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FOR PROFESSIONAL INVESTORS ONLY
Sarasin Smart Beta
Enhancing Returns through Premias and Equally Weighting: The Sarasin Efficient Approach
November 2015
Andrea NardonPartnerSarasin & Partners LLP
1Sarasin Systematic
Source: IPE Sub-group of 22 smart beta investors from a sample of 36 European pension funds. Numbers sum to more than 22 as some funds are considering more than one smart beta concept. http://www.ipe.com/reports/smart-beta/focus-group-pension-funds-get-smart/10006906.fullarticle
1. Does your fund allocate to any investment that employs smart beta concepts?
European Pension Funds are moving towards Smart Beta2. Which smart beta concepts does your fund currently employ in
equities?
3. Which smart beta concepts are you currently considering in equities?
4. Do you think the smart beta concept is readily applicable in other asset classes than equity?
Not currently allocated and
not considering; 10
Currently allocated and considering
further allocations; 9
Not currently allocated but considering; 7
Currently allocated; 10
Factor Optimised; 3
Risk Parity; 3
High-Dividend; 1
Minimum variance/Low volatility; 10Equal
weighted; 5
Fundamental indexation; 7
Maximum diversification/ Risk efficient indexation, 4
Other; 2
Factor Optimised; 14
Risk Parity; 2
High-Dividend; 5
Minimum variance/ Low
volatility, 7
Equal weighted; 3
Fundamental indexation; 4
Maximum diversification/ Risk efficient indexation, 7
Other; 1
Yes; 17
No; 8
2Sarasin Systematic
Source: EPFR, Nomura Quantitative strategy, September 2015
PercentagePercentage
SHARE OF INDEX-MANAGED EQUITIES
Source: EPFR, Nomura Quantitative strategy, September 2015
USD bnUSD bn
GLOBAL EQUITY MUTUAL FUND FLOWS ACTIVE PASSIVE
The inexorable trend of indexed products
-1500
-1000
-500
0
500
1000
1500
2000
2002 2004 2006 2008 2010 2012 2014
Active Indexed All funds
14
16
18
20
22
24
26
28
30
32
34
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
3Sarasin Systematic
Smart-Beta Strategies:
Differ from conventional discretionary investment processes as it is the process that dictates the investment decision
Follow a series of transparent rules which determine the decision to buy/sell securities and as a result systematic strategies can be indexed
Are designed to exploit risk premia and market anomalies
Can be considered as active investment products as they generate a tracking error versus market cap indices
Agreeing on a definition proved to be complicated
Where do systematic strategies sit in the active-passive space?
4Sarasin Systematic
Breaking down the outdated binary active / passive classification
Positioning Smart Beta in the active/passive space
PASSIVE
Investment Process
Non discretionary Discretionary
Systematic Quant
Market CapSmart-Beta /
Alternative Weighting
ACTIVE
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The US equity market presents an interesting opportunity:
Why considering a Smart Beta process?
