Evidence-based investing

Quantitative Portfolio Management

Amsterdam | October 6, 2017

Robeco | Jeroen van Zundert, CFA

j.van.zundert@robeco.com

For institutional investors

1
Agenda

→ Asset management

→ Theoretical bases: Insights from the asset pricing theory

→ Factor Investing: Strategic allocation to factor premiums

→ Diversification Matters

→ What can we offer you?

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Quant

Life as a Quant

October 2017 Quantitative Investing at Robeco 3

Who we are

Robeco is an international asset manager offering a wide range of active investment products
and solutions in equity, fixed income and alternative investments.

At a glance
> Headquartered in Rotterdam, the Netherlands
> Founded in 1929
> 869 employees at 15 offices worldwide
> EUR 147.3 bln in Assets under Management (2017)

Our approach
> Investment approach is based on a long-term view and thorough research. This enables us to
avoid unnecessary risks and provides the basis for innovation. It is solid but unconventional.
> Market leader in quantitative and sustainability investing, uniquely integrating both techniques
for our clients.

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 What is a mutual fund:

An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of
investing in securities such as stocks, bonds, money market instruments and similar assets.

Mutual Funds Closed-end Funds ETFs UITs

$18,000

$16,000

$14,000

$12,000

$10,000

$8,000

$6,000

$4,000

$2,000

$0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Investment company institute, 2015 Investment Company Fact Book

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 Why invest in a mutual fund?
6%
→ Cost of acquiring information 11% United States

Europe
→ Risk sharing & Diversification
Africa and Asia
→ Liquidity 54%
Pacific
Other Americas
29%
→ Convenience

Worldwide $33.4 trillion are invested in mutual funds and ETFs

Chart source: Investment company institute, 2015 Investment Company Fact Book
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From theory to application: Empirical Asset Pricing

→ Capital Asset Pricing Model:

𝐸 𝑅𝑖 − 𝑅𝑓 = 𝛼0 + 𝛽𝑖 (𝐸 𝑅𝑀 − 𝑅𝑓 ) + 𝜀𝑖
→ Three Factor Model:

𝐸 𝑅𝑖 − 𝑅𝑓 = 𝛼0 + 𝛽𝑀,𝑖 (𝐸 𝑅𝑀 − 𝑅𝑓 ) + 𝛽𝑆𝑀𝐵,𝑖 𝐸 𝑅𝑆𝑀𝐵 + 𝛽𝐻𝑀𝐿,𝑖 𝐸 𝑅𝐻𝑀𝐿 + 𝜀𝑖

→ More than 300 anomalies have been identified in the last two decades!

→ So, what is evidence-based Investing?

CAPM Four Factor Model

??
1964 1997

MVO Three Factor

Five Factor Model
1952 Model
2014
1993

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Value, Momentum and Low Volatility are robust across regions and sample periods

Sample: USA 1963/01 – 2014/12

18%

17%
Winners
16%
Value
15%

14%
LowVol
Return

13%
HighVol
12%

11%
Market Growth
10%

9%
Losers
8%
8% 10% 12% 14% 16% 18% 20% 22% 24% 26% 28%
Volatility (Risk)

Source: Kenneth French’s Data Library, VW factors (S+B); Volatility portfolios from MV library
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Value: Buy cheap companies with strong fundamentals

Graham & Dodd Fama & French

1934 1992/3

Empirical observation: Value stocks outperform Growth socks, on average

Why?
→ Risk base explanations:

• Distress risk: generic value strategies load heavily on distress risk

• Liquidity risk: generic value strategies can be concentrated in illiquid small-caps

→ Behavioral explanations: market overestimates the poor prospect of value firms leading to correction
over time

→ Data mining

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 Can distress risk explain the value anomaly?

Relation return, value and distress risk US 1991-2009*

20%
Low credit spread
High credit spread
16%

12%
Return

8%

4%

0%
Value (High B/M) 2 3 4 Growth (Low B/M)

Safe value stock outperform distressed value stocks!

