Quant or fundamental? Experts weigh in on maximising returns in booming EMs

A roughly even mix of quantitative, or ‘quant’, and fundamental investment strategies in a booming emerging markets (EM) equities asset class would deliver a marked improvement in investor returns over either strategy applied individually, researchers from global investment firm Robeco have revealed.

In an analysis of more than 160 strategies within its database (comprising 123 fundamental and 39 quant strategies) as part of a just-released whitepaper, Robeco analysts have proposed that an average 50/50 split strategy – a veritable “sweet spot” – between quant and fundamental investment strategies would deliver a 25% improvement in returns over the average of the two subgroups.

“These returns would primarily be driven by reduced active risks,” Robeco analysts wrote in the just-released Embracing fundamental and quant investing in emerging markets report, noting the historic volatility and “more severe drawdowns” of EM equities, particularly over the last decade.

Acknowledging the higher risks that fundamental portfolio managers are known to take, quant strategies were noted for their notably higher information ratios (IRs) over fundamental strategies (0.47 vs. 0.32).

“On average, quant strategies exhibit lower active risks than fundamental ones, with a mean tracking error of 4.2% for quant strategies compared to 5.2% for their fundamental counterparts.”

“This finding suggests that, on average, fundamental managers are taking higher active risks,” according to the Robeco analysts.

However, the analysts noted, higher active risks or tracking errors (TEs) are most often a prerequisite for high outperformance.

“Interestingly, the high TEs of the top-performing strategies often derive from below-average absolute volatility, highlighting the effectiveness of low-volatility strategies in emerging markets,” Robeco wrote.

“Over time, we see that fundamental and quantitative strategies alternate in terms of which has the best performance.”

“Even if you had been highly skilled (or lucky) enough to be invested in the three best-performing fundamental or quant strategies, adding a complementary strategy proposition of the other group would, on average, preserve risk-adjusted returns and improve the overall risk profile.”

The analysts added: “From an investment style perspective, quant strategies typically exhibit exposure to four style factors, while fundamental strategies do not; they instead load negatively on value, resonating with a growth-like investing style.”

Quant strategies adopt a ‘scientific’ investment approach using data models to analyse a broad universe of stocks; fundamental strategies, on the other hand, emphasise a more traditional approach, with portfolio leads applying in-depth analyses of the performance of a particular company, its management team and board, and market opportunity.

Robeco warns, however, that combining fundamental and quant strategies “should not be done in an arbitrary manner” but, rather, “in style”.

“Specifically, the combination should reinforce and strengthen a given investment objective, such as outperforming the MSCI EM Index in clearly contained risk limits just like a typical core investment would.”

“Overall,” they said, “fundamental and quant are natural complements”.

The global investment firm is overall sanguine about the prospects for emerging markets over the medium term, forecasting investment returns of 8.25% over the next five years, a premium of 1.5% compared to developed markets.

Among Robeco’s fundamental emerging market (EM) strategies include Robeco EM Core, Robeco EM Stars (high-conviction counterpart to EM Core), and Robeco EM Sustainable Stars (which adds an enhanced sustainability profile to the EM Stars portfolio), which have, since inception, generated average excess returns of 1.91%, 3.08% and 2.80% per year, respectively, gross of fees.

Among its quant EM strategies include the Robeco QI Emerging Markets Enhanced Indexing Equities (an actively managed multi-factor emerging markets equities strategy), its QI Emerging Markets Active Equities (a more active counterpart to the former), and the QI Emerging Markets Sustainable Active Equities (sustainable counterpart of Robeco QI Emerging Markets Active Equities).

Since inception, these funds have generated average excess returns over the benchmark of 1.72%, 3.11% and 2.22% per year, respectively, gross of fees.