Beyond active vs passive Barbara Vintcent For professional clients / qualified investors only
Why The Art of Indexing? Institutional US domiciled funds: AUM split by ETPs, index and active funds 100% Institutional European domiciled funds: AUM split by ETPs, index and active funds 100% 95% 95% 90% 90% 85% 85% 80% 80% 75% 75% 70% 2004 2006 2008 2010 2012 Mar-14 % of AUM in Active Funds % of AUM in Index Funds % of AUM in ETPs 70% 2004 2006 2008 2010 2012 Feb-14 % of AUM in Active Funds % of AUM in Index Funds % of AUM in ETPs Source: BlackRock, Bloomberg, Simfund. Please note, the data excludes AUM in Cayman Islands, British Virgin Islands and Bermuda domiciled funds For professional clients / qualified investors only
1 Selecting the right benchmark Example: Coverage 1. Benchmark selection 2. Instrument selection 3. Manager selection EM Equity coverage disparity: MSCI Emerging Markets Index vs FTSE Emerging Index Country and Sector mis-weights lead to differences in performances and risk Source: Bloomberg and BlackRock. All figures in USD, Total Return Net indices. As at 31 August 2013. Past performance does not guarantee future results.. For professional clients / qualified investors only
2 Selecting the right investment vehicle 1. Benchmark selection 2. Instrument selection 3. Manager selection There are 7 dimensions to consider: Source: BlackRock. For professional clients / qualified investors only
2 Selecting the right investment vehicle Cost dimension: ETFs vs index funds 1. Benchmark selection 2. Instrument selection 3. Manager selection The cost dimension is much more than a TER / MF assessment DM Equity example The index fund has a lower TER but higher entry/exit costs than the ETF. Therefore, the ETF is the cheaper instrument below an eight-month holding period; but as the investment horizon increases beyond this threshold the index fund becomes the cheapest Source: BlackRock. For illustrative purposes only. For professional clients / qualified investors only
Performance difference (%) 2 Selecting the right investment vehicle Cost dimension: ETFs vs futures 1. Benchmark selection 2. Instrument selection 3. Manager selection The comparison of futures and ETFs can be conducted along three angles: operational perspective holding cost perspective (performance difference) trading cost perspective 0.5 0-0.5-1 -1.5 Future ETF -2-2.5 Source: BlackRock. For illustrative purposes only. For professional clients / qualified investors only
We believe the growth of indexing will continue Looking into the future, we see the growth of index investing continuing both in terms of AUM and available strategies. This trend will be supported by three main catalysts: 1. Increased investor adoption 2. Expansion of the product breadth 3. Increased blending of index vehicles For professional clients / qualified investors only
2. Expansion of the product breadth A myriad of new indices have emerged over the years across different asset classes and segments, often collectively termed by the financial press and community as smart beta. We see this trend continuing, as the beta spectrum enlarges to capture additional exposures and risk factors How to navigate this range of choices? Are non-market capitalisation strategies really smart? For professional clients / qualified investors only
2. Expansion of the product breadth Are non market-cap weighted strategies really smart? US Equities example 140 120 100 80 60 40 20 2000-2003 1996-2000 300 250 200 150 100 50 0 2000 2001 2002 2003 S&P500 TR Index S&P 500 Equally Weighted Index 0 1996 1997 1998 1999 2000 S&P 500 TR Index S&P 500 Equally Weighted Index Source: BlackRock, Bloomberg. For professional clients / qualified investors only
3. Increased blending Blending of different types of betas will be a key trend for index investing. As investors become more acquainted with different index vehicles we see greater blending in that context, for example pension funds increasing their use of ETFs as a complement to futures Blending betas and vehicles will be driven by risk tolerance, performance objectives, forward-looking views of the markets and the time horizon of the investment. For professional clients / qualified investors only
Blending insights survey We interviewed: 35 Multi-asset, Advisory and Discretionary institutions across EMEA Investors with predominantly active, blended or passive portfolios Our respondents manage ~ 2.5 Trillion* 5 of the top 10 Global Private Banks** *Source: BlackRock, as of Year End 2011 **Source: Scorpio Partnership Private Banking Benchmark 2012 FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 11
Three identities emerge Actively Active Currently focused on using active management to generate alpha and not actively blending Indexing, where it is used, is only for cash management or as a last choice if other alternatives are unavailable. Embracing Blending Adopting indexing for tactical or short-term exposures, or Moving towards a more comprehensive approach to blending Agnostic Allocators Agnostic process for blending and the use of indexing. Primary focus on asset allocation to deliver alpha implementation choice often a secondary consideration. FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 12
What criterion would drive you to use indexing as opposed to active funds? A. Underlying market efficiency B. Availability of alpha-generating PMs C. Internal business structure D. Costs 13
What criterion would drive you to use indexing as opposed to active funds? A. Underlying market efficiency 35% B. Availability of alpha-generating PMs 20% C. Internal business structure 11% D. Costs 24% E. Investment horizon 10% 14
Which exposure would you see as being the most inefficient and therefore consider using active products for? A. Developed market equities B. Emerging markets equities C. Emerging markets debt D. Commodities 15
Which exposure would you see as being the most inefficient and therefore consider using active products for? A. Developed market equities 18% B. Emerging markets equities 25% C. Emerging markets debt 23% D. Commodities 16% E. Corporate debt 15% F. Government bonds 4% 16
Which catalyst has driven blending the most in your business/market? A. Clients B. Costs C. Investment markets and business opportunity D. Performance of active funds 17
Which catalyst has driven blending the most in your business/market? A. Clients 12% B. Costs 20% C. Investment markets and business opportunity 27% D. Performance of active funds 26% E. Growth in index product range 10% F. Regulation 5% 18
Looking ahead, which identity do you believe could resonate closest to your approach to index and active blending in future? A. Actively Active B. Embracing Blending C. Agnostic Allocators FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 19
Looking ahead, which identity do you believe could resonate closest to your approach to index and active blending in future? A. Actively Active 12% B. Embracing Blending C. Agnostic Allocators 40% 48% FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY 20
Strategic beta Active strategies with some of the benefits of passive strategies Enhance risk-adjusted returns through exposure to desirable specific factors Examples include funds that systematically overweight value or small stocks, highdividend stocks, momentum stocks and low beta, low vol stocks Can also encompass bonds, currencies and commodities, and can be multi-asset strategies Available as mutual funds, institutional portfolios (separate accounts and commingled funds) and ETFs Portfolio construction is simple, rules-based and transparent, which tends to lead to low fees and costs, and high capacity relative to traditional active strategies 21
Passive, active and strategic beta strategies: costs, capacity and manager discretion 22
Strategic beta: median mutual fund management fees and turnover levels 23
Strategic beta: levels of responsibility 24
How to fit strategic beta within existing asset allocations There are three main ways to fit strategic beta into existing asset allocations: 1. Directly substituting for active products 2. Directly substituting for passive products 3. Augmenting existing combination of passive and active products, to hedge or enhance factor exposures arising through active products 25
Conclusion Index investing will continue to grow and play a key role in financial markets over the next 10 years and beyond The breadth of strategy and product offer will increase Blending index and active strategies will become increasingly prevalent Strategic beta strategies are active strategies with some of the benefits of passive strategies Due diligence will be key! The Art of Indexing and Who Should Buy Strategic Beta? equip you with the knowledge and framework to take advantage of the benefits offered by this evergrowing and evolving range of strategies For professional clients / qualified investors only
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