Robeco Emerging Conservative Equities: an uncommon but proven combination of 3 factors

Robeco Emerging Conservative Equities: an uncommon but proven combination of 3 factors

12-11-2015 | Insight

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.”

  • Arlette van Ditshuizen
    van Ditshuizen
    Portfolio Manager and Head of the Quant Equity Portfolio Management team

Speed read

  • Emerging markets are attractive for investors with a long horizon
  • The strategy of of the fund pays off in volatile markets
  • Low volatility, momentum and value have positive overall impact

Emerging markets have showed mixed emotions in recent years. They have had to deal with slowing economic growth, rising current account deficits, high leverage and capital outflows. Government reforms that bring about economic recovery and debt reduction are needed, but it has to be said that not all emerging countries are equal.

“I realize that emerging markets have recorded disappointing performances over the past year,” says Arlette van Ditshuizen, portfolio manager in Robeco's Quantitative Equity team. Together with Pim van Vliet and Jan Sytze Mosselaar, she is responsible for Robeco’s Emerging Conservative Equities fund. “But emerging markets offer long-term potential and are therefore attractive for investors with a long horizon. By the way, we do not use any macroeconomic vision for the fund. Bottom up stock picking forms the basis.”

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Low volatility, valuation and momentum

In the current declining markets, the defensive investment strategy of Robeco Emerging Conservative Equities has proven its worth. While its reference index – the MSCI Emerging Markets Index – recorded a year-to-date loss of -8.37%, the fund performed -4.6%1 and posted a 12-month performance of -4.59%, compared to -8.65% for the index. Emerging Conservative Equities has therefore fallen considerably less than the MSCI Emerging Markets Index in these times of downturn.

The investment philosophy of the fund is that higher risk is not always rewarded and that low-risk stocks achieve returns in line with the market. The fund invests in low-volatile stocks in emerging markets across the world. Its long-term aim is to achieve returns comparable to those from emerging-market stocks, but at a distinctly lower level of downside risk. The focus is not just on outperforming the benchmark but the fund aims to offer downside risk protection with a superior Sharpe ratio.
The low-volatile stocks are selected using a quantitative model developed by Robeco that ranks them in a variety of ways, including on the basis of market sensitivity, volatility, distress risk, valuation and momentum.

“The focus on factors like low valuation and high momentum distinguishes Robeco Emerging Conservative Equities from standard low-volatility funds. The combination with low volatility is not common. The fund itself is already quite unique as there are not many emerging markets equity funds with such a distinct low volatility philosophy,” says Ronald van Genderen, fund analyst at Morningstar.

“However in its short history – the fund was launched in March 2011 – Robeco Emerging Conservative Equities has achieved excellent returns, which confirms Morningstar’s positive view,” says Van Genderen. “Over the past four years the fund has certainly demonstrated its defensive qualities. 2012 Was a notable year: emerging markets performed well, the benchmark rose 16.4% and the Morningstar category ‘emerging markets equities’ gained 15.3%. The fund outperformed both the reference index and the category, with returns of 21.7%.”

Conservative and low or minimum-volatility equity funds generally deliver an atypical performance. In rising markets, such a defensive fund will lag but in declining markets it can be expected to fall considerably less than comparable funds in its category and the benchmark. But Robeco Emerging Conservative Equities has proved the opposite so far. Since its inception in 2011, the fund has outperformed the benchmark with a return of 6.33%, compared -0.14% for the MSCI Emerging Markets Index.

According to Van Ditshuizen, it is the combination of factors that adds value. “A factor like valuation or momentum has weak moments over time, but the combination has a positive overall impact on the low volatility factor. Especially in upward markets these factors contribute to the performance. The valuation factor has disappointed in recent years but is amply compensated by the momentum factor. And vice versa for other periods. But the basis of our strategy remains the low risk factor. As a result, we are losing less in down markets. And if you lose less, you also have to gain less to make up for the loss. It is really winning by losing less.”

‘It’s the combination of low volatility, momentum and valuation factors that adds value’

Human overview

The stock selection for Robeco Emerging Conservative Equities is based on a quantitative model, which may suggest a fully automated investment process. This forms the basis, but ultimately the fund managers are responsible for the implementation of the investment ideas that are being generated by the portfolio construction algorithm. Van Ditshuizen: “On a daily basis we check for example the quantitative rankings that the model generates as well as all the proposed trades given the cash flows that we expect to occur.” For example: if we have a cash outflow today, while we know that there will be a large cash inflow tomorrow, it makes sense to manage these flows carefully in order to minimize any unnecessary turn over. No matter how sophisticated our algorithm might be, you still need a human portfolio manager to address these issues on a daily basis, explains Van Ditshuizen.”

