Fundamental indexing - BetaShares

Fundamental indexing:

“The outperformance that had to happen”

Housekeeping

• Questions – please ask any questions and we will endeavour to answer them at the end

of the presentation

• Recording – a copy of the presentation slides and a recording will be sent this afternoon

• Website – all our fund information is available at www.betashares.com.au

• Survey – a short survey will pop up on completion

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http://www.betashares.com.au/

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Disclaimer

Financial Intermediary use only. Not for distribution clients.

The information contained in this document is general information only and does not constitute

personal financial advice. It does not take into account any person’s financial objectives,

situation or needs. It has been prepared by BetaShares Capital Limited (ABN 78 139 566 868,

Australian Financial Services Licence No. 341181) (“BetaShares”). The information is provided

for information purposes only and is not a recommendation to make any investment or adopt

any investment strategy. BetaShares assumes no responsibilities for errors, inaccuracies or

omissions in this document. Past performance is not indicative of future performance.

Investments in BetaShares Funds are subject to investment risk and investors may not get back

the full amount originally invested. Any person wishing to invest in BetaShares Funds should

obtain a copy of the relevant PDS from www.betashares.com.au and obtain financial advice in

light of their individual circumstances.

4

Speaker Profile – Rob Arnott, Research Affiliates LLC

Chairman & Chief Executive Officer, Research Affiliates LLC

• Rob has endeavoured to bridge the worlds of academic theorists and financial markets, challenging conventional

wisdom and searching for solutions that add value for investors. He has pioneered several unconventional portfolio

strategies that are now widely applied, including tactical asset allocation, global tactical asset allocation, tax-advantaged

equity management, and the Fundamental Index approach to investing.

• Rob has published more than 100 articles in such journals as the Journal of Portfolio Management, Harvard Business

Review, and Financial Analysts Journal, where he also served as editor in chief from 2002 through 2006.

Speaker Profile – Rob Arnott, Research Affiliates

Speaker Profile – Vinnie Wadhera, BetaShares

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Director – Institutional Business and National Accounts, BetaShares

• Vinnie is responsible for BetaShares’ distribution strategy to institutional investors and financial advisory groups.

• He has held senior distribution roles with ING Australia, Allianz Dresdner Asset Management and Third Link Investment

Managers.

• Prior to that he was Head of Research at AMP Financial Services responsible for fund manager selection & review and

model portfolio construction.

• Vinnie has attained the Certified Investment Management Analyst (CIMA®) designation and holds a Bachelor of

Commerce degree.

What we will discuss today…

A recap of Fundamental Indexing, and how it seeks to overcome the limitations of market capitalisation indices

What has driven the historical outperformance of Fundamental Indexing over Australian shares relative to a number of other passive indexing methodologies

Market impact costs – The “dirty little secret of passive investing”

How Fundamental Index ETFs can benefit your client portfolios

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Contents





7

8

Fundamental Indexing –

10-years on

9

RAFI Fundamental Index

The RAFI Fundamental Index strategy is a broadly diversified equity strategy

built on the principles of contrarian investing and disciplined rebalancing

As of 6/30/2016 based on estimates in USD. Includes assets managed or sub-advised by Research Affiliates, LLC or licensees using RAFI strategies. Note: please refer to the

important information slide at the end for all relevant disclaimers, disclosures, and information on our intellectual property.

» A history of outperformance based on sound investing principles

» Broad economic representation, with low implementation costs and high capacity

» Launched in 2005, with $121B in assets.1

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Picking Active Managers: A Game with Poor Odds

Source: Research Affiliates, LLC, based on Lipper data for US large capitalization mutual funds. Mutual fund returns are net of fees. Chart has been recreated but based

on Burton G. Malkiel, 2005, “Reflections on the Efficient Market Hypothesis: 30 Years Later,” The Financial Review, p. 40.

