have looked more typical with Treasuries, and even certain commodities, providing decent returns (see chart 1).  Today, many assets remain far more attractively valued than the S&P 500 Index, in our opinion, meaning that when the equity market eventually rebounds, it may not prove to be such a dominant source of return.

Year-to-date, precious metals and long Treasuries have provided meaningful returns

Sources: Datastream and Invesco analysis. Performance from Dec. 31, 2015, to Feb. 9, 2016. Precious metals: S&P GSCI Precious Metals Index. Long Treasuries: Barclays US Treasury 20+ Year Index. T-Bills: Barclays 3-Month T-Bill Index. Emerging debt: JPMorgan EMBI Global Composite Index. Industrial metals: S&P GSCI Industrial Metals Index. Agriculture: S&P GSCI Agriculture Index. High yield: Barclays US Corporate High Yield 2% Issuer Capped Index. Emerging: MSCI Emerging Markets Index. US large cap: S&P 500 Index. International developed: MSCI EAFE Index. US small cap: Russell 2000 Index. Energy: S&P GSCI Energy Index. Past performance cannot guarantee future results. An investment cannot be made in an index.

2. Something’s doing well.  This is an important variation on the first observation.  In 2015, no asset among a broad set of stocks, bonds, and commodities returned more than 2%.  That’s the first time in at least 40 years that has been the case (see chart 2.)  So far in 2016, many assets have fallen, but a few have offered double-digit gains, as noted in the first point.  When there is greater disparity in the markets, there is greater scope for asset allocation strategies to help investors stay prepared.

In 2015, no asset class returned more than 2%

Sources: Datastream and Invesco analysis. Performance from Dec. 31, 2014, to Dec. 31, 2015. Precious metals: S&P GSCI Precious Metals Index. Long Treasuries: Barclays US Treasury 20+ Year Index. T-Bills: Barclays 3-Month T-Bill Index. Emerging debt: JPMorgan EMBI Global Composite Index. Industrial metals: S&P GSCI Industrial Metals Index. Agriculture: S&P GSCI Agriculture Index. High yield: Barclays US Corporate High Yield 2% Issuer Capped Index. Emerging: MSCI Emerging Markets Index. US large cap: S&P 500 Index. International developed: MSCI EAFE Index. US small cap: Russell 2000 Index. Energy: S&P GSCI Energy Index.

3. Volatility has reverted to more normal levels.  We all became spoiled with equity volatility below 15%.  But it’s far more typical to see volatility in the 15% to 20% range (see chart 3).  Even when the current bout of fear subsides, volatility seems unlikely to return to the exceedingly low levels of 2013 and 2014 as we see interest rates begin to normalize from their historically low levels.  The transition from central bank-driven markets — while perhaps necessary — was never likely to be terribly pleasant, and the resumption of higher volatility was inevitable, in our view.

Historically, it’s typical for equity volatility to be more than 15%

Sources: Datastream and Invesco analysis. Performance from Jan. 31, 1986, to Feb. 9, 2016. Equity market volatility represented by the CBOE Volatility Index® (VIX®).

Our approach to asset allocation

Many investors rely on a 60% stock/40% bond portfolio to provide both offense and defense during volatile markets. However, that type of portfolio may not be as durable as investors believe — it’s heavily exposed to the risks of the equity market, which, in our view, limits its effectiveness in different economic environments.

In contrast, Invesco Balanced-Risk Allocation Fund seeks to balance its risks between stocks, government bonds and commodities¹— each of which has historically outperformed in different types of environments. At the same time, we make monthly tactical adjustments that are designed to capitalize on timely market opportunities in these asset classes.

To learn more about my team’s approach, read my previous blog: Risk Parity: It’s About Preparation, Not Predictions. You can also find more information on the fund page for Invesco Balanced-Risk Allocation Fund.

Important information

1 Under normal conditions, the strategy invests in derivatives and other financially-linked instruments whose performance is expected to correspond to U.S. and international fixed income, equity and commodity markets. However, the performance of the asset classes cannot be guaranteed.

The S&P GSCI Precious Metals Index is a benchmark for investment performance in the precious metals market.

The Barclays US Treasury 20+ Year Index is an unmanaged index considered representative of US Treasury bonds with maturities longer than 20 years.

The Barclays 3-Month T-Bill Index is an unmanaged index considered representative of US Treasury bills with maturities of three months.

The JPMorgan EMBI Global Composite Index measures the performance of emerging markets bonds.

The S&P GSCI Industrial Metals Index is a benchmark for investment performance in the industrial metals market.

The S&P GSCI Agriculture Index is a benchmark for investment performance in the agriculture market.

The Barclays US Corporate High Yield 2% Issuer Capped Index is an unmanaged index that covers US corporate, fixed-rate, noninvestment-grade debt with at least one year to maturity and $150 million in par outstanding.

The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

The MSCI EAFE Index is an unmanaged index considered representative of stocks of Europe, Australasia and the Far East.

The Russell 2000® Index, a trademark/service mark of the Frank Russell Co.®,  is an unmanaged index considered representative of small-cap stocks.

The S&P GSCI Energy Index is a benchmark for investment performance in the energy market.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.

Stock and other equity securities values fluctuate in response to activities specific to the company as well as general market, economic and political conditions.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

Scott Wolle, CFA

Portfolio Manager

CIO of Invesco Global Asset Allocation

Scott Wolle is the chief investment officer (CIO) and a portfolio manager for the Invesco Global Asset Allocation team, which invests in stock, bond and commodity markets worldwide.

Mr. Wolle joined Invesco in 1999 as an analyst and portfolio manager, and became a member of the Global Asset Allocation team in 2001. He assumed his current role in 2005. He began his investment management career in 1991 with Bank of America.

Mr. Wolle graduated magna cum laude from Virginia Tech with a degree in finance. He earned an MBA from the Fuqua School of Business at Duke University, with the distinction of Fuqua Scholar. He is a CFA charterholder.

With today’s market environment being marked by downturns, volatility and rising rates, some investors have been seeking strategies that enable them to diversify with little-to-no correlation to the broad equity and bond markets. I believe market neutral strategies can help investors accomplish that goal by potentially generating return regardless of the general movement of the markets.

The Invesco All Cap Market Neutral Fund is a high-conviction portfolio that is designed to potentially neutralize the overall direction of the market and relies on skillful stock-picking to generate portfolio returns. Below, I explain how this approach works, and its potential benefits to investors.

What is a market neutral strategy?

Unlike traditional equity strategies, where portfolio managers can only generate returns by buying stocks that they expect to perform well, market neutral strategies can also borrow and sell stocks expected to perform poorly in a process known as “short selling,” or “shorting.”

With this approach, long positions profit when the price of an investment goes up, and short positions profit when the price of an investment goes down. For a market neutral strategy to produce attractive portfolio returns, the stocks being held long must outperform the stocks sold short, thus earning a positive “spread.”

Potential benefits of market neutral

Market neutral strategies offer several important potential benefits to investor portfolios, including diversification from traditional asset classes, the ability to dampen overall volatility, a cushion against severe equity market declines and a return boost from rising interest rates. Here are several key reasons to consider market neutral equity strategies.

Potential for positive returns whether the stock market is up, down or sideways

Market neutral equity strategy returns are not dependent on the direction of the market. Rather, their key return driver is the spread earned between the long and short holdings. If, on balance, the portfolio manager can correctly identify industry winners and losers relative to each other, then a market neutral equity strategy will deliver a positive return regardless of market direction.

Source: Invesco. The above chart is for illustrative purposes only and does not represent any particular Invesco product. Long/Short spread represents the return an investor would earn.

Lower levels of total volatility

Because market neutral strategies typically seek lower volatility than the market, they may provide a smoother ride for investors. This contrasts sharply with traditional, benchmark-centric strategies, which don’t have the ability to buffer portfolios from roller-coaster markets.

Sources: Invesco and StyleADVISOR. (January 1997 – August 2015). BarclayHedge Alternative Investment Database. Past performance is not a guarantee of future results. Investments cannot be made directly into an index.

