Nomura’s September Quant research report looks at three separate themes in the quant space. Alternative beta is a popular term and used generally with single strategies – Nomura investigates the possibilities of constructing a viable portfolio out of different alternative beta strategies. The second theme revolves around emerging market portfolios and whether value can be introduced therein using currency-based momentum strategies. The third theme addresses the simultaneous use of both an earnings momentum strategy as well as a contrarian strategy depending upon changes in stocks’ earnings trends.
Quant alternative beta strategies
Indigo Fraser Jenkins, Global Head, Quantitative Strategy (Equities) and Gerard Alix Guerrini point to the hype surrounding alternative beta and warns that it may be used too broadly, even though in essence most money is invested in single-strategy betas such as minimum variance or value. That investor interest exists in alternative betas is apparent from the growth in the AUM of alternative beta ETFs as shown here:
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The approach proposed is to create a bouquet of alternative betas that could be tailored to investors’ views on the market, their investing objective or mandate, and their strengths – the adoption of whole programs of alternative beta investment.
Within these programs Nomura feels investors can be guided to their objectives based on their confidence in return prediction and confidence in the risk model, all the time making a distinction between screening and weighting.
Emerging market portfolios
The second theme of the report is to bullet-proof emerging market portfolios by looking beyond just asset classes and varying the investment methodology by adding a momentum component, preferably FX, to the portfolio. Analysts Swati Aggarwal, Qilong Zhang and Chein-Hua Chen examine this innovative theme.
Why momentum? This is because in a sell-off all EM assets (equity, debt, FX) tend to move down together – “there is no place to hide” – even surprisingly EM debt, which is as pro-cyclical as EM equities and EM FX. During such runaway trends, a momentum strategy can pay rich dividends.
Why FX momentum? This is because currencies afford liquidity, possibility of shorting, performance and high EM beta. The chart below is instructive:
According to Nomura, “An EM currency momentum overlay can add significant value to typical EM equity-bond portfolios,” due primarily to low correlation with long-only equities and bonds.
The strategy also adds diversification and acts as a cushion against drawdowns.
Using momentum and contrarian strategies simultaneously
Analysts Akihiro Murakami and Naoko Kato suggest a strategy that uses both momentum-based strategies and contrarian approaches for stocks depending upon the timing of breaks in upward or downward earnings momentum.
The analysts base their approach on the ‘polarization’ in earnings trends witnessed in Japanese companies at the time of extreme events such as Lehman, the earthquake and the European crisis – a large number of companies saw earnings slide, but at the opposite end of the spectrum, a large number saw earnings grow. During such times, strategies that utilized earnings momentum performed well.
However, a contrarian approach needs to kick in when continuous growth levels off and analysts revise downwards their estimates and valuations. The analysts suggest that a break in earnings growth may be used as a trigger for entering the contrarian strategy. Stocks may therefore be segregated between those with an unbroken earnings momentum and others where a contrarian approach would be more profitable.
The analysts tested the hypothesis and found that it indicated stable performance as per the chart below.