Download Going Beyond Style Box Investing

Going Beyond Style Box Investing
NCPERS
Presented by
Erin Doyle Orekhov, Client Portfolio Manager
May 22, 2017
For financial professional or qualified institutional investor use only.
Not for inspection by, distribution or quotation to, the general public.
IM0517-34449-0518 NCPERS
Session Description
Going Beyond Style Box Investing
While the advent of the style box in the 1990s has provided a useful framework for constructing a diversified
equity portfolio, investing strictly within the style box framework may create portfolio gaps that can lead to
unintended consequences. This presentation aims to help plan sponsors think about 1) how they can go
beyond the confines of style boxes to help participants achieve a secure retirement; 2) how outcome oriented approaches can help balance between maximizing total return and minimizing volatility; and 3)
what they should look for when evaluating outcome-oriented strategies.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
2
Table of Contents
 How we got here
 Why we need to think outside the box
 Thinking outside the box
 Thinking outside the box: a case study
 Key takeaways
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
3
How We Got Here
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
4
History of The Style Box Approach
Morningstar Style Box TM
Large
Medium
Small
Value
Blend
Growth
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
5
A Strong Case for Diversification
2006
2007
2008
Emerging Market Equity
Intermediate Bond
2009
Commodities
Short Term Bond
Emerging Market Equity
2010
2011
2012
2013
2014
TIPS
Global Bonds
High Yield Bond
Developed
International
TIPS
Senior Debt
U.S. Small Cap
REITs
Global Bonds
High Yield Bond
U.S. Mid Cap
U.S. Mid Cap
TIPS
Emerging Market Equity
Emerging Market Equity
Intermediate Bond
Senior Debt
REITs
REITs
Intermediate Bond
Developed
International
Emerging Market Equity
Global Bonds
U.S. Mid Cap
U.S. Small Cap
Commodities
High Yield Bond
U.S. Small Cap
U.S. Mid Cap
REITs
Developed
International
Short Term Bond
U.S. Small Cap
Developed
International
U.S. Small Cap
U.S. Mid Cap
Commodities
U.S. Small Cap
15.8%
5.5%
-37.0%
26.5%
U.S. Mid Cap
High Yield Bond
2015
2016
REITs
U.S. Large Cap Calendar Year Returns
15.1%
2.1%
16.0%
U.S. Small Cap
High Yield Bond
U.S. Mid Cap
32.4%
13.7%
1.4%
12.0%
U.S. Mid Cap
REITs
Commodities
High Yield Bond
U.S. Mid Cap
Commodities
High Yield Bond
Short Term Bond
High Yield Bond
Developed
International
Senior Debt
Developed
International
TIPS
Senior Debt
Senior Debt
Senior Debt
High Yield Bond
Intermediate Bond
Short Term Bond
Emerging Market Equity
U.S. Mid Cap
TIPS
REITs
U.S. Small Cap
Intermediate Bond
Senior Debt
U.S. Small Cap
Global Bonds
Senior Debt
TIPS
Senior Debt
REITs
TIPS
Senior Debt
U.S. Small Cap
REITs
Global Bonds
Developed
International
Global Bonds
REITs
Emerging Market Equity
Intermediate Bond
Intermediate Bond
TIPS
REITs
Intermediate Bond
Short Term Bond
High Yield Bond
Developed
International
Short Term Bond
Global Bonds
Developed
International
Short Term Bond
Intermediate Bond
Senior Debt
TIPS
Intermediate Bond
Commodities
Short Term Bond
Commodities
Commodities
Global Bonds
Short Term Bond
U.S. Mid Cap
Global Bonds
Emerging Market Equity
Global Bonds
Global Bonds
Short Term Bond
TIPS
Emerging Market Equity
U.S. Small Cap
Developed
International
Commodities
Developed
International
High Yield Bond
Commodities
Emerging Market Equity
Intermediate Bond
TIPS
Short Term Bond
Emerging Market Equity
Commodities
Source: Morningstar Direct.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
6
Why We Need to Think Outside the Box
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
7
A Slightly Different Perspective on the Style Box
Morningstar Style Box TM
Large
Medium
Small
Value
Blend
Growth
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
8
Challenges Facing Plan Sponsors in Today’s World
The Search for Yield
Volatility
Interest Rate Risk
Fiduciary Responsibility
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
9
Volatility: why do we care?