History of attractive downside mitigation during market stress

Market neutral strategies may offer investors a way to mitigate severe losses during a sharp equity market sell-off. Because these strategies typically have beta exposure to the market that hovers around zero, a big drop (or surge) in equities should not influence the performance of the strategy. This contrasts sharply with traditional, benchmark-centric strategies, which typically have very high levels of market exposure and tend to move similarly to the broader market.

Sources: Invesco and StyleADVISOR. January 1997 – August 2015. BarclayHedge Alternative Investment Database. Past performance is not a guarantee of future results. Investments cannot be made directly into an index.

Opportunity for higher returns in a rising interest rate environment

For market neutral equity strategies, a rise in interest rates – specifically short-term interest rates — can potentially provide a boost to returns. This occurs when market neutral equity strategies short a stock and receive proceeds from that sale. Those proceeds typically earn a rate of return tied to the prevailing short-term interest rate, such as the Fed funds rate. When that rate increases, so does the interest earned by market neutral equity strategies on their short sale proceeds.

Key takeaway

Overall, we believe the Invesco All Cap Market Neutral Fund can be a valuable complement to a traditional portfolio of stocks and bonds, as well as an excellent diversification tool that enables investors to pursue increased returns from assets that respond differently to changing market conditions. Such characteristics may be important to today’s investors given the recent market downturn, volatility and expectation of rising interest rates.

Learn more about Invesco All Cap Market Neutral Fund.

Learn more about high-conviction investing.

Read more blogs from our high-conviction investment managers.

Important information

Diversification does not guarantee a profit or eliminate the risk of loss.

Beta is a measure of risk representing how a security is expected to respond to general market movements.

Spread represents the difference between two values.

About risk

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.

Stocks of small and mid-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.

The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.

Bernhard Langer, CFA

CIO of Invesco Quantitative Strategies

Bernhard Langer is Chief Investment Officer (CIO) of Invesco Quantitative Strategies. He was named CIO in January 2009 and is responsible for the quantitative equities investment approach, related products and clients. He is responsible for more than 40 investment professionals worldwide, and his team members are in New York, Boston, Frankfurt, Melbourne and Tokyo.

Mr. Langer began his investment career in 1989 with Bayerische Vereinsbank. He moved to its asset management function and led the strategy team from 1992 until his departure. He joined Invesco in 1994 as a portfolio manager for equities and became head of equities in 1996 and chief investment officer for Germany in 2000. In 2002, he took over the responsibility for the Quantitative Strategies Group (International).

Mr. Langer earned an MBA with a focus on economics and banking from the University of Munich. He is also a CFA charterholder.

With the first four months of the year in the books, I’d like to take a moment to break down the performance of alternatives thus far.

As readers of Invesco’s blog may already know, I am a big believer of investing “by looking through the windshield, rather than looking in the rearview mirror,” meaning investors need to invest in anticipation of what lies ahead, rather than based on past market performance. Furthermore, I continue to believe that after several years of equities generating returns well above their long-term average — while at the same time experiencing volatility well below the historical average — we are due to see lower returns and higher volatility return to the markets.

Looking at the markets this year, it clearly has been a tale of two periods. The first period occurred in the first six weeks of the year, as the S&P 500 Index sold off by over 10% and volatility, as measured by the CBOE Volatility Index (VIX), spiked to over 28. In the second period, from mid-February through April 30, 2016, the S&P 500 shot up about 13%, while volatility fell back to about 15. Clearly the first six weeks, can be characterized as a “risk off” environment in which investors fled risk assets, while the second period was a “risk on” period in which investors flocked back to risk assets.

Before I delve into the details, I wanted to note that I’m evaluating performance across the various categories used in Invesco’s alternatives framework, as shown below.

Framework applies to liquid alternatives and nonaccredited, retail investors. There is no guarantee the strategies will be successful.

Let’s now examine the performance of alternatives against the backdrop of today’s volatile markets:

Alternative assets – Alternative assets are long-only investments in assets other than stocks and bonds. Common examples include REITs (real estate investment trusts), infrastructure, MLPs (master limited partnerships) and commodities. Alternative assets are considered “risk assets,” and experienced negative performance during the first six weeks of the year. However, they have rebounded strongly since that time and, on a year-to-date basis, have outperformed equities.¹ Invesco offers a full range of alternative asset funds: Invesco Global Real Estate Fund, Invesco Global Real Estate Income Fund, Invesco Real Estate Fund, Invesco Global Infrastructure Fund, Invesco MLP Fund, Invesco Balanced-Risk Commodity Strategy Fund.

Relative value strategies – For this category, I’m going to focus on market neutral strategies, which can potentially generate return regardless of the general movements of the markets. As discussed in my last blog, I believe market neutral strategies can be valuable for investors, especially given my belief about equities facing lower returns and higher volatility. Market neutral as a category is more or less flat for the year.² With that said, market neutral is a strategy whose performance is highly dependent on a manager’s stock selection. Because of this, results can vary widely from manager to manager.

Invesco offers two market neutral funds: Invesco All Cap Neutral Fund and Invesco Global Market Neutral Fund.

Global investing and trading strategies – For this category, I’m going to focus on global macro strategies, which invest on a long and short basis across the global equity, fixed income, currency, commodity and derivative markets. I believe global macro funds are attractive because of their ability to invest on an unconstrained, opportunistic basis. As a whole, this strategy³ is up slightly on a year-to-date basis. As with relative value, this strategy is also highly dependent on the manager, and performance varies widely from manager to manager.

Invesco offers two global macro funds: Invesco Global Targeted Returns Fund and Invesco Global Markets Strategy Fund.

Alternative equity strategies – For this category, I’m going to focus on long/short equity. This strategy combines both long and short equity positions in a portfolio, while typically being net long to stocks. I believe long/short equity is attractive because it has shown the ability to limit downside relative to equities, while retaining its ability to participate in a rising equity market.⁴ Funds following this strategy performed⁵ as I would have expected, outperforming equities during the “risk off” period when equities sold off and underperforming during the “risk on” period in which equities rebounded.

Invesco offers two long/short equity funds: Invesco Long/Short Equity Fund and Invesco Macro Long/Short Fund.

Alternative fixed income strategies – For this category, I want to look at two different strategies, unconstrained bond and bank loans:

Unconstrained bond funds – They have the freedom to invest on a long and short basis across the entire fixed income universe. Conceptually, I believe unconstrained bond funds are attractive because of their ability to invest opportunistically and ability to positon the portfolio, attempting to take advantage of a rising interest rate environment. This strategy is highly manager dependent, and performance can vary widely by manager. As of April 30, 2016, this strategy⁶ has generated a positive return but trails the Barclays US Aggregate Bond Index.

Invesco Unconstrained Bond Fund is an example of this strategy.

Bank loans – This asset class consists of pools of senior secured loans made to non-investment grade companies. Bank loans are fully collateralized, reside at the top of the capital structure and can offer attractive yield, which is appealing to many investors in a low rate environment. As you would expect, performance of bank loans is often correlated with the current economic environment, as a favorable environment makes it more likely loans will be repaid, while a difficult environment can cause an increase in default risk. Given this characteristic, it’s not surprising that bank loans experienced negative performance during the “risk off” portion of the year, before rebounding strongly during the “risk on” period that followed. Bank loans are now up over 3%, according to the Morningstar Bank Loan category.

Invesco offers two bank loan mutual funds: Invesco Senior Loan Fund and Invesco Floating Rate Fund.

For more information about alternatives

• To learn more about Invesco’s alternative strategies, please visit invesco.com/alternatives.
• You can also read previous blogs from Walter Davis, and ask Walter your questions about alternatives with our Ask the Expert feature.
• And, learn why it’s time to say goodbye 60/40 and to consider alternatives as more of your core.

1 Alternative assets represented by the FTSE NAREIT All Equity REIT Index and the Bloomberg Commodity Index. Equities represented by the S&P 500 Index. The FTSE NAREIT All Equity REIT Index is up 4.89% year-to-date through April 30, 2016, the Bloomberg Commodity Index is up 8.86% and the S&P 500 Index is up 1.74%.

