Speaker:Lowell Yura CFA, ASA, Head of Multi-Asset Solutions, North America

Improving Outcomes ThroughData and Judgement

For P&I Conference Use Only. Investment Professional Use. Not for further distribution.

2

The proliferation of ‘Big Data’

For illustrative purposes only.Source: IDC’s Data Age 2025 study, sponsored by Seagate, April 2017

Annual Size of the Global Datasphere

Those who believe that what you cannot quantify does not exist also believe that what you can quantify, does

- Aaron Haspel

3

The proliferation of factors

For illustrative purposes only.Source: Morningstar.

As of May 1, 2018

0

10

20

30

40

50

60

70

80

90

100

Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 May-18

Number of “Factor” ETFs

4

One factor…many definitions…wildly different results

Past performance cannot guarantee future results.For illustrative purposes only.A sample of 12 funds were used for the value factor analysis shown above from Morningstar database.Source: Morningstar.

Monthly Return Dispersion of sampled ‘Value Factor’ ETF’sFor 12 months ending October 31, 2018

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18

First Quartile

Second Quartile

Third Quartile

Fourth Quartile

5

Same portfolio, many different measures of ‘alpha’

For illustrative purposes only.Source: T. Rowe Price.

‘Alpha’

Market

‘Alpha’

Fama-French Factors

Market Beta

Sour

ces

of T

otal

Ret

urn

and

Ris

k

Which measure of idiosyncratic risk and alpha are right?

‘Alpha’

Fama-French plus other factors

Market Beta

Sour

ces

of T

otal

Ret

urn

and

Ris

k

Sour

ces

of T

otal

Ret

urn

and

Ris

k

6

If portfolio factors are dynamic, shouldn’t it be alpha?

For illustrative purposes only.See slide 17 for factor definitions.Analysis of sample global equity portfolio by T. Rowe Price using MSCI data.Please see slide 18 for MSCI information.

From June 30, 2002 through September 30, 2018

Figures shown in USD

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

Trac

king

Err

or, A

nnua

lized

(%)

Con

trib

utio

n to

Ann

ualiz

ed T

rack

ing

Erro

r(%

)R

elat

ive

to T

otal

Tra

ckin

g Er

ror

Factor Decomposition of Active Risk (Rolling 3 Years) – An Example

Value Growth Size Momentum Quality Beta Unexplained Tracking Error, Annualized (RHS)

7

Now that we have our factors, what about the model?

For illustrative purposes only.Source: MSCI.Source: Barra. Barra and its affiliates and third party sources and providers (collectively, “Barra”) makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any Barra data contained herein. The Barra data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by Barra. Historical Barra data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. None of the Barra data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.Please see slide 18 for MSCI information.

January 31, 2003 through September 30, 2018

0

5

10

15

20

25

30

35

40

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18

MSCI World Ex-Ante risk with S-L-XL risk models

Barra BIM303XL (X-Long) Barra 303L (Long) Barra IM303S (Short)

Models Variance Half-Life Correlations Half-LifeBIM303 Short 90 Days 2 YearsBIM303 Long 1 Year 3 YearsBIM303 X-Long 8 Years 8 Years

8

What about environment?

For illustrative purposes only.Source: MSCI, Russell, S&P, J.P. Morgan, Bloomberg Barclays, Federal Reserve Economic Data- St. Louis Fed.Financial data and analytics provider FactSet. Copyright 2018 FactSet. All Rights Reserved.Bloomberg Index Services Ltd. Copyright © 2018, Bloomberg Index Services Ltd. Used with permission.Please see slide 18 for MSCI information.Source: London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group [year]. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication.

As of October 1, 2018

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

18.0%S&P500

MSCI EAFE

Bloomberg Barclays US Aggregate

Russell 2000

BofAML HY Master II

MSCI ACWI

MSCI EM

JPM EMBI Global

10 Year Treasury Rate and Index inception dates

10-Yr Treasury Rate

9

The benefits of complementary approaches

For illustrative purposes only.Source: MSCI.Please see slide 18 for MSCI information.

March 31, 1988 through September 28, 2018

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Regional Allocations Across TimeFor MSCI Emerging Markets Index

Asia Europe Latin America Middle East & Africa

10

Infinity x Infinity X Infinity X Infinity = Infinity

For illustrative purposes only.

