Damien Blomeley 1663897 Alessandro Caruso 1576321

Gustavo Taucei Schellenberger 1587286 Ludovico Van Wijk 1342872

The Blackrock Global Small Cap fund - Characteristics and

Performance.
The aim of this report is to provide the reader with a Style Analysis of the BlackRock Global SmallCap Fund.

The BGF Global Small Cap fund is managed by BlackRock and has as its objective the maximization of total
returns. The vehicle is constrained to invest at least 70% of its total assets in equity securities of smaller
capitalization companies, namely in the bottom 20% of market capitalization in global stock markets. With the
remaining capital BGF pursues investment in largely capitalized firms and in low-risk short-term investments for
liquidity purposes. The fund is free to invest in developed as well as in developing markets and it has further
significantly diversified into diverse industries.

It is important to premise, since it will not be further object of discussion in this report, that the quality of this
style analysis could also benefit from the fact that, according to the prospectus of the fund, the Expected level
of leverage of the fund is equal to 0% of Net Asset Value. Thanks to this policy of the fund the analysts could
be sure that their results were not going to be biased because of the imposition of the w 0 constraint (where
w is the vector of the weights).

A theoretical premise to the execution of the Style Analysis

In order to have a full comprehension of the outcomes of this technique, the reader should be aware of the fact
that the Style Analysis may have a double orientation:

1) To find the effective asset mix of a fund. This is the goal on which Sharpe based his first paper. In
reality, it is impossible to find out what is the exact composition of a fund through a Style Analysis,
even because this would be like assuming that over the period under consideration the fund has been
maintaining a constant relative proportion strategy, which is clearly unlikely.

2) To find a way to replicate the returns of a fund at a lower cost. Technically this approach may not
depend on the true composition of the fund and is mainly addressed to investigate the quality of the
Asset Manager. Lets say, for example, that the result of our Style Analysis shows that the BGF Global
SmallCap fund returns could have been easily replicated by an average investor through the use of 3 or
4 indices (hence investing on funds that track these indices). This would prove that, at least as concerns
the 5 year period we have been considering, the Asset Manager did not deserve the 1,5% Annual
Management Fee it has been asking for. Of course, this conclusion is based on the assumption, actually
quite reasonable, that investing in one or more ETF tracking an index is cheaper than investing in an
actively managed Fund.

This report does not choose one approach over the other; instead it tries to exploit the points of strength that
derive from their combined use. In other words, the goal of this report is to find a cheaper way to replicate the
BlackRock Fund returns through a mix of asset classes in which the same fund may have reasonably invested in
conformity with its nature and mission.

We would like to strengthen this argument by showing the following figure, which illustrates the performance of
the fund over the 5 years going from September 2007 to October 2012. It proves that, if replicating the BGF
Global SmallCap fund returns was the only goal of the investor, then for the period under consideration she
should just have invested in the ETF tracking the fund benchmark (MSCI World SmallCap).
BGF Global Small Cap Fund performance from 3/10/2007 to 30/09/2012

After looking at this graph the reader may wonder why even try to find the composition of a mimicking portfolio
at all, given that replicating the fund returns is easily done through the benchmark.

The opinion of the writer is that the performance of the fund in the last five years had been heavily and
negatively impacted by the adverse state of the economy. It is evident, indeed, that before the financial crisis the
Fund was outperforming the MSCI World SmallCap and, hence, a good style analysis would have better served
the purpose of identifying an asset mix able to consistently beat the benchmark.

BGF Global SmallCap Fund performance from Fund creation to

10/2012 (BlackRock official website)

According to Sharpe (1992), when evaluating the usefulness of a style analysis model, it is desirable to select
asset classes which are 1) mutually exclusive, 2) exhaustive and 3) that have either different return correlations
or standard deviations. In the style analysis of the BGF Global Small Cap Fund, this report has taken close
consideration of the previous three criteria when selecting the asset factors.
Alas, the desire of respecting these guidelines, while at the same time giving a particular meaning and
orientation to this report, quickly proved to the analysts that the two things often operate on a trade-off basis,
rising unavoidably from the attempt to build both interesting and meaningful empirical results out of sound
theoretical framework.

For example, in some cases this report has chosen to maintain two or more indices that it deemed particularly
significant, even at the cost of an high correlation between them (and hence a lower reliability of the overall
result). In other cases, fewer indices have been preferred to a higher correlation.

Two Style Analyses at work

This report is divided into two different style analyses with complementary investigative approaches that have as
their objective the evaluation of the replicability of the fund return through a similar asset-mix.