2 As measured by the Credit Suisse Equity Market Neutral Index.

3 As measured by the HFRX Macro/CTA Index.

4 For example, in the bear market of 2008, the S&P 500 Index lost 37.00%, while the BarclayHedge Long/Short Index lost much less: 11.88%. In the up year of 2013, when the S&P 500 Index gained 32.39%, the BarclayHedge Long/Short Index participated in some of those gains, earning 13.85%.

5 As measured by the Morningstar Long/Short Equity category.

6 As measured by the Morningstar Nontraditional Bond category.

Important information

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility.

The BarclayHedge Long/Short Index includes funds that employ a directional strategy involving equity-oriented investing on both the long and short sides of the market.

The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment grade, fixed-rate bond market.

The FTSE NAREIT All Equity REIT Index is an unmanaged index considered representative of US REITs.

The Bloomberg Commodity Index is an unmanaged index designed to be a highly liquid and diversified benchmark for the commodity future market.

The Credit Suisse Equity Market Neutral Index is an asset-weighted hedge fund index covering the equity market neutral sector.

The HFRX Macro/CTA Index is constructed using a UCITS III-compliant methodology that is based on defined and predetermined rules and objective criteria to select and rebalance components to maximize representation of the hedge fund universe.

The Morningstar Long/Short Equity category contains funds that will shift their exposure to long and short positions depending on their macro outlook or the opportunities they uncover through bottom-up research.

The Morningstar Nontraditional Bond category contains funds that pursue strategies divergent in one or more ways from conventional practice in the broader bond-fund universe.

The S&P 500 Index is an unmanaged index considered representative of the US stock market.

Past performance cannot guarantee future results. An investment cannot be made in an index.

Certain indexes reflect performance of hedge funds, not of retail investment strategies, and are used for illustrative purposes only solely as points of reference in evaluating alternative investment strategies.

Hedge funds are typically aggressively managed portfolios of investments for high net worth investors that use advanced investment strategies such as leverage, long, short and derivative positions with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). Hedge fund managers have less restriction on their investment methodologies than mutual fund managers, and hedge funds are less regulated and therefore offer less investor protection than mutual funds. Mutual funds are more transparent with regard to disclosure of underlying holdings and have lower fees than hedge funds.

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.

Most senior loans are made to corporations with below investment grade credit ratings and are subject to significant credit, valuation and liquidity risk. The value of the collateral securing a loan may not be sufficient to cover the amount owed, may be found invalid or may be used to pay other outstanding obligations of the borrower under applicable law. There is also the risk that the collateral may be difficult to liquidate, or that a majority of the collateral may be illiquid.

Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Alternative products typically hold more nontraditional 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.

Walter Davis

Alternatives Investment Strategist

As Alternatives Investment Strategist, Walter Davis serves as Invesco’s primary alternatives representative to retail, high net worth and institutional clients across the major broker dealers, wirehouses and RIAs. He is responsible for collaborating across Invesco’s alternative strategies to develop a cohesive alternatives education program for financial advisors and investors.

Prior to joining Invesco in 2014, Mr. Davis served as a managing director in Morgan Stanley’s Alternative Investments Department, and earlier as director of High Net Worth and Institutional Sales. Prior to Morgan Stanley, he worked at Chase Manhattan Bank in the Alternative Investments Department. He has worked in the industry since 1991.

Mr. Davis graduated cum laude with a BA in economics from the University of the South. He earned an MBA in finance and international business from Columbia Business School. He holds the Series 3, 7, 24 and 63 registrations.

Invesco Balanced-Risk Allocation Fund is built on a foundation of economic diversification that seeks to participate during periods of economic growth and to defend during more difficult environments when equity-oriented approaches tend to struggle — such as the environment markets are experiencing in the immediate aftermath of the UK’s decision to leave the European Union.

How do we approach this task? By seeking to balance the fund’s risks between stocks, government bonds and commodities¹ — each of which has historically outperformed in different types of environments. At the same time, we make monthly tactical adjustments that are designed to capitalize on timely market opportunities in these asset classes.

Not all asset classes fell after the ‘Brexit’ vote

While the Brexit headlines have focused on the post-vote performance of stock markets and currencies, assets that are perceived to be “safe havens” — such as gold and currency-hedged government bonds — have played their intended role in the portfolio in the aftermath of the Brexit vote, helping to cushion against losses in equities and economically sensitive commodities.

Of note, we are pleased with the impact that our yield skew adjustment² process has had within the strategic portion of our government bond portfolio following Brexit, as yields in markets favored by this process (US, Canada, Australia and the UK) rallied more on June 24, the day after the vote, than markets in which the portfolio has a reduced allocation (Germany and Japan).

I believe that the diversified nature of Invesco Balanced-Risk Allocation Fund, implemented through a disciplined, high-conviction investment process, can help investors play defense during difficult environments and remove the emotion that can negatively impact long-term investment returns. The investment team will continue to adhere to our process and update investors on our portfolio positioning at month-end.

Read more about Brexit from our experts. 

Important information

1 Under normal conditions, the strategy invests in derivatives and other financially linked instruments whose performance is expected to correspond to US and international fixed income, equity and commodity markets. However, the performance of the asset classes cannot be guaranteed.

2 Yield skew adjustment refers to the process by which the fund’s managers reduce exposure to a bond market to the extent that a one-standard-deviation move in the yield would result in a negative yield.

Diversification does not guarantee a profit or eliminate the risk of loss.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.

Invesco Balanced-Risk Allocation Fund risks

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds, and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

Should the fund’s asset classes or the selected countries and investments become correlated in a way not anticipated by the adviser, the risk allocation process may result in magnified risks and loss instead of balancing (reducing) the risk of loss.

An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

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.

The risks of investing in securities of foreign issuers, including emerging markets, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.

By investing in the subsidiary, the fund is indirectly exposed to risks associated with the subsidiary’s investments, including derivatives and commodities. Because the subsidiary is not registered under the Investment Company Act of 1940, as amended (1940 Act), the fund, as the sole investor in the subsidiary, will not have the protections offered to investors in US registered investment companies.

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.

Underlying investments may appreciate or decrease significantly in value over short periods of time and cause share values to experience significant volatility over short periods of time.

The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.

Scott Wolle, CFA

Portfolio Manager

CIO of Invesco Global Asset Allocation

Scott Wolle is the chief investment officer (CIO) and a portfolio manager for the Invesco Global Asset Allocation team, which invests in stock, bond and commodity markets worldwide.

Mr. Wolle joined Invesco in 1999 as an analyst and portfolio manager, and became a member of the Global Asset Allocation team in 2001. He assumed his current role in 2005. He began his investment management career in 1991 with Bank of America.

Mr. Wolle graduated magna cum laude from Virginia Tech with a degree in finance. He earned an MBA from the Fuqua School of Business at Duke University, with the distinction of Fuqua Scholar. He is a CFA charterholder.

2016 figures to be a momentous year for the real estate investment trust (REIT) industry, which will soon become a class unto itself. Literally. But first, a little background.

In 1999, MSCI Inc. and S&P Dow Jones Indices established the Global Industry Classification Standard (GICS) — a hierarchical industry classification system consisting of 10 sectors, 67 industries and 156 sub-industries. Currently, REITs are classified as a sub-industry of the real estate industry, which, in turn, falls under the financials sector.

That is about to change.

Real estate will soon be a GICS sector

Beginning after market close on Aug. 31, 2016, real estate will get a much-anticipated promotion to global sector status — the first such addition since the establishment of GICS. As part of this move, REITs will be divided into two categories:

1. Mortgage REITs, which purchase or originate mortgages and tend to be sensitive to interest rates, will remain a sub-industry of the financials sector.
2. All other REITs will be classified as equity REITs, which will form a separate industry under the real estate sector. Equity REITs are companies that own and invest in properties that produce cash flow streams from rents.

Classification change underscores real estate’s unique characteristics

While it is impossible to know the ultimate effects of this landmark change, there could be many potential benefits. We at Invesco Real Estate believe the new, dedicated real estate sector will showcase fundamental differences between real estate and other businesses, and make it easier to see how investment managers are allocated to this area.

Segregating real estate into a class by itself highlights the sector’s potential diversification benefits, yield potential and historical total returns. This change may also shine a light on diversified managers who have been underweight real estate stocks for years.

