investment advisory solutions

134 Pages·2017·8.82 MB·English

ADVANCING THE FUTURE OF
INVESTMENT ADVISORY SOLUTIONS
Journal of
INVESTMENT ADVISORY
SOLUTIONS
Volume 1 n Number 1 n Fourth Quarter 2017
Inside
INVESTMENT ADVISORY SOLUTIONS
DATA AND INSIGHTS
broad trends in market segments and product
development and usage
ACTIVE AND PASSIVE
balanced perspective on the appropriate use of
active and passive strategies
BUSINESS MODEL EVOLUTION
how distributor, asset manager and advisor
business models are changing
Money M an2age0mentT IHnstitute MoneyM an2age0mentTHInstitute
ANNIVERSARY
WWW.MMINST.ORG
Journal of
INVESTMENT ADVISORY SOLUTIONS
BOARD OF GOVERNORS
Roger Paradiso Marilee Ferone Thomas Malone Ram Subramaniam
Chairperson, MMI UBS Financial Services Lord Abbett Fidelity Brokerage
Board of Governors, Services
Keith Glenfield John Moninger
Legg Mason
Bank of America Eaton Vance Eric Sutherland
Jennifer Abate Merrill Lynch PIMCO
Cheryl Nash
Lazard Asset
Matthew Johnson Fiserv Investment Pete Thatch
Management
Brandes Investment Services Capital Group
David Berkowitz Partners
Greg Nordmeyer Troy Thornton
Lincoln Financial
Carl Katerndahl Ameriprise Financial Goldman Sachs
Network
Nuveen Investments Services
William Turchyn
Yanni Bousnakis
Scott Kilgallen Daniel O’Lear Mariner Investment
Cetera Financial Group
Neuberger Berman Franklin Templeton Group
John Brett Investments
Eric Koestner Jake Tuzza
Pershing LLC
Edward Jones Kevin Osborn Voya Investment
Marc Brookman Envestnet Management
Michael Lewers
Morgan Stanley
BlackRock Stuart Parker Burton White
Wealth Management
PGIM Investments LPL Financial
David Lindenbaum
John Coyne
Charles Schwab & Co. Craig Pfeiffer Bebe Wilkinson
Brinker Capital
Money Management MassMutual
Andrea Lisher
Jeffrey Cusack Institute
J.P. Morgan William Golden
Nuveen Investments
Joseph Schultz MMI Board Advisor
Patty Loepker
Jeff Dowdle American Century
Wells Fargo Advisors John Sweeney
Raymond James Investments
MMI Board Advisor
Financial
MMI JOURNAL OF INVESTMENT ADVISORY SOLUTIONS
Volume 1 n Number 1 n Fourth Quarter 2017
©2017 Money Management Institute. All rights reserved. Articles may be reprinted only with the
permission of the Money Management Institute (MMI) and the respective author(s).
The MMI Journal of Investment Advisory Solutions is published by MMI for the use of its members.
The publication focuses on thought leadership, including reports, articles, and commentary,
from respected subject matter experts and authorities, on topics critical to the ongoing evolution
of investment advisory solutions. The publication is intended to provide accurate and informed
information on the topics covered. The commentary provided by the authors who appear in the
Journal does not necessarily represent the opinions of MMI, its staff, Board of Governors, or
members. Neither MMI nor its staff, Board of Governors, or members is responsible for facts and
opinions contained in the reports, articles, and commentary herein.
Article submissions and questions about the Journal can be directed to Joan Lensing at
[email protected] or [phone].
