1. Not all passives are alike
Leigh Stephens
Director of Investment Specialists
November 2016
For Investment Professionals only

2. Important information & risks
This material is for information purposes only. It is not intended to be relied upon to make any investment decision. Although the information herein has been obtained from sources believed to be reliable, neither Close Brothers Asset Management or any of its employees guarantee its accuracy, completeness or fairness. The most recent data has been used where possible. Except in so far as liability under any statute cannot be excluded, no member of Close Brothers Asset Management accepts liability (whether arising in contract, tort or negligence) for any error or omission in this document. The information contained in this presentation is believed to be correct but cannot be guaranteed where data is sourced from third parties. Opinions constitute our judgment as at the date shown & are subject to change without notice. This document is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation. Past performance is not a reliable indicator of future returns. No investment, or investment strategy, is without risks. The value of investments will go up & down & clients may get back less than invested. Issued & approved by Close Asset Management Limited (Company No ) which is registered in England & Wales, is authorised & regulated by the Financial Conduct Authority & is a subsidiary of Close Brothers Group plc. Close Asset Management Limited uses the trading name Close Brothers Asset Management. Registered office at 10 Crown Place, London EC2A 4FT. Unless otherwise stated, the source of all information or figures is Close Brothers Asset Management.

3. Learning outcomes
Understand the basics of passive investments and how to use them.
Why do some passives track differently to others?
Due diligence and what you need to know.

4. Passive growth has been phenomenal
Born in 1989, the AUM of passives has seen extraordinary growth. 25 years of history
Over 100% growth
in only 5 years
Equity
Fixed Income
Commodities & others
Source: iShares ETP Landscape Report August As at end of August 2016

5. Passives taking market share
Size
Flows
Total Active Equity
Passive Mutual Fund Flows
Billions
Trillions
Active Mutual Fund Flows
Total Passive Equity
Source: Strategas Investment Research, Nov 2016

6. Costs matter, for both active and passive
Average annual returns over the ten years to 31 December 2014 from both Active and Passive funds
Average annualised return (%)
Past performance is not a reliable indicator of future results. Source: Vanguard calculations, using data from calculations using Morningstar, Inc. Notes: All mutual funds in each Morningstar category were ranked by their expense ratios as of 31 December They were then divided into four equal groups, from the lowest-cost to the highest-cost funds. The chart shows the ten-year annualised returns for the median funds in the lowest cost and highest cost quartiles. Returns are in sterling terms with income reinvested, net of expenses, excluding loads and taxes. Both actively managed and indexed funds are included. For funds with both income and accumulation share classes, we use only accumulation share classes to avoid double counting.

7. Competition has forced fees lower
Tracker funds engage in cut-throat price war. Index tracker fund price war heats up!
The world’s largest money manager is cutting fees at more than a dozen exchange-traded funds…
The move by BlackRock Inc. covers $216 billion in assets and will lower expenses below or on par with those offered by low-cost pioneer Vanguard Group.
Does a price war loom for ETF providers?
Some observers argue that the competitive nature of ETF fees means that more cuts beckon…
After BlackRock's move to reduce expense fees for more than a dozen of its ETFs, The Charles Schwab Corporation is also treading the same path... It is one of the major investment firms that initiated this price competition.
Source: Wall Street Journal, Financial Times and Nasdaq November 2016

8. How the market has changed1 2 3 4
Cost
Lower portfolio & transaction costs =
Lower fees & costs
Trading cost efficiencies
Automatic rebalancing
Cost
Beta
Beta
Accurate market returns
Avoids biases and reduces downside risks against benchmark e.g. S&P Indices vs Active Funds.
When whole of market works. Managing risk and diversification
Tilting
Tilting
Effective & efficient method of adopting directional views, through various styles
Sector
Market cap
Theme
Systematic
Several techniques to capture systematic market tilts
Optimisation =
Risk model to build desired characteristics
Low Beta
Managed Volatility
Value
Growth
Quality
Smart Beta

9. Some Smart Beta examples
Seek enhanced returns
Quality
Return on equity
Earnings variability
Debt to equity
Value
Forward earnings/price
EV/Operating cash flow
Price to book
Momentum
Momentum based on MSCI Barra Momentum Factor weighing relative strength and historical alpha.
Low Size
Market capitalisation based on MSCI Barra Size Factor
Own companies with stable earnings and strong balance sheets
Own companies that are cheap vs. fundamentals
Own companies that have been steadily rising
Seek to capture small cap performance premium
While having low correlation among excess returns
Quality
Value
Momentum
100%
-34% 1%
-16%
Source: BlackRock, Seek Enhanced Returns, Nov 2016

10. No longer one or the other
Investment management styles
Passive asset allocation +
Passive ‘pure’ beta security selections
Active asset allocation +
Passive ‘pure’ beta security selections
Active asset allocation +
Market ‘pure’ beta, index tilts and Smart Beta
No longer one or the other

