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 ‘We want to learn from centuries of investment history’

‘We want to learn from centuries of investment history’

23-11-2018 | インサイト

Rules-based investing can be very transparent. Belying the ‘black box’ misconception, Robeco’s Jan Sytze Mosselaar discusses how quant-based strategies can be more transparent than conventional fundamental investing and outlines his views on the future development of quant-based methodologies.

  • Jan Sytze  Mosselaar
    Jan Sytze
    Mosselaar
    CFA, Director, Portfolio Manager

Speed read:

  • Quant models can be transparent
  • Human oversight remains key
  • History matters to quants

Quants are often seen as solely focused on databases and rules-based models, and therefore detached from the market’s daily ups and downs. Would you agree?

“Not at all. Robeco’s quant managers closely follow market developments and their influence on our clients’ money. Even though we invest in a rules-based manner, it’s important that we can explain our performance in a logical and sensible way. This is possible because our factor-based stock selection models are transparent – not complicated black-box processes.“

“Within Robeco, there’s a clear divide between researchers and portfolio managers (PMs). Researchers tend to be more detached from the daily ups and downs. I think that’s a good thing – they should focus on developing and enhancing models that work in the long-term. But we PMs need to be able to explain what’s happening in our client portfolios, something that my 10-year role as a multi-asset allocator comes in handy for. An advantage of rules-based investing is that you don’t act on noise, you keep calm in volatile periods and don’t fall for one of the many behavioral pitfalls.”

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So are quants that different from fundamental investors?

“Yes and no. Yes, because the process is rules-based, choosing stocks in an emotion-free way. That’s very different from fundamental investing, where human judgement is the main decision driver.”

“In another sense, quants aren’t so different. In our quant equity funds we select stocks based on factors that many fundamental investors use, such as balance sheet leverage, downside risk, dividend stability, valuation measures like price-to-earnings and price-to-book, and earnings revisions. We just use these easily understandable factors in a rules-based way. Mind you, there are many different quant approaches, from Robeco’s factor-based stock selection to very complicated mathematical optimization processes. In that sense we’re close to fundamental approaches.”

“But our human overview allows us to overrule models when it makes sense, for example when we spot data issues, M&A activity, suspected fraud, etc. Having a large PM team means we’re in full control of every step of the process in managing over 100 client portfolios.”

For many years quant investing remained niche. Do you feel the way quants are perceived is also changing?

“It has become indeed much more mainstream. During my time in the asset allocation team, I witnessed how pension funds started to incorporate a strategic allocation to factors, especially after the financial crisis. Nowadays, pension funds around the world allocate to quant funds, and it’s all about the differences between quant managers, uniqueness of their approach, fee levels and long-term performance.”

“The perception of quant being an obscure approach has certainly gone. Clients realize that there are many different ways to apply quant strategies, and I always say that at Robeco we apply long-term rules-based investing, instead of ‘quant’. We apply understandable factors based on long-term holding periods and long-term datasets.”

“I want to convince prospects who have a natural aversion against quant investing, because of its perceived black box character, that rules-based investing can actually be very transparent, even more so than fundamental investing, which relies on actions of the human brain, the biggest black box of all!”

What challenges do you see for the development of quant investing?

“Firstly, too much money chasing the same factors and the same stocks, particularly passive factor indices that have a low capacity which can’t be controlled. Therefore, we monitor factor indices constituents and exclude stocks from our investment universe if we think they are overcrowded, carefully considering the investable market cap and liquidity of a stock. So the human overview is becoming more important.”

“Other challenges include too many asset managers jumping on the bandwagon, and overreliance on short-term simulations. Also, some managers aren’t putting enough resources into quant investing processes, preferring to overspend on marketing. If some strategies fail, quant managers generally could become guilty by association. But prudency, long-term simulations and economic rationale of the existence of factor premiums are at the heart of Robeco’s investment philosophy – we try to live and breathe those values every single day.”

You recently wrote a book on the history of European financial centers. How does this fit with your role at Robeco?

“We quant investors like to analyze very long datasets. But, without the context of when the data were collected, the numbers are not enough. So history matters to quants. We want to know and understand what was going on and how markets worked at the time, which is what the book1 is about.”

Ultimately, quant investors want to exploit human biases like greed, fear, overconfidence, underreaction and overreaction

What’s the takeaway for quant investors?

“Ultimately, quant investors want to exploit human biases like greed, fear, overconfidence, underreaction and overreaction. The first book on stock market investing from 1688 is full of great examples of these biases and is structured as a lively theatre play, making it very human, not some theoretical piece. Lots of books and plays about investment behavior popped up around the 1720 market bubbles, many of which are well worth reading today.”

“As conservative quant investors, 1830’s Prudent Man Rule corresponds neatly with our beliefs. It states that investors should focus on capital protection, a high and stable income, without speculation, hence investing for the long term. This is exactly what we are aiming for with Conservative Equities. Interestingly, the first mutual funds, dating back to the late 18th century in Europe, and subsequently in the UK and the US, had the same objectives.”

“Nowadays, many fund managers focus on short-term performance, tracking errors and active portfolio changes to prove their ‘worth’ to clients. We like to think the other way around: we have a long-term investment objective, aren’t constrained by any tracking error and we trade infrequently, just like the first fund managers. Stay cool, and don’t microscope daily noise and short-term performance.”

This article was initially published in our Quant Quarterly magazine.

1 J. S. Mosselaar, 2018, ‘A concise financial history of Europe’.

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