Fundamental indexing: The outperformance that had to happen

Transcription

1 Fundamental indexing: The outperformance that had to happen

2 Housekeeping Questions please ask any questions and we will endeavour to answer them at the end of the presentation Recording a copy of the presentation slides and a recording will be sent this afternoon Website all our fund information is available at Survey a short survey will pop up on completion 2

3 Disclaimer Financial Intermediary use only. Not for distribution clients. The information contained in this document is general information only and does not constitute personal financial advice. It does not take into account any person s financial objectives, situation or needs. It has been prepared by BetaShares Capital Limited (ABN , Australian Financial Services Licence No ) ( BetaShares ). The information is provided for information purposes only and is not a recommendation to make any investment or adopt any investment strategy. BetaShares assumes no responsibilities for errors, inaccuracies or omissions in this document. Past performance is not indicative of future performance. Investments in BetaShares Funds are subject to investment risk and investors may not get back the full amount originally invested. Any person wishing to invest in BetaShares Funds should obtain a copy of the relevant PDS from and obtain financial advice in light of their individual circumstances. 3

4 Speaker Profile Rob Arnott, Research Affiliates LLC Chairman & Chief Executive Officer, Research Affiliates LLC Rob has endeavoured to bridge the worlds of academic theorists and financial markets, challenging conventional wisdom and searching for solutions that add value for investors. He has pioneered several unconventional portfolio strategies that are now widely applied, including tactical asset allocation, global tactical asset allocation, tax-advantaged equity management, and the Fundamental Index approach to investing. Rob has published more than 100 articles in such journals as the Journal of Portfolio Management, Harvard Business Review, and Financial Analysts Journal, where he also served as editor in chief from 2002 through

5 Speaker Profile Vinnie Wadhera, BetaShares Director Institutional Business and National Accounts, BetaShares Vinnie is responsible for BetaShares distribution strategy to institutional investors and financial advisory groups. He has held senior distribution roles with ING Australia, Allianz Dresdner Asset Management and Third Link Investment Managers. Prior to that he was Head of Research at AMP Financial Services responsible for fund manager selection & review and model portfolio construction. Vinnie has attained the Certified Investment Management Analyst (CIMA ) designation and holds a Bachelor of Commerce degree. 5

6 What we will discuss today A recap of Fundamental Indexing, and how it seeks to overcome the limitations of market capitalisation indices What has driven the historical outperformance of Fundamental Indexing over Australian shares relative to a number of other passive indexing methodologies Market impact costs The dirty little secret of passive investing How Fundamental Index ETFs can benefit your client portfolios 6

7 Contents A recap of Fundamental Indexing, and how it seeks to overcome the limitations of market capitalisation indices What has driven the historical outperformance of Fundamental Indexing over Australian shares relative to a number of other passive indexing methodologies Market impact costs The dirty little secret of passive investing How Fundamental Index ETFs can benefit your client portfolios 7

8 Fundamental Indexing 10-years on 8

9 RAFI Fundamental Index The RAFI Fundamental Index strategy is a broadly diversified equity strategy built on the principles of contrarian investing and disciplined rebalancing» A history of outperformance based on sound investing principles» Broad economic representation, with low implementation costs and high capacity» Launched in 2005, with $121B in assets. 1 As of 6/30/2016 based on estimates in USD. Includes assets managed or sub-advised by Research Affiliates, LLC or licensees using RAFI strategies. Note: please refer to the important information slide at the end for all relevant disclaimers, disclosures, and information on our intellectual property. 9

10 Picking Active Managers: A Game with Poor Odds Excess Returns of Surviving US Large Cap Mutual Funds, Outperformers 12% 3% or more 2% to 3% % to 2% 98 Market Equivalent 45% 0 to 1% to -1% 307 Underperformers 43% -1% to -2% 292-2% to -3% 138-3% or less 69 Number of Funds Excludes over 1000 funds that did not survive the 10 years presumably underperformers Source: Research Affiliates, LLC, based on Lipper data for US large capitalization mutual funds. Mutual fund returns are net of fees. Chart has been recreated but based on Burton G. Malkiel, 2005, Reflections on the Efficient Market Hypothesis: 30 Years Later, The Financial Review, p

11 The Solution: Thoughtfully Designed Smart Beta Delivering well understood sources of excess returns through simple, transparent, low cost indices» Smart Beta strategies combine the benefits of:» Active management; The opportunity for outperformance» Passive management; Transparent, rules-based, low cost 11