* De Groot & Huij, “Is the Value Premium Really a Compensation for Distress Risk?”, SSRN working paper no. 1840551
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Robustness: Value across Regions

16%

14%

12%

10%

8%
Return

6%

4%

2%

0%
Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5
-2%

USA Europe Japan

Robustness: Book-To-Market ratio is not the only value definition

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Momentum: Past Winners continue to outperform Past Losers over various holding periods

Jegadeesh & Titman Carhart

1993 1997

Sample: USA 1963/01 - 2014/12

25%

20%

15%
Return

10%

5%

0%
Winners D2 D3 D4 D5 D6 D7 D8 D9 Losers

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Behavioral Explanations of Momentum

→ Under-reaction (convergence towards intrinsic value)

→ Over-reaction (move away from the intrinsic value)

Risk-based explanations?

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Robustness: Momentum across Regions

20%
18%
16%
14%
12%
Return

10%
8%
6%
4%
2%
0%
Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5

USA Europe Japan

Robustness: Momentum is robust over different look-back and holding periods

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Residual Momentum: Eliminating dynamic factor exposures

Momentum Residual Momentum

25%
→ Naïve momentum strategies exhibit large dynamic risks
20%
o E.g. bias towards high-beta (low-beta) stocks in rising
(falling) markets 15%
o These exposures make momentum highly vulnerable to
market reversals 10%

→ Robeco developed proprietary risk management technique to 5%

take out these unnecessary risks
0%
Return Volatility
→ Volatility is half that of conventional momentum, while return
is similar Sharpe ratio doubles

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Robustness: Residual Momentum across Regions

18%

16%

14%

12%

10%
Return

8%

6%

4%

2%

0%
Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5
-2%

USA Europe Japan

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Low Volatility: Return/Risk (Beta) relationship is much flatter than CAPM predicts!

Sample: USA 1963 - 2014

10%
D8
9%

D4
8% D6
D3 D7
7%
D5 D9
D2
6%
Excess Return

Market
LowVol
5%

4%

3%

2%
High Vol
1%

0%
0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0
Beta

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Consider the following example:

MSCI World Index has an expected return of 8% and a volatility of 20%

Stock X also has an expected return of 8%, but with a volatility of only 10%
Stock Y has an expected return of 9%, but with a volatility of 40%

Conflict of interest:

Stock X is preferred investment for a pension fund

 Substantial reduction of risk
Stock Y is preferred investment for a portfolio manager
 No expected outperformance for stock X

Potential Explanations:

→ Leverage Restrictions
→ Benchmark driven investing
→ Interest Rate Risk
→ Low Vol anomaly is just value in disguise 3

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Robustness: Low Volatility across Regions

1.2

1.0

0.8
Return/Risk

0.6

0.4

0.2

0.0
Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5 Q1 Q2 Q3 Q4 Q5

USA Europe Japan

Low Volatility effect is closely related to the Low Beta effect but it is stronger!

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Main take away: Passive investing is inefficient!

Step 1 Step 2 Step 3

Universe Selection Portfolio

Factor Identification Portfolio
& Optimization Construction

› Which factors are › Choose › Determine

priced? Investment region/sector
Universe exposures

› How to combine › Determine risk budget

factors

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Growth of $100 from 1963 till 2014

$250,000
$230,238.45

$200,000
$180,716.58

$150,000
$127,229.42 $128,183.67

$100,000

$58,763.94
$50,000
$16,009.31
$5,411.68 $6,169.42
$0
Winners Value LowVol Market V+W V+W+LV G+L G+L+HV

Why not simply invest in momentum or value?

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Simple answer: Investors have difference preferences!

→ High versus Low volatility

→ Tracking error limitations: benchmark-driven investing

→ Factor premiums exhibit cycles

→ Diversification Value-Growth Log Cumulative Returns

Winners-Losers
5.00
50-50
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00

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Investors have difference preferences!

