Factoring in Behavior

Transcription

1 Factoring in Behavior Mike Fardy, National Sales Manager, CIMA, FlexShares Not For Use with Retail Investors

2 Return (%) Global Equities Performance Dec-08 Dec-11 Dec-14 Dec-17 U.S. Dev. ex-u.s. Emerging markets Global equities Source: Northern Trust Investment Strategy, Index data for the various return calculations above are as follows: U.S. is the MSCI U.S. Equities IMI; Emerging Markets is the MSCI Emerging Market Equities Index; Dev. ex-u.s. is the MSCI World ex-u.s. IMI; Global Equities is the MSCI ACWI (All Country World Index) and is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. Indexes are gross of fees and indexes cannot be invested in directly. Past returns are no guarantee of future results. Charts are as of December 31, FlexShares.com

3 Global Equities Had Historically low Volatility in 2017 Source: Northern Trust Investment Strategy, Bloomberg. MSCI ACWI (All Country World Index). Indexes are gross of fees. Past returns are no guarantee of future results. Data through 2/15/2018 FlexShares.com

4 What is Behavioral Finance? The study of Psychology as it relates to the economic decision-making processes of individuals and institutions * 2002 Daniel Kahneman wins Nobel Prize in Behavioral Economics 2017 Richard Thaler wins Nobel Prize in Behavioral Economics Image Source: Image Source: FlexShares.com

5 The Market Cycle of Emotions Source: FlexShares.com

6 Why Should You Care? a 5% increase in customer retention produces more than a 25% increase in profit Acquiring a new customer is anywhere from 5 to 25 times more expensive than retaining an existing one. Source: Harvard Business Review, The Value of Keeping the Right Customers, October 29, 2014 FlexShares.com

7 Common Pitfalls Your Clients Face Anchoring Status Quo Cognitive Overconfidence Overchoice Herd Mentality (aka FOMO ) Endowment Theory Regret Aversion FlexShares.com

8 Common Pitfalls Clients Face Framing Sunk Cost Confirmation Disposition Effect Risk Aversion Selective perception Recency Effect Guessing at Patterns FlexShares.com

9 The Problem Are you and your clients buying and selling at the wrong times due to behavioral biases? Information Ratios during Manager Life Cycles After Manager Fired Before Manager Hired- Before Previous Manager 3 Years Hired After Manager Hired After Manager Fired After Manager Hired- Next 3 After Manager Fired- Next 3 Years Years For Illustrative Purposes Only: Source Norther Trust data dervied from Goyal, A. and Wahal, S., The Selection and Termination of Investment Managers by Plan Sponsors, Journal of Finance 63(4) , 2008 Data based on 3400 plan sponsors between 1994 and 2003 FlexShares.com

10 The Solutions SMAs / Multi Asset Class Solutions Factors ETFs FlexShares.com

11 Defining Factor Investing Factor investing seeks to identify and target these drivers of return through systematic strategies that can be implemented in risk-controlled portfolios. Quality Value Low Volatility Dividend Yield Size Momentum FlexShares.com

12 Consequences of Cancellation ACTUAL INVESTOR PORTFOLIO EXAMPLE Strategies Growth Value Momentum Size Volatility Small-Cap Value + + Small-Cap Growth Small-Cap Growth Mid-Cap Value + Mid-Cap Growth Large-Cap Value + Large-Cap Value + + Large-Cap Growth Aggregate Portfolio Exposure Note: + denotes an addition to factor exposure, while the denotes a detraction from factor exposure. FlexShares.com

13 Factors Have Driven Mutual Fund Excess Returns For 50 Years 6.6% 5% Common Style Factor Exposure -1.6% Annual Excess Return Skill Stock Picking Northern Trust. Decomposition of mutual fund excess (monthly) for top performing mutual funds over time derived from Source: For Illustrative Purposes Only. Carhart, Mark M. On persistence in mutual fund performance. The Journal of Finance 52.1 (1997): FlexShares.com

