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Factor Investing & Smart Beta - ETF.com Flipbook PDF
©2014 MSCI Inc. All rights reserved. msci.com 4 Factor investing is the investment process that aims to harvest risk pre
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Factor Investing & Smart Beta Raina Oberoi VP, Index Applied Research MSCI
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Outline What is Factor Investing? Minimum Volatility Index Methodology Historical Performance and Index Characteristics Risk Premia: Combining Minimum Volatility with Other Factor Indexes MSCI Quality Mix Indexes
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What is Factor Investing?
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What is Factor Investing? Factor investing is the investment process that aims to harvest risk premia through exposure to factors
6 KEY FACTORS
A large body of academic research highlights that long term equity portfolio performance can be explained by systematic factors. Some factors represent exposure to systematic risk and have historically earned a long term risk premium We currently identify six risk premia factors. They are grounded in academic research and have solid explanations as to why they have provided a premium
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Low Size
Value
Momentum
Quality
Yield
Low Volatility
Yesterday’s Alpha is Today’s Beta 1970s
1980s
2000s
Alpha Alpha Factor Beta
Portfolio Return
Regional Beta Beta
Country Beta Sector Beta
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Low Size Value Quality Momentum Yield Low Volatility
What Attracts Investors to Factor Investing? Performance Characteristics (November 2001 to August2014) (Gross Total Return in USD)
12.00%
Annualized Return
11.00%
Risk Weighted
10.00%
Equal Wtd
Momentum
9.00%
8.00%
Min Vol
HDY
Quality
Value Wtd World
7.00%
6.00% 11.00%
12.00%
13.00%
14.00%
15.00% Annualized Risk
* Simulated history from December 1998 to April 2008; Index was launched in April 2008.
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16.00%
17.00%
18.00%
19.00%
What Causes Risk Premia and How Persistent Are These Effects? There are two main views on why these excess returns exist, which result from different perspectives on market efficiency:
1. Systematic Risks
2. Systematic Errors
Certain stocks are highly correlated with the economic cycle and earn a risk premium
Certain stocks may be systematically under priced and subsequently earn a high return
The important question for long term investors considering an allocation to risk premia strategies is not only which theory explains them but whether they are likely to persist Both theories attempting to explain historical return regularities may allow for risk premia to persist, provided that the same historical behavior persists in the future Factors are cyclical and there may be periods of prolonged underperformance
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The Trade-Off Between Exposure and Investability Exposure Pure Factors Mkt Neutral Factor Indexes
MSCI Market Neutral Barra Volatility
Long Short Factor Indexes High Exposure Factor Indexes High Capacity Factor Indexes Cap Weighted Parent Indexes Investability ©2014 MSCI Inc. All rights reserved.
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MSCI Momentum Tilt (130/30)
MSCI Quality
MSCI Value Weighted
MSCI ACWI IMI
Minimum Volatility Index Methodology
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MSCI Minimum Volatility Index Methodology Parameter
Methodology
Comments Derived indexes benefit from parent index construction rules
Universe
Parent index constituents
Optimization
MSCI’s market leading Barra Global Equity Model (GEM2)
Weighting
Minimize index volatility subject to constraints
Constraints
• Stocks: Lower of 1.5% or 20x the cap-weight, with a minimum of 5bps • Sectors:-/+5% relative to the parent index • Countries: -/+5% or 3x relative to the parent index • Style: -/+ 0.25 relative to Barra factor of the parent index (except for Volatility) • Turnover: Maximum 10% one-way turnover per rebalancing
Account for Factor volatility and correlation Comprehensive and robust risk measures Ensure high investability and liquidity
Stock weight cap ensures adequate capacity and replicability Style and Sector caps ensure no unintended exposure Turnover limit ensures lower cost replication
Number of Constituents
Subset of parent index, number will vary
High level of diversification achieved by a subset of parent index
Rebalancing
Semi-annual (May and November)
Timely data updates, consistent with MSCI rebalancing calendar
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Historical Performance and Characteristics
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Relative Performance of the MSCI World Minimum Volatility Index* Crisis periods are typically characterized by spikes in market volatility
150
Eurozone Crisis
140 Cumulative outperformance
The MSCI World Minimum Volatility Index has historically outperformed the MSCI World Index across the periods of market crisis
MSCI World Minimum Volatility (USD) Relative Performance
130 120
Tech Burst
110 100
US Savings and Loan Crisis
90 80
Sub Prime Crisis
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Period: May 1988 – August 2014
* Simulated history from December 1988 to April 2008 and the Index was launched in April 2008.
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Historical Performance from December 1998 to August 2014 Historical Gross Total Returns, USD
MSCI World
MSCI World Minimum Volatility
Annualized Return (%)
5.1
6.6
Annualized Risk (%)
15.8
11.1
Return/Risk
0.32
0.59
Sharpe Ratio
0.17
0.38
Tracking error (%)
0.0
7.7
Correlation
1.0
0.90
Historical Beta
1.00
0.63
Information Ratio
NA
0.20
Max Drawdown (%)
57.5
47.7
Avg. Annual Turnover (%)
3.2
20
Price to Book
2.2
2.5
Price to Earnings
18.6
18.7
Div. Yield (%)
2.3
2.6
December 1998 - August 2014
* Simulated history from December 1998 to April 2008; Index was launched in April 2008.
