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This year is the tenth anniversary of the launch of Robeco Global Conservative Equities. It is more than just a pure low-volatility fund.
“It's no coincidence that the Netherlands was the place where the Conservative Equities strategy was born, exactly ten years ago in September. The country was a natural location for the innovation cluster that this required: the right combination of large pension funds with sufficient funds and an environment with plenty of financial econometrists. It was bound to succeed.” We talk with Pim van Vliet, who in 2005 pioneered the Conservative Equities strategy. Van Vliet, who wrote a thesis (on Low Volatility, but also on Value and Momentum) at Erasmus University Rotterdam, was part of that innovation cluster.
When Van Vliet arrived at Robeco, anomalies were already being exploited by the quant team, with factors such as Value, Momentum, analyst revisions and management policy being integrated in benchmark-oriented products. “But what struck me was that the Low Volatility factor was missing. The reason was that you can achieve constant outperformance with Value and Momentum, but not with Low Volatility. Low Volatility's high tracking error makes it less appealing.” Or, as current Head of Quantitative Equity Research, David Blitz, put it in a discussion with Van Vliet in 2005: “Low Volatility generates limited outperformance and it deviates significantly from the benchmark.”
This is because Low Volatility strategies are characterized by their high tracking error, while outperformance versus the index is limited. From this point of view, Low Volatility was a no-go. “Value, Momentum and - more indirectly - Size and Quality were already fully accepted. Low Volatility was a newer factor, and required a different way of thinking – moving away from a benchmark.”
Robeco's first quantitative multi-factor models were developed back in 1994, with the aim of delivering consistent outperformance. Since 2003 these factors have been used as a basis for investments. Although Low Volatility did not come into the picture until later, Van Vliet sees 1994 and 2003 as milestones in the pre-conceptual phase of Conservative Equities. “Low Volatility didn't align with the existing product range, mainly because it reduced the information ratio of the existing strategy. So a new strategy was needed to take advantage of the low-volatility anomaly.”
The timing was favorable, because 2005 was the heyday of hedge funds and private equity and the time when absolute return became mainstream. The world was ready for Low Volatility as a new asset class in its own right. “We saw the rise of Minimum Variance, followed by Minimum Volatility and then Low Volatility. We were also moving in more or less the same direction. Conservative Equities is similar enough to Low Volatility to fall into the same category, but unique enough to outperform the index,” explains Van Vliet.
The launch of the first Minimum Volatility Index in in 2008 was an important moment for Conservative Equities. “Firstly, because it enabled our clients to compare our strategy with a transparent alternative –the strategy had to offer added value relative to the index. Clients won't pay for a tracking error of 0, but the tracking error couldn't be too high either. Eventually it turned out to be 3 - right in the middle of the sweet spot.” All the right ingredients were there for innovation, says Van Vliet. “And then you have to seize the opportunity.” In the ten years that followed, the model and the research were further enhanced, and the market also continued to develop.
In September 2006 the global Conservative Equities fund itself was launched. The low-volatility style took its place alongside the traditional quant styles during this period. But it wasn't a match made in heaven - at least not all the time. According to critics, the strategy was sometimes too concentrated in certain sectors and it lagged significantly in bull markets. “But taking Value and Momentum factors into account when selecting the low-volatility stocks – creating the active low-volatility strategy that was christened Conservative Equity – enabled us to succeed in achieving several aims.”
‘If I were a pure low-volatility manager, I wouldn't be able to sleep as well at night now’
The combination of these three factors results in a higher Sharpe ratio - but also a better diversification over sectors, a lower tracking error and a higher up capture. “I'm just very happy that we chose an enhanced strategy for Conservative Equities. For example, low-volatility stocks have now become much more expensive than they were ten years ago. On average Conservative Equity stocks are around 25% cheaper than pure low-volatility stocks.” Including Momentum is also “very beneficial”, according to Van Vliet, especially for timing the sale of losers. “If I were a pure low-volatility manager, I wouldn't be able to sleep as well at night now”.
Most potential pitfalls were circumvented from the outset in the model, but according to Van Vliet improvements have still been made over the years. “We have further refined the model: more effective implementation, limited transaction costs, efficient cash flow processing.” The last aspect is mainly a result of working with client portfolios, rather than model portfolios. “When processing cash flows, we can easily sell weaker stocks and buy good ones, whereas with a model portfolio you adjust the entire portfolio.”
