risk-based asset allocation & risk parity - granicus
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Risk-Based Asset Allocation & Risk Parity
Lee Partridge, CFARoberto Croce, Ph.D.Todd Centurino, CFA
SDCERA 2014 Board of Trustees RetreatMarch 2014
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DisclosuresThe opinions expressed in these materials represent the personal views of Salient’s investment professionals and are based on their broad investment knowledge, experience,research and analysis. However, market conditions, strategic approaches, return projections and other key factors upon which the views presented in these materials arebased remain subject to fluctuation and change. Consequently, it must be noted that no one can accurately predict the future of the market with certainty or guarantee futureinvestment performance.
This presentation contains "forward-looking statements." Forward-looking statements can be identified by the words "may," "will," "intend," "expect," "estimate," "continue,""plan," "anticipate," "could," "should" and similar terms and the negative of such terms. By their nature, all forward-looking statements involve risks and uncertainties, andactual results could differ materially from those contemplated by the forward-looking statements. Several factors that could materially affect actual results are theperformance of the portfolio of securities, the conditions in the U.S. and international financial, natural gas, petroleum and other markets and other factors. Actual results coulddiffer materially from those projected or assumed in our forward-looking statements.
Please note that the returns presented in this presentation are the result of a hypothetical investment framework. Backtested performance is NOT an indicator of future actualresults and do the results above do NOT represent returns that any investor actually attained. Backtested results are calculated by the retroactive application of a modelconstructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses. Certain assumptionshave been made for modeling purposes and are unlikely to be realized. No representations and warranties are made as to the reasonableness of the assumptions. Changes inthese assumptions may have a material impact on the backtested returns presented. This information is provided for illustrative purposes only. Backtested performance isdeveloped with the benefit of hindsight and has inherent limitations. Specifically, backtested results do not reflect actual trading or the effect of material economic andmarket factors on the decision-making process. Since trades have not actually been executed, results may have under- or over-compensated for the impact, if any, of certainmarket factors, such as lack of liquidity, and may not reflect the impact that certain economic or market factors may have had on the decision-making process. Further,backtesting allows the security selection methodology to be adjusted until past returns are maximized. Actual performance may differ significantly from backtestedperformance. Backtested results are adjusted to reflect the reinvestment of dividends and other income. The above backtested results are do not include the effect ofbacktested transaction costs, management fees, performance fees or expenses, if applicable. No cash balance or cash flow is included in the calculation.
This presentation does not constitute an offering of any security, product, service or fund. No investment strategy can guarantee performance results. Past performance is noguarantee of future results. All investments are subject to investment risks, including loss of principal invested.
Research and advisory services are provided by Integrity Capital, LLC, a wholly owned subsidiary of Salient Partners, L.P. and a U.S. Securities and Exchange CommissionRegistered Investment Adviser. Salient research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Salientrecommends that investors independently evaluate particular investments and strategies, and encourage investors to seek the advice of a financial advisor. Theappropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
Salient is the trade name for Salient Partners, L.P., which together with its subsidiaries provides asset management and advisory services. Insurance products offered throughSalient Insurance Agency, LLC (Texas license #1736192). Trust services provided by Salient Trust Co., LTA. Securities offered through Salient Capital, L.P., a registered broker-dealer and Member FINRA, SIPC. Each of Salient Insurance Agency, LLC, Salient Trust Co., LTA, and Salient Capital, L.P., is a subsidiary of Salient Partners, L.P.
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What is a Risk-Based Asset Allocation?
