U.S. Factor Defensive Equity

Transcription

1 U.S. Factor Defensive Equity Newfound Case ID: December 2015

2 The Newfound Mission Defensive Simple Consistent Thoughtful In August 2008, Newfound Research was founded based on a simple, but powerful, premise: investors care deeply about capital preservation. Newfound Research offers a full suite of tactically risk-managed ETF portfolios that seek to participate in market growth and avoid significant market declines. We believe in portfolio processes that are simple, consistent, and thoughtfully designed. Most of all, we believe that managing risk is paramount to achieving superior risk-adjusted returns. Volatility happens. Have a plan with Newfound Research. Defensive Simple Consistent Thoughtful Views risk management from the investor s point of view, seeking to participate in bull markets and avoid large losses during bear markets. Volatility will happen. It is the price of admission to the financial markets. Investors need a thoughtful plan to deal with this volatility before it happens. We believe that each strategy should seek to adhere to a simple investment objective, providing transparency both in expected outcome and process. Our research shows that simple processes are more robust to uncertainty than complicated processes an important factor in delivering consistent and repeatable results. To meet a simple objective, a strategy must be governed by a guiding policy. At Newfound, we believe that the best way to ensure consistency in our process is through a quantitatively-enabled, rulebased approach, which can help mitigate the behavioral biases that often compound into investment errors. At Newfound, we recognize the clear distinction between the algorithms that generate our investment signals and the rules we use to translate those signals into portfolios. We believe that it is with these rules the design of the portfolio that we seek to achieve our objective and manage model risk. 2

3 About Newfound Defensive Simple Consistent Thoughtful Founded to license output from our core momentum models Began to actively develop and manage customized tactical overlays and portfolios for institutions, asset managers, and large RIAs Made strategies directly available to advisors under the Newfound brand for the first time Full Suite of Tactically Risk-Managed ETF Portfolios Equity Risk Managed Global Sectors Risk Managed U.S. Sectors Risk Managed Small-Cap Sectors U.S. Factor Defensive Equity Alternative Income Multi-Asset Income Bond Alternative Total Return Newfound Strategy Suite Fixed Income 1% Target Excess Yield 2% Target Excess Yield 3% Target Excess Yield 4% Target Excess Yield Liquid Alternatives Dynamic Alternatives 3 Total Portfolio Tailwinds Conservative Tailwinds Moderate Tailwinds Growth Simple Objective Consistent Process Thoughtful Design

4 U.S. Factor Defensive Equity A Simple Objective A Consistent Process A Thoughtful Design A simple objective The strategy seeks to provide intelligent access to U.S. equity factors including value, size, volatility, dividend growth and momentum within a risk managed framework. A consistent process When Newfound s quantitative models indicate increased risk of loss in U.S. equity markets, a short-term Treasury position may be introduced. A thoughtful design The portfolio is allocated such that each factor contributes equally to overall portfolio volatility to encourage factor diversification. There is no assurance that the strategy will achieve its investment objective. Newfound reserves the right to substitute the ETFs used in the investment universe. 4

5 The What & Why of Equity Factors Rules-Based Strategies Seeking to Capture Equity Risk Premiums Value Size What is it? Stocks with low price relative to fundamental value Stocks with smaller market capitalizations Theoretical Basis Higher systematic (business cycle) risk Loss aversion Higher systematic (business cycle) risk Higher liquidity risk Momentum Stocks with stronger recent past performance Underreaction and overreaction to information Low Volatility Stocks with lower-than-average volatility or beta Lottery effect Leverage aversion Dividend Growth Stocks with higher-than-average dividend growth Maximize key component of longterm stock growth 5

