A Better Way to Assess Global Risk & Return Ronnee Ades Senior Director, Institutional Markets

A Better Wayto Assess Global Risk & Return

Ronnee AdesSenior Director, Institutional Markets

A Better Way to Assess Risk & Return

AGENDA Risk Management

Index Methodology

Market Representation

Market Segmentation

Conclusions


Risk Management

Trustees

Money M

anagers

Con

sultan

ts

InvestmentStrategyDecisionMaking


Risk Management

Pension Plan’s #1 Objective:

Meet Funding Obligations

Pension Plan’s #1 Problem:

Projected Payments Out > Projected Payments In


Risk Management

The Plan Sponsor’s Responsibility to Meet Funding Obligations involves the process of Risk Management.

The overall goal of the risk management process should be an investment fund having well understood and desirable risk and return characteristics.


Risk Management

BUT what is risk?

The definition of risk is variability of return.

For the Pension Plan it is commonly the percentage change in assets over 1 Qtr., 1 year.


Risk Management—Developing an Investment Strategy

Investment strategies behave differently relative to the chosen definitions of risk and return.

The First step in the process requires assumptions about asset class behavior.

Then you choose your Plan’s investment strategy (policy portfolio) having what you judge to be the optimal risk versus return trade off.

Then you choose managers to implement the strategy.

You may use passively managed index funds and/or add what may be termed implementation risk and hire active managers.


Risk Management

Benchmarks are used in the process as:

Proxies for Asset Class behavior

Targets for Investment Return in passive portfolios

Performance benchmarks for the active managers and also, their universe for stock selection


Index Methodology

Knowing the construction parameters (methodology) of the popular benchmarks is critical to assessing the best choice for your Plan.

Criteria for a good benchmark:

Rules-based & transparent

Market representation

Market segmentation


Index Methodology—Market Representation

Typical Investment Strategy Starts With a 60/40 Asset Allocation

Equities60%

FixedIncome

40%



Actual Investing is Typically in Market Segments

Large Cap35%

FixedIncome

40%

InternationalEquity10%

Small Cap10%

Alternative Investments5%


Index Methodology—Rules Based

Committee-based indexes

• Subjective selection

• Review frequency is

usually as needed

• Examples – Dow Jones

Industrial Average,

S&P 500

Rules-based indexes

• Objective selection

• Review frequency are

usually scheduled

• Examples – Dow Jones

Wilshire 5000,

Russell 2000


Index Methodology—Rules Based

Rules–based and Representative

David Blitzer from S&P on CNBC’s “Squawk on the Street”:

“we were slightly underweight technology throughout most of the tech boom specifically because we look for companies that have at least a year of solid profit.”

“…stood us in very good stead”

Good stead versus what? – the market?Underweight versus what? – the market?


Wilshire 5000Today


Evolution of US Stock Market Benchmarks

In the 1970s there was the S&P 500

Then in the 1990s there was the Russell 3000

And now there is the Dow Jones Wilshire 5000 1990s

1970s

DJW 5000

Russell 3000

S&P 500



The S&P 500 components are selected by committee, in private.

The DJW 5000 is rules based and those rules are transparent.

The S&P 500 components are not the 500 biggest stocks. In fact, after the top 350, they scatter down to nearly the 2000 rank within the DJW 5000.

DJ Wilshire 5000S&P 500

Rank #1788



Evolution of Global Stock Market Benchmarks

DJWG ~12000

FTSE ~7900

EAFE ~1140

ACWI ~2600

In 1969 there was the MSCI EAFE

Then in 1987 there was the MSCI All-Country World Index

Then in 1993 the FTSE World Index started

And now there is the Dow Jones Global Total Market Index

Today

1993

1987

1969


Depth of Coverage within the Counties

Investable Universe

Number of Countries Covered

WorldINDEX B

50 Countries

World INDEX A

InvestableUniverse

InvestableUniverse

40 Countries


Index Methodology—Market Segmentation

Segmentation is a extension of Representation:

How is the broad market sliced?:

Industry Groups/Sectors

Size Segments

Style Segments


DOW JONES GLOBAL TOTAL MARKET INDEX


Market Size Distinctions

RUSSELL

DOW JONES WILSHIRE

S&P

Small-Cap1,750 Stocks

Micro-Cap2,500+ Stocks

Large-Cap750 Stocks

Small-Cap2,000 Stocks

Large-Cap1,000 Stocks Micro-Cap

2,000 Stocks

Large-Cap500

Stocks

Small-Cap600

Stocks

Mid-Cap400

Stocks Micro-Cap0 Stocks

US ~5000 World ExUS ~7000



YEARLY TOTAL RETURN PERFORMANCE

Index 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995

DJ Wilshire 5000 6.34 12.62 31.64 -20.86 -10.97 -10.89 23.56 23.43 31.29 21.21 36.45

DJ Wilshire U.S.Large-Cap Index

6.38 11.65 28.89 -21.07 -12.96 -10.50 21.93 28.59 32.97 22.52 37.61

DJ Wilshire U.S.Small-Cap Index 7.37 19.46 49.02 -18.98 3.13 -9.08 29.25 1.35 24.87 17.38 31.07

DJ Wilshire U.S.Micro-Cap Index 1.21 17.18 83.20 -8.71 24.31 -18.29 40.99 5.95 22.02 17.81 36.42

Shaded values indicate top-performing segments.

7.37 19.46

83.20 -8.71 24.31

-9.08

40.99

28.59 32.97 22.52 37.61



YEARLY TOTAL RETURN PERFORMANCE

Index 2006 2007

DJ Wilshire Global

DJ Wilshire GlobalLarge-Cap Index

DJ Wilshire GlobalSmall-Cap Index

?