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CONNECT KNOW GROW
Volume 1 n Number 1 n Fourth Quarter 2017
TABLE OF CONTENTS
Letter to Members 4
Investment Advisory Solutions Data and Insights 5
broad trends in market segments and product development and usage
Calculating Upside/Downside Capture Ratios for
Equity Hedge and Tactical Managers 6
Ricardo L. Cortez, CIMA, Broadmark Asset Management LLC
Discovering Phi: Motivation as the Hidden Variable of Performance 13
The Center for Applied Research (State Street Corporation) | CFA Institute
Blockchain Innovation in Wealth and Asset Management:
Benefits and Key Challenges to Adopting this Technology 69
EY (Ernst & Young)
Sustainable Investing: Investor’s Guide to Corporate Governance 85
Stephen Freedman, CFA and Renato Grandmont, UBS
Active AND Passive 100
balanced perspective on the appropriate use of active and passive strategies
Active Versus Passive Investing: Our Perspective 101
Lockwood Advisors | BNY Mellon
The Death of Active Management Has Been Greatly Exaggerated:
Active investing will never die, but it’s being forced to evolve. 105
Ben Johnson, CFA, Morningstar
Business Model Evolution 108
how distributor, asset manager and advisor business models are changing
Links in the Chain: Why Asset Managers Must Embrace the Digital Revolution 109
Artivest
Behavioral Alpha: An Advisor’s Greatest Value 113
Dr. Daniel Crosby, The Center for Outcomes | Brinker Capital
TAMP Market Overview 120
FUSE Research Network
Why Advisors Have Never Been So Valuable: 2017 Value of an Advisor Study 126
Russell Investments
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ADVANCING THE FUTURE OF INVESTMENT ADVISORY SOLUTIONS
CONNECT KNOW GROW
Journal of
INVESTMENT ADVISORY SOLUTIONS
LETTER TO MEMBERS
December 2017
To MMI Members and Friends,
As MMI concludes its 20th anniversary celebration, we are pleased to introduce you to a
new MMI publication—the MMI Journal of Investment Advisory Solutions—a compendium
of original research reports and articles by industry thought leaders and subject matter
experts. In launching the Journal, our goal is to collect and present to members informed
perspective on topics critical to the ongoing evolution of investment advisory solutions.
For this inaugural Journal, we called for submissions addressing three specific topics:
• Investment Advisory Solutions Data and Insights—broad trends in market segments
and product development and usage,
• Active AND Passive—balanced perspective on the appropriate use of active and passive
strategies, and
• Business Model Evolution—how distributor, asset manager and advisor business models
are changing.
We were extremely pleased by the strong response and the quality of the submissions
received, and we extend our special thanks to those industry partners whose work appears
in this first edition. Our plan is to publish the Journal on a biannual basis. We trust you
will find this new resource valuable and look forward to your feedback.
Roger Paradiso Patty Loepker Craig Pfeiffer
MMI Chairman MMI Chair Elect President & CEO
Legg Mason Wells Fargo Advisors Money Management Institute
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CONNECT KNOW GROW
Volume 1 n Number 1 n Fourth Quarter 2017
INVESTMENT ADVISORY SOLUTIONS
DATA AND INSIGHTS
broad trends in market segments and product
development and usage
5
ADVANCING THE FUTURE OF INVESTMENT ADVISORY SOLUTIONS
CONNECT KNOW GROW
Journal of
INVESTMENT ADVISORY SOLUTIONS
Calculating Upside/Downside Capture Ratios
for Equity Hedge and Tactical Managers
Ricardo L. Cortez, CIMA
Broadmark Asset Management LLC
Summary securities. This approach is used because the goal of
these managers is primarily to regulate the exposure
The upside/downside capture ratio is an important
of the portfolio to the market rather than the selection
analytical tool for the investment management
of individual long and short securities. Tactical
consultant. While they may be calculated for managers
strategies are more directional in nature.
in all asset classes, in this paper we focus on upside/
downside capture ratio calculations for equity hedge Upside/downside capture ratios for tactical managers
and tactical managers. We believe that the time period should provide insight into their ability to manage
used with the ratio is significant when evaluating each systemic risk and preserve capital during down market
of these types of managers. cycles. We suggest that the best way to achieve this goal
is to use a time period that is related to the overall
For the purposes of this paper, we define those
market environment—e.g., up, down, flat, volatile
managers who are generally hedged (usually long
cyclical markets—which may be longer than their
and short at all times) as “equity hedge.” This
monthly variance versus a benchmark. While the
designation includes market neutral, relative value
investment management consultant is able to use the
and long/short managers. We define managers who
same mathematical formula for both calculations, we
are directional and not necessarily hedged at all
believe that the selection of the measurement period is
times as “tactical,” including global macro, managed
important in evaluating the manager’s particular skill
futures and tactical managers.
in their area of expertise.
The traditional upside/downside capture ratio, which
is usually calculated using a monthly time series, is Why Is Upside/Downside Capture
best at evaluating an equity hedge manager’s security Analysis Important Now?
selection and portfolio construction expertise. As the
The rush to passive investing has accelerated in
equity hedge portfolio fluctuates versus its benchmark,
recent years. In 2016, there was a record net new cash
the investment consultant is able to assess an equity
inflow in domestic equity index funds (including
hedge manager’s performance versus the benchmark
ETFs) of over $250 billion. At the same time, there
during the up and down periods.
was a record net outflow in domestic equity active
Tactical strategies, on the other hand, often make funds of over $300 billion. Many market participants
extensive use of broad market indexes through ETFs, have asked if this is the new model for investment
futures contracts and derivatives rather than individual management. Figure 1 seems to suggest that this trend
is secular in nature, having persisted for 25 years,
rather than merely a cyclical phenomenon. It leaves
many wondering: why should an investor hire an
active manager if active management returns have not
exceeded that of unmanaged market indices? Is active
management dead?
6 Calculating Upside/Downside Capture Ratios for Equity Hedge and Tactical Managers
Volume 1 n Number 1 n Fourth Quarter 2017
FIGURE 1. RECORD FLOWS INTO PASSIVE FUNDS AND OUT OF ACTIVE FUNDS
YEARLY DATA, DECEMBER 31, 1993—DECEMBER 31, 2016
252.79
Net New Cash Flow Into Domestic Equity Index Funds, Including ETFs
Net New Cash Flow Into Domestic Equity Active Funds
-320.43
Sources: Ned Davis Research, Investment Company Institute, as of 12/31/16
We believe that a good way to manage risks in a
passive portfolio is to allocate a significant portion of “The essence of portfolio management
the portfolio to tactical strategies that are designed
is the management of risks, not the
to manage portfolio risks. We believe this active
management allocation is essential to portfolio
management of returns.”
management, particularly now.
—Benjamin Graham
At the current point in the economic and stock
market cycle, after the U.S. stock market has
produced continuous positive returns every year since at passive versus active investing is that the market
2009, it is prudent to ask at what point the market advance since 2009 has been indiscriminate in
will undergo the type of correction to the uptrend driving up stocks; high-quality and low-quality
that typically occurs after economic expansions. This securities alike have been buoyed upward by the
question is particularly important for those investors rising stock market tide. Active investment managers
whose time horizon is less than 10 years. Remember that discern higher quality from lesser quality
that if an investment portfolio declines 50%, as it securities have been at a disadvantage because the
did during the last recession, it must subsequently stock market has not rewarded this distinction.
double in value just to get back even, which begs
the question: does the portfolio have sufficient time
to recover? Another consideration when looking
Broadmark Asset Management LLC 7
Journal of
INVESTMENT ADVISORY SOLUTIONS
Calculation of the Upside/Downside been negative. In the case where a manager registers
Capture Ratio positive returns when the benchmark declines,
the fund’s downside capture ratio will be negative
Upside/downside capture ratios show how much a
(meaning it has moved in the opposite direction of the
manager has gained or lost compared to a broad
benchmark). The selection of a particular benchmark
market benchmark over a specified time period. The
is important and is usually the stated benchmark for
ratios are usually calculated using monthly data,
the manager.”1
but any time period can be used. The investment
consultant might want use daily or weekly data to
Upside/Downside Capture Ratio
examine the manager’s sensitivity to very short-term
Measurements for Equity Hedge
market movements or extend the time period under
Managers
review to one year or more to measure a manager’s risk
capabilities during a large market decline (2008, for Upside/downside capture ratios are commonly
instance) and ability to participate in the subsequent calculated using monthly return data. Monthly
market advance. calculation is an appropriate measure for those
managers who employ security selection as their
Monthly upside/downside capture ratios are calculated
focus, as this analysis captures how well their positions
by taking the manager’s monthly return during
contribute to the overall portfolio movement versus the
months when the benchmark had a positive return
benchmark without regard to the market environment,
and dividing it by the benchmark return during that
as measured monthly. The goal for an equity hedge
same month. Downside capture ratios are calculated
portfolio is to select both long and short positions they
by taking the manager’s monthly return during the
believe will contribute positively to returns.
periods of negative benchmark performance and
dividing it by the benchmark return. Generally,
Upside/Downside Capture Ratio
upside/downside capture ratios are calculated
Measurements for Tactical Managers
over one-, three-, five-, 10- and 15-year periods by
calculating the geometric average for both the A tactical manager’s goal is often to capture upward
manager’s returns and index returns during the up moves during up market cycles and to avoid losses
and down months, respectively, over each time period. during down market cycles. The traditional method
of calculating upside/downside capture ratios using
According to Morningstar, “An upside capture ratio
monthly data does not address the tactical manager’s
over 100 indicates that the manager has outperformed
use of risk management techniques through portfolio
the benchmark during periods of positive returns for
exposure in different market environments because
the benchmark. A downside capture ratio of less than
one month doesn’t capture the full range of a market
100 indicates that the manager has declined less than
cycle. By using only monthly data without regard to
its benchmark in periods when the benchmark has
the market environment, the traditional method does
not provide insight into a manager’s timing ability
and success at mitigating systemic risk over a full
market cycle.