6 The Case for a Multi-Factor Approach Combine Complementary Factor Exposures within a Single Portfolio Equity factor exposures have historically outperformed the broad market and are widely used by institutional investors to increase risk-adjusted returns. Unfortunately, short-term performance of these factors is unpredictable. By diversifying across multiple factors, we seek to smooth out shortterm randomness and harvest their long-term performance more consistently. Annual Returns (1996 to 2015) Sharpe Ratio Momentum Minimum Volatility S&P Equal Weight Dividend Growth Size Value 0.32 Source: Yahoo! Finance, S&P, MSCI. Analysis provided by Newfound Research. Past performance does not guarantee future results data is through 12/31/15. Value is represented by the Guggenheim S&P 500 Pure Value ETF and the underlying index prior to the ETF s launch. Volatility is represented by the ishares MSCI USA Minimum Volatility ETF and the underlying index prior to ETF launch. Size is represented by the Guggenheim S&P 500 Equal Weight ETF and the underlying index prior to ETF launch. Momentum is represented by the ishares MSCI USA Momentum Factor ETF and the underlying index prior to ETF launch. Dividend is represented by the ProShares S&P 500 Dividend Aristocrats ETF and the underlying index prior to ETF launch. Proxy indices are adjusted down for estimated ETF management fees. The S&P 500 is represented by the SPDR S&P 500 ETF. The equal weight factor portfolio consists of an equal (20%) allocation to momentum, minimum volatility, size, dividend growth, and value, rebalanced annually. The referenced ETFs/indices are shown for general market comparisons and are not meant to represent any Newfound index or strategy. You cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges, unless otherwise noted. Hypothetical performance results have many inherent limitations, some of which, but not all, are described in the disclosures at the end of this presentation. No representation is being made that any fund or account will or is likely to achieve profits or losses similar to those shown on this page. 6

7 Large Drawdowns Can Damage Long- Term Equity Prospects Diversifying equity exposure cannot eliminate the risk of substantial loss of capital. The equity markets are risky. Volatility is the price of admission. Significant losses can and will happen. These losses can take significant time to recover from and in certain situations may permanently impair growth prospects. While diversifying equity exposure is a strong first line of defense against drawdowns, it is not perfect. -15% Size and Duration of Large Drawdown for Select U.S. Equity ETFs (June-95 to Dec-15) Peak to Trough Loss -25% -35% -45% -55% -65% -75% -85% Sector and Country ETFs Broad Market U.S. (SPY) Broad Market International (EFA) Individual Factors S&P 500 (SPY) Equal Factor Weight Duration of Drawdown in Years (Time to Return to Breakeven) Source: Yahoo! Finance, S&P, MSCI. Analysis provided by Newfound Research. Past performance does does guarantee future results. Data is for the period from June 1995 to December The ETFs used in the analysis are RPV, RSP, MTUM, NOBL, USMV, and SPY. Hypothetical index data is used as a proxy for the factor ETFs (RPV, RSP, MTUM, NOBL, USMV) prior to ETF launch.. Proxy indices are adjusted down for estimated ETF management fees. The equal weight factor portfolio consists of an equal (20%) allocation to momentum, minimum volatility, size, dividend growth, and value, rebalanced annually. The referenced ETFs/indices are shown for general market comparisons and are not meant to represent the strategy. You cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges, unless otherwise noted. The referenced index is shown for general market comparisons and is not meant to represent any Newfound index or strategy. Hypothetical performance results have many inherent limitations, some of which, but not all, are described in the disclosures at the end of this presentation. No representation is being made that any fund or account will or is likely to achieve profits or losses similar to those shown on this page. The duration of the drawdown is the number of years it takes for the ETF to return to its pre-drawdown level. 7

8 Traditional Risk Management Tools Aren t Perfect Portfolios seemingly diversified by asset class can still be dominated by equity risk. Diversification, the first line of defense for most investors, is not a perfect risk management tool. While most traditional asset allocation portfolios (e.g. 60/40 ) appear diversified, they are actually dominated by equity risk. Significantly increasing the fixed income allocation can better balance risk, but can be costly in a low yield environment. Stock Contribution to Portfolio Risk 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 60% Stocks / 40% Bonds 96% of risk contributed by stocks 19% Stocks / 81% Bonds 50% of risk contributed by stocks 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% Stock Allocation Source: Yahoo! Finance. Analysis provided by Newfound Research. Data uses monthly returns from September 2003 to November Bonds are represented by the ishares Aggregate Bond ETF (ticker: AGG). Stocks are represented by a portfolio of the SPDR S&P 500 ETF (ticker: SPY), the ishares MSCI EAFE ETF (ticker: EFA), and the ishares MSCI Emerging Markets ETF (ticker: EEM). Results are for general market comparisons and are not representative of any Newfound index or strategy. This content should not be considered investment advice. 8

9 Risk-Managed Equity Strategies The essence of investment management is the management of risks, not the management of returns. * The objective of traditional active equity managers is return focused. The objective of risk-managed equity strategies is risk focused. Market Manager In probability terms, these managers try to shift the return distribution to the right. If the market is up X%, they aim to be up more than X%. If the market crashes 50% and the managers only lose 45%, they will have achieved their goal. However, the clients have still lost almost half their money. Market Manager In probability terms, these managers try to cut-off the left tail (i.e. extreme negative events) from the distribution, even if this also means sacrificing the right tail (i.e. extreme positive events). The return over any specific period may be higher or lower than the average depending on the relative frequency of up vs. down markets. * Benjamin Graham There is no assurance that any strategy will achieve its investment objective. 9

