Speakers:Jeff McGrew, CFA, Institutional Portfolio Manager, MFS

Christine Girvan, Managing Director – Canada, MFS

Defining and Demystifying Smart Beta:Implications for Active Management

34054.1

Agenda

• Smart beta around the world

• From theory to reality

• Managing factors in an integrated investment program

2

Which of the following best describes your organization:1. Have a smart beta strategy

2. Have evaluated smart beta but did not allocate

3. Currently evaluating or plan to evaluate

4. Do not plan to evaluate

3

23%38%

25%11%

2% 4%

16%

13%27%

7%19% 18% 21%

18%

19% 14%

23% 15%21%

5%

22%

19%14%

32%

23%

36%

5%

21%13%

21%27%

40%

21%

68%

Total <$1B $1-$10B $10B+ Total <$1-$10B $10B+

Have smart betaallocation

Evaluated and decidednot to implement

Currently evaluating smartbeta

Anticipate evaluatingsmart beta in the next 18months

Do not anticipateevaluating smart beta inthe next 18 months

North America Europe

Sample size for $10B+ for Europe is 19 and below preferred threshold of 30

Source: FTSE Russell – 2015 Global Survey Findings from asset owners

Europe leads in adoption of smart beta strategies

Who?

4

What?Low Volatility and Value are the most used strategies as part of a smart beta combination.What type of smart beta strategies are you using? (Combination of strategies)

Low volatility Value Fundamental Multi-factor combination

Minimum variance

Momentum High quality Maximum diversification

Equal weight

Risk parity Dividend/ income/

yield

Other (please specify)

Defensive

54% 51% 31% 29%

26% 26% 20% 17% 17% 17%11% 11%3%

Segment = Have smart beta allocation, AND using 2 or more strategies.Source: FTSE Russell – 2015 Global Survey Findings from asset owners

5

Do you consider smart beta strategies to be:1. Active investment management

2. Passive investment management

6

Return enhancement

Risk reduction

Improve diversification

Provide specific factor exposure

Cost savings

Income generation

Other

Multi-pick; Segment = Have smart beta allocation, Evaluated and decided not to implement, Currently evaluating smart beta

Smart beta adoption is not a replacement for passive

Why?What investment objective initiated the evaluation of smart beta strategies?

3%

5%

16%

24%

40%

52%

52%

Source: FTSE Russell – 2015 Global Survey Findings from asset owners

7

An improvement in explanatory power and a loss of simplicity

Evolution of Factors

Market Betaβ

Marketβ

Capital Asset Pricing Model (1960s)

Sizeβ

Valueβ Trading Yield Size NonLin Leverage

Value Volatility EY Er Var

Value Momentum Size Growth

Fama-French Three Factor Model (1990s)The market, company size and valuation Today's Multi-Factor Model Proliferation

Numerous models seek to explain a range of style, fundamental and geographic factors that drive returns

8

Source: Spence Johnson

Factor beta is being further refined into risk focused beta and return focused beta

The Evolution and Separation of Performance

'Traditional' Active

Portfolio Return

Alpha

Beta

Alpha

Regional Beta

'Return focused'

Beta

'Risk focused'

Beta

Alpha

'Broad market'

Beta

Factor Beta

Country Beta

Sector Beta

1970s 1980s 1990s 2000s

Smart Beta

'Traditional' Passive

9

Source: MSCI Harvesting Risk Premia for Large Scale Portfolios March 2013

Research illustrates structural and behavioral drivers for risk premia

Structural

Behavioural

Higher systematic risk Less flexibility

Market placeIndex sensitivity

Theories varyHigher turnover

LiquidityInformation uncertainty

VALUE

MOMENTUM

VOLATILITY

SIZE

This factor captures the excess performance of stocks with low prices relative to their fundamentals.

This factor captures excess returns to stocks with lower than average beta or volatility.

This factor captures excess returns to stocks with stronger past performance

This factor captures excess returns of smaller firms relative to their larger counterparts.

Risk Factors to Risk Premiums

10

Wor

st

perf

orm

ing

Best

pe

rfor

min

g

Market leadership varies from year to year

Source: ISI based on S&P 500 Unconstrained Index using ISI's quantitative research factor definitions to the group the underlying index constituents. As of December 31, 2014.

A Multitude of Potential Factors

11

Source: MSCI Barra US Equity Risk Model

• Returns can be volatile

• Underperformance can be prolonged

• Timing can make a big difference

The magnitude and timing of risk factor impact varies

Rolling 1-year returns for momentum factor 1973-2013Smart Beta Challenges: Drawdowns

12

Are you prepared to short or leverage?

Q1-Universe and Q1-Q5 compounded total return indices. Monthly rebalancing with monthly forward returns. Stock universe is MSCI World, data from 12/31/1997 through 12/31/2014. All factors ranked universe relative. Forward returns are capped at the stock level, +/- 75%/month. Quality = Last year Cash Flow from Operations minus Last Year's Net Income) / Average Assets.