GICS change could have ramifications for portfolio managers

Index providers have suggested that differentiating real estate into its own sector “reflects the position of real estate as a distinct asset class and a foundational building block of a modern portfolio” and may serve to increase the visibility of the sector to generalist investors.¹

We believe there is also potential for a reduction in long-term volatility, as the independent classification may help to decouple real estate from other financials, like banks and insurance companies, and increase real estate’s investor base. This is because GICS is accepted as the primary framework for investment research, portfolio management and asset allocation. As such, it has helped to drive product development — including the rapidly growing exchange-traded-fund market.

Market cap of equity REITS has grown more than sixfold

REIT Magazine notes that the GICS change is “reminiscent of the decision in 2001 to include REITs in the S&P Indexes.”² Following that decision, the market capitalization of US equity REITs ballooned from $147 billion to $886 billion from 2001 through 2015.³

Source: NAREIT, as of May 31, 2016

We at Invesco Real Estate applaud the GICS changes as a potential catalyst for equity REITs, and believe real estate as a whole will benefit from its elevated status as the 11^th global sector. We look forward to the continued adoption of REITs by both institutional and individual investors alike.

1 MSCI Inc., Dow Jones Indices, March 8, 2016

2 REIT.com, May 24, 2016

3 National Association of Real Estate Investment Trusts, May 31, 2016

Important information

Real estate companies, including REITs or similar structures, tend to be small; mid-cap companies and their shares may be more volatile and less liquid.

The Global Industry Classification Standard was developed by and is the exclusive property and a service mark of MSCI Inc. and Standard & Poor’s.

Joe Rodriguez

Managing Director

Head of Global Real Estate Securities

Invesco Real Estate

In addition to portfolio management, Mr. Rodriguez is a managing director and the head of real estate securities for Invesco Real Estate, where he oversees all phases of the unit, including securities research and administration.

Mr. Rodriguez began his investment career in 1983 and joined Invesco Real Estate, the Dallas-based investment management affiliate of Invesco Institutional (N.A.), Inc., in 1990. He has served on the editorial board for the Financial Times Stock Exchange National Association of Real Estate Investment Trusts (FTSE NAREIT), as well as the editorial board of the Institutional Real Estate Securities newsletter. He is a member of the National Association of Business Economists, American Real Estate Society and the Institute of Certified Financial Planners. He has also served as adjunct professor of economics at The University of Texas at Dallas.

In addition, Mr. Rodriguez was a contributing author to Real Estate Investment Trusts: Structure Analysis and Strategy, published by McGraw-Hill. He made contributions as editor and author to several industry publications, and has been featured as a real estate expert by both financial industry print and television media such as CNBC and Bloomberg News.

Mr. Rodriguez earned a Bachelor of Business Administration degree in economics and finance as well as an MBA in finance from Baylor University.

The Invesco Perpetual Multi Asset team believes that identifying investment opportunities requires a comprehensive view of economic and market dynamics — one that accounts for short-term, cyclical drivers but also looks beyond to incorporate longer-term, structural trends. We believe a two- to three-year time frame can help account for both types of trends to reveal attractive investment opportunities. In this blog, we explain why.

Cyclical versus structural drivers

First, let’s define what we mean by structural versus cyclical drivers.

• Cyclical drivers, or indicators, tend to be more volatile, reflecting shorter-term changes. For example, the Purchasing Manager Indices (PMI), which reflect growth in the manufacturing sector, are a cyclical indicator of economic recovery.

• Structural drivers are typically slower-moving factors that can reflect longer-term, secular changes across economies and markets. At the macroeconomic level, one such example is public debt, which is accumulated over an extended time period and may take an even longer period to unwind.

Case study: Bond yields

Let’s explore an investment opportunity in bond yields around the fall of 2010, and the potential impact of considering both cyclical and structural drivers. Historically, bond yields have tended to rise during periods of economic growth, as increased economic activity creates upward pressure on inflation and increases the demand for borrowing.

• Cyclical signals: In the period following the 2008 financial crisis, short-term indicators like the PMI signaled the economy was moving toward recovery. Expectations of higher inflation and increased borrowing would then suggest higher bond yields. But that conclusion would fail to take into consideration the impact of longer-term factors, such as debt.

• Structural drivers: Borrowing — especially in developed markets — grew rapidly in the early 2000s, leading to unsustainable levels of private sector debt in the run-up to the financial crisis. Historically, unwinding these heavy debt burdens has been a major component of post-crisis periods. Such episodes of deleveraging have often been protracted and complicated, and have weighed heavily on the pace of economic recovery, as credit creation slows dramatically. New banking regulations introduced after the 2008 crisis compounded that effect, further reducing credit creation. Other structural drivers such as demographics and quantitative easing created additional downward pressure on yields.

An intermediate time period of two to three years to evaluate an investment opportunity — such as this one in bond yields — provides the team with the appropriate framework to consider a more complete investment picture.

Incorporating a medium-term outlook into our investment process

Examples like these help confirm our belief that taking a two- to three-year view is the most appropriate for our investment process. Each investment idea within Invesco Global Targeted Returns Fund is, therefore, designed to seek a positive return over a two- to three-year period. We believe this time frame has the potential to uncover investment opportunities by taking into consideration both structural and cyclical economic drivers, especially if other market participants are exclusively focused either on shorter-term views or much longer-term, mean-reverting valuations.

This perspective is imbedded into every step of our TEAM investment process, which suggests that for every idea considered for the portfolio, the sponsor of the idea needs to lay out the: (T) Theme of the idea; (E) Economic drivers; (A) Analytics and valuation supporting the idea; and incorporate the views of the relevant Invesco managers (M) outside of the Multi Asset team to reflect the views of a bottom-up, asset class specialist.

Conclusion

In financial markets, accounting for and considering both structural and cyclical drivers can help reveal investment opportunities. In order to identify these opportunities, an appropriate time frame — one that captures both types of drivers — must be defined. The Invesco Perpetual Multi Asset team believes this time frame is reflected in a two- to three-year period, which is an under-researched outlook in the marketplace.

This time frame is a critical component of the team’s investment process. It not only helps shape our view of the markets and the economy in the intermediate term, it helps us identify and vet investment ideas that are ultimately included in the strategy. Generating a comprehensive picture of the investment landscape represents one way in which the team can distinguish its approach to investing.

Read more expert views about alternatives investing.

Important information

There is a risk that the Federal Reserve Board (FRB) and central banks may raise the federal funds and equivalent foreign rates. This risk is heightened due to the potential “tapering” of the FRB’s quantitative easing program and other similar foreign central bank actions, which may expose fixed income investments to heightened volatility and reduced liquidity, particularly those with longer maturities. As a result, the value of the fund’s investments and share price may decline.

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. These risks are greater for the fund than most other funds because its investment strategy is implemented primarily through derivatives rather than direct investments in more traditional securities.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The fund is subject to the risks of the underlying funds. Market fluctuations may change the target weightings in the underlying funds, and certain factors may cause the fund to withdraw its investments therein at a disadvantageous time.

Leverage created from borrowing or certain types of transactions or instruments may impair liquidity, cause positions to be liquidated at an unfavorable time, lose more than the amount invested or increase volatility.

The fund is nondiversified and may experience greater volatility than a more diversified investment.

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 fund may invest in derivatives either directly or, in certain instances, indirectly through Invesco Cayman Commodity Fund VII Ltd., a wholly owned subsidiary of the fund organized under the laws of the Cayman Islands (subsidiary). Because the subsidiary is not registered under the Investment Company Act of 1940, as amended (1940 Act), the fund, as the sole investor in the subsidiary, will not have the protections offered to investors in US registered investment companies.

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

Debt securities are affected by changing interest rates and changes in their effective maturities and credit quality.

Underlying investments may appreciate or decrease significantly in value over short periods of time and cause share values to experience significant volatility over short periods of time.

The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.

Danielle Singer, CFA

Senior Client Portfolio Manager¹

Danielle Singer is a Senior Client Portfolio Manager for the Invesco Multi Asset team.