19%

Winners
17%
V+M
V+W+LW
15% Value

13% LowVol
Return

Growth HighVol
11% Market
G+L+HV
G+L
9%
Losers
7%

5%
5% 10% 15% 20% 25% 30%
Volatility

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Real World Considerations:

→ Transaction costs and liquidity constraints

→ Portfolio Turnover

→ Overcrowding

→ Factors go against each other

→ Benchmark driven investing

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 Efficiently capturing factor premiums

Robeco Value equity model: Higher returns and lower risk

First increase return and second reduce factor risk

Market capitalization weighted index

> Inefficient
Robeco
Return

Value
> Underperformance with respect to factor
premiums
Value factor premium
> Single proven return factor
> High risks and value traps
Value
Robeco value strategy
Market > Combination of proprietary valuation
multiples
> Integration of low-risk and momentum
Risk factors
> Avoid unrewarded risks and limit turnover
> High conviction, higher active share

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 Efficiently capturing factor premiums

Robeco Momentum equity model: Higher returns and lower risk

First increase return and second reduce factor risk

Market capitalization weighted index

Robeco
Return

> Inefficient
Momentum
> Underperformance with respect to factor
premiums
Momentum factor premium
> Single proven return factor
Momentum
> High risks and high turnover
Market Robeco momentum strategy
> Combination of proprietary momentum factors
> Avoid unrewarded risks and unnecessary turnover
Risk > Integration of low-risk and valuation factors
> High conviction, higher active share

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 Efficiently capturing factor premiums

Robeco Conservative equity model: Lower risk and enhanced returns

First reduce risk further and second enhance return

Broad portfolio of low volatility stocks

Return

Conservative
Equities > Single statistical risk measure
> Low conviction, large number of stocks
Robeco proprietary low-risk factors
Low Risk Low > Combination of statistical risk factors
Factors Volatility > Proprietary distress factors
Robeco Conservative Equity
> Integration of valuation and momentum
Risk factors
> High conviction, higher active share

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Conclusions:

→ Passive investing is inefficient

→ Investors should explicitly allocate to proven factor premiums

→ Investors have different risk-return preferences

→ Active management can be superior to the passive counterpart

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Write your master thesis at Robeco

October 2017 Quantitative Investing at Robeco 29

Three reasons to join Robeco Super Quant Internship

1. Dedicated supervision

2. Topics for econometrics students

• Quant trading
• Factor investing
• Big data

3. Direct impact

For more information, see www.robeco.com/superquant

October 2017 Quantitative Investing at Robeco 30

Quant

What is it to be a quant at Robeco?

> Develop investment strategies
– Analyzing models
– Build infrastructure (databases and tools)

> Promote quant products

– Writing commercial and academic articles
– Clients and sales activities around the globe

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Career opportunities at Robeco

> Quantitative researcher

> Portfolio manager

> Risk manager

> Investment specialist / sales

> Combination with PhD track

October 2017 Quantitative Investing at Robeco 32

If you want to learn more about investing at Robeco

October 2017 Quantitative Investing at Robeco 33

Disclaimer

This document has been carefully prepared by Robeco Institutional Asset Management B.V. (RIAM). It is intended to provide the
reader with information on RIAM’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or
investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and
legal advice.

The content of this document is based upon sources of information believed to be reliable, but no warranty or declaration, either
explicit or implicit, is given as to their accuracy or completeness. This document is not intended for distribution to or use by any
person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Historical returns are provided for illustrative purposes only and do not necessarily reflect RIAM’s expectations for the future. Past
performances may not be representative for future results and actual returns may differ significantly from expectations expressed in
this document. The value of investments may fluctuate.

All copyrights, patents and other property in the information contained in this document are held by Robeco Institutional Asset
Management B.V. No rights whatsoever are licensed or assigned or shall otherwise pass to persons accessing this information.

Robeco Institutional Asset Management B.V. is registered with the Autoriteit Financiële Markten in Amsterdam.

18 February 2015 Factor Investing -- Guest lecture ESE 34