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DIVERSIFICATION 2.0

Lode DevlaminckManaging Director, Equities

WHY TALK ABOUT DIVERSIFICATION ?

Page 1

Is diversification still one of the last free lunches in capital markets?

❖ High conviction strategies can simply become high vol strategies without risk insights.

❖ Understanding the underlying risks increases conviction in the long term sustainability of the Alpha.

❖ But the way to achieve more effective diversification has changed.

X-Axis: 3 YR annualized performance, Y-Axis: Active sharePortfolios Benchmarked against the S&P500 (core) with AUM over 100 million and Active Share over 30%Data as of 09/30/2019Source: eVestment, DCM

30%

40%

50%

60%

70%

80%

90%

100%

0.0 2.5 5.0 7.5 10.0 12.5 15.0 17.5 20.0 22.5 25.0

S&P 500 Portfolios: 3 Year Return versus Active Share

DISCUSSION TOPICS

❖ Diversification and Risk

❖ Avoiding risk: the traditional way of diversifying

❖ Embracing risk: a different way of diversifying

❖ Conclusion

Page 2

DIVERSIFICATION IS ABOUT MANAGING RISKS

❖ Systemic Risks

❖ Geo-Political Risk

❖ Interest Rate Risk

❖ Volatility

❖ Country & Currency

❖ Sectors & Industries

❖ Company

❖ …

Page 3

In Real Life

We diversify to mitigate risks

In Equity Markets

❖ Life Insurance

❖ Health Insurance

❖ Home

❖ Car

❖ Travel

❖ Back Up Generator

❖ AAA

❖ Product Warranties

❖ ….

DIVERSIFICATION AND RISK MANAGEMENT

Page 4

Similarities and Differences between Insurance and Public Equities

Cost of Risk

Impact

Probability

Location

Time

People

THE OBJECTIVE OF PORTFOLIO CONSTRAINTS

Page 5

Types of Risk

• Systemic

• Geopolitical

• Country

• Currency

• Volatility

• Style

• Sector

• Company

• ….

Portfolio Construction

• Tracking Error

• Country

• Sector

• Stock

• Style Exposures

• …

Risk Characteristics

• Cost

• Impact

• Probability

• Location

• Time

• …

Are traditional portfolio constraints adequately capturing risk characteristics?

DISCUSSION TOPICS

❖ Diversification and Risk

❖ Avoiding risk: the traditional way of diversifying

❖ Embracing risk: a different way of diversifying

❖ Conclusion

Page 6

USING DIFFERENT RISK MODELS IS LIKE HAVING DIFFERENT CLOCKS

Page 7

The utility is in the composition and relative ranking of the risks

Data as of 09/30/2019Source Data: Barra, Citigroup, DCMSource Picture: Google, Zazzle.com

International Portfolio Barra Citigroup

Tracking Error 1.68 1.71

Market Sensitivity 1.01 1.00

Risk Decomposition (%)

Macro Factors 22.7

Style Factors 11.9

Sector / Industry 2.6 2.2

Country 15.1 4.2

Currency 5.8

Risk Interaction 2.1 -9.5

Stock Specific 66.1 80.5

Risk Models

HAVE RISK MODELS TAKEN A YEAR OFF?

Page 8

Information Ratios have Bifurcated

IR Range of Portfolios

Sample of Theoretical Style Portfolios IR for 2019 Calculated as YTD return to 10/31/2019 divided by Barra ex ante TE as of 10/31/2019Source: Barra, FactSet, MSCI, DCM

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Portfolio IR -0.6 IR +06

TOP DOWN OR BOTTOM UP?

Page 9

❖ Most models and portfolio managers look at risk from a top down perspective.

❖ Risk is mostly managed one dimension at a time.

❖ Interaction and correlation between risks is often misunderstood

❖ Company characteristics and Sub-industry drivers have become much more important.

Citigroup GRAM Model median raw beta sensitivitiesData as of: 07/31/2019Source: Citigroup, DCM

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

Median Long Interest Rate Sensitivity

Understanding the interaction and correlation between risks

THE COST OF OVER-DIVERSIFICATION

Page 10

A case for bottom up portfolio construction

❖ Potential to capture multiple risk dimensions

❖ Avoiding transaction and holding costs

❖ Avoiding “Dead Wood” or unproductive positions in the portfolio

❖ Possibility to increase the active share in the portfolio without unduly increasing the risk.

Source: Google, Mies Van Der Rohe, by Oskar Mielczarek

DISCUSSION TOPICS

❖ Diversification and Risk

❖ Avoiding Risk: the traditional way of diversifying

❖ Embracing Risk: a different way of diversifying

❖ Conclusion

Page 11

THE NEED FOR SOME LEVEL OF CONCENTRATION

Page 12

Returns are not evenly distributed

S&P 500 Top 20 Contributors

Return and Weight Contributions on Left Hand Scale, S&P Return on Right Hand ScaleFrom 12/31/2008 to 10/31/2019Source: S&P, FactSet, DCM

46.1%

40.5%

544.8%

40.6%

26.8%

41.2%

345.0%

43.4%44.3%

81.2%

40.2%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

% of S&P 500 Return % of S&P 500 Weight Total S&P Return

COMBINING HIGH CONVICTION PORTFOLIOS

Page 13

❖ Core portfolios under threat of ETF’s and Passive.

