Going Beyond Style Box Investing

Transcription

1 Going Beyond Style Box Investing NCPERS Presented by Erin Doyle Orekhov, Client Portfolio Manager May 22, 2017 For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public. IM NCPERS

2 Session Description Going Beyond Style Box Investing While the advent of the style box in the 1990s has provided a useful framework for constructing a diversified equity portfolio, investing strictly within the style box framework may create portfolio gaps that can lead to unintended consequences. This presentation aims to help plan sponsors think about 1) how they can go beyond the confines of style boxes to help participants achieve a secure retirement; 2) how outcomeoriented approaches can help balance between maximizing total return and minimizing volatility; and 3) what they should look for when evaluating outcome-oriented strategies. 2

3 Table of Contents How we got here Why we need to think outside the box Thinking outside the box Thinking outside the box: a case study Key takeaways 3

4 How We Got Here 4

5 History of The Style Box Approach Morningstar Style Box TM Large Medium Small Value Blend Growth 5

6 A Strong Case for Diversification Emerging Market Equity Intermediate Bond Commodities Short Term Bond Emerging Market Equity TIPS Global Bonds High Yield Bond Developed International TIPS Senior Debt U.S. Small Cap REITs REITs Global Bonds High Yield Bond U.S. Mid Cap U.S. Mid Cap TIPS Emerging Market Equity Emerging Market Equity Intermediate Bond Senior Debt REITs REITs Intermediate Bond Developed International Short Term Bond U.S. Small Cap Developed International Developed International U.S. Small Cap Emerging Market Equity Global Bonds U.S. Mid Cap U.S. Small Cap High Yield Bond U.S. Small Cap U.S. Mid Cap Commodities U.S. Small Cap Commodities High Yield Bond U.S. Small Cap U.S. Mid Cap REITs U.S. Mid Cap U.S. Large Cap Calendar Year Returns 15.8% 5.5% -37.0% 26.5% 15.1% 2.1% 16.0% 32.4% 13.7% 1.4% 12.0% U.S. Mid Cap High Yield Bond U.S. Mid Cap Commodities High Yield Bond Short Term Bond High Yield Bond High Yield Bond Senior Debt Developed International Senior Debt U.S. Small Cap REITs Global Bonds Developed International U.S. Mid Cap REITs Commodities TIPS Senior Debt Senior Debt Senior Debt High Yield Bond Intermediate Bond Short Term Bond Emerging Market Equity Developed International U.S. Mid Cap TIPS REITs U.S. Small Cap Intermediate Bond Senior Debt Global Bonds REITs Emerging Market Equity Intermediate Bond Intermediate Bond U.S. Small Cap Global Bonds Senior Debt TIPS Senior Debt REITs Intermediate Bond Short Term Bond TIPS REITs Intermediate Bond Short Term Bond High Yield Bond Short Term Bond Global Bonds Developed International Developed International Short Term Bond Intermediate Bond Senior Debt TIPS Intermediate Bond Commodities Short Term Bond Commodities Commodities Global Bonds Short Term Bond U.S. Mid Cap Global Bonds TIPS TIPS Emerging Market Equity Emerging Market Equity Global Bonds Global Bonds Short Term Bond TIPS Emerging Market Equity U.S. Small Cap Commodities Developed International High Yield Bond Developed International Commodities Emerging Market Equity Commodities Source: Morningstar Direct. 6

7 Why We Need to Think Outside the Box 7

8 A Slightly Different Perspective on the Style Box Morningstar Style Box TM Large Medium Small Value Blend Growth 8

9 Challenges Facing Plan Sponsors in Today s World The Search for Yield Volatility Interest Rate Risk Fiduciary Responsibility 9

10 Return Volatility: why do we care? Compounded returns for high volatility stocks are dramatically lower 12% Q1 (Lowest Vol) Q5 (Highest Vol) 10% Volatility Drag 8% 6% Average Returns Compounded Returns 4% 10% 15% 20% 25% 30% Risk For illustrative purposes only. Data shown above represents performance for the Russell 1000 Index from 1/1/97 12/31/15. Past performance is no assurance of future results. Source: Voya IM and FactSet. 10

11 Fees Active vs. Passive Management For illustrative purposes only. Source: Voya Investment Management and Zephyr Style Advisor. Category median represents the 50 th percentile breakpoint for the Morningstar Large Cape Growth category at the end of each rolling 3-year period as calculated by Zephyr Style Advisor. Rolling 36-month data from December 1961-December 2015 completed monthly. Performance is no guarantee of future results. 11

12 Thinking Outside the Box 12

13 How to Identify and Fill the Gaps: A New Paradigm Morningstar Style Box TM V O L A T I L I T Y FEE PRESSURE Large Medium ETFs SMART BETA Small Value Blend Growth 13

14 Building Blocks for Delivering Cost-Effective, Custom Solutions Thinking outside the box Willingness to consider a solution that does not fit in a style box and hire a manager based on back-tested results Collaboration Partnership between plan sponsor and manager Analytics Deeper due diligence and analysis on how a manager will fit into the overall portfolio 14

15 Back-testing: De-Mystifying the Black Box Look for managers that: Use multiple factors Test the efficacy of factors over a range of market environments Look for factors that have low correlation to one another Look for managers that: Provide transparency around methodology and results Avoid look ahead bias, survivorship bias, and data mining Use multiple factors, test the efficacy of factors over a range of market environments, and look for factors that have low correlation to one another 15

