Download Not All Benchmarks Are Created Equal

Not All Benchmarks
Are Created Equal
Tuesday 25th March 2014
1
Benchmark Proliferation
How can we make sense of the apparent
proliferation of benchmarks available?
Which have merit to be used as
benchmarks and which do not?
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
2
LDI Hub
Liquid Markets
Liquid Credit
Illiquid Credit
Illiquid Markets
Collateral Mgt.
Equities (EM, DM)
Sterling Credit (IG)
Structured Finance
Reinsurance
Pooled vs. Seg
DGFs
Global Credit (IG)
Infrastructure Debt
Private Equity
Leverage & Liquidity
Style Premia
HY/Loans
Senior Direct Lending
Infrastructure
Overlay Strategies
Risk Parity
ABS
Mezzanine Finance
Real Estate
CTA
Emerging Market Debt
Distressed Debt
Global Macro
Absolute Return Bonds
Senior CRE Debt
Equity Long-Short
Total Return Sub-IG
Credit Relative Value
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
3
Is Alpha Just Beta Waiting to be Discovered?
Time
Alpha
Alpha
Alpha
Equity
Risk
Premium
Prior to capweighted indices, all
returns were
effectively viewed as
alpha
With the
introduction of
CAPM, the equity
market effect was
separated from
returns
Other
Market
Risk
Premia
Equity
Risk
Premium
This was then
extrapolated to
include other asset
classes such as
bonds and
commodities
Alpha
Style Premia
Other Market
Risk Premia
Equity Risk
Premium
Now we can
separate out a
number of risk
premia with much
less being left as
pure alpha
Source: AQR
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
4
What should a benchmark be trying to achieve ?
Liquid Markets
Access/capture the desired market “beta” in the most effective way
•
•
•
Transparent
•
No unintended biases
•
Sectors
•
Geography
•
Issuer
•
No unnecessary transaction costs in tracking the index
•
Captures evolution in market development
Different approaches to weighting components
•
Market capitalization – retains a lot of the above properties (but not always all)
•
Equal weighting/capped
•
Risk weighting
•
Optimized, eg minimum variance
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
5
What characteristics do we look for in forming benchmarks for our clients ?
Liquid Markets
•
Performance metric for fund management
•
•
Assess the performance of fund managers relative to relevant benchmark net of fees
Basis for synthetic allocations
•
Total Return Swap and Futures exposures
•
Take liquidity considerations into account (other things being equal) as this affects pricing
•
Liquidity concentrated in market capitalization indices
•
Places a high “bar” on non-market capitalization approaches
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
6
Style Premia Case Study
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
7
Neil Woodford: Style Premia in Practice
350
300
250
200
150
100
50
0
Invesco Perpetual High Income Fund
FTSE All Share
- Neil Woodford presents us with an intriguing practical look into style premia investing in the UK.
- His track record is impressive – he has beaten the FTSE All Share over the past 12 years by 3.4% p.a.
- But is this the correct benchmark to use to assess his performance?
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
8
Applying Style Premia to Neil Woodford
350
300
250
200
150
100
50
0
Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
Regressed
Portfolio Weights
Invesco High Income Fund
FTSE All Share
Source: Deutsche Bank, Invesco,
Bloomberg; Calculations: Redington
Market
Value
Momentum
Defensive
75%
13%
19%
52%
Woodford’s performance can broadly be explained by: a lower than 100% weight to the market
(represented by the FTSE All Share) along with allocations to value, momentum and defensive factors.
