The Fron er Line. GLI Benchmarks. Thought Leadership and insights from Fron er Advisors. Issue 103, March 2015

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1 Thought Leadership and insights from Fron er Advisors GLI Benchmarks Issue 103, March 2015 Fron er Advisors has been at the forefront of ins tu onal investment advice in Australia for over two decades and provides advice over more than $230B in assets across the superannua on, charity, public sector and higher educa on sectors. The fact our advice is fully independent of product, manager or broker conflicts, means our focus is firmly on tailoring op mal solu ons and opportuni es for our clients. explores a range of investment issues and ideas to explain and illuminate areas for investors to be aware of and be thinking about. Our specialist and sector research teams constantly review and discover topics to provide new perspec ves and enrich understanding of cri cal risks and opportuni es. Fron er Advisors Level 16, 222 Exhibi on Street Melbourne, Victoria 3000 Tel eradvisors.com.au Tony Singh is an Associate Consultant working in our Real Assets Team. Tony provides investment strategy advice across a range of large and small superannua on and corporate clients. His fund manager and investment research coverage extends across mul ple asset classes with a specialised focus on the unlisted and listed property and sectors. This includes extensive due diligence and ongoing monitoring of pooled funds and direct investments through all phases of the investment lifecycle. Tony has completed a Bachelor of Business (Economics and Finance) (Applied) and is currently comple ng a Master of Applied er_adv

2 Global listed benchmarks UBS recently announced it planned to re re its global suite of listed indices from 31 March The ming for that decommissioning has now been postponed which allows investors addi onal me to transi on to alterna ve sources. The new effec ve date for the discon nua on of the UBS and U li es Indices is a er the close on Friday, May 29, Timing aside, this change has various implica ons for investors (and fund managers) with exposures that are currently benchmarked to a UBS listed index. Background At Fron er, our primary preference for listed investment is through unconstrained, high convic on, bo om up fundamental managers. While this approach is generally more expensive than a benchmark aware or indexed strategy, it provides more flexibility to ac vely allocate to sectors/securi es which comprise a true exposure (e.g. essen al monopolis c assets with high barriers to entry, predominantly contracted/regulated income profiles with low vola lity and strong infla on linked cash flows), which is expected to provide stronger risk adjusted returns over me. Unconstrained strategies o en feature CPI based benchmarks and, with the excep on of performance fees which may be linked to market returns, market benchmark selec on is generally less focused on realised investment outcomes. For investors who are intent on capturing broader industry dynamics at lower cost, benchmark aware or indexed strategies may make more sense and in this context, benchmark selec on is cri cal in shaping investment outcomes. In this issue of Fron er Line we evaluate key alterna ve global listed ( GLI ) benchmarks and discuss our preferred benchmark index for use with benchmarkaware or indexed GLI investment strategies; and unconstrained, high convic on GLI investment strategies as it relates to the determina on of manager performance fees and performance a ribu on. Fron er Advisors Page 1

3 Global listed benchmarks Review of alterna ve GLI indices The main alterna ve GLI index providers are S&P, FTSE, Dow Jones/Brookfield ( DJB ) and. has recently developed a new core index in direct response to UBS announcement. FTSE has also recently developed a capped and reweighted version of its exis ng GLI index in conjunc on with a focus group of fund managers including Maple Brown Abbo, Colonial First State Global Asset Management and Cohen & Steers. A summary of the main GLI indices is provided in Table 3, over the page.. Historical Performance The historical return, vola lity (as measured by standard devia on of monthly returns) and return/vola lity ra o (risk adjusted return) for each benchmark index is provided in Tables 1, 2 and 4. Cells are highlighted from green to red with green (red) represen ng the strongest (weakest) outcomes for each measurement period. In terms of risk, the FTSE Global Index has displayed the lowest annualised vola lity over longer periods, supported by its balanced exposure across the market and its construc on criteria of having at least 65% of stock revenues sourced from ac vi es. The DJB Index, whilst focused on companies with strong characteris cs, exhibits biases (par cularly a concentra on to North America and to oil & gas storage and transporta on) which have resulted in somewhat higher vola lity. Table 1: Historical return to 31 December 2014 ($A Unhedged) UBS DJB S&P GI Core Infra World Year Years (p.a.) Years (p.a.) Years (p.a.) Since Jan Source: Maple Brown Abbo, Bloomberg, Fron er Table 2: Historical vola lity to 31 December 2014 ($A Unhedged) UBS DJB S&P GI Core Infra World 1 Year Years (p.a.) Years (p.a.) Years (p.a.) Since Jan Source: Maple Brown Abbo, Bloomberg, Fron er Fron er Advisors Page 2

4 Global listed benchmarks UBS Global and U li es S&P/DJ/ Brookfield Global Composite Launch year FTSE Global Core FTSE Global Core 2015 (Release scheduled for 1 March 2015) S&P Global No. Stocks Summary Sector alloca ons Balanced exposure to both and u li es based on floatadjusted market cap based on UBS defini on of and sell side analyst coverage 50% 50% U li es Other caps Ind. Stock 5% EM alloca on Free float Market cap Developed inhouse by Brookfield to ensure stocks represent pure play on a fundamental basis Minimum 70% revenue sourced from pure play Pure Play Sectors Ind. Stock 5% Industry 50% Country 50% Specific defini on of based on FTSE Industry Classifica on Benchmark (ICB) subsectors Minimum 65% revenue sourced from None Specific defini on of based on FTSE Industry Classifica on Benchmark (ICB) sub sectors and fund manager/ consultant input Minimum 65% revenue sourced from 50% U li es 30% Transport 20% Other (Pipelines, Rail, Satellites) Broad defini on of based on GICS (global industry classifica on standard) Provides exposure to and services companies 40% U li es 40% Transport 20% Energy None Ind. Stock 5% Ind. Stock 5% Less than 1% 4% 4% 12% 8% 0% World Core Defini on of based on restricted set of GICS sectors 60% U li es 40% Sub sectors 15% Ind. Stock 5% >USD500m >USD500m >USD500m >USD500m >USD500m >USD500m Rebalancing Quarterly Quarterly Semi Annually Semi Annually Semi Annually Semi Annually Available in AUD Hedged / Unhedged Table 3: GLI index summaries Yes / Yes Yes / Yes Yes / Yes Yes / Yes Yes / Yes Yes / Yes Source: FTSE, S&P, Dow Jones, S&P,, Macquarie, Maple Brown Abbo, CFSGAM, Bloomberg, Fron er. Fron er Advisors Page 3

5 Global listed benchmarks For risk adjusted returns, the DJB Index has delivered the strongest outcomes over longer periods, followed by the two FTSE indices. In contrast, the UBS 50 50, the S&P Index and the Core Index have all trailed the broader equity market over the seven years to December 2014 and this is reflec ve of the broader defini ons used across both indices. The strong historical performance of the DJB and FTSE indices is also evidenced when considering historical drawdown, as shown in Chart 1. The historical drawdown of the DJB and FTSE indices has tracked reasonably closely with trough and dura on of drawdown far less pronounced than the other GLI indices. Drawdown of the S&P and Core indices has closely tracked that of the broader global equity market, reflec ng lower diversifica on benefits in the context of por olio construc on. Table 4: Historical return/vola lity to 31 December 2014 ($A Unhedged) UBS DJB Source: Maple Brown Abbo, Bloomberg, Fron er S&P GI Core Infra World 1 Year Years (p.a.) Years (p.a.) Years (p.a.) Since Jan Chart 1: Historical drawdown (underwater) Source: Maple Brown Abbo, Bloomberg, Fron er Fron er Advisors Page 4

6 Global listed benchmarks The DJB and FTSE indices have historically displayed demonstrable diversifica on benefits (albeit moderate) with a correla on to global listed equi es of below 0.7. For the S&P and Core indices, correla on and beta to global listed equi es has been rela vely higher which, in historical terms, would have delivered less por olio diversifica on and risk benefits. Transi on from UBS Analysis provided by Macquarie es mates the required por olio turnover for transi oning a purely passive por olio exposure currently invested in the UBS towards the key alterna ve benchmarks. Of the alterna ves, the Core index has the lowest es mated trading for transi on, followed by the FTSE indices. To World Table 5: Correla on and beta to Global Listed Equi es 1 January 2006 to 31 December 2014 ($A Unhedged) UBS DJB Source: Maple Brown Abbo, Bloomberg, Fron er S&P GI Core Infra World Correla on Beta Chart 2: Es mated trading for transi on Source: Maple Brown Abbo, Bloomberg, Fron er Fron er Advisors Page 5

7 Global listed benchmarks Fron er Assessment In our review of the alterna ve GLI indices, we have found that each op on presents its own set of benefits and considera ons. As such, the choice of a single GLI benchmark presents trade offs and ul mately, the preferred index for each investor should reflect their individual por olio objec ves and GLI investment strategy. Table 6: Views of alterna ve GLI indices Benefits Considera ons DJB FTSE Global S&P Core Pure play which is expected to maximise performance benefits from this asset class Strongest historical returns and riskadjusted returns Fundamental input from Brookfield analysts Posi ve historical performance Large, diversified universe Minimum revenue requirement Transparent, rules based construc on Strong historical performance with lowest historical vola lity Fund manager input on design results in balanced exposure, representa ve of global market including EM Minimum revenue requirement Large, diversified universe Transparent, rules based construc on Diverse exposure to the broader sector Transparent, rules based construc on Transparent, rules based construc on Least trading required for transi on from UBS Conflicted construc on methodology given input from Brookfield s funds management team Low transparency on index changes Concentra on to North America and oil & gas with minimal transport exposure High stock concentra on Minimal exposure to EM High US and U li es concentra on given uncapped construc on Very li le Airports exposure, excessive exposure to Rail Long tail of low weighted stocks Newly constructed index Poor historical performance Broad defini on of based on GICS Small investment universe with low por olio diversifica on benefits Newly constructed index Poor historical performance Broad defini on of based on GICS Excessive exposure to u li es No exposure to EM Fron er Advisors Page 6

8 Global listed benchmarks In arriving at our preferred GLI benchmark indices, we have taken into account the expected absolute and rela ve performance profile of each index. This focuses par cularly on expected vola lity, correla on and drawdown as these characteris cs are cri cal for aligning with what we view as the primary investment objec ves of (i.e. low vola lity and drawdown, low correla on to equi es and infla on linkage). In this context, the DJB and FTSE Global indices present strongly. We have also considered the concentra on of the benchmark universe at a stock, sub sector and country level. The DJB index as well as the S&P index have narrow universes and as a result, exhibit the highest concentra ons to subsectors/geographies. This may make these indices less suitable for investors seeking a broad exposure to industry dynamics. We are mindful that global listed as an asset class is con nuing to evolve given its rela vely short track record. We view favourably that in its design, the FTSE Global index has benefited from fund manager and consultant input, which has led to the development of a balanced exposure to. This is consistent with the way in which our preferred ac ve managers invest in prac ce and therefore makes this benchmark par cularly suitable for performance a ribu on in the context of ac vely managed strategies as well as for determina on of market linked performance fees. In addi on, because this index captures a representa ve share of the GLI market, we would also consider it suitable for use with benchmark aware or index strategies. Lastly, we are cognisant that the DJB index receives input from Brookfield s funds management team who at the same me, are also an ac ve investment par cipant in the GLI market. While this index aligns strongly with our preferred investment characteris cs from core, we acknowledge that this conflict may impede the use of this index by investors and some fund managers. No ng this, for investors targe ng a true exposure with less of a focus on diversifica on, the DJB Index provides a robust proxy for core performance. Fron er Advisors Page 7

9 Global listed benchmarks Fron er Advisors Page 8

10 Fron er Advisors Level 16, 222 Exhibi on Street Melbourne, Victoria 3000 Tel er_adv About Fron er Advisors: Fron er Advisors is one of Australia s leading asset consultants. We offer a range of services and solu ons to some of the na on s largest ins tu onal investors including superannua on funds, chari es, government / sovereign wealth funds and universi es. Our services range from asset alloca on and por olio configura on advice, through to fund manager research and ra ng, investment audi ng and assurance, quan ta ve modelling and analysis and general investment consul ng advice. We have been providing investment advice to clients since Our advice is fully independent of product, manager, or broker conflicts which means our focus is firmly on tailoring op mal solu ons and opportuni es for our clients. Fron er does not warrant the accuracy of any informa on or projec ons in this paper and does not undertake to publish any new informa on that may become available. Investors should seek individual advice prior to taking any ac on on any issues raised in this paper. While this informa on is believed to be reliable, no responsibility for errors or omissions is accepted by Fron er or any director or employee of the company. Fron er Advisors Pty Ltd ABN AFS Licence No