2015 MDRT Annual Meeting e Handout Material. Active or Passive? They are both irrelevant if they fail the investor

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1 2015 MDRT Annual Meeting e Handout Material Title: Speaker: Active or Passive? They are both irrelevant if they fail the investor John E. Coyne, III Presentation Date: Tuesday, June 16, :00 11:30 a.m. The Million Dollar Round Table (MDRT) does not guarantee the accuracy of tax and legal matters and is not liable for errors and omissions. You are urged to check with tax and legal professionals in your state, province or country. MDRT also suggests you consult local insurance and security regulations and your company s compliance department pertaining to the use of any new sales materials with your clients. The information contained in this handout is unedited and errors, omissions and misspellings may exist. Content may be altered during the delivery of this presentation Million Dollar Round Table Million Dollar Round Table 325 West Touhy Ave. Park Ridge, IL USA

2 John Coyne E-Handout material Active or Passive? They Are Both Irrelevant If They Fail the Investor Industry Trends Active vs. Passive Goals-Based Wealth Management - Behavioral Finance Was a Good Year for Passive Percent of Managers in Lipper Universes Outperforming their Index in 2014 Source: Fact Set. 3 1

3 Cost Has Been an Appeal for Passive Investing Average Annual Returns Over The Ten Years Through 2013 Source: Morningstar and Vanguard, 12/31/13. Vanguard calculations, using data from Morningstar. All Mutual funds in each Morningstar category were ranked by their expense ratios as of 12/31/13. They were then divided into four equal groups, from the lowest-cost to the highest-cost. The chart shows the ten-year annualized returns for the median funds in the lowest-cost and highest-cost quartiles. Returns are net of expenses, excluding loads and taxes. Both actively managed and indexed funds are included, as are all share classes with at least ten years of returns. 4 Tax Efficiency Has Also Increased Demand for Passive Index Funds Have Lower Tax Costs Than Actively Managed Funds Morningstar and Vanguard. Data cover the ten years ended 12/31/13. The actively managed funds are those listed in the respective Morningstar categories. index funds are represented by those funds with expense ratios of 20 basis points or less as of 12/31/13. All returns used were for the Investor share class. 5 Increased Sector Dispersion Helps Build a Case for Active Management Top 10 Narrowest Dispersions. Rolling 3-Month Moving Average Dispersion (Best Sector Less Worst Sector) Source: Fundstrat Global Advisors, Bloomberg, Fama/French 6 2

4 Dispersion Historically Widens to 25% in the Next 6 Months Following a -1.0 Standard Deviation Move Dispersion: Rolling 3 months moving average (best less worst) Source: Fundstrat Global Advisors, Bloomberg, Fama/French 7 Record inflows to domestic equity index funds in 2013 and 2014 further advance the case for active management in 2015 Net New Cash Flow into Domestic Equity Index Funds Source: Investment Company Institute, 8 Volatility and the Growth of Wealth Dick and Jane receive $1M on 21 st birthday Neither principal nor interest would be paid out until 10 years later Over the course of 10 years, the twins must invest their inheritance Winner will be chosen by who has accumulated the greatest dollar figure after the decade Source: Greycourt. Dick Passive strategies $1,936,412 Jane Active strategies $2,387,

5 Volatility and the Growth of Wealth A healthy double-digit return might even lead to substantial losses if volatility is great enough. Arithmetic Annual Return Standard Deviation Geometric Annual Return Starting Funds Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Scenario 6 10% 10% 10% 10% 10% 10% 0% 10% 20% 30% 40% 50% 10% 9.6% 8.3% 6.03% 2.58% -2.42% $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000 Ending Funds $2,593,742 $2,501,561 $2,219,353 $1,796,293 $1,290,725 $782,784 Total Period Return 159% 150% 122% 80% 29% -22% Source: Greycourt. 10 Careful Combination of Both Active and Passive Leads to Better Investor Outcomes Growth of $1,000,000 (January September 2014) Source: Brinker Capital, Inc., Fact Set, Cambridge Associates, NCREIF. Data from 1/1/71 through 9/30/14. This Growth of $1M chart is for illustrative purposes only. No representation that the results represent performance of actual client accounts is intended. The chart is intended to demonstrate the impact on a traditional portfolio of diversification through the inclusion of additional asset classes over a long-term investment horizon. An investor cannot invest directly in an index. Past performance is no guarantee of future results. 11 Industry Trends Active vs. Passive Goals-Based Wealth Management Behavioral Finance 12 4

