Sustainable Systematic Equities Multifactor
Multifactor: Smart beta to the power of four
Smart beta strategies are getting increasingly popular in equity portfolio management. Smart beta portfolios generate alpha from one factor, whereas the next level of evolution, the multi-factor portfolios, harvest alpha from several factors. Besides the outperformance target, multifactor approaches are used for portfolio diversification and risk mitigation.
A factor can be thought of as any characteristic that is important in explaining their return and risks. Within equities, there are many factors that influence returns. Empirical research suggests that some factors are positively rewarded by the market over time.
Our multifactor selection contains value, momentum, quality and low volatility. Each of these four factors has its own characteristic:
A value stock tends to trade at a lower price relative to its fundamentals and is thus considered undervalued. They typically comprise unexciting businesses.
Momentum stocks have outperformed in the past and tend to exhibit strong returns going forward. Acceleration in a stock's price and earnings are used to take a long position in the hope that its momentum will continue.
Quality companies tend to have strong balance sheets, trade at higher multiples and appear less likely to outperform. Investors generally underestimate the persistency of their competitive positioning, as well as their ability to continue to perform in downturns.
Low volatility stocks are often overlooked by investors who tend to overinvest in volatile names in order to get better returns. Historically, stocks with low volatility earn greater risk-adjusted returns than highly volatile assets.
No factor outperforms the investment universe in all stages of the economic cycle. Every factor has its “preferred” phase. It is essential to know the current stage and to allocate the factors accordingly. To do so, we established a systematic approach (“Global Adaptive Allocation”) to determine the current position in the economic cycle. In uptrends we overweight the more aggressive factors: value and momentum. At the same time we underweight quality and low volatility. In downtrends we focus on quality and low volatility only.
We feel confident that our multifactor delivers alpha over time, is able to mitigate the maximum drawdown and provides diversification in an equity portfolio.
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