Boston QWAFAFEW Meeting: 18 Feb 2020
On The Value of Portfolio Construction
A QWAFAFEW discussion led by:
Most Style factor ETFs use some simple heuristic method of portfolio construction, such as equal-weighting or capitalisation-weighting. This inevitably results in inefficient portfolios which are likely to have significant unintended factor bets, and the returns to these can easily dominate the returns to these chosen Style factor.
This paper uses a simple stock selection rule to create Style Factor ETFs, using a number of standard heuristic portfolio construction methods, including equal-weighting, capitalisation-weighting, attribute-weighting, inverse volatility, risk parity and Markowitz optimisation. It also introduces a modified version of Markowitz optimisation which identifies the most inefficient holdings in an existing portfolio and only allows limited trading in those stocks; the purpose is to gain a significant improvement in overall efficiency without too much turnover.
Each of the strategies is rebalanced quarterly from the beginning of 2006 to 2019. Since the stock selection is always the same, the differences in performance and turnover are due entirely to the different methods of portfolio construction.
In 1980 Jason MacQueen founded QUANTEC, which was the first firm to develop risk models for equity markets outside the USA, and which ultimately built risk models for all of the developed and most of the emerging markets. In 1984 QUANTEC launched the first global asset allocation model, including currency hedging overlays and the first use of reverse optimisation for efficient portfolio rebalancing.
Jason also pioneered the development of multi-factor stock selection models in both the U.S.A. and Japan, and the investment track records of his long-term collaborators are exceptional. In the early 1990s QUANTEC developed the first global risk model, as well as a global stock selection model.
In the late 1990s Jason and his colleagues at Alpha Strategies developed a statistical risk model based technique for the American Stock Exchange, which enabled them to offer Exchange Traded Funds (ETFs) on Actively-managed Mutual Funds without knowing the underlying holdings. This technology can also be used to enable pension funds and other asset owners to manage their overall portfolio risks without having full transparency from their external managers.
QUANTEC was sold to Thomson Financial in February 2001, and after consulting to them for two years, he co-founded R-Squared Risk Management in 2003 to develop Custom Hybrid Risk Models for institutional investors to enable them to manage their portfolios more efficiently. R-Squared also developed a unique set of XRD equity risk models covering different geographies. Among other custom risk models, Jason and his colleagues developed the global equity risk model in FactSet’s Multi-Asset Class (MAC) product.
In December 2014, R-Squared;s business was acquired by Northfield, where Jason became the Director of Research. His main focus at Northfield was developing a second-generation global equity model for FactSet’s MAC product, which included additional style factors, regional sector factors and other enhancements.
Smart Portfolio Strategies (SPS) was founded in April 2015 to provide sophisticated portfolio rebalancing services to fund managers and asset owners. Active fund managers seek to outperform their benchmarks primarily by having superior stock selection skill, but its potential value can easily be lost if the portfolio is not constructed in a way that maximises the effects of this skill while minimising all other influences on the portfolio’s performance.
However, these two tasks require very different skill sets, and not all active managers are comfortable using optimisers and risk models to rebalance their portfolios. SPS draws on its decades of experience to rebalance portfolios more efficiently while also minimising turnover. SPS also monitors the portfolio’s efficiency so that it can be rebalanced whenever appropriate.
Since founding QUANTEC in 1980 Jason has developed the theoretical framework of Markowitz and his successors into a practical set of tools for institutional fund managers. By his passionate pleas for a disciplined and logically coherent approach to portfolio management, he has acquired an international reputation as speaker, consultant and iconoclast. He was educated at Oxford and London Universities, where he read Mathematics and Theoretical Physics.
He has been an Honorary Lecturer at Lancaster University Management School, and a Visiting Professor at Tokyo University’s Center for Advanced Research in Finance. He was the founder and first Chairman of the London Quant Group, a not-for-profit organisation established in 2007 to arrange Seminars on the practical application of quantitative investment technology, and is also a Director of the Society of Quantitative Analysts in New York.
Time: 6:15 PM sharpe
3rd Floor of the Tennis & Racquet Club
939 Boylston Street
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As always, if you have names or discussion topics, please forward them to any member of the Steerage Committee
Donna Cool Murphy
The members of the Steerage Committee are responsible for coordinating the program content.
Program suggestions from members are always welcome.
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