Smart Beta: Why the popularity and what s under the bonnet?

Transcription

1 APPLIED FINANCE CENTRE Faculty of Business and Economics Smart Beta: Why the popularity and what s under the bonnet? SLAVA PLATKOV PORTFOLIO MANAGER, DIMENSIONAL FUND ADVISORS Sydney CBD, 27 February 2018 Note to user: Replace this image with your own. Right click on this Placeholder box Replace image Select image and click Resize image to fit in placeholder ) 1

2 Agenda What is Smart Beta? Why the popularity? What s under the bonnet? Summary

3 What is Smart Beta? Low cost alpha offer the benefits of passive strategies combined with some of the advantages of active ones, placing it at the intersection of efficient-market hypothesis and classic value investing Versions of indexing use other factors to weight stocks in the portfolio. Such factors are often fundamental in nature, such as sales and dividends, but can also be market-based, such as volatility. seek to exploit these market inefficiencies by anchoring on factors other than price (S&P Dow Jones) can you pay the low fees of a passive index fund but enjoy higher returns than the typical index fund? (WSJ) exploit these market inefficiencies by anchoring on factors other than price (RAFI) an attempt to avoid concentration in mega-caps led to the next innovation in index investing: smart beta

4 What is Smart Beta?

5 What is Beta? PASSIVE Market cap based PRICE COST EFFECTIVE TRANSPARENT DIVERSIFIED

6 The power of staying invested INVESTORS GET COMPENSATED FOR TAKING ON RISK Growth of $1 (AUD) $30 Bloomberg AusBond Bank Bill Index Citi WGBI ex Australia (hedged to AUD) MSCI World ex Australia Index S&P/ASX 300 Index $22 $20 $10 Feb-85 Aug-85 Feb-86 Aug-86 Feb-87 Aug-87 Feb-88 Aug-88 Feb-89 Aug-89 Feb-90 Aug-90 Feb-91 Aug-91 Feb-92 Aug-92 Feb-93 Aug-93 Feb-94 Aug-94 Feb-95 Aug-95 Feb-96 Aug-96 Feb-97 Aug-97 Feb-98 Aug-98 Feb-99 Aug-99 Feb-00 Aug-00 Feb-01 Aug-01 Feb-02 Aug-02 Feb-03 Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13 Aug-13 Feb-14 Aug-14 Feb-15 Aug-15 Feb-16 Aug-16 Feb-17 Aug-17 6

7 Pioneering Index Investing VANGUARD, THE 2 ND LARGEST MANAGER GLOBALLY Vanguard assets under management $3.5 T 3.0 T $3.4 trillion 2.5 T 2.0 T 1.5 T 1.0 T 500 B DEC 75 DEC 85 DEC 95 DEC 05 DEC 15 7

8 Smart Beta is Active ACTIVE Portfolio Weight Market Weight Selection Weighting Stock/Bond Pickers Quant/Black Box Factor-based Systematic Tracking an Index Factor-based Systematic NOT Tracking an Index

9 What is Smart Beta? Smart beta strategies are designed to add value by systematically weighting, and rebalancing portfolio holdings on the basis of factors or characteristics other than market capitalisation

10 Smart Beta Products FUNDS track indices not based on market cap SMART BETA ETFs track indices not based on market cap FUNDS weights systematically different to market cap

11 Percentage of Assets in Strategies VALUE, GROWTH AND DIVIDEND MOST POPULAR Multi-Factor, 7 Growth, 23 Low Vol, 6 Equal Weighted, 6 Fundamental, 3 Dividend, 24 Fixed, 2 Momentum, 2 Commodity, 1 Value, 24 Quality, 1 Other, 2 Source: Morningstar Direct, US Strategic Beta ETPs Data as of 6/30/

12 Largest Smart Beta Managers Source: Morningstar Direct, Morningstar Research. Data as of 6/30/16. 12

13 Why the popularity?

14 Growth in Smart Beta Funds (USD billions) TOTAL NET ASSETS IN SMART BETA FUNDS ( ) USD $b Source: Morningstar. Smart beta funds are all US equity funds and ETFs classified as Strategic Beta by Morningstar.

15 Why the popularity? Traditional active management has failed to deliver Competitive Markets High Fees Suboptimal Implementation

16 Competition Makes it Difficult to Outguess the Market MARKETS INTEGRATE THE COMBINED KNOWLEDGE OF ALL PARTICIPANTS 82.7 million Average Number of World Equity Daily Trades $478.4 Billion Average Dollar Volume of World Equity Daily Trades Source: World Federation of Exchanges. Global electronic order book figures gathered from the 60 WFE member exchanges.

17 Many Paths to Price Discovery 105 Million Shares Average Daily Trade Volume of SPY 1.1 Million Options Average number of put and call contracts traded daily 1,131 IPOs 3,509 Offerings Seasoned Equity Offerings $179.9 Billion Futures Average value of equity futures traded daily 3,544 Buybacks Share Repurchase Programs The supply and demand of securities is determined in many markets and by many participants. Options, SPY trade volume, futures, and corporate action data are from Bloomberg L.P. Option contract volume is the sum of the 2016 daily average put and call volume of options on the S&P 500, Russell 2000, MSCI EAFE Index, and MSCI EM Index. Equity futures volume is equal to total 2016 futures volume traded divided by 252, where annual volume traded is estimated as the sum of monthly volume times month end contract value for S&P 500 Mini futures, Russell 2000 Mini futures, MSCI EAFE Mini futures, and MSCI EM Mini futures. IPO, seasoned equity offering, and share repurchase data are based on Bloomberg corporate actions data and include countries which are eligible for Dimensional investment. This is for illustrative purposes only. Not representative of holdings of any Dimensional Strategy or Portfolio.

18 Few Equity Mutual Funds Have Survived and Outperformed AS OF 31 DECEMBER Years 2,863 funds at beginning 10 Years 2,944 funds at beginning 15 Years 2,587 funds at beginning 79% Survive 29% Outperform 58% Survive 21% Outperform 48% Survive 17% Outperform Analysis performed by Dimensional Fund Advisors. The sample includes funds at the beginning of the five-, 10-, and 15-year periods ending 31 December The number of funds as of the beginning of each sample time period is indicated next to the period label. Survivors are funds that had returns for every month in the sample period. Winners are funds that survived and outperformed their respective Morningstar category benchmark over the period. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Past performance is no guarantee of future results. See Data Appendix for more information.

19 Few Fixed Interest Mutual Funds Have Survived and Outperformed AS OF 31 DECEMBER Years 952 funds at beginning 10 Years 1,022 funds at beginning 15 Years 958 funds at beginning 85% Survive 50% Outperform 66% Survive 26% Outperform 57% Survive 18% Outperform Analysis performed by Dimensional Fund Advisors. The sample includes funds at the beginning of the five-, 10-, and 15-year periods ending 31 December The number of funds as of the beginning of each sample time period is indicated next to the period label. Survivors are funds that had returns for every month in the sample period. Winners are funds that survived and outperformed their respective Morningstar category benchmark over the period. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Past performance is no guarantee of future results. See data appendix for more information.

20 Other Benefits of Smart Beta Transparency (ETFs in particular) Simple & liquid way to gain exposure to well-known premiums (avoid dumb beta) Diversification Liquidity Easy to Research

21 Smart Beta ETFs

22 What s under the bonnet?

23 Explained by Traditional Factors? VALUATION EQUATION Price = Book Equity + (Expected) Future Profits Discount Rate The price market participants are willing to pay depends on What a company owns minus what it owes Plus, the company s ability to produce cash flows in the future Discounted to the present value at the required rate of return. Be sensible and supported by financial economics 23

24 Traditional Factors SIZE, VALUE AND PROFITABILITY AUSTRALIA STOCKS US STOCKS DEVELOPED EX US MARKETS STOCKS EMERGING MARKETS STOCKS SMALL* LARGE SMALL* LARGE SMALL* LARGE SMALL* LARGE Profitability Relative Price Size Dimensional Australia Small Cap Index LOW Fama/French Australia Value Index HIGH Dimensional Australia High Profitability Index MSCI Australia Index (gross div.) HIGH Fama/French Australia Growth Index LOW 6.88 Dimensional Australia Low Profitability Index Dimensional US Small Cap Index LOW Fama/French US Value Index HIGH Dimensional US High Profitability Index S&P 500 Index HIGH 9.54 Fama/French US Growth Index 8.35 LOW Dimensional US Low Profitability Index LOW Dimensional Intl. Small Cap Index Fama/French International Value Index HIGH 6.95 Dimensional International High Profitability Index MSCI World ex USA Index (gross div.) HIGH Fama/French International Growth Index LOW Dimensional International Low Profitability Index Dimensional Emerging Markets Small Cap Index LOW Fama/French Emerging Markets Value Index HIGH 9.35 Dimensional Emerging Markets High Profitability Index MSCI Emerging Markets Index (gross div.) HIGH Fama/French Emerging Markets Growth Index LOW Dimensional Emerging Markets Low Profitability Index All figures represent annualised compound returns (%) in US dollars, with the exception of the Australian stock returns, which are in Australian dollars. Profitability is measured as operating income before depreciation and amortisation minus interest expense scaled by book. 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. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. S&P data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data copyright MSCI 2018, all rights reserved.*the calculation methodology applied from 1975 for the US Small Cap Index, 1982 for the Australia Small Cap Index, and from 1994 for the other Dimensional Small Cap Indices, was amended (in 2014) to include profitability as a factor in selecting securities for inclusion in the indices. See "Index Descriptions" in the appendix for descriptions of Dimensional and Fama/French index data. Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP. 24

25 Low Volatility PORTFOLIO WEIGHTS BASED ON VOLATILITY OR BETA 25

26 Low Volatility PORTFOLIO WEIGHTS BASED ON VOLATILITY OR BETA The volatility sorted portfolios in Exhibits 4 5 each contain 20% of market capitalization and are formed by sorting stocks on market beta. Securities are weighted by market capitalization, and portfolios are rebalanced annually. Market beta is estimated using daily returns for one year. Returns are regressed on the daily market portfolio s return with five lags, and the market beta is the sum of the current and lagged slope coefficients. 26

27 Low Volatility OTHER VARIATION OF LOW VOLATILITY Systematic Exposures of Low Volatility Portfolios (Jan 1962 Dec 2012) Inverse Volatility Low Beta Minimum Variance Cap Weighted Market-wide Value Alpha (%) 0.08% 0.08% 0.10% 0.02% -0.04% T-stat (1.85) (1.11) (1.72) (1.83) (-0.88) Market Beta Size Value R-Square

28 Fundamental Index PORTFOLIOS WEIGHTS BASED ON FUNDAMENTALS The fundamental-weighted strategy in Exhibits 1 3 consists of the largest 1,000 securities, weighted proportional to their current book equity and the five-year average dividends, book equity, sales, and cash flows. The large/large value blend in Exhibit 3 comprises 75% large value, represented by the Dimensional US Large Cap Value Index, and 25% large, represented by the Dimensional US Large Cap Equity Index. 28

29 Missing Link b/w Price and Portfolios Weight EQUAL WEIGHT SAME SIZE ALLOCATION TO EVERY SECURITY 29

30 Missing Link b/w Price and Portfolios Weight EQUAL WEIGHT SAME SIZE ALLOCATION TO EVERY SECURITY Russell 3000 Mcap- Wght Equal- Wght WA BTM WA MCap ($b) 177,846 11,080 30

31 Missing Link b/w Price and Portfolios Weight Weight ratios relative to Russell 1000 Index, as of June % 50 to % 20 to 50 80% 10 to 20 70% 5 to 10 60% 2 to 5 50% 1 to 2 40% 30% 20% 10% 0% Large Cap Equity Portfolio High Profitability Portfolio Large Cap Value Portfolio Minimum Volatility Fund X Fundamental Indexing Fund Y Equal Weighting Fund Z 0 to 1 Extreme overweights can result in excessive turnover and add unnecessary risk to a portfolio

32 Ignoring Price Can Be Costly LEHMAN BROTHERS IN 2008 Quarter Book Value Date Price Q ,395 11/30/ Q ,839 2/29/ Q ,283 5/31/ Weight = Fundamentals Fundamentals alone: Are stale (even as of the reporting date) Do not reflect current news events (market perceived risks are not incorporated) Q ,283 8/31/ Q ,283 11/30/ Prices contain information on market expectations 32

33 Index Reconstitution EQUAL-WEIGHTED ADDITIONS RELATIVE TO S&P 500 INDEX (JAN 2000 DEC 2016) Trading Volume Performance 35,000,000 10% Multiples of 30,000,000 t-40 Volume 8% Shares Traded 25,000,000 20,000,000 15,000,000 10,000,000 Multiples of t-40 Volume 5,000,000 Cumulative Return 6% 4% 2% Days -20 from -10 Reconstitution 0 10 Date % Days from Reconstitution Date Days From Effective Date Days From Effective Date In US dollars. Source: Center for Research and Security Prices, University of Chicago, and Standard and Poor s. For more on index reconstitution see Chen, Noronha, and Singal (2004) [Equity] and Dick-Neilsen (2012) [Fixed Income]. Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. 33

34 Index Reconstitution STYLE DRAG (RUSSELL 2000) Assets In Small Cap Companies (Bottom 10% Of Market Cap) JUNE 2004 JUNE 2005 JUNE 2006 JUNE 2007 JUNE 2008 JUNE 2009 JUNE 2010 JUNE 2011 JUNE 2012 JUNE 2013 JUNE 2014 JUNE 2015 JUNE % 90% 85% Russell 2000 Index Annual Rebalance As of 31 December, Monthly data, Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Indices are not available for direct investment. 34

35 Summary

36 Summary Smart Beta includes strategies that systematically deviate form market cap weights to target various factors Same reasons behind growth as those behind Passive, plus perhaps.. Disappointing experience investing with traditional active managers Popularity of ETPs is further turbo-charging the growth in Smart Beta The devils is in the detail. Be mindful of Research, Design, Implementation

37 APPLIED FINANCE CENTRE Faculty of Business and Economics Thank you for attending today s talk ARE YOU INTERESTED IN OUR UPCOMING TALKS? Visit mafc.mq.edu.au to register for upcoming talks and subscribe to the mailing list