Asian investors will warm to low-volatility investing, argues – and patently hopes – Robeco’s senior quantitative researcher Winfried Hallerbach.
The Rotterdam-based manager’s 18-strong quant team is on a mission to change traditional beliefs that high risk necessarily yields higher returns. Lower-risk stocks can provide alpha, too, insists Hallerbach.
The firm launched its first low-vol equities fund targeting institutional investors in Europe in 2006. Now Hallerbach and his colleagues are structuring more solutions based on factor investing.
A portfolio of low-volatility stocks lies at the heart of such a strategy from a top-down approach.
Hallerbach points to research on low-vol investing dating to the 1970s indicating the relationship between expected return of an asset and its risk, or beta, is not necessarily upward sloping as portrayed by the capital asset pricing model (CAPM) – the financial basics for pricing securities.
“The slope of the curve that shows where the risk premium of an asset lies is, in fact, flat or negative – revealing that you are not rewarded for taking on any more risks,” says Hallerbach. “CAPM is a theory that doesn’t hold.”
He highlights studies showing the downside risk-reduction of a low-volatility portfolio as measured against an index for emerging markets tends to be higher than the average 33% reduction that could be achieved in developed markets. This, he argues, can be achieved while maintaining full equity premium – so investors can raise equities exposure without adding portfolio risk.
The quant model he and his team have devised seeks to profit from systematic errors that investors make in their choice of investment, looking for a recurring pattern of “stylised facts” that they can draw about these mistakes based on behavioural analysis.
Hallerbach argues that low-volatility investing supersedes CAPM’s core principal due to “low volatility anomaly” – that as long as managers continue to manage a portfolio against a benchmark, they will continue to prefer high-risk stocks in the belief that low-risk stocks lead to tracking error.
The irony is, he notes, that the more they pick high-beta stocks, the higher they bid up the prices and, hence, their returns go down.
“Besides harvesting market premium [the difference between expected market return and the risk-free rate of return], investors should recognise there are other factors, such as low volatility, that also deliver a premium to equities investing,” Hallerbach states.
Another pillar to factor investing is that it recognises the premium of value stocks (stocks that are cheap compared to their intrinsic value) over growth stocks. Hallerbach says investors make the mistake of extrapolating past growth as a reference for future growth potential, and often end up overpaying for growth opportunities.
Robeco’s quant team believes premium can be gained in developed markets by looking at the momentum of stock-price movement over a period of time, preferring those that have trended upwards.
Together, these three styles form Robeco’s factor-investing strategy, which as at September had €3.5 billion in AUM of the firm’s €13.5 billion in quantitative equities strategies globally.
Active in behavioural finance academia, Hallerbach had been an associate professor in Rotterdam for more than 20 years. He joined Robeco in 2008, working in quant research as well as taking responsibility for risk management of the firm’s overall portfolios.
Quantitative investing is a key facet of the €186 billion asset manager’s capability that it is showcasing to Asian investors.
But while managers such as State Street and Russell Investments have also diversified into factor-investing, whether Robeco’s approach will convince investors to revamp the way they diversify their portfolios remains to be seen.