Why Use Smart Beta in DC?

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1 Smart Beta for DC

2 Smart Beta for DC Why Use Smart Beta in DC? Increasing numbers of our DC clients are looking to us to help them use smart beta solutions in their schemes. Offering improved risk-adjusted returns and drawdown reduction, we believe that smart beta strategies are an excellent value proposition for both DC schemes and their members. SMOOTHER INVESTMENT JOURNEY We know from our research that DC members value a smoother investment journey and smart beta strategies can help achieve that. Better Performance and Risk Management Smart beta strategies have been shown to provide better risk-adjusted returns over time, when compared to traditional cap-weighted indexes. Additionally, when strategies such as quality or low volatility are used they also offer lower overall volatility and better drawdown performance. Adding an allocation to smart beta also introduces additional diversification for the scheme. GOVERNANCE BENEFITS Carefully designed, managed and governed by investment professionals; these are efficient, good value-for-money strategies with a transparent, rules-based nature. Their predictable exposures and straightforward implementation help reduce governance burdens on DC scheme management. A PASSIVE EVOLUTION, NOT A REVOLUTION Low management fees, transparency, flexibility and lower turnover relative to active mean that these strategies maintain much of the appeal of familiar passive indexing. 2

3 Understanding Smart Beta Smart beta strategies aim to isolate factors that have been shown to outperform market-cap-weighted indexes over time. Rather than simply weighting stocks by their market capitalization, these indexes are constructed to identify specific factor exposures that are believed to drive investment returns. Smart beta strategies allow schemes to target the underlying drivers of investment return that were once the sole preserve of active managers all in a cost-effective, easy-to-implement solution. Best Factors for DC There are four key factors we see as appropriate for DC investment strategies: Value Value stocks are those that trade at a lower price than their fundamentals (earnings, sales etc.) would imply. Value stocks have been shown to outperform the broader market indices over the long term. Small Cap The small-cap effect has been reproduced for most major securities markets around the world. The effect observed here is that smaller-capitalization companies have tended to outperform larger-capitalization companies over the long term. Low Volatility Creating a portfolio with lower volatility or tilting towards lower risk stocks can likely generate improved risk-adjusted return. Many low volatility indices attain a 20 30% reduction in volatility, compared to their equivalent cap-weighted indices. Quality Investing in higher quality companies has been shown to deliver greater downside protection, i.e. in down markets their stock price is less impacted than the overall market. Combining Factors Combining factors makes sense it can reduce volatility while enabling enhanced returns, it increases diversification and helps to smooth the investment journey. Quality + Low Volatility Combining the quality and low volatility factors makes for a defensive allocation that is complementary to value-based strategies. Such an approach might be adopted if the portfolio already has an exposure to value or if a generally more conservative investment approach is preferred. It offers the potential for a smoother risk/return pattern relative to single-factor exposures. Quality + Low Volatility + Value Adding the value factor builds on the above combination and allows the investment to increase allocations to securities that are attractive across multiple dimensions. This approach may be preferred by investors looking to further increase diversification and willing to accept marginally more risk in return for increased projected returns. State Street Global Advisors 3

4 Smart Beta for DC How To use Smart Beta in DC There are a number of ways that smart beta can be used in DC and we believe that the best strategic implementations use the low volatility, quality and value factors, either alone or in combination. We know that smart beta is often a complement to traditional passive strategies and we can help clients evaluate the effectiveness of single-factor versus multi-factor approaches given current goals, holdings and constraints. SSGA has many years of working with smart beta and we look to bring practical, real-life experience to strategy design and execution helping DC schemes bring better risk-adjusted returns and reduced volatility to their members. 4

5 0 % Target Improved Risk-Adjusted Returns DGF Bonds Multi-Factor 50 % Passive Equity 100 % Years to Retirement Introduce an allocation to Multi-factor Multi-factor funds combine a number of the prime smart beta factors such as Quality, Low Volatility and Value. Combining factors helps the scheme to diversify and take advantage of low/negative correlations between factors. These types of funds help dampen the cyclical effects of smart beta and offer schemes a potentially smoother risk/return profile when compared to single-factor exposures. Have Age-Appropriate Factor Exposures 0 % DGF Bonds Value 50 % Passive Equity Low Vol 100 % Years to Retirement Allocate to the most appropriate exposure at the right time Here, a larger allocation is made to the value or small-cap factors early in the glide path in order to target better risk-adjusted returns. As retirement nears and members ability to sustain losses reduces low volatility or quality factors are progressively switched in to ramp down the volatility profile yet further. Timewise We take this approach in our flagship Timewise Target Retirement Funds This approach helps optimize allocations throughout the lifetime of the scheme more return-seeking assets earlier in the glide path, more safety towards retirement. Again, this helps enable better member retirement outcomes. State Street Global Advisors 5

6 Smart Beta for DC SSGA MULTI-FACTOR Funds Low Volatility High Quality SSGA All World Equity Low Volatility / High Quality Screened Index Sub-Fund Passive fund. Covers developed markets and emerging markets. Defensive allocation that is complementary to more active and/or value strategies. Benchmark-aware for a lower tracking error. Built from the stock level up using a consistent methodology to capture factors. Potentially smoother risk/return pattern relative to single factor exposures. Low Volatility High Quality Low Valuation SSGA Global Developed Multi-Factor Passive fund. Covers developed markets. Benchmark-aware for a lower tracking error. Potential smoother risk/return pattern relative to single-factor exposures. Built from the stock level up using a consistent methodology to capture factors. Increased weighting to securities that are attractive across multiple dimensions. 6