Underperformers

43%

Market Equivalent

45%

Outperformers

12%

Excludes over 1000 funds that did not survive the 10 years – presumably underperformers

69

138

292

307

213

98

37

10

-3% or less

-2% to -3%

-1% to -2%

0 to -1%

0 to 1%

1% to 2%

2% to 3%

3% or more

Number of Funds

Excess Returns of Surviving US Large Cap Mutual Funds, 2005-2015

11

The Solution: Thoughtfully Designed Smart Beta

» Smart Beta strategies combine the benefits of:

» Active management; The opportunity for outperformance

» Passive management; Transparent, rules-based, low cost

Delivering well understood sources of excess returns through simple,

transparent, low cost indices

12

Building a Superior Index Strategy

» FTSE RAFI Index Series - a broadly diversified equity strategy built

on the principles of contrarian investing and disciplined rebalancing

1. Measure the relative size of companies using fundamental measures

• Sales – Total Annual Sales (averaged over 5 years)

• Cash Flow – Operating Income + Depreciation & Amortization (averaged over 5 years)

• Dividends – Total Annual Dividends (averaged over 5 years)

• Book Value – Total Common Equity (most recent fiscal year ending)

2. Determine Average

Fundamental Size 3. Security Selection 4. Rebalance

• Equally weighted

average of the four

fundamental measures

• Dividends are excluded

for non-dividend payers

• For example, the FTSE

RAFI Australia 200 Index is

comprised of the 200

largest Australian

companies ranked by

overall fundamental size

• Annually on the third

Friday of March

13

Steep Discounts Lead to Higher Subsequent Returns

Source: Research Affiliates, LLC., based on data from CRSP/CompuStat and WorldScope/DataStream. Index returns represent the subsequent 3-year excess return for RAFI vs. Cap. Index returns and characteristics for both RAFI and cap-weighted indices are simulated. Please see Important Information at the end for additional material on simulated data.

Current Valuation

Discount (7/31/2016)

All World: 32%

US: 29%

Dev. ex-US: 28%

EM: 29%

UK: 28%

-10%

-5%

0%

5%

10%

15%

20%

25%

-70% -60% -50% -40% -30% -20% -10% 0%

Subsequent

3-Year

Excess

Return

Valuation Discount

All World Developed ex-US EM UK US

Win Rate 100%

Win Rate 100%

Win Rate 89%

Win Rate 66%

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RAFI Consistency Helps Investors Achieve Their Goals

Source: Research Affiliates, LLC, based on data from Factset. Data prior to index launch is simulated. The FTSE RAFI US 1000 Index and FTSE RAFI Developed ex-US

1000 Index were launched on 11/28/2005. The FTSE RAFI All World 3000 Index was launched on 10/6/2008. The FTSE RAFI Emerging Markets Index was launched on

7/9/2007. Past Performance is not indicative of Future Performance.

StrategyAnnualized

Excess Return

3-Yr Rolling

Win-Rate

5-Yr Rolling

Win-Rate

Start

Date

FTSE RAFI US 1000 Indexvs. S&P 500 Index

1.9% 74.6% 83.2% 1962

FTSE RAFI Australia 200 Indexvs. S&P/ASX 200 Index

2.1% 88.2% 97.8% 1992

FTSE RAFI Developed Ex US 1000 Indexvs. MSCI EAFE Index

2.1% 79.4% 90.9% 1984

FTSE RAFI Emerging Markets Index

vs. MSCI Emerging Markets Index6.2% 77.9% 82.9% 1994

FTSE RAFI All World 3000 Indexvs. MSCI All Country World Index

3.2% 79.5% 86.6% 1988

Through June 2016

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Ben

efit

s

» Have shown to provide excess returns vs. cap-weight

» Broadly diversified and economically representative

» Low tracking error relative to cap-weight

» High capacity

» Low implementation costs

RAFI Fundamental Index Strategies

The RAFI Fundamental Index strategy is a

broadly diversified equity strategy built on the principles

of contrarian investing and disciplined rebalancing

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Excess Returns Should Accrue to the Investor

Active Managers excess returns calculated by using the 75th percentile gross return of Lipper US Large Cap Core, US Large Cap Growth, and US Large Cap Value

database minus the return of the S&P 500 Index for the period 1/1/2006–12/31/2015. Fees are represented by the average fee charged by active managers in the 20th–

30th percentile ranking for the period 1/1/2006–12/31/2015 using the Lipper database for US Large Cap Core, US Large Cap Growth, and US Large Cap Value. The

Fundamental Index strategy represents the average excess returns, before fees, of the PowerShares FTSE RAFI US 1000 (PRF) ETF minus the S&P 500 and the PIMCO

RAE Fundamental PLUS Fund Institutional Class (PXTIX) minus the S&P 500 for the period 1/1/2006–12/31/2015. Fees are represented by the average expense ratio of

the two funds. Source: Research Affiliates based on data from eVestment Alliance and Factset.

Active Managers vs. Fundamental Index Strategies (2006–2015)

71%

100%

33%

29%

67%

Average of U.S. top quartile active

managers

2nd , 3rd, and 4th quartile U.S.

managers all fail to add value net of

expenses

Live U.S. Fundamental Index

Strategies

% of

Excess

Returns

vs.

S&P 500

Index

Percent of Excess Returns Passed On to Manager Percent of Excess Returns Passed On to Client

Look Before You Leap! The Impact of Rising Valuations

in Smart Beta

18

19

Trend Chasing Everywhere – Survivorship Bias

Practitioners look for best historical performance.

Academics look for best historical performance.

Asset Owners look for best historical performance.

» Problem: Not all factors are robust.

» Selection bias and data mining are mistaken for persistent alpha.1

» Rising valuations are mistaken for persistent alpha.2

1. Harvey, Liu, Zhu (2015); Beck, Hsu, Kalesnik, Kostka (2016) 2. Fama, French (2002); Arnott, Bernstein (2002); Campbell, Shiller (1988); Cochrane (2008)

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Alpha Decomposition

» Alpha due to change in relative valuation

» is mean reverting and averaging roughly zero in the long run.

» contributes significantly to strategy performance in the “short run.”

» “Short run” can mean decades!

» Alpha adjusted for change in relative valuation is a good measure of unconditional

expected return of a strategy.

Portfolio

Alpha ≈ +

Return due to change

in relative valuation

“Situational Alpha”

Valuation-

Adjusted Alpha

“Structural Alpha”

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-5.41%

-0.16% -0.76%

3.92%

3.40%

5.48%

Value Momentum Small Cap Illiquidity Low Beta Gross

Profitability

10 Year Annualized Excess Returns (as of 2/2016)

Low Beta and Quality were two of the Best Performers

Recent Factor Returns

Source: Research Affiliates. For more information, see full paper at: http://www.researchaffiliates.com/Our%20Ideas/Insights/Fundamentals/Pages/442_How_Can_Smart_Beta_Go_Horribly_Wrong.aspx

http://www.researchaffiliates.com/Our Ideas/Insights/Fundamentals/Pages/442_How_Can_Smart_Beta_Go_Horribly_Wrong.aspx

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3.04%

3.80%

2.02%

3.08%

-1.54%

-0.17%


Profitability

Annualized Excess Returns, Net of Change in Valuation (1/1967 - 2/2016)

While Low Beta and Quality provide diversification benefits, they

historically have provided no excess return net of Changes in Valuation!

Full Sample Factor Returns, Net of Valuation Change

Source: Research Affiliates. For more information, see full paper at: http://www.researchaffiliates.com/Our%20Ideas/Insights/Fundamentals/Pages/442_How_Can_Smart_Beta_Go_Horribly_Wrong.aspx


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The Journey Ahead

Source: Research Affiliates. For more information, see full paper at: .Actual outcomes may differ materially from expected results. http://www.researchaffiliates.com/Our%20Ideas/Insights/Fundamentals/Pages/442_How_Can_Smart_Beta_Go_Horribly_Wrong.aspx

7.88%

2.92%

4.41%

2.99%

-0.91%

-4.64%


Profitability

Expected 5-Year Excess Returns (Conditional on Current Valuations)



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-0.3%

2.0%

1.3%

-1.7%

0.4%

0.0%

Equally

Weighted

Fundamental

Index

Risk Efficient Low Vol Index Maximum

Diversification

Quality Index

Expected 5-Year Excess Return (Conditional on Current Valuations)

Low Volatility strategies still provide an excellent source of diversification

and equity risk reduction.

