BATSETA Durban Mark Davids Head of Pre-retirement Investments

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1 BATSETA Durban 2016 Mark Davids Head of Pre-retirement Investments

2 Liberty Corporate VALUE Dividend yield Earning yield Key considerations in utilising PASSIVE and Smart Beta solutions in retirement fund default investments. Mark Davids Head of Pre-retirement Investments Liberty Corporate PRICE MOMENTUM 12 month price movements

Investment Continuum Critical active decision Strategies that are focused on achieving target return Strategies that aim to maximise Alpha SAA (Specialist Active Managers) SAA (With TAA overlay)

3 Investment Continuum Critical active decision Strategies that are focused on achieving target return Strategies that aim to maximise Alpha SAA (Specialist Active Managers) SAA (With TAA overlay) Balanced mandate (ALM- Constraints) SAA (Passive asset Blocks) Passive No active asset management decisions - Index tracking - Lower cost Pure Balanced Mandate Pure Active Active asset management decisions - Manager skill dependent - Higher cost

4 Question What percentage of the SA Retirement Fund industry are invested in Passive funds? A. 40% B. 10% C. 4%

5 Question What percentage of the SA Retirement Fund industry are invested in Passive funds? A. 40% B. 10% C. Answer: 4%

investing Strategy in which an investor invests in accordance with a pre-determined strategy that doesn't entail any

6 Passive investing why now..? Total value of assets from December 2004 to June 2015 % of managers outperforming benchmark since % Passive investing Strategy in which an investor invests in accordance with a pre-determined strategy that doesn't entail any forecasting No use of market timing No stock picking Why..? minimize investing fees - Lower costs avoid the adverse consequences of failing to correctly anticipate the future Client and regulatory push Source:

7 What are key consideration on Passive investing Cost After fees you will underperform the index..! By how much..? How cheap is cheap..? What is reasonable..? Tracking Error What is tracking error..? Why does it matter..? What is reasonable..?

8 Question In South Africa, what is the average cost of a Passively managed Balanced Regulation 28 compliant portfolio? A. 70bps B. 27bps C. 10bps

9 Question In South Africa, what is the average cost of a Passively managed Balanced Regulation 28 compliant portfolio? A. 70bps B. Answer: 27bps C. 10bps

10 How Cheap is cheap? Cost How much do Active Managers charge..? R100 million invested Fee band Average Fee 0 50 million 0.68% million 0.65% Total Fee including global 0.72% International Assets 0.88% How much do Passive Managers charge..? R100 million invested Fee band Fee range Average fee million 0.15% % 0.27% Source:

11 Question What is Tracking Error? A. A new Microsoft Word document B. A measure of how closely a portfolio follows the index to which it is benchmarked C. A breed of dog

12 Question What is Tracking Error? A. A new Microsoft Word document B. Answer: a measure of how closely a portfolio follows the index to which it is benchmarked C. A breed of dog

13 And Tracking Error how much is too much? Tracking Error Tracking error is a measure of the variability of the manager's returns relative to the benchmark returns. Passive single asset class 1 Year Fund Return 1 Year Benchmark Return Tracking error Manager O 3.03% 3.17% Manager S 2.66% 3.17% (0.14%) (0.51%) What causes tracking error Frequency of cash flows, Trading costs, Corporate Actions, Administration efficiency What is acceptable tracking error +- 20basis points per annum Does zero tracking error exist..?? Yes.

14 Question Why has your fund not invested Passively to date? A. Do not know enough about it B. Still seems too expensive C. The timing has not been right

15 Passive investments and Active Active management can be successful but it is not easy Difficult for active managers to consistently beat the market Passive currently outperforming Active, these strategies ebb and flow Even successful active management strategies will have periods of underperformance that could extend over many years

16 Contact details Investment Product Contact Details: Mark Davids Head of Pre-retirement Investments Tel: (011) Cell: Libridge Building 25 Ameshoff Street Braamfontein 2001

18 Sources of Equity Returns Traditional Perspective Alpha Alpha = outperformance of the index; or performance due to stock picking ability of manager Total return Market Beta Market beta = correlation of portfolio returns with the index; or the return driven purely by market movements

19 Sources of Equity Returns Emerging Perspective Total return Alpha Factor Beta Alpha = outperformance of the index; or performance due to stock picking ability of manager Factor beta = return due to correlation with other securities with similar factors Market Beta Market beta = correlation of portfolio returns with the index; or the return driven purely by market movements

20 Equity Factors Explained Systemic risk characteristics Drive Security Performance Can be: Fundamental Technical Geographic Size-based, etc 20

21 Equity Factors Explained Examples: Equity Emerging Markets Small Cap Value Change over time Investors are usually compensated for assuming exposure to these risks over the long term Risk Premium 21

22 Why Should You Consider Smart Beta Seeks to improve returns, reduce risk and enhance diversification Smart beta has been part of active funds Most active managers use screening tools that employ factors used in the creation of smart betas Blackrock study: 35% of the active risk of international equity portfolios is accounted for by smart beta Smart betas can now be sourced easily through passively managed strategies at lower fees The push for passive in the new retirement reforms Smart beta provides excess return at lower fees

23 Determination of Composite Factors 23

24 Determination of Composite Factors 24

25 Recommenda tion revisions Debt Technicals Value and Volatility Growth and Quality Analyst Revision Price Momentum Determination of Composite Factors 25

26 Resultant Four Driving Factors VALUE Dividend yield Earning yield Cash-flow yield ANALYST SENTIMENT Earnings revision Dividend revision GROWTH and QUALITY Earnings growth Dividend growth ROE ROA PRICE MOMENTUM 12 month price movements

27 Strong performance and persistency (Last 15 years) Value Growth and Quality Momentum Size Low Volatility Information coefficient Relative return 2% 4% 5% -3% 6% Hit rate 53% 61% 62% 42% 58%

28 Jun-03 Nov-03 Apr-04 Sep-04 Feb-05 Jul-05 Dec-05 May-06 Oct-06 Mar-07 Aug-07 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 May-11 Oct-11 Mar-12 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Feb-15 Jul-15 Dec-15 Diversification 1 year relative returns Momentum Value Growth & Quality Source: Factset

29 Diversification Sentiment Value Growth Momentum Size Low Vol Active fund 1 Active fund 2 Active fund 3 Active fund 4 Sentiment Value Growth Momentum Size Low Vol Active fund 1 Active fund 2 Active fund 3 Active fund Low correlations amongst factors Negative correlated with active fund mostly Source: Factset and STANLIB Quants Research

30 Ingredients for a Good Smart Beta Product Strong performance and persistency over time Good economic intuition Reward for systematic risk Exploiting behavioral biases Diversification benefits Sector neutrality Not overly concentrated in any sector Improves risk adjusted returns

31 Benefits of Sector Neutrality Sharpe ratio 1.20 A general pick up in sharpe ratios as a result of declines in volatility Value Growth & Quality Momentum Size Volatility Non Sector Neutral Sector Neutral Source: STANLIB Quants Research

33 How to use Smart Beta Buy and hold an individual smart beta product Factors are highly cyclical thus require long investment horizon Long investment horizon required vs. performance measurement period which is typically 3-5 years Employ factor timing techniques Very challenging - factor performance affected by a variety of unpredictable factors Create solutions Factors perform differently at different times Combining them results in more consistent and stable performance Blends well with market cap beta and active funds

35 Risk Management /Complementing a Portfolio Example: Hedging of Risk in a Portfolio (last 3 years data) Low Volatility Value Growth Size Momentum Source: Morningstar, Factset and STANLIB Quants Research

36 Risk Management /Complementing a Portfolio Example: Hedging of Risk in a Portfolio (last 3 years data) Low Volatility Value Growth Size Momentum Active fund Source: Morningstar, Factset and STANLIB Quants Research

37 Risk Management /Complementing a Portfolio Example: Hedging of Risk in a Portfolio (last 3 years data) Low Volatility Value Growth Size Momentum SWIX Active fund Source: Morningstar, Factset and STANLIB Quants Research

38 Risk Management /Complementing a Portfolio Example: Hedging of Risk in a Portfolio (last 3 years data) Low Volatility Value Overweight Value Growth Underweight Growth Size Momentum Underweight Momentum SWIX Active fund Source: Morningstar, Factset and STANLIB Quants Research

39 Risk Management /Complementing a Portfolio Example: Hedging of Risk in a Portfolio (last 3 years data) Low Volatility Value Growth 3 year stats Active Fund Active Fund + 25% Momentum Annualised return 7.33% 10.41% Volatility 12.05% 11.04% Sharpe ratio Size Momentum SWIX Active fund Source: Morningstar, Factset and STANLIB Quants Research

40 Example of Client Solution 1. Client Need To identify the dominant risk factor in their portfolio (actively managed) and diversify away from it without changing current managers. 2. Resultant Factor Weights 3. Resultant Portfolio Predictive Ability Price Momentum, 20% Sentiment, 40% Growth and Quality, 40% Forecasting ability Hit rate Quintile spread (Q1 - Q5) Min required % 0.50% 4 Factor MFM % 1.18% 3 Factor MFM % 1.30% Source: STANLIB Quants Research Source: Factset

41 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Example of Client Solution Value Managers vs SWIX 15% 1 Year Relative Return 10% 5% 0% -5% -10% -15% Avg Value Manager -SWIX Source: Morningstar

42 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Example of Client Solution 3 Factor model (Backtest) vs SWIX 25% 20% 15% 10% 5% 0% -5% -10% -15% 1 Year Relative Return 3 Factor Model - SWIX Avg Value Manager -SWIX Source: Morningstar and STANLIB Quants Research

43 In Conclusion WHY SMART BETA Seeks to improve returns, reduce risk and enhance diversification INGREDIENTS FOR SMART BETA Performance and persistency Diversification HOW TO USE SMART BETA Single factor strategies Multifactor strategies PRACTICAL EXAMPLES Blending with active funds Hedging out unwanted risk

44 Contact Details Liberty Corporate Mark Davids Head of Pre-retirement Investments Tel: (011) Cell: Libridge Building, 25 Ameshoff Street, Braamfontein STANLIB Len Jordaan Head of Distribution for STANLIB Index Trackers Tel: (011) Cell: Melrose Boulevard Melrose Arch 2196

45 Thank you

Evolving Equity Investing: Delivering Long-Term Returns in Short-Tempered Markets

March 2012 Evolving Equity Investing: Delivering Long-Term Returns in Short-Tempered Markets Kent Hargis Portfolio Manager Low Volatility Equities Director of Quantitative Research Equities This information