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Smart beta’s evolution: factors have their own cycles
(pictured: Susanne Willumsen)
As demand for smart beta strategies grows, so does the range of offerings from managers looking to assist further in the evolution of quantitative investing. For some, such as Lazard Asset Management, this involves blending factors and staying one step ahead of the herd.
Susanne Willumsen, Lazard Asset Management director, portfolio manager and analyst at the nine-person quantitative investment team, says the evolution of smart beta follows the realisation that different factors have different cycles and that it is very difficult to time their deployment. For all but the very largest of funds, such as some sovereign wealth funds, this involves a move from single-factor to multi-factor strategies.
“This is the next step for factor investing,” the London-based Willumsen said on a trip to Australia last week. “There hasn’t been a lot of action yet but there are lot of questions being asked about it.”
One of the attributes that sets Lazard’s quant team apart is that it has embraced the firm’s history and culture as an “alpha generator” rather than a packager of “solutions”.
Lazard’s team is based on a group who left State Street Global Advisors in 2007 – six of them remaining in Boston and three in London, to set up the quant unit for Lazard. Willumsen has been investing that way for more than 20 years.
“Lazard has always been about providing alpha. That’s where our skills are,” she says. After a while at Lazard, the new quant team could see that the wider firm had a wealth of research opportunities from which to draw. “We could see that, speaking to our analyst colleagues, they also have tremendous insights,” she says.
“We can check and use their theses. We can also help them, of course. We help their emerging markets team a lot… We are still fundamental investors; we just do it in a quantitative way. We look at stocks with the same aims in mind, but the data we look at and portfolio construction are different. Nevertheless, we are philosophically aligned.”
In broad-market portfolios, where they tend to shine because of their greater breadth of coverage of stocks – unarguably – quants are good at shorting. Fundamental stock pickers tend to struggle to get their heads around the “other side of the coin” to look for stocks likely to head south rather than north.
Lazard has a 130:30 fund, run by Willumsen’s team, but has not yet launched a market neutral fund. When you look at using factors to build a market-neutral strategy you find that not all factors are suitable.
Low-volatility, for instance, in which Lazard has a strong capability and also a standalone fund, tends to be a bit problematic. Value, momentum and quality, among the main factors, tend to work better. At the moment low-volatility spreads are low, so there is not much for the manager to harvest in alpha.
The reason this is important is because of the herding which took place around August 2007 when a number of big quant managers’ returns slumped because of, it is generally agreed, a weight of money going into their momentum strategies. Willumsen says that quant managers need to try to stay ahead of the herd mentality. They should be able to do so if they have a long-term horizon, as Lazard does, she says, rather than the very short-term horizon of the average hedge fund manager.
A study byLazard, from 1998 to June 2016, shows how four main factors – value, growth, momentum and quality – compare on a two-yearly basis. As you’d expect, as with asset classes themselves, each period has a different winner and loser. The latest winner, for 2015-2016, is momentum, also unsurprisingly.
From another study, by broker Bernstein, the evidence is that fund managers which tilt between styles struggle to add value. That Bernstein study assessed the performance of “dynamic” style/factor management by managers, where the information was available, versus “static” style management. Over the last 10 years, for which they had the information, static style allocations outperformed dynamic.
So, why not blend them?
– Greg Bright