12 Building a Superior Index Strategy» FTSE RAFI Index Series - a broadly diversified equity strategy built on the principles of contrarian investing and disciplined rebalancing 1. Measure the relative size of companies using fundamental measures Sales Total Annual Sales (averaged over 5 years) Cash Flow Operating Income + Depreciation & Amortization (averaged over 5 years) Dividends Total Annual Dividends (averaged over 5 years) Book Value Total Common Equity (most recent fiscal year ending) 2. Determine Average Fundamental Size 3. Security Selection 4. Rebalance Equally weighted average of the four fundamental measures Dividends are excluded for non-dividend payers For example, the FTSE RAFI Australia 200 Index is comprised of the 200 largest Australian companies ranked by overall fundamental size Annually on the third Friday of March 12

13 Steep Discounts Lead to Higher Subsequent Returns Subsequent 3-Year Excess Return 25% 20% 15% 10% 5% Win Rate 100% Win Rate 100% Win Rate 89% Win Rate 66% Current Valuation Discount (7/31/2016) All World: 32% US: 29% Dev. ex-us: 28% EM: 29% UK: 28% 0% -5% -10% -70% -60% -50% -40% -30% -20% -10% 0% Valuation Discount All World Developed ex-us EM UK US Source: Research Affiliates, LLC., based on data from CRSP/CompuStat and WorldScope/DataStream. Index returns represent the subsequent 3-year excess return for RAFI vs. Cap. Index returns and characteristics for both RAFI and cap-weighted indices are simulated. Please see Important Information at the end for additional material on simulated data. 13

14 RAFI Consistency Helps Investors Achieve Their Goals Strategy Annualized Excess Return 3-Yr Rolling Win-Rate 5-Yr Rolling Win-Rate Start Date FTSE RAFI US 1000 Index vs. S&P 500 Index FTSE RAFI Australia 200 Index vs. S&P/ASX 200 Index FTSE RAFI Developed Ex US 1000 Index vs. MSCI EAFE Index FTSE RAFI Emerging Markets Index vs. MSCI Emerging Markets Index FTSE RAFI All World 3000 Index vs. MSCI All Country World Index 1.9% 74.6% 83.2% % 88.2% 97.8% % 79.4% 90.9% % 77.9% 82.9% % 79.5% 86.6% 1988 Through June 2016 Source: Research Affiliates, LLC, based on data from Factset. Data prior to index launch is simulated. The FTSE RAFI US 1000 Index and FTSE RAFI Developed ex-us 1000 Index were launched on 11/28/2005. The FTSE RAFI All World 3000 Index was launched on 10/6/2008. The FTSE RAFI Emerging Markets Index was launched on 7/9/2007. Past Performance is not indicative of Future Performance. 14

15 Benefits RAFI Fundamental Index Strategies The RAFI Fundamental Index strategy is a broadly diversified equity strategy built on the principles of contrarian investing and disciplined rebalancing» Have shown to provide excess returns vs. cap-weight» Broadly diversified and economically representative» Low tracking error relative to cap-weight» High capacity» Low implementation costs 15

16 Excess Returns Should Accrue to the Investor Active Managers vs. Fundamental Index Strategies ( ) 29% % of Excess Returns vs. S&P 500 Index 71% 100% 67% 33% Average of U.S. top quartile active managers 2nd, 3rd, and 4th quartile U.S. managers all fail to add value net of expenses Live U.S. Fundamental Index Strategies Percent of Excess Returns Passed On to Manager Percent of Excess Returns Passed On to Client Active Managers excess returns calculated by using the 75th percentile gross return of Lipper US Large Cap Core, US Large Cap Growth, and US Large Cap Value database minus the return of the S&P 500 Index for the period 1/1/ /31/2015. Fees are represented by the average fee charged by active managers in the 20th 30th percentile ranking for the period 1/1/ /31/2015 using the Lipper database for US Large Cap Core, US Large Cap Growth, and US Large Cap Value. The Fundamental Index strategy represents the average excess returns, before fees, of the PowerShares FTSE RAFI US 1000 (PRF) ETF minus the S&P 500 and the PIMCO RAE Fundamental PLUS Fund Institutional Class (PXTIX) minus the S&P 500 for the period 1/1/ /31/2015. Fees are represented by the average expense ratio of the two funds. Source: Research Affiliates based on data from evestment Alliance and Factset. 16