The First style analysis is geographically based. It considers the BGF geographical investment allocation
and uses equity indexes that focus on different regions across the globe in an attempt to mimic the
portfolios territorial allocation mix.
The Second analysis is based on the Funds style, that is on the broadest categories of which the
securities universe is composed. It considers the BGF investment strategy style and uses indexes that are
similar to the vehicles investment proposition in an attempt to mimic the portfolios strategic allocation
mix. We considered such an approach especially desirable, as opposed to, say, a breakdown by
industries, because of the funds quoted aim of reflecting the small caps global equity by holding
predominantly securities of this type.

Style Analysis - Geographical

In consideration of the Funds global investment policy the following indexes have been selected, with the
respective resulting weights for the analyses over 60 monthly returns, and 52 weekly returns:

ASSET CLASSES Monthly Weights Weekly Weights

MSCI US 64.2% 2.4%
MSCI Canada 0.0% 16.6%
MSCI Emerging Market Latin America 9.0% 0.0%
MSCI Japan 0.0% 0.0%
MSCI Europe 9.7% 0.0%
MSCI AC Free Asia ex Japan 11.4% 6.9%
Citigroup Fixed Income Global All Maturities 0.0% 0.0%
Euribor 3 Months 5.7% 15.5%
JPM USA 3 Months 0.0% 58.7%
100% 100%
The previous indexes were selected after careful discussion of Sharpes considerations regarding exhaustibility,
mutually exclusivity and correlations. The indexes strictly speaking do not represent all global regions (e.g.
Australia and Africa) although the most relevant regions are indeed represented and at least reflects all the
regions that Blackrock has concentrated its holdings in. Such a decision is justified when taking into
consideration the trade-off between being mutually exclusive and exhaustive, since no single index combination
optimally satisfied both conditions. Furthermore, additional examinations of BGFs geographical allocation,
made it clear that its exposure to the regions that were excluded by the final set is not significant. We therefore
deemed that the inclusion of further indexes to represent regions such as Australia would harm the results
through effects such as co-linearity more than help.

The Citigroup Fixed Income All Maturities Index, used in order to include the consideration of Fixed Income in
the model, served as well the purpose to test the reliability of the analysis: the resulting null weight matches the
a priori knowledge that BGF does not invest in any type of bond. Finally, the Euribor and JPM USA 3 months
were added to act as a global proxy of the funds cash holdings and liquidity reserves.

The Style Analysis is correctly able to recognize the fact that the biggest share of the investments is addressed to
the Equity universe and, in particular, to the US market. The reliability of these findings is proved by the
knowledge, derived from several databases (Bloomberg, Morningstar), of the true geographic allocation of the
funds assets, illustrated by the following figure. The reader must keep into account that the goal to obtain
exactly those values with a style analysis was non particularly attractive to the eye of the analysts, because they
are representative of present allocations, that is they show more the tactical strategy of the fund rather than the
strategic one.

Bloomberg: Main allocations of the BGF Global Small Cap fund

A possible point of weakness in the model is that too much weight is put in the Latin American and Asian
securities. One possible explanation is that Asian and Latin American securities like small cap securities are
riskier assets and are usually liquidated by investors in times of economic uncertainty. The emerging markets
regions such as Latin America and Asia ex Japan also exhibit this behavior in times of economic uncertainty
such as the recent GFC and debt crisis, which would partially explain their extra significance in the model. It
was unlikely to be able to completely replicate all of the behavior of small caps using indexes constructed of
their regionally associated large cap equities.
In order to assess the quality of the analysis and, in case, choose more appropriate factors, the correlations
among the different indexes have been taken in careful consideration. According to Sharpe, indexes should have
either low correlations, or different standard deviations.

A significant number of trials brought to a combination of indexes that, although not perfect, considerably
outperform the other possible scenarios. The following figures demonstrate that around only 16% of the indexes
show a correlation parameter greater than 0,8 in both weekly and monthly analysis (the red cells are those in
which the value for correlation is higher than 0.8). Moreover the reader will easily acknowledge that the
mentioned cases presented significantly different Standard Deviations .

Figure 1 - Monthly Correlations and Standard Deviations:

Figure 2 - Weekly Correlations:

The following statistic offer further space for reflection:

As far as concerns the Style Analysis conducted on the monthly returns the R 2, higher than 80%, shows that an
extremely relevant part of the variability of BGF Fund returns is explained by the variability of the factors
included in the mimicking portfolio, according to the resulting weights.
The writer considers this value to be very positive, particularly in light of the fact that it was impossible to get
better results out of factors able to keep in account at the same time both geographical divisions and market
capitalization. An attempt performed in that direction (using for example MSCI USA Small Cap and similar
indices) proved to the analysts that the benefit deriving from a greater precision was soon offset by the excessive
number of indices required to build an exhaustive analysis and by their high correlations.