The Journey Ahead

Source: Research Affiliates. For more information, see full paper at: Actual outcomes may differ materially from expected results. http://www.researchaffiliates.com/Our%20Ideas/Insights/Fundamentals/Pages/442_How_Can_Smart_Beta_Go_Horribly_Wrong.aspx



Market Impact Costs

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Market Impact : The Dirty Little Secret of Passive Investing

27

1001 1005

505

100 177 125

58

United States

RAFI is Designed with Ease of Implementation in Mind

Source: Research Affiliates, LLC., based on data from Evestment, Factset and FTSE Russell. Each strategy listed represents the following indices: Cap Weight - Russell 1000 Index, Fundamental Weighting – FTSE RAFI US 1000 Index, Equal Weighting – S&P 500 Equal Weight Index, 1/Volatility – S&P 500 Low Volatility Index, Minimum Variance – MSCI USA Minimum Volatility Index, Quality – MSCI Quality Index. Median Active Manager represents the Median US Large Cap Equity Manager as reported by Evestment. Turnover for Russell 1000 is annual turnover for the period 2006-2015, FTSE RAFI US 1000 Turnover is for the period 2006-2015, S&P 500 Equal Weight is annual turnover for 2007 – 2015 and uses the ETF RSP as a proxy, S&P 500 Low Volatility turnover is for 2012-2015 and uses the ETF SPLV as a proxy, turnover for MSCI USA Minimum Variance is for 2012-2015 and uses the ETF USMV as a proxy, turnover for the MSCI Quality Index is for 2013 – 2015 and uses the ETF QUAL as a proxy., Median Active Manager turnover is for the period 2006-2015.

Average Annual Turnover

Number of Holdings – June 2016

Weighted Average Market Cap in USD Billions – June 2016

115 102

37 55

77

136

111

United States Cap Weight

Fundamental Weighting

Equal Weighting

1/Volatility

Minimum Variance

Quality

Median Active Manager

2%

14%

26%

45%

26% 27%

49%

United States

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Equal Weight & Fundamental Weight Index Investing

Past performance is not an indicator of future performance..

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financial instrument, nor is it advice or a recommendation to enter into any transaction. Any offer to sell or a solicitation of an offer to buy or sell shall be made solely by

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should not be construed as financial or investment advice on any subject matter. Research Affiliates, LLC and its related entities do not warrant the accuracy of the

information provided herein, either expressed or implied, for any particular purpose.

The index data published herein may be simulated and in such instances, no allowance has been made for trading costs, management fees, or other costs, are not

indicative of any specific investment, are unmanaged and cannot be invested in directly. Past performance, including simulated performance, is no guarantee of future

performance and actual investment results may differ. Any information and data pertaining to an index contained in this document relate only to the index itself and not to

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profits or any indirect, consequential, special or similar damages whatsoever, whether in contract, tort or otherwise, even if advised of the possibility of such damages.

Frank Russell Company is the source and owner of the Russell index data contained or reflected in this material and copyrights related thereto. Frank Russell Company

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Research Affiliates’ presentation thereof.

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Important Information The FTSE Research Affiliates Fundamental Indexes are calculated by FTSE International Limited (“FTSE”) in conjunction with Research Affiliates, LLC, (“RA”). All rights

and interests in the FTSE Research Affiliates Fundamental Indexes vest in FTSE. All rights in and to the RA Fundamental Index™ weighting methodology used in the

calculation of the FTSE Research Affiliates Fundamental Indexes vest in RA. All rights in the FTSE indexes and / or FTSE ratings (together the “FTSE Data”) vest in

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representation regarding the advisability of investing in any security. Inclusion of a security in an index is not a recommendation to buy, sell or hold such security. No

further distribution of FTSE Data is permitted without FTSE’s express written consent.

The RAFI™ Bonds US Investment Grade Index and RAFI® Bonds US High Yield Index is calculated by ALM Research Solutions, LLC. in conjunction with Research

Affiliates, LLC. All rights and interests in the RAFI™ Bonds US Investment Grade Index and the RAFI™ Bonds US High Yield Index vest in Research Affiliates, LLC. All

rights in and to the Research Affiliates, LLC Fundamental Index™ concept used in the calculation of the RAFI™ Bonds US Investment Grade Index and the RAFI™

Bonds US High Yield Index vest in Research Affiliates, LLC. The RAFI™ Bonds US Investment Grade Index and the RAFI™ Bonds US High Yield Index are not

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investing in such product(s). Neither ALM Research Solutions, LLC. nor Research Affiliates, LLC make any warranties, express or implied, to any of their customers nor

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arising from the use of information in this publication.