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
9
Major Style Premia Families Cutting Across Liquid Markets
Value
Momentum
•Buying assets that are “cheap” relative to their
fundamental value and selling “expensive” assets
•For example: go long lowest price-to-book stocks,
go short highest price-to-book stocks
•Involves buying assets that recently outperformed
peers and selling those that recently underperformed
•For example: go long stocks with highest 3 month
return, go short stocks with lowest 3 month return
Carry
•Implies buying high-yielding assets and selling lowyielding assets
•For example: go long highest yielding currencies, go
short lowest yielding currencies
Defensive
•Consists of buying low-risk, high-quality assets and
selling high-risk, low-quality assets
•For example: go long high return-on-equity stocks,
go short low return-on-equity stocks
Need to be able to go long, go short and to leverage across multiple asset classes
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
10
Style Premia Decomposition of A Fundamental Index
250
200
150
100
50
0
Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
Regressed
Portfolio Weights
RAFI Fundamental Index
Source: Deutsche Bank, Research Affiliates,
Bloomberg; Calculations: Redington
Market
Value
Momentum
Defensive
100%
21%
8%
0%
Mostly market exposure gained along with some value and momentum style premia
 Is this the most effective way of gaining these exposures ?
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
11
What characteristics do we look for in forming benchmarks for our clients ?
Multi-Asset
•
Diversified Growth Fund
•
•
Risk Parity
•
•
Static / Dynamic / Total Return / Absolute Return
Fully Systematic / Systematic with active overlay
“Traditional” comparison often used is either “equity returns with lower volatility” or simple 60/40 equity
bond asset mix which has a number of shortcomings
•
Allocations are more dynamic
•
Much greater range of assets/strategies employed
•
Credit
•
Options
•
Illiquid assets
•
Commodities
•
Global interest rates / FX
•
Relative value (market neutral)
•
Risk control
 Is it possible to create a multi-asset benchmark suitable for assessing these products ?
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
12
Conclusions
•
Access/capture the desired market “beta” in the most effective way
•
Transparent
•
No unintended biases
•
No unnecessary transaction costs in tracking the index
•
Captures evolution in market development
•
Market capitalization indices satisfy a lot of these requirements (although not necessarily all of them, all of the
time)
•
Makes market cap logical starting point
•
Although there are situations when an alternative is more appropriate
•
Be cognisant of tilts being introduced by new indices – are they just giving largely market exposure with small
style tilts ?
Teach-in
Not All Benchmarks Are Created Equal
25 March 2014
13
Contact
Dan Mikulskis FIA
Director
Direct Line: 020 3326 7129
[email protected]
Disclaimer
For professional investors only. Not suitable for private
customers.
The information herein was obtained from various sources.
We do not guarantee every aspect of its accuracy. The
information is for your private information and is for
discussion purposes only. A variety of market factors and
assumptions may affect this analysis, and this analysis does
not reflect all possible loss scenarios. There is no certainty
that the parameters and assumptions used in this analysis
can be duplicated with actual trades. Any historical
exchange rates, interest rates or other reference rates or
prices which appear above are not necessarily indicative of
future exchange rates, interest rates, or other reference
Teach-in
rates or prices. Neither the information, recommendations
or opinions expressed herein constitutes an offer to buy or
sell any securities, futures, options, or investment products
on your behalf. Unless otherwise stated, any pricing
information in this document is indicative only, is subject to
change and is not an offer to transact. Where relevant, the
price quoted is exclusive of tax and delivery costs. Any
reference to the terms of executed transactions should be
treated as preliminary and subject to further due diligence.
This presentation may not be copied, modified or provided
by you , the Recipient, to any other party without Redington
Limited’s prior written permission. It may also not be
disclosed by the Recipient to any other party without
Redington Limited’s prior written permission except as may
be required by law.
Registered Office: Austin Friars House, 2-6 Austin Friars,
London EC2N 2HD.
Redington Limited is an investment consultant company
regulated by the Financial Conduct Authority. The company
does not advise on all implications of the transactions
described herein. This information is for discussion purposes
and prior to undertaking any trade, you should also discuss
with your professional, tax, accounting and / or other
relevant advisers how such particular trade(s) affect you. All
analysis (whether in respect of tax, accounting, law or of any
other nature), should be treated as illustrative only and not
relied upon as accurate.
Redington Limited (reg no 6660006) is registered in England
and Wales.
Not All Benchmarks Are Created Equal
©Redington Limited 2014. All rights reserved.
