Active investing cuts through the noise, says SSgA
Richard Lacaille, global active equities head at State Street Global Advisors, talks about how to design portfolios that beat indexes in a risk-controlled way.
Richard Lacaille is a London-based head of global active equities at State Street Global Advisors (SSgA). He focuses on strategic direction, oversight and risk management. Prior to his current role, Lacaille was the European chief investment officer with responsibility for all investment activity undertaken in the London, Paris, Munich and Zurich investment centres. He is a board member of SSgA, and also serves on the European executive committee and the SSgA investment committee. He shares with AsianInvestor how SSgA uses quant screens to build portfolios.
Can you talk a little bit more about your role in SSgA?
Lacaille: I am the head of the global active equities team, which manages money in various locations around the world. We run, for example, single market strategies here in Hong Kong that are designed to outperform the Hang Seng Index or the MSCI Hong Kong Index. The regional team between Sydney and Hong Kong that run Asia-Pacific active equities are also part of the global active equities team. We have an emerging markets team here as well. We have a team in Japan, in Europe, and in Boston. We run individual country strategies and then we run global strategies that are managed in Boston.
How much in AUM are you responsible for?
About $30 billion. State StreetÆs total AUM is around $2.1 trillion. What my team handles is a small portion of that.
What is the merit of active investing?
Our strategies are designed to outperform markets or to deliver market neutral returns of Libor plus 3% or 4%. We use a quantitative approach by which I mean that we developed some hypothesis about what drives stock prices and then we build models which give us an indication of the attractiveness of all the stocks in the universe. For example, in the global portfolio, we look at 3,000 stocks everyday. We look at many dimensions of each of those securities. We look at things like value (is the company cheap compared to its competitors in the same industry or in the same country), the outlook for the company from an earnings and cash flow perspective (using analysts data that are external to SSgA), investor sentiment (as indicated by price momentum and other measures that give us a idea of what the market itself thinks of that company).
Broadly speaking, we have other factors as well. But when those three factors are positive or when we have a balance of the factors that is positive, then that company will get a high ranking. We rank all the stocks in the universe and then we construct portfolios that are designed to beat the index in a very risk-controlled fashion.
In many ways we are doing a similar job to a traditional manager who would look at the balance sheet and the income statement. They would look at the prospects of the company and they would make an assessment of what they are willing to pay for the growth that the company might deliver. We are doing it in a more structured way. We are trying to cut through all the noise that often gives people a little bit of a bias in their evaluation of the companies.
How do your quantitative models allow you to take advantage of investment themes?
We are looking at a very large number of stocks every single day. We have a large number of value measures that will tell us if a company is cheap and if there has been a long term over reaction in which investors have simply become too pessimistic about that company, and that might be the price-to-book ratio adjusted for return on equity, it might be Ebitda or some other measure that compares the market value of the company to some longer term measure of value. That will be one of the measures we will use.
On growth, we might use measures that we developed that would look at all stock analysts but then weight analysts differently. If you have an analyst for example who is already more optimistic than the average analyst and then he become seven more optimistic, then that would be a very strong signal for us compared for example to an analysts who was less optimistic that the average and simply moved towards the average.
Not every forecast is treated equally. We are not pretending that we understand the individual specificities of the company from a fundamental perspective as we donÆt visit the company. But in some aspects that is an advantage because those measures encompass a lot of other peopleÆs analysis of that company. In particular when we look at earnings changes in a companyÆs outlook, in order for people to make a change, they have to evoke some inertia. The fact that they have already seen the company, or attended a road show, or unearth some information, it doesnÆt really matter to us. What matters to us is that people who have studied the company very deeply have overcome the inertia and have made a change in their forecast.
Do you overlay any qualitative analysis?
ItÆs all quantitative and then we have a process of due diligence that makes sure that we really do make decisions that are consistent with the spirit of them all. The role of the portfolio manager is to really manage the portfolio and the whole process.
The qualitative input is important but itÆs also important to understand what we do. We are not going to try and second guess whