The growing popularity of passive investing using index trackers has enabled many investors to access emerging markets, of which Brazil is a prominent member, at relatively low cost. However, trackers lack the positive exposure to factors which can identify the most attractive stocks.
One way to get the best of both worlds is to use a quantitative emerging markets strategy that follows the MSCI Emerging Markets Index as the benchmark, says Robeco Portfolio Manager Wilma de Groot. “These strategies take the capitalization-weighted index as a starting point, and then give more weight to stocks with favorable factor characteristics and less weight to stocks with unfavorable ones.”
She manages two benchmark-related emerging markets strategies together with Tim Dröge and Michael Strating: Core Quant Emerging Markets (Core) and Active Quant Emerging Markets (Active), which has a more concentrated portfolio. It is just over 15 years since Robeco first discovered that quantitative stock-selection techniques which were known to be effective in developed markets also worked in emerging markets.
“With our approach, investors can efficiently capture the market return, as is the case with passive investing. But at the same time, they can benefit from established factor premiums,” says De Groot. “These factor premiums are valuation and momentum. There has been a lot of empirical research on these factors. Stocks with a cheap valuation or a low price to fundamentals tend to outperform. Stocks with positive sentiment such as a high price momentum and positive earnings revisions from analysts also tend to outperform. We go overweight on stocks that score well on these premiums.”
De Groot emphasizes the distinctive features and benefits of the two quantitative strategies. “Having quantitative and fundamental strategies under one roof has real benefits for our clients,” she says. “There is close cooperation with the Robeco Emerging Markets Equities team that looks at the fundamentals in these markets.“
“We apply their knowledge to improve data quality for the stock-selection model and to reduce trading costs. We look at which listing and share class has the best data quality. This can depend on the number of analysts who cover it, for example. For trading purposes, we look for the most liquid share class in order to minimize trading costs.“
‘We go overweight on stocks that score well, while avoiding stocks that are expected to perform badly’
Another feature is the way the Active and Core Emerging Markets strategies deal with risk. “We adopt an integrated risk management technique,” she says. “We prefer to start incorporating risk management when defining our variables for stock selection, for example, by avoiding traditional momentum strategies which are highly vulnerable to market reversals.
Integrated risk management reduces the most important undesirable time-varying style tilts.” The way portfolios are constructed is different from other active managers, says De Groot. “We do not use statistical portfolio optimizers which build a portfolio based on the correlations between stocks. These optimizers might distort portfolio characteristics in unpredictable ways.”
“Instead we use a proprietary portfolio construction algorithm that it is fully tailored to our needs. Our approach uses fixed active stock weights for selecting new stocks and avoids extreme weightings. Because our approach is different from other investors, we also avoid overcrowded trades.”
“The stock selection model is the same, but there is a difference in universe and portfolio limits,” adds De Groot. “Core uses only the constituents of the MSCI Emerging Markets Index to determine its universe. Active can invest in stocks outside this index as long as they are part of other wellknown emerging markets indices. This also means that investments in some frontier markets can be made.”