NewFunds Volatility Managed SA Equity range

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1 Absa Index and Structured Solutions NewFunds Managed SA Equity range First range of ETF investments in South Africa to explicitly manage risk

2 The NewFunds Managed SA Equity range of exchange traded funds allow you to gain exposure to a universe of liquid, JSE-listed shares whilst actively managing risk to minimise losses. There are three funds in the range to cater for different risk appetites: High Growth, Moderate and Defensive. We focus on active risk management because we know that it is not only vital to manage potential losses - it is also fundamental to improving long-term return potential.

3 Why is it so important to manage risk? Risk in the investment world is predominantly associated with the risk of losing money, but effective risk management is also fundamental to improving long-term return potential. The reason for this is that markets are disproportionate - any fall in value experienced requires a subsequently higher percentage increase to get it back to its original position. A well-implemented risk management strategy should reward you with superior performance over the long term. Chart 1: Example to illustrate percentage returns required to break even after a percentage portfolio value decline Percentage Portfolio price fall Increase required to recover Chart 1 above gives you some examples of required break-even points for a range of assumed losses (in other words, the percentage increase in value, or return, required in order for a portfolio to get back to its original value before it fell). You will see that the greater the loss, the proportionately greater percentage increase required to get the portfolio back to its previous level. To put this into perspective, if a portfolio falls by 1, it only needs to increase by 11% to recover, but a 5 fall would require a considerable 10 increase to recover. How is risk measured? There are two main measures of risk: is a universal measure of risk that measures the degree of variation of share price returns around their average over a period of time. It is an indication of how rapidly and widely prices change (in other words, the extent to which they move up and down) and implies the level of uncertainty, and therefore risk, of the future performance of a share. To make the concept more tangible, we can look at the volatility of shares versus cash: Shares: The future price, or return, of a share is extremely difficult to predict, as it is influenced by a vast number of external factors. For this reason, equity shares have a high volatility, as their prices can fluctuate significantly around their longterm average. The size and speed with which these price movements occur means that equities are considered to be a risky investment. Cash: By contrast, the future value of cash is relatively easy to predict, as it is predominantly influenced by short-term interest rates. It is therefore possible to predict with a small margin of error what the future return of cash will be, and for this reason cash has virtually no volatility it is considered to be risk-free. Drawdown is another important measure of risk. It represents the maximum loss that a share price has achieved over a period of time and expresses it as a percentage of its highest price in that time period. The potential for higher drawdown would represent a riskier investment. As an example, if over a period of time a share s lowest price was 80 and its highest was 100, then the maximum drawdown (maximum loss) would have been 2. In this instance, it is possible to avoid any realized loss by remaining invested in equity until the price has recovered back to its highest point at 100, however this may take a long period of time. But what happens if you don t have time, or if markets fall further? Would it not be logical to try and avoid or minimize drawdowns to not have to make these difficult decisions? NewFunds Managed SA Equity Range 1

4 How these risks can impact returns Equity share returns tend to be negatively correlated with volatility under most circumstances. In other words, periods of high volatility are almost always followed by poor or negative equity returns. The management of volatility is therefore an indirect method of preventing drawdowns (share price falls) and strategies that manage volatility (also known as target-volatility strategies, as opposed to target-return strategies) have been shown to generate higher returns for each unit of risk. Drawdown While there is a high correlation between volatility and drawdown (the higher the volatility, the greater the drawdown/potential for loss), it is possible for drawdowns to occur without a preceding spike in volatility (see the green rectangle in Chart 2). In these market conditions, managing volatility in isolation would not effectively manage the risk of drawdown (losing money). Chart 2: and share price returns of the Allshare Index (JALSH) Portfolio return 45% 4 35% 3 Rolling 250 day (LHS) Rolling 250 day Return (RHS) As volatility increases, we see a fall in share prices. As volatility decreases, we see an increase in share prices. 25% % 1-2 Drawdown can occur without a preceding spike in volatility. 5% -4-6 May 2006 Sep 2006 Jan 2007 May 2007 Sep 2007 Jan 2008 May 2008 Sep 2008 Jan 2009 May 2009 Sep 2009 Jan 2010 May 2010 Sep 2010 Jan 2011 May 2011 Sep 2011 Jan 2012 and returns data based on the Allshare Index (JALSH). This is past performance and is no indication of future performance. Source: Bloomberg, January 2019 How our funds manage volatility and drawdown to control risk and increase return potential We actively manage each fund s allocation to equity shares (the risky asset) and cash (the risk-free asset) on a daily basis, in order to manage the amount of market exposure that each fund has and to add a layer of protection if markets were to fall. In practice, our strategy applies a consistent Target and then overlays a Drawdown Tolerance mechanism. Each fund in the range will have a different volatility and drawdown tolerance depending on its respective risk appetite. The Target is the primary risk management tool of the funds. It sets a Target that the fund attempts to maintain, and fund allocation is readjusted daily in order to achieve this. This results in the fund increasing allocation to cash in periods of high equity market volatility (risky markets), whilst remaining fully invested in equity markets during periods where volatility is below the fund s target threshold (less risky markets). 2 NewFunds Managed SA Equity Range