1 See www.morningstar.com/InvGlossary/upside-downside-capture-ratio.aspx
8 Calculating Upside/Downside Capture Ratios for Equity Hedge and Tactical Managers
Volume 1 n Number 1 n Fourth Quarter 2017
Evaluating Equity Hedge and Tactical 2. The securities used reflect the different investment
Managers Using the Upside/Downside approaches. Equity hedge managers generally have
long and short individual securities positions in the
Capture Ratio
portfolio. The upside/downside capture ratio as
The CFA Institute has stated that “At the manager calculated monthly gives the investment consultant
level, we can think of a benchmark as a passive a good idea of how the long and short positions
representation of the manager’s investment style, have contributed to the performance of the overall
incorporating the salient investment features (such equity hedge portfolio, which in turn offers insight
as significant exposures to particular sources of into the manager’s stock selection capabilities.
systematic risk) that consistently appear in the
manager’s portfolios. A manager’s benchmark However, tactical managers often use broad market
encompasses the manager’s ‘area of expertise.’”2 indexes and derivatives rather than individual
Investment consultants evaluate a manager’s securities. The evaluation of tactical managers is
capability versus a benchmark by identifying the not based upon stock selection, but rather upon
relevant features of that manager’s strategy. The the portfolio’s performance during up- and down-
appropriate benchmark should encompass the market cycles. By extending the time period to
manager’s “area of expertise.” The investment encompass a market cycle or a specific time period
consultant should therefore determine how best to within a market cycle, the investment consultant
measure this expertise in relation to the benchmark. can better evaluate the correlation of investment
returns compared to the benchmark with respect to
We suggest that the investment consultant consider systemic risk.
four factors when evaluating a manager’s performance
versus a benchmark when using the upside/downside 3. The types of risks being measured. Upside/
capture ratio: downside capture ratios using monthly data do
a good job of assessing a manager’s ability to
1. The investment time horizon. Tactical managers construct and manage security-specific risks. The
often take a top-down macroeconomic or a tactical manager’s primary goal is often to capture
quantitative approach to the markets, or use a the larger market upward moves and protect
combination of the two. The time horizon targeted the portfolio from systemic, or market, risk. By
by these managers might be longer and encompass adjusting the time period used in the calculation,
more of an intermediate- or long-term economic and the investment consultant can make sure to
stock market cycle—from three months to a year or measure the manager’s skill at managing each type
more. The traditional monthly calculations used may of risk—specific risk and systemic risk.
be not be helpful in measuring a tactical manager’s
success or failure over a longer market cycle.
2 2 014 CFA Program Curriculum, Level III, “Portfolio: Execution, Evaluation
and Attribution, and Global Investment Performance Standards,” page 136
Broadmark Asset Management LLC 9
Journal of
INVESTMENT ADVISORY SOLUTIONS
4. The stock market environment. If the stock Conclusion
market environment in the next five years is
The upside/downside capture ratio can be a powerful
similar to the last five years of rising stock prices,
tool in evaluating both equity hedge and tactical
then the traditional monthly upside/downside
managers. However, adjusting the time horizon for
capture ratio calculation may be the best way to
each of these types of managers can better evaluate
assess a manager because it demonstrates the
each manager’s area of expertise and management of
stock picking and portfolio construction ability
specific risk versus systemic risk.
of the manager. However, if the approaching
stock market environment has more economic The commonly used method of calculating upside/
contractions, declining stock prices or increased downside capture ratios using monthly data is an
volatility, then we suggest that a better way to excellent method for assessing an equity hedge
assess risk management may be to evaluate how manager’s area of expertise, namely individual
a manager performed during longer periods security selection and portfolio construction.
of time compared to the benchmark. Adjusting However, when evaluating the area of expertise of
the time horizon to reflect the anticipated tactical managers, we suggest broadening the time
market environment may enhance an investment period under investigation to include various market
consultant’s ability to evaluate each manager’s environments. By expanding the time period used
particular area of expertise. in the calculation, a consultant can better evaluate
the tactical manager’s expertise at managing risk
and return during rising, flat, declining or higher
volatility market environments. We believe that
examining performance over various time periods
and market environments may give the consultant a
more robust assessment of the skills of equity hedge
and tactical investment managers.
10 Calculating Upside/Downside Capture Ratios for Equity Hedge and Tactical Managers