SMART BETA INVESTING A fad or a trend? Thursday,  4  February  2016  |  Grand  Hya7  New  York  Amit  Sinha  

All views expressed in this presentation are that of the presenter and do not necessarily reflect the views of his employer or any of its affiliates.

Disclaimer

n  Defining Smart Beta

n  Advances in data and computing have fueled its growth

what

why do we care? where is the industry headed?

n  Helps investors construct better portfolios

n  At lower cost

n  But can it persist?

n  At the crossroads of key industry trends

n  $12T opportunity, but at what price?

n  Business models are rapidly evolving

Agenda

What is Smart Beta?

n  Smart Beta ETF assets have tripled globally since 2010

n  In 2015, Smart Beta ETF launches (492) surpassed Non-Smart Beta ETF launches (192)

Year 2010 2011 2012 2013 2014 2015

# of Global Non-Smart Beta ETF launches 556 403 347 336 309 192

# of Global Smart Beta ETF launches 90 215 179 113 307 492

Source: Morningstar

90

215 179 113

307

492 556

403 347 336 309

192

0

200

400

600

800

1000

0

500

1,000

1,500

2,000

2,500

2010 2011 2012 2013 2014 2015

# of launches Net

Ass

ets

($ b

n)

# of Global Smart Beta launches # of Global Non-Smart Beta launches

Global Smart Beta Net Assets ($ bn) Global Non-Smart Beta Net Assets ($ bn)

Growth of global Smart Beta ETFs

“Today’s biggest trend is not smart beta, it’s wishing we had a better

name for it than smart beta” Jim King, Managing Director, ETF portfolio management, Guggenheim Investments

Smart Beta also known as

Alternative Beta

Strategic Beta

Advanced Beta

Systematic Beta

Enhanced Beta

A systematic approach to earn risk premia that exist in markets due to structural or behavioral factors

Structural or behavioral basis for results

Portfolios that produce superior results vs. total market and pure index funds

Persistent over long periods of time and across regimes

Not driven by discretionary human decisions

1969 – 1971 Wells Fargo developed, and then abandoned an equally weighted index

1977 The original Vanguard S&P 500 index fund could only trade about 200 stocks

2000 – 2014 15x growth in the number of Smart Beta funds

INDEX INVESTING

INDEX MUTUAL FUND

SMART BETA

500+

Advances in data and computing have fueled the exponential growth of Smart Beta

why do we care?

Smart Beta helps investors construct better portfolios

63%

62%

43%

29%

15%

3%

0% 10% 20% 30% 40% 50% 60% 70%

Risk reduction

Return enhancement

Improve diversification

Provide specific factor exposure

Cost savings

Other

Source: Russell Indexes Global Smart Beta Survey 2014

What investment objective initiated the evaluation of Smart Beta strategies?

Equity Fixed Income Alternatives

–  Manager selection

–  Alpha/Beta

Exposures Risk

Exposure-driven portfolio construction

Risk premia Economic Liquidity Default

Strategy

Value Momentum Carry

Volatility Curve Fundamentals

ERP Duration etc.

etc…

Construction Risk Return Diversity

etc.

Equity Fixed Income Alts Observe

Traditional portfolio

Smart Beta is not a fund or a strategy – it makes an investor think about the exposures that drive risk and return in a portfolio

Superior risk-adjusted returns persist from structural or behavioral factors

Systematic approaches can deliver these exposures at lower cost, across asset classes

This is because…

MSCI single factor indices vs. MSCI World Index performance since 2000

Source: MSCI and Bloomberg as of 6/30/2015 The index values are rebased to 100 on 1/3/2000

0

100

200

300

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Jan-

12

Jan-

13

Jan-

14

Jan-

15

The MSCI World Index MSCI World Value Index MSCI World Momentum (Net USD) Index MSCI World Minimum Volatility (USD) Index MSCI World Mid Cap Equal Weighted (Net USD) Index

Superior risk-adjusted returns persist from structural or behavioral factors

Source: Towers Watson

Risk and return characteristics of a range of Smart Beta strategies from February 2002 to December 2012

Systematic approaches can deliver these exposures at lower cost, across asset classes

10 – 25 bps

50 – 75 bps

Traditional Equity Factors

Alternatives, Dynamic, etc.