Copyright MSCI. All Rights Reserved. Without prior written permission of MSCI, this information and any other MSCI intellectual property may only be used for your

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© 2016 Research Affiliates, LLC. All rights reserved. Duplication or dissemination prohibited without prior written permission.

30

Contents





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Product Name: BetaShares FTSE RAFI Australia 200 ETF

Index Tracked &

Description of Index

FTSE RAFI® Australia 200 Index. Contains the top 200 eligible securities with the largest RAFI fundamental scores listed

on the ASX. The FTSE RAFI Index Series selects and weights index constituents using four fundamental factors, rather

than market capitalisation, reflecting the company’s economic footprint . The factors are sales, cash flows, dividends and

book value.

Confidential – may not be distributed without the consent of BetaShares Capital 32

BetaShares FTSE RAFI Australia 200 ETF

*Between annual rebalance dates the index components may differ from 200 due to corporate events.

ASX: QOZ

Key Information

ASX Code QOZ

Index Name FTSE RAFI Australia 200

Index

Index ASX Code FRAUSTR Index

Bloomberg Code QOZ AU

# of components 200*

Asset backing Equities

Management

Fee 0.30% p.a

Expense

recovery Capped at 0.10% p.a

ETF Inception

Date 10 July 2013

Top 10 Index Components

As at October 31 2016

Sector Allocation

As at October 31 2016

Company Weighting

BHP Billiton Ltd 10.3%

Commonwealth Bank of

Australia7.5%

Australia & New Zealand

Bankin7.5%

Westpac Banking Corp 7.3%

National Australia Bank Ltd 6.7%

Wesfarmers Ltd 3.9%

Woolworths Ltd 3.7%

Rio Tinto Ltd 2.4%

Suncorp Group Ltd 2.0%

Woodside Petroleum Ltd 1.7%

Financials 39.0

Materials 22.6

Consumer Staples 9.5

Energy 7.4

Real Estate 5.2

Industrials 5.1

Consumer Discretionary 4.3

Health Care 2.7

Telecommunication Services 2.1

Utilities 1.7

Information Technology 0.4


FTSE RAFI Australia 200 Index has outperformed S&P/ASX 200 Index since inception

Graph shows performance of underlying index relative to S&P/ASX 200 index, not ETF performance and does not take into account ETF management costs. You cannot invest directly in an

index. Returns for periods longer than one year are annualised. Past performance is not an indicator of future performance of index or ETF. The FTSE RAFI Australia 200 Index was

launched on 10/8/2009. Index returns prior to launch are simulated based on Research Affiliates’ patented non-capitalisation weighted indexing system, method and computer program

product. Actual investment results may differ from simulated results. Source: Bloomberg, FTSE

50

250

450

650

850

1,050

1,250

1,450

1,650

May-92 May-94 May-96 May-98 May-00 May-02 May-04 May-06 May-08 May-10 May-12 May-14 May-16

FTSE RAFI Australia 200 TR Index (index BetaShares FTSE RAFI Australia 200 ETF seeks to track)

S&P/ ASX 200 TR Index

FTSE RAFI Australia 200 Index v S&P/ASX 200 Index: May 1992 – 31 October 2016

TOTAL

RETURN

FTSE RAFI

AUSTRALIA

200

S&P/ASX

200

3M 1.3% -3.2%

6M 6.7% 3.5%

1 YR 9.8% 6.1%

3 YR (p.a) 5.1% 3.9%

5 YR (p.a) 11.0% 9.2%

10 YR (p.a) 6.7% 4.6%

20 YR (p.a) 11.2% 8.8%

Incept (p.a) 11.4% 9.2%

Volatility (p.a) 12.9% 13.1%

Risk-

adjusted

return 0.884 0.703

Ending value

of $100 $ 1,398.69 $ 867.89

Value added since inception:

2.1% p.a


FTSE RAFI Australia 200 Index has outperformed S&P/ASX 200 Index most years since inception

FTSE RAFI Australia 200 Index v S&P/ASX 200 Index Total Returns by Calendar Year

Table shows performance of underlying index relative to S&P/ASX 200 index, not ETF performance and does not take into account ETF management costs. You cannot

invest directly in an index. Past performance is not an indicator of future performance of index or ETF. The FTSE RAFI Australia 200 Index was launched on 10/8/2009.