7 Get More with SSGA When you begin a relationship with State Street Global Advisors, you benefit from more than just the investment solutions we provide. We work with you to create comprehensive solutions that include thoughtful investment design, results-driven member communications and insightful member research. Dedicated to Your Success Our dedicated DC team and Investment Solutions Group work closely with consultants, platforms, trustees and scheme sponsors. In a world where you balance multiple responsibilities, we can help you do more with and get more from your defined contribution plan. For further information, please us at ukdc@ssga.com or visit ssga.com/ukdc State Street Global Advisors 7

8 About SSGA For nearly four decades, State Street Global Advisors has been committed to helping our clients, and the millions who rely on them, achieve financial security. We partner with many of the world s largest, most sophisticated investors and financial intermediaries to help them reach their goals through a rigorous, research-driven investment process spanning both indexing and active disciplines. With trillions* in assets, our scale and global reach offer clients unrivalled access to markets, geographies and asset classes, and allow us to deliver thoughtful insights and innovative solutions. SSGA is the investment management arm of State Street Corporation. *Assets under management were $2.80 trillion as of 31 December Marketing Communication. For Plan Sponsor Use Only. State Street Global Advisors Limited. Authorised and regulated by the Financial Services Authority. Registered in England. Registered No VAT No Registered office: 20 Churchill Place, Canary Wharf, London E14 5HJ. T: F: +44 (0) The information provided does not constitute investment advice as such term is defined under the Markets in Financial Instruments Directive (2014/65/EU) and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor s or potential investor s particular investment objectives, strategies, tax status, risk appetite or investment horizon. If you require investment advice you should consult your tax and financial or other professional advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information. This document contains certain statements that may be deemed forwardlooking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions. Asset allocation is a method of diversification which positions assets among major investment categories. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss. Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. Value stocks can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time. Past performance is not a guarantee of future results. Investing involves risk including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA s express written consent. This communication is directed at professional clients (this includes eligible counterparties as defined by the Financial Conduct Authority who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication. Companies with large market capitalizations go in and out of favour based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations. Investments in small/mid-sized companies may involve greater risks than in those of larger, better known companies. Investing in foreign domiciled securities may involve risk of capital loss from unfavourable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries. All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment. While diversification does not ensure a profit or guarantee against loss, investors in Smart Beta may diversify across a mix of factors to address cyclical changes in factor performance. However, factors may have high or increasing correlation to each other. Low volatility funds can exhibit relative low volatility and excess returns compared to the Index over the long term; both portfolio investments and returns may differ from those of the Index. The fund may not experience lower volatility or provide returns in excess of the Index and may provide lower returns in periods of a rapidly rising market. Active stock selection may lead to added risk in exchange for the potential outperformance relative to the Index. Assumptions and forecasts used by SSGA in developing the Portfolio s asset allocation glide path may not be in line with future capital market returns and participant savings activities, which could result in losses near, at or after the target date year or could result in the Portfolio not providing adequate income at and through retirement. SSGA Target Date Funds are designed for investors expecting to retire around the year indicated in each fund s name. When choosing a Fund, investors should consider whether they anticipate retiring significantly earlier or later than age 65 even if such investors retire on or near a fund s approximate target date. There may be other considerations relevant to fund selection and investors should select the fund that best meets their individual circumstances and investment goals. The funds asset allocation strategy becomes increasingly conservative as it approaches the target date and beyond. The investment risks of each Fund change over time as its asset allocation changes. Investing in the Managed Pension Fund is effected by means of an insurance policy written by Managed Pension Funds Limited, a member of the State Street group of companies. This document should not be construed as an invitation or inducement to engage in investment activity. The Managed Pension Fund is available to pension schemes (including overseas schemes) registered with HM Revenue and Customs for the purposes of Chapter 2 of Part IV of the Finance Act This document should therefore only be circulated to the Trustees of such schemes and their advisers who are deemed to be professional persons (this includes professional clients and eligible counterparties as defined by the Financial Conduct Authority). It should not be circulated to or relied upon by any other persons. In particular scheme members should consult with their employer or scheme trustee. Please note that neither State Street Global Advisors Limited or Managed Pension Funds Limited offer actuarial services and any investment service undertaken by those firms with an objective of matching projected pension fund liabilities does not include, or take responsibility for, the calculation of projected liabilities. Any illustrations exclude the impact of fees, and actual investment returns may differ from projected cashflows, these projected cashflows are not projections of any future benefit payable under a specific policy. This document should be read in conjunction with its Strategy Disclosure/Supplemental/Policy Document. All transactions should be based on the latest available Strategy Disclosure/Supplemental/ Policy Document which contains more information regarding the charges, expenses and risks involved in your investment. The information contained in this communication is not a research recommendation or investment research and is classified as a Marketing Communication in accordance with the Markets in Financial Instruments Directive (2014/65/EU). This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research. State Street Global Advisors 2018 State Street Corporation. All Rights Reserved EMEA.INST Exp. Date: 28/02/2019