MAX FACTOR SMART BETA INVESTING IN DC Factor investing, or Smart Beta, is providing a new frontier for DC schemes to address a range of investing needs. Improved diversification and better risk-adjusted returns, together with the cost-efficiency and transparency characteristics of index investing, are key attractions. BY SOPHIE BALLARD, SENIOR DC RELATIONSHIP MANAGER Rather than simply weighting stocks by their market cap, as is done in index investing, Smart Beta is changing the investing landscape. And DC investors are catching on. Compared to market cap-weighted benchmarks, these factor-based strategies give schemes the opportunity to target higher returns over time, lower risk, or a combination of both, using cost-efficient implementation approaches. Targeting factors in this way allows schemes to seek the underlying drivers of investment return that were once the sole preserve of active managers. Smart Beta effectively combines some of the benefits of both active and index management. Predictable exposures and straightforward implementation can also help to reduce the governance burdens on DC scheme management. 12 Contribute Autumn 2017 State Street Global Advisors
Integrating Smart Beta into DC Schemes There are a number of ways Smart Beta can be used in DC. Strategic implementations can introduce factors either alone or in combination. Looking at past performance, some factors are more pro-cyclical, i.e. they tend to do better in stronger, positive markets (Value, Small Cap), while others are more defensive (Low Volatility, High uality). Smart Beta is often a complement to traditional index strategies so an analysis of the wider portfolio can help to align the portfolio to the scheme s goals, existing holdings and constraints. CHOOSING FACTORS Smart Beta strategies target a range of factors including: VALUE Value stocks trade at a lower price than their fundamentals (earnings, sales etc.) would imply. Inexpensive stocks have been shown to out-perform more expensive stock over time. Regardless of the intended objective, it s crucial to remember that the best risk-adjusted returns are achieved from long-term exposures and that patience is necessary to get the best from factor investing. Target Improved Risk-adjusted Returns We know from our research that DC members generally value a smoother investment journey. When Smart Beta strategies that target uality or Low Volatility factors are introduced, they can help to lower overall volatility and limit the impact of market falls, at relatively low cost. Multi-factor funds that combine a number of Smart Beta factors can help the scheme to diversify even further and take advantage of low or negative correlations between factors. Combining the uality and Low Volatility factors, for example, can build a defensive allocation that complements value-based strategies. Such an approach might be adopted if the portfolio already has exposure to Value or if a more conservative investment approach is preferred. Combining factors in this way can help dampen the cyclical effects of Smart Beta and offer schemes a potentially smoother risk/return profile compared to single-factor exposures. SMALL CAP LOW VOLATILITY UALITY Smaller-cap companies have tended to outperform larger-cap companies over the long term. Tilting towards lower risk stocks can generate improved risk-adjusted returns. Many Low Volatility indices attain a 20 30% reduction in volatility, compared to their cap-weighted indices. Investing in higher-quality companies (high profitability, earnings stability, low leverage etc.) has been shown to deliver greater downside protection. In falling markets their stock price tends to be less impacted than the overall market. Refining the Glide Path Glide Path Asset Allocation Target Date Funds have the ability to continually evolve and utilise new investment ideas, such as Smart Beta. The growth phase of their glide path can, for example, invest in Value and Small Cap factors, then transition to uality and Low Volatility strategies as the fund matures and looks to derisk. 0% DGF Multi-factor Bonds A larger allocation is made to Value or Small Cap factors early in the investment glide path in order to target improved risk-adjusted returns. 50% As retirement nears and members ability to sustain losses reduces Low Volatility or uality factors are progressively introduced to narrow the volatility profile further. This approach helps optimise allocations throughout the lifetime of the scheme more return-seeking assets earlier in the glide path, less volatility towards retirement. 100% Passive equity 40 35 30 25 20 15 10 5 0 Years to retirement Source: SSGA 2017. For illustrative purposes only. ssga.com/ukdc 13
