Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
How new quants combine best of both worlds
Quantitative investment management has undergone a massive lift in profile in recent years, largely due to the rise of ETFs and smart-beta strategies. But the ‘new quants’, as they are being called, are going much further than that.
While hardly new to the space, Harindra (Harin) de Silva, a lead portfolio manager at Allspring Global Investors and former president at Analytic Investors, says the new quants are active, rather than traditional, and this goes beyond smart beta or tilted index products.
“If you go back 25 years or more when I got started you would find some characteristic which was common to a group of stocks and build a portfolio around that. The conversation was around the factors,” he said last week (March 29) on a visit to Australia.
“In some ways, that’s a very passive approach. Now you can buy that strategy through an ETF for less than 15bps. It’s no longer considered a value-added proposition. You have to ask: ‘how can you do something better than that?”
de Silva joined Analytic Investors, a leading US quant boutique, in 1995 after 10 years at Analysis Group Inc, a global economics consultancy.
Wells Fargo, Allspring’s former owner, acquired Analytic Investors, which forms the core of the Systematic Edge group within Allspring, in 2016. Overall, Allspring has about US$40 billion invested across quant teams including equity, fixed income, multi-asset and solutions.
To demonstrate his prowess with things new to his new employer, de Silva immediately started developing some of the industry’s first long-short factor-driven ETFs in 2017. He had already identified ESG elements as factors in about 2014, which have been enormously impactful on markets in the past two-three years.
He said last week that there were three ways that the new quants such as Allspring provided a more active solution to the task:
- They actively manage the portfolio’s factor exposures. “Value doesn’t work all the time, momentum doesn’t work all the time. So, you vary the exposures. You see whether they can be managed appropriately to the business cycle.”
- Quants have tended to take a certain universe, such as US listed stocks, and use the whole universe in the investment process. But there are many stocks which will not be factor driven and should be removed from the universe, he says.
de Silva gives as an example the so-called ‘meme’ stocks, which he says should be actively managed through fundamental techniques. The same goes for takeover targets or big geopolitical events such as the Russian invasion of Ukraine. Interestingly, de Silva removed his Russian exposure in the lead-up to the conflict as, on his team’s analysis, the stocks had cease to be factor driven.
He agrees, though, that some quants would argue the toss on whether or not factors can be identified with certain data sources on such events, for example tracking social media commentary through AI to attempt to locate meme stocks. With takeovers, there are strategies which concentrate on hostile bids and always sell the bidding stock and buy the target, which tends to work most of the time.
Quants can also look for new factors, not just rotating the major style factors through a cycle. The work-from-home phenomenon during Covid is a factor, de Silva says. “It was a huge driver.”
Winners in the same industry as losers included Netflix in entertainment versus Disney with its hotels and theme parks, and Home Depot led by online shopping versus Macy’s and its store-based business. A passive ETF approach won’t necessarily catch such trends.
“The modern quant recognises the need for constant monitoring and awareness,” he says. “Part of this goes to a philosophical difference within the discipline. A lot of quants believe you shouldn’t change factor weights.”
de Silva was drawn into the quantitative world when he was working as a consultant, where one of his major tasks was to analyse on behalf of the big stockbroker Merrill Lynch the performance of about 150 managers for the firm’s then-new separate-accounts investment program. He noticed that all the managers which had done well at least part of the time had focused on one factor.
“I thought: ‘why don’t we dynamically allocate to individual managers like that?’ But that’s a very coarse way to approach it.”
Allspring, and a handful of other quant managers which operate across asset classes, try to identify themes or drivers for a particular group of securities. “We never buy a stock; we buy a factor,” de Silva says.
“I don’t think there’s a finite number of factors. If you’d have asked me three years ago whether there was a difference at the factor level between Netflix and Disney, I would have said ‘no’.
“Another example is energy companies. Green energy companies have different characteristics and currently have huge valuation differences compared with traditional.
“You can’t do back-tests for that. In a dynamic world you can’t rely on back testing. With greenhouse gas emissions there has been a huge factor at play, but people only started taking notice of about three years ago.”
With respect to the Allspring client base around the world, he says the most important thing is to have a philosophical alignment between the client and the investment manager. He believes that because Allspring does not have a house view on particular factors or styles, that is an advantage in discussions with client funds.
As an aside on the subject of the moment – Russia – Wall Street is looking at ways to provide relief for foreign investors needing to trade their holdings through the development of a secondary market for shares.
On wars in general, de Silva sounds a cautionary note, from those who have observed only a short-term fall in markets before a spending-related upturn. Even quants, he said, often made the mistake of examining the longer-term impact on markets from the victors’ perspective, especially that of the US.
With Russia, in which many investors are looking to exit completely, he points out that finding assets which people have dumped because of lack of liquidity could be a very successful strategy. “They are still real assets. Nickel is still valuable,” he said, without making a moral judgement call on the situation.
Visiting Australia with de Silva was Martha Delgado, a frequent visitor who has been looking after clients across the region for more than 10 years.
Their visit marked the first since the firm opened an Australian office this year under Andy Sowerby, who is managing director for Asia Pacific, based in Melbourne. He said that several other thought leader visits were planned to take place over the course of the year.
Sowerby pointed out that, as a group, with nearly US$600 billion under management, Allspring is a big believer in active management, be it fundamental or systematically driven.
“We don’t have a house view, as Harin says. What we offer is a diversity of thought and investment capabilities that we can then tailor, in partnership with our clients, to meet specific goals,” he says.
“At the end of the day, it always comes down to the client’s return objective, their risk budget, the price and, importantly, the philosophical alignment.”
Allspring’s new-found independence, with more than 20 per cent now owned by current staff, along with a firm commitment to develop its international business, are further advantages, he says.