Passive US Equity S&P have released research2 stating that the S&P 500
has historically achieved a low efficiency than alternative weighted indices
Large concentration in the large cap stocks3
Lack of risk/return efficiency4,5
$5.1 trillion is invested in the S&P 500 market cap weighted ETF
Active US Equity Active managers may have a hard time outperforming
the index- Only 3% of active US equity managers have
historically generated a true alpha1
Investors are paying a premium for active management which has not been rewarded
This opens the door for a systematic process that combines features of active and passive investing
1 E. F. Fama and K. R. French, Luck versus Skill in the Cross-Section of Mutual Fund Returns, The Journal of Finance, Volume 65, Issue 5, pages 1915–1947, October 20102 X. Kang, “Evaluating Alternate Beta Strategies”, S&P Dow Jones Indices, McGraw Hill Financial, March/April 20123 Y. Malevergne, P. Santa-Clara, D. Sornette, Professor Zipf goes to Wall Street. NBER Working Paper No. 152954 W. E. Ferson, S. Kandel, R.F. Stambaugh, “Tests of Asset Pricing with Time-Varying Expected Risk Premium and Market Betas”, Journal of Finance 42(2)5 F. Golz and V. Le Sourd, “Does Finance Theory Make the case for Capitalization-Weighted Indices?”, Journal of Index Investing 2
Morningstar Global Equity US ‐ Cumulative Returns 1yr 3yr 5yr 10yr
S&P 500 TR ‐0.6 (1) 42.0 (1) 87.0 (1) 93.0 (1)
Median Peer Group ‐3.4 33.5 64.9 59.9
Top Quartile ‐1.8 38.1 73.8 72.4
Source: Morningstar Direct, US Large Cap Blend Equity, 30.09.15, numbers in brackets refer to the quartiles
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Alternative weighting methodologies have historically performed better than the market cap S&P 500 because of the underlying risk premia
Traditional market cap investing can be inefficient- Large concentration in the large cap stocks1
- Lack of risk/return efficiency2,3
The challenges for investors are choosing which factors to use, when to use them, and how to combine them in a portfolio
US market cap vs alternative weighting methodologies
1 Y. Malevergne, P. Santa-Clara, D. Sornette, “Professor Zipf goes to Wall Street”, NBER Working Paper No. 152952 W. E. Ferson, S. Kandel, R.F. Stambaugh, “Tests of Asset Pricing with Time-Varying Expected Risk Premium and Market Betas”, Journal of Finance 42(2)3 F. Golz and V. Le Sourd, “Does Finance Theory Make the case for Capitalization-Weighted Indices?”, Journal of Index Investing 2
Alternative Beta Strategies Total Return
Total Risk Sharpe Ratio ActiveReturn
ActiveRisk
InformationRatio
S&P500 (Market Cap Weighted) 8.8 15.1 0.35
Equal-Weighted 11.2 16.9 0.47 2.5 5.7 0.4
Low-Volatility Strategy 10.2 11.4 0.60 1.4 9.9 0.1
Momentum Strategy 10.6 18.2 0.39 1.8 9.1 0.2
Fundamentally Weighted 9.6 15.6 0.40 0.8 4.0 0.2Source: Standard & Poor’s, Dow Jones Indices, Source: S&P Dow Jones Indices, FTSE, AQR Capital Management LLC. Data from December 31, 1990 to October 31, 2011. The Fundamentally Weighted Strategy is represented by MSCI USA Value weighted Index; the Equal-Weighted Strategy is represented by S&P 500 Equal Weight Index, the Low-Volatility Strategy is represented by S&P 500 Low Volatility Index, and the Momentum Strategy is represented by AQR US Large Cap Momentum Index. Some of the S&P 500 Equal Weight Index and S&P 500 Low Volatility Index data reflected in this chart may reflect hypothetical historical performance.
7Sarasin Systematic
Years 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
SizeS&P500 vs S&P500 Equally Weighted
73 months-7.2% p.a.
21 months-5.5% p.a.
14 months-5.8% p.a.
Low volatilityS&P500 vsS&P500 Low Volatility
110 months-8.4% p.a.
61 months-2.3% p.a.
25 months-9.8% p.a.
34 months-6.0% p.a.
MomentumS&P500 vs MSCI USA Momentum
18 months-5.4% p.a.
14 months-8.7% p.a.
22 months-8.1% p.a.
19 months-14.2% p.a.
ValueS&P500 vs MSCI USA Value
40 months-6.5% p.a.
21 months -4.9% p.a.
35 months-1.8% p.a.
11 months-2.7% p.a
Periods of prolonged relative underperformance
Source: Sarasin & Partners, March 2015. Data shown is relative return, computed using total return, monthly data in USD.
All risk premia have experienced periods of underperformance
8Sarasin Systematic
There is no arbitrage in risk-premia!