Compounded returns for high volatility stocks are dramatically lower
12%
Q5
(Highest
Vol)
Q1
(Lowest
Vol)
Return
10%
Volatility Drag
8%
Average Returns
6%
Compounded Returns
4%
10%
15%
20%
Risk
25%
For illustrative purposes only. Data shown above represents performance for the Russell 1000 Index from 1/1/97 – 12/31/15. Past performance is no assurance of future results.
Source: Voya IM and FactSet.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
10
30%
Fees
Active vs. Passive Management
For illustrative purposes only. Source: Voya Investment Management and Zephyr Style Advisor.
Category median represents the 50th percentile breakpoint for the Morningstar Large Cape Growth category at the end of each rolling 3-year period as calculated by Zephyr
Style Advisor. Rolling 36-month data from December 1961-December 2015 completed monthly.
Performance is no guarantee of future results.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
11
Thinking Outside the Box
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
12
How to Identify and Fill the Gaps: A New Paradigm
Morningstar Style Box TM
Large
V
O
L
A
T
I
L
I
T
Y
FEE PRESSURE
ETFs
SMART BETA
Medium
Small
Value
Blend
Growth
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
13
Building Blocks for Delivering Cost-Effective, Custom Solutions
Thinking “outside the box”
Willingness to consider a solution that
does not fit in a style box and hire a
manager based on back-tested results
Collaboration
Partnership between plan
sponsor and manager
Analytics
Deeper due diligence and analysis on
how a manager will fit into the overall
portfolio
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
14
Back-testing: De-Mystifying the Black Box
Look for managers that:
• Use multiple factors
• Test the efficacy of
factors over a range of
market environments
• Look for factors that
have low correlation to
one another
Look for managers that:
• Provide transparency around methodology and results
• Avoid “look ahead” bias, survivorship bias, and data mining
• Use multiple factors, test the efficacy of factors over a range of market
environments, and look for factors that have low correlation to one another
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
15
Assessing Multiple Factors Over a Range of Market Environments
2009
2010
2011
2012
2013
2014
2015
2016
2017
Earnings
momentum
0%
0%
0%
15%
17%
11%
5%
0%
0%
Earnings
growth
2%
0%
7%
0%
0%
0%
0%
0%
0%
Price
Momentum
2%
0%
1%
0%
0%
0%
0%
0%
0%
Cash to
EV
1%
0%
0%
0%
0%
0%
0%
0%
0%
Tangible
Book Yield
12%
25%
25%
16%
1%
6%
0%
7%
1%
Dividend
Yield
17%
5%
4%
10%
21%
12%
9%
11%
10%
For illustrative purposes only.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
16
Thinking Outside the Box: A Case Study
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
17
Case Study: Building a Portfolio to Meet a Style Box Gap - Volatility
Plan Sponsor Objectives
 Generate income
 Low volatility and strong downside capture (lower risk)
 Maximize total return
“Off the Shelf” Solutions
Large Cap Value (Style Box Solution)
Custom Solution
Low/Min Vol ETF (Passive Solution)
 Low beta
Unintended Consequences:
 Robust alpha source
 No explicit beta target
 Above-benchmark
dividend yield
 Overexposed to sectors that are
interest-rate sensitive
 Sector-neutral
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
18
Case Study: Pitfalls of “Off the Shelf” Solutions
Active Sector Weights (%)
Sector crowding
Defensive
Cyclical
40
30
27.5%
24.1%
20
10
0
-10
-20
-30
-27.3%
-40
S&P Low Vol vs. S&P 500
MSCI Min Vol vs. MSCI USA
For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98 -12/31/15. Past performance is no assurance of future results. Interest rate sensitivity
measures the sensitivity of returns to the change in 10-year bond yields.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
19
-24.1%
Case Study: Pitfalls of “Off the Shelf” Solutions
Correlation to interest rates
0.15
0.10
Cyclical
Interest Rate Sensitivity
Energy
0.05
Diversified
Materials
Banks
Discretionary
Industrials
0.00
Tech
Defensive
Insurance
Health Care
-0.05
Staples
Telecom
-0.10
Real Estate
-0.15
0.40
Utilities
0.60
0.80
1.00
1.20
1.40
Equity Market Beta (β)
For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98 -12/31/15. Past performance is no assurance of future results. Interest rate sensitivity
measures the sensitivity of returns to the change in 10-year bond yields.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
20
1.60
Case Study: Pitfalls of “Off the Shelf” Solutions
Managing downside protection
6.0%
4.3%
2.0%
-2.0%
-2.5%
-3.0%
-3.2%
-6.0%
10-YR Yield
Russell 1000 Index
S&P Low Vol ETF
S&P High Div Low Vol ETF
For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98 -12/31/15. Past performance is no assurance of future results. Interest rate sensitivity
measures the sensitivity of returns to the change in 10-year bond yields.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
21
Case Study: A Different Framework for Evaluating an Outcome-Oriented
Mandate, Focused on Desired Outcomes
Higher Income
Rolling 3-Year Average Dividend Yield
Dividend Yield (%)
4
3
2
1
Sample High-Dividend
low volatility strategy
Voya
Low Volatility
R1000
Performance data from 01/01/97 – 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly.