25 March 2014
14
Not All Benchmarks are Created Equal:
Building Better Benchmarks – The MSCI Way
 Altaf Kassam – Managing Director
©2014. All rights reserved.
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Presentation Overview
I. Introduction to MSCI
II. Not All Benchmarks Are Created Equal
III. Building Better Benchmarks
IV. Evolution of Benchmarks
V. Appendix
©2014. All rights reserved.
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I. Introduction to MSCI
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MSCI is More Than Indexes
 MSCI provide investors with world-class, investment decision support tools
• Indexes
• Risk and Portfolio Analytics
• Corporate Governance
1969
2012
Index
©2014. All rights reserved.
Research & Innovation
2004
2013
2010
2004
Analytics
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II. Not All Benchmarks Are Created Equal
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Why should anyone care about benchmarks?
 The concept of a market portfolio plays an important role in many financial models,
including the Capital Asset Pricing Model (CAPM). In theory, the market portfolio
should be the portfolio of choice for a truly passive investor 1
 Widely used in the investment process in several applications:
 Tools for investment research and strategic asset allocation
 Performance benchmarks for actively managed portfolios
 Index-linked vehicles to capture the market beta (equity risk premium)
 The broad acceptance of market cap weighted indices does not rely on (potentially
flawed) academic theories, such as the CAPM; it stems from practical considerations
linked to the institutional investment process:
 Automatic rebalancing, replicate simple buy and hold strategy
 Low turnover, implying low transaction / implementation costs
 High trading liquidity and high (maximum) investment capacity
1
“Global Invested Capital Market”, Hewitt ennisknupp, February 2014
©2014. All rights reserved.
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What Matters Most and How MSCI Builds Better Benchmarks
MSCI puts emphasis on:

Leading to MSCI indices being:
 Accuracy, timeliness and transparency
 Consistent global framework: no gap, no overlap
 Timely reflection of market changes
1. Accurate measures of markets
 Transparent methodology and market
classification framework
2. Fair benchmarks for managers
 Investability and replicability
 Systematic use of buffer zones to reduce turnover
3. Cost effective solutions for
index replication
 Accurate implementation of corporate events
 Stringent short and long term liquidity measures
©2014. All rights reserved.
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MSCI has been defining the Equity space for 40+ years
©2014. All rights reserved.
Removal of
home and size biases
MSCI
ACWI
All Country
World Index
MSCI
ACWI IMI
(45 countries)
MSCI
EAFE
was
created
in 1969
MSCI
EM
99%
coverage
No GAPS &
OVERLAPS
EM SC
International SC
was
created
in 1988
Domestic SC
Emerging Markets LC & MC
EM SC
International LC & MC
International SC
Domestic SC
Domestic LC & MC
Home and size biases
Removal of home
bias
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MSCI Index Families
MSCI Country &
Regional Indices
All Country
(DM+EM)
MSCI Size
Indices
Large Cap
MSCI Style
Indices
Value
MSCI Sector
Indices
Sector
MSCI Thematic
Indices
Commodity
Producers
MSCI ESG
Indices
Best-in-Class
MSCI Strategy
Indices
Risk Premia
- Value Weighted
Custom Indices
Equity
Screening
- Risk Weighted
Developed
Markets (DM)
Mid Cap
Growth
Industry
Agriculture &
Food Chain
- Equal Weighted
Socially
Responsible
- GDP Weighted
- Minimum Volatility
Custom
Weighting
- Factor
Emerging
Markets (EM)
Standard (Large
+ Mid)
Infrastructure
Sub-industry
Ex-Controversial
Weapons
- High Div Yield
- Risk Control
- Quality
- Momentum
Faith-Based
Frontier
Markets (FM)
Domestic
-US
Small Cap
SMID
(Small + Mid)
-China
- Catholic
Environmental
- Quality Mix
- Islamic
Economic
Exposure
Capped
- 10/40
Custom
Delivery and
File Format
- 25/50
-Australia
- Standard Capped
Tradable
-Asia APEX
IMI
(Large+ Mid +
Small)
Hedged & Currency
- Hedged
-EM 50
-FM 100
Real Estate
Custom
Currencies and
Tax Rates
Micro Cap (DM
Only)
All Cap (DM
Only)
©2014. All rights reserved.