10 Active Risk Management with Absolute Momentum Buy Outperforming Securities, Avoid Underperforming Ones At Newfound, our tactically risk-managed strategies use momentum to navigate market volatility. Momentum is a system of investing that buys and sells based upon recent returns. Momentum investors buy outperforming securities and avoid or sell short underperforming securities. Momentum is one of the oldest and most historically successful approaches to investing and has been called the premier market anomaly. Empirically, diversified momentum strategies have exhibited consistent risk-reducing characteristics. Why is that? Because absolute momentum is closely related to common sense stop-loss rules ( cut your losers short; let your winners run ). This helps counterweight behavioral biases that may compound the negative impact of large drawdowns. 100% 50% 60/40 Total Returns of U.S. 60/40 Stock/Bond Portfolio and Time Series Momentum in the 10 Worst Drawdowns for the 60/40 between 1880 and 2013 Trend Following (Momentum) 0% -50% -100% Panic of 1893 (Feb-93 to Aug-93) Panic of 1907 WW1 (Dec-16 to (Oct-06 to Dec-07) Dec-17) Great Depression 1937 Recession (Sep-29 to Jun-32) (Mar-37 to Mar-38) Stagflation Oil Crisis (Jan-73 (Dec-68 to Jun-70) to Sep-74) 1987 Crash (Sep-87 to Nov-87) End of Dot-Com Bubble (Sep-00 to Sep-02) Financial Crisis (Nov-07 to Feb-09) Source: AQR. Results are hypothetical and backtested. Results are not indicative or any Newfound index or strategy. Hypothetical performance results have many inherent limitations, some of which, but not all, are described in the disclosures at the end of this presentation. No representation is being made that any fund or account will or is likely to achieve profits or losses similar to those shown on this page. The trend following strategy uses an equal weight combination of 1-month, 3-month, and 12-month time series momentum strategies for 67 markets across four major asset classes 29 commodities, 11 equity indices, 15 bonds markets, and 12 currency pairs. The individual momentum strategies go either long or short the individual asset class or security depending on whether the trailing return is positive or negative. Each position is sized to target equal volatility and the portfolio as a whole targets a 10% volatility level. The 60/40 portfolio has 60% of the portfolio invested in the U.S. Equity market and 40% invested in 10-year U.S. government bonds. The 60/40 portfolio is rebalanced monthly. A full description of the indices analyzed, assumed transaction costs and fees, portfolio construction methodology, and results can be found in AQR s A Century of Evidence on Trend-Following Investing by Brian Hurst, Yao Hua Ooi, and Lasse H. Pedersen ( 10

11 U.S. Factor Defensive Equity Newfound s Dynamic, Volatility-Adjusted Momentum Model Building quantitative models is easy. Building quantitative models that stand the test of time is not. Our Dynamic, Volatility-Adjusted Momentum Model is based on our philosophy of Quantitative Integrity, which requires that models be simple, robust, adaptive, and reactive. Our models have helped power the tactical decisions for over $10 billion in client assets across a range of asset classes since Simple Robust Adaptive Reactive Our investment models are simple by design. Our research shows that simple models are more robust than complicated ones in uncertain and complex environments. Simplicity reduces the risk of over-optimization. Empirically, diversified absolute momentum strategies exhibit consistent risk-reducing characteristics across both timeframes and asset-classes. The Greek philosopher Heraclitus said, the only constant is change, which holds especially true for market dynamics. We believe quantitative models should be designed to constantly update their internal metrics to stay relevant in the current market environment. Predictive models are most effective when current market conditions mirror history. We believe exogenous events cannot be predicted and fall outside of historical data. Therefore, models should be reactive, i.e. durable and flexible in changing markets. 11

12 U.S. Factor Defensive Equity Building a Diversified Factor Portfolio To target an equal volatility contribution from each factor, allocations to each factor ETF are made in inverse proportion to their volatility. Therefore, higher volatility factors receive lower weights, and lower volatility factors receive higher weights. Volatility Inverse Volatility (1/Volatility) Weights Dividend Growth Value Size Low- Volatility Momentum 1. Compute an estimate of volatility for each factor 2. Turn volatilities into inverse volatilities ; high volatilities become low and low volatilities become high 3. Set weights for each factor equal to pro-rata inverse volatilities There is no assurance that the strategy will achieve its investment objective. Newfound reserves the right to substitute the ETFs used in the investment universe. 12