?

2008 2009 2010 2011 2012 2013 2014 2015

?

? ?

?

?

? ?

?


Market Segmentation—Style Methodology Distinctions

Factors used for Mapping Stocks into Growth and Value Segments

HistoricalTrailing Revenue Growth

Trailing Earnings Growth

CurrentPrice-to-Book Ratio

Dividend Yield

ProjectedProjected Earnings Growth

Projected Price-to-Earnings Ratio

DOW JONES WILSHIRE RUSSELLS&Pciti



Style Distinctions

RUSSELL

DOW JONES WILSHIRE

Micro-caps

Small Cap Growth

Small Cap Value

Large Cap Growth

Large Cap Value

Micro-caps

Large Cap Growth

Large Cap Value

Small Cap Growth

Small Cap Value


Index Methodology

We know that the Benchmarks are different – S&P 500 vs. DJW 5000

Over a 10 year period we can reasonably expect the returns will be significantly different

55% probability the 1 year return difference exceeds 1.5%




Impact on $50 million @ 1% (100bps) = $500,000

It does matter in the long run – it does make a difference!


Compare Broad Market Managers to the Broad Market Benchmarks Should your Plan pay for BETA?

Should a manager who had 5.75% return be given a performance bonus or potentially fired?

Returns S&P 500 Russell 1000 DJW 750

6.34%6.27%4.91%1 Year 1 Year 4.91% 6.27% 6.34%

Comparative Index Returns, Major US Index FamiliesAs of December 31,2005

Large

GROWTH VALUE

S&P Russell DJW S&P Russell DJW

0.02% -0.31% -0.05% 0.05% 0.61% 0.29%

1.27% 2.98% 3.12% 2.94% 1.27% 1.61%

1.14% 5.26% 7.13% 8.71% 7.05% 5.72%

11.20% 13.23% 14.36% 17.69% 17.49% 16.16%

-3.68% -3.58% -2.74% 4.54% 5.28% 4.8%

8.47% 6.85% 7.61% 9.60% 11.24% 10.29%


1 Month 0.03% 0.14% 0.13%

3 Months 2.09% 2.12% 2.32%

1 Year 4.91% 6.27% 6.34%

3 Years (% pa)

14.39% 15.42% 15.24%

5 Years (% pa)

0.54% 1.07% 1.01%

10 Years (% pa)

9.07% 9.29% 9.17%


1 Year 7.68% 4.55% 7.37%

Compare Small-Cap Market Managers to the Small-Cap Benchmarks Should your Plan pay for BETA?

Should a manager who had 5.75% return be given a performance bonus or potentially fired?


7.37%4.55%7.68%1 Year

Comparative Index Returns, Major US Index FamiliesAs of December 31,2005

Small

GROWTH VALUE

S&P Russell DJW S&P Russell DJW

-1.04% -0.15% 0.54% -0.81% -0.77% -0.32%

-0.48% 1.61% 2.49% 1.24% 0.66% 0.85%

7.27% 4.15% 9.68% 8.47% 4.71% 5.3%

22.69% 20.93% 25.4% 22.28% 23.18% 22.75%

9.68% 2.28% 5.32% 11.76% 13.55% 13.74%

10.69% 4.46% 7.13% 14.25% 13.31% 13.73%


1 Month 0.92% -0.46% 0.10%

3 Months 0.39% 1.13% 1.65%

1 Year 7.68% 4.55% 7.37%

3 Years (% pa)

22.38% 22.13% 24.10%

5 Years (% pa)

10.76% 8.22% 9.82%

10 Years (% pa)

11.17% 8.88% 10.80%


Index Methodology

Using indexes from multiple providers has serious implications for your investment strategy.

What happens when you don’t use one consistent index methodology?


Methodology—Multiple Vendor Dilemma—An Example

S&P 500 + S&P Mid Cap 400 + Russell 2000

Missing 250 names from the universe of 3000

Over 130 of top 750 stocks missing

Double count 140 stocks with median market cap over $1 Billion

Missing micro cap



Some Missing CompaniesAmazon.com

Directv Group

Fox Entertainment Group

Genentech

Kraft Foods



Double Counted CompaniesCallaway Golf

Calpine

Cooper Tire & Rubber

Delta Air Line

Goodyear Tire & Rubber


Methodology—Multiple Vendor Dilemma—The Point (on a global scale)

S&P 500 + Russell 2000 + MSCI EAFEGaps

Overlaps


TrusteesTRUSTEES

Conclusions —The Process Begins and Ends with the Investors

Consultants Money Managers


Conclusions—What Every Trustee Should Know

Benchmarks should be rules-based and transparent

Objective Selection

Scheduled Reviews


Today


The benchmark selected

should provide the relevant

opportunity set of stock

market returns.

1990s

1970s

DJW 5000

Russell 3000

S&P 500



Discrete market size segments that add up to the total market

Large Cap

FixedIncome

International Equity(Ex-US)

Small Cap

Alternative Investments

MicroCap

Exclusive style segments with an emphasis on purity

Growth

Value

Gro

wth

Valu

eGreater explanatory power (of Benchmark Mismatch,

Asset Class Misfit, Alpha) can be obtained by using an index family with:

Risk management in the global space requires:

Rules Based Indexes

Consistent Methodology

Size and Style (growth/value) segmentation matters.


Conclusions

Not all Benchmarks are the same

Don’t make the Benchmark decision lightly

Seek information from the index provider

Dow Jones Wilshire: A Better Way to Assess Risk & Return

Documents

A Better Way to Assess Global Risk & Return Ronnee Ades Senior Director, Institutional Markets