- FX Hedged
- Global Currency
Short & Leveraged
(Daily)
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III. Building Better Benchmarks
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How MSCI Does it
Key benefits that make MSCI the number one choice for global institutional
investors include:
 Emphasis on objectivity, accuracy and transparency:
- Transparent market classification framework
- Comparability of size segments across markets
- Exclusion of non-equity like securities
- Precise methodology to assign companies to markets
 Emphasis on investability and replicability:
- Precise free float factors
- Stringent short and long term liquidity measures
- Minimum foreign room requirements
- Effective migration buffer mechanism
- Predictable implementation of corporate events
©2014. All rights reserved.
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25
The MSCI Market Classification Framework
 The MSCI Market Classification Framework consists of three criteria:
economic development, size & liquidity and market accessibility
 In order to be classified in a given investment universe, a country must meet
the requirements of all three criteria
Criteria
Frontier
Emerging
Developed
No requirement
No requirement
Country GNI per
capita 25% above the
World Bank high
income threshold* for
3 consecutive years
2
USD 449 mm
USD 33 mm
2.5% ATVR
3
USD 898 mm
USD 449 mm
15% ATVR
5
USD 1796 mm
USD 898 mm
20% ATVR
At least some
At least partial
Modest
Modest
Significant
Significant
Good and tested
Modest
Very high
Very high
Very high
Very high
A Economic Development
A.1
Sustainability of economic development
B Size and Liquidity Requirements
B.1
Number of companies meeting the following Standard Index criteria
Company size (full market cap) **
Security size (float market cap) **
Security liquidity
C Market Accessibility Criteria
C.1
C.2
C.3
C.4
Openness to foreign ownership
Ease of capital inflows / outflows
Efficiency of the operational framework
Stability of the institutional framework
* High income threshold for 2010: GNI per capita of USD 12,276 (World Bank, Atlas method)
** Minimum in use for the May 2012 Semi-Annual Index Review, updated on a semi-annual basis
©2014. All rights reserved.
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MSCI Country Classification
©2014. All rights reserved.
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MSCI Has Captured the Evolution of Markets For 40+ Years
2013
©2014. All rights reserved.
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Size Segments: Global Investable Market and All Cap Indices
Large Cap
Total Listed
Equity
Universe
Investable
Equity
Universe
Investable
Market
Indices
All Cap
Indices
Mid Cap
Large Cap
Mid Cap
Small Cap
Micro Cap
Small Cap
Micro Cap
Universe
©2014. All rights reserved.
Micro Cap
Indices
Micro Cap
Indices
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Breadth vs. Coverage: Number and Size
Global Market Cap and Coverage
Market Cap (in USD)
100
97.9
98.8
99.4
99.7
99.9
100.0
96.6
95
Market Coverage (% of full market cap)
94.4
90
90.3
85
81.3
80
Largest company
506,035,318,230
5%
9,638,785,576
10%
4,058,595,491
20%
1,562,054,938
30%
792,022,114
40%
474,873,840
50%
302,909,404
60%
192,671,360
70%
122,852,450
80%
74,378,487
90%
40,621,572
75
70
70.2
65
<5%
5 to 10% 10 to 20% 20 to 30% 30 to 40% 40 to 50% 50 to 60% 60 to 70% 70 to 80% 80 to 90% 90 to 100%
Smallest company
1,529
Global Companies (sorted by full market cap, as % of total)
Source: MSCI
Goal: represent the global equity universe, while keeping the number of securities and size of
the smallest security at reasonable levels
©2014. All rights reserved.
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IV. Evolution of Benchmarks
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Yesterday’s Alpha is Today’s Beta
1970s
1980s
2000s
Alpha
Alpha
Factor
Beta
Portfolio
Return
Regional
Beta
Beta
Country
Beta
Sector
Beta
©2014. All rights reserved.
