Product overview FTSE Diversified Factor Indexes Introduction The FTSE Diversified Factor Indexes are designed to evenly distribute risk across regions and industries, and provide exposure to securities exhibiting attractive factor characteristics. The index methodology seeks to address two potential drawbacks of traditional market cap-weighted indexes: concentration of risk, and inclusion of securities based solely on market valuation. Insight 1: Risk concentration Market cap-weighted indexes rank and weight companies based on their market value. Consequently, these indexes may be prone to periods of concentration arising from market fads, resulting in excessive exposure to individual companies, sectors or countries. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan-79 Sep-80 May-82 Jan-84 Sep-85 May-87 Jan-89 Sep-90 May-92 Jan-94 Sep-95 May-97 Jan-99 Sep-00 May-02 Jan-04 Sep-05 May-07 Jan-09 Sep-10 Utilities Materials & Processing Consumer Disc Historical Sector Weights: Russell 1000 Financials Services Energy Health Care The weight of the Technology sector increased from 11.5% on January 1 st 1998 to 30% at the peak of the tech bubble (March 31 st 2000). Producer Durables Consumer Staples Technology Without conclusive research suggesting region or industry risk will be rewarded, an index constructed to diversify these risks may be desirable. Key Features The FTSE Diversified Factor Indexes use a rules-based risk allocation and multi-factor selection process, co-developed with J.P. Morgan Asset Management. The indexes are designed to exhibit high liquidity and capacity with low turnover. Capping is applied to ensure stock level diversification and tradability. The indexes are reviewed quarterly. Factors Quality Good companies tend to perform better than bad ones Value Stocks that appear cheap tend to perform better than stocks that appear expensive Size Smaller companies tend to perform better than larger ones Low Volatility Stocks that exhibit low volatility tend to outperform their more volatile counterparts Momentum Stocks tend to continue to do what they re already doing (either rising or falling in price) ftserussell.com 1
Insight 2: Factor screening Market cap-weighted indexes increase weight to relatively expensive securities. Conversely, the FTSE Diversified Factor Indexes screen for stocks exhibiting attractive relative valuation, positive price momentum, low volatility, high quality and small market capitalization. The resulting indexes are less exposed to stocks with relatively high valuations, and exhibit higher exposure to those common characteristics which have historically been rewarded. Methodology overview Risk framework START MARKET CAP-WEIGHTED INDEX Split universe into regional industry risk categories Within each region, stocks are grouped based on their industry, creating regional industry categories. Determine the risk weights Each regional industry is weighted by the inverse of its volatility. This results in a more even distribution of risk. Securities which pass the selection criteria are added within each regional industry until the target weights are achieved, subject to implementation considerations. HIGHLY CONCENTRATED IN CERTAIN SECTORS RISK WEIGHTING Security selection Score & select stocks Within each regional industry risk-category, stocks are ranked by each target factor and the lowest ranked stocks are excluded. This step creates constituents of each single factor index. Combine the factors A weighted average of the individual factor scores is used to form a composite score. The weights are the inverse volatility of the single factor index return series created in the previous step.* Stocks are ranked by composite factor score and the lowest ranked stocks are excluded from the final index. REGION AND SECTOR WEIGHTS ARE ADJUSTED TO MORE EVENLY DISTRIBUTE RISK VALUE 1,300 SECURITIES MULTI-FACTOR SCREENING MOMENTUM SIZE LOW VOLATILITY 300 400 SECURITIES SELECTED RESULT FTSE DIVERSIFIED FACTOR INDEX 1 1 1 *composite factor = factor score * i.e. value * + momentum σ of factor index σ of value index * σ of momentum index... Product overview 2
Historically, the diversified factor indexes have captured more of the markets upside than downside relative to their cap-weighted benchmarks 100 50 50 95.77 FTSE Diversified Factor Indexes 94.57 93.40 101.06 97.11 0-50 73.66 79.81 72.99 88.00 77.63-100 Developed Developed Europe Developed ex North America Emerging U.S. Up Capture Ratio Down Capture Ratio Source:. Data from March 2001 to January 2016. Past performance is no guarantee of future results. Returns shown may reflect hypothetical historical performance. Up and down capture ratios show whether the FTSE Diversified Factor Index has gained more or lost less than the market capweighted benchmark during periods of market strength and weakness respectively, and if so, by how much. Over the available 15 year index history, each index has closely tracked the benchmark during rising markets while only suffering between 73% and 88% of the downside. In other words, the indexes have allowed upside participation while offering downside protection. The FTSE Diversified Factor Index has consistently displayed improved risk-adjusted outcomes relative to its benchmark 2.0 Rolling 3 year sharpe ratio 1.5 1.0 0.5 0-0.5-1.0-1.5 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 FTSE Developed ex North America Diversified Factor Index FTSE Developed ex North America Index Source:. Data from December 31 st 2008 to January 31 st 2016. Past performance is no guarantee of future results. Returns shown may reflect hypothetical historical performance. Product overview 3
The FTSE Diversified Factor Index has displayed less concentrated regional and industry weights 30% 25% 20% 15% 10% 5% 0% Oil & Gas Basic Materials Industrials Consumer Goods Industry exposure Health Care Consumer Services Telecommunications Utilities Financials Technology FTSE Developed ex North America Diversified Factor Index FTSE Developed ex North America Index 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Regional exposure UK Europe ex UK Japan Asia ex Japan FTSE Developed ex North America Diversified Factor Index FTSE Developed ex North America Index Source:. Data as of December 31, 2015 Summary The FTSE Diversified Factor Indexes consist of five rules-based indexes which reflect the performance of stocks exhibiting specific factor characteristics, and use a top-down risk allocation framework to determine geographic and industry index weights. There are subtle regional methodology differences, but each index broadly seeks to achieve the same objective: more even distribution of potentially uncompensated sources of risk (region & industry) and exposure to potentially compensated sources of risk (equity factors such as value, momentum, quality, low volatility and size). Alternatively Weighted (Inverse) risk-weight to achieve diversification objective across industries & regions + Factor Exposure Select stocks to achieve factor exposure objectives = FTSE Diversified Factor Index A series of rules-based indexes which reflect the performance of stocks exhibiting specific factor characteristics, and use a top-down risk allocation framework to diversify across regions and industries Product overview 4
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