Risk-based asset allocation schemes typically exhibit several features Allocate by risk: Investments are allocated or thought of in units of risk, such as
volatility Target Risk: Allocations target an aggregate level of risk that is less sensitive to
changing market risk Dynamic and Adaptive: By targeting a fixed risk level, allocations will change
dynamically to adapt to changing markets
Risk-Based Asset Allocation
Integrity Capital, LLC 2014Diversification can not assure a profit or guarantee against loss
“Worldly wisdom teaches us that it is better for reputation to fail conventionally than succeed unconventionally.” -- John Maynard Keynes
“If you want to have a better performance than the crowd, you must do things differently from the crowd.” -- Sir John Templeton
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Dynamic and Adaptive Response to Changes in Volatility
The ability to adapt to changes in market volatility allows for a more constant volatility over time
Achieving more consistent levels of risk is important for investors with fixed return targets (such as actuarial returns)
Risk-Based Asset Allocation
Fore illustrative purposes onlySource: Bloomberg and Integrity Capital LLC, 2014
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Rolli
ng V
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Rolling S&P Vol (66 days)
Rolling RPV15+ Index Vol (66 days)
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Dynamic and Adaptive Response to Changes in Volatility
Risk-based asset allocation incorporates a dynamic weighting scheme that quickly adjusts to changing market regimes
Risk-Based Asset Allocation
For illustrative purposes onlySource: Bloomberg and Integrity Capital LLC, 2014
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RPV15+ Index Monthly Equity Exposure (LHS) S&P 12 Month Rolling Vol (RHS)
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Advantages of Risk-Based Asset Allocation
Does not rely on uncertain return forecasts
Seeks intentional risk exposure
May lead to more predictable volatility levels and downside profile
May provide the ability to adapt and take advantage of low volatility and high Sharpe ratio environments
Risk Parity is a special case of risk-based asset allocation in which different investments target the same level of risk By adding this feature, risk-based allocation may also provide access substantially
greater diversification
Risk-Based Asset Allocation
Integrity Capital, LLC 2014
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Risk Parity is a global asset allocation framework that seeks to:
Equally weight risk within and across asset classes
Allow investors to target a specific level of investment risk
Deliver efficient diversification
Provide liquidity
Take the emotion out of investing
What is Risk ParityRisk-Based Asset Allocation
Integrity Capital, LLC 2014Diversification can not assure a profit or guarantee against loss
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Traditional Institutional Investor PortfolioRisk-Based Asset Allocation
For illustrative purposes onlyIntegrity Capital, LLC 2014
For the purposes of this presentation, the Traditional Institutional Investor Portfolio will be allocated as follows:
45%
35%5%
5%
5%
5%
Global Equities (MSCI World Index)
Credit (Barclays Aggregate Bond Index)
Real Estate (Dow Jones US Real Estate Index)
Hedge Funds (HFRI Macro Total Index)
Commodities (S&P GSCI Total Return CME)
Private Equity (MSCI Daily TR Net USA (Levered 30%))
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$0
$500
$1,000
$1,500
$2,000
$2,500
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
DO
LLA
RS
YEAR
MSCI AC World Index (Stocks)
Barclays Aggregate Bond Index (Bonds)
Traditional Institutional Portfolio
Equity Risk Has Dominated a Traditional Allocation
The traditional allocation framework historically has had greater dependence on equity risk than dollar allocation implied
Risk-Based Asset Allocation
For illustrative purposes onlySource: Bloomberg, March 2014.
Past performance is not a guarantee of future results.
Growth of $1,000: Stocks, Bonds & a Typical Institutional Portfolio February 2004 through January 2014
Bonds
Inst. Port
Stocks
Movements in the equity markets surmount bond markets in determining
the experience of many investors
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The calculation of risk contribution from equities and bonds is based on modern portfolio theory's calculation of portfolio risk where the contribution of equities and bonds to the portfolio risk are calculated based on the dollar weights, standard deviation, and correlation of
equities and bonds. Integrity Capital, LLC. uses this portfolio theory calculation to assess risk allocation.
Comparing Investment ApproachesRisk-Based Asset Allocation
For illustrative purposes only.
PRO
Systematic rebalancing over time, meaning adjustments are made to portfolio to counteract the fact that different assets have performed differently and now comprise different percentages of portfolio than they were intended to
CON
Often dominated by Equity Risk, which is the risk that one’s investments will depreciate due to stock market dynamics, resulting in loss of investment value
TRADITIONAL INSTITUTIONAL PORTFOLIO BY DOLLAR ALLOCATION
TRADITIONAL INSTITUTIONAL PORTFOLIO BY RISK ALLOCATION
Traditional Institutional Portfolio dollar allocation vs. risk allocation
45%
35%5%
5%
5%
5%
Global EquitiesCreditReal EstateHedge FundsCommoditiesPrivate Equity
70.7%
2.4%10.1%
0.9%
6.9%
9.1%
Global EquitiesCreditReal EstateHedge FundsCommoditiesPrivate Equity
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10.5%
9.8%
26.5%
17.9%
35.3%
20%
20%
20%
20%
20%
Risk Parity Portfolios Aim for Broader DiversificationRisk-Based Asset Allocation
Source: Bloomberg and Salient Advisors, L.P. Data from 2/1/2004 to 1/31/2014.1 The asset allocation percentages have been rounded for illustrative purposes. Note: The Sample Risk Parity Portfolio is constructed using the MSCI AC World Index (Equities), Continuous CommodityIndex (Commodities), Barclays US Aggregate Long Treasury Index (Rates), Barclays US Corporate High Yield Index (Credit), and Barclay CTA Index (Momentum). For illustrative purposes only.See Index Glossary for the definitions of Dollar Allocation, Risk Allocation, Volatility and Notional.