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Active Style Factor and GICS Sector Exposures
From December 1998 to August 2014 using Barra GEM2 based on simulated history from December 1998 to April 2008 and the Index was launched in April 2008.
Historically, the MSCI World Minimum Volatility Index has substantially lower active exposure to Volatility The MSCI World Minimum Volatility Index over-weighted defensive sectors such as Utilities , Consumer Staples and Health Care while underweighting cyclical sectors such as Materials, Financials and Information Technology
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Minimum Volatility Indexes Across Regions in the Past 10 Years MSCI ACWI
MSCI ACWI Minimum Volatility
MSCI World
MSCI World Minimum Volatility
MSCI EM
MSCI EM Minimum Volatility
MSCI USA
MSCI USA Minimum Volatility
MSCI Europe
MSCI Europe Minimum Volatility
Total Return* (%)
8.4
10.2
8.2
8.9
12.9
16.2
8.6
9.5
8.0
10.0
Total Risk* (%)
16.5
11.1
16.0
11.6
23.7
19.0
14.7
11.3
19.9
16.0
Risk Adjusted Return
0.5
0.9
0.5
0.8
0.5
0.9
0.6
0.8
0.4
0.6
Active Return* (%)
0.0
1.8
0.0
0.7
0.0
3.3
0.0
1.0
0.0
2.0
Tracking Error* (%)
0.0
7.5
0.0
7.0
0.0
6.2
0.0
5.8
0.0
5.7
Information Ratio
NA
0.2
NA
0.1
NA
0.5
NA
0.2
NA
0.4
Historical Beta
1.00
0.62
1.00
0.67
1.00
0.79
1.00
0.72
1.00
0.78
Risk Reduction (%)
NA
32.6
NA
27.4
NA
19.7
NA
23.2
NA
19.9
Historical Gross Total Returns, USD
* Annualised from August 2004 to August 2014
Historically, the MSCI Minimum Volatility Indexes demonstrated around 21 – 33 % reduction in risk, across regions, during the observed period The most effective risk reduction was in the ACWI Index and the World Index
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Risk Premia: Combining Minimum Volatility and Other Factor Indexes
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Is there a Free Lunch? Relative performance of MSCI World Factor Indexes 190
170
150
130
110
90
70
MSCI World Equal Weighted/MSCI World MSCI World Risk Weighted/MSCI World
MSCI World Quality/MSCI World MSCI World Value Weighted/MSCI World
50
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MSCI World Min Vol/MSCI World MSCI World HDY/MSCI World
Deploying Multi-Factor Indexes Global Equity Beta
Added Value
Passive Investing
Factor Investing
Active Management
Benchmark Indices
Multi-Factor Index
Active Mandates
Momentum
Volatility
Quality
Yield
Value
ACWI IMI
Size
Strategic Factor Tilts
Tactical Factor Tilts & Overlay Strategies
ESG Beliefs & Constraints
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Tactical Asset Allocation Security Selection Market Timing
Considerations for Combining Factor Indexes Factor
Risk
Correlation
Business Cycle
Value
Comparable to market
Low with Momentum and Quality
Pro-cyclical
Momentum
Comparable to market
Low with Value, Yield, and Quality
Pro-cyclical
Low Size
Higher than market
Low with Min Volatility, Yield, and Quality
Pro-cyclical
Quality
Lower than market
Low with Value, Size, Yield and Momentum
Defensive
Low Volatility
Lower than market
Low with Value and Momentum
Defensive
Yield
Lower than market
Low with Size, Quality and Momentum
Defensive
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Value and Volatility Experienced Different Performance Cycles MSCI World Minimum Volatility (USD) and MSCI World Value Weighted Relative Performance 120
120
Cumulative Outperformance
Value outperformance, Minimum Volatility underperformance 110
110
100
100
Minimum Volatility performed defensively, Value performed cyclically 90
90
2002
2004
2006
MSCI World Minimum Volatility / MSCI World
2008
2010
2012
MSCI World Value Weighted / MSCI World
Period: October 2002 – August 2014
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Combined Factor Index Strategy Achieved Superior IR in the Past 10 Years Historical Performance* Gross Total Return, USD
MSCI World Index
MSCI World Minimum Volatility (USD) Index
MSCI World Value Weighted
Combined 50/50
Total Return** (%)
7.4
7.8
7.0
7.6
Total Risk** (%)
16.2
11.7
17.7
14.3
Risk Adjusted Return
0.46
0.67
0.40
0.53
Active Return** (%)
0.0
0.4
-0.3
0.2
Tracking Error** (%)
0.0
7.2
2.7
3.3
Information Ratio
NaN
0.06
-0.12
0.05
One-Way Turnover**
2.5
20
15.6
21.9
Transaction Cost (bps)
50
50
50
50
Impact on Return **
-0.01
-0.10
-0.08
-0.11
Max Drawdown (%)
57.5
47.7
61.6
54.9
1-Month 95% VaR (%)
-8.6
-5.7
-9.8
-7.7
Historical Beta
1.00
0.66
1.09
0.87
* Simulated history : MSCI World Minimum Volatility (USD) from Nov 2004 to Apr 2008 and MSCI World Value Weighted from Nov 2004 to Nov 2010
Historical Analysis November 2004 to August 2014
* August 2004 to August 2014 ** Annualised in %
MSCI World Index
MSCI World Minimum Volatility (USD) Index
MSCI World Value Weighted
Separate 50/50
Combined 50/50
Annual One-way Turnover (%)
2.5
20.0
15.6
24.8
21.9
Transaction Cost (%)
0.50
0.50
0.50
0.50
0.50
Annual Impact on Return (%)
-0.01
-0.10
-0.08
-0.12
-0.11
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MSCI Quality Mix Indexes
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MSCI Quality Mix Indexes Equal weighted combination of the MSCI Value Weighted, Minimum Volatility and Quality Indexes