Implementation Matters

-10%

0%

10%

20%

30%

40%

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Dec

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Quality Factor Q1-Q5

Quality Factor Q1-Universe

"Implementation Shortfall"

13

(30)

(20)

(10)

0

10

20

30

40

50

Yield Size Moment-um

Value Multi-factor

Funda-mentalIndex

Quality Beta Growth Event/Other

Volatility

%

Strong correlation between past performance and future flows

Smart Beta ETFs & Past PerformanceSmart-Beta ETFs¹

Correlation Between the Relative Return in Prior Quarter and Net New Money in the Subsequent One²2007 Through Q1 2015

Source: Strategic Insight Simfund, Empirical Research Partners Analysis. ¹ Based on underlying securities held being U.S.-listed.² Relative return is equally-weighted return of all ETFs in each category less the S&P 500 return. Relative net new money flow is the net flow into all ETFs in each category as a percent of start-of-period assets less that for all ETFs.

14

Source: Strategic Insights, Empirical Research Partners Analysis. ¹ Based on underlying securities held being U.S.-listed.² Relative return is equally-weighted return of all ETFs in each category less the S&P 500 return.

(30)

(25)

(20)

(15)

(10)

(5)

0

5

10

15

20

Size Multi-factor

Event/Other

Value Growth Funda-mentalIndex

Beta Moment-um

Volatility Quality Yield

%

Past & Future PerformanceU.S. Equity and Alternatives ETFs¹

Correlation Between Relative Return in Prior Quarter and Relative Return in Subsequent Quarter²2007 Through Q1 2015

Beware of backward looking bias15

Smart Beta ETFs Investment Horizon

0%

10%

20%

30%

40%

50%

60%

2007 2008 2009 2010 2011 2012 2013 2014

Average = 40%

U.S. Smart Beta ETFsAverage Monthly Turnover by Quarter1

2007 Through Mid-Q2 2015

Source: Empirical Research Partners Analysis. ¹ Monthly turnover computed as dollar value traded during month divided by the market capitalization. Quarterly turnover is average of monthly turnover over the quarter.

16

Source: MSCI World Index from 12/31/1997 to 12/31/2014; Quality = Last year Cash Flow from Operations minus Last Year's Net Income) / Average Assets; Momentum = 12M – 1M Momentum; Allocations to Factor Returns combines the return streams of the five factors in an asset allocation approach with monthly rebalancing (12m minus 1m Momentum; Trailing Earning/Price; Book/Price; Return on Equity; Quality). Multi-Factor Model is a composite of all of the factor returns; the mean monthly return is compounded to an annual return.

Multifactor More Robust Than Single Factor

5.0%6.0%7.0%8.0%9.0%

10.0%11.0%12.0%13.0%14.0%15.0%

Momentum Quality Multi-Factor Model

Annualized Cumulative Returns(1997-2014)

The Power Of A Multi-Factor Model

17

The Benefit Of Combining Factor Based Approach With Fundamental Research

Hypothetical annualized stock returns by MFS ratings – Feb 1995 – June 2015 (in USD). Past performance is no guarantee of future results. All annualized returns of MFS 1,2 and 3 rated stocks: 10.2%Period represents entire data set for stored MFS stock level ratings. Analysis assumes buy and hold with a monthly rebalance. Each month MFS calculates the equal weighted average of the monthly returns of all stocks rated 1,2 or 3 at the prior month end. The monthly returns are then linked and annualized. No transaction costs are assumed in this analysis.

Clear alpha benefit from combining fundamental and quantitative research

Per

cent

(%)

Buys Sells

11.6

3.2

-1.4

18.2

Buy rated stocks

Sell rated stocks

-5.9

21.4

Fundamental-Quant Intersections Quantitative Fundamental

18

Fundamental median manager return (%) minus quantitative median manager return (%)

Fundamental and quantitative approaches work in different environments

-0.8

-2.9

-0.4

-4.8 -4.8

1.5

5.8

4.3

-0.3 -0.1-1.4 -1.0 -0.8

2.0 2.0

4.8

-0.7

-3.6

-0.5-1.6 -2.0

Rel

ativ

e R

etur

n %

Different Approaches Benefit From Different Environments

Past performance is no guarantee of future results.Source: eVestment. Based on monthly returns. Products in large-cap U.S. core equity universe. Products are then split into those that identified themselves as having a "fundamental" approach or a "quantitative" approach

19

Sources: FactSet and MFS research. MSCI World holdings as of 31 March 2010. Forward total cumulative returns around the mean in USD from 31 March 2010 to 31 March 2015; 10th to 90th percentile range.

-125-100-75-50-25

0255075

100125

1D 1W 1M 3M 6M 1Y 2Y 3Y 4Y 5Y

Exce

ss re

turn a

roun

d mea

n (%

)

Lengthening time horizon creates greater alpha opportunities

Time Arbitrage OpportunityMSCI World total returns dispersion around the mean return (2010-2015)

20

Considerations For Investors • Factor investing involves active decisions

• Move from theory to implementation is complex and behaviouralbiases can be challenging

• Combining multiple factors with traditional fundamental analysis can create a more robust alpha stream while reducing risk overall

• Factor framework can also assist in better understanding your existing managers' exposures and where alpha is coming from

21

Thank You!

The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.

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Issued in Canada by MFS Investment Management Canada Limited. No securities commission or similar regulatory authority in Canada has reviewed this communication.