Sample Risk ParityPortfolio1
Credit
Rates
Volatility: 10.0%Notional: 1.8x
Dollar Allocation Risk Allocation
Traditional Institutional
Portfolio
Volatility: 10.0%Notional: 1x
Dollar Allocation Risk Allocation
Data shown here represents the historical data of the indices selected to represent each asset class, as specified below.
Momentum
Rates
Stocks
Credit
CommoditiesMomentum
Commodities
Stocks
45%
35%5%
5%5%
5%
70.7%
2.4%10.1%0.9%
6.9%
9.1%
Equities
Credit
Commodities
Real Estate
Hedge Funds Commodities
Real Estate
Hedge FundsCredit
EquitiesPrivate Equity
Private Equity
The Traditional Institutional Portfolio targets a specific dollar allocation and allows the risk allocation to float.
The risk parity investment process starts with a target risk allocation and then allows the dollar allocation to adjust to maintain the target risk.
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A Portfolio Designed for a Variety of Conditions
In seeking to harvest potential returns across markets, risk parity invests in liquid asset classes that provide the potential for positive return (e.g., currencies are excluded because they are a “zero sum” game) and we believe are explainable by economic and behavioral factors:
Risk Parity Strategy
For illustrative purposes onlySource: Integrity Capital, LLC 2014
Inflation
EQUITIES
Growth
CREDIT
DeflationSentiment
MOMENTUM
FACTOR:
Momentum strategies are designed to capture
market returns during periods of strong investor
sentiment – by either buying securities during
times of positive sentiment or selling
securities during times of negative sentiment.
During periods of falling interest rates, fixed
interest rate securities, like treasuries have
generally performed well.
During periods of rising prices, real assets, like
commodities, generally perform as their prices
also rise.
COMMODITIESEquity returns – a
function of cash flow growth – have historically
been strong during periods of economic
expansion.
RATES
Low Growth
While also driven by growth, credit strategies
tend to outperform during sustained periods
of low growth.
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Building an Efficient Portfolio
Accessing leverage offers the opportunity to increase a portfolio’s expected return at the same level of risk
Risk Parity Strategy
*There can be no assurance that a levered or unlevered Risk Parity Portfolio can provide higher level returns to any other comparable portfolio, including a 60/40 portfolio, at the same level of risk. Source: Integrity Capital, LLC 2014Note: Chart is for illustrative purposes only, is hypothetical and is not based on an actual portfolio.
Portfolio Risk
Expe
cted
Por
tfol
io R
etur
n
Risk Free Rate
The Universe of Efficient Portfolios
60/40 Portfolio
Risk ParityPortfolio*
Efficient Frontier
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US EquityOther
Developed Equity
Emerging MarketEquity
DevelopedCorporate
Credit
High Yield
Emerging Market
DebtMomentum
DevelopedSovereign
Debt
Metals
Agriculture
Energy
Multiple Layers of Risk Parity
Gas O
il
US
Larg
e Ca
p
Emerging MarketDebt
(46 Futures Contracts)10 Yr. UK Govt. Debt
10 Yr. Australian Govt. Debt
US High Yield
European High Yield
10 Yr. GermanGovt. Debt
10 Yr. JapaneseGovt. Debt
European Investment Grade Corporate Credit
Equities20%
Credit20%
Momentum20%
Rates20%
Commodities
20%
This graph represents the target portfolio risk allocations. An investor’s portfolio allocation may vary from the target strategic asset allocation at any point in time. There can be no assurance that the portfolio’s targets may be achieved. There are special risks associated with an investment in commodities and futures, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Transactions in futures are speculative and carry a high degree of risk.