Before joining Invesco in 2014, Ms. Singer was a strategist and director of the Global Investment Solutions (GIS) team at UBS. Her responsibilities included participating in the review and setting of multi-asset and currency strategies, interacting with the investment team to coordinate investment strategy, and assisting clients as part of the GIS initiative. Previously, Ms. Singer was an account manager for UBS’s Institutional Investment Management group, where she maintained client portfolios and presented investment reviews. Prior to joining UBS in 2004, Ms. Singer worked on the auction rate securities desk at Deutsche Bank.

Ms. Singer earned a BA degree at Middlebury College and an MBA at the University of Chicago with concentrations in analytic finance and econometrics. She holds the Series 3, 7 and 66 registrations. Ms. Singer is a CFA charterholder and a member of the New York Society of Security Analysts.

1 Not involved in managing assets of any fund.

Georgina Taylor

Product Director, Multi Asset

Georgina Taylor is Product Director for the Multi Asset team at Invesco Perpetual. Ms. Taylor joined Invesco in 2013 and is based in Henley-on-Thames outside of London.

Before joining Invesco, Ms. Taylor was head of Equity Strategy, EMEA at State Street Global Markets where she was involved in enhancing the macro input to specific State Street products and presenting these to clients. Ms. Taylor began her career in 2001 as an equity strategist at HSBC, followed by a similar role at Goldman Sachs in 2004 where she was involved in global equity and asset allocation research. Ms. Taylor then gained asset management experience at Legal & General Investment Management, contributing to the overall asset allocation outlook for the firm and its multi asset funds.

Ms. Taylor graduated in 2000 from the University of Bath, where she earned a BSc (Hons) degree in economics.

After five decades of influencing global oil prices, the Organization of the Petroleum Exporting Countries (OPEC) has lost its ability to act in a coordinated manner, in my view. This sets the stage for the US to become the world’s “swing producer” — the region that can most easily loosen or tighten its flow of oil in response to changing global demand.

Let’s take a look at how the industry got here, and what I expect to see going forward.

OPEC and oil prices: Not too high, not too low

OPEC was formed in 1960 to coordinate oil policies among its members. Today, there are 14 members: Algeria, Angola, Ecuador, Gabon, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela.

Historically, OPEC has banded together to keep oil prices in its desired range — high enough to generate profits, but just low enough to keep out higher-cost producers in the US, Canada and elsewhere. In essence, OPEC set oil prices, and everyone else simply accepted them. But in recent years, two forces have worked together to disrupt OPEC’s modus operandi:

1. Saudi Arabia wants to keep production flowing.

Saudi Arabia — OPEC’s largest producer — has outlined a long-term agenda for economic growth. The Kingdom recently released a long-term plan to diversify its petroleum-focused economy into areas such as mining and tourism. In 2015, oil represented more than 70% of the government’s revenue, and leaders want to more than triple their economy’s nonoil revenue by 2020.¹

But kick-starting new industries will take investment. Most likely, Saudi Arabia will need to generate as much oil revenue as possible today and direct that money into the development of these new industries — regardless of what that means for the rest of OPEC. From November 2014 to December 2015, while the price of oil fell by about 50%, OPEC’s production increased by 1.5 million barrels — fueled in large part by Saudi Arabia.² The Kingdom’s desire to keep its wells flowing was reflected in OPEC’s recent failure to cap oil production during its June meeting in Vienna.

2. US shale plays have become competitive with OPEC

Technology has lowered the cost of US shale production to the point where it’s a viable competitor to OPEC, even at lower prices. The chart below shows how US shale compares with other major sources of oil. The width of the boxes measures the size of the estimated resource base, and the height illustrates the break-even oil price range needed to fund these projects.

As illustrated, onshore OPEC fields in the Middle East have the lowest break-even costs at $10 to $40 per barrel. US shale remains competitive in the higher part of that band, requiring an oil price of $30 to $80 per barrel to break even, depending on the project. Non-Middle Eastern OPEC projects actually have a higher break-even price than US shale, requiring $40 to $100 per barrel.

US shale projects are cost-competitive with most OPEC production

The horizontal axis represents the total estimated resource base (millions of barrels). The vertical axis represents the break-even oil price range ($).

Sources: Invesco Real Estate and Barclays Research as of September 2015. Total estimated resource base includes estimates for discovered and undiscovered resources.

The evolving role of the US

As an investor in global infrastructure and master limited partnerships, I see a lot to be excited about in the US energy space. Permits to drill in the Rockies have risen in early 2016, the Bakken shale play enjoyed relatively steady production throughout 2015, and production in the Permian Basin has actually increased dramatically since 2014.

Beyond the oil patch, the US has become a major exporter of propane and ethane and is poised to become a global force in liquefied natural gas (LNG), with 14 export terminals under construction and 11 more that have been proposed. Additionally, I expect the US to triple its natural gas exports to Mexico over the next 10 years via new pipelines.

Even with the recent commodity price correction, the US remains on the path of being a dominant global energy exporter, thanks in part to its relatively recent ability to stay cost-competitive with OPEC. I believe this trend should continue to provide investors with many opportunities across the energy and infrastructure spectrum.

1 Source: The Wall Street Journal, June 6, 2016, “Saudi Arabia approves plan to diversify economy”

2 Source: US Energy Information Administration as of January 2016

Important information

Businesses in the energy sector may be adversely affected by foreign, federal or state regulations governing energy production, distribution and sale as well as supply-and-demand for energy resources. Short-term volatility in energy prices may cause share price fluctuations.

Darin Turner

Managing Director

Portfolio Manager

Invesco Real Estate

Darin Turner is a Managing Director and Portfolio Manager for Invesco Real Estate. He performs quantitative and fundamental research on real asset securities, and his primary portfolio responsibilities include midstream energy, utilities, renewables, and transportation infrastructure on a global basis.

Mr. Turner joined Invesco in 2005 as an acquisitions analyst and later served as the associate portfolio manager for Invesco Real Estate’s US Value Added Funds. Prior to joining Invesco, Mr. Turner was a financial analyst in the corporate finance group of ORIX Capital Markets where he was responsible for the daily evaluation of a structured finance portfolio, as well as for analyzing the performance of specific collateralized debt obligations. Additionally, he was responsible for the execution of a high yield repurchase facility and a leveraged loan swap agreement, as well as the implementation of certain portfolio hedging strategies.

Mr. Turner earned a BBA degree in finance from Baylor University, an MS degree in real estate from the University of Texas at Arlington, and an MBA degree specializing in investments from Southern Methodist University. 

Invesco’s alternative framework, shown below, identifies five common investment objectives and aligns them with five types of alternatives that Invesco believes can potentially help investors achieve those objectives. In this blog, I’d like to focus on alternative assets, particularly, the infrastructure subcategory.

Invesco’s alternatives framework: Aligning client objectives with different types of alternatives

Framework applies to liquid alternatives and nonaccredited, retail investors. There is no guarantee the strategies will be successful.

It is not unusual for investors seeking inflation protection to invest in alternative assets. Furthermore, there are several types of alternative asset investments that have the potential to generate attractive levels of current income. The two best known examples are real estate and commodities. Infrastructure and master limited partnerships (MLPs) are also examples of alternative assets that have the ability to generate income.

An introduction to infrastructure

As I mentioned in my previous blog post, of all the alternative assets, I find infrastructure to be the most attractive today. For this reason, I’d like to explore infrastructure in greater detail and explain why I believe this category may present an opportunity.

Merriam-Webster defines infrastructure as “the basic equipment and structures (such as roads and bridges) that are needed for a country, region or organization to function properly.” This definition is a good starting point, as it links infrastructure to the needs of society. Roads, bridges, tunnels, power lines, water supply, airports, shipping ports and railroads are all examples of infrastructure assets.

On a global basis, there is a strong need for infrastructure among both emerging and developed economies. For example, emerging economies need infrastructure to support their growth and increased urbanization. Meanwhile, developed countries need to make investments in order to upgrade and improve their existing infrastructure. For example, in New York, officials are in the process of building a new Tappan Zee Bridge that will replace the current dilapidated bridge. Additionally, the Port Authority, which oversees much of the regional transportation infrastructure in the New York/Tri-State area, has announced plans to redevelop LaGuardia Airport.

