Video: A dynamic approach to equity investing

TED: I'd love to ask you about different trends you're seeing.

MO:. So within equities, I think one of the things that is really interesting, and part of the reason we went down this path of creating the dynamic strategies. Is for a long time the trend was there's no alpha here. So let me just index it. Lowest cost possible.

And it's really convenient right. It makes life a lot easier. There's zero risk of getting fired right. Match the benchmark I think what we're seeing, especially on the institutional side, is a desire to rethink that. Is a desire to be cost conscious. Absolutely, but not necessarily give up all expectations of excess return. So equities I think are going through a little bit of a revival.

They're going through a little bit of a renaissance where clients are starting to rethink that allocation. They're willing to take risk there again. And for a long time I had not seen that. I'd seen, you know, basically a cost mitigation exercise.

TED: So if you take equities, an example that you mentioned value valuation, you could think of the basic factor assessment quality size. What are the levers that you guys like to pull within. Just say your equities portfolio.

MO: this is where we have spent a lot of time over the last few years taking asset allocation frameworks and applying them within an asset class. We, like everyone else, noticed that it was increasingly difficult to add value to drive alpha within parts of the equity portfolio. So think large cap U.S equities very difficult to add excess returns.

But it was harder to generate returns beyond the broad-based indices. And we developed something that I think is quite innovative. We started out thinking about asset allocation decisions. We use a regime-based framework. So we want to understand economic growth and changes in economic growth, in the sensitivity of asset classes to those changes. So what are cyclical assets or what are countercyclical assets.

And then we said, okay, what if we just took that same framework and applied it within equities. Are there factors or sectors that also behave that way. And what we found is the answer is yes. Right. So things like size and value tend to be more pro cyclical. Things like quality and low volatility tend to be countercyclical or more defensive.

And are we able to actually systematically harvest those style preferences using a business cycle framework. And in 2017 we partnered with FTSE Russell. We created a suite of indices. And we started allocating based on historically rewarded factors during stages of the business cycle. So think recovery, expansion slowdowns and contractions. How should we overweight or underweight factors to get potentially the best possible outcome in the shorter period.

We know over the long term, structurally allocating to factors are rewarded. But most CIOs, most people sitting in portfolio management seats don't have 20 years. They have to also generate returns over three-, five-, seven- and ten-year horizons to keep their jobs. So we felt like it was very important to kind of think about equities a slightly different way. And we've been quite successful.

TED: How do you get from looking at the set of factors to making the decision about where you want to bring your client portfolios?

MO: We take all the emotion out of it. That's the first step. We aren't waking up every day and saying, how do we feel about the market? we build models. So we have a model for leading economic indicator, basically trying to understand through the data whether the economy is growing above or below its long term trend. We also have a model for risk appetite. This basically measures, in aggregate, what capital market participants are experiencing as they move out on the risk curve.

Those two models combined tell us a little bit about how we should position across the factors set. So if leading economic indicators suggest that the economy is growing above its long term trend and risk appetite is accelerating, that's a pretty healthy environment for risk assets. That's an expansionary environment. And we're going to favor, as I mentioned, small and mid-cap stocks and maybe momentum because, you know, there's a clear trend with growth.

Conversely, if our leading economic indicators are showing that growth is below trend and decelerating, that's generally a sign of a contraction. So we would then get more defensive in the portfolio. We would increase the weight to higher quality larger companies, lower volatility companies. All of that is systematically done. There is no discretion per se. The discretion is how we build the models, how we think about the world. But then as we implement the portfolio, we try to remove the emotion. We try to remove the day-to-day biases.

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All information as of April 29, 2024, in USD, unless stated otherwise.

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