The A,B & C of Returns A : Alpha B : Beta C : Gamma.

The A,B & C of Returns

A : Alpha B : Beta C : Gamma

BETA

GAMMA

ALPHA

Breaking Down Returns

Uncertain

Certain

B: Beta

1. Costs erode investment returns 2. To be an investor not a speculator 3. The arithmetic of active management

1

2

3

1. Costs Erode Investment Returns 1

The Gotrocks parable..

Taxes

Total Cost

Behavioral

Structural

Source: Rick Ferri, 3 Costs Investors Must Control

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’.

Structural

Table 1: US Equity Mutual Fund Returns Sorted by Fund Expenses 1991-2013

Behavioral

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’.

Table 2: US Equity Mutual Fund Returns Sorted by Fund Expenses 1991-2013

2. Investing not speculating 2

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

Investment Return Versus Market Return

3. Playing the winners game 3

Weighted Average Return of the Market for Any Given Period

PASSIVE ACTIVE

< 0.3% 1% +

WINNERLOSER

C: What is Gamma?

C : Gamma

Tax : Asset Allocation / Withdrawal Asset Allocation : Risk preference vs. Risk capacity Annuity Allocation : Hedge Dynamic Withdrawal Strategy : Revisit assumptions Match liabilities with investment strategies

1

2

3

4

5

A: Alpha

BETA

GAMMA

ALPHA

Smart Beta / Factor Based Investing

Pure Manager Skill

Alpha

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:

Source: Goldman SachsFor illustrative purposes only

Market

Value

Volatility

Momentum

Size

Quality

Return Drivers of Equity Markets

Co-movement with the overall equity market (beta)

Relatively cheap stocks outperform expensive ones

Low risk stocks tend to outperform high risk stocks over the long term

Capture of trends and patterns in the market

Small cap stocks tend to outperform large cap stocks

Companies with high and sustainable profitability

outperform

Smart Beta: 2015 Global Survey (Russell)

North America Europe0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

21%

40%

22%

23%18%

15%16%

19%23%

2%Do not anticipate evaluating smart beta in the next 18 months

Anticipate evaluating smart beta in the next 18 months

Currently evaluating smart beta

Evaluated and decided not to implement

Have smart beta allocation

Which Best Describes Your Organization’s Usage of Smart Beta Strategies?

What % of Your Organization’s Equity Portfoliois Invested in Smart Beta Strategies?

Over 20%

16% to 20%

11% to 15%

6% to 10%

0% to 5%

0% 5% 10% 15% 20% 25% 30%

20%

22%

13%

22%

24%

67% 47% 41% 41% 32% 31%

What Smart Beta Strategies Have You Evaluated or Are You Currently Evaluating?

Low volatilityMulti-factorcombination Fundamental Value

Minimumvariance

Equalweight

1 2

3

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

Low-Volatility Portfolios Performance

Low Volatility Anomaly Hypothesis• Leverage aversion• Lotteries• Delegated Agency Model• Analyst Optimism

All of these seem to suggest that the performance advantage of low volatility stocks are robust and potentially hard to eliminate

1

2

3

4

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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