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For financial professional or qualified institutional investor use only.
Not for inspection by, distribution or quotation to, the general public.
IM0517-34449-0518 NCPERS
Going Beyond Style Box Investing
NCPERS
Presented by
Erin Doyle Orekhov, Client Portfolio Manager
May 22, 2017
2
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Session Description
Going Beyond Style Box Investing
While the advent of the style box in the 1990s has provided a useful framework for constructing a diversified
equity portfolio, investing strictly within the style box framework may create portfolio gaps that can lead to
unintended consequences. This presentation aims to help plan sponsors think about 1) how they can go
beyond the confines of style boxes to help participants achieve a secure retirement; 2) how outcome-
oriented approaches can help balance between maximizing total return and minimizing volatility; and 3)
what they should look for when evaluating outcome-oriented strategies.
3
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Table of Contents
How we got here
Why we need to think outside the box
Thinking outside the box
Thinking outside the box: a case study
Key takeaways
4
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How We Got Here
5
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
History of The Style Box Approach
Large
Medium
Small
Value Blend Growth
Morningstar Style Box TM
6
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
A Strong Case for Diversification
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Emerging Market Equity Intermediate Bond
Commodities Short Term Bond Emerging Market Equity
TIPS Global Bonds High Yield Bond
Developed International
TIPS Senior Debt U.S. Small Cap REITs
REITs Global Bonds High Yield Bond U.S. Mid Cap U.S. Mid Cap TIPS Emerging Market Equity
Emerging Market Equity Intermediate Bond Senior Debt REITs REITs Intermediate BondDeveloped
InternationalU.S. Small Cap
Developed International
Short Term Bond U.S. Small CapDeveloped
InternationalEmerging Market Equity Global Bonds U.S. Mid Cap U.S. Small Cap High Yield Bond
U.S. Small Cap U.S. Mid Cap Commodities U.S. Small Cap Commodities High Yield Bond U.S. Small Cap U.S. Mid Cap REITs U.S. Mid Cap
U.S. Large Cap Calendar Year Returns
15.8% 5.5% -37.0% 26.5% 15.1% 2.1% 16.0% 32.4% 13.7% 1.4% 12.0%
U.S. Mid Cap High Yield Bond U.S. Mid Cap Commodities High Yield Bond Short Term Bond High Yield BondDeveloped
InternationalU.S. Mid Cap REITs Commodities
High Yield Bond Senior DebtDeveloped
InternationalTIPS Senior Debt Senior Debt Senior Debt High Yield Bond Intermediate Bond Short Term Bond Emerging Market Equity
Senior Debt U.S. Small Cap REITs Global BondsDeveloped
InternationalU.S. Mid Cap TIPS REITs U.S. Small Cap Intermediate Bond Senior Debt
Global Bonds REITs Emerging Market Equity Intermediate Bond Intermediate Bond U.S. Small Cap Global Bonds Senior Debt TIPS Senior Debt REITs
Intermediate Bond Short Term Bond TIPS REITs Intermediate Bond Short Term Bond High Yield BondDeveloped
InternationalTIPS
Short Term Bond Global BondsDeveloped
InternationalShort Term Bond Intermediate Bond Senior Debt TIPS Intermediate Bond
Commodities Short Term Bond Commodities Commodities Global Bonds Short Term Bond U.S. Mid Cap Global Bonds
TIPS Emerging Market Equity Emerging Market Equity Global Bonds Global Bonds Short Term Bond
TIPS Emerging Market Equity U.S. Small CapDeveloped
International
CommoditiesDeveloped
InternationalHigh Yield Bond
Commodities Emerging Market Equity
Commodities
Source: Morningstar Direct.
7
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Why We Need to Think Outside the Box
8
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
A Slightly Different Perspective on the Style Box
Large
Medium
Small
Value Blend Growth
Morningstar Style Box TM
9
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Challenges Facing Plan Sponsors in Today’s World
Fiduciary Responsibility
The Search for Yield
Volatility
Interest Rate Risk
10
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Volatility: why do we care?
Compounded returns for high volatility stocks are dramatically lower
For illustrative purposes only. Data shown above represents performance for the Russell 1000 Index from 1/1/97 – 12/31/15. Past performance is no assurance of future results.
Source: Voya IM and FactSet.