Integrity Capital, LLC 2014
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Correlation
As Nobel Prize-winning economist Harry Markowitz famously noted, the one “free lunch” in finance is available to investors who can spread portfolio risk across asset classes that exhibit low or negative correlation to one another.
That is why a risk parity strategy seeks to balance risk across equities, credit, interest rates, commodities and momentum.
Risk Parity Strategy
Source: PerTrac, Bloomberg and Integrity Capital, LLC 2014See Index Glossary for the definition of Correlation Analysis.
Global Equities
Corporate and High Yield
Bonds
IntermediateGovernment
TreasuriesCommodities Momentum
Global Equities 1
Corporate and High Yield Bonds 0.56 1
Intermediate Government Treasuries -0.10 0.24 1
Commodities 0.37 0.31 -0.05 1
Momentum -0.07 0.00 0.26 0.19 1
Correlation Analysis January 1990 – December 2013*
Low Correlation Medium Correlation High Correlation
The data above is not representative of any portfolio holdings or portfolio performance. Data shown here represents the historical data of the indices selected to represent each asset class. Past performance is not necessarily indicative of future results.
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/200
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10/1
/201
2
7/1/
2013
S&P Annualized 1 Month Returns
S&P Annualized 1 Month Volatility
Tracking Volatility and Return Streams
Risk Parity strategies rebalance each month based on expected future volatility and correlation, statistical measures that are more stable than returns over time.
Risk Parity Strategy
For illustrative purposes onlyPast performance is not indicative of future resultsSource: Integrity Capital, LLC 2014
Retu
rn/V
olat
ility
(%)
Year
Near-term returns are volatile, and hard to
predict
Volatility streams are persistent month-to-month
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Dynamic Index AllocationIn order to maintain a targeted risk level, Risk Parity or any risk-based framework should constantly change
Index performance shown is not indicative of Fund performance and is for illustrative purposes only.Source: Bloomberg, Integrity Capital, LLC. data from January 1990 to December 2013.1 Salient Risk Parity Index allocations are the result of a hypothetical model portfolio of 46 exchange-traded futures contracts and five over the counter Credit Default Swap contracts. Values plotted for the Equity, Rates, Commodity, and Credit allocations show the gross notional exposure of the allocation to the respective asset class as a fraction of portfolio Net Asset Value. Values plotted for the Momentum allocation show the absolute value of the net exposure as a fraction of portfolio Net Asset Value. The “Implied Volatility Index” represents the CBOE Volatility Index from 1/30/1990 to 12/31/2011. For a detailed look at the underlying assets within each composite, please refer to slide 11. The Salient Risk Parity V15+ Index has been retrospectively calculated by Salient Index Management, LLC, and did not exist prior to January 2012. Accordingly, the allocations shown during the retrospective periods do not reflect actual allocations. Certain futures contracts and credit default swap instruments comprising the underlying assets classes were not available at inception of the retrospective Index allocation calculation beginning in January 1990. Futures contracts unavailable at Index inception were included in the underlying asset classes as available. Credit default swaps comprising the Global Credit asset class were included beginning April 2009. Past performance is not necessarily indicative of how the Index will perform in the future. Index performance does not reflect the deduction of fees or expenses. The performance of any investment product based on the Salient Risk Parity Indices would have been lower than the indices as the result of fees and/or costs. Note that an investor cannot invest directly in the Index.
