Smart Beta and Factor Investing Global Trends for Pension Investors

Transcription

1 Smart Beta and Factor Investing Global Trends for Pension Investors Pascal Blanqué CIO Amundi

2 Executive summary Risk factor investing: Seeing a strong momentum among long-term investors (pension funds, SWFs, etc.); Allows long-term investors to capture outperformance over the long run; Can be reinforced with a dynamic allocation based on market conditions. Best practice: Diversified smart beta and factors strategies; Dynamic allocation among risk factors, based on statistical processes; Dynamic allocation among risk factors based on the macroeconomic scenario; Decarbonization of equity portfolios 2

3 Smart Beta: Global trends and mapping 3

4 Why Smart Beta: cap weighted indices are not well diversified 35% 30% 25% 20% Weight of sectors in global capitalization weighted indices Oil & Gas Technology Financial Capitalization weighted indices: Are poorly diversified and have a history of sector and style bubbles; Are pro-cyclical and can exhibit massive drawdown; 15% 10% Are negatively exposed to rewarded risk factors such as Value or Small Cap. 5% 0% Source: Datastream 4

5 Why: cap weighted Indices deliver poor performance over the long run Market Cap Weighted Equal Weights Monkeys $100 invested with market cap weighted indexes would lead to $5, years later vs. more than $9,000 for about 50% of the cases with random (monkeys) portfolios. (1) Clare, Motson &Thomas (2013) 5

6 Why Smart Beta: a market monitor Survey by Longitude Research on behalf of State Street Global Advisors (2014): 300 US and Europe Asset Owners: Private Pension Funds, Public Pension Funds, Endowment Funds, Foundations, with more than USD 1bn in AuM Which of the following statements best describes your current opinion of smart/advanced beta? Most Institutional Investors have either committed a portion of their portfolios to advanced beta or intend to do so; This trend is particularly strong among Dutch, Belgian, and German pension funds; PGGM (Dutch pension fund with EUR 160bn) currently allocates 40% of its investment to advanced beta; Danish PKA, Taiwan Labor PF, UK s Strathclyde PF have allocated part of their portfolios to advanced beta products. Please indicate the extent to which you agree or disagree with the following statements. Smart beta strategies are a viable alternative to traditional index strategies Smart beta is here to stay as an evolution in indexing Smart beta is a viable alternative to active management 75% 66% 65% Source: Longitude Research on behalf of State Street Global Advisors 6

7 Why Smart Beta: a market monitor Survey by Russell Investments (2014): 181 US and European Asset Owners with more than USD 1 bn in AuM; Among Institutional Investors with more than $10 B, 75% are investing in, evaluating or considering smart beta; This percentage is 60% overall, 70% in Europe, 50% in USA. Source: Russell Investments Business Survey 7

8 Why Smart Beta: a market monitor Survey by Russell Investments (2014): 181 US and European Asset Owners with more than USD 1 bn in AuM; Russell anticipates a strong positive trend in investment flows. Source: Russell Investments Business Survey 8

9 What are Smart Beta? Alternative weighting schemes (Investment Process) Risk Factors (Stock Selection) Smart Beta has been traditionally identified with alternative weighting schemes, but Factor Investing is gaining remarkable momentum Source: Russell Investments Business Survey 9

10 Exhaustive mapping Mono Mid cap Selection + Investment Process Mono Momentum Low volatility Value Risk Factors Stock Selection Alternative weighting schemes Investment Process Min Variance Risk Parity Diversification Quality Multi Multi Dynamic allocation based on market signals Market Signals Market timing Dynamic allocation based on market signals Market regime (Markov Process) Market indicators (volatility, correlation, turbulence) 10

11 Institutional Investors in the Netherlands: approach to Smart Beta investing All of the 20 largest pension funds in the Netherlands have an allocation to Smart Beta; The typical first step has been an allocation to an alternative weighting scheme; the most widely adopted are minimum volatility and maximum diversification; The next step is a multi-factor approach where institutional investors typically allocate 20-40% to a combination of risk factors to (i) harvest targeted risk premia, (ii) balance the existing exposure to risk premia via existing active managers, (iii) reduce drawdown; The most popular factors are Value, Low Volatility and Quality due to defensive characteristics/benefits. 11

12 Institutional Investors in the Netherlands: Pension Fund case study Asset Manager of a multi-national company Pension Fund (employees in 80 countries); EUR 20bn in assets under management; In 2012 converted its Value/Growth mix into a 5-factor mix: Value, Momentum, Quality, Low Volatility, and Dividend Yield; In 2013 introduced a defensive mix (Low Volatility, Maximum Diversification, and Equal Risk Contribution). 12

