OCTOBER Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index Construction and Methodology

Transcription

1 OCTOBER 2013 Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index Construction and Methodology

2 OCTOBER 2013 Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index Construction and Methodology TABLE OF CONTENTS Introduction Construction and Methodology Index Components Construction and Maintenance Process... 3 Index Calculation... 4 Return on Cash Investment... 4 Return on the Underlying Index... 4 Return Contribution from the Underlying Index... 4 Return Contribution from the Cash Investment... 4 Index Fee Total Return version of the Russell Volatility Control Index... 5 Index Level Calculation of Russell Volatility Control Index Total Return... 5 Excess Return version of the Russell Volatility Control Index... 5 Index Level Calculation of Russell Volatility Control Index Excess Return Appendix I: Index Specifications Summary... 6

3 SECTION 1 Introduction Russell Investments has been providing float-adjusted, market capitalization weighted indexes for more than 27 years. Today, more institutional funds track the Russell Indexes than all other U.S. equity indexes combined. 1 In 2007, Russell seamlessly applied its innovative and pioneering U.S. Indexes methodology to the world s equity markets and launched its family of global indexes. Covering 47 global markets, the Russell Global Indexes provide comprehensive, global-relative benchmarks representing approximately 98% of the investable global equity market. Russell Indexes Benefits: Objective and comprehensive.. Russell Indexes are constructed to be unbiased and comprehensive with full coverage of the underlying market segment. There is no sampling. Transparent and rules-based. Russell Indexes are constructed using a rules-based, transparent methodology for creating ideal benchmarks. Construction and methodology documents are publicly available to maintain full transparency. Full annual reconstitution. To ensure that market segments are accurately represented, Russell Indexes are reconstituted annually. Over time, securities change in their size and style characteristics. Annual reconstitution ensures securities are accurately classified and included in the appropriate market cap and style indexes. New entries to the market specifically, initial public offerings are added separately. Leading methodology. Russell Indexes have been fully float-adjusted adjusted since their inception. Multi-factor and multi-style methodology was incorporated in 1994 allowing for over fifteen years of comprehensive style and factor history. Much of Russell s Indexes innovative methodology is now considered industry-standard. As managers seek new alpha generating strategies and alternative weighting methods, Russell Indexes designed benchmarks to accurately capture these investment strategies and alternative weighting methods including GDP weighting, equal weighting and fundamental weighting. 1 U.S. Equity Indexes: Institutional Benchmark Survey, December PAGE 1

4 SECTION 2 Construction and Methodology The Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index combines the benefits of Research Affiliates Fundamental Index approach with the advantages of a volatility control wrapper. The index aims to represent the returns of a target volatility, fundamentally weighted portfolio with a risk target of 7% by dynamically allocating between the Russell Fundamental U.S. Top 100 Index Total Return the underlying index, and the Effective Federal Funds Rate the cash investment, based on the observed volatility of the underlying index. By targeting a specific level of volatility, the index is designed to provide stability and downside protection in unpredictable markets while preserving the advantages of the Fundamental Index methodology. In today s markets, investors are looking for ways to potentially mitigate and effectively manage their level of risk and the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index provides investors with these needed tools. The components and construction process of the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index are outlined below. Index Components Underlying Index The underlying index is the Russell Fundamental U.S. Top 100 Index Total Return, which selects and weights the top 100 U.S. securities ranked on three fundamental measures of company economic size including adjusted sales, retained operating cash flow, and dividends plus buybacks. The total return variant measures the price performance of the constituents plus income from constituent dividend payments. All securities within the underlyingng index will be members of the volatility control index and their risk patterns will determine the volatility control index s allocation between the underlying index and the cash investment. For more information on the construction of the Russell Fundamental U.S. Top 100 Index Total Return, please refer to the Russell Fundamental Index Series Construction and Methodology located on Cash Investment The cash investment component of the volatility control index is the Effective Federal Funds Rate, which reflects the interest cost or gain. A 360-day year is assumed for the calculation of the cash investment s return in accordance with standard U.S. banking practices. Target Volatility Level The target volatility for the index is set to 7%. This volatility level will serve as the index s target volatility throughout its daily calculation. The volatility control index s allocation between the underlying index and the cash investment will be adjusted daily to achieve and maintain this 7% target volatility. Leverage No leverage is currently employed within this index. Thus, the maximum allowable leverage is equal to 1: L =1 and is a constant, representing the maximum assets-to-equity equity leverage ratio allowed. PAGE 2

5 Realized Volatility Calculation The realized volatility of the underlying index serves to monitor the volatility control index s risk level to ensure its target volatility is maintained. The realized volatility is calculated as the maximum of the 20-day and 40-day standard deviation of the log return of the Russell Fundamental U.S. Top 100 Index Total Return. The calculation of the 20-day and 40-day realized volatility follows the U.S. market calendar (excludes holidays and other market closures) and is implemented with a two-day lag. RVol ୲ = 252 MAX ୧ ୲ ଶ ඩ 1 20 (X X ഥ) ଶ, ୧ ୲ ଶଵ ୧ ୲ ଶ ඩ 1 40 (X X ഥ) ଶ ୧ ୲ ସଵ RVol ୲ is the annualized realized volatility used for the index calculation at time t. X is defined as the ln ௫ ݔ ܫݍܧ where ௫ is the index level of the underlying equity index at షభ time i. Xഥ is defined as the sample mean; Xഥ = స౪షమ స౪షమభ ଡ଼ for the 20-day standard deviation calculation and ଶ Xഥ = స౪షమ స౪షరభ ଡ଼ for the 40-day standard deviation calculation. ସ t is the most recent trading day. Construction and Maintenance Process In its initial construction and ongoing maintenance, the index uses a participation ratio to determine the index s allocation between the Russell Fundamental U.S. Top 100 Index Total Return and the Effective Federal Funds Rate. The participation ratio is based upon the maximum allowable leverage and the ratio of the volatility control index s target volatility to the realized volatility of the underlying index. Participation Ratio and Index Rebalancing The index s Participation Ratio determines its allocation to the underlying index versus the cash investment. The participation ratio equals the percentage allocated to the Russell Fundamental U.S. Top 100 Index Total Return. It is defined as the minimum of the ratio of the index s target volatility (7%) to the realized volatility of the underlying index and the maximum allowable leverage (1x). The Participation Ratio is calculated daily and the volatility control mechanism will rebalance between the Russell Fundamental U.S. Top 100 Index Total Return and the Effective Federal Funds Rate based on this daily value. No buffer is applied to the Participation Ratio calculation. The Participation Ratio is defined as follows: β ୲ is the participation ratio at time t and is calculated as: β ୲ ቀܮǡ ୭୪ ౪ ୭୪ ౪ ቁ L=1 is a constant, representing the maximum assets-to-equity equity leverage ratio allowed. TVol ୲ is the annualized target volatility level at time t. RVol ୲ is the annualized realized volatility used for the index calculation at time t. PAGE 3

6 SECTION 3 Index Calculation The return of the Index consists of two components the return of the underlying index, the Russell Fundamental U.S. Top 100 Index Total Return and the return on the cash investment, the Effective Federal Funds Rate. Below we include the calculation details for these two components as well as both the Total Return and Excess Return variants of the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index. Return on Cash Investment The return on the cash component, the Effective Federal Funds Rate, is calculated as follows: ௧ ݎݑݐ = ݎݑݐ ݐ ݐݏ ݒ ܫ ݏ ܥ Effective Federal Funds Rate ଷ ௧ ଵ ACT = number of calendar days between the last trading day and the current trading day Return on the Underlying Index The return on the underlying index, the Russell Fundamental U.S. Top 100 Index Total Return, is calculated as follows: ௧ = ୬ ୶ୟ୪୳ ౪ ୬ ୶ୟ୪୳ ୱ ౪షభ 1 ௧= = the return of the underlying index between time t-1 and time t ௧ ݑ ݔ ܫ is the underlying index value at time t ௧ ଵ ݑ ݔ ܫ is the underlying index value at time t-1 Return Contribution from the Underlying Index The return contribution from the Russell Fundamental U.S. Top 100 Index Total Return is calculated as the participation ratio multiplied by the return of the Russell Fundamental U.S. Top 100 Index Total Return: Return Contribution from Underlying Index ୲ = β ୲ R ୲ ௧= = the return of the underlying index between time t-1 and time t. β ୲ is the participation ratio at time t. Return Contribution from the Cash Investment The return contribution from the Effective Federal Funds Rate is calculated as one minus the participation ratio multiplied by the return from the Effective Federal Funds Rate: Return Contribution from Cash Investment ୲ = (1 β ୲ ) Cash Investment Return ୲ β ୲ is the participation ratio at time t. Cash Investment Return ୲ = return on the cash investment PAGE 4