14 ETFs Traditional Index Management Factor-based Outcomes-Focused Traditional Active Management FlexShares.com

15 3 Actionable Items Deploy factors to stave off effects of behavioral concerns Be cognizant of your client s risk tolerance AND how they behave Become dispassionate. about your positions FlexShares.com

16 Focusing on Factors in Foreign Markets

17 Do Factors Work? FlexShares.com

18 Research has been clear for some time 1960 s Expected Return = Risk-free Rate + (Market Beta * Market Premium) 1992 Expected Return = Risk-free Rate + (Market Beta * Market Premium) + (Size Beta * Small Minus Big) + (Value Beta * High Minus Low) Source: Eugene Fama & Kenneth French, The Cross-Section of Expected Stock Returns, The Journal of Finance, June FlexShares.com

19 But behavior makes it difficult 120 Average Factor Cycle Length # of Months Low Volatility Dividend Yield Momentum Value Size Source: Northern Trust Quantitative Research, cycle lengths as determined using spectral analysis, Dec 2016 FlexShares.com

20 Should I Even Bother with Factors? FlexShares.com

21 Barra Factor Exposure We are all factor investors 0.40 S&P 500 Factor Exposure as of 2/28/ US Earnings Yield US Value US Volatility US Leverage US Earnings Variation US Dividend Yield US Momentu m US Growth US Size Factor FactSet. Data as of 2/28/2018 from the Barra USE3L risk model factor exposure subject to change. FlexShares.com

22 Return assumptions declining 8.40% State & Local Pension Plan Return Assumptions Return Assumption 8.20% 8.00% 7.80% 7.60% 7.40% 7.20% Source: Public Plans Data Center for Retirement Research at Boston College, Center for State and Local Government Excellence, and National Association of State Retirement Administrators. National data averages, weighted by plan size. FlexShares.com

23 Why international? 20 Global Equity Market Valuations Normal Range Median Current United States Developed ex US Emerging Markets 8 Source: FactSet P/E Ratios, Monthly data through 2/28/2018. Indices are the MSCI USA Index, MSCI World Excluding United States Index and the World Excluding United States Index begins 1/31/1997, MSCI Emerging Markets Index 10/31/1999. Normal range is +/- 1 standard deviation from median Past performance is no guarantee of future results. Periods greater than one year are annualized except where indicated. Returns reflect the reinvestment of dividends and other earnings and are shown before the deduction of investment management fees, unless indicated otherwise. Returns of the indexes also do not typically reflect the deduction of investment management fees, trading costs or other expenses. It is not possible to invest directly in an index. Indexes are the property of their respective owners, all rights reserved FlexShares.com

24 Breaking Bad Factor Habits FlexShares.com

25 Flows, $ Billions Returns, % The temptation of factor timing U.S. Listed Small Cap ETF Flows and Returns 15.00% % % 0.00% -5.00% % Monthly Net Flows Russell 2000 Performance Index Return- - Russell 1000 Performance Source: Bloomberg, as of 7/3/17, FlexShares Market Signal dated July 2017 Past performance is no guarantee of future results. Periods greater than one year are annualized except where indicated. Returns reflect the reinvestment of dividends and other earnings and are shown before the deduction of investment management fees, unless indicated otherwise. Returns of the indexes also do not typically reflect the deduction of investment management fees, trading costs or other expenses. It is not possible to invest directly in an index. Indexes are the property of their respective owners, all rights reserved FlexShares.com

26 Are more factors better than fewer? Momentum Quality Dividend Yield Size Value Volatility FlexShares.com

27 The Importance of Implementation FlexShares.com

28 Evolution of factor investing Smart Beta 1.0 Fundamental/ Alternatively Weighted Smart Beta 2.0 Single Factor Strategies Smart Beta 3.0 Multi-Factor Strategies FlexShares.com

29 Refined factor models Smart Beta 4.0? How efficiently is the factor captured? Unintended factor exposures Sector, country, industry biases Broad universe vs. sector neutral Factor maximization or incremental exposure How are factors combined? Target each independently, then combine (sub-index approach) Apply each in succession (step-through approach) Apply all factors in concert (optimization approach) FlexShares.com