13 French public Pension Fund FRR mixing alternative weighting schemes Weighting Scheme Risk Efficient What it does Increases portfolio diversification Minimizes portfolio Min Variance volatility Equalizes Equal Risk contribution to risk Contribution between stocks in the portfolio Weighs stocks based on RAFI fundamental characteristics (dividend, sales ) How you measure it Diversification ratio Volatility Entropy, effective number of stocks Fundamental score Constant mix of alternative weighting schemes; 2.0bn in Equity Smart Beta strategies; Combining several Smart Beta strategies: Help reduce the portfolio tracking error Without reducing expected record Exploiting implicit exposures to Value, Size (small), Low Volatility; In 2014: 2.38% outperformance in the Eurozone; 3.23% outperformance in North America. 13

14 Swiss private Pension Fund combines diversification scheme with dividend bias Weighted Average Crossed Correlations Diversification focused weighting schemes; 60% 50% 40% 30% 20% 10% 0% D-03 D-04 D-05 D-06 D-07 D-08 D-09 D-10 Optimum Diversification World MSCI World 160m in High Diversification High Dividend Equity Smart Beta, managed by Amundi; High diversification: Reduces risk and maximum drawdown; Does not impact expected return. Weighting schemes can be mixed with factor biases: Dividend, Value, Momentum 14

15 Investing with Risk Factors 15

16 Why factor investing makes sense Theme Risk-Based explanation Behavioral Value Momentum Captures excess returns on stocks that have low prices relative to their fundamental value Captures excess returns on stocks with stronger past performance Costly reversibility of assets in place leads to high Overreaction to bad news sensitivity to economic and subsequent reversal. shocks in bad times. Zhang Lakonishok et al. (1994) (2005) High Sensitivity to shock to expected growth. Liu and Zhang (2008) Underreaction to good news and return continuation. Daniel et al. (1998) Among available factors, some have positive long term expected rewards; Low Risk Size Quality Captures excess returns on stocks with lower than average volatility Captures excess returns of smaller firms relative to their larger counterparts Captures excess returns on stocks that are characterized by low debt, stable earnings growth, etc. Liquidity constraints. Frazzini Pedersen (2014) - Leverage constraints. Frazzini Pedersen (2013) Higher Earning uncertainty and distressed risk. Fama French (1992) Quality of accounting data affects systematic risk and the cost of capital. Campbell, Polk, and Vuolteenaho(1992) Two-layer portfolio theory and lottery-type investments. Shefrin and Statman (2000) - Hong Sraer (2012) Limited investor attention to small cap stocks Risk-seeking investors drive up the price of low quality/high-risk stocks. Hunstad (2013) They are supported by empirical evidence; They rely on solid economic rationale. 16

17 Risk factors outperform cap-weighted indexes over the long run All main factor indices have outperformed the market capitalization based index; But they can face some major drawdowns. MSCI World Source: Amundi Quantitative Research, FactSet. data from 05/31/1994 to 02/28/2014 Performance in USD. 17

18 Diversifying allows performances to be increased MSCI Indices: Annual return Sharp ratio Active return MSCI World Minimum Volatility Moment um Quality Value Small & Mid Cap High Dividend Equally Weighted Basket 7.0% 7.9% 10.6% 10.6% 8.1% 8.1% 9.3% 9.3% % 3.6% 3.6% 1.1% 1.1% 2.3% 2.3% Information ratio Single-Factor Indices have a better likelihood to perform (vs. indexes): 3 years: 60-70%; 5 years: 65-90%. Volatility 15.4% 11.1% 16.2% 14.1% 16.1% 16.9% 15.1% 14.0% Max Drawdown 54.0% 43.5% 52.8% 44.9% 57.9% 56.4% 59.4% 52.7% Tracking Error 7.1% 8.2% 4.8% 3.3% 6.0% 5.8% 2.8% Max Relative DD 20.1% 20.3% 19.6% 13.1% 34.3% 23.4% 4.7% Probability of outperformance (3Y) 62% 76% 76% 57% 66% 72% 97% Probability of outperformance (5Y) 74% 93% 75% 65% 80% 70% 100% Source: Amundi Quantitative Research, FactSet data from 05/31/1994 to 02/28/2014 Performance in USD. Multi-Factor Indices have even: Better returns; Lower Volatility; Lower max relative drawdowns Higher likelihood to outperform: 3 years: 96.5%; 5 years: 100%. 18

19 Timing factors with a statistical process Distribution of returns in turbulent and quiet regime Probability of being in a high volatility regime: /9/1995 6/9/1997 6/9/1999 6/9/2001 6/9/2003 6/9/2005 6/9/2007 6/9/2009 6/9/2011 6/9/ % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% A Markov process is a statistical tool that can be used to discriminate between market regimes: Quiet regime: returns tend to be high, volatility low; Turbulent regime: returns to be low, volatility high. A dynamic risk factor allocation invests: in a Defensive Mix when the Markov Model is detecting turbulent regimes (risk-off); in a Dynamic Mix when the Markov Model is detecting quiet regimes (risk on). Example - Defensive Mix: Minimum Volatility, Quality, High Dividend Yield Example - Dynamic Mix Momentum, Equal Weight (Size), Enhanced Value In-Sample Proba Vol HighRegime SP500 Multi Factor Dynamic Allocation 19