4%
6%
8%
10%
12%
10% 15% 20% 25% 30%
Re
turn
Risk
Compounded Returns
Average Returns
Q1
(Lowest
Vol)
Q5
(Highest
Vol)
Volatility Drag
11
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Fees
Active vs. Passive Management
For illustrative purposes only. Source: Voya Investment Management and Zephyr Style Advisor.Category median represents the 50th percentile breakpoint for the Morningstar Large Cape Growth category at the end of each rolling 3-year period as calculated by Zephyr Style Advisor. Rolling 36-month data from December 1961-December 2015 completed monthly. Performance is no guarantee of future results.
12
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Thinking Outside the Box
13
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How to Identify and Fill the Gaps: A New Paradigm
Large
Medium
Small
Value Blend Growth
V
O
L
A
T
I
L
I
T
Y
FEE PRESSURE
ETFs SMART BETA
Morningstar Style Box TM
14
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Building Blocks for Delivering Cost-Effective, Custom Solutions
Partnership between plan
sponsor and manager
Collaboration
Willingness to consider a solution that
does not fit in a style box and hire a
manager based on back-tested results
Thinking “outside the box”
Deeper due diligence and analysis on
how a manager will fit into the overall
portfolio
Analytics
15
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Back-testing: De-Mystifying the Black Box
Look for managers that:
• Use multiple factors
• Test the efficacy of
factors over a range of
market environments
• Look for factors that
have low correlation to
one another
Look for managers that:
• Provide transparency around methodology and results
• Avoid “look ahead” bias, survivorship bias, and data mining
• Use multiple factors, test the efficacy of factors over a range of market
environments, and look for factors that have low correlation to one another
16
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Assessing Multiple Factors Over a Range of Market Environments
2009 2010 2011 2012 2013 2014 2015 2016 2017
Earnings
momentum0% 0% 0% 15% 17% 11% 5% 0% 0%
Earnings
growth2% 0% 7% 0% 0% 0% 0% 0% 0%
Price
Momentum 2% 0% 1% 0% 0% 0% 0% 0% 0%
Cash to
EV1% 0% 0% 0% 0% 0% 0% 0% 0%
Tangible
Book Yield12% 25% 25% 16% 1% 6% 0% 7% 1%
Dividend
Yield17% 5% 4% 10% 21% 12% 9% 11% 10%
For illustrative purposes only.
17
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Thinking Outside the Box: A Case Study
18
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Case Study: Building a Portfolio to Meet a Style Box Gap - Volatility
Plan Sponsor Objectives
Generate income
Low volatility and strong downside capture (lower risk)
Maximize total return
“Off the Shelf” Solutions
Large Cap Value (Style Box Solution)
Low/Min Vol ETF (Passive Solution)
Unintended Consequences:
No explicit beta target
Overexposed to sectors that are
interest-rate sensitive
Custom Solution
Sector-neutral
Low beta
Robust alpha source
Above-benchmark
dividend yield
19
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Case Study: Pitfalls of “Off the Shelf” Solutions
27.5%
-27.3%
24.1%
-24.1%
-40
-30
-20
-10
0
10
20
30
40
Defensive Cyclical
Activ
e S
ecto
r W
eig
hts
(%
)
S&P Low Vol vs. S&P 500 MSCI Min Vol vs. MSCI USA
Sector crowding
For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98 -12/31/15. Past performance is no assurance of future results. Interest rate sensitivity
measures the sensitivity of returns to the change in 10-year bond yields.
20
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Case Study: Pitfalls of “Off the Shelf” Solutions
Correlation to interest rates
DiversifiedEnergy Materials
Banks
TechDiscretionaryIndustrials
InsuranceHealth Care
StaplesTelecom
Real Estate
Utilities-0.15
-0.10
-0.05
0.00
0.05
0.10
0.15
0.40 0.60 0.80 1.00 1.20 1.40 1.60
Inte
rest
Ra
te S
en
siti
vity
Equity Market Beta (β)
Cyclical
Defensive
For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98 -12/31/15. Past performance is no assurance of future results. Interest rate sensitivity
measures the sensitivity of returns to the change in 10-year bond yields.
21
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Case Study: Pitfalls of “Off the Shelf” Solutions
Managing downside protection
4.3%
-2.5%-3.0%
-3.2%
-6.0%
-2.0%
2.0%
6.0%
10-YR Yield Russell 1000 Index S&P Low Vol ETF S&P High Div Low Vol ETF
For illustrative purposes only. Source: Voya IM and FactSet. Data as of 1/1/98 -12/31/15. Past performance is no assurance of future results. Interest rate sensitivity
measures the sensitivity of returns to the change in 10-year bond yields.
