The A,B & C of Returns
A : Alpha
B : Beta
C : Gamma
Breaking Down Returns
ALPHA
Uncertain
GAMMA
BETA
Certain
B: Beta
1 Costs erode investment returns
1.
2 To be an investor not a speculator
2.
3 The arithmetic of active management
3.
1 Costs Erode Investment Returns
1.
The Gotrocks parable..
Structural
Total Cost
Behavioral
Source: Rick Ferri, 3 Costs Investors Must Control
Taxes
Structural
Table 1: US Equity Mutual Fund Returns Sorted by Fund Expenses 1991-2013
Fund Expense Ratio
Time Weighted Return
Low
9.22%
2
8.85%
3
8.35%
4
7.84%
High
6.88%
Source: Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies by Jason Hsu, Brett Myers and
Ryan Whitby. Rick Ferri ‘3 costs and investor must control’.
Behavioral
Table 2: US Equity Mutual Fund Returns Sorted by Fund Expenses 1991-2013
Fund Expense
Ratio
Dollar Weighted
Return
Time Weighted
Return
Difference
Low
7.88%
9.22%
-1.34%
2
6.93%
8.85%
-1.92%
3
6.07%
8.35%
-2.28%
4
4.80%
7.84%
-3.04%
High
2.87%
6.88%
-4.01%
Source: Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies by Jason Hsu, Brett Myers and
Ryan Whitby . Rick Ferri ‘3 costs investors must control’.
2 Investing not speculating
2.
Investment Return Versus Market Return
Source: John Bogle's Keynote Speech – The Money Show - What's Ahead for Stocks and Bonds - And How to Earn Your Fair Share,
May 15, 2006
3 Playing the winners game
3.
Weighted Average Return of the Market for Any
Given Period
1% +
< 0.3%
ACTIVE
PASSIVE
LOSER
WINNER
C: What is Gamma?
C : Gamma
1
2
3
4
5
Tax : Asset Allocation / Withdrawal
Asset Allocation : Risk preference vs. Risk capacity
Annuity Allocation : Hedge
Dynamic Withdrawal Strategy : Revisit assumptions
Match liabilities with investment strategies
A: Alpha
Alpha
ALPHA
Pure Manager
Skill
GAMMA
Smart Beta / Factor
Based Investing
BETA
Smart Beta
• “Severing index weighting from price”
• “Price weighting the “Achilles heal” of Market Cap Index”
Rob Arnott, founder of RAFI
Breaking Down the Factors:
Market
Companies with high and
sustainable profitability
outperform
Co-movement with the overall
equity market (beta)
Quality
Value
Relatively cheap stocks
outperform expensive ones
Return Drivers of
Equity Markets
Small cap stocks tend to
outperform large cap stocks
Size
Capture of trends and
patterns in the market
Source: Goldman Sachs
For illustrative purposes only
Volatility
Momentum
Low risk stocks tend to
outperform high risk stocks
over the long term
Smart Beta: 2015 Global Survey (Russell)
1
Which Best Describes Your Organization’s Usage of Smart Beta
Strategies?
100%
90%
19%
Do not anticipate evaluating
smart beta in the next 18
months
0% to 5%
16%
15%
Anticipate evaluating smart
beta in the next 18 months
6% to 10%
18%
23%
Currently evaluating smart
beta
11% to 15%
Evaluated and decided not to
implement
16% to 20%
2%
23%
80%
70%
What % of Your Organization’s Equity Portfolio
is Invested in Smart Beta Strategies?
2
24%
22%
60%
50%
40%
30%
22%
20%
10%
40%
20%
Have smart beta allocation
0%
3
22%
Over 20%
21%
North America
13%
0%
Europe
5%
10%
15%
20%
25%
What Smart Beta Strategies Have You Evaluated or Are You Currently Evaluating?
67%
Low volatility
47%
41%
41%
32%
31%
Multi-factor
combination
Fundamental
Value
Minimum
variance
Equal
weight
Source: Smart beta: 2015 global survey findings from asset owners
(1) 214 asset Owners. Sample size for $10B+ for Europe is 19 and below preferred threshold of 30
(2) Segment: Participants who have smart beta allocation
(3) Segment: Participants Have smart beta allocation, Evaluated and decided not to implement or Currently evaluating smart beta
30%
Low-Volatility Portfolios Performance
Low Volatility Anomaly Hypothesis
1
•
Leverage aversion
2
• Lotteries
3
• Delegated Agency Model
• Analyst Optimism
4
All of these seem to suggest that the performance advantage of low
volatility stocks are robust and potentially hard to eliminate
In Summary




Keep costs low
Bank on Beta
Far more to financial advice than the pursuit of Alpha
Factor Indices
 Active strategies: commoditized
 Reliable, consistent and low cost
Thank You, Questions?
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