17 Look Before You Leap! The Impact of Rising Valuations in Smart Beta

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19 Trend Chasing Everywhere Survivorship Bias Practitioners look for best historical performance. Academics look for best historical performance. Asset Owners look for best historical performance.» Problem: Not all factors are robust.» Selection bias and data mining are mistaken for persistent alpha. 1» Rising valuations are mistaken for persistent alpha Harvey, Liu, Zhu (2015); Beck, Hsu, Kalesnik, Kostka (2016) 2. Fama, French (2002); Arnott, Bernstein (2002); Campbell, Shiller (1988); Cochrane (2008) 19

20 Alpha Decomposition Portfolio Alpha Return due to change + in relative valuation Valuation- Adjusted Alpha Situational Alpha Structural Alpha» Alpha due to change in relative valuation» is mean reverting and averaging roughly zero in the long run.» contributes significantly to strategy performance in the short run.» Short run can mean decades!» Alpha adjusted for change in relative valuation is a good measure of unconditional expected return of a strategy. 20

21 Recent Factor Returns 10 Year Annualized Excess Returns (as of 2/2016) 5.48% 3.92% 3.40% -0.16% -0.76% -5.41% Low Beta and Quality were two of the Best Performers Value Momentum Small Cap Illiquidity Low Beta Gross Profitability Source: Research Affiliates. For more information, see full paper at: 21

22 Full Sample Factor Returns, Net of Valuation Change Annualized Excess Returns, Net of Change in Valuation (1/1967-2/2016) 3.04% 3.80% 2.02% 3.08% While Low Beta and Quality provide diversification benefits, they historically have provided no excess return net of Changes in Valuation! -0.17% -1.54% Value Momentum Small Cap Illiquidity Low Beta Gross Profitability Source: Research Affiliates. For more information, see full paper at: 22

23 The Journey Ahead Expected 5-Year Excess Returns (Conditional on Current Valuations) 7.88% 2.92% 4.41% 2.99% -0.91% -4.64% Value Momentum Small Cap Illiquidity Low Beta Gross Profitability Source: Research Affiliates. For more information, see full paper at:.actual outcomes may differ materially from expected results. 23

24 The Journey Ahead Expected 5-Year Excess Return (Conditional on Current Valuations) 2.0% 1.3% Low Volatility strategies still provide an excellent source of diversification and equity risk reduction. 0.4% 0.0% -0.3% -1.7% Equally Weighted Fundamental Index Risk Efficient Low Vol Index Maximum Diversification Quality Index Source: Research Affiliates. For more information, see full paper at: Actual outcomes may differ materially from expected results. 24

25 Market Impact Costs

26 Market Impact : The Dirty Little Secret of Passive Investing 26

27 RAFI is Designed with Ease of Implementation in Mind Weighted Average Market Cap in USD Billions June Number of Holdings June United States Cap Weight Fundamental Weighting Equal Weighting 1/Volatility Minimum Variance Average Annual Turnover United States 45% 26% 26% 27% 49% Quality Median Active Manager 14% 2% United States Source: Research Affiliates, LLC., based on data from Evestment, Factset and FTSE Russell. Each strategy listed represents the following indices: Cap Weight - Russell 1000 Index, Fundamental Weighting FTSE RAFI US 1000 Index, Equal Weighting S&P 500 Equal Weight Index, 1/Volatility S&P 500 Low Volatility Index, Minimum Variance MSCI USA Minimum Volatility Index, Quality MSCI Quality Index. Median Active Manager represents the Median US Large Cap Equity Manager as reported by Evestment. Turnover for Russell 1000 is annual turnover for the period , FTSE RAFI US 1000 Turnover is for the period , S&P 500 Equal Weight is annual turnover for and uses the ETF RSP as a proxy, S&P 500 Low Volatility turnover is for and uses the ETF SPLV as a proxy, turnover for MSCI USA Minimum Variance is for and uses the ETF USMV as a proxy, turnover for the MSCI Quality Index is for and uses the ETF QUAL as a proxy., Median Active Manager turnover is for the period

