Invesco team ensures the head rules the heart in Germany
Invesco Global Strategies’ Michael Fraikin talks about why a quant approach can help during market turbulence.
In volatile markets it is easy to get carried away in the emotion of the moment, and for fear and greed to replace rational thinking.
It might be useful at such times to have exposure to quant managers, who remove the heart from its often dominant role during turbulent times, and replace it with cool thinking.
In August, the cool-headed approach of Invesco Global Strategies, based partly in Frankfurt, helped investors.
As European shares fell by 10.9% and global shares dropped 7.5%, the $21bn quant unit fell on average 0.4% less in 25 key strategies, and in the case of low volatility strategies 2% to 3% less than the market.
Easing into quant
Michael Fraikin, head of portfolio management, global quantitative equity, at Invesco Global Strategies, explains the key difference between quant and fundamental fund managers:
“As a quant, you record what you did, what you did not do, and you quantify questions and answers to them. Stocks differ in terms of characteristics and performance. Quants ask themselves, ‘What is happening and why should that be?’
Fundamental equity fund managers can struggle to disentangle if they managed to get somewhere by sheer luck, or by skill.
He says a lot of value managers got into trouble in 2007 to 2008 by buying banks that they felt were ‘cheap’.
He emphasises the word: ‘felt’. “If I measure cheapness by looking at earnings and book value, for example, many banks were indeed cheap, based on historical data in 2007. All those measures would today be much lower than in 2007.”
Much the same could be said about other sectors. Good quant strategies should prevent over-confidence that can increase risk-taking and increase position size. Fraikin’s team of 49 in Frankfurt and New York has decreased maximum position sizes in typical funds since late 2008, by between 0.5% and 1%.
Fraikin adds: “Quants know as much about stocks we do not like, as about those we do like.
Most fundamental managers have a ‘waterfall’ approach, knowing almost nothing about stocks they do not like.
But there is possibly more to be gained by knowing which stocks are least attractive.
“The kind of active bets that can be taken on the attractive and the unattractive stocks becomes more symmetrical. In a market neutral portfolio, I short as much as I go long. To add to this, we find the market appears to be slightly less efficient in comparatively unattractive stocks, probably because many managers do not try to differentiate between them.”
Fundamental managers who know a lot about fewer stocks might lead to concentrated portfolios, whereas quants can increase holdings, because they analyse their universe statistically.
Fraikin’s consists of 3,000 developed world companies, plus 1,000 in emerging markets.
About 800 are attractive, but in a typical global core portfolio, he holds about 140.
Among the 16 factors Fraikin employs to analyse entities, some cover a few months, while others look back four years.
To answer whether a company is getting or taking cash from the market, his team looks over the preceding two years.
Price trends are gauged over one month up to one year, or longer when you look at reversals.
Contrary to the notion some investors may have, that quant systems jump in and out of positions rapidly, Fraikin’s average holding period is much longer than the market’s average, of about nine months. “He tends to shift about 50% to 70% of a portfolio in a year.“
So how should investors assess quants? Fraikin suggests examining the approach itself and assumptions underlying it.
“Study the rationale, and why quants do what they do, and look for evolutionary development rather than no development, or revolutionary development.”
Be sceptical of talk of ‘proprietary factors’ in analysis and be willing to accept some staff turnover as new staff bring new ideas.