22
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Case Study: A Different Framework for Evaluating an Outcome-Oriented
Mandate, Focused on Desired Outcomes
Higher Income
0
1
2
3
4
Dec
-99
Dec
-01
Dec
-03
Dec
-05
Dec
-07
Dec
-09
Dec
-11
Dec
-13
Dec
-15
Div
iden
d Y
ield
(%
)
Rolling 3-Year Average Dividend Yield
Voya High-Dividend Low Volatility R1000
Performance data from 01/01/97 – 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly.
Source: FactSet and Voya Investment Management. Past performance is no assurance of future results.
Sample low volatility strategy
23
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Lower Risk
-30%
-25%
-20%
-15%
-10%
-5%
0%
Dec-9
9
Dec-0
1
Dec-0
3
Dec-0
5
Dec-0
7
Dec-0
9
Dec-1
1
Dec-1
3
Dec-1
5
Risk Reduction versus the Russell 1000 Index3 Year Rolling Standard Deviation (January 1, 1997 - December 31, 2015)
Performance data from 01/01/97 – 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly.
Source: FactSet and Voya Investment Management. Past performance is no assurance of future results.
Case Study: A Different Framework for Evaluating an Outcome-Oriented
Mandate, Focused on Desired Outcomes
24
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Maximize Total Return
-20
-15
-10
-5
0
5
10
15
20
25
30
35
-20 -10 0 10 20 30 40
Manager
Retu
rns
Index Returns
Voya High-Dividend Low Volatility Equity vs. Russell 1000 Index3 Year Rolling Returns (January 1, 1997 - December 31, 2015)
Manager Outperformancevs. the Benchmark
93%
Case Study: A Different Framework for Evaluating an Outcome-Oriented
Mandate, Focused on Desired Outcomes
Sample low volatility strategy vs. Russell 100 Index
Performance data from 01/01/97 – 12/31/15 is based on a simulated portfolio vs. Russell 1000 Index, rebalanced quarterly.
Source: FactSet and Voya Investment Management. Past performance is no assurance of future results.
25
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Key Takeaways
26
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Why You Need to Think Outside of the Style Box
Unintended risks of pure style box approach
Changing market structure
Benefits of custom solutions
Last but not least…
1
2
3
4
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The #1 reason we all need to think outside the box
28
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Appendix
29
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
This information is proprietary and cannot be reproduced or distributed. Certain information may be received from sources Voya
Investment Management (“Voya IM”) considers reliable; Voya IM does not represent that such information is accurate or complete.
Certain statements contained herein may constitute “projections,” “forecasts” and other “forward-looking statements” which do not
reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical
financial data. Actual results, performance or events may differ materially from those in such statements. Any opinions, projections,
forecasts and forward-looking statements presented herein are valid only as of the date of this document and are subject to change.
Nothing contained herein should be construed as (i) an offer to buy any security or (ii) a recommendation as to the advisability of
investing in, purchasing or selling any security. Voya IM assumes no obligation to update any forward-looking information.
Past performance is no guarantee of future results.
©2017 Voya Investments Distributor, LLC • 230 Park Ave, New York, NY 10169. All rights reserved.
Disclosure
30
For financial professional or qualified institutional investor use only. Not for inspection by, distribution or quotation to, the general public.
Backtested Performance Information
Backtested performance is NOT an indicator of future actual results. The results reflect the performance of a strategy
not historically offered to investors and do not represent returns that any investor actually attained. Backtested results
are calculated by retroactive application of a model constructed on the basis of historical data and based on
assumptions integral to the model which may or may not be testable and subject to losses.
General assumptions include that the firm would have been able to purchase the securities recommended by the
model and the markets were sufficiently liquid to permit all trading. Changes in these assumptions may have a
material impact on the backtested returns presented. Certain assumptions have been made for modeling purposes
and are unlikely to be realized. No representations and warranties are made as to the reasonableness of the
assumptions. This information is provided for illustrative purposes only.
Backtested performance is developed with the benefit of hindsight and has inherent limitations. Specifically,
backtested results do not reflect actual trading or the effect of material economic and market factors on the decision
making process. Since trades have not actually been executed, results may have under- or over-compensated for the
impact, if any, of certain market factors may have had on a decision-making process. Further, backtesting allows the
security selection methodology to be adjusted until past returns are maximized. Actual performance may differ
significantly from backtested performance.
Backtested results are adjusted to reflect the reinvestment of dividends and other income and except where otherwise
indicated, are presented gross-of fees and do not include the effect of backtested transaction costs, management
fees, performance fees or expenses, if applicable. No cash balance or cash flow is included in the calculation.
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