long/short equities, managed futures and fixed income arbitrage. Why? Basically, because adding alternatives to a portfolio of traditional assets may potentially lower risk and increase returns. A clear understanding of how this happens requires study of alternative strategy returns and their correlation to the returns of stocks and bonds. The chart to the right highlights alternative strategy returns and their correlation to equities during bear and bull market conditions. Notice that the Alternative Average, which represents a blend of these strategies, acts like bonds in the bear market cycle but responds like equities when the bull market cycle returns. Bear Market Bull Market April 2000 to March 2003 Performance Correlation Return Risk S&P 500 Strategies April 2003 to March 2006 Performance Correlation Return Risk S&P 500 TIPS 12.0% 5.3% -85% 4.8% 5.2% 20% REITs 13.4% 14.6% 62% 34.0% 18.9% 46% Long/Short Currency 14.3% 5.3% 35% 11.7% 7.8% 37% Commodities 10.6% 14.3% -12% 34.9% 17.0% -31% Gold 6.4% 11.5% -5% 20.0% 13.6% 16% Private Equity -9.6% 6.0% 82% 27.4% 9.4% 62% Long/Short Equity -3.3% 5.3% 57% 15.3% 6.9% 78% Managed Futures 11.3% 16.9% -77% 5.9% 12.7% 57% Fixed Income Arbitrage 7.3% 2.6% -34% 4.9% 3.2% 55% Alternative Average 6.9% 9.1% 2% 17.6% 10.5% 38% LB Aggregate Bond 9.8% 3.7% -85% 2.9% 3.6% 9% MSCI EAFE -19.3% 14.1% 83% 31.7% 17.8% 94% S&P 500 -16.1% 16.6% 100% 17.2% 12.2% 100% April 2000  – March  2006     25% REITS Commodites 20% ALTERNATIVE  AVERAGE 15% RETURN   Long/Short Currency 10% Gold Managed Futures TIPS Private  Equity   Fixed Income   Arbitrage 100%  Bonds 5%   Long/Short Equity 60% Equities  & 40% Bonds       0% 100%  Equities RISK -5% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Combining assets which do not exhibit a high correlation to one another gives investors an opportunity to reduce risk without sacrificing return. To realize the benefit of diversification, a portfolio’s underlying asset classes must behave differently in varying market conditions.

The graph above contrasts alternative strategy risk and return with that of the equity and bond frontier. The graph also illustrates the response of a 60/40 equity/bond portfolio as an alternative strategy is incorporated: the blue line shows the portfolio moving away from its original 60/40 equity/bond allocation toward the Alternative Average, in 10% increments. This shows that adding alternatives to a portfolio can increase diversification, boost returns, and help manage risk, because alternative strategies are not correlated to stocks and bonds. If the investor’s goal is to secure higher returns at a lower risk, then integrating alternatives into a traditional portfolio should help reduce portfolio volatility and improve the odds of preserving capital over the long term. Disclosure Performance displayed represents past performance, which is no guarantee of future results.The information provided here is for informational purposes only, is not intended as investment advice and should not be construed as a recommendation with regard to investment decisions.

Source for charts and graphs: Morningstar, Bloomberg, Deutsche Bank calculated by Arrow Investment Advisor, LLC. Equity returns are based on the S&P 500 Index, which includes the reinvestment of dividends. Bond returns include the reinvestment of dividends are based on two data sets: Lehman Aggregate Bond Index and Ibbotson’s Long- Term Government Bonds portfolio.The indices are unmanaged and are not available for direct investment.The frontier returns assumes re-investment of all dividends but do not reflect any management fees, transaction costs or expenses. .