SMART BETA IN THE INVESTMENT TOOLKIT CASE STUDY 1 DC schemes describe their decision to implement Smart Beta as part of their investment strategy. CONSUMER GOODS 50M 2,500 MEMBERS Scheme size Is type of factors are you targeting with Smart Beta strategies? We are targeting Value, Size, uality and Low Volatility. this replacing or complementing a market cap approach? It is replacing our market cap allocation. attributes of the approach make it attractive for your plan/strategy? Access to fundamentally desirable characteristics such as Value Higher expected risk-adjusted returns compared with market cap passive investing Avoiding biases associated with market cap investing such as placing higher weight to the most expensive companies Adding value through sensible annual rebalancing Similar charges to passive market cap investing In essence, the strategy is passively managed with a set of rules regarding stock weightings. It targets particular stock characteristics like low valuation companies, which outperform over the longer term which is relatively intuitive for members. Communications are similar to those for passive investing the fund is a passive fund, which means that the shares are chosen in such a way as to track a broad index of shares in a mechanistic manner rather than relying on a particular investment manager to individually choose shares. do you see as the potential benefits for members over the long term? Higher net risk-adjusted returns in the growth phase that will contribute to better member outcomes at retirement. Smart Beta Essentials 1 = not important, 4 = essential How are you communicating with members about Smart Beta? We recommended the Global Multi-Factor Strategy within a blended fund, combining an allocation to an Emerging Markets Index Fund. Governance Cost Factor targeting Return potential Diversification 14 Contribute Autumn 2017 State Street Global Advisors
CASE STUDY 2 ENGINEERING > 1BN 30,000 MEMBERS Scheme size Is How type of factors are you targeting with Smart Beta strategies? Fundamental indexation and Low Volatility. this replacing or complementing a market cap approach? As a complement to existing market cap index strategies within our default investment option. attributes of the approach make it attractive for your plan/strategy? It introduces an element of diversification away from a pure market cap equity strategy. It s expected to modestly improve the risk/return profile for a member over the long run, without compromising on overall returns. The lower fees and governance requirements (relative to an active equity strategy) also appeal as a DC investor. are you communicating with members about Smart Beta? The Smart Beta funds are wrapped within a white-labelled fund. Members will see they hold units in a single fund which has an objective to deliver long-term growth that is similar to equities but with less variability in returns. do you see as the potential benefits for members over the long term? From an investment perspective, Smart Beta provides diversification from traditional equity exposure with improved long-term risk/return. Plus, it offers reduced fees for members and lower governance needs for trustees. Smart Beta Essentials 1 = not important, 4 = essential Governance Return potential Factor targeting Diversification Cost NEXT STEPS To learn more about the potential of Smart Beta for your scheme, visit the Smart Beta section of our website. ssga.com/ukdc 15
CONTRIBUTE For subscriptions, email us at ukdc@ssga.com or visit ssga.com/ukdc Marketing Communication Belgium: State Street Global Advisors Belgium, Chaussée de La Hulpe 120, 1000 Brussels, Belgium. T: +32 (0) 2 663 2036. SSGA Belgium is a branch office of State Street Global Advisors Limited. State Street Global Advisors Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Dubai: State Street Bank and Trust Company (Representative Office), Boulevard Plaza 1, 17th Floor, Office 1703 Near Dubai Mall & Burj Khalifa, P.O Box 26838, Dubai, United Arab Emirates. T: +971 (0) 4 437 2800. France: State Street Global Advisors France, Immeuble Défense Plaza, 23-25 rue Delarivière-Lefoullon, 92064 Paris La Défense Cedex, France. T: +33 (0) 1 44 45 40 00. Authorised and regulated by the Autorité des Marchés Financiers. Registered with the Register of Commerce and Companies of Nanterre under the number 412 052 680. Germany: State Street Global Advisors GmbH, Brienner Strasse 59, D-80333 Munich, Germany. T: +49 (0) 89 558 78 400. Authorised and regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht ( BaFin ). Registered with the Register of Commerce Munich HRB 121381. Ireland: State Street Global Advisors Ireland Limited, Two Park Place, Upper Hatch Street, Dublin 2. T: +353 (0) 1 776 3000. Incorporated and registered in Ireland. Registered Number: 145221. Regulated by the Central Bank of Ireland. Member of the Irish