13 U.S. Factor Defensive Equity Seeking to Protect Capital With Momentum In seeking to protect capital against significant losses in bear markets, we utilize our proprietary momentum models to gauge overall U.S. equity market strength. Strong Equity Momentum Dividend Growth Value Mixed Equity Momentum Short-Term U.S. Treasuries Weak Equity Momentum In weak momentum environments, a position in short-term U.S. Treasuries can be built. Low- Volatility Momentum Size 100% invested in diversified, factor-based equity portfolio Selectively introduce shortterm U.S. Treasuries; reduce equity sleeve allocations prorata Allocate up to 100% of the portfolio to short-term U.S. Treasuries There is no assurance that the strategy will achieve its investment objective. Newfound reserves the right to substitute the ETFs used in the investment universe. 13

14 U.S. Factor Defensive Equity Harnessing the Power of Tactically Risk-Managed Strategies Use USFDE Example Allocations 1 as a sleeve in a diversified equity portfolio. Divide the overall equity allocation between risk mitigators and return generators and allocate accordingly. Value Momentum Small-Cap Return Generators Minimum Volatility Dividend Growth Risk Mitigators USFDE 2 to implement asset class views without unnecessarily increasing risk. A moderate risk profile client would traditionally be allocated 60% to stocks and 40% to bonds, but currently wants to minimize fixed income exposure due to low yields. Equity Fixed Income 3 in a core/satellite approach to complement a strategic asset allocation. An advisor uses a 20% allocation to low correlation alternatives strategies to complement a traditional 60/40 allocation. 14 USFDE Equity Strategic 60/40 Fixed Income Other Alts. USFDE This content should not be considered investment advice.

15 U.S. Factor Defensive Equity Under the Hood of the Factor ETFs in Our Universe (as of 12/31/2015) Factor Dividend Growth Low Volatility Momentum Size Value Ticker NOBL USMV MTUM RSP RPV # of Holdings Avg. Price/Earnings Avg. Price/Book Sector Exposures Consumer Disc. 11.8% 8.5% 29.5% 16.4% 15.3% Consumer Staples 26.1% 14.7% 16.7% 7.9% 5.6% Energy 3.8% 1.9% 0.6% 7.8% 10.7% Financials 13.3% 21.7% 8.7% 17.5% 27.1% Health Care 14.8% 19.6% 12.1% 11.4% 4.9% Industrials 15.0% 4.5% 5.9% 13.1% 8.1% Materials 9.3% 2.0% 1.0% 5.2% 6.1% Technology 3.9% 18.6% 25.2% 14.3% 7.7% Utilities 2.1% 8.3% 0.2% 6.3% 14.5% Top Holdings 1 Hormel Foods (2.4%) Public Storage (1.7%) Amazon (4.8%) First Solar (0.3%) NRG Energy (2.4%) 2 AbbVie (2.3%) McDonald s (1.6%) Facebook (4.7%) Southwestern Energy (0.3%) HP (2.2%) 3 Wal-Mart (2.3%) AT&T (1.5%) Home Depot (4.6%) ONEOK (0.2%) Archer Daniels (2.0%) 4 Cardinal Health (2.2%) Procter & Gamble (1.5%) Visa (3.9%) Range Resources (0.2%) Leucadia National (1.7%) 5 Kimberly-Clark (2.1%) Johnson & Johnson (1.5%) Starbucks (3.8%) NRG Energy (0.2%) Valero Energy (1.6%) 6 McDonald s (2.1%) Pepsico (1.5%) Altria (3.5%) Consol Energy (0.2%) Alcoa (1.6%) 7 Clorox (2.1%) Verizon (1.4%) McDonalds (3.3%) Consolidated Edison (0.2%) Anthem (1.5%) 8 Becton Dickinson (2.1%) Paychex (1.4%) Nike (3.1%) Spectra Energy (0.2%) Prudential (1.5%) 9 C.R. Bard (2.1%) General Mills (1.4%) Alphabet Class C (2.6%) Time Warner (0.2%) Exelon (1.5%) 10 Medtronic (2.1%) ADP (1.4%) Alphabet Class A (2.6%) EQT Corp. (0.2%) Staples (1.5%) Source: Guggenheim, ishares, ProShares. Data as of 12/31/2015. The price/earnings ratio, or P/E ratio, is an equity valuation multiple. It is defined as market price per share divided by last reported annual earnings per share. The price/book ratio, or P/B ratio, is also an equity valuation multiple. It is defined as market price per share divided by last reported book value per share. 15