As shown in the chart below, there is a tremendous need to make sizeable investments in infrastructure on a global basis. It is estimated that the current need for global infrastructure is $89 trillion.¹  The challenge is how to pay for such investments when global GDP is approximately $78 trillion.²

The demand for infrastructure

A significant issue for many governments is funding. They have a strong need to make infrastructure investments but have limited ability to pay for them — partly due to the large deficits many governments face. This mismatch has created an opportunity for private investors to step in and fill the void.

For example, the LaGuardia Airport project will be built through a public-private partnership. While the use of private funds for infrastructure is viewed as novel within the US, it is actually quite common outside of the US, as most global airports are publicly listed and generate significant earnings from their retail business tenants, as well as airline passenger fees.

Investors looking to gain exposure to infrastructure can do so either through listed infrastructure securities, including equities of firms that own and operate infrastructure, or through unlisted infrastructure investments, which could include private ownership of assets or shares of unlisted funds. Typically only large investors, such as institutions, invest via unlisted investments, whereas individual investors typically invest through listed infrastructure securities or through funds that invest in them.

Why infrastructure?

There are several reasons why infrastructure looks attractive:

• Attractive return potential — Global infrastructure has historically provided competitive returns relative to the broad market. For the 10 years ending May 31, 2016, the Dow Jones Brookfield Global Infrastructure Index returned 8.8% in average annual returns versus the MSCI World Index return of 4.6%.³

Growth of $10,000

The following example shows the performance of a $10,000 investment from December 31, 2006 to May 31, 2016 into the various indexes, including the Dow Jones Brookfield Global Infrastructure Index

• The potential for capital growth — A significant portion of infrastructure returns comes from recurring income. At the end of 2015, the dividend yield on the Dow Jones Brookfield Global Infrastructure Index was 3.4% versus 2.7% for the MSCI World Index.⁴ Moreover, global infrastructure has experienced 12% annual dividend growth in the years following the global financial crisis (from 2008 to 2015), compared with 2% and 3% annual dividend growth for global stocks and global real estate, respectively.⁵
• Potential for inflation protection — Historically, infrastructure has provided inflation-hedging characteristics. In a review of inflationary periods from 1995 until 2015 — defined as the US consumer price index above 2.5% — US infrastructure stocks (defined as a simple average of annual returns of the S&P 600 Water Utilities, S&P 500 Utilities and S&P 500 Road & Rail Indexes) outperformed US stocks (as measured by S&P 500 Index) by 6.5% annualized.⁶
• Diversification — An investment in infrastructure can provide diversification to a portfolio as infrastructure has had a low correlation to fixed income and a moderate correlation to equities.⁷

Investment in infrastructure-related companies may be subject to high interest costs in connection with capital construction programs, costs associated with environmental and other regulations, the effects of economic slowdown and surplus capacity, the effects of energy conservation policies, governmental regulation and other factors.

For all these reasons, I’d encourage you to talk to your advisor about infrastructure investments if you are contemplating an investment in alternative assets. Invesco Global Infrastructure Fund (GIZAX) is an example of a fund that invests in infrastructure.

1 Sources: McKinsey Center for Business and Environment and the World Bank. Investment need projection was as of January 2016, and does not include projections for sustainable costs. There is no guarantee that the projections shown will come to pass.

2 Source: The World Bank, as of April 2016

3 Sources: Invesco Real Estate, StyleADVISOR, as of May 31, 2016

4 Source: Bloomberg LP, as of Dec. 31, 2015

5 Sources: Invesco Real Estate, Bloomberg LP, as of Dec. 31, 2015. Global infrastructure is represented by the Dow Jones Brookfield Global Infrastructure Index, global stocks represented by the MSCI World Index and global real estate represented by the FTSE EPRA/NAREIT Developed Index. The annual dividend growth rate is the annualized percentage rate of growth that a particular stock’s dividend undergoes over a period of time, calculated as a simple average.

6 Sources: Invesco and StyleADVISOR, as of Dec. 31, 2015. US infrastructure average calculated using a simple average of annual returns of the S&P 600 Water Utilities, the S&P 500 Utilities Sector, and the S&P 500 Road and Rail indexes. US stocks represented by the S&P 500 Index.

7 Source: StyleADVISOR, from January 2003 to June 2015, based on the Dow Jones Brookfield Global Infrastructure Index, the MSCI World Index and the Barclays US Aggregate Bond Index. Equities are represented by the S&P 500 Index.

Important information

Correlation is the degree to which two investments have historically moved in relation to each other.

The FTSE EPRA/NAREIT Developed Index is an unmanaged index considered representative of global real estate companies and REITs.

The MSCI World Index is an unmanaged index considered representative of stocks of developed countries.

The S&P 500^® Index is an unmanaged index considered representative of the US stock market.

The US consumer price index measures the prices consumers pay for a basket of consumer-based goods and services.

The Dow Jones Brookfield Global Infrastructure Index measures the stock performance of companies that exhibit strong infrastructure characteristics.

The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market.

The Barclays Global Aggregate Index is an unmanaged index considered representative of the global investment-grade, fixed-income markets.

The S&P 600^® Water Utilities Index is a float-adjusted, market-capitalization-weighted index representing the US small-cap market water utilities industry.

The S&P 500^® Utilities Sector Index is an unmanaged index considered representative of the utilities market.

The S&P 500^® Road Index is an unmanaged index considered representative of US toll road stocks.

The S&P 500^® Rail Index is an unmanaged index considered representative of US rail stocks.

Diversification does not guarantee a profit or eliminate the risk of loss.

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.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The Invesco Global Infrastructure Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.

Infrastructure risks

Walter Davis

Alternatives Investment Strategist

Invesco

As Alternatives Investment Strategist, Walter Davis serves as Invesco’s primary alternatives representative to retail, high net worth and institutional clients across the major broker dealers, wirehouses and RIAs. He is responsible for collaborating across Invesco’s alternative strategies to develop a cohesive alternatives education program for financial advisors and investors.

Prior to joining Invesco in 2014, Mr. Davis served as a managing director in Morgan Stanley’s Alternative Investments Department, and earlier as director of High Net Worth and Institutional Sales. Prior to Morgan Stanley, he worked at Chase Manhattan Bank in the Alternative Investments Department. He has worked in the industry since 1991.

Mr. Davis graduated cum laude with a BA in economics from the University of the South. He earned an MBA in finance and international business from Columbia Business School. He holds the Series 3, 7, 24 and 63 registrations.

As noted in our previous blog, Real estate’s elevated sector status could be a catalyst for equity REITs, real estate will become the 11^th Global Industry Classification Standard (GICS) sector beginning after market close on Aug. 31, 2016. Below, we examine the potential impact for investors as certain indexes, and the exchange-traded funds (ETFs) that follow them, realign to reflect this historic change.

As a result of real estate’s new sector status, S&P Dow Jones Indices announced in June that it would modify the index constituents of its Financial Select Sector Index. Accordingly, the Financial Select Sector SPDR Fund (ticker: XLF) will also make adjustments in order to continue to track that index. With $15.7 billion in assets under management as of Aug. 23, 2016, XLF is one of the largest ETFs available and makes up over 40% of the Lipper Financial Services Funds Category.¹ Furthermore, XLF holds close to $3 billion in equity real estate investment trusts (REITs).² While REITs were initially expected to remain in XLF, they will now be spun off into a separate ETF called the Real Estate Select SPDR Fund (ticker: XLRE) on Sept. 16, 2016.

In addition, we expect other ETFs that track a GICS-defined financial sector index to reduce real estate exposure at the end of August. (Indexes that use other classification systems besides GICS would not be affected.)

As indexes realign, will investors follow?

Current XLF holders will receive shares of XLRE in order to maintain their current real estate exposure. It is uncertain if investors will keep their newly created XLRE holdings or if they will sell this security once it’s received. While we cannot forecast the future, we believe this has the potential to introduce volatility to the US REIT market over the next few weeks.

Taking the long-term view

From a portfolio management perspective, we continue to view REITs’ elevated sector status as a long-term positive. Potential benefits include increased visibility, a larger investor base and a reduction in long-term volatility. We will closely monitor the REIT market for relative value opportunities that may arise from index and ETF changes, essentially nonfundamental drivers of performance, over the short term.