The automated portfolio construction tool has the possibility overweight or underweight countries up to 10 percent in order to differ from the MSCI Emerging Markets Index. Chinese stocks are currently strongly underweighted while Malaysian stocks are overweighted in the Emerging Conservative Equities portfolio. “China is being underweighted by the algorithm as Chinese stocks tend to be very volatile. This worked against us when Chinese equities soared, but paid off during the turmoil of last summer. Malaysia on the other hand is a low-risk emerging country, with stocks that score well on valuation.”

Rate rise

The low volatility nature of the Robeco Emerging Conservative Equities portfolio means there is a preference for more defensive sectors like, utilities and telecom. The utility and telecom industries are overweight relative to their reference index, the MSCI Emerging Markets Index. Volatile sectors like cyclical consumer goods, energy and IT are the most underweight. Remarkably, all of the companies in the portfolio are ‘real’ emerging market companies. The fund does not invest in developed market companies with a high exposure to developed markets.

But industries like utilities and telecom are sensitive to interest rates. Higher interest rates make this type of stock less attractive. How will the expected US rate rise, which has many emerging markets in its grip, impact Emerging Conservative Equities?” We have researched the fund’s sensitivity to interest rates,” explains Van Ditshuizen.” Equities in general are sensitive towards rising rates, and especially ‘low vol’ equities. But this is more relevant in the short term than the long term. Also, keeping an eye on valuations and momentum factors mitigate this risk partially. We’ve researched whether we can eliminate this rate sensitivity completely and found that this is possible, however doing so would not be beneficial for our long term performance.”

Future performance

Van Genderen is curious how Robeco’s Emerging Conservative Equities will perform in an upward market that holds for some time.“ Because of its relatively short existence, the fund has not yet experienced a full market cycle. What will the returns be when emerging markets are trending? Will the momentum factor play a role? But Morningstar’s Bronze rating because of the experience of the fund management team, distinctive investment process and low costs suggests that we expect that Emerging Conservative Equities to outperform the benchmark and its category in the future over a full investment cycle.”

The fund analyst is also impressed by the fund’s cost structure: “Robeco Emerging Conservative Equities is one of the cheapest funds in the Morningstar category ‘Global emerging markets equity’. The ongoing charges are acceptable for an emerging markets equity fund in absolute terms and cheap in a relative sense. And, last but not least, the fund managers invest in their own fund, aligning the interests of investors with their own interests.”

1Source: F share class figures net return based on net asset value in EUR. The value of your investments may fluctuate. Results obtained in the past are no guarantee for the future.

Morningstar Rating for Robeco Emerging Conservative Equities

**** (as of October 2015)

Morningstar Analyst Rating for Robeco Global Premium Equities
Silver (as of April 2015)

Process: Positive
Performance: Positive
People: Positive
Parent: Neutral
Price: Positive

Morningstar operates independently and uses two different methods to analyze and rate mutual funds: the first is quantitative – based on historical returns (the Morningstar Rating, also known as the ‘Star Rating’). The second is qualitative in nature, focusing on several characteristics of a fund (the Morningstar Analyst Rating).

The Morningstar Rating uses an automated process with a scale of one to five stars to assess a fund’s historical returns. These returns are adjusted for risk and compared to the fund’s peers. Funds that have performed better than their peers over a period of several years receive four or five stars. Funds that perform less well are awarded one or two stars and those in between, three stars.

Forward looking
Since only historical data is used in the Morningstar stars calculation, the valuation is backward looking and says nothing about a mutual fund’s future performance. This is where the Morningstar Analyst Rating comes in, which is forward looking and takes into account factors that affect the future performance. The Morningstar Analyst Rating is given by an analyst after a thorough analysis of the fund. He awards the qualifications of Gold, Silver, Bronze, Neutral or Negative.

In order to arrive at an Analyst Rating, the Morningstar analyst assesses the five Ps of a mutual fund: People (management team), Parent (fund company), Process (investment process), Performance (for risk adjusted return) and Price (ongoing charges). Each P is rated with Positive, Neutral or Negative.

Based on the overall analysis, the analyst gives a positive (Gold, Silver or Bronze), neutral (Neutral) or negative rating (Negative). Mutual funds that are rated as Negative have a low score on one or more of the Ps. In the case of the Neutral rating, the Morningstar analysts believe that the fund will not make a negative or positive difference at the current time. Funds with the Gold, Silver or Bronze rating – ‘medalists’ – are expected to structurally achieve higher overall returns than similar funds and/or the benchmark in the long term – over an economic cycle. They are the winners of the future.

Under Review
A mutual fund can also have the status Under Review. The Morningstar analysts put a fund Under Review when there is a major change in the fund or the fund house, for example if the fund manager has left. They then determine whether the change affects the investment philosophy and revise their rating if needed.


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