16 Assessing Multiple Factors Over a Range of Market Environments Earnings momentum Earnings growth Price Momentum Cash to EV Tangible Book Yield Dividend Yield 0% 0% 0% 15% 17% 11% 5% 0% 0% 2% 0% 7% 0% 0% 0% 0% 0% 0% 2% 0% 1% 0% 0% 0% 0% 0% 0% 1% 0% 0% 0% 0% 0% 0% 0% 0% 12% 25% 25% 16% 1% 6% 0% 7% 1% 17% 5% 4% 10% 21% 12% 9% 11% 10% For illustrative purposes only. 16

17 Thinking Outside the Box: A Case Study 17

18 Case Study: Building a Portfolio to Meet a Style Box Gap - Volatility Plan Sponsor Objectives Generate income Low volatility and strong downside capture (lower risk) Maximize total return Off the Shelf Solutions Large Cap Value (Style Box Solution) Low/Min Vol ETF (Passive Solution) Unintended Consequences: No explicit beta target Overexposed to sectors that are interest-rate sensitive Custom Solution Sector-neutral Low beta Robust alpha source Above-benchmark dividend yield 18

19 Active Sector Weights (%) Case Study: Pitfalls of Off the Shelf Solutions Sector crowding 40 Defensive Cyclical % 24.1% % -24.1% -40 S&P Low Vol vs. S&P 500 MSCI Min Vol vs. MSCI USA For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98-12/31/15. Past performance is no assurance of future results. Interest rate sensitivity measures the sensitivity of returns to the change in 10-year bond yields. 19

20 Interest Rate Sensitivity Case Study: Pitfalls of Off the Shelf Solutions Correlation to interest rates Cyclical Defensive Energy Materials Banks Discretionary Industrials Diversified Tech Insurance Health Care Staples Telecom Real Estate Utilities Equity Market Beta (β) For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98-12/31/15. Past performance is no assurance of future results. Interest rate sensitivity measures the sensitivity of returns to the change in 10-year bond yields. 20

21 Case Study: Pitfalls of Off the Shelf Solutions Managing downside protection 6.0% 4.3% 2.0% -2.0% -2.5% -3.0% -3.2% -6.0% 10-YR Yield Russell 1000 Index S&P Low Vol ETF S&P High Div Low Vol ETF For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98-12/31/15. Past performance is no assurance of future results. Interest rate sensitivity measures the sensitivity of returns to the change in 10-year bond yields. 21

22 Case Study: A Different Framework for Evaluating an Outcome-Oriented Mandate, Focused on Desired Outcomes Higher Income Rolling 3-Year Average Dividend Yield 4 Dividend Yield (%) Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13 Dec-15 Voya Sample High-Dividend low volatility strategy Low Volatility R1000 Performance data from 01/01/97 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly. Source: FactSet and Voya Investment Management. Past performance is no assurance of future results. 22

23 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13 Dec-15 Case Study: A Different Framework for Evaluating an Outcome-Oriented Mandate, Focused on Desired Outcomes Lower Risk Risk Reduction versus the Russell 1000 Index 3 Year Rolling Standard Deviation (January 1, December 31, 2015) 0% -5% -10% -15% -20% -25% -30% Performance data from 01/01/97 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly. Source: FactSet and Voya Investment Management. Past performance is no assurance of future results. 23

24 Manager Returns Case Study: A Different Framework for Evaluating an Outcome-Oriented Mandate, Focused on Desired Outcomes Maximize Total Return Voya Sample High-Dividend low volatility strategy Low vs. Russell Volatility 100 Index Equity vs. Russell 1000 Index 3 Year Rolling Returns (January 1, December 31, 2015) % Manager Outperformance vs. the Benchmark Index Returns Performance data from 01/01/97 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly. Source: FactSet and Voya Investment Management. Past performance is no assurance of future results. 24

25 Key Takeaways 25

26 Why You Need to Think Outside of the Style Box 1 Unintended risks of pure style box approach 2 Changing market structure 3 Benefits of custom solutions 4 Last but not least 26

27 The #1 reason we all need to think outside the box 27

28 Appendix 28

29 Disclosure This information is proprietary and cannot be reproduced or distributed. Certain information may be received from sources Voya Investment Management ( Voya IM ) considers reliable; Voya IM does not represent that such information is accurate or complete. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements which do not reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical financial data. Actual results, performance or events may differ materially from those in such statements. Any opinions, projections, forecasts and forward-looking statements presented herein are valid only as of the date of this document and are subject to change. Nothing contained herein should be construed as (i) an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Voya IM assumes no obligation to update any forward-looking information. Past performance is no guarantee of future results Voya Investments Distributor, LLC 230 Park Ave, New York, NY All rights reserved. 29

30 Backtested Performance Information Backtested performance is NOT an indicator of future actual results. The results reflect the performance of a strategy not historically offered to investors and do not represent returns that any investor actually attained. Backtested results are calculated by retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and subject to losses. General assumptions include that the firm would have been able to purchase the securities recommended by the model and the markets were sufficiently liquid to permit all trading. Changes in these assumptions may have a material impact on the backtested returns presented. Certain assumptions have been made for modeling purposes and are unlikely to be realized. No representations and warranties are made as to the reasonableness of the assumptions. This information is provided for illustrative purposes only. Backtested performance is developed with the benefit of hindsight and has inherent limitations. Specifically, backtested results do not reflect actual trading or the effect of material economic and market factors on the decision making process. Since trades have not actually been executed, results may have under- or over-compensated for the impact, if any, of certain market factors may have had on a decision-making process. Further, backtesting allows the security selection methodology to be adjusted until past returns are maximized. Actual performance may differ significantly from backtested performance. Backtested results are adjusted to reflect the reinvestment of dividends and other income and except where otherwise indicated, are presented gross-of fees and do not include the effect of backtested transaction costs, management fees, performance fees or expenses, if applicable. No cash balance or cash flow is included in the calculation. 30