Association of Investment Managers. Italy: State Street Global Advisors Limited, Milan Branch (Sede Secondaria di Milano), Via dei Bossi, 4-20121 Milano, Italy. T: +39 02 3206 6100. State Street Global Advisors Limited, Milan Branch (Sede Secondaria di Milano) is registered in Italy with company number 06353340968 - R.E.A. 1887090 and VAT number 06353340968. State Street Global Advisors Limited, Milan Branch (Sede Secondaria di Milano) is a branch office of State Street Global Advisors Limited. Street Global Advisors Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Netherlands: State Street Global Advisors Netherlands, Apollo Building, 7th floor, Herikerbergweg 29, 1101 CN Amsterdam, Netherlands. T: +31 (0) 20 718 17 01. SSGA Netherlands is a branch office of State Street Global Advisors Limited. State Street Global Advisors Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Switzerland: State Street Global Advisors AG, Beethovenstr. 19, CH-8027 Zurich. T: +41 (0) 44 245 7000. Authorised and regulated by the Eidgenössische Finanzmarktaufsicht ( FINMA ). Registered with the Register of Commerce Zurich CHE-105.078.458. United Kingdom: State Street Global Advisors Limited, 20 Churchill Place, Canary Wharf, London, E14 5HJ. T: +44 (0) 20 3395 6000. Authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 2509928. VAT No. 5776591 81. Branch office websites: www.ssga.com This communication is directed at professional clients (this includes eligible counterparties as defined by the Financial Conduct Authority (FCA)) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication. This document contains certain statements that may be deemed forwardlooking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Risks associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions. Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Target Date Funds are designed for investors expecting to retire around the year indicated in each fund s name. When choosing a fund, investors should consider whether they anticipate retiring significantly earlier or later than age 65 even if such investors retire on or near a fund s approximate target date. There may be other considerations relevant to fund selection and investors should select the fund that best meets their individual circumstances and investment goals. The funds asset allocation strategy becomes increasingly conservative as it approaches the target date and beyond. The investment risks of each fund change over time as its asset allocation changes. The information provided does not constitute investment advice as such term is defined under the Markets in Financial Instruments Directive (2004/39/EC) and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor s or potential investor s particular investment objectives, strategies, tax status, risk appetite or investment horizon. If you require investment advice you should consult your tax and financial or other professional 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. 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. Investing involves risk including the risk of loss of principal. Past performance is not a guarantee of future results. Diversification does not ensure a profit or guarantee against loss. A Smart Beta strategy does not seek to replicate the performance of a specified cap-weighted index and as such may underperform such an index. The factors to which a Smart Beta strategy seeks to deliver exposure may themselves undergo cyclical performance. As such, a Smart Beta strategy may underperform the market or other Smart Beta strategies exposed to similar or other targeted factors. In fact, we believe that factor premia accrue over the long term (5-10 years), and investors must keep that long time horizon in mind when investing. Low volatility funds can exhibit relative low volatility and excess returns compared to the Index over the long term; both portfolio investments and returns may differ from those of the Index. The fund may not experience lower volatility or provide returns in excess of the Index and may provide lower returns in periods of a rapidly rising market. Active stock selection may lead to added risk in exchange for the potential outperformance relative to the Index. Asset Allocation is a method of diversification which positions assets among major investment categories. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss. The information contained in this communication is not a research recommendation or investment research and is classified as a Marketing Communication in accordance with the European Communities (Markets in Financial Instruments) Regulations 2007. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research. 2017 State Street Corporation All rights reserved. DC-4203 Exp. Date: 30/09/2018