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What Attracts Investors to Factor Investing?
Performance Characteristics
(June 1988 to June 2013) (Gross Total Return in USD)
LOW RISK & HIGH RETURN
HIGH RISK & HIGH RETURN
11.5%
Annualized Return
Quality
High Dividend Yield
10.5%
Momentum
Risk Weighted
9.5%
Value Weighted
8.5%
Equal Weighted
Minimum Volatility
7.5%
MSCI World
HIGH RISK & LOW RETURN
LOW RISK & LOW RETURN
6.5%
11.0%
12.0%
13.0%
14.0%
15.0%
16.0%
17.0%
18.0%
19.0%
Annualized Risk
©2014. All rights reserved.
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What is Factor Investing?
 Factor investing is the investment
process that harvests risk premia
through exposure to factors
 A large body of academic research
highlights that long term equity portfolio
performance can be explained by
systematic factors. Some factors
represent exposure to systematic risk
and have historically earned a long term
risk premium
 We currently identify six risk premia
factors. They are grounded in academic
research and have solid explanations as
to why they have provided a premium
©2014. All rights reserved.
6 KEY FACTORS
Low Size
Value
Momentum
Quality
Yield
Low Volatility
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Is This a Free Lunch? Cyclicality is a Key Dimension
300
Relative Performance of Factor Indexes
(June 88 – June 2013)
250
200
150
100
50
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
Risk Weighted/World
Value Weighted/World
Min Volatility/World
Quality/World
Momentum/World
High Div Yield/World
©2014. All rights reserved.
07
08
09
10
11
12
13
Equal Weighted/World
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The MSCI Family of Factor Indexes
MSCI Return-Based Factor Indexes
MSCI Risk-Based Factor Indexes
MSCI Value Weighted Indexes
MSCI Minimum Volatility Indexes
Weighted according to four fundamental variables
(Sales, Earnings, Cash Flow, Book Value)
Constructed using minimum variance optimization
• Semi-annual rebalancing
• Launched in 2008, index history from 31 May 1988 (World) / 31 May 1993
(EM)
• Semi-annual rebalancing
• Launched in 2010, index history from 31 May 1973 (World)/31 May 1991
(EM)
MSCI Quality Indexes
MSCI Risk Weighted Indexes
Weights derived from market cap times a quality score based on D/E, ROE,
earnings variability
• Semi-annual rebalancing
• Launched in 2012, index history from 28 Nov 1975 (World)/29 May 1992
(EM)
Weights based on the inverse of historical variance
• Semi-annual rebalancing
• Launched in 2011, index history from 31 May 1973 (World) / 31 May 1991
(EM)
MSCI Momentum Indexes
MSCI Equal Weighted Indexes
Weights derived from market cap times a momentum score based on shortand long-term momentum signals
• Semi-annual rebalancing along with conditional rebalancing
• Launched in 2013, index history from 31 May 1973 (World) / 31 May 1991
(EM)
Equal allocation across parent index constituents
• Quarterly rebalancing
• Launched in 2008, index history from 31 May 1973 (World) / 31 May 1991
(EM)
MSCI High Dividend Yield* Indexes
MSCI Quality Mix Indexes
High dividend yield opportunity set within parent index constituents
• Semi-annual rebalancing
• Launched in 2006, index history from 28 Nov 1975 (World) / 29 May 1992
(EM)
Combining Quality, Value and Minimum Volatility Strategy Indexes with
equal weights
• Semi-annual rebalancing
• Launched in 2013, index history from 31 May 1988 (World)/ 31 May 1993
(EM)
MSCI Multi-Factor Indexes
* On June 3, 2013, MSCI launched the enhanced HDY Indexes to incorporate additional screens which exclude stocks based on certain “low quality" characteristics and recent 12-month price
performance.
©2014. All rights reserved.
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36
V. Appendix
©2014. All rights reserved.
