Integrating quantitative analytics and data science to gain an unfair investment advantage

By Maybank Asset Management

2 Feb 2021

Investors have always been adept at using new technologies to gain an advantage. Traders from ancient Venice would use telescopes to inspect the flags of incoming vessels, guessing the cargo they were carrying, and then buying and selling commodities accordingly. Today, the investment industry’s unending information war has been supercharged by the era of big data and artificial intelligence.

After scoring significant wins at the 2020 Refiniv Lipper Funds Awards and 2020 Citywire Asia Awards, Maybank Asset Management continues to surprise with new and exciting innovation. Investors will now be able to gain access to the enhanced computing power of quantitative investing through the newly launched Maybank All-Weather Quantitative Fund.
Mark Chua, Fund Manager and Lead Data Scientist, will be giving us insights on how quantitative investing can help investors navigate the investing environment in 2021.

Why Quantitative Investing?
2020 is a year where the global economy has been brought down to its knees by Covid-19. As we battle the virus, everyone is now living in a new normal - one in which innovation has been supercharged and accelerated. Fund management is no different in the sense that we too have to use new technologies such as quantitative analytics and data science to improve our investment outcomes.

In recent years, quantitative strategies has seen strong interest and adoption. JP Morgan estimates that over $2.5 trillion, or more than 20% of U.S. equity market capitalization, is now managed by quant-style funds.

While quantitative investing is relatively common in the US and Europe, we believe that it is under-penetrated in Asian financial markets. By being a first mover to apply quantitative investing in Asian equities, we believe we can create opportunities to generate strong performance.

Outlook for 2021?
The backdrop for Asian equities in 2021 looks promising with a global growth recovery, an improved commodities outlook, a weak USD, (likely) less-hostile US-China relations and still-accommodative monetary and fiscal policy. With Asian equities now trading at 16X forward P/E (versus historical average of 12X), the positives have been partially priced in and we expect that market performance will largely depend on whether earnings expectations are met rather than P/E multiple expansion. Nevertheless, we believe that improving economic fundamentals, still-ample liquidity and positive sentiment will help compensate for high valuations.

Our top three preferred markets are China, Taiwan and South Korea. China is attractive because of low valuations and improving Momentum scores, particularly in the Materials, Financials, Real Estate sectors. Taiwan is seeing improving revisions especially in its Energy sector. The case for South Korean is very similar to China with returns driven by low valuations and strong momentum. Our least preferred markets are Australia, New Zealand and Thailand. Valuations are relatively high in Australia and New Zealand while Thailand continues to be affected by political tensions and poor Momentum and Revisions scoring.

Why invest in the Maybank All-Weather Quant Fund?
A unique feature of the fund is the “all-weather” feature that helps investors manage the ups and downs of investing. We noticed that Asian equities were more volatile than developed market equities. Volatility usually hurts investors because of our behavioural biases. Most people cannot bring themselves to invest in a bear market, nor do they like the feeling of missing out in an exciting bull market. Unlike conventional equity funds, the quant fund actively allocates assets between cash and equities. There will be months when the fund is fully invested in equities and months when the fund is sitting in cash or highly liquid securities. As a result, this feature lowers the volatility of the fund especially during bear markets, and we hope that we can give our investors a smoother ride.

Sustainable Investing
The All-Weather Quant fund will also be our first product launched in Singapore that integrates Environmental, Social and Governance (ESG) considerations in our investments. We consider alternative data on a company’s performance on Environmental, Social and Governance (ESG) metrics. A company with a higher ESG score has a higher chance of being selected for investment.

How does it work exactly?
The Maybank All-Weather Quant Fund (MAQF) will invest primarily in Asia (ex-Japan) equities, with the flexibility to invest up to 30% of its NAV in equities outside of Asia (ex-Japan) region.

Stocks are selected using Factor Investing. Factor Investing is not new. Investors have been employing factor-based techniques in some form for decades. Academic underpinnings can be traced as far back as to the Capital Asset Pricing Model (CAPM) in the 1960s, the Arbitrage Pricing Model in 1976, and Fama and French in 1992. While participation was limited to institutions in the early days, the advent of greater computing power today has made Factor Investing accessible to more people.