Together with other researchers, Van Vliet invested a lot of time and energy in market education in the first five years: promoting the asset class to enhance its scope. “We positioned Conservative Equities as a new investment style – enthusiastically and with all the means at our disposal.” Seminars, academic articles, white papers, the development of an interactive tool, press conferences, discussions with consultants: they were all aimed at generating an understanding of the added value of this new investment style and how, for instance, it can help stabilize the coverage ratio of pension funds, where following a benchmark results in unnecessary risks.
While the first five years were marked by enthusiasm within the team to draw attention to Low Volatility itself, the main focus in the following five years of Conservative Equities was on clarifying Robeco’s unique approach – something they also managed successfully. From 2010, several major clients invested and the assets under management soared. “The niche grew rapidly and we succeeded in building a significant market share, and even increasing it.” The strategy was rolled out further in 2007 with European Conservative Equities and 2011 with Emerging Conservative Equities, using the same model.
With EUR 12.5 billion under management, Robeco had now become number 1 worldwide, with only a limited number of providers managing more than EUR 5 billion in low-volatility strategies. For Van Vliet, the primary focus between 2011 and 2015 was on managing expectations. “We did a lot of research into the valuation of low volatility, into interest-rate risk. This requires self-reflection and a healthy dose of skepticism. What we discovered is that in the long term the enhanced low-volatility strategy generates alpha, but you shouldn't invest in it just for a couple of years.” The number of published articles gradually increased and the first thirteen were published in book form in 2012. A second print followed in 2015, this time with 24 articles - the last seven of which critically reviewed the topic.
“The decision to invest in Conservative Equities requires a sensible approach,” explains Van Vliet. “If you can explain that, you buy clients' patience and they in turn can generate alpha over the cycle as a whole. This is a necessary step, because you can't constantly deliver outperformance with Low Volatility. People who expect this are bound to be disappointed.” We also benefited from the increasing demand for income solutions in this period. Conservative Equities pays a high dividend – and its main added value relative to high dividend funds are its more stable returns.
In the coming five years, the main focus will be on a dual positioning for Conservative Equities - both as the best low-volatility investment method for institutional investors specifically opting for this style, and as a reliable solution for investors looking for stable earnings from equities. The range of quant products is growing rapidly, and includes weaker propositions that for the most part sell a concept based on backtests. Van Vliet is aware that Robeco needs to clarify to investors that its Conservative Equities is not among this category of providers.
‘Low Volatility is becoming popular so providers may well resort to more complex variants’
Our pioneering approach and long track record form a good basis for this, but according to Van Vliet the fund needs to continue forging ahead. “The low volatility factor is popular and attracts many providers that are also resorting to more complex variants. For the wider public, we want to move away from this technical realm and communicate the simple message that Conservative Equities is a reliable, defensive equities solution. Stable, with a focus on dividend; a strategy that can also lag somewhat in bullish markets, but for defensive investors is a good alternative to a global fund at Vanguard or Fidelity or a high dividend fund.”
Van Vliet does not consider himself and his team as pure quant players. “We regard ‘quants’ as rather an honorific title, but we prefer to read history books to math books in our free time. We implement our philosophy systematically and consistently, making things as simple as possible and no more difficult than is absolutely necessary. We can make it as difficult as our clients want it to be – and that is sometimes quite technical - but we will also do our best to keep it simple. Back to basics.”
“You can compare a quantitative fund with an iPhone: most people don't need a high-tech manual explaining how the underlying technology works; they just want to know that the smartphone does what it is supposed to do. We'd like to exploit this paradox of 'difficult, but still easy’ in the coming period. An advanced model under the hood, but one that is easy and reliable to drive.”
Given the increasing amount of chaff amongst the wheat in this market, Van Vliet expects these funds to come under fire in the years ahead. “A healthy dose of skepticism is good for managing expectations. A shake-out in the coming period will also be good for the low-volatility landscape.” He also sees plenty of opportunities, especially given the desperate search for yield in countries with a large aging population: Japan and Spain, for example. Conservative Equities is already an export product and this aspect will become even stronger. “Institutional investors too will realize that exploiting factors like Value, Momentum and Low Volatility is a means to an end rather than a goal in itself. Ultimately, for our clients, it's all about attractive dividends and stable returns. That's it."