PRUDENTIAL INVESTMENTS, A PGIM BUSINESS STRATEGIC INVESTMENT RESEARCH GROUP POST-ELECTION ACTIVE MANAGEMENT PERFORMANCE December 216 CHART 1: QUALITY ROE (3Y Avg) ROIC (3Y Avg) Earnings Stability (Last 3Y) 113 111 19 17 15 13 11 99 97 95 12/31/15 2/16/16 3/3/16 5/11/16 6/23/16 8/5/16 9/19/16 1/31/16 President-elect Trump s pro-growth agenda is widely believed to be the impetus driving the equity markets higher since the election on November 8. However, in looking more closely at the data, the market has been in a risk-on regime since mid-february, the bond proxy trade withstanding. This was largely centered on technology stocks and higher beta. The graph left illustrates the reversal in high quality (which is another way to define risk-on ). Since the election, however, the risk-on trade quickly pivoted to those sectors expected to benefit the most under Trump s proposed economic agenda, namely interest-rate-sensitive sectors like Financials (up 11%), which is evidenced in the sharp downturn in quality factors post election. Source (as of 11/16/16): FactSet Research Systems, Inc. and SIRG Quality Factors. CHART 2: BOND PROXY TRADE PERFORMANCE Bond Proxy (Left) US Treasury - 1Y (Right) 12 115 11 15 1 95 1/26 9/26 8/27 7/28 6/28 5/29 4/29 3/3 2/29 1/3 12/31 2.4 2.2 2 1.8 1.6 1.4 1.2 1.8.6.4.2 President-elect Trump s pro-growth agenda does bring about a new set of risks not previously priced into the market, namely that of inflation. Not surprising, this resulted in an accelerated sell-off of bond proxy sectors, with Utilities lower by 6%, Consumer Staples by 4%, and REITs by 3% following the election. It is important to note, however, that this trend was well in place before his victory. This reversal started in early Q3 following several economic data releases that signaled favorable economic conditions to support higher interest rates. The key differentiator before and after the election centers on inflation expectations as the primary determinant of future rate hikes; replacing the uncertainty of lower for longer mechanism that has been place since the crisis. Source (as of 11/16/16): FactSet Research Systems, Inc. Bond Proxy definition included in the disclosures.
CHART 3: LARGE GROWTH MANAGERS EXCESS RETURN CUMULATIVE GROWTH 25 2 15 1 5-5 -1 Active Momentum Active GARP Active Traditional Growth Russell 1 Growth Index ACTIVE MANAGEMENT Despite the risk-on trade for much of 216, active management results have been mixed. Performance for growth managers were improving in early 216, but really gained momentum in Q3 when the risk-on accelerated following the Brexit vote. Value managers, on the other hand, struggled in light of the bond proxy trade. Post election, however, active management results accelerated for growth managers, namely that of GARP strategies. As a peer group, they tend to have a value bias, are underweight bond proxy sectors, have a slightly higher beta profile and most importantly, a substantial overweight to Financials. -15 2/12/16 4/8/16 6/3/16 7/29/16 9/23/16 11/18/16 CHART 4: LARGE VALUE MANAGERS EXCESS RETURN CUMULATIVE GROWTH 1 Active Deep Value Active Relative Value Active Traditional Value Russell 1 Value Index -1-2 -3-4 -5 2/12/16 4/8/16 6/3/16 7/29/16 9/23/16 11/18/16 DECEMBER 216 2
CHART 5: LARGE GROWTH (11/9/16-11/15/16) Total Annualized Return, % 11/9/16-11/18/16 2.16.98.43 1.24 Value managers remain challenged, namely due to the benchmark s bias toward Financials, which is 25%. In this regard, deep value manages are best positioned to exploit the bond proxy reversal and financials recovery given their higher relative exposure to Financials (23%) among other things. This cannot be said for the Traditional and Relative Value managers, who have swapped the bond-proxy headwind with that of a Financials headwind given their average exposures to Financials, which average 21% and 15%, respectively. Active Momentum Active Traditional Growth Active GARP Russell 1 Growth Index CHART 6: LARGE VALUE (11/9/16-11/15/16) 11/9/16-11/18/16 3.93 Total Annualized Return, % 3.38 2.87 3.46 Active Deep Value Active Traditional Value Active Relative Value Russell 1 Value Index DECEMBER 216 3
DISCLOSURES SIRG Quality Factors Equity Risk Factors are derived from the largest 1, stocks by market cap listed on US exchanges. The universe is then segmented into quintiles of stocks that meet certain fundamental characteristics. Factor performance is the return differential between the top and bottom quintiles, while factor valuation represents the P/E spread between the quintiles. ROE (3 Yr. Avg.) High return on equity over the last three years ROIC (3 Yr. Avg.) High return on invested capital over the last three years Earnings Stability (Last 3 Yrs.) High earnings stability over the last five years, as measured by net income divided by the volatility of earnings Bond Proxies Defensive equities such as Utilities, Consumer Staples, and Telecom that have attractive yields relative to the bond market. Active GARP Morningstar Large Valuation Sensitive Growth Universe. Large valuation sensitive growth portfolios typically exhibit both growth and value characteristics, as managers in this group are generally interested in growing companies but are also sensitive to valuations. Stocks in these portfolios may have somewhat lower projected growth ratios than