Source: FactSet and Voya Investment Management. Past performance is no assurance of future results.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
22
Dec-15
Dec-13
Dec-11
Dec-09
Dec-07
Dec-05
Dec-03
Dec-01
Dec-99
0
Case Study: A Different Framework for Evaluating an Outcome-Oriented
Mandate, Focused on Desired Outcomes
Lower Risk
Risk Reduction versus the Russell 1000 Index
3 Year Rolling Standard Deviation (January 1, 1997 - December 31, 2015)
0%
-5%
-10%
-15%
-20%
-25%
Dec-15
Dec-13
Dec-11
Dec-09
Dec-07
Dec-05
Dec-03
Dec-01
Dec-99
-30%
Performance data from 01/01/97 – 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly.
Source: FactSet and Voya Investment Management. Past performance is no assurance of future results.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
23
Case Study: A Different Framework for Evaluating an Outcome-Oriented
Mandate, Focused on Desired Outcomes
Maximize Total Return
Voya
Volatility
Equity vs. Russell 1000 Index
Sample High-Dividend
low volatility strategyLow
vs. Russell
100 Index
Manager Returns
3 Year Rolling Returns (January 1, 1997 - December 31, 2015)
35
30
25
20
15
10
5
0
-5
-10
-15
-20
93%
Manager Outperformance
vs. the Benchmark
-20
-10
0
10
Index Returns
20
30
40
Performance data from 01/01/97 – 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly.
Source: FactSet and Voya Investment Management. Past performance is no assurance of future results.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
24
Key Takeaways
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
25
Why You Need to Think Outside of the Style Box
1 Unintended risks of pure style box approach
2 Changing market structure
3 Benefits of custom solutions
4 Last but not least…
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
26
The #1 reason we all need to think outside the box
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
27
Appendix
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
28
Disclosure
This information is proprietary and cannot be reproduced or distributed. Certain information may be received from sources Voya
Investment Management (“Voya IM”) considers reliable; Voya IM does not represent that such information is accurate or complete.
Certain statements contained herein may constitute “projections,” “forecasts” and other “forward-looking statements” which do not
reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical
financial data. Actual results, performance or events may differ materially from those in such statements. Any opinions, projections,
forecasts and forward-looking statements presented herein are valid only as of the date of this document and are subject to change.
Nothing contained herein should be construed as (i) an offer to buy any security or (ii) a recommendation as to the advisability of
investing in, purchasing or selling any security. Voya IM assumes no obligation to update any forward-looking information.
Past performance is no guarantee of future results.
©2017 Voya Investments Distributor, LLC • 230 Park Ave, New York, NY 10169. All rights reserved.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
29
Backtested Performance Information
Backtested performance is NOT an indicator of future actual results. The results reflect the performance of a strategy
not historically offered to investors and do not represent returns that any investor actually attained. Backtested results
are calculated by retroactive application of a model constructed on the basis of historical data and based on
assumptions integral to the model which may or may not be testable and subject to losses.
General assumptions include that the firm would have been able to purchase the securities recommended by the
model and the markets were sufficiently liquid to permit all trading. Changes in these assumptions may have a
material impact on the backtested returns presented. Certain assumptions have been made for modeling purposes
and are unlikely to be realized. No representations and warranties are made as to the reasonableness of the
assumptions. This information is provided for illustrative purposes only.
Backtested performance is developed with the benefit of hindsight and has inherent limitations. Specifically,
backtested results do not reflect actual trading or the effect of material economic and market 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 certain market factors may have had on a decision-making process. Further, backtesting allows the
security selection methodology to be adjusted until past returns are maximized. Actual performance may differ
significantly from backtested performance.
Backtested results are adjusted to reflect the reinvestment of dividends and other income and except where otherwise
indicated, are presented gross-of fees and do not include the effect of backtested transaction costs, management
fees, performance fees or expenses, if applicable. No cash balance or cash flow is included in the calculation.
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
30