Index returns prior to launch are simulated based on Research Affiliates' patented non-capitalisation weighted indexing system, method and computer program product.

Actual investment results may differ from simulated results. Source: Bloomberg, FTSE

Total Return FTSE RAFI 200 S&P/ASX 200 Difference

2016 (YTD) 9.65% 6.29% 3.36%

2015 0.43% 2.56% -2.13%

2014 5.60% 5.61% -0.01%

2013 25.49% 20.20% 5.29%

2012 21.95% 20.26% 1.69%

2011 -9.42% -10.54% 1.12%

2010 0.60% 1.57% -0.97%

2009 48.58% 37.03% 11.55%

2008 -36.90% -38.44% 1.55%

2007 20.07% 16.07% 4.00%

2006 21.78% 24.22% -2.44%

2005 23.10% 22.83% 0.27%

2004 26.52% 27.99% -1.47%

2003 14.43% 14.61% -0.18%

2002 -2.96% -8.77% 5.82%

2001 17.40% 10.36% 7.05%

2000 7.81% 6.36% 1.45%

1999 19.13% 18.74% 0.39%

1998 19.97% 9.80% 10.17%

1997 13.22% 12.67% 0.55%

1996 16.39% 14.35% 2.04%

1995 20.41% 21.10% -0.70%

1994 -7.93% -8.76% 0.83%

1993 48.68% 40.05% 8.63%


Holdings comparison – FTSE RAFI Australia 200

Source: Research Affiliates, FTSE, Bloomberg

As at 30 September 2016

Top 10 Holdings

FTSE RAFI Australia 200 Index S&P/ASX 200 Australia 200 Index

COMPANY WEIGHTS COMPANY WEIGHTS

1 BHP Billiton Ltd 9.95% Commonwealth Bank of Australia 8.70%

2 Commonwealth Bank of Australia 7.43% Westpac Banking Corp 6.92%

3 Australia & New Zealand Banking Group Lt 7.42% Australia & New Zealand Banking Group Lt 5.66%

4 Westpac Banking Corp 7.02% National Australia Bank Ltd 5.19%

5 National Australia Bank Ltd 6.63% BHP Billiton Ltd 5.03%

6 Wesfarmers Ltd 4.27% Telstra Corp Ltd 4.44%

7 Woolworths Ltd 3.57% Wesfarmers Ltd 3.47%

8 Rio Tinto Ltd 2.25% CSL Ltd 3.42%

9 Suncorp Group Ltd 1.94% Woolworths Ltd 2.09%

10 Woodside Petroleum Ltd 1.75% Macquarie Group Ltd 1.95%

Top 10 Over/Under Weights v S&P/ASX 200 Index

OVERWEIGHTS UNDERWEIGHTS

COMPANY WEIGHTS COMPANY WEIGHTS

1 BHP Billiton Ltd 4.92% Telstra Corp Ltd -2.83%

2 Australia & New Zealand Banking Group Lt 1.76% CSL Ltd -2.64%

3 Woolworths Ltd 1.49% Commonwealth Bank of Australia -1.27%

4 National Australia Bank Ltd 1.44% Transurban Group -1.13%

5 Origin Energy Ltd 1.06% Sydney Airport -0.93%

6 Suncorp Group Ltd 0.85% Scentre Group -0.80%

7 Fortescue Metals Group Ltd 0.83% Brambles Ltd -0.70%

8 WorleyParsons Ltd 0.80% Westfield Corp -0.69%

9 Wesfarmers Ltd 0.80% Aristocrat Leisure Ltd -0.50%

10 Rio Tinto Ltd 0.72% Newcrest Mining Ltd -0.50%

Application for Australian Investment Portfolios

36

1. Core Passive Exposure

• Economy-centric view

• Broad-market exposure

2. Complement your existing active managers

• Lower overall fee

• Potential for outperformance still exists

3. Complement your own stock selection

• Diversification

• Potential for outperformance still exists

4. Value Investing

• Dynamic value tilt

• Current cyclical low for ‘value’

Confidential – may not be distributed without the consent of BetaShares capital

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