6 Lack of Time Weakens Advisor Effectiveness Advisors Must Possess Wide Array of Knowledge and Skills Source: Natixis Global Asset Management, Getting to the Goal: Markets, emotions and the risks advisors must manage Markets, Emotions and the Risks Advisors Must Manage May, 2014 Natixis Study Key Findings Advisors are responding to investor demand: 78% recommend setting goals 70% recommend target returns independent of benchmarks 77% say clients are OK if during a year they achieve target return but don t beat benchmark Advisors need to be a planner who discusses goals, helps investors define goals and explains how investments achieve investor goals. Source: Natixis Global Asset Management, Getting to the Goal: Markets, emotions and the risks advisors must manage Outsource to Help Manage Risk Risk brings investing into perspective 70% 75% of advisors say clients are more interested in discussing risk of advisors say clients want to minimize risk even if it means minimizing returns As investment life-cycle shifts from accumulation to distribution, it is key to protect capital during downturns so investors don t have to sell underpriced assets to fund distribution. Therefore, the focus is to build risk-based portfolio strategies. Source: Natixis Global Asset Management, Getting to the Goal: Markets, emotions and the risks advisors must manage

7 Annualized Return % A Collective Report Card on Investor Behavior Don Phillips Managing Director, Morningstar, Inc. The Dalbar Effect is a collective report card on the advice industry. We have not served the average investor well. We need to change the advice delivery system. Source: Tiburon Conference, 4/8/ Help Investors Fight Emotions that Lead to Bad Behavior Performance of the markets vs. an average mutual fund investor January 1, 1984 to December 31, % 11% 11.11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% S&P 500 Index Investor 9.73% Behavior 7.67% Gap Investor Investor Behavior 3.69% Behavior Gap Gap 1.85% 0.70% Average Equity Hypothetical Average Asset Barclays Average Fund Investor Balanced Allocation Aggregate Bond Fixed Income Investment Fund Investor Index Fund Investor Source: Quantitative Analysis of Investor Behavior (QAIB), 2014, DALBAR, Inc. Average equity fund investor and average bond fund investor performance results are based on the DALBAR 2014 QAIB study. DALBAR is an independent, Boston-based financial research firm. Using monthly fund data supplied by the Investment Company Institute, QAIB calculates investor returns as the change in assets after excluding sales, redemptions and exchanges. This method of calculation captures realized and unrealized capital gains, dividends, interest, trading costs, sales charges, fees, expenses and any other costs. After calculating investor returns in dollar terms, two percentages are calculated for the period examined: Total investor return rate and annualized investor return rate. Total return rate is determined by calculating the investor return dollars as a percentage of the net of the sales, redemptions, and exchanges for the period. Hypothetical balanced Investment based on the performance of an investment weighted 50% to the S&P 500 index and 50% to the Barclays Aggregate Bond Index and rebalanced monthly. Equity benchmark performance is represented by the Standard & Poor's 500 Composite Index, an unmanaged index of 500 common stocks generally considered representative of the U.S. stock market. Fixed income benchmark performance is represented by the Barclays Aggregate Bond Index, an unmanaged index of bonds generally considered representative of the bond market. Indexes do not take into account the fees and expenses associated with investing, and individuals cannot invest directly in any index. Performance of an index is not illustrative of any particular investment. Past performance is no guarantee of future results. 17 The Other Behavior Gap 83% of advisors see bad behavior as threat Only 6.4% of investors own their bad behavior Emphasize the two way commitment Source: Natixis Global Asset Management, Getting to the Goal Study, September

8 Make the Client Experience Positive Make the BeFi conversation positive: Use natural constructive behaviors to manage more negative behaviors. Use mental accounting, framing, and purpose to manage herding, risk aversion, etc. Thereby nudge investors in a productive direction. Source: Dr. Daniel Crosby. 19 Helping Manage Behavioral Biases 117 documented behavioral biases Boiled down to three pillars of investor behavior: Simple Safe Sure Source: Dr. Daniel Crosby. 20 Brinker Capital Personal Benchmark: Visually Intuitive Allocation Tool Helps Simplify the Process for Investors 1.Mental accounting 2.Framing through discussion of personal purpose 3.A joint commitment 4.More opportunities for advisor to reinforce success Conservative Strategies Income Strategies Growth Strategies Simple Safe Sure Source: Brinker Capital, Inc. For illustrative purposes only. Holdings as of 12/31/14 and are subject to change. 21 7

9 Important Information Opinions and research referring to future actions or events, such as the future financial performance of certain asset classes, indexes or market segments, are based on the current expectations and projections about future events provided by various sources, including Brinker Capital s Investment Management Group. Information contained within may be subject to change. Investing in any investment vehicle carries risk, including the possible loss of principal, and there can be no assurance that any investment strategy will provide positive performance over a period of time. The asset classes and/or investment strategies described in this publication may not be suitable for all investors. Investment decisions should be made based on the investor s specific financial needs and objectives, goals, time horizon, tax liability, and risk tolerance. When investing in managed accounts and wrap accounts, there may be additional fees and expenses added onto the fees of the underlying investment products. 22 8