Furthermore, it is interesting to notice that the unexplained variability can be interpreted, according to Sharpe, as
the contribution of the Asset Manager to the Fund Performance.

Selection; 20%

Style; 80%

One last consideration, relative to the monthly data, must be devoted to the mean error: its negative value proves
that over the period under consideration the Geographical Style Portfolio outperformed the BlackRock Global
Small Cap Fund. This remark should immediately communicate to the reader a negative impression about the
quality of the Asset Manager. Indeed, his strategy (for which he is asking a considerable annual compensation)
could have been easily beaten by an investment in 4 ETFs tracking geographical area indices and by keeping
some liquidity invested at the Euribor 3 Months rate.

As far as concerns the statistics obtained by the analysis conducted on weekly data, instead, the writers opinion
is that, at least in the case of this precise fund and of the period under consideration, the Style Analysis is not a
reliable tool. This is probably motivated by the fact that weekly returns are too noisy and the linear regression
struggles to find a stable pattern. Much more reliable results were obtained from the monthly returns which
exhibit more the smoothed long-term trends of each investment class.

Rolling Analysis
The Rolling Analysis helps the reader to formulate an idea about the dynamic evolution of the fund composition.

In total 25 different rolling regressions were performed and the R2 level fell between 0,823 and 0,8695; while it
averaged 0,8426. Among the most notable weights, it can be noticed the decreasing exposure to the US and Asia,
that is accompanied by an increase in the Latin America, Japan and Canada. The Fixed Income, Euribor, USA 3
months weights and the portfolio have varied during the observed period but never accounted for more than 10%
of the portfolio. The indices weight dynamics can be better understood by the Graph 2 below. Furthermore, it is
interesting to notice that the most recent weight allocation of the analysis is very similar to the current actual
geographical allocation of the BGF fund (look at the previous Figure from Bloomberg).
Confidence Analysis
The Geographical confidence estimation yielded the following results for the 95% confidence level:

Considering the confidence level (alpha=0,05) the indexes presented different levels of variability between the
max/min range. Such max/min variance ranged from around 60% to 20% depending on the index factor. It is
interesting to consider that this variability is capped at the 0% allocation, since the model is constrained to
positive weights only. In our confidence level, the MSCI US index was the only factor to be definitely assigned a
positive weight. All the other eight indexes had within their confidence level the zero allocation mark, it is
therefore difficult to infer their power in explaining the BGFs variance.

These results are, however, partially in line with our a priori knowledge of the actual geographical allocation of
the fund, since it was known that the US was geographically the most important securities market in which the
fund allocates its capital. Finally, considering the relative low explanation power model, the group has followed
Loboscos suggestion and re-run the confidence analysis by discarding the 0% weight factors as estimated in the
geographical style analysis. This second study has dropped the MSCI Canada, MSCI Japan, Citi FI and the JPM
USA, and the results are presented below:
Graph 4: Confidence Level Loboscos Suggestion

70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%

Even after following Loboscos suggestion of dropping the zero weight factors, the MSCI US index is still the
only factor that the group can state with 95% confidence to have a true weight that is non-zero. The variability
between the max/min ranged from around 60% to 20%. As mentioned above, given our constrains the variability
is capped at the 0% minimum weight allocation.
We begin the efficient frontier analysis with a graphical presentation of the efficient frontier formed from the
indexes used in our Geographic Style Analysis.

The first interesting points to note are that:

- The geographic style portfolio dominates the BGF Global Small Cap from a risk return
perspective.
- The MSCI benchmark outperformed the BGF Fund in overall return for the period, but at the cost of
greater risk.
- All of the equity based indexes have fallen far short of the efficient frontier.
- The efficient frontier is formed almost exclusively of combinations of the fixed income securities.

Due to the period under investigation including the GFC, equities in general did not perform well, as is
evidenced from the relative positions of the equity indexes to the money market indexes.

It is also important to note that the vertical axis here does not represent expected returns, but realized returns. Of
course if the equities had been expected to attract such low returns, their pricing five years ago would have been
very different.

