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Q&A on Robeco Emerging Conservative Equities

28-03-2011 | Insight | Pim van Vliet, PhD A rare application of a low-volatility strategy in emerging markets, Robeco Emerging Conservative Equities was launched in February 2011. Pim van Vliet, Senior Portfolio Manager, Low-Volatility Equities, explains  the new strategy, the research underpinning it and how it fits into an institutional portfolio.

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What’s behind the introduction of Emerging Conservative Equities?
We believe it is a natural development for us and our clients. There is a good argument to be made for benefiting from emerging market equity returns at substantially lower risk. It is also another way for clients to leverage Robeco’s expertise in low-volatility strategies and our experience in emerging markets. Our fundamental emerging markets equities team has been successfully investing in the region since 1994 and now manage about EUR 11 billion. Meanwhile, our low-volatility strategies have attracted EUR 1 billion in assets in just four years. It also builds on our successful record of rules-based investing in emerging markets, which we’ve been doing since 2006 with our Enhanced Emerging Markets strategy.

What’s the business case for investors?
There is an obvious case for applying our low-volatility strategy to emerging markets. Let’s first look at the region. The IMF is forecasting 9.6% real GDP growth in 2011 for China and 8.3% for India, while expansion in the developed world is put at just 2.2%. Emerging markets currently account for about 14% of the MSCI All-Country Index, rising from just 2% in 2000. And it’s expected to continue to grow. It’s no wonder that we see demand from both institutional and retail clients for emerging markets exposure.

On the other hand, while emerging markets have matured, they are still volatile. Witness the recent events in the Middle East. It makes sense that investors look to begin to diversify their emerging markets exposure, especially to include a lower-volatility strategy, such as Robeco Emerging Conservative Equities.

What exactly are you offering?
We offer our clients the opportunity to achieve emerging markets returns with a significant reduction in risk, as measured by volatility, the size of draw-downs and beta. Moreover, based on our research, we expect the potential for risk reduction in emerging markets to exceed that of developed markets. We’ve found with our Conservative Equity strategies, that the higher the volatility, the more powerful the risk reduction. (See the volatility comparison and risk reduction of our developed and emerging markets strategies below.)

Emerging Conservative Equity is also a good opportunity for income. Conservative Equity portfolios select low-volatility stocks which, in general, are characterized by above-average dividend yields.  With the launch of the Emerging Conservative Equities fund, investors can choose an accumulating or a distributing share class paying 1.25% per quarter (5% annually).

Portfolio simulation of rolling volatility for developed and emerging markets Conservative Equity strategies and reference benchmarks, using a five-year investment horizon

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We use monthly return series hedged to Euro for Jan 1996 – Dec 2010 period for developed markets and USD-return series for the Jan 1996 – Dec 2010 period for emerging markets. Prior to Oct 2006, Conservative Equity (Global) is based on portfolio simulations and is net 75 bp in  transaction costs. Conservative Equities Emerging Markets is based on portfolio simulations and is net transaction costs of 100 bp.

The value of your investments may fluctuate. Results obtained in the past are no guarantee for the future.

Can you explain a little more about your research?
When clients invest in our strategies, they benefit from an entire team of Quantitative Equity researchers. We are always pleased to share the results of our work with our clients.

Our portfolio simulation results for Emerging Conservative Equities have been very positive. While we aim for equity returns, the back-test performance results were better, as has been the case with the live performance of the other Conservative Equity strategies since inception.

The reduction in volatility over the portfolio simulation was substantial. The simulated portfolio had a volatility of 18.6% versus 24.7% for the index. In terms of the maximum drawdown, the strategy’s ability to reduce losses and preserve capital appears significant. The Emerging Conservative Equities portfolio had a maximum drawdown of 43% versus 60% for the index. These results are based on stocks with a market cap of at least USD 100 million in the IFC Emerging Markets Investable universe over a back-test period of 1996-2008.

What’s your advice regarding the positioning of Emerging Conservative Equities in an institutional emerging markets portfolio?
The answer depends on the client’s investment beliefs related to such issues as thematic, fundamental, rules-based and value investing. Conservative Equity strategies rely on an absolute approach to risk. We do not use a benchmark for portfolio construction and expect there to be large deviations from indexes. So if a pension fund is using tracking error, a position of more than 50% would probably not make much sense. On the other hand, if the client is investing based on the Sharpe ratio or to improve liability coverage ratios, then 100% allocation to low-volatility strategies in an emerging markets portfolio is reasonable.

Clients looking to affect the absolute risk/return profile of their overall portfolio should consider an allocation of at least 10-15%. All of the Conservative Equity strategies are excellent diversifiers, as they perform better in down markets, when active strategies typically have difficulty. Most active managers are biased towards higher risk, so adding a low-volatiltiy strategy can help to stabilize performance.

Emerging Conservative Equities is designed for clients who are explicitly interested in equity capital preservation, dividend income or diversification within equity markets. 

1. Information and Robeco research papers on low-volatility investing are available at www.robeco.com/lowvolatility. Additional proprietary material is available to clients on request.
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Pim van Vliet, PhD
Senior Portfolio Manager