Risk-premia and more in general systematic strategies can experience prolonged periods of underperformance
Their validity is assessed in the long-run, hence this is more suited to an institutional clientele
Predicting when, for example, value outperforms momentum is difficult. For many decades quant managers have been developing dynamic models trying to identify which factor to be invested in, but:- The results produced did not always match expectations- Complexity has often proven to be a problem for investors
Risk-Premia: Lessons learned
We believe investors should focus on improving the efficiency of their portfolio rather than trying to optimise factor exposures
9Sarasin Systematic
Objective Outperform the market cap index over the medium to long term and across market cycles
Investment philosophy Efficiency: maximising portfolio returns over risk
Process Systematic – Long only – Fully invested – UCITs compliant
Rebalancing frequency Monthly
Stock selection Sarasin Efficiency Ratio
Asset Allocation Equal weighting
Risk-premia exposure 1. The momentum premium – strongest stocks will continue to perform2. The low volatility anomaly – stocks with lower volatility outperform stocks with higher volatility3. The size premium – small caps outperform large cap in the long run
Investments available Single country, regional, global
Core market exposure with enhanced diversification
Sarasin Systematic Efficient Approach
Momentum
Volatility
Size
10
Sarasin Systematic Efficient Index – World
Source: Bloomberg. 30.09.15. Please note this analysis contains simulated data and does not represent actual performance achieved by investors. Past performance is not a reliable guide to future performance. The simulation is calculated using USD total returns. Rebalancing occurs at the beginning of each month. No costs are included.
11
Sarasin Systematic Efficient Index – Europe
Source: Bloomberg. 30.09.15. Please note this analysis contains simulated data and does not represent actual performance achieved by investors. Past performance is not a reliable guide to future performance. The simulation is calculated using USD total returns. Rebalancing occurs at the beginning of each month. No costs are included.
12Sarasin Systematic
Sarasin Systematic Efficient Index – US
Source: Bloomberg. 30.09.15. Please note this analysis contains simulated data and does not represent actual performance achieved by investors. Past performance is not a reliable guide to future performance. The simulation is calculated using USD total returns. Rebalancing occurs at the beginning of each month. No costs are included.
13Sarasin Systematic
This document is for investment professionals only and should not be relied upon by private investors.This promotion has been approved by Sarasin & Partners LLP of Juxon House, 100 St Paul’s Churchyard, London, EC4M 8BU, a limited liabilitypartnership registered in England & Wales with registered number OC329859 which is authorised and regulated by the Financial Conduct Authoritywith firm reference number 475111 and passported under MiFID to provide investment services in the Republic of Ireland.The investments of the strategy are subject to normal market fluctuations. The value of the investments of the strategy and the income fromthem can fall as well as rise and investors may not get back the amount originally invested. If investing in foreign currencies, the return inthe investor’s reference currency may increase or decrease as a result of currency fluctuations. Past performance is not a guide to futurereturns and may not be repeated.There is no minimum investment period, though we would recommend that you view your investment as a medium to long term one (i.e. 5 to 10years). The strategy will be implemented either by physically replicating the full efficient portfolio or by using a structured product. In the latter casethis will involve the use of derivatives. The value of these investments may fluctuate significantly. Investing in a concentrated portfolio of stocks willtend to expose the strategy to greater fluctuations in the prices of stocks within the portfolio than a strategy spread across a large number of stocks,and will therefore carry more risk.Neither Sarasin & Partners LLP nor any other member of Bank J. Safra Sarasin Ltd. accepts any liability or responsibility whatsoever for anyconsequential loss of any kind arising out of the use of this document or any part of its contents. The views expressed in this document are those ofSarasin & Partners LLP and these are subject to change without notice.
© 2015 Sarasin & Partners LLP – all rights reserved. This document can only be distributed or reproduced with permission from Sarasin & PartnersLLP. Please contact [email protected].
Important Information
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