A Factor is any characteristic of a basket of securities that is important in explaining their return and risk. The following factors have been identified by academics and widely adopted by investors over the years as key exposures in their portfolios:

• Value. Fama-French suggested that inexpensive stocks should outperform more expensive ones. In 1949, Benjamin Graham urged investors to buy stocks at a discount to intrinsic value. One view is that value investing works because stock valuation shows a tendency to revert to the mean over time. Investors tend to be overly optimistic about expensive, high-growth stocks and overly pessimistic about cheap, slower-growth stocks. Two common measures of value are the book-to-price ratio and earnings yield, but investors may also examine other measures such as sales or cash flows.
  
  
• Momentum. Empirical evidence of the Momentum factor was first published in 1993 by Jegadeesh and Titman. They demonstrated that stocks that had outperformed in the medium term would continue to perform well, and vice versa for underperforming stocks. It is debatable why momentum works, but one view highlights a behavioural bias among investors to underreact to improving fundamentals. It is not until a stock has done well that it catches investors’ attention and they pile into the trade. This dynamic allows winners to keep winning and momentum investing to work. A common way to measure momentum is to classify stocks by 12-month price returns.
  
  
• Quality. Richard Sloan and Scott Richardson in 2005 showed that companies with higher earnings quality have outperformed over time. Although there is a lack of consensus on the exact definition of quality, many investors agree on common hallmarks of quality companies, such as higher profitability, stable income and cash flows, a lack of excessive leverage, and higher return on equity. In other words, Quality companies tend to have competitive advantages that enable them to earn excess profits over time, and such competitive advantages should drive long term investment performance.
  
  
• Low Risk or Volatility. Research has shown that low risk or low volatility portfolios may outperform the broader market over time. Robert Haugen and James Heins in 1975 showed that stock portfolios with less variance in monthly returns tend to produce higher returns than those that are riskier. By investing in stocks with more stable revenues and earnings, investors can lower their exposure to recessions and other macroeconomic events. Low volatility portfolios tend to perform best during market downturns as investors tend to favour these stocks rather than riskier stocks.

For our quant fund, we use a combination of over 20 proprietary factors which we term as “M-TIGER” for short – it stands for Momentum, Total Capital Management, Intrinsic Value, Growth, Expectations and Risk. The underlying factor model is also deployed regionally to help our discretionary portfolio managers and analysts make better decisions, through an investment dashboard that we developed in-house.

What are the risks of factor investing?
No single factor works all the time and returns tend to be cyclical. Value stocks fell out of favour during the technology bubble in the late 1990s but came back in the years that followed. For Momentum stocks, major changes in market direction are usually detrimental, such as during the Global Financial Crisis in 2008-09. Quality and Low Volatility portfolios typically lag during market rallies following bear markets – such as in 2009. These performance swings can be unsettling to investors, causing them to sell and miss out on rebounding performance. However, we can make use of the fact that factor performance is not highly correlated with each other by combining them into a diversified multi-factor strategy.

The combination of individual factors into a blended multi-factor fund delivers a better risk-reward ratio than any of the individual factors. This can lead to higher performance and more consistency across market cycles. Diversification across factors is a sound option for long-term investors. However, investors should note that it does not fully eliminate equity market risk. For the quant fund, risk is controlled using the following 3 main features:

• Market Hedging Overlay. The quant fund is designed to systematically allocate between cash and equities. The allocation changes dynamically over time and the fund does not stay fully invested in equities at all times. A market hedging overlay is employed to determine the overall asset allocation between stocks and cash, with the aim of avoiding large market corrections. This lowers the expected long-term volatility to 12% for the fund vs 20% for the MSCI Asia ex-Japan Index, in our back-tests.
  
  
• Diversification across Factors. While individual factors tend to perform well at different parts of the economic cycle, a combination of multiple factors aim to diversify across factors and aim to reduce the effect of cyclicality. The fund uses a multi-factor approach which diversifies across factors.
  
  
• Diversification across Stocks. The fund typically holds 90-100 stocks, and on average any position is around 1% of fund NAV. Therefore, the fund does not have large concentrated exposures to any one stock. These holdings are rebalanced monthly. Therefore, the fund systematically sells stocks that drop in their rankings in order to buy stocks that rank at the top of the universe.

We are excited to bring to market a new and innovative product. We have designed the All-Weather Quant fund to work in most equity market conditions. During normal market conditions, investors in the fund gain exposure to multiple Factors to drive investment returns. During major market downturns, the Quant Fund will allocate assets from equities into cash in an attempt to reduce downside risk. We are also developing new investment strategies using Artificial Intelligence and Machine Learning which we hope to integrate into this fund in the future.

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