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Throughout his career, Noël Amenc has championed the incorporation of academic research into the decision-making of finance professionals and regulators. Having set up the Edhec Risk Institute in 2001, today he is chief executive of ERI Scientific Beta, the institute’s initiative to put its research on smart beta into practice. We spoke to him to find out his views on the state of the smart beta industry today and what the future may bring.
This paper challenges the earlier work of Fu (2009), who claims to find a positive empirical relationship between risk and return using a sophisticated (EGARCH) idiosyncratic volatility measure for risk. Fu’s result flies directly in the face of the large number of studies that find strong evidence for a low-volatility anomaly.
One of the explanations for the low-volatility anomaly is that stocks with lottery-like characteristics (a small chance of experiencing a large positive payoff) are overpriced. This paper finds a similar result for stock options. The authors find that the degree of lottery-like features can explain differences in expected option returns between 10% and 50% per week.
As portfolio managers of Robeco Conservative Equities, we want to place our role into a historical perspective and learn from the history of financial markets, and mutual funds in particular. History teaches us that good ideas do not necessarily guarantee successful funds. Timing is everything. Still, capital protection, high income and low turnover are timeless factors that are still relevant today.
Although Factor Investing is rapidly gaining popularity, there are still ongoing debates about this concept. In our view, the key feature of Factor Investing is that asset owners select factors and their weights themselves, rather than leaving this up to their asset managers.
Recently a new factor was added to the literature: Quality. In credits, we see Quality as a natural extension of pure Low-Risk. All our credit factor models have used Quality since inception, and have expanded its use over the years.
Investors are worried about the high valuations of stocks in general and low-volatility stocks in particular. And so are we! In relative terms, low-volatility stocks have become more expensive during the last two years, but it’s not the first time. It happened first in 2008 and again in 2011.
Some people argue that the low risk anomaly can be explained by ‘profitability’, an example of a ‘quality’ factor. In our paper ‘The Profitability of Low Volatility’, we challenge this hypothesis and conclude that the low-risk anomaly is a distinct phenomenon, which cannot be attributed to profitability alone.
“Putting your research to the test is always exciting, and if it then works out well, then that’s very satisfying.” That’s how Patrick Houweling describes celebrating the first anniversary of the Global Multi-Factor Credits fund, with an outperformance chart to go with the birthday cake.
Robeco has added Quality to the key list of factors that it follows when constructing factor investing portfolios in equities. But how to define it? There is a disconnect between definitions of the factor ‘quality’ by academics and how it is defined by many in the asset management industry.
Smart beta indices are a popular way of implementing a factor investing strategy. However, research suggests that this may not the best way, as the factor exposure provided by popular smart beta strategies varies greatly and they do not unlock the full potential of factor premiums.
Factor investing – the investment strategy that aims to capture ‘hidden’ returns in financial markets – is rapidly gaining in popularity. However, it is important to follow the right factors, and to be wary of one factor counteracting another, to get the best results. Otherwise, investors might follow generic factor strategies that expose them to risks that are not properly rewarded, resulting in inferior performance.
A study* by three Blue Sky pension provider researchers (Bastiaan Pluijmers, Imke Hollander and Ramon Tol) together with Dimitris Melas from MSCI compares the characteristics of nine different low-volatility strategies.
To the best of our knowledge, no study has been conducted on the added value of innovative investment strategies that incorporate academic insights. As a result, we do not know how many investment managers have incorporated academic insights or how successful they are. We have researched the topic to fill this gap in the literature.
Emerging markets are going through a volatile period, but the defensive investment strategy of Robeco Emerging Conservative Equities is proving its worth by outperforming the index. “Despite its relatively short history, we are very confident about the fund as is demonstrated by its Bronze Morningstar Analyst Rating. The results are more than promising.”
Trading is necessary to follow an active strategy, but excessive trading is linked to human behavior. In his new paper just published on SSRN Pim van Vliet looked into why investors trade and how much trading is needed for an effective low-volatility strategy.
A paper* argues that size, value, momentum and other factor portfolios might be considered as alternative building blocks for strategic asset allocation, because these offer an attractive risk premium and powerful diversification benefits.
Usually focusing on how to design the best low-volatility strategy, David Blitz, Matthias Hanauer and Pim van Vliet have set out to construct a very bad low-volatility strategy. Comparing good and bad low-volatility strategies they found very different performance characteristics. Clearly, not all low-volatility stocks are created equal. The results highlight the importance of being selective when investing in low-volatility stocks.
Some argue that the mere mechanism of rebalancing increases returns, and that this explains the success of factor investment strategies. Although factor strategies do need rebalancing to maintain their exposures, there are several reasons why it is unlikely that this is their source of added value.
Low-volatility stocks are known to lag in rising markets and lose less in falling markets. On average this is true, but is it always the case? Examining the historical evidence we find that unlikely scenarios – both positive and negative - do occur once in a while. Low-volatility investors should therefore not only focus on averages, but consider a broader range of possible outcomes.
The application of Gordon’s growth formula to a ‘Japan scenario’, low bond yields in combination with low expected growth and low inflation, supports the case for low volatility stocks. This simple formula (left side) states that the value of a stock is equal to the present value of the expected stream of dividends.
Generic strategies designed to harvest a certain factor premium regularly conflict with other factor premiums. We find that the premiums associated with these strategies tend to shrink, sometimes even to zero, in these periods of factor disagreement. But enhanced factor strategies avoid stocks that are unattractive on other established factors and continue to deliver when generic factor strategies struggle.
Low-volatility investing is becoming more popular. Many professional investors currently explicitly allocate a significant portion of their portfolio to low-volatility stocks. Robeco uses an enhanced approach to increase returns and reduce risk.
Robeco’s assets under management in Quant Equities recently surpassed the EUR 20bn milestone. On this occasion, we asked Peter Ferket, CIO Equity Rotterdam and closely involved in Robeco Quant Equity since the late 1990s, how he explains the success of quant equity investing and Robeco’s role as a thought leader in this field.
Low-volatility stocks are in high demand. According to Pim van Vliet, portfolio manager of Conservative Equities, a generic low-volatility strategy is getting more expensive. An enhanced approach is necessary to prevent buying too expensive stocks.
Risk and return do not always go hand in hand. But why? Watch Pim van Vliet, Portfolio Manager Conservative Equities.
Robeco’s Conservative Equities strategies aim for equity returns with lower downside risk. Get to know our approach in just ten steps. Pim van Vliet, Portfolio Manager Conservative Equities, explains the advantages of low-volatility investing and how it fits into your portfolio.