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MSCI – The Index That Matters
40+
Years of experience
in index calculation
and maintenance
150,000
Indices calculated
daily
9,000+
in real-time
99.8%
Accuracy
rate1
$8.4tn
In assets is
benchmarked to
MSCI indices2
600+
7,500
ETFs are based on
MSCI indices3
Clients supported across
83
countries
1
Accuracy calculated based on number of corrections performed over total number of securities or data points covered.
As of September 30, 2012, as published by eVestment, Lipper and Bloomberg on January 31, 2013.
3 As of February 2013.
2
©2014. All rights reserved.
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How MSCI Does It
Over the last four decades MSCI has been recognized as the preferred index
provider for global institutional investors based on:
1. Methodology that promotes a global framework, broad coverage, investability and
representativeness, while reflecting our clients’ investment process
2. Construction process that supports data quality, index stability and continuity, with low
error rates and low index turnover
3. Innovative new products through thought leadership and research that captures the
evolution of investment best practices
4. Superior client service focused on responsiveness and adding value
©2014. All rights reserved.
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39
MSCI Investability
MSCI
MSCI Rationale
Minimum Equity Universe Size
Indexed to 99th percentile of DM universe
($100M)
Objective and dynamic market-based
definition
Minimum Equity Universe Size
50% of minimum full market cap size ($50M)
Facilitates replication in institutional
portfolios
Liquidity
Minimum Annualized Traded Value Ratio
(ATVR) of
20% for DM
15% for EM
Allows only inclusion of relevant liquid
securities and recognizes liquidity
differences between DM & EM
Global Minimum Foreign Inclusion Factor
15% in general or (or 1.8 X Standard
minimum size)
Ensures meaningful access to publicly owned
securities
Free Float Bands
5% bands, free float rounded up to nearest
5%
Captures availability to foreign investors in
the most accurate way
Seasoning
Minimum of 3 months of trading history; 10
business days for larger IPOs
Reduces volatility impact around small
issuances and includes large IPOs to reflect
key market changes
©2014. All rights reserved.
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40
MSCI : Index Maintenance & Additional Features
MSCI
MSCI Rationale
Reconstitution
Semi-annual rebalancing + quarterly index
reviews (all synchronized)
Frequently and regularly reflects market
changes on a timely basis
Buffer Zones
Yes (Upper band +50%; lower band -33% of size
segment cut-off)
Reduces turnover and reflects managers’
investment processes
Size Indices
Yes
Offers value and growth segmentation at each
size segmentation
Index Structure
Country Indices (with the exception of Europe
being considered as a single country from an
index construction and maintenance
perspective)
Reflects the institutional process
Sector Classification
Global Industry Classification Standard (GICS®)
GICS® is widely adopted by institutional
investors
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41
Assets Benchmarked to MSCI indices
 Over $8.4 trillion in assets are benchmarked to MSCI
indexes
 Over $60 billion in assets are benchmarked to MSCI Factor
Indexes
Assets Benchmarked to Key MSCI Indexes
$ billion
Total
Mar-13
**
Sep-13#
Δ
ACWI
1,364
1,714
26%
EAFE
1,496
1,682
12%
EM
1,434
1,364
-5%
World
2,161
2,388
10%
US
190.8
199.6
5%
Europe
281.3
336.9
20%
APAC
415.4
371.8
-11%
Other
363.9
387.1
TOTAL
7,707
8,442
6%
10%
©2014. All rights reserved.
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MSCI Factor Indexes as of 30 September 2013
Over USD 60 billion in assets benchmarked to MSCI Factor Indexes
(USD bn)
Active
Passive
Total
All MSCI Factor Indexes
25.9
37.9
63.8
High Dividend Yield
19.8
4.2
24
Minimum Volatility
3.5
19.7
23.2
Equal Weighted
0
8.3
8.3
GDP Weighted
2.3
0.6
2.9
Value Weighted
0
3.3
3.3
0.3
1.3
1.6
Momentum
0
0.2
0.2
Quality
0
0.3
0.3
Active
Passive
Total
Global
25.9
37.9
63.8
Americas
5.5
15.1
20.6
EMEA
20.4
19.1
39.5
0
3.7
3.7
Risk Weighted
(USD bn)
Asia
Data segregated by index family and region for active and passive funds as of September 30, 2013 and reported as of December 31, 2013 by eVestment, Lipper,
Morningstar, Bloomberg and MSCI data
©2014. All rights reserved.