5 The Drawdown Tolerance mechanism is applied as a further measure of risk management when the market is falling, to prevent losses beyond a specified percentage (the Drawdown Tolerance). It is a fixed percentage target that serves as the maximum loss an investor can experience relative to the highest value of the basket of equity shares that the portfolio invests in over the preceding 125 days. This part of our strategy will again allocate more to cash as markets fall. If the equities fall to a certain point (the Drawdown Floor), it would be fully allocated to cash, so that no further losses are possible. This enables the fund to allocate proportionately more to cash the closer we are to breaching the Drawdown Tolerance even without an increase in equity volatility (refer to the worked example below to see how this works in practice). The overlay of the Drawdown Tolerance mechanism not only adds a further layer of risk management, but it also improves long term return potential: It allows the portfolio to sell shares extremely quickly if a market is falling rapidly to avoid losses beyond a certain point. It is only applied in down-trending markets. This allows the fund to purchase shares quickly when markets start to recover and participate in any equity market growth. How the funds work in practice Each fund has a fixed Target that it attempts to maintain and a Drawdown Tolerance mechanism that is applied only in downward-trending (falling) markets. These are risk measures that aim to both prevent significant losses and improve long term performance. We monitor the performance of the fund and the equity basket referenced by the fund on an ongoing basis. The equity basket is also specifically monitored by trend analysis that compares its short-term average price to its long-term average price. This is an indicative measure of whether we are experiencing a downward trend in share prices (a falling market), i.e. a short-term average price that is below the long-term average price. On a daily basis we re-adjust our exposure to equity shares and cash with the following objectives: Ensure that the Target of the fund is maintained. If our trend analysis indicates that we are in a falling market, the Drawdown Tolerance mechanism kicks in to ensure that losses cannot occur beyond a certain point. 04 Buffer rule To minimize unnecessary daily trading and immaterial changes in exposure of the funds, we apply a buffer rule. Only changes in equity allocation that exceed 1 will be executed. This also prevents any associated unnecessary and excessive costs to the fund. Examples Example 1: Falling market Current equity* price: 130 Peak equity price (over last 125 trading days): 150 target: 12% Current equity market volatility: 16% Drawdown Tolerance: 2 Drawdown floor (Drawdown Tolerance applied to peak equity price): (1-2) *150 =120 *Equity refers to the basket of equity shares that the portfolio invests in. NewFunds Managed SA Equity Range 3

6 Chart 3: Example 1 illustrated graphically Equities' price Historical peak: 150 Drawdown floor: 120 Equity price Current price is far away from the Drawdown floor 115 NB: This is example data only and is not indicative of market returns or future performance. T Time In the above scenario, with the given inputs and assuming that we are in a falling market and based on the current time, marked as T: 1. calculation: Given that the current volatility is above our Target, the allocation to equity is reduced and calculated as follows: Allocation based on Target = Target divided by current equity volatility = 12%/16% = 75% allocation to equities. 2. Drawdown calculation: The market is falling, so we also apply the Drawdown Tolerance mechanism. As we said, this needs to be calculated with the equity peak price in mind in order to allows us to allocate more to cash the closer we are to the Drawdown Tolerance (the Drawdown Tolerance is the maximum percentage loss an investor can experience relative to the highest value of the equities over the preceding 125 days). Drawdown calculation = (Current equity price Drawdown floor) divided by (Peak equity price Drawdown floor) = ( )/ ( ) = 33% allocation to equities. 3. Then take the product of the two risk measures to calculate actual allocation: Exposure to equities = (33% x 75%) = 25% This final allocation lends itself to reducing both volatility and drawdown risk concurrently. The remaining 75% of the portfolio would be allocated to cash in order to protect investors in this falling market. Example 2: Rising market Current equity* price: 150 Peak equity price (over last 125 trading days): 150 Target: 12% Current equity volatility: 16% *Equity refers to the basket of equity shares that the portfolio invests in. 4 NewFunds Managed SA Equity Range