Infinite Factors

Infinite Definitions

Infinite Model

Parameters

Infinite Market

ScenariosX X X

11

Recommendations for better decision making

Do not blindly rely on any approach

Use science and art

Consider evolving market regimes

Understand how the behaviors of market participants have changed

Focus on directional improvement; not absolute precision

Establish a culture of challenge

APPENDIX

13

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Con

trib

utio

n to

Tra

ckin

g Er

ror (

%)

Factor Risk & Idiosyncratic Risk as % of Tracking ErrorJPM (Security)

Factors Idiosyncratic

Factor and idiosyncratic risk can be poor indicators of how active a portfolio is

For illustrative purposes only.Sources: Analysis by T. Rowe Price, MSCI, Thomson Reuters, I/B/E/S, Compustat, and IDC.The specific security identified and described above do not necessarily represent the security purchased or sold by T. Rowe Price. This information is not intended to be a recommendation to take any particular investment action and is subject to change. No assumptions should be made that the securities identified and discussed above were or will be profitable. J.P. Morgan Chase & Co. is shown for illustrative purposes..The analysis is backward looking and should be supplemented with a forecast risk framework.Please see slide 18 for MSCI information.

From June 30, 2005–September 30, 2018

Figures shown in USD

14

Investors need to look at the sources of risk and return separately…

For illustrative purposes only.

June 30, 2002 through September 30, 2018

0

2

4

6

8

10

Con

trib

utio

n to

Tra

ckin

g Er

ror

(%)

Factor Decomposition of Active Risk (Rolling 3 Years) – An ExampleIdiosyncraticFactorsTracking Error, Annualized

-10

-5

0

5

10

Con

trib

utio

n to

Exc

ess

Ret

urn

(%)

Active Return Decomposition, Factor vs. Idiosyncratic (Rolling 3 Years) IdiosyncraticFactorsActive Return, Annualized

15

…and together

For illustrative purposes only.

From June 30, 2002 through September 30, 2018. Shown in USD.

-5

-4

-3

-2

-1

0

1

2

3

4

5

Con

trib

utio

n to

Exc

ess

Ret

urn

/ Con

trib

utio

n to

TE

Information Ratio: Factor vs. Idiosyncratic (Rolling 3 Years)

Factors Idiosyncratic

16

So which measure of alpha is right?

For illustrative purposes only.See slide 17 for factor definitions.Source: T. Rowe Price, MSCI.Sample Global Equity Portfolio as of October 1, 2018Please see slide 18 for MSCI information.

As of October 1, 2018

How Many Factors? Which factors?

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

CAPM, ACWI Fama-French Beyond

Sour

ces

of T

otal

Ris

k

Market Beta Factors 'Alpha'

17

Factor Analysis Definitions

1Valuation composite is an equal-weighted average of the market-cap weighted factor performance of EV/EBITDA, EV/Sales, FCF Yield, Price/Book, and Price/Forward 12 Month EPS. 2Growth composite is an equal-weighted average of the market-cap weighted factor performance of Forward 2 year EPS Growth, Forward 2 year Sales Growth, Trailing 12 Month EPS Growth, and Trailing 12 Month Sales Growth. 3Quality is a composite measure that includes return stability, payout policy, leverage, EPS stability, ROE and CFO/Sales and earnings quality.

Value1: The return differential of undervalued stocks versus overvalued stocks in MSCI ACWI Index.

Growth2: The return differential of high growth stocks versus low growth stocks in MSCI ACWI Index.

Size: The return differential of small market capitalization stocks versus large market capitalization stocks in MSCI ACWI Index.

Quality3: The return differential of high-quality stocks versus low-quality stocks in MSCI ACWI Index.

Momentum: The return differential of high-momentum stocks versus low-momentum stocks in MSCI ACWI Index.

Beta: Global equity market factor using MSCI ACWI Index excess return over cash.

18

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial, and tax advice before making any investment decision. T. Rowe Price group of companies, including T. Rowe Price Associates, Inc., and/or its affiliates, receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation, or a solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

It is not intended for distribution to retail investors in any jurisdiction.

Source for Morningstar data: © 2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.

Source for Compustat data: S&P Global Market Intelligence is the source of Compustat data, but T. Rowe Price is the source of the analysis.

Source: MSCI. MSCI and its affiliates and third party sources and providers (collectively, “MSCI”) makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. Historical MSCI data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

Russell - FTSE Russell is a trading name of certain of the LSE Group companies. “Russell®”, “FTSE Russell®” are trade marks of the relevant LSE Group companies and is/are used by any other LSE Group company under license. Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a trademark of Russell Investment Group.

JPMorgan - Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2018, J.P. Morgan Chase & Co. All rights reserved.

I/B/E/S - © 2018 Thomson Reuters. All rights reserved.

S&P - Copyright © 2018, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of indices shown on slide 8 in any form is prohibited except with the prior written permission of S&P Global Market Intelligence (“S&P”). None of S&P, its affiliates or their suppliers guarantee the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions, regardless of the cause or for the results obtained from the use of such information. In no event shall S&P, its affiliates or any of their suppliers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of S&P information

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