28 Equal Weight & Fundamental Weight Index Investing Past performance is not an indicator of future performance.. 28

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30 Important Information The FTSE Research Affiliates Fundamental Indexes are calculated by FTSE International Limited ( FTSE ) in conjunction with Research Affiliates, LLC, ( RA ). All rights and interests in the FTSE Research Affiliates Fundamental Indexes vest in FTSE. All rights in and to the RA Fundamental Index weighting methodology used in the calculation of the FTSE Research Affiliates Fundamental Indexes vest in RA. All rights in the FTSE indexes and / or FTSE ratings (together the FTSE Data ) vest in FTSE and/or its licensors. Except to the extent disallowed by applicable law, neither FTSE nor RA nor their licensors shall be liable (including in negligence) for any loss arising out of use of the FTSE Research Affiliates Fundamental Indexes, the FTSE Data or underlying data by any person. FTSE is a trademark of the London Stock Exchange Plc and is used by FTSE under license. Research Affiliates and Fundamental Index are trademarks of RA. 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31 Contents A recap of Fundamental Indexing, and how it seeks to overcome the limitations of market capitalisation indices What has driven the historical outperformance of Fundamental Indexing over Australian shares relative to a number of other passive indexing methodologies Market impact costs The dirty little secret of passive investing How Fundamental Index ETFs can benefit your client portfolios 31

32 BetaShares FTSE RAFI Australia 200 ETF Product Name: BetaShares FTSE RAFI Australia 200 ETF ASX: QOZ Index Tracked & Description of Index FTSE RAFI Australia 200 Index. Contains the top 200 eligible securities with the largest RAFI fundamental scores listed on the ASX. The FTSE RAFI Index Series selects and weights index constituents using four fundamental factors, rather than market capitalisation, reflecting the company s economic footprint. The factors are sales, cash flows, dividends and book value. Key Information ASX Code Index Name Index ASX Code Bloomberg Code QOZ FTSE RAFI Australia 200 Index FRAUSTR Index QOZ AU # of components 200* Asset backing Management Fee Expense recovery ETF Inception Date Equities 0.30% p.a Capped at 0.10% p.a 10 July 2013 Top 10 Index Components As at October Company Weighting BHP Billiton Ltd 10.3% Commonwealth Bank of Australia Australia & New Zealand Bankin 7.5% 7.5% Westpac Banking Corp 7.3% National Australia Bank Ltd 6.7% Wesfarmers Ltd 3.9% Woolworths Ltd 3.7% Rio Tinto Ltd 2.4% Suncorp Group Ltd 2.0% Woodside Petroleum Ltd 1.7% Sector Allocation As at October Financials 39.0 Materials 22.6 Consumer Staples 9.5 Energy 7.4 Real Estate 5.2 Industrials 5.1 Consumer Discretionary 4.3 Health Care 2.7 Telecommunication Services 2.1 Utilities 1.7 Information Technology 0.4 *Between annual rebalance dates the index components may differ from 200 due to corporate events. Confidential may not be distributed without the consent of BetaShares Capital 32

33 FTSE RAFI Australia 200 Index has outperformed S&P/ASX 200 Index since inception FTSE RAFI Australia 200 Index v S&P/ASX 200 Index: May October ,650 1,450 1,250 1, FTSE RAFI Australia 200 TR Index (index BetaShares FTSE RAFI Australia 200 ETF seeks to track) S&P/ ASX 200 TR Index TOTAL RETURN FTSE RAFI AUSTRALIA 200 S&P/ASX 200 3M 1.3% -3.2% 6M 6.7% 3.5% 1 YR 9.8% 6.1% 3 YR (p.a) 5.1% 3.9% 5 YR (p.a) 11.0% 9.2% 10 YR (p.a) 6.7% 4.6% 20 YR (p.a) 11.2% 8.8% Incept (p.a) 11.4% 9.2% Volatility (p.a) 12.9% 13.1% May-92 May-94 May-96 May-98 May-00 May-02 May-04 May-06 May-08 May-10 May-12 May-14 May-16 Riskadjusted return Ending value of $100 $ 1, $ Value added since inception: 2.1% p.a Graph shows performance of underlying index relative to S&P/ASX 200 index, not ETF performance and does not take into account ETF management costs. You cannot invest directly in an index. Returns for periods longer than one year are annualised. Past performance is not an indicator of future performance of index or ETF. The FTSE RAFI Australia 200 Index was launched on 10/8/2009. Index returns prior to launch are simulated based on Research Affiliates patented non-capitalisation weighted indexing system, method and computer program product. Actual investment results may differ from simulated results. Source: Bloomberg, FTSE Confidential may not be distributed without the consent of BetaShares Capital 33

