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Facilitating debate on the markets, strategies and investing | @PortfolioForum | 19/20 May 2015
Portfolio construction of the future will focus on 3 risk buckets
Portfolio construction should focus on three risk buckets – beta, smart beta, and alpha. If not, you run the risk of creating a poorly diversified (that is, over diversified) portfolio – and, worse, a portfolio that costs far more than it should.
Facilitating debate on the markets, strategies and investing | @PortfolioForum | 19/20 May 2015
Facilitating debate on the markets, strategies and investing | @PortfolioForum | 19/20 May 2015
Portfolio construction of the future will focus on 3 risk buckets
Michael Furey
Managing Director, Delta Research & Advisory (Brisbane)
Facilitating debate on the markets, strategies and investing | @PortfolioForum | 19/20 May 2015
Only once in a generation there is an opportunity to look at portfolios in a different way and this is the way
Its part of the evolution of developing our Investment Philosophy and beliefs
It will change the way investing is done by portfolio manager at the securities level and strategy design and manager selection levels
You will hear more and more of this into the future
Portfolio Construction of the Future
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
According to Investopedia…
Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices
Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way
Examples include Value (low PE or Price/Book), Size (Small market cap), Momentum (last year’s best performers), Carry (Higher yielding securities), Low Volatility to name a few.
Smart beta strategies may offer the return benefits of active strategies but with the low cost implementation benefit of passive strategies
What is Smart Beta
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The components of returns are…1. Market index (market beta)2. Smart Beta (or risk factors)3. Pure alpha above and beyond smart beta
A significant proportion of active management comprises beta and smart beta…so…
Investors should have greater consideration of smart betas in their portfolios
Investors will demand active managers stop producing smart beta and focus on pure alpha
Key Messages
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The framework
Source: Smart Beta: The Owner’s Manual, R Kahn & M Lemmon, Journal of Portfolio Management (Winter 2015)
“Investment policy explains more than 90% of variability in total returns” – Brinson, Hood, and Beebower (1986)
Styles such as Value, Growth, Size, Momentum, and Carry
Why we pay the big bucks
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Market Index
Australian Debt
Bloomberg Ausbond Composite 0+ TR
Australian Shares
S&P/ASX 200 TR
Global Debt
BarCap Global Aggregate TR Hgd $A
Global Shares
MSCI World GR
Market and Smart Beta Definitions(for the purposes of the research about to be presented)
Smart Beta Australian Debt
BBB - AAA
Australian Shares Value – Growth Small – Large
Global Debt High Yield – Market
Global Shares Value – Growth Small – Large
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
Active Core funds are all actively managed funds that are likely to play a core asset class role in a broader portfolio.
The market is the most influential factor
How much risk is explained by the Market (Active Core Funds)
Average = 82% Average = 92% Average = 63% Average = 72%
n=21 n=97 n=17 n=101
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How much risk is explained by the market?(All Flagship Strategies)
Average = 66% Average = 82% Average = 45% Average = 59%
n = 42 n = 215 n = 56 n = 197
Flagship strategies are all wholesale funds in the investment universe
A spread of market influence exists…but still the market is a dominant factor
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
On average across all managers, security selection and timing accounts for most risk by individual managers…but there is still a reasonable proportion accounted for by Smart Beta
Risk explained from non-market bets
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Created 1,000 portfolios by randomly selecting combinations of 10 managers equal-weighted for each asset class...Monte Carlo simulation
How does the make-up of the risks change?
Let’s Diversify
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Smart Beta contribution to total active risk has increased significantly
…meaning “Pure Alpha” provided by the active managers contributes less
How does the make up of active risk change?
Up from 6%
Up from 33%
Up from 37%
Up from 18%
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
Smart Beta strategies must play a bigger role in portfolios
We still must form views of Smarter Beta return and risk potential
Investors will demand less smart beta and greater focus on “pure alpha” from active managers
Smart Beta is cheaper so why pay the big bucks to active managers
Active managers achieving returns from Smart Beta will become less and less as Smart Beta strategies become more and more
Portable alpha?
Portfolio Construction of the future
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
Lower costs
Higher returns for same risk
Risk reduction from high cost underperformance
Clear explicit roles for each investment in a portfolio
Evidence supported investment strategy
What does this mean for investors?
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Thank you & QuestionsMichael Furey
+61 432 002 472
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
Positive Alpha across Minimum Vol, Momentum, Small Cap and Value
Why Smart Beta?
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
The best managers have produced Alpha that is barely better than the “Smart Beta” indices
Best & Worst Managers
Top 6 Performing Global Managers over last 10 Years
Market Factor
Alpha 3.3% 3.5% 3.1% 2.6% 1.9% 1.5%
Beta 0.84 0.79 0.71 0.78 0.99 0.86
R-Squared 0.71 0.61 0.65 0.81 0.92 0.85
Multi Factor
Alpha 3.9% 3.2% 3.2% 2.0% 2.0% 1.5%
Beta 0.89 0.76 0.69 0.80 1.01 0.86
VMG 0.02 0.06 0.06 -0.13 -0.17 0.05
se(VG) 0.12 0.14 0.12 0.08 0.06 0.09SMB -0.40 0.27 0.12 0.03 -0.09 0.01
se(SMB) 0.09 0.11 0.09 0.06 0.05 0.07Momentum 0.05 -0.01 -0.06 0.13 -0.08 0.01
se(Mom) 0.08 0.10 0.09 0.06 0.05 0.06R-Squared 0.75 0.63 0.65 0.83 0.93 0.85
Smart Beta % 16% 5% 2% 11% 8% 0%
MSCI World
Growth GR USD
MSCI World Large
GR USD
MSCI World
Minimum Vol
(USD) GR USD
MSCI World
Momentum GR USD
MSCI World Small
Cap GR USD
MSCI World Value
GR USD
Average Alpha -1.06% -0.16% 1.99% 3.06% 2.97% 1.11%
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Australian Shares
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Size Premium
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Multi-Factor Alpha over last 5 years
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
Markets…
Bloomberg AusbondComposite 0+
S&P/ASX 200 TR
BarCap Global Aggregate (Hedged $A)
MSCI World GR $A
So how much does the market explain?
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
What proportion of on-market risk is explained by Smart Beta
Smart Beta
Citi BBB Spread
MSCI Aust Value-Growth + MSCI Aust Small-Large
BarCap High Yield Spread
MSCI World Value-Growth + MSCI World Small-Large
PortfolioConstruction Forum Symposium 2015 (PortfolioConstruction.com.au/Symposium)
Facilitating debate on the markets, strategies and investing | @PortfolioForum | 19/20 May 2015
QUESTIONS?
For further information:Refer to the Due Diligence Forum Research Paper available at http://portfolioconstruction.co.nz
Facilitating debate on the markets, strategies and investing | @PortfolioForum | 19/20 May 2015
Facilitating debate on the markets, strategies and investing | @PortfolioForum | 19/20 May 2015
Facilitating debate on the
markets, strategies& investing