11. How to choose the right passive
Universe of indices
Index Selection
>1000
~500
Significant
concentration here
Index fund/ ETF providers
>10
Instrument
Analysis
>100

12. But what to buy? Confusing terminology
Investment vehicles
ETFs
ETNs
Open ended funds
Exchange traded products (ETP)
ETPs
Tracker funds
Exchange traded funds (ETF)
ETCs
Exchange traded notes (ETN)
Exchange traded commodity (ETC)
Logos used for illustrative purposes only

13. Buying and selling …
At NAV or daily traded
Some are priced continuously throughout the day while others are priced once a day
Open ended tracker funds can only be created or redeemed at NAV.
Knowing the pricing time is crucial as dealing is forwarded to tomorrow’s price
Creation/redemption process for ETPs accommodate liquidity and eradicates any premium or discount to NAV
Investors can buy and sell ETPs like any other listed securities (e.g. stocks, bonds, REITs)
KNOW YOUR SECURITY

14. Research process Index Selection Index fund/ETF Providers
Not all the index investments are the same.
We have a rigorous, robust and methodical process to analyse them.
Quantitative, Qualitative, Index calculation agent, Methodology, Stress test, Rebalancing
Index Selection
Counterparty risk, Capitalization, Headcount, Legal structure, Expertise, Stock lending policy, Due Diligence, Business support etc.
Index fund/ETF Providers
Replication, Swap terms, Liquidity, Level of stock lending, Collateral, Bid/Ask, Tracking error, OCF, etc.
Instrument Analysis
Logos used for illustrative purposes only

15. Smart Beta can result in better performance
Index Selection
Broad Market indices
Smart Beta indices
100 Biggest UK listed companies
500 Biggest US listed companies
50 Biggest EU listed companies
Optimise the portfolio of companies to provide minimum volatility
Only include companies that have 10/20 years of sustained dividend growth
Smart Beta can result in better performance
Source: Vanguard,Nov 2016.

16. Understand your index - they are not the same
Different index providers would have different definitions
For example what passes as a Value stock
MSCI =
Earnings to price
Book to Price
EV/CFO*
S&P =
Earnings to Price
Book to Price
Sales to Price
FTSE =
Earnings
Yield
Sales to Price
Cash Flow Yield
*Enterprise Value (EV)
Cash from operations (CFO)

17. S&P 500 companies included in the most numbers of ETFs
Beware of duplication
S&P 500 companies included in the most numbers of ETFs
Company
Number of ETF’s
250
246
243
240
Company
Number of ETF’s
239
238
233
232
230
Source: Strategas Investment Research, November 2016
Logos used for illustrative purposes only

18. Instrument providers Replication methodology (Physical/Synthetic)
Many you will know
Replication methodology (Physical/Synthetic)
Securities lending policy
Due Diligence
Update and monitoring meetings v
Some you may not v
Logos used for illustrative purposes only

19. The hidden cost of passive
Tracking difference = The returns of fund relative to the returns of the index
Fund performance =
1.5% -
Index performance 1%
Tracking difference
0.5%
INDEX
FUND
Tracking error = the standard deviation of Tracking difference
The lower the tracking error, the more faithfully the fund is matching its index.
Source: Monevator, November 2016

20. Have to look through multiple features
Instrument analysis
Have to look through multiple features
Performance
Tracking Error
Average B/A Spread
OCF
AUM
1 Year (%)
YTD (%)
1 Year (Weekly)
30 Days
(% from mid) %
USD (M)
DB x trackers FTSE 100 UCITS ETF
16.02
13.05
0.03
0.26
0.09
84.8
Vanguard FTSE 100 UCITS ETF
15.54
12.38
0.05
3064.9
iShares Core FTSE 100 UCITS ETF
15.53
13.07
0.04
0.07
5429.3
HSBC FTSE 100 UCITS ETF
15.30
12.28
0.06
0.11
172.9
Lyxor FTSE 100 UCITS ETF
15.90
12.70
0.15
799.8
Source FTSE 100 UCITS ETF
15.47
12.43
0.00
0.20
90.3
Worst
Best
Source: Close Brothers Asset Management, as at 27/09/2016
Indexes used for illustration purposes only. Not a recommendation

21. Close Tactical Select Passive Funds
3 Multi-Asset, Risk-Rated Funds – mapped to Dynamic Planner
Active Asset Allocation, Market Beta, Index Tilts and Smart Beta
Comprehensive Due Diligence on providers and instruments
5 year track record
Comprehensive adviser support

22. Learning outcomes
Understand the basics of passive investments and how to use them.
Why do some passives track differently to others?
Due diligence and what you need to know.

23. Close Brothers Asset Management
10 Exchange Square
Primrose Street
EC2A 2BY