high growth stocks but come with lower price valuations. As a result, the style scores for these funds are lower than both high growth and core growth funds. Active Traditional Growth Morningstar Large Core Growth Universe. Large core growth portfolios typically exhibit classic growth characteristics. These funds favor returns through capital appreciation and tend to focus on proven industries that still have opportunities for expansion. Their style scores are somewhat lower than those of their high growth counterparts. Active Momentum Morningstar Large High Growth Universe. Large high growth portfolios have lower size scores than giant cap-focused portfolios but maintain the highest style scores of funds in the large capitalization range. These portfolios tend to maintain exposure to the most rapidly growing industries as they seek opportunities for capital appreciation regardless of the price. Active Deep Value Morningstar Large Deep Value Universe. Large-income oriented value portfolios favor stocks that promise high current income through reliable dividends. These portfolios may also choose some stocks considered to be in distress or out of favor. Style scores for this group are the lowest of funds in the large cap range. Active Traditional Value Morningstar Large Core Value Universe. Large core value portfolios exhibit classic value characteristics. As a result, their style scores generally end up directly in the middle of the value-oriented range. These managers generally seek capital appreciation at low prices but also favor a notable amount of dividend income. Active Relative Value Morningstar Large Relative Value Universe. Large relative value portfolios hold stocks that exhibit attractive price multiples but that also have some sort of growth catalyst. These funds may seek returns through dividend income but also through capital appreciation. Style scores for this group are a step lower than funds with a blended style, reflecting the additional emphasis on low valuation. The Russell 1 Value Index measures the performance of those Russell 1 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 1 Growth Index measures the performance of those Russell 1 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1 Growth Index measures the performance of those Russell 1 companies with higher price-to-book ratios and higher forecasted growth values. Beta measures the performance of a manager s portfolio in relationship to the market. A manager who performs directly in line with the market will typically have a beta equal to 1.. A manager whose returns are more volatile than the market will have a beta greater than 1., and a manager whose returns are less volatile than the market will typically have a beta less than 1. REITs companies whose charters are the equity ownership and operation of commercial real estate and which operate under the REIT Act of 196. Value Managers: funds that invest primarily in big U.S. companies that are less expensive or growing more slowly than other large-cap stocks. Stocks in the top 7% of the capitalization of the U.S. equity market are defined as large cap. Value is defined based on low valuations (low price ratios and high dividend yields) and slow growth (low growth rates for earnings, sales, book value, and cash flow). Growth Managers: funds invest primarily in big U.S. companies that are projected to grow faster than other large-cap stocks. Stocks in the top 7% of the capitalization of the U.S. equity market are defined as large cap. Growth is defined based on fast growth (high growth rates for earnings, sales, book value, and cash flow) and high valuations (high price ratios and low dividend yields). DECEMBER 216 4
This report is produced by the Strategic Investment Research Group (SIRG), a unit of Prudential Investments LLC, and a research unit of Prudential Financial. SIRG provides research, analysis, and due diligence on investment management firms and the vehicles and strategies they offer.t Diversification and asset allocation do not guarantee a profit or protect against a loss in declining markets. Investing involves risks. Some investments have more risk than others. The investment return and principal value will fluctuate, and the investment, when sold, may be worth more or less than the original cost, and it is possible to lose money. Past performance is not a guarantee of future results. Since no one manager/investment program is suitable for all types of investors, this material is provided for informational purposes only. Clients investment objectives, risk tolerances, and liquidity needs must be reviewed before introducing suitable manager/ investment programs. Indices are unmanaged and an investment cannot be made directly into an index. The information contained herein has been obtained from sources that Prudential Financial believes to be reliable. Prudential Financial does not guarantee the accuracy or completeness of data received from outside sources, including investment managers. CONTACT US For questions, email us at investment.research@prudential.com or visit us online at http://prusirg.prudential.com 216 Prudential Financial, Inc. and its related entities. The Prudential logo and the Rock symbol are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. 29968-1- Expiration: 6/3/217 DECEMBER 216 5