‘Quality strategies’ the smarter way to make excess returns from global equity
The over reliance on momentum-based strategies, which aims to capitalise on the continuance of existing trends in the market, can lead to disastrous results through times, if they do not work, says Justin Abercrombie, head of QEP global equity at Schroders. “We are looking for stocks that are basically driven by either a valuation or a ‘quality’, by which we mean the profitability, the financial strength of the company and also its stability through time.”
One of the advantages of quant investing, especially in global equity, is that it is able to extract many opportunities around the world. With a massive universe of stocks, a more traditional based approach cannot cover that breadth of opportunity like a quant manager.
Within the equity universe, generally divided into value and growth, the non value or growth sub-segment should be divided into ‘quality’ stocks, which tend to have predictable returns through times, and ‘glamour’ stocks that have a more story-driven outcome and can represent the latest market theme, such as technology or biotech or even emerging markets. Their returns are much more unpredictable, says Mr Abercrombie.
He compares relative returns of his ‘quality’ strategies to those following the minimum variance strategies, which construct portfolios with low volatility stocks as they are believed to generate the best returns. While he believes the latter is just a beta or market sensitivity play, the ‘quality strategies’ have good downmarket behaviour, generating excess returns where they are most needed, but without giving them all back when the market recovers, says Mr Abercrombie. “We would argue that our quality strategy is a smarter way of making excess returns, whereas I would describe minimum variance as an un-ambitious strategy.”
According to Nicolas Gaussel, CIO of the quantitative management team at Lyxor, it is not worth debating whether low risk stock portfolios produce higher returns, a concept pioneered by Professor Robert Haugen, CEO Haugen Custom Financial Systems and academic adviser to Alfred Berg – and increasingly accepted by many quant managers, such as Robeco – or embrace the opposing Efficient Market Hypothesis, according to which with the price of every stock at all times reflects a company’s true value.
“I guess that investors expect investment professionals to remain very pragmatic, and not include any kind of ‘religious’ debate in investment practice,” says Mr Gaussel. “Things such as the Efficient Market Hypothesis or behavioural bias are somehow impossible to test, as they are not scientific concepts that you can validate or refute. What you can do is maybe less ambitious and test more limited statements,” he says.
For example, analysis of fund managers’ performance over the past 20 years indicates the large majority fail to outperform their benchmark. As the probability to hire a star fund manager is very low, it is vital to put together a solid infrastructure, a process to collect and analyse information, and to hire and retain smart portfolio managers to generate value added, adds Mr Gaussel.
“As a key strength, the quantitative approach is very repeatable. It is then about the structure of the organisation to make it collective, so that investor does not put the money in the hands of a single individual.”
The main behavioural bias about so called conviction managers is overconfidence, he says.
“For me it is very difficult to understand how a single individual can be self-convinced that, based on the same information anybody has on the market, he can outsmart the market.”