30 Using the factor cycle to drive design 120 Average Factor Cycle Length # of Months Low Volatility Dividend Yield Momentum Value Size Source: Northern Trust Quantitative Research, cycle lengths as determined using spectral analysis, Dec 2016 FlexShares.com

31 Percentage Holding period matters 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% Value Win % Over Growth US Equity, % 1-year 3-year 5-year 10-year 15-year 20-year 30-year 40-year Value Wins 62% 75% 83% 96% 100% 100% 100% 100% Source: Ken French Data Library, monthly observations, Dec 2017 U.S. Growth Index is Fama/French U.S. Growth Index (ex utilities), provided by Fama/French. U.S. Value Index is Fama/French U.S. Value Index (ex utilities), provided by Fama/French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Values change frequently and past performance may not be repeated. There is always the risk that an investor may lose money. Even a long-term investment approach cannot guarantee a profit. Economic, political and issuer-specific events will cause the value of securities, and the portfolios that own them, to rise or fall. Because the value of your investment in a portfolio will fluctuate, there is a risk that you will lose money. Indexes are referred to for comparative purposes only and do not represent similar asset classes in terms of components or risk exposure; thus, their returns may vary significantly. U.S. Growth Index measures the performance of U.S. stocks with higher price-to-book ratios. U.S. Value Index measures the performance of U.S. stocks with lower price-to-book ratios. FlexShares.com

32 Complimentary factors ARE Key 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% -5.00% % Five Year Moving Average of U.S. Size Factor: 1926 to % % 15.00% 10.00% 5.00% 0.00% -5.00% Five Year Moving Average of U.S. Value Factor: 1926 to % Multifactor data provided by SmB and HmL research factors. Past performance is not a guarantee of future results. Values change frequently and past performance may not be repeated. There is always the risk that an invest may lost money. Securities of small firms are often less liquid than those of large companies. As a result, small company stocks may fluctuate relatively more in price. Even a long-term investment approach cannot guarantee a profit. Economic, political, and issuer-specific events will cause the value of securities, and the funds that own them, to rise or fall. Because the value of investments will fluctuate, there is a risk that investors will lose money. FlexShares.com

33 Factor tilt: different than factor weighted Tilting is a nuanced approach to factor investing that seeks to generate the targeted, systematic exposure through weighting adjustments to its holdings. Design of a tilted approach Total market ownership: exposure to entire investable universe even large cap growth stocks Targets a specific exposure to size and value in an effort to enhance returns while maintaining a consistent level of risk to those factors across entire product suite By targeting specific levels of factor exposure and rebalancing to those exposures at reconstitution, there should be less drift compared to other methodologies Lower turnover compared to other factor-based strategies Lower tracking error to the market FlexShares.com

34 Questions? FlexShares.com

35 LinkedIn.com/FlexShares FlexShares.com flexetf ( ) Built by investors, for investors FlexShares.com

36 FlexShares.com Your Advisor Portal A redesigned advisor site gives you unique access to performance information, in-depth commentary and fund analysis FlexShares.com

37 The FlexShares mission is to provide exchange traded funds that serve as the building blocks for outcome-oriented portfolios. This focus on investing with purpose is at the heart of our unique brand of ETFs. FlexShares.com

38 FlexShares.com

39 Important Information Before investing, carefully consider the FlexShares investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by visiting Read the prospectus carefully before you invest. Foreside Fund Services, LLC, distributor. An investment in FlexShares is subject to investment risk, including the possible loss of principal amount invested. Funds returns may not match the returns of their respective Indexes. The Funds may invest in emerging and foreign markets, derivatives and concentrated sectors. In addition, the Funds may be subject to asset class risk, small cap stock risk, value investing risk, non-diversification risk, fluctuation of yield, income risk, interest rate/maturity risk, currency risk, passive investment risk, inflation protected security risk, market risk and manager risk. For a complete description of risks associated with each Fund please refer to the prospectus. FlexShares.com