1 Source: Lipper, data as of July 31, 2016

2 Source: State Street Global Advisors, data as of Aug. 23, 2016

Important information

Investments in real estate-related instruments may be affected by economic, legal or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small- and mid-cap companies, and their shares may be more volatile and less liquid.

The profitability of businesses in the financial services sector depends on the availability and cost of money and may fluctuate significantly in response to changes in government regulation, interest rates and general economic conditions. These businesses often operate with substantial financial leverage.

Investments concentrated in a comparatively narrow segment of the economy may be more volatile than nonconcentrated investments.

Paul Curbo, CFA

Portfolio Manager

Invesco Real Estate

Paul Curbo is a portfolio manager and member of the Real Estate Securities Portfolio Management and Research team with Invesco Real Estate.

Mr. Curbo entered the industry in 1993 and joined Invesco in 1998. Prior to assuming his current position, Mr. Curbo served as a senior research analyst in the real estate research group. He led one of Invesco’s regional teams and directed the firm’s research and strategy efforts in the Western region of the US.

Before joining Invesco, Mr. Curbo was a senior research associate with Security Capital Group, where he was responsible for analyzing multifamily, industrial and office real estate markets. He produced research on economic, demographic and real estate market information for Security Capital’s affiliate companies. Mr. Curbo previously held a position with Texas Commerce Bank.

Mr. Curbo earned a BBA in finance from The University of Texas at Austin and has completed graduate coursework in economic theory and econometrics at The University of Texas at Dallas. He is a CFA charterholder.

It seems as if every day brings another article discussing how much difficulty hedge funds are experiencing — be it poor performance, redemptions or both. Despite the challenges at hedge funds, a number of strategies and funds in the alternatives space overall are performing well so far this year.

Before diving into the performance of alternatives, I’d like to provide a short refresher on how we at Invesco define these investments. Alternatives invest in things other than publicly traded, long-only equities and fixed income. We separate the alternatives universe into two baskets: alternative asset classes and alternative investment strategies.

Alternative asset classes defined

Alternative asset classes comprise assets other than stocks and bonds. Investments in real estate (direct investment or real estate investment trusts [REITs]), commodities, infrastructure and master limited partnerships (MLPs) are all examples of alternative asset classes. Given that alternative asset managers primarily take long-only exposure across a specific asset class, these investments frequently have a high market exposure to the underlying asset class. As a result, the performance of the underlying asset class often drives returns.

Alternative investment strategies defined

Alternative investment strategies are investments in which the fund manager is given a high degree of flexibility with how to invest. For example, the manager often has the ability to trade across multiple markets and asset classes, including stocks, bonds, currencies and commodities. The manager is also afforded the ability to short markets (i.e., establish positions that profit from an investment declining in value.) Strategies such as global macro, equity long/short, market neutral, managed futures, banks loans and unconstrained fixed income, are all examples of alternative strategies.

Alternatives have generated strong returns in 2016

While there are a wide variety of indexes available that seek to measure the performance of alternatives, I’d like to focus on the Morningstar fund category returns, as they are easily viewed and show the performance of widely available mutual funds. A look at the fund category returns below reveals that, through the end of August, a number of alternative categories have generated strong returns in 2016.

Past performance cannot guarantee future results. An investment cannot be made in an index.

As the above table illustrates, several alternative asset classes have been a standout in 2016, providing strong returns well above the S&P 500 Index. And for some asset classes, such as MLPs, commodities and infrastructure, the gains achieved in 2016 follow losses incurred in 2015. Other assets have remained solid, such as real estate, as the asset class (represented by the FTSE NAREIT All Equity REITs Index) has generated strong returns from Jan. 1, 2009, through Aug. 31, 2016.

Given that funds that invest in alternative asset classes typically have a high exposure to the underlying asset class, it’s not surprising that funds that invest in alternative asset classes (as defined by the Morningstar categories above) have generated returns that reflect the strong performance of the underlying asset class thus far in 2016.

Why consider alternatives?

Alternative asset classes have generated equity-like returns with equity-like levels of volatility,² while offering diversification to traditional equity investments. Additionally, certain alternative asset classes, such as MLPs, infrastructure and certain real estate funds, may provide investors with attractive levels of current income. As a result, investors often use alternative asset classes as a potential source of returns and much-needed yield in the current low yield environment.

For example, bank loans have provided yield this year in addition to competitive returns. In addition to generating a year-to-date return of 6.30%, bank loans currently have a yield of 5.25%.³

Bank loans are pools of senior secured loans made to non-investment grade companies. They are popular because they are fully collateralized, sit at the top of the capital structure and potentially offer attractive yield. The performance of bank loans can tend to track the economic environment: A favorable economic environment makes it more likely loans will be repaid, while a difficult economic environment can cause an increase in default risk.

As a whole, alternative investment strategies are lagging thus far

While alternative assets have been standouts, several alternative strategies are having an uneventful year:

Past performance cannot guarantee future results. An investment cannot be made in an index.

The performance numbers for alternative strategies look lackluster on the surface. However, there are nuances to the category that deserve further examination. For example, manager selection has a strong impact on the returns achieved. Because alternative investment strategies may vary in their return and risk objectives and managers utilize their own unique investment approach, returns may vary widely across managers. Therefore, simply looking at broad categories, as we do above, is only useful in getting a sense for how the strategy has performed as a whole.

In my view, a better way to gauge the performance of alternative investment strategies is to look at the returns of the individual funds that make up the various Morningstar categories for alternatives. Through this lens, investors will be able to see that some managers have generated returns well above the category average, while others have generated returns well below the average. For this reason, I believe investors need to look beyond the broad categories when evaluating performance and focus on the performance of the specific manager.

1 The Morningstar category return was not available. The returns shown represent the range of returns for the funds tracked by Morningstar for their Infrastructure category.

2 From January 1997 through December 2015, the alternative assets category (as defined by a 75% allocation to FTSE NAREIT All Equity REIT Index and a 25% allocation to Bloomberg Commodity Index) had an annualized return of 7.73% with 17.01% standard deviation. That compares with an annualized return of 7.46% and a standard deviation of 15.52% for the S&P 500 Index. The 75%/25% split reflects Invesco’s belief that investors tend to invest in strategies with which they are more familiar.

3 Yield to maturity of S&P/LSTA US Leveraged Loan 100 Index as of Aug. 31, 2016.

Important information

The Alerian MLP Index is a composite of the 50 most prominent energy master limited partnerships calculated by Standard & Poor’s using a float-adjusted market capitalization methodology.

The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market.

The Bloomberg Commodity Index is a broadly diversified commodity price index.

The Dow Jones Brookfield Global Infrastructure Index measures the stock performance of companies that exhibit strong infrastructure characteristics.

The FTSE NAREIT All Equity REITs Index is an unmanaged index considered representative of US REITs.

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

The S&P/LSTA US Leveraged Loan 100 Index is representative of the performance of the largest facilities in the leveraged loan market.

Yield to maturity is the rate of return anticipated on a bond if it is held until the end of its lifetime.

Hedge funds are typically aggressively managed portfolios of investments for high net worth investors that use advanced investment strategies such as leverage, long, short and derivative positions with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). Hedge fund managers have less restriction on their investment methodologies than mutual fund managers, and hedge funds are less regulated and therefore offer less investor protection than mutual funds. Mutual funds are more transparent with regard to disclosure of underlying holdings and have lower fees than hedge funds.

Alternative products typically hold more nontraditional 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.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Stock and other equity securities values fluctuate in response to activities specific to the company as well as general market, economic and political conditions.

Most MLPs operate in the energy sector and are subject to the risks generally applicable to companies in that sector, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk. MLPs are also subject the risk that regulatory or legislative changes could eliminate the tax benefits enjoyed by MLPs which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the portfolio’s investments.

Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

Investment in infrastructure-related companies may be subject to high interest costs in connection with capital construction programs, costs associated with environmental and other regulations, the effects of economic slowdown and surplus capacity, the effects of energy conservation policies, governmental regulation and other factors.