7 Index Fee The index decays at a rate of 0.7% per annum or 0.7%/365 per day. Index Fee ୲ = ACT Total Return version of the Russell Volatility Control Index The total return of the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index equals the sum of the return contribution from underlying index (Russell Fundamental U.S. Top 100 Index Total Return) and the cash investment (Effective Federal Funds Rate): R ୲ = β ୲ R ୲ + (1 β ୲ ) Cash Investment Return ୲ Index Fee ୲ R ୲= = the volatility control index total return between time t-1 and time t. ௧= = the return of the underlying index between time t-1 and time t. β ୲ is the participation ratio at time t. Cash Investment Return ୲ = return on the cash investment Index Fee ୲ = index fee Index Level Calculation of Russell Volatility Control Index Total Return The index level of the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index Total Return is calculated as follows: VC Index Level Excess Return ୲ = VC Index Level Excess Return ୲ ଵ (1 + R ୲) The index base date is June 30, 2000 set to a value of Excess Return version of the Russell Volatility Control Index The excess return of the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index is calculated as the total return of the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index Total Return less the return of 3M LIBOR USD: R ୶ ୲ = R VC t ቀ ACT 3M M LIBOR USD 360 t 1 ቁ Index Level Calculation of Russell Volatility Control Index Excess Return The index level of the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index Excess Return is calculated as follows: VC Index Level Excess Return ୲ = VC Index Level Excess Return ୲ ଵ (1 + R ୶ ୲) The index base date is June 30, 2000 set to a value of PAGE 5

8 SECTION 4 Appendix I: Index Specifications Summary The specifications outlined below apply to the Russell Fundamental U.S. Top 100 Daily Volatility Control 7% Index. Input Specifications Underlying or Parent Index Cash Investment Target Volatility Maximum Allowable Leverage Realized Volatility Calculation Rebalancing Frequency Borrowing Cost Index Fee Index Variants Index Settings Russell Fundamental U.S. Top 100 Index Total Return Effective Federal Funds Rate; 360-day convention 7% 1.0x Maximum of the 20 day and 40 day sample standard deviation of the log return, excludes non-market days Daily 3M LIBOR USD; 360-day convention 0.7%; 365-day convention Total Return, Excess Return PAGE 6

9 For more information about Russell Indexes call us or visit Americas: ; APAC: ; EMEA: Copyright Russell Investments All rights reserved. Russell Investments is a trade name and registered trademark of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide and is part of London Stock Exchange Group. Russell Investments is the owner of the trademarks, service marks and copyrights related to the Russell Indexes. The trade names Fundamental Index, RAFI, Fundamental U.S. Large Company, the RAFI logo, and the Research Affiliates corporate name and logo are registered trademarksrks and are the exclusive intellectual property of Research Affiliates, LLC. Any use of these trade names and logos without the prior written permission of Research Affiliates, LLC is expressly prohibited. Research Affiliates, LLC reserves the right to take any and all necessary action to preserve all of its rights, title and interest in and to these marks. Fundamental Index, the non-capitalization method for creating and weighting of an index of securities, is patented and patent-pendingpending proprietary intellectual lectual property of Research Affiliates, LLC (US Patent No. 7,620,577; 7,747,502; 7,778,905; 7,792,719; Patent Pending Publ. Nos. US A1, US A1, US A1, US A1, WO 2005/076812, WO 2007/ A2, WO 2008/118372, 8372, EPN , and HK ). Indexes are unmanaged and cannot be invested in directly. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell l Investments. It is delivered on an as is basis without warranty. Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitationon of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. First use: October Revised January 2015 CORP PAGE 7