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.
Scientific Beta plots how deglobalisation hits stocks
If COVID exposed the flaws of “just-in-time” supply chains, the outbreak of conflict in Ukraine and growing tensions elsewhere (notably between China and the US, and Gaza) put the globalisation trend on ice.Offshoring has been replaced by “reshoring” or “friendshoring” in world power-broker jargon as US Treasury Secretary, Janet Yellen, noted in a 2022 speech.
“Rather than being highly reliant on countries where we have geopolitical tensions and can’t count on ongoing, reliable supplies, we need to really diversify our group of suppliers,” Yellen said.
The changing ‘deglobalisation’ trade dynamic also requires investors to better-understand any ensuing risks or opportunities for their portfolio companies, factor index specialist, Scientific Beta, argues in a new paper.“
Shifts in trade policy influence the structure of the economy, creating winners and losers,” the Scientific Beta study says.
“Trade policy clearly influences the financial performance of firms. Moreover, shifts in trade policy will have heterogeneous effects across such businesses; some may benefit from a more globalised market via reduced input costs or more export opportunities, while others may benefit from the introduction of protectionist policies via a reduction in foreign competition.”
The analysis found a “statistically and economically significant” difference of 1.4 per cent weekly price change in the shares of companies with high and low exposures to trade policy changes (such as tariff increases). Erik Christiansen, Scientific Beta head of investment solutions, said the new company-level trade exposure offers “another risk management” metric for portfolio investors.
In NZ last week, Christiansen said the trade-related overlay could help investors reduce exposure to “unrewarded risks”, a core part of the Scientific Beta process.
“Among others, we expect the measure to be useful for investors who want to manage the trade policy risk exposure in their equity portfolio, or for researchers interested in the economic effects of international trade policy or asset pricing,” the Scientific Beta study says.
The index firm, majority owned by the Singapore Stock Exchange, offers a range of factor-based indices as well as ESG (especially climate-related) benchmarks with various risk-tuning options.
“We focus on diversification,” he said, which has seen the Scientific Beta benchmarks underperform the US cap-weighted indices over the last few years where a handful of stocks have dominated returns.
But while the Magnificent Seven may have distorted the US index – for now at least – Christiansen said less-concentrated emerging markets have proven more fertile ground for highly diversified multi-factor strategies. Diversification, he said, is primarily for risk management rather than to juice returns.
Founded in France in 2012 as part of the academic, EDHEC-Risk Institute, Scientific Beta has about US$60 billion in ‘assets under replication’. The group opened an office in Australia in 2022 with Susan Rodgers as business development director and senior investment specialist, Mike Aked. Last month Aked left to take up the role of senior investment manager in the Australian wealth management division of Credit Suisse (now part of UBS).