7 Chart 4: Example 2 illustrated graphically Equities' price Historical peak: 150 Drawdown floor: 120 Equity price Current price is far away from the Drawdown floor 115 NB: This is example data only and is not indicative of market returns or future performance. T Time In the above scenario, at point T being current time, with the given inputs and assuming that we are in a rising market, the Drawdown Tolerance Mechanism is not applicable, and we only use the Target to calculate our exposure: calculation: Allocation based on Target = Target/current equity volatility = 12%/16% = 75% allocation to equities and therefore 25% allocation to cash. Historical analysis Below are some graphical examples that apply the target volatility and drawdown tolerance measures. The examples also illustrate how allocation to equity is adjusted in practise over time and during different market conditions. Chart 5 below shows how, if volatility is left unmanaged, the equity portfolio in the fund can experience severe drawdowns. For illustrative purposes, we have shown the equity basket of Managed Moderate Equity ETF only. It is clear to see that in periods of high volatility (where, as we have discussed above, the volatility vastly exceeds the Target level) and markets are rapidly approaching the drawdown floor, the allocation to equity is low or zero (see November 2008). On the other hand, as seen in November 2017, the market was experiencing low volatility and was far from the drawdown floor, therefore the fund was fully allocated to equities. Chart 5: and drawdown of moderate equity portfolio prior to applying the target volatility and drawdown methodology Allocation to Equity (RHS) EWMA Drawdown of Underlying Equity Target = 15% Drawdown Tolerance = 25% Nov 2004 Nov 2005 Nov 2006 Nov 2007 Nov 2008 Nov 2009 Nov 2010 Nov 2011 Nov 2012 Nov 2013 Nov 2014 Nov 2015 Nov 2016 Nov 2017 Nov 2018 This is past performance and is no indication of future performance. Source: Absa, January 2019 NewFunds Managed SA Equity Range 5

8 However, with both the Target and Drawndown Tolerance applied, you can clearly see that by managing volatility and keeping it close to 15%, as is the case for the Managed Moderate Equity ETF, we reduce drawdowns relative to the unchecked moderate equity portoflio. You will note in Chart 6 how volatility tracks the 15% target and almost always lower than this level and in Chart 7 how the drawdowns are significantly less as a result and never exceed the Drawdown Tolerance level. Chart 6: Comparison of volatility before and after application of 15% Target and 25% Drawdown Tolerance measures 35% 3 Underlying Moderate Equity Basket Managed Moderate Equity 25% 2 Target = 15% 15% 1 5% Nov 2005 Nov 2006 Nov 2007 Nov 2008 Nov 2009 Nov 2010 Nov 2011 Nov 2012 Nov 2013 Nov 2014 Nov 2015 Nov 2016 Nov 2017 Nov 2018 This is past performance and is no indication of future performance. Source: Absa, January 2019 Chart 7: Illustration of lower drawdowns from our moderate volatility-managed portfolio versus an unchecked moderate equity portfolio Underlying Moderate Equity Basket Managed Moderate Equity -5% -1-15% -2-25% Drawdown Tolerance = 25% -3-35% -4-45% Nov 2004 Nov 2005 Nov 2006 Nov 2007 Nov 2008 Nov 2009 Nov 2010 Nov 2011 Nov 2012 Nov 2013 Nov 2014 Nov 2015 Nov 2016 Nov 2017 Nov 2018 This is past performance and is no indication of future performance. Source: Absa, January NewFunds Managed SA Equity Range

9 Conclusion The end result is detailed in Chart 8 below. The link between volatility and drawdowns is indisputable, which is why we focus on active risk management - because we know that risk management is not only vital to manage potential losses but is also fundamental to improving long-term return potential. Chart 8: Equity allocation of the Managed Moderate Equity ETF (shaded grey area) and cumulative performance of the ETF versus a simple 25/75 cash equity portfolio (moderate risk portfolio) Equity Allocation (RHS) Managed Moderate Equity Comparative: 75% Equity; 25% Cash Nov 2004 Nov 2005 Nov 2006 Nov 2007 Nov 2008 Nov 2009 Nov 2010 Nov 2011 Nov 2012 Nov 2013 Nov 2014 Nov 2015 Nov 2016 Nov 2017 Nov 2018 This is past performance and is no indication of future performance. Source: Absa, January 2019 NewFunds Managed SA Equity Range 7