34 FTSE RAFI Australia 200 Index has outperformed S&P/ASX 200 Index most years since inception FTSE RAFI Australia 200 Index v S&P/ASX 200 Index Total Returns by Calendar Year Total Return FTSE RAFI 200 S&P/ASX 200 Difference 2016 (YTD) 9.65% 6.29% 3.36% % 2.56% -2.13% % 5.61% -0.01% % 20.20% 5.29% % 20.26% 1.69% % % 1.12% % 1.57% -0.97% % 37.03% 11.55% % % 1.55% % 16.07% 4.00% % 24.22% -2.44% % 22.83% 0.27% % 27.99% -1.47% % 14.61% -0.18% % -8.77% 5.82% % 10.36% 7.05% % 6.36% 1.45% % 18.74% 0.39% % 9.80% 10.17% % 12.67% 0.55% % 14.35% 2.04% % 21.10% -0.70% % -8.76% 0.83% % 40.05% 8.63% Table shows performance of underlying index relative to S&P/ASX 200 index, not ETF performance and does not take into account ETF management costs. You cannot invest directly in an index. Past performance is not an indicator of future performance of index or ETF. The FTSE RAFI Australia 200 Index was launched on 10/8/2009. Index returns prior to launch are simulated based on Research Affiliates' patented non-capitalisation weighted indexing system, method and computer program product. Actual investment results may differ from simulated results. Source: Bloomberg, FTSE Confidential may not be distributed without the consent of BetaShares Capital 34

35 Holdings comparison FTSE RAFI Australia 200 As at 30 September 2016 Top 10 Holdings FTSE RAFI Australia 200 Index S&P/ASX 200 Australia 200 Index COMPANY WEIGHTS COMPANY WEIGHTS 1 BHP Billiton Ltd 9.95% Commonwealth Bank of Australia 8.70% 2 Commonwealth Bank of Australia 7.43% Westpac Banking Corp 6.92% 3 Australia & New Zealand Banking Group Lt 7.42% Australia & New Zealand Banking Group Lt 5.66% 4 Westpac Banking Corp 7.02% National Australia Bank Ltd 5.19% 5 National Australia Bank Ltd 6.63% BHP Billiton Ltd 5.03% 6 Wesfarmers Ltd 4.27% Telstra Corp Ltd 4.44% 7 Woolworths Ltd 3.57% Wesfarmers Ltd 3.47% 8 Rio Tinto Ltd 2.25% CSL Ltd 3.42% 9 Suncorp Group Ltd 1.94% Woolworths Ltd 2.09% 10 Woodside Petroleum Ltd 1.75% Macquarie Group Ltd 1.95% Top 10 Over/Under Weights v S&P/ASX 200 Index OVERWEIGHTS UNDERWEIGHTS COMPANY WEIGHTS COMPANY WEIGHTS 1 BHP Billiton Ltd 4.92% Telstra Corp Ltd -2.83% 2 Australia & New Zealand Banking Group Lt 1.76% CSL Ltd -2.64% 3 Woolworths Ltd 1.49% Commonwealth Bank of Australia -1.27% 4 National Australia Bank Ltd 1.44% Transurban Group -1.13% 5 Origin Energy Ltd 1.06% Sydney Airport -0.93% 6 Suncorp Group Ltd 0.85% Scentre Group -0.80% 7 Fortescue Metals Group Ltd 0.83% Brambles Ltd -0.70% 8 WorleyParsons Ltd 0.80% Westfield Corp -0.69% 9 Wesfarmers Ltd 0.80% Aristocrat Leisure Ltd -0.50% 10 Rio Tinto Ltd 0.72% Newcrest Mining Ltd -0.50% Source: Research Affiliates, FTSE, Bloomberg Confidential may not be distributed without the consent of BetaShares Capital 35

36 Application for Australian Investment Portfolios 1. Core Passive Exposure Economy-centric view Broad-market exposure 2. Complement your existing active managers Lower overall fee Potential for outperformance still exists 3. Complement your own stock selection Diversification Potential for outperformance still exists 4. Value Investing Dynamic value tilt Current cyclical low for value Confidential may not be distributed without the consent of BetaShares capital 36

37 Questions? Keep in touch BetaShares Client Service