16 Important Disclosures Newfound began to actively calculate the performance of the Newfound U.S. Factor Defensive Equity index on December 22, Performance results prior to December 22, 2014 are all backtested and hypothetical. Newfound began to manage and trade a brokerage account on December 30, 2014, which sole purpose was to track the performance of the index. Before you invest in the Newfound U.S. Factor Defensive Equity strategy, you are strongly encouraged to consult with your financial advisor. Newfound shall have the right at any time, in its sole discretion, to substitute any or all of the ETFs or other securities utilized within the investment strategy. This presentation (including the hypothetical/backtested performance results) is provided for informational purposes only and is subject to revision. This presentation relates to a rule-based index and related investment strategy which are managed by Newfound. This presentation is not an offer to sell or a solicitation of an offer to purchase an interest or shares ( Interests ) in any pooled vehicle. Newfound does not assume any obligation or duty to update or otherwise revise information set forth herein. This document is not to be reproduced or transmitted, in whole or in part, to other third parties, without the prior consent of Newfound. Certain information contained in this presentation constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as may, will, should, expect, anticipate, project, estimate, intend, continue, or believe, or the negatives thereof or other variations or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of an investment managed using the Newfound index or investment strategy may differ materially from those reflected in such forward-looking statements or in the hypothetical backtested composite results or the index s model performance results included in this presentation. The information in this presentation is made available on an as is, without representation or warranty basis. There can be no assurance that the Newfound index or related investment strategy will achieve any level of performance, and investment results may vary substantially from year to year or even from month to month. An investor could lose all or substantially all of his or her investment. Both the use of a single adviser and the focus on a single investment strategy could result in the lack of diversification and consequently, higher risk. The information herein is not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. You should consult your investment adviser, tax, legal, accounting or other advisors about the matters discussed herein. These materials represent an assessment of the market environment at specific points in time and are intended neither to be a guarantee of future events nor as a primary basis for investment decisions. The hypothetical/backtested performance results and model performance results should not be construed as advice meeting the particular needs of any investor. Past performance (whether actual, hypothetical/backtested or model performance) is not indicative of future performance and investments in equity securities do present risk of loss. The ability to replicate the hypothetical or model performance results in actual trading could be affected by market or economic conditions, among other things. 16

17 Important Disclosures Investors should understand that while the performance results may show a general rising trend at times, there is no assurance that any such trends will continue. If such trends are broken, then investors may experience real losses. None of Newfound nor any other person managed any product or account seeking to track the performance of the index prior to December 30, No representation is being made that any account will achieve performance results similar to those shown in this presentation. In fact, there may be substantial differences between backtested performance results and the actual results subsequently achieved by any particular investment program. As a result, the index theoretically may be changed from time to time to obtain more favorable performance results. There are other factors related to the markets in general or to the implementation of any specific investment program which have not been fully accounted for in the preparation of the hypothetical/backtested performance results, all of which may adversely affect actual portfolio management results. The information included in this presentation reflects the different assumptions, views and analytical methods of Newfound as of the date of this presentation. The index s performance during the Backtested Period is not based on live results produced by an investor s actual investing and trading, but was achieved by the retroactive application of a model designed with the benefit of hindsight, and, other than the composite results, the index model performance subsequent to December 22, 2014 is not based on live results produced by an investor s investment and trading, and fees, expenses, transaction costs, commissions, penalties or taxes have not been netted from the gross performance results except as is otherwise described in this presentation. The performance results include reinvestment of dividends, capital gains and other earnings. As the Hypothetical Information was backtested, it does not reflect contemporaneous advice or record keeping by an investment adviser. Actual, live client results may have materially differed from the presented performance results. All information presented after the index inception date (December 22, 2014) is the index s model performance, which means it was calculated by Newfound in real-time (not on a backtested basis), but does not reflect the payment of any fees, commissions or expenses (except as otherwise described in this presentation). Accounts and funds managed by an adviser using the Newfound model portfolios are subject to additions and redemptions of assets under management, which may positively or negatively affect performance depending generally upon the timing of such events in relation to the market s direction. The Hypothetical Information and model performance assume full investment, whereas actual accounts and funds managed by an adviser would most likely have a positive cash position. Had the Hypothetical Information or model performance included the cash position, the information would have been different and generally may have been lower. While there have been periodic updates and improvements to the Newfound model, there have not been any material changes in the objectives or strategies of the model that have occurred that may affect results. While Newfound believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information. 17