In order to thrive, quant strategies do not necessarily have to be black boxes. Quite the opposite, in fact. Robeco’s transparent quantitative stock selection models and portfolio construction processes always produce portfolios with easily explainable positions and transactions. For Conservative Equities, this means we can not only explain why we have tilts towards certain sectors or countries, but also provide a good picture of the overall attractiveness of the different sectors and countries in our investable universe, from a low-risk perspective.
Detractors of quantitative investment strategies often dub them ‘black boxes’ owing to some of the complex tools they can rely on. But while this may sometimes be the case, it is far from always being true. Robeco’s Conservative Equites, our approach to low volatility investing for equities, are a case in point.
Our proprietary bottom-up, straightforward and transparent ranking approach enables us to explain to clients each and every position, or transaction, as well as the resulting country or sector tilts. We see this as a clear advantage compared to the more complicated mathematical techniques used by some of our competitors, such as minimum variance optimizations.
Conversely, the outcome of our model also provides a bottom-up picture of the relative attractiveness of countries and sectors at any given moment, which is complementary to the many top-down analyses that are performed by fundamental analysts and economists. In fact, this sort of analysis helps bridge the gap between factor investing and more traditional country and sector-based asset allocation approaches.
As an example, we recently dug deeper into the 1,200-stock investment universe of Robeco’s European Conservative Equities. This strategy is an active approach to low-volatility investing based on award-winning research. It applies a multi-factor stock selection model to select European stocks with a low absolute and distress risk, and attractive upside potential.
We take a multi-dimensional approach to risk, to include return factors like value and momentum, in order to avoid low-risk stocks that are expensive and/or in a negative trend. In our view, selecting stocks based solely on one measure of risk such as volatility or beta is suboptimal, as it ignores information from other factors and variables.
Unsurprisingly, we found that more defensive sectors like Utilities, Real Estate and Consumer Staples score well on the different factors considered in the model, although Consumer Staples remains relatively expensive and therefore relatively less attractive than other sectors. Meanwhile, the cyclical Information Technology, Materials, Consumer Discretionary and Industrials sectors are clearly less attractive. Moreover, the value character of both the Financials and Energy sector is clearly visible, as are the growth-like characteristics of the Information Technology and Health Care sectors, which tend to have a higher valuation and a lower dividend yield. Also, we note that the Financials sector is a special case as it consists of high-beta banks such as the universal large-cap banks in the Eurozone and low-risk financials such as reinsurance companies and low-beta, high-dividend banks in Scandinavia and Switzerland.
In terms of countries, we found that, despite relatively high valuations, Switzerland is the best-ranked country based on our bottom-up approach, primarily due to the relatively low volatility of Swiss stocks. The UK comes out as relatively uncorrelated with the rest of the European market and as quite attractive from a dividend perspective, but the volatility of UK stocks is rather high, on average.
Meanwhile, the cyclical German market scores poorly on beta and negatively on momentum, while having an average valuation. The Italian market, which is characterized by a large portion of volatile banks, shows a higher risk profile. Finally, the above-average beta of the Spanish and French markets can mainly be attributed to the high-beta character of their large banks. Overall, we find that sectors matter more than countries in Europe, which is no surprise in Europe’s integrated markets. For instance, the characteristics of a British bank stock will be closer to those of a French bank stock than those of a British telecom company stock.
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