For this reason we have performed the analysis again, this time making the efficient frontier only with the MSCI
equities indexes.
This analysis shows that, when compared to equity asset classes alone, the performance of the BGF Global
Small Cap still underperformed, but was positioned more reasonably for an equity class asset.
The Investment Style Analysis
In consideration of the Funds investment style policy the following indexes have been selected, with the
respective resulting weights for the analyses over 60 monthly returns, and 52 weekly returns:

ASSET CLASSES Monthly Weights Weekly Weights

MSCI World Small Cap 66.0% 17.88%
Value Global 16.4% 6.41%
Citigroup Fixed Income Global All Maturities 0.0% 53.36%
Euribor 3 Months 17.6% 22.34%
JPM USA 3 Months 0.0% 0.00%
100% 100%

The previous indexes were selected after careful discussion of Sharpes considerations regarding exhaustibility,
mutually exclusivity and correlations. The MSCI World Small Cap Index (which is, indeed, the benchmark of
the fund under analysis) is of course representative of the small cap investable equity universe. The Value
Global, instead, represents the stocks of largely capitalized companies. The reader will notice that the other main
exponent of Large Cap Equities, namely the Growth Global Index, is missing. The analysts removed it from the
factors set after having realized that Growth Caps and Small Caps were presenting a similar behavior owing to
their high correlation. This resulted in a regression unable to distinguish efficiently between the two indices and,
hence, in weights less reliable and interesting from the analysts point of view.

Obviously, the observations made about the correlations of weights in the Geographical Analysis hold for this
analysis as well. (The red cells are those in which the value for correlation is higher than 0.8)

Figure 1 Monthly Correlations and Standard Deviations:

Figure 2 Weekly Correlations:

Again, the statistics resulting from the analysis offer material for further reflection:

Probably, even in this case the first thing to draw the readers attention will be the difference between the R 2 of
the two analyses. This may be taken as a confirmation that (we want to stress it: at least for this specific fund and
the period under consideration) the Style Analysis is a tool that doesnt work optimally in a noisy environment
such as the one of weekly returns. For this reason, we decided to not deepen further the study of the funds
tactical approach. As far as concerns the R 2 for monthly returns, instead, the results present once again
significant explanatory capability.
The value obtained would imply that the personal selection of the asset manager contributed for the 21.53% of
the Funds returns variability.

Selection; 22%

Style; 78%

Moreover it is interesting to notice how, once again, over the period considered, the Style Portfolio would have
outperformed the BlackRock Fund (look at the negative mean error). The following graph shows this clearly for
both the Geographical and the Investment Style Portfolios:
Rolling Analysis
The Rolling Analysis shows a more stable dynamic composition of the style portfolio with respect to
the Geographical Analysis. Moreover the soundness of the analysis is witnessed by the fact that it is
correctly able to recognize how almost the 70% of the NAV is invested in Small Caps.

Several hypotheses could be made about the sudden drop experienced by the portfolio share invested in Small
Caps (center of the graph) in relation to the fact that it seems to happen right in the period coinciding with the
beginning of the financial crisis and the sequential European debt crisis. The writer is however careful to do that,
well aware that every point on the X Axis corresponds to 36-month window, and hence the effect of the crisis
should heavily impacting all of the graph. The writer prefers, therefore, to attribute much of the variability
between the regions to the fact that there exists a high correlation between the MSCI Global Small Cap and
Global Value indexes. Therefore the style analysis method would not be able to adequately distinguish between
the two indexes to a high resolution.

Investment Style Analysis Confidence levels

The Investment Style confidence estimation yielded the following results:

Confidence Level
100.00%
90.00%
80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
MSCI World Small Cap Value Globale Euribor 3 mesi

Considering the confidence level (alpha=0,05) the indexes presented different levels of variability between
between the max/min range. Such max/min variance ranged from around 60% to 12% depending on the index
factor. It is interesting to consider that this variability is capped at the 0% allocation, since the model is
constrained to positive weights only. In our confidence level, the MSCI World and the Euribor were the only
indexes to be definitely assigned a positive weight. The Value Global index had within its confidence level the
zero allocation mark, it is therefore not possible to infer their power in explaining the BGFs variance.

These results show the advantage of using fewer indexes for assessing confidence levels, given the
comparatively stronger resolution achieved in this example, to the Geographical analysis breakdown, which had
a greater number of indices.
Efficient Frontier Investment Style Analysis

The image shows the efficient frontier resulting from non-negative combinations of the following indices:

- MSCI Small caps Globale

- MSCI Value Globale
- Citygroup Tutte le Scadenze
- Euribor 3 Month
- JPM USA 3 Month

Which were selected as a proxy for the complete global equity and fixed income markets. The BGF Global Cap
performed poorly compared to the wider range of investment opportunities over the period. Much of the cause
of this can be attributed to the GFC during which equities in general lost much of their value. Mid to long
term fixed income securities earned an average of 9% over the period and they dominate much of the
composition of the efficient frontier, along with the Euribor 3 Month.

In an attempt to understand the BGF funds performance relative to just the equities investment space we
constructed an alternative efficient frontier using the following indexes. Note that we have reintroduced the
Global Growth index for completeness.

- MSCI Small caps Globale

- MSCI Growth Globale
- MSCI Value Globale
The image shows that the fund is still underperformed relative to the global equities space, but to a lesser degree
than against wider investment university considered previously.