Most senior loans (or bank loans) are made to corporations with below investment-grade credit ratings and are subject to significant credit, valuation and liquidity risk. The value of the collateral securing a loan may not be sufficient to cover the amount owed, may be found invalid or may be used to pay other outstanding obligations of the borrower under applicable law. There is also the risk that the collateral may be difficult to liquidate, or that a majority of the collateral may be illiquid.

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.

Walter Davis

Alternatives Investment Strategist

Invesco

As Alternatives Investment Strategist, Walter Davis serves as Invesco’s primary alternatives representative to retail, high net worth and institutional clients across the major broker dealers, wirehouses and RIAs. He is responsible for collaborating across Invesco’s alternative strategies to develop a cohesive alternatives education program for financial advisors and investors.

Prior to joining Invesco in 2014, Mr. Davis served as a managing director in Morgan Stanley’s Alternative Investments Department, and earlier as director of High Net Worth and Institutional Sales. Prior to Morgan Stanley, he worked at Chase Manhattan Bank in the Alternative Investments Department. He has worked in the industry since 1991.

Mr. Davis graduated cum laude with a BA in economics from the University of the South. He earned an MBA in finance and international business from Columbia Business School. He holds the Series 3, 7, 24 and 63 registrations.

This year, I’ve written several blogs highlighting the strong performance of alternative assets, including real estate, commodities and infrastructure. In this installment, I want to give particular focus to an area that many investors may not be familiar with, but that offers the potential for attractive returns, income, inflation hedging and portfolio diversification — master limited partnerships (MLPs).

Introduction to MLPs

Before delving into the performance of MLPs, and the factors behind the numbers, I want to first offer some background about their history and potential benefits.

MLPs are publicly traded limited partnerships that are focused on energy infrastructure in the US. Pipelines, storage facilities and processing plants are all examples of assets that MLPs own, operate and build. As of the end of 2015, there were approximately 180 MLPs, with a market capitalization of more than $300 billion.¹

MLPs are typically classified into three categories:

1. Upstream, which are involved in the exploration, recovery, development and production of crude oil and natural gas
2. Midstream, which are involved in the gathering, processing, storage and transportation of oil and gas
3. Downstream, which are involved in the distribution of fuels to end customers, such as homes, businesses and factories.

Given that MLPs are limited partnerships, they do not pay federal income tax. Rather, MLPs pass their income on to the limited partners, who are then subject to income tax. Also, unlike many limited partnerships that are privately placed and offer limited liquidity, MLPs are publicly traded and provide investors with the same liquidity as a publicly traded stock.

MLPs are expected to fuel energy infrastructure expansion

Energy production in the US has evolved over the past decade. While crude oil and natural gas production declined by about 20% from 1980 to 2006,² that trend has reversed over the past 10 years thanks to new technologies, especially fracturing technology, which have allowed the extraction of hydrocarbons from previously uneconomical locations. As a result, the US Energy Information Administration estimates that energy production in the US could grow by 77% from 2006 levels by 2030.²

The increasingly diverse geography of US energy production, combined with the increase in US energy production overall, has created a strong need for additional energy infrastructure. To this end, the American Petroleum Institute estimates that it will take $890 billion in total direct investment of oil and gas transportation and storage infrastructure through 2025 to support US energy production levels.³ MLPs are expected to play an important role in providing the capital to build this needed infrastructure.

As energy production in the US has evolved, so too have MLPs. Today, most MLPs primarily focus on midstream energy infrastructure and natural gas, as it provides the plumbing that transports and stores oil and gas. Furthermore, revenue from midstream infrastructure is based on the volume of oil and gas processed, which tends to be insulated from fluctuations in the price of oil and gas.

MLPs have posted solid performance thus far in 2016

As you can see from the chart below, MLPs have provided an attractive level of yield over the past several years. From a return perspective, it’s clear that while MLPs have the potential to generate attractive returns, they can also experience sharp losses and returns can be quite volatile. For example, after posting a negative total return in 2015, as represented by the Alerian MLP Index, MLPs rebounded this year to post a positive total return as of Sept. 30, 2016.

Annual performance and yield of MLPs since the financial crisis

Past performance cannot guarantee future results. An investment cannot be made in an index.

While many investors may assume that oil prices are the biggest determinant of MLP performance, especially since MLPs and oil both fell in 2015, correlations between oil prices and MLP performance are relatively low over the longer term.5 MLP performance has historically been tied more closely to the level of energy production in the US. Additionally, natural gas, not oil, is the primary focus of most MLPs.

However, last year the correlation between MLPs and oil prices were higher than usual,5 as investors may have been concerned about whether the US could sustain its record output of oil production in the face of low prices. As a result, we believe last year’s MLP market was overbuilt from an oil production standpoint, leading to volatility in the MLP market that hasn’t been seen since the global financial crisis.

Today, we believe the MLP market presents a better risk/reward opportunity, as evidenced by the positive performance so far this year. We also believe US oil production is sustainable, particularly in West Texas, which helps make the case for long-term exposure to MLPs.

It’s important that investors understand the correlation between oil and gas prices and MLP performance, as it’s clear, from a return perspective, that while MLPs have the potential to generate attractive returns, they can also experience sharp losses.

Ways to invest in MLPs

There can be distinct advantages and disadvantages to the various investment vehicles that investors choose for their MLP exposure – whether it’s investing directly in MLPs, or through open-end mutual funds and exchange-traded funds (ETFs). Each individual’s situation is unique, so selecting the right vehicle is important.

For example, some investors might not want to deal with the paperwork involved with a direct MLP investment, namely the Schedule K-1 process and the requirement to file state income taxes in each state where the MLP operates.

Other investors may not be aware that open-end mutual funds and ETFs pay corporate-level taxes, which can potentially eat into the performance of the underlying MLPs, but also alleviate the tax filing burdens because the funds handle the K-1 process by providing shareholders with 1099s instead.

What’s more, potential investors need to be aware that open-end mutual funds and ETFs tend to offer more diversification than buying MLPs directly.

Learn more about MLPs

Talk to your advisor about MLPs if you’re seeking an investment that has the potential to generate attractive returns, provide attractive levels of current income, serve as a hedge against inflation and/or provide portfolio diversification.

Learn more about Invesco MLP Fund

Learn more about the MLP & Income Portfolio

Learn more about alternative investing

Important information

Blog header image: wang song/Shutterstock.com

1. Source: Alerian, as of Dec. 31, 2015

2. Source: US Energy Information Administration, Dec. 4, 2014

3. Source: “Oil & Natural Gas Transportation & Storage Infrastructure: Status, Trends, & Economic Benefits,” IHG Global Inc., December 2013

4. Source: Alerian. The Alerian MLP Index is a composite of the 50 most prominent energy master limited partnerships calculated by Standard & Poor’s using a float-adjusted market capitalization methodology.

5. Sources: Bloomberg L.P., StyleADVISOR. Based on 10-year correlation of 0.48 and 2015 correlation of 0.55 between the Alerian MLP Index and West Texas Intermediate oil prices, as of Dec. 31, 2015

Correlation is the degree to which two investments have historically moved in relation to each other.

Most MLPs operate in the energy sector and are subject to the risks generally applicable to companies in that sector, including commodity-pricing risk, supply-and-demand risk, depletion risk and exploration risk. MLPs are also subject the risk that regulatory or legislative changes could eliminate the tax benefits enjoyed by MLPs which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the portfolio’s investments.

Diversification does not guarantee a profit or eliminate the risk of loss.

Walter Davis

Alternatives Investment Strategist

As Alternatives Investment Strategist, Walter Davis serves as Invesco’s primary alternatives representative to retail, high net worth and institutional clients across the major broker dealers, wirehouses and RIAs. He is responsible for collaborating across Invesco’s alternative strategies to develop a cohesive alternatives education program for financial advisors and investors.

Prior to joining Invesco in 2014, Mr. Davis served as a managing director in Morgan Stanley’s Alternative Investments Department, and earlier as director of High Net Worth and Institutional Sales. Prior to Morgan Stanley, he worked at Chase Manhattan Bank in the Alternative Investments Department. He has worked in the industry since 1991.

Mr. Davis graduated cum laude with a BA in economics from the University of the South. He earned an MBA in finance and international business from Columbia Business School. He holds the Series 3, 7, 24 and 63 registrations.