Source: Blackrock, GSAM, Industry reports

But how can it work if everyone knows about it?

“if something is rational compensation for risk, then there is no reason it should

ever completely disappear or necessarily fall below a

rational level.”

Factors such as low vol, value, momentum have been actively traded since the 1980s, and continue to persist

According to State Street:

“just because they are now known doesn’t mean

everyone believes in them or is comfortable with them!”

Cliff Asness, AQR How Can a Strategy Still Work If Everyone Knows About It?

53 % OF INDIVIDUAL INVESTORS BELIEVE ALPHA IS DRIVEN BY SKILL

42 % OF INVESTMENT PROFESSIONALS BELIEVE SKILL IS THE PRIMARY DRIVER OF OUTPERFORMANCE

+ organizational decision processes, constraints = persistence

where is the industry headed?

Investor appetite for index/ETFs

Broad adoption of alternatives

Unconstrained fixed income

Shift to outcomes and solutions

Focus on income

Longevity and retirement

Evolution of emerging markets

Source: Trends from Blackrock Investor day 2014

Smart Beta is at the crossroads of key industry trends

$225T total assets

$65T investible

$1T smart beta

$12T

Sources: Estimates based on analysis of data from Blackrock, Russell, Morningstar, Towers Watson

The potential for growth is there

$28T US assets

6.3

0.8

5.7 1.9 7.3

5.7

2.0

0.0 5.0 10.0 15.0 20.0 25.0

DB Pension

Target Date Funds

Other DC

Annuities

IRAs

Other

19.0 17.0

24.0

6.5

0.0 10.0 20.0 30.0 40.0

Retirement

Insurance

High Net Worth

$65T Global assets

Sources: PWC, Morningstar, ICI, NAIC, Towers Watson, P&I, Knight Frank, Blackrock

Retirement solutions represent the largest opportunity

bps x AUM

Despite complexity, the economics of our business is simple

With bps cratering, most players will be relying on AUM growth…

1 T

3 T

9 T

0.50% 0.17% 0.06% Fees

Assets

Current revenue estimated at $5B

…in an increasingly challenging environment

Product

Operations

Distribution

n  Equity indices getting commoditized

n  Regulation, compliance, execution

n  Differentiation? n  Higher marketing costs

n  As a niche player n  As a large traditional manager n  As a hedge fund

Acquire/Sub Advise

Outsource/ Consolidate Solutions

Derivatives Niche products Brand

How do we deal with it? Challenges

n  Dimensional: probably the oldest and largest provider – moving into solutions, ETFs

n  AQR: strategy shift in 2009: $100B+ manager, thought leadership, data

n  GSAM: acquired product (westpeak), 9bps

n  Hedge Fund A: providing Smart Beta to TDF providers, ~ 30% of their assets

n  Mutual Fund B: insurance-linked securities

n  Index: RAFI – content and education

A few different approaches

n  Smart Beta helps investors build better portfolios that meet their needs, using systematic strategies, at lower cost

n  Structural and behavioral biases will likely cause factor premia to persist

n  It’s a $12T opportunity, but in a good product alone is not enough to succeed

In Conclusion

n  Will large players dominate based on distribution and pricing?

n  How can a fund differentiate itself?

n  How to gain traction in the absence of a track record?

n  Does format (i.e. mutual fund, ETF, managed account, indexed) matter?

What do you think?

Amit Sinha Portfolio Manager

Pacific Private Fund Advisors LLC

www.linkedin.com/in/amitsinha1978  

amit.sinha@mac.com

Thank you