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43
Why Classification Matters: The Korea example
 A developed economy does not imply a developed capital
market
 Korea’s capital market is not yet at the developed level.
 Why does this matter to investors?
 Difficulties trading the Korean currency outside Korea
 Local currency ONLY during local business hours
 Inability to transfer shares between different accounts
operational difficulties +
higher portfolios management costs
 Korea has been under review by MSCI for 5 years and will stay
in Emerging Markets until accessibility issues are resolved
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Introducing Multi-Factor Indexes
 Multi-Factor Indexes blend
standardized factor Indexes
into a composite index which
serves as a benchmark for
passive replication
 Multi-Factor Indexes may
provide investors with a
transparent, flexible and costeffective way to passively seek
systematic exposure to
premium factors
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Passive
Investing
Market
Return
Factor
Investing
Rules Based
&
Transparent
Active
Management
Active
Return
Discretionary
Implementation
Implementation
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Allocating to Multiple Factors
1. State objectives for the allocation: risk
reduction, enhance returns at market
level risk, increase yield, …
Due Diligence Considerations
1. Investment Beliefs
2. Strategic vs. Tactical Allocations
3. Selection of Individual Factors
2. Select the desired factor exposures
based upon:
4. Global vs. Domestic
5. Optimal Allocation
 investment beliefs (value premium, …)
6. Funding of the Factor Allocation
 risk/return characteristics (minimum volatility, …)
7. Active vs. Passive Implementation
 investibility constraints (size of allocation, shorting, …)
8. Index and Manager Selection
(methodology, turnover, transparency,
fees, … )
3. Seek combination benefits:
9. Governance and Operational Risk
 Diversification through low correlation of active returns
 Trading cost reduction through natural crossing
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Considerations for Combining Factor Indexes
Factor
Risk
Correlation
Business Cycle
Value
Comparable to
market
Low with Momentum and
Quality
Pro-cyclical
Momentum
Comparable to
market
Low with Value, Yield, and
Quality
Pro-cyclical
Low Size
Higher than market
Low with Min Volatility, Yield,
and Quality
Pro-cyclical
Quality
Lower than market
Low with Value, Size, Yield and
Momentum
Defensive
Low Volatility
Lower than market
Low with Value and
Momentum
Defensive
Yield
Lower than market
Low with Size, Quality and
Momentum
Defensive
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Potential Benefits of Multi-Factor Indexes
 Historically, tracking errors and information ratios for multi-factor Indexes
improve substantially compared to standalone factor Indexes
 Turnover and cost of replication are reduced due to natural crossing
World
Standard
Quality
Total Return* (%)
4.2
5.3
8.6
5.5
6.9
6.7
Total Risk* (%)
16.3
14.3
14.6
17.2
16.7
14.9
Sharpe Ratio
0.18
0.26
0.47
0.25
0.33
0.34
Annualized Active Return (%)
1.1
4.4
1.2
2.7
2.5
Tracking Error* (%)
4.5
5.6
3.6
9.0
3.0
Information Ratio
0.25
0.79
0.35
0.30
0.83
52
10
9
19
2
Max Relative Drawdown Period (months)
Risk
Value
Momentum
Weigthed Weighted
Multi Factor
Index
Natural Crossing Benefits
Turnover** (%)
3.1
23.0
22.0
18.3
89.6
Turnover if implemented as separate mandates -->
32.0
40.8
* Annualized in USD for the 05/31/1999 to 09/30/2013 period
** Annualized one-way index turnover for the 05/31/1999 to 09/30/2013 period
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