TAKE CONTROL OF YOUR INVESTMENT DESTINY Increasing control over your investments.
Challenge for Investors Case for Factor-based Investing What Next? The Real World
Economic and Market Outlooks are Constrained Economic Growth Forecasts Volatility Risk is to the Downside 2015 2016 Developed Global 3.1% 3.3% US 2.5% 2.5% Eurozone 1.5% 1.7% Japan 0.8% 1.2% Emerging Markets 4.2% 4.1% Low economic growth will impact profitability, and therefore equity returns Weakness in global trade and strong US dollar will weigh on EM equities Ripple effect of decelerating growth in China Continued weakness in commodity prices Geopolitical risks SSGA forecasts, as of 31 December 2015. The above estimates are based on certain assumptions and analysis made by SSGA. There is no guarantee that the estimates will be achieved. 3
Creating a Mismatch Between Expected and Required Returns Equity Return Forecasts are Low State Retirement Systems Target 1 Year 10 Year Developed Global 2.1% 6.1% US LC 1.4% 6.0% Europe 2.6% 6.1% UK 0.4% 6.4% Japan 5.9% 6.4% Emerging Markets 1.2% 6.9% SSGA forecasts, as of 31 December 2015. The above estimates are based on certain assumptions and analysis made by SSGA. There is no guarantee that the estimates will be achieved. % Source: NASRA, Public Pension Plan Investment Return Assumptions, September 2015. 4
Investors are Looking for Ways to Close the Gap SEEKING HIGHER RETURN OPTIONS More active management Illiquid assets Tactical overlays MANAGING RISK Minimize drawdowns Liability matching Manage risk budget EVALUATING COSTS Align costs with value Manage implementation Consider soft costs Factor-based investing strategies can help meet each of these aims. 5
Challenge for Investors Case for Factor-based Investing What Next? The Real World
Firmly Grounded in Academic Research 1980 s 1990 s 2000 s 2010 s Cap weighted e.g. S&P 500 Style aware e.g. Value, Growth, Small Alternative weighting e.g. Fundamental Factor targeted e.g. Smart Beta Black, Jensen and Scholes, The Capital Asset Pricing Model: Some Empirical Tests (1972) Rosenberg, Reid & Lanstein Persuasive Evidence of Market Inefficience (1985) Fama & French, Common risk factors in the returns on stocks and bonds (1992) Arnott, Hsu & Moore, Fundamental Indexation (2005) Ang, Goetzmann & Schaefer Evaluation of Active Management (2009) Baker, Bradley & Wurgler Benchmarks as Limits to Arbitrage: Understanding the Low Volatility Anomaly (2011) 7
What Are Factors? Factors are the underlying drivers of the risks and return of an asset class. They re the building blocks that enable investors to shape investment returns. Sample Equity factors include: Value Size Volatility Quality Momentum Premium in Low Valuation stocks. Smaller cap stocks tend to outperform. Lower volatility stocks tend to generate a higher riskadjusted return. Quality companies are rewarded with stronger share prices. Stocks which have done well recently tend to carry on doing well in the near term. 8
Factors Can Generate Positive Excess Annual Returns Value Size Volatility Quality Momentum Backtested Annualized Excess Returns Over Developed Equities Since 1993 Source: SSGA as of 31 December 2015. The above results are derived from backtested data covering the period from April 1993 to December 2015. Backtested performance is not indicative of the past or future performance of any SSGA offering. The results represent a backtest of SSGA's Factor-Tilted models, which means that those results were achieved by means of the retroactive application of the models which were developed with the benefit of hindsight. All data shown above does not represent the results of actual trading, and in fact, actual results could differ substantially, and there is the potential for loss as well as profit. The performance does not reflect management fees, transaction costs, and other fees and expenses a client would have to pay, which reduce returns. Please reference the Backtested Methodology Disclosure for a description of the methodology used as well as an important discussion of the inherent limitations of backtested results. The results show annualized excess returns over the MSCI Developed Equities Index since April 1, 1993. February 2016. 9
Factors are Present Across Asset Classes, Not Just Equity EQUITY Value Size Volatility Quality Momentum FIXED INCOME Value Size Volatility Quality Momentum Term Premium CURRENCY Value Trend Carry 10
Challenge for Investors Case for Factor-based Investing What Next? The Real World
How Can investors Use Factors Effectively? Value? Size? Momentum? Quality? 12
