A quarter of a century in the making, as of this year, the process that underpins the Quantitative Equity Products – or QEP – at Schroders is a systematic framework that enhances a fundamental investment process to offer consistency, breadth and scalability. That being so, it seems appropriate to explain it by way of the systematic framework that underpins any factual writing: who, what, where, how, when and why?
With the ‘who’ covered off by that one name in the first sentence, let’s move swiftly onto the ‘what’. The dual focus of the QEP approach is, and has been since its creation in 2000, upon company valuations and business quality. The idea here is these two investment styles of ‘value’ and ‘quality’ are complementary because they tend to do well at different times of the market cycle and combining them should therefore offer better overall returns to investors over time.
The QEP investment approach is very much a blend of human and machine, with the former element embodied in the question, How would a fundamentals-oriented investor analyse an individual company and its business model? The machine element, meanwhile, involves the QEP team using the powerful statistical and systematic techniques and tools at their disposal to apply that thinking across the broadest possible investable universe.
Analysing that universe of more than 10,000 companies, the management team constructs highly diversified portfolios of around 300 to 500 businesses, with stock selection grounded in the analysis of objective company fundamentals indicating value (assets, cashflows, dividends, earnings) and quality (financial strength, good governance, profitability, structural growth and stability), with portfolios typically exhibiting a style bias towards both factors.
With the investment universe essentially being any listed stock around the globe – that is the ‘where’ – the quantitative techniques allow the QEP team to apply scale and ‘industrialise’ their approach to enhance diversification, maximise the opportunity set and capitalise on the opportunities, wherever they might exist. In contrast, such advantages are denied to more traditional fundamental managers simply by virtue of capacity, workload and available hours in the day.
Balanced stock selection
As for the ‘how’, clearly the QEP models pinpointing the most attractive value and quality stocks are screening for very distinct factors but the management team believe the highest probability of generating outperformance of the broader market will occur when they ‘condition’ for both value and quality – in other words, when they identify companies that offer a good combination of both characteristics.
For that, they use a ‘decision-tree’ process – a scalable yes/no structure where they can define not only a whole range of underlying value and quality metrics but also the cut-off points for each of these that they believe make for the best investments. Trading off all these various data points provides the team with a precise picture of which of their criteria a company has met – and to what extent.
At the same time, this process offers a very clear idea of the characteristics that, for different business models and different economic styles, the market most cares about from a valuation or a quality perspective. Tailoring the decision-tree framework in this way – to account for the most appropriate measure to value a US bank, say, or a European pharmaceutical – captures key metrics on what is driving future risk and reward.
And if the decision trees do their job then, regardless of what style is in favour at any given time, the QEP portfolios should end up being exposed to the stronger names and avoiding the weaker ones, which in turn should allow them to outperform across the kind of multi-market environment that happens on a year-to-year basis. At heart, the aim is for that balanced stock selection to drive consistent, incremental outperformance over the longer term.
This balanced exposure also helps the QEP portfolios to remain ‘true to badge’ – something that is of increasing importance to investors, who need to know the building blocks of their own portfolios are doing precisely what they bought them to do. An extreme example of this came in 2020 when, after the pandemic struck, valuations in certain sectors – most notably technology – became hugely detached from their fundamentals.
This is a time when the QEP strategy can struggle but, while the process accepts you sometimes have to pay a little over the odds for company attributes prized by the market, that does not extend to chasing stocks at any price when the relationship between valuations and fundamentals completely breaks down. The team held firm in 2020, assuring clients it was an irrational market and they would recapture the performance when it unwound – and so it proved in 2021.
Why QEP? Why now?
The ‘why’ element of this analysis can reasonably be split into two parts – the first being: Why should investors allocate money towards QEP in general? One reason is the strategy’s longevity – the fact it has now been operating with such consistent results for 25 years is not just ‘proof of concept’ in itself, it also means it is firmly embedded in the DNA of the managers, whose tenure on the team averages almost 15 years.
Next, the strategy consistently does just what its investors have been told it should. Taking the Global Core portfolio as an example, its managers have targeted a return of plus-1%, gross of fees, over the MSCI World index – and this it has achieved over short, medium and long-term periods. Importantly, these returns have been smooth rather than ‘lumpy’ – with the strategy beating its benchmark in 20 out of 25 calendar years and in 80% of rolling three-year periods.
One final ‘general’ reason is QEP’s competitive ongoing charge figure. Positioning the strategy as an alternative to pure passive approaches begs a telling question of investors and their advisers: Why choose an index-tracker when, for a comparable price, you could buy into something that has consistently generated incremental outperformance of its own benchmark, thereby enabling a core element of an overall investment portfolio to punch above its weight?
The other ‘why’ is: Why would investors choose to allocate money to the strategy now? Well, in addition to the reasons mentioned above, a core facet of the QEP approach is the team’s refusal to participate in the prediction game. While many other asset managers will position their portfolios according to what they think will happen in their markets, the stark reality is that it is just not possible to make accurate forecasts about the future, consistently and over time.
That being so, the QEP managers’ focus is wholly on company-level attributes and achieving appropriate diversification and balance in the underlying portfolios to help them to weather a range of market outcomes – because, again, no-one knows what is going to happen. Better by far to position the portfolios so they are exposed to those companies that, by virtue of their valuation and business quality, are best-placed to cope with whatever the future may have in store.
Aiman Shanks is investment director for Quantitative Equity Products at Schroders
“Better by far to position the portfolios so they are exposed to those companies that, by virtue of their valuation and business quality, are best-placed to cope with whatever the future may have in store.
See market volatility as a potential source of return
Volatility is a fact of investment life. Sudden lurches up and down are in the nature of markets and, as such, instead of ‘How can we avoid volatility?’, the question investors might more usefully ask is: ‘How can we harness the opportunities volatility creates?’ In this regard, a key benefit of the sort of systematic models employed by the QEP strategies is that they are able to pick up swings in market sentiment very rapidly.
This in turn allows the management team to reallocate to positions very effectively in order to harvest the additional excess market returns or ‘alpha’ that can result from volatility. Whether you use pure stock volatility or the Vix volatility index as a measure, extensive back-testing has indicated that big market swings – whether they are short-term spikes or they play out over time – do tend to generate additional alpha for the QEP strategies.
Provided you therefore have the tools, first, to see through any passages of volatility and, second, to capitalise speedily on the market swings – and the QEP team certainly does – volatility need not be seen as a negative but, rather, as an additional source of portfolio returns.