❖ Avoid playing in the middle of the court.

❖ Bottom up alpha opportunities reside at all 4 corners of the perimeter.

❖ Uncovering these inefficiencies requires a long term horizon and a disciplined and consistent approach.

Quality Growth

Value Volatility

Core

Looking for a better overall risk reward

MORE EFFECTIVE DIVERSIFICATION

Page 14

Adding Risk Can Lead to Better Risk Reward

Theoretical Example of Sample Style PortfoliosRisk and Portfolio Data as of 12/31/2017Source: Barra, FactSet, MSCI, DCM

1.46

0.93 0.89

2.07

0.83

-

0.5

1.0

1.5

2.0

2.5

US Large Cap

Fundamental

US Large Cap

Multi Factor

US Large Cap

Core

US Large Cap

Quality

US Large Cap

Core Satellite

US Large Cap Equities: Core Satellite Risk Impact

MORE EFFECTIVE DIVERSIFICATION

Page 15

Adding Risk Can Lead to Better Risk Reward

Theoretical Example of Sample Style PortfoliosRisk and Portfolio Data as of 12/31/2017Source: Barra, FactSet, MSCI, DCM

2.19

3.10

6.06

2.20

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Global Equities

Core

Global High

Conviction

Global Small Cap

Growth

Global Equities

Core Satellite

Global Equities: Core Satellite Risk Impact

COMBINING HIGH RISK PORTFOLIOS

Page 16

Theoretical Example of Sample Style PortfoliosRisk and Portfolio Data as of 12/31/2017 Source: Barra, FactSet, MSCI, DCM

with Satellites w/o Satellites

US Lage Cap Core 1.46 1.46

US Large Cap Quality 2.07

US Large Cap Core Value 0.93 0.93

US Large Cap Composite 0.83 0.89

US Mid Cap Core Value 1.88 1.88

US Mid Cap Quality 2.99

US Mid Cap Composite 1.74 1.88

US Small Core Value 2.24 2.24

International Core 1.94 1.94

Intenrational GARP 3.26

International Index Plus 0.56

International Value 2.40

International Equities 1.65 1.94

Global Equities Core 2.19 2.19

Global High Conviction 3.10

Global Small Cap Growth 6.06

Global Equities 2.20 2.19

Global Small Cap 2.74 2.74

Aggregate Portfolio 1.01 1.15

Tracking Error

DISCUSSION TOPICS

❖ Diversification and Risk

❖ Avoiding Risk: the traditional way of diversifying

❖ Embracing Risk: a different way of diversifying

❖ Conclusion

Page 17

CONCLUSION

Page 18

❖ We see many Equity Portfolios that either over-diversify or under-manage risk.

❖ Are structural changes impacting the effectiveness of old risk models?

❖ Taking Risk in Public Equities is a good thing if managed appropriately.

❖ Combining High Conviction Strategies may provide a better risk reward over time than large integrated portfolios.

Source: Google, Daily Mail.co.uk, Andy Hooper

More Effective Diversification = Better Risk Reward

Above all, avoid playing in the middle of the court

PAGE 19

DISCLOSURES

These materials contain the current opinions of DuPont Capital Management and such opinions are subject to change without notice. These materials are for informational purposes only.Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation to buy or sell anyparticular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but DuPont Capital does not guarantee the accuracy,adequacy or completeness of such information.

This document is provided for informational purposes only. It is not intended as an offer or recommendation with respect to the purchase or sale of any security, option, future or otherderivatives in such securities.

Indexes are unmanaged and have been provided for comparison purposes only. You cannot invest directly into an index.

RISK OF LOSS: Investing in securities involves risk of loss, including loss of principal. The level of risk varies by asset class and product. Clients should be prepared to bear any losses that resultfrom investing in a particular strategy or product. Past performance of DuPont Capital’s investment strategies is not indicative of how those strategies will perform in the future.

SECURITIES EXAMPLE: References to specific securities are presented to illustrate the application of our investment philosophy only and not to be considered recommendations by DuPontCapital Management. The specific securities identified and described in this presentation do not represent all of the securities purchased, sold or recommended for the portfolio, and it shouldnot be assumed that investments in the securities identified were or will be profitable. Upon request, we will furnish a listing of all investments made during the prior one-year period.

NO PART OF THIS PRESENTATION MAY BE REPRODUCED IN ANY FORM.

FOR INSTITUTIONAL INVESTORS ONLY. NOT TO BE SHOWN OR DISTRIBUTED TO THE PUBLIC WITHOUT THE APPROVAL OF DUPONT CAPITAL MANAGEMENT.

REGISTRATION OF AN INVESTMENT ADVISER WITH THE SEC DOES NOT IMPLY ANY LEVEL OF SKILL OR TRAINING.

DuPont Capital ManagementOne Righter Parkway, Suite 3200

Wilmington, DE 19803302-477-6000

www.dupontcapital.com