10 The Range The NewFunds Managed SA Equity range of exchange traded funds includes three funds based upon different risk appetites, each with its own equity strategy, Target and Drawdown Tolerance: Fund Target Drawdown Tolerance Equity universe NewFunds Managed High Growth Equity ETF 2 3 From all listed shares on the JSE, a liquidity filter is applied to reduce the investable universe to compose the 40 most liquid shares. Each share is analysed for its Momentum score (positive price performance over the last 250 days) and Low score (inverse standard deviation), and a weighted score is calculated (7 Momentum: 3 Low ). The 15 shares with the highest weighted scores are included in the portfolio. ISIN code: ZAE / JSE share code: NFEHGE NewFunds Managed Moderate Equity ETF 15% 25% From all listed shares on the JSE, a liquidity filter is applied to reduce the universe to the 40 most liquid shares. Each share is analysed for its Momentum score (positive price performance over the last 250 days) and Low score (inverse standard deviation), then a weighted score is calculated (5 Momentum: 5 Low ). The 25 shares with the highest weighted score are included in the portfolio. ISIN code: ZAE / JSE share code: NFEMOD NewFunds Managed Defensive Equity ETF 8% 15% From all listed shares on the JSE, a liquidity filter is applied to reduce the universe to the 40 most liquid. Each of these shares is analysed for their Defensive is 10 Low. The 30 shares with the highest Low score (inverse standard deviation) are included in the portfolio. ISIN code: ZAE / JSE share code: NFEDEF 8 NewFunds Managed SA Equity Range

11 Legal Disclaimer NewFunds (RF) Proprietary Limited ( NewFunds ) is a registered and approved Collective Investment Scheme in Securities (NewFunds CIS) under the Collective Investment Schemes Control Act 45 of The information contained in this document is provided for information purposes only and does it constitute (i) financial advice as contemplated in terms of the Financial Advisory and Intermediary Services Act, 37 of 2002; or (ii) any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever ( advice ) or (iii) provide the basis of any credit, financial or other evaluation. It does not purport to be a prospectus for any security, financial product, transaction or service nor is it deemed appropriate and/or suitable for any particular investment, investor s objectives or financial circumstances. This document is neither an offer to sell nor a solicitation of an offer to buy any of the products and, while every effort is made to ensure the information contained herein is complete and accurate, any pricing and other information included herein is indicative only and is not binding as such on Absa Bank Limited and NewFunds (collectively the Promoters ). Accordingly, the information contained herein merely contains a description of certain facts as at the date hereof and investors are advised to carry out their own independent investigation and appraisal and seek their own advice prior to making any decision or taking action based on information contained herein. The Promoters disclaim any liability for any direct, indirect or consequential damage or losses that may be suffered as a result from using or relying on the information disclosed. Investors are advised that not all risks and issues related to the products are disclosed and therefore, Investors should familiarize themselves with the products and the risks and issues related to or associated with them. Collective Investments Schemes in Securities ( CIS ) are generally medium to long term investments where the investor essentially owns a proportionate share (in proportion to the participatory interest held in the fund) of the underlying investments held by the fund. The value of participatory interests may fluctuate as a result of market moves, associated external factors and risks, and past performance is not generally a guide to future performance. Any information on past financial returns, modelling or back-testing cannot be guaranteed nor does NewFunds guarantee with respect to the capital or return of any portfolio of NewFunds CIS. Listed CIS products are traded at ruling prices and can engage in borrowing and scrip lending. A schedule of fees and charges is available from NewFunds upon request. Absa Bank Limited Reg No 1986/004794/06, an Authorised Financial Services Provider (FSP 72), Registered Credit Provider Reg No NCRCP7. NewFunds (RF) Proprietary Limited registration number 2005/034899/07. NewFunds Managed SA Equity Range 9

12 Contact details Call: , choose option 2 aiss@absa.co.za Website: etfcib.absa.co.za Absa NewFunds Managed SA Equity Range