GREAT LAKES ADVISORS THE CASE FOR INTERNATIONAL SMALL CAP

Transcription

1 GREAT LAKES ADVISORS THE CASE FOR INTERNATIONAL SMALL CAP PRESENTED BY: Jon Quigley Chief Investment Officer, Portfolio Manager NCPERS 2018 Annual Conference & Exhibition May New York, NY 1

2 THE EMERGENCE OF INTERNATIONAL SMALL CAP 2

3 WHERE EAFE GOT IT WRONG National Conference on Public Employee Retirement Systems 3

4 MAYBE MSCI STILL HAS IT WRONG? National Conference on Public Employee Retirement Systems Source: Russell Investments

5 AN INTERNATIONAL SMALLER-CAP PROXY 5

6 INVESTOR CONCERNS HAVE SLOWED UPTAKE Some investors are aware of the potential benefits of smaller cap investing, but have a mix of concerns which have delayed investment. Country and currency risk is one are area of concern. Both country and currency specific risk can be greatly reduced via diversification. 6

7 COUNTRY RISK Source: FTSE Russell, DE Research. As of 6/30/17. 7

8 CURRENCY RISK Source: FTSE Russell, DE Research. As of 6/30/17. 8

9 LIQUIDITY 9

10 TRANSACTION COSTS 10

11 FEE PREMIUM Source: Evestment Alliance database as of 6/30/17. 11

12 VOLATILITY Source: FTSE Russell, DE Research 12

13 WHY ALLOCATE TO INTERNATIONAL SMALL CAP? Return Opportunity Small Cap Premium Increased Diversification Low Percentage Free Float Dominates an Emerging Markets Allocation from a return, risk, and risk adjusted return standpoint 13

14 SMALL CAP PREMIUM Higher asset class volatility/higher systematic risk Liquidity Premium Information Uncertainty Financial Distress/Default Risk Behavioral Biases 14

15 EXCESS RETURNS Source: FTSE Russell, DE Research 15

16 DIFFERING RETURN PATTERN National Conference on Public Employee Retirement Systems Source: FTSE Russell, DE Research as of 6/30/17. 16

17 ENHANCED DIVERSIFICATION National Conference on Public Employee Retirement Systems Source: FTSE Russell, DE Research 17

18 LOWER PERCENTAGE FREE FLOAT National Conference on Public Employee Retirement Systems Closely held and family run businesses are often more conservative These types of businesses also typically pay a higher dividend to shareholders 18

19 DOMINATES EMERGING MARKETS PERFORMANCE National Conference on Public Employee Retirement Systems Source: FTSE Russell, DE Research 19

20 WHY ACTIVE? As of 6/30/2017. Source : Evestment Alliance 20

21 BREADTH OF OPPORTUNITY The international arena provides substantial breadth of opportunity for investment teams. The Russell Global ex US Small cap Index has about 4,700 constituents much higher than either the Russell Global ex US Large cap Index (2,300) or the small cap Russell 2000 index. The Russell Global ex US Mid cap Index has about 1,800 constituents, and the Russell Global ex US Smid cap Index contains about 2,700 stocks. 21

22 GREATER DISPERSION Source: FTSE Russell, DE Research 22

23 LOWER ANALYST COVERAGE National Conference on Public Employee Retirement Systems Source: FTSE Russell, DE Research 23

24 LOWER BENCHMARK CONCENTRATION National Conference on Public Employee Retirement Systems Source: FTSE Russell, DE Research. As of 6/30/17. 24

25 A DURABLE ADVANTAGE Less Liquid Universe > Lower Capacity $1B Capacity > Low Revenue Opportunity Wide Geographic Footprint + Increased Data Needs > Higher expenses 25

26 HOW MUCH SHOULD WE ALLOCATE? National Conference on Public Employee Retirement Systems We suggest plan sponsors and individual investors should have at least proportional, market weight representation to international small cap equities. In 2000, the evestment Alliance database showed only 2% of the combined international large and small cap assets under management were small cap. As of 2017, 15%+ of international AUM is allocated to smaller cap strategies. 26

27 MARKET REPRESENTATION Source: evestment Alliance, DE Research 27

28 RISK BUDGETING From a plan sponsor s risk management perspective, under allocating can expend a significant proportion of the overall risk budget as much as 75% of the total risk budget: The exclusion of small caps from the equity portfolio represents between one half to three quarters of the active risk budget (Bender, Briand, Fachinotti, & Ramachandran, 2012). Equally important are the implications of excluding small caps for the risk budget. Risk budgeting is very often expressed in terms of a maximum tracking error relative to the fund s benchmark. The tracking error of the equity portfolio with small caps relative to the one without small caps reflects the relative risk that an investor incurs by not investing in small caps. The tracking error of MSCI ACWI IMI relative to MSCI ACWI has been 75 bps annually over the last decade, a relatively large amount when one considers the size of an average investor s risk budget. Large institutional investors, for example, typically take on % tracking error for their entire equity portfolio. 28

29 CONCLUSION International smaller cap is an under exploited opportunity The Risks of the asset class appear overstated The Benefits of the asset class are: Enhanced Diversification Historical Return Premium Stronger Risk adjusted Returns Strong Results by Active Managers Lack of competition due to Capacity Restraints 29

30 BIOGRAPHY Jon E. Quigley, CFA Chief Investment Officer Disciplined Equities Jon E. Quigley is the Chief Investment Officer of Disciplined Equities for Great Lakes Advisors. He leads the management of all Disciplined Equity portfolios, provides oversight of the Disciplined Equity Team, leads efforts in enhancing existing portfolio management systems and is a member of the firm s Investment Committee. Jon has worked in the investment industry since Prior to joining the firm in 2000, Jon was a Portfolio Manager with LBS Capital Management where he was responsible for the global tactical asset allocation and tactical sector selection strategies. ABOUT GREAT LAKES ADVISORS Founded in 1981, Great Lakes Advisors is headquartered in Chicago, Illinois with an additional office in Tampa, Florida. The firm has $9 billion in assets under management and advisement and offers a wide range of fixed income and equity strategies across all market capitalizations. We have deep portfolio management capabilities within ESG, Socially Responsible, Tax Managed, and Customized account solutions. Our clients include public funds, multi employer plans, corporations, religious communities, endowments/foundations, health care plans, and private wealth management clients. Jon earned a BA in Economics from Wake Forest University and an MS in Predictive Analytics from Northwestern University. He has obtained the Chartered Financial Analyst designation, and is a member of the Society of Quantitative Analysts, the CFA Institute, the CFA Tampa Bay Society and the Chicago Quantitative Alliance. Jon is a graduate of Leadership St. Petersburg, and has served as Treasurer for the Board of Creative Clay as well as having served on the Boards of the Salvador Dali Museum s Zodiac Group, and the Museum of Fine Arts Contemporaries Group. 30

31 DISCLOSURES Sources: The IMI methodology includes a set of more complex requirements, detailed in MSCI s GIMI Methodology document. AMG Funds. (2017, March). The Case for International Small Cap. Perspective. Amihud, Y. (2002). Illiquidity and stock returns: cross section and time series effects. Journal of Financial Markets, 5(1), Aon Hewitt. (2017, March). Think Big by Going Small Putting the Spotlight n Global Small Caps. Axtell, J. (2014, April). The case for global small and mid cap investing. Deutsche Asset & Wealth Management. Bender, J., Briand, R., Fachinotti, G., & Ramachandran, S. (2012, March). Small Caps No Small Oversight. MSCI Research Insight. Chan, L., & Chen, N. (1991). Structural and Return Characteristics of Small and Large Firms. Journal of Finance, 46, Dichev, I. (1991). Is the Risk of Bankruptcy a Systematic Risk? Journal of Finance, 53, Fama, E., & French, K. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), Feldman, R., Horn, N., & Steward, C. (2013, August). International Total Market Investing Does Your Plan Have a Global Small Cap Gap. Retrieved from Pyramis Global Advisors: management/does your plan have a global small cap gap.pdf Johnson, G., & Ericson, S. (2017). Q & A With the Portfolio Manager. Endeavor Investment Partners. LLC. Lakonishok, J., Shleifer, A., & Vishny, R. (1994). Contrarian Investment, Extrapolation, and Risk. Journal of Finance, 49(5), Liu, W. (2006). A liquidity augmented capital asset pricing model. Journal of Financial Economics, 82(3), Lord Abbett. (2017, July 17). International Equities: Why Small Caps Are Making Waves. Market view. MSCI. (2017, June). MSCI Global Investable Market Indexes Methodology. Index Methodology. MSCI Barra. (2007, March 28). MSCI Barra Announces MSCI Global Investable Market Indices Methodology... Geneva, SUI. Nielsen, F. (2007, October). International Small Cap A Distinct Asset Class. Research Insights. MSCI Barra. Russell Investments. (2013, June). Russell Global Indexes Construction and Methodology. Russell Indexes. Soe, A. M., & Dash, S. (2009, August). It s a Small World: Manager Dynamics in International Small Caps. Standard & Poor s. Tessin, C., Jensen, D., & Stoner, B. (2011, October). Why Are Institutional Investors Missing the International Small Cap Opportunity? Seattle, WA. Vassalou, M., & Xing, Y. (2004). Default Risk in Equity Returns. Journal of Finance, 59, Zhang, X. (2006). Information uncertainty and stock returns. Journal of Finance, 61(1), Great Lakes Advisors, LLC ( Great Lakes or GLA ) is an investment advisor registered with the Securities and Exchange Commission under the Investment Advisors Act of Established in 1981, Great Lakes is a subsidiary of Wintrust Financial Corporation and a part of the Wintrust Wealth Management family of companies. On October 1, 2013, majority owned subsidiary Advanced Investment Partners, LLC ( AIP ) became fully owned and integrated into Great Lakes. Great Lakes is a distinct business unit with distinct investment processes and procedures relating to the management and/or trading of investment portfolios for its clients. Great Lakes Advisors, LLC claims compliance with the Global Investment Performance Standards (GIPS ). A complete list of firm composites and performance results, and the policies for valuing portfolios, calculating performance, and preparing GIPS compliant presentations are available upon request by calling The GLA Form ADV Part 2A advisory disclosure document which includes a description of services, fees and expenses is also available upon request. The views expressed are the views of Great Lakes Advisors through the period ended June 30, 2017 and are subject to change based on market and other conditions. Manager commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice. To determine if this strategy is appropriate for you, carefully consider the investment objectives, risk factors, and expenses before investing. The holdings, industry sectors, and asset allocation are presented to illustrate examples of the securities bought and the diversity of areas in which we may invest, and may not be representative of current or future investments. Portfolio holdings subject to change and should not be considered investment advice. All holdings available upon request. Past performance is not indicative of future results. All indices are unmanaged and performance of the indices includes reinvestment of dividends and interest income, unless otherwise noted. The indices are not illustrative of any particular investment and it is not possible to invest directly in an index. 31