20 Timing factors according to the economic cycle 1- Recovery Winners Mid Cap Value 2- Expansion Winners Momentum Quality 3- Deceleration Winners Min Vol High Div. 4- Recession winners Min Vol Quality How to combine risk factors depending on economic cycles Statistical tests enable detection of opportunities Mid Cap & Value (Recovery) Momentum & Quality (Expansion) Min Vol & High Div. (Deceleration) Min Vol & Quality (Recession) and risks Quality (Recovery) (Momentum) Quality Losers Min Vol Losers (Growth) (Momentum) Losers Momentum Losers 0.2 Min Vol (Expansion) Growth & Momentum (Deceleration) Momentum (Recession) Source: Amundi Quantitative Research Factors in bracket are less statistically significant Smart Beta & Risk Factors 20

21 Minimizing Turnover 21

22 Specificities of Smart Beta strategies Compared to Market Cap weighted indices, Smart Beta strategies exhibit challenging specificities for index funds: Higher turnover; More liquidity issues; Less concentrated weight distribution; Greater difficulties in predicting quarterly index changes (for optimization based indices). A proper indexing process will have addressed those specificities: Within the replication phase; When implementing value added strategies. 22

23 Conclusion 23

24 Conclusion In a low yield environment, all asset owners are chasing returns: Long-term investors are benefiting from a competitive advantage: their investment time horizon; They can monetize it by implementing simple and transparent risk-factor investing strategies. In both cases, there is a need to: Have a clear understanding of the mechanisms (no black box); Deal with trusted partners that will work with them over the long run. 24

25 Disclaimer This material is communicated solely for information purposes and neither constitutes an offer to buy, an investment advice nor a solicitation to sell a product. This material is neither a contract nor a commitment of any sort. The provided information is not guaranteed to be accurate, exhaustive or relevant: although it has been prepared based on sources that Amundi considers to be reliable it may be changed without notice. Information remains inevitably incomplete, based on data established at a specific time and may change. Any projections, valuations and statistical analyses provided herein are provided to assist the recipient in the evaluation of the matters described herein. Such projections, valuations and analyses may be based on subjective assessments and assumptions and may use one among alternative methodologies that produce different results; accordingly such projections, valuations and statistical analyses should not be viewed as facts and should not be relied upon as an accurate prediction of future events. There is no guarantee that any targeted performance will be achieved. The information contained in this material shall not be copied, reproduced, modified, translated or distributed without the prior written approval of Amundi, to any third person or entity in any country or jurisdiction which would subject Amundi or any of its products, to any registration requirements within these jurisdictions or where it might be considered as unlawful. All potential investors should determine prior to any investment decision the suitability of any investment as regards the enforceable regulations as well as the tax consequences of such an investment and should inspect regulatory documents in force for each product. All potential investors should seek the advice of their legal and/or tax counsel or their financial advisor prior to any investment decision in order to determine the suitability of any investment before making any commitment or investment, in order to determine whether the investment is suitable for them, and should not only consider this material alone to make investment decisions. This material is solely for the attention of institutional, professional, qualified or sophisticated investors and distributors. It is not to be distributed to the general public, private customers or retail investors in any jurisdiction whatsoever nor to US Persons. It is not intended for citizens or residents of the United States of America or to any «U.S. Person», as this term is defined in SEC Regulation S under the U.S. Securities Act of 1933 and in the prospectus of the sub-fund. Moreover, any such investor should be, in the European Union, a Professional investor as defined in Directive 2004/39/EC dated 21 April 2004 on markets in financial instruments ( MIFID ) or as the case may be in each local regulations and, as far as the offering in Switzerland is concerned, a Regulated Qualified Investor within the meaning of the provisions of the Swiss Collective Investment Schemes Ordinance of 23 June 2006 (CISA), the Swiss Collective Investment Schemes Ordinance of 22 November 2006 (CISO) and the FINMA s Circular 08/8 on Public Offering within the meaning of the legislation on Collective Investment Schemes of 20 November In no event may this material be distributed in the European Union to non Professional investors as defined in the MIFID or in each local regulation, or in Switzerland to investors who do not comply with the definition of regulated qualified investors as defined in the applicable legislation and regulation. Amundi, French joint stock company ( Société Anonyme ) with a registered capital of and approved by the French Securities Regulator (Autorité des Marchés Financiers-AMF) under number GP as a portfolio management company 91 boulevard Pasteur Paris- France RCS Paris. 25