MSCI Quality MIX
MSCI Value Weighted Index
• Re weights parent index according to four fundamental variables: Sales, Earnings, Cash Flow, Book Value • Semi-annual rebalancing
MSCI Quality Index
• Identifies quality growth stocks within parent index by calculating a quality score based on: high return on equity, stable earnings growth and low leverage
MSCI Minimum Volatility Index
• Identifies stocks from the parent index with the potential to provide lowest total risk and superior risk-adjusted performance • Constructed using minimum variance optimization
• Semi-annual rebalancing • Semi-annual rebalancing
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Quality, Value and Volatility Have Different Performance Cycles MSCI World Quality, MSCI Minimum Volatility (USD) and MSCI Value Weighted Relative Performance During the long bull-run, Value Weighted outperformed, Minimum Volatility tracked the benchmark and Quality lagged
Both Minimum Volatility and Quality outperformed during the recent crisis, Value Weighted performed cyclically
Performance through April 2014
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Relative Performance of the MSCI Quality Mix Indexes MSCI World Quality Mix Index has historically outperformed MSCI World Combining the 3 Factor Indexes diversified returns during periods of volatility MSCI World Quality Mix Index Relative Performance 200
Sub Prime
Cumulative outperformance
180
160
140
Global Financial Crisis
Tech US Savings & Loans
120
100
80
1988
1991
1993
1995
1997
2000
2002
Simulated history from May 1988 to February 2014.
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2004
2006
2009
2011
2013
MSCI World Historical Performance from 1998 to 2014
Simulated history from Dec 1998 to April 2014.
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Questions?
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Notice and Disclaimer (continued) Index returns do not represent the results of actual trading of investible assets/securities. MSCI maintains and calculates indices, but does not manage actual assets. Index returns do not reflect payment of any sales charges or fees an investor may pay to purchase the securities underlying the index or Index Linked Investments. The imposition of these fees and charges would cause the performance of an Index Linked Investment to be different than the MSCI index performance. The Information may contain back tested data. Back-tested performance is not actual performance, but is hypothetical. There are frequently material differences between back tested performance results and actual results subsequently achieved by any investment strategy. Constituents of MSCI equity indexes are listed companies, which are included in or excluded from the indexes according to the application of the relevant index methodologies. Accordingly, constituents in MSCI equity indexes may include MSCI Inc., clients of MSCI or suppliers to MSCI. Inclusion of a security within an MSCI index is not a recommendation by MSCI to buy, sell, or hold such security, nor is it considered to be investment advice. Data and information produced by various affiliates of MSCI Inc., including MSCI ESG Research Inc. and Barra LLC, may be used in calculating certain MSCI equity indexes. More information can be found in the relevant standard equity index methodologies on www.msci.com. MSCI receives compensation in connection with licensing its indices to third parties. MSCI Inc.’s revenue includes fees based on assets in investment products linked to MSCI equity indexes. Information can be found in MSCI’s company filings on the Investor Relations section of www.msci.com. MSCI ESG Research Inc. is a Registered Investment Adviser under the Investment Advisers Act of 1940 and a subsidiary of MSCI Inc. Except with respect to any applicable products or services from MSCI ESG Research, neither MSCI nor any of its products or services recommends, endorses, approves or otherwise expresses any opinion regarding any issuer, securities, financial products or instruments or trading strategies and neither MSCI nor any of its products or services is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Issuers mentioned or included in any MSCI ESG Research materials may include MSCI Inc., clients of MSCI or suppliers to MSCI, and may also purchase research or other products or services from MSCI ESG Research. MSCI ESG Research materials, including materials utilized in any MSCI ESG Indexes or other products, have not been submitted to, nor received approval from, the United States Securities and Exchange Commission or any other regulatory body. Any use of or access to products, services or information of MSCI requires a license from MSCI. MSCI, Barra, RiskMetrics, IPD, FEA, InvestorForce, and other MSCI brands and product names are the trademarks, service marks, or registered trademarks of MSCI or its subsidiaries in the United States and other jurisdictions. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard & Poor’s. “Global Industry Classification Standard (GICS)” is a service mark of MSCI and Standard & Poor’s.
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