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The Illusion of Cheap Beta from ETFs. There is a Solution. Tel Aviv Institutional Investment Conference 2012. Tim Matthews. Senior Fund Manager, QEP Investment Team. March 2012. For professional investors or advisers only. Not for distribution.

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The Illusion of Cheap Beta from ETFs

There is a Solution

Tel Aviv Institutional Investment Conference 2012

Tim Matthews

Senior Fund Manager, QEP Investment Team

March 2012

For professional investors or advisers only. Not for distribution.


Market Cap weighted Index Funds (and Passive ETFs)

The positives and negatives


  • Diversification – reduces the risk of single stock damaging your portfolio
  • Systematic – creates a repeatable and transparent investment
  • Fees for “index” solutions are typically lower – but what about ETFs?


  • Concentrated – excessive stock concentration in certain indices e.g. Vodafone, oil stocks
  • Lack of breadth – universe restriction limits opportunities e.g. Emerging Markets
  • Anti-Value – encourages investors to buy high and sell low e.g. Tech stocks

Market Cap weights follow momentum

Back the winners of yesterday and losers of tomorrow

Technology/Telecoms bubble

of 1999/2000

Japanese stock market bubble

of the late 1980s

% Weight

% Weight

44% of MSCI World is comprised of Japanese stocks here

36% of MSCI World is comprised of tech stocks here

Source: Schroders, MSCI


indices can restrict your investment universe
Indices can restrict your investment universe

Significant opportunities exist outside of the index

  • Typical indices like MSCI World only cover large cap stocks from developed markets
  • Significant opportunities from emerging markets, small and mid caps
  • We believe there is a global investible universe of 15,000 stocks compared with only 1,613 stocks in MSCI World

MSCI World

Emerging markets

Mid caps

Small caps

Source: Schroders, MSCI. MSCI index constituents as at 31st January 2012.


exploiting every opportunity

MSCI AC World >2,400 stocks 45 countries

MSCI World >1,600 stocks 24 countries

Exploiting every opportunity

All global stocks > 15,000 stocks > 50 countries

MSCI Europe

Source: Schroders, MSCI as at 31st January 2012

benchmarks typically concentrated in big stocks
Benchmarks typically concentrated in big stocks

Market Cap weighted indices will always be biased to the biggest stocks

MSCI World by size

Schroders global universe by number

Source: Schroders, MSCI. MSCI World as at 31st January 2012

Big doesn’t mean better so why concentrate to mega/large cap stocks?


Backing the largest stocks has underperformed

Backing yesterday’s winners not necessarily a smart strategy

Underperformance of largest stocks

  • Historically, mega caps have underperformed.
  • From 1926 to 2004, if each year you had bought the 10 largest stocks in the S&P 500 you would have under-performed the market average by 3% pa for the next 10 years

% pa

Source: Robert D. Arnott. FAJ March/ April 2005

challenging conventional wisdom in global equities
Challenging Conventional Wisdom in Global Equities

Conventional wisdom

Our approach

Embrace breadth

Be unconstrained

Systematically rebalance

Diversification can increase returns (not reduce them!)

Focus on Value and Quality

  • Follow benchmarks, go passive and use Cap weighted index funds or ETFs
  • Only concentrated portfolios give high conviction
  • Big stocks are better

Alternatives to Passive

The pros and cons of market cap-weight index solutions revisited

Passive IndexAlternative Solution


  • Diversification Yes Yes
  • Systematic & Transparent Yes Yes
  • Low management fees Yes Yes (if fee is justifiable)


  • Concentration No (too concentrated) Yes (reduced concentration)
  • Breadth No (limited breadth) Yes (maximise opportunity)
  • Return Drivers No (buy high, sell low) Yes (clear investment rationale)
the alternative solution
The Alternative Solution

A strategic approach to investing

Start with the fundamentals: Quality of business and stock valuations

Quant advantage:Portfolio construction maximises the opportunity across a global universe of over 15,000 stocks

Decisions taken by the Portfolio Manager:Emphasis on understanding the current environment & forward-looking research


So does this work in practice?

An enhanced-index approach as an example

  • Performance needs to be repeatable
  • Needs to work in different market environments

Relative Performance – Gross of Fees in USD

Since inception*

Relative Return = +1.3% p.a.

Tracking Error = 1.1%

Information Ratio = 1.2

Source: Schroders. Schroder QEP Global Core composite compared with MSCI World NDR. Past performance is no guarantee of future results.. * since inception 31 January 2000.



How does it look over the longer term?

Compounding of returns adds value to the long-term investor

Performance Since Inception (%)

  • Lower performance target e.g. Index +1% pa
  • Limited index-relative risk
  • A commensurate fee

Source: Schroders. Schroder QEP Global Core Composite compared with MSCI World NDR in USD from 31 January 2000 to 30 December 2011. Assumes TER of 51bps.



A Superior Alternative to ETFs

…with index plus rather than index minus performance

Source: Bloomberg as at 29th February 2012 with total returns in USD net of fees. Schroder ISF Global Core C Share Class (BB ticker: SCHGLEC) – TER 51bps. Fund inception date: 30th September 2001. iShares MSCI World (BB ticker: IDWR) – TER 50bps, Lyxor ETF MSCI World (BB ticker: LYWLD) – TER 45bps


What are the key return drivers?

Rebalancing versus momentum

  • Contra-trading against market fads (e.g. rebalancing)
  • Need an anchor that is not price sensitive
  • This anchor can be anything measurable (equal weighting or even the length of a company’s name)
  • How do we define Value? Dividends, Cash, Earnings, Sales & Assets

Cumulative return

Source: Schroders, Worldscope, QEP. The Equally weighted index and “Length of company name” indices were both calculated using the same universe as the Fundamental Index (simulated by QEP) Developed 1000 index and rebalanced in March of each year with stocks either weighted equally or weighted by the length of the company name (companies with longer names were assigned higher weights). All returns are local (gross).


What are the key return drivers?

Quality performs when risk aversion is rising

Monthly win rate higher in times of market stress


  • An alternative approach to value investing
  • Quality is ‘Growth style’ investing without the return drag associated with purchasing glamour stocks
  • How do we define it?Profitability, Stability, Financial Strength










Down Markets

Up Markets

Volatile Markets

Stable Markets

Source: Schroders, QEP. Live performance has been included from November 2007 to October 2010 onwards prior to this simulated results are shown back to 1988. They are the result of quantitative back-testing which are based on a number of assumptions. There are a number of limitations on the retroactive reconstruction of any performance results based on simulations and simulated results must be considered as no more than approximate representation of the strategy’s potential performance.



QEP Global Equity Funds

A proven track record

Returns of QEP Global Equity Funds versus index and ETF

Source: MSCI, Schroders as at 31st January 2012. Cumulative and annualised returns, calculated net of fees, USD. Benchmark is MSCI World Net Dividends Reinvested




A range of solutions for different types of client

  • Highly Fee-Sensitive Clients with a preference for the Index QEP Global Core
    • Incremental, repeatable returns compound over time to be significant
  • Longer Horizon Investors Looking to Harvest the Equity Risk Premium QEP Global Value
    • Unconstrained strategies offer higher relative returns to those willing to step away from the index
  • Risk-Averse Equity Investors with a Shorter Investment Horizon QEP Global Quality
    • Quality strategies work well in distressed markets which is often when pension fund investors are most interested in their investments
  • The QEP Investment Team has over US$ 20bn of assets under management
  • Majority of clients are sophisticated institutional investors who have discovered there is an alternative way to invest in Global Equities

Source: Schroders as at 30th September 2011


This presentation is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations.

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