Salient Risk Parity V15+ IndexPercentage Dollar Allocation: 1990 – 20131
10
20
30
40
50
60
70
80
0%
100%
200%
300%
400%
500%
600%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Implied V
olatility IndexN
otio
nal E
xpos
ure
YearGlobal Equity Composite Commodity Composite Global Interest Rates CompositeGlobal Credit Composite Implied Volatility Index (VIX)
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Risk Parity Strategy Growth and Drawdown: 1990-20131
$700
$2,800
$11,200
$44,800
Gro
wth
of $
1,00
0
-40%
-30%
-20%
-10%
0%
1989 1991 1993 1994 1996 1998 1999 2001 2003 2004 2006 2008 2009 2011 2013
Draw
downSalient Risk Parity Index
Salient Risk Parity V12+ IndexSalient Risk Parity V15+ Index60/40 Index
Year
Salient Risk Parity Index – Performance*
Salient Risk Parity Index Salient Risk Parity V12+ Index Salient Risk Parity V15+ Index 60/40 IndexAnnualized Return 10.90% 15.28% 18.47% 6.77%Annualized Volatility 9.87% 11.95% 14.93% 9.49%Risk-Adjusted Return 1.10 1.28 1.24 0.71
Past performance is not a guarantee of future results. Index performance shown is not indicative of Fund performance and is for illustrative purposes only.Source: Bloomberg, Salient Index Management, LLC. Data from January 1990 to December 31, 2013.*For a detailed look at the underlying assets within the Salient Risk Parity Indices, please refer to slide 11. The Salient Risk Parity Indices have been retrospectively calculated by Salient Index Management, LLC, and did not exist prior to January 2012. Accordingly, the results shown during the retrospective periods donot reflect actual returns. Certain futures contracts and credit default swap instruments comprising the underlying assets classes were not available from January 1990 to January 2012, during which period the Index was backtested. Futures contracts unavailable during this time were included in the underlying assetclasses as available. Credit default swaps comprising the Global Credit asset class were included beginning February 2009. Past performance is not necessarily indicative of how the Indices will perform in the future. Performance of the Indices does not reflect the deduction of fees or expenses. The performance of anyinvestment product based on the Salient Risk Parity Indices would have been lower than the Indices as the result of fees and/or costs. Note that an investor cannot invest directly in the Indices. The Salient Risk Parity Index represents hypothetical performance since the Index does not reflect any particular investmentprogram and may, therefore, have certain inherent limitations, some of which are described below. Since this is Index performance, it does not represent the performance of any investment account or the results of actual trading, and no representation is being made that any account using the Index as a benchmarkwill experience performance similar to the Index’s performance. In fact, it is not uncommon for investment programs targeting a particular index to have performance that diverges materially from the performance of the relevant index. In addition, hypothetical performance does not involve financial risk, and nohypothetical performance record can completely account for the impact of financial risk that exists in an investment program that is actually trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affectactual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.1 The 60/40 Index represents an allocation of 60% MSCI AC World Index Total Return, 40% Barclays Aggregate Bond Index - formerly the Lehman Aggregate Bond Index through Nov. 2008.See Slide 22 for a full description of each index referenced above.
$58,385
$30,329
$11,989
$4,821
1994 - 95-12.02%-17.05%-21.25%-5.39%
2000 - 02-16.38%-15.97%-20.46%-23.66%
2008 - 09-23.38%-16.07%-19.92%-35.68%
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Index GlossaryEach Index contained or referenced in the presentation is defined below:
Salient Risk Parity Index: a composite, USD-based, total return index. The Salient Risk Parity Index (“SRPI”) was designed to provide Salient Index Management, LLC,. a benchmark for an equally risk-weighted investment across global securities markets. It represents the value of a basket of global equity, global fixed income, global interest rate and commodity derivatives. The SRPI weights are calculated given a 10% targeted level of risk, as measured by annualized standard deviation.Salient Risk Parity V12+ Index: same as SRPI, but the Salient Risk Parity V12+ Index has been calculated given a 12% targeted level of risk, as measured by annualized standard deviation.Salient Risk Parity V15+ Index: same as SRPI, but the Salient Risk Parity V15+ Index has been calculated given a 15% targeted level of risk, as measured by annualized standard deviation. MSCI ACWI Index: a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI consists of 45 country indices comprising 24 developed and 21 emerging market country indices. Barclays Aggregate Bond Index: a U.S. Aggregate index that covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities. The index includes government securities, mortgage-backed securities, asset-backed securities and corporate securities all with a maturity of greater than one year.Barclays U.S. Aggregate Long Treasury Bond Index: a U.S. Aggregate index that measures the investment return of U.S. Treasury securities that have a remaining maturity of at least 20 years. Barclays U.S. High Yield Bond Index: a U.S. Aggregate index that is composed of fixed-rate, publicly issued, non-investment grade debt. Barclay CTA Index: an unweighted index that measures the composite performance of established programs. For purposes of this index, an established trading program is a trading program that has four years or more documented performance history. Barclays Intermediate Treasury Index: includes all publicly issued, U.S. Treasury securities that have a remaining maturity of greater than or equal to 1 year and less than 10 years, are rated investment grade, and have $250 million or more of outstanding face value.Continuous Commodity Index: a commodities index that is made up of 17 commodities whose futures trade on U.S. Exchanges. The index is a broad measure of overall commodity price trends within six component groups: energy, grains, industrials, metals, livestock and softs. CRB Spot Index: a commodity price index made up of 19 commodities sorted into 4 groups, each with different weightings. The groups are: petroleum based products, liquid assets, highly liquid assets and diverse commodities.
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DefinitionsDollar Allocations are the particular number of dollars that are set apart for the purchase of a specific asset within a portfolio. For example,if a 60/40 portfolio was purchased at $100, $60 would be used to purchase equities, while $40 would be used to purchase bonds.
Risk Allocations, alternatively, are to the total amounts of risk that are associated with each asset within a portfolio.
Volatility is a mathematical measure of uncertainty or risk about the size of changes in a security’s value. A higher volatility means thefluctuations in value will be higher, while a lower volatility means those peaks and valleys will be smaller.
Notional refers to the amount of money, or exposure, used to calculate payments. In other words, every dollar invested in this sample riskparity portfolio is exposed to $1.90 worth of assets.
Correlation Analysis evaluates the strength of the relationship between various asset classes. In other words, it measures the alignmentbetween movements in their value. A low correlation indicates that the asset classes do not move in relation to one another while assetswith high correlation do (a perfect correlation of 1 translates to exact similarities in movement). The correlation asset classes correspond tothe following indices - Global Equities: MSCI AC World Index, Intermediate Government Treasuries: Barclays Intermediate Treasury Index,Commodities: CRB Spot Index, Momentum: Barclay CTA Index and uses data from 9/30/2002 to 8/31/2012. Please note that pastperformance is not necessarily indicative of how the Indices will perform in the future. Index performance does not reflect the deduction offees or expenses. Note that an investor cannot invest directly in an index.
Expected Portfolio Return is a measure of future portfolio returns based on historical performance and weights of the portfolio’sunderlying components.
Portfolio Risk is a measure of the annualized standard deviation of a portfolio.
Lending refers to a portfolio that has an allocation to cash, which has been invested at the risk-free rate.
Borrowing refers to a portfolio that pays the risk-free rate to gain a notional exposure greater than 100%.
The Efficient Frontier is a plot of optimal portfolios that have the highest expected return for the given amount of risk.
The Capital Market Line illustrates every combination of the risk free rate and the efficient (tangency) portfolio and is represented by theline from the risk free rate of return through the tangency point on the efficient frontier.
60/40 portfolio represents a portfolio with a 60% equities and 40% bond allocation.
Risk Parity Portfolio is a portfolio with equally weighted risk contributions from each underlying asset class (equities, rates, commodities,credit and momentum).
The Risk Free Return is the theoretical rate of return of an investment with zero risk.
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Investment Risk FactorsIn considering an investment in a risk parity strategy, prospective investors should be aware of certain specialconsiderations and risk factors, which include, but are not limited to, the following:
General Investment Risk, i.e., the risk of deterioration in the financial markets in general;Strategy Risk, i.e., the risk that the investment strategies and/or investment techniques may not work as intended;Institutional Risk, i.e., the risk that the investment strategy could incur losses due to: (i) the failure of counterpartiesto perform their contractual commitments to the investor or (ii) the financial difficulty of brokerage firms, banks orother financial institutions that hold the assets of the investor;Operational Risk, i.e., the special considerations and risks arising from the day-to-day management of a pooledinvestment strategy; andUse of Leverage, i.e., the strategy may utilize leverage and may also invest in forward contracts, options, swaps andover-the-counter derivative instruments, among others. Like other leveraged investments, trading in these securitiesmay result in losses in excess of the amount invested.Counterparty and Bankruptcy Risk, i.e., although Salient will attempt to limit its transactions to counterpartieswhich are established, well-capitalized and creditworthy, the investor will be subject to the risk of the inability ofcounterparties to perform with respect to transactions whether due to insolvency, bankruptcy or other causes, whichcould subject the investor to substantial losses.Volatile Market Risk, i.e., market prices are difficult to predict and are influenced by many factors, including: changesin interest rates, weather conditions, government intervention and changes in national and international political andeconomic events.
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