You re Already a Factor investor, but You Can Increase Your Control Factor exposures are a significant component of active management returns. On average, 50% of active management excess returns can be accounted for by exposure to factors. PORTFOLIO RETURN = Cap Weighted Index Return + Factor Returns + Manager Skill Passive Return Active Return Source: Bender, Hammond and Mock; Journal of Portfolio Management, May 2013 13
Factors Returns Vary Under Different Environments Downturn Recession Recovery Boom Positive Economic Growth but Slowing Negative Economic Growth and Slowing Negative Economic Growth but Improving Positive Economic Growth and Improving MARKET CYCLE VALUE Mixed + + + SIZE + + VOLATILITY + + + QUALITY + + + MOMENTUM Mixed Mixed + Source: Russell, SSGA. Example for illustrative purposes only. Past performance is not a guarantee of future results. 14
Factor Valuations What Looks Good Now? Base = 0 2.0 Current Average 1.5 Attractive 1.0 Attractive 0.5 0 Expensive Expensive Attractive Attractive Attractive 0.5 1.0 Expensive Expensive 1.5 Expensive VALUE Looks expensive SIZE Looks fairly neutral VOLATILITY Not currently attractive QUALITY Looks attractive MOMENTUM Looks expensive Source: SSGA, FactSet based on estimates. As of December 31, 2015. Universe: MSCI World Index. For each factor, spreads calculated by subtracting the median Book to Price (B/P) of bottom quintile (lowest ranked stocks) from the median B/P of top quintile (highest ranked stocks). Quintiles contain equal weighted number of securities. Average Spread represents the average median B/P spread over previous 120 months. Valuation spread data is as of the date indicated, are subject to change, and should not be relied upon as current thereafter. Valuation spreads may be different when measured within different equity universes. 15
3 Approaches to Implement Your Factor Convictions APPROACH 1 APPROACH 2 APPROACH 3 Value Value Value Quality Size Volatility Momentum Quality SINGLE FACTOR Focus on individual factors MULTI-FACTOR or combine factors such as Value and Quality. ACTIVE QUANT Dive deeply into advanced factor definitions. 16
Challenge for Investors Case for Factor-based Investing What Next? The Real World
What Problems Can Factor Investing Solve? Managing Downside Volatility The Search for Yield The Need for Excess Returns Getting the Most Out of Fees Uncorrelated Returns 18
In Our Recent Global Survey of 400 Institutional Investors % reported moderate to significant improvement in meeting their long-term aims. of respondents who had implemented Smart Beta Source: SSGA, FT Remark, The Great Divide. March 2016. About this study: FT Remark, in association with State Street Global Advisors (SSGA), surveyed senior executives with asset allocation responsibilities at 400 institutional investors (with at least $200Mn AUM). The Respondents are distributed: 24% Asia, 38% Americas, 38% EMEA. The survey included a combination of qualitative and quantitative questions and all interviews were conducted by phone. The results were analyzed and collated by FT Remark and all responses are anonymized and presented in aggregate. 19
CASE 1 Improving passive exposure CASE 3 Replacing/reducing active manager allocations CLIENTS CASE 2 Taking the desired risk exposures 20
Improving Passive Exposure CASE STUDY CHALLENGE Remain passive but achieve better risk adjusted returns. SOLUTION Reduce risk and improve return with a multi factor allocation. 100% MSCI World Index (Passive Strategy) 25% MSCI Quality Mix Index (Smart Beta) 75% MSCI World Index (Passive Strategy) Return PA Sharpe Ratio Return PA Sharpe Ratio +5.51 0.20 + 6.02 0.24 RESULTS BETTER RETURNS, BETTER SHARPE RATIO Source: State Street Global Advisors. As of 31 December 2015.Represents results for a period of 5 years to 31 December 2015. The information contained above is for illustrative purposes only. Forecasted returns are based upon estimates and reflect subjective judgments and assumptions. These results were achieved by means of a mathematical formula and do not reflect the effect of unforeseen economic and market factors on decision making.the Forecasted returns are not necessarily indicative of future performance, which could differ substantially. 21
Taking the Desired Risk Exposure CASE STUDY CHALLENGE US Defined Benefit Fund needed to improve fixed income performance relative to liabilities without jeopardizing funding status. SOLUTION Optimize portfolio s credit risk premium. Assess Quality versus Value and capture mispriced credit risk. Return + BPS RESULTS FUNDING PRESERVED, BETTER RETURNS Source: State Street Global Advisors. Results illustrated represent the effect of the change on 31 August 2014. The information contained above is for illustrative purposes only. 22
Reducing Active Manager Allocations CASE STUDY CHALLENGE 50 % Passive 50 % Active Managers SOLUTION 75 % Active Beta Value Low Vol Size 25 % Active Managers Classic Core-Satellite Fundamental Characteristics Security Count 708 Active Risk 0.43 Portfolio Ending Active Share 23.63 Risk (%) Asset Specific Risk 57.33 Factor Risk 42.67 Total Fees (%) 0.28 Factorized Core Portfolio Fundamental Characteristics Security Count 737 Active Risk 1.21 Portfolio Ending Active Share 31.76 Risk (%) Asset Specific Risk 22.71 Factor Risk 77.29 Total Fees (%) 0.19 RESULTS FOCUSED EXPOSURES, REDUCED FEES Source: State Street Global Advisors. The information contained above is for illustrative purposes only. 23
WHY FACTOR INVESTING? Fee Productivity Flexibility Meet Challenges Control Cost-efficient implementation. You decide what matters. Aim for growth. Control volatility. Take control of your investment destiny. 24
Disclosures FOR INSTITUTIONAL USE ONLY. Not for Use with the Public. Value stocks can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time. The strategy employs a momentum style of investing that emphasizes investing in securities that have had higher recent price performance compared to other securities, which is subject to the risk that these securities may be more volatile and can turn quickly and cause significant variation from other types of investments. This document provides summary information regarding the Strategy. This document should be read in conjunction with the Strategy's Disclosure Document, which is available from SSGA. The Strategy Disclosure Document contains important information about the Strategy, including a description of a number of risks. Investments in small/mid sized companies may involve greater risks than in those of larger, better known companies. Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations. Risk associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions. Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations. Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries. Investing involves risk including the risk of loss of principal. Diversification does not ensure a profit or guarantee against loss. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information. Past index performance is not a guarantee of future results. Investing involves risk including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA's express written consent. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. SSGA Global Value, Volatility, Size, Quality and Momentum Tilted Performance: Returns are back tested from April 1, 1993 to December 31, 2014, unless stated otherwise. The testing methodology is a rules based process to generate historical portfolios. The data used was only the data which would have been available at the time when the historical portfolios were generated, now what is available now. These processes help to eliminate various forms of survivorship bias, both in terms of a smarter model and in terms of making decisions based on information that was not available at the time. The results shown do not represent the results of actual trading using client assets but were achieved by means of the retroactive application of an investment process that was designed with the benefit of hindsight, otherwise known as back testing. Thus, the performance results noted above should not be considered indicative of the skill of the advisor or its investment professionals. The back tested performance was compiled after the end of the period depicted and does not represent the actual investment decisions of the advisor. These results do not reflect the effect of material economic and market factors on decision making. In addition, back tested performance results do not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risks associated with actual investing. No representation is being made that any client will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently significant differences between back tested performance results subsequently achieved by following a particular strategy. The back tested performance data is reported on a gross of fees basis, but net of administrative costs. Web: www.ssga.com State Street Global Advisors, One Lincoln Street, Boston, MA 02111 2900 2016 State Street Corporation All Rights Reserved. 2016 State Street Corporation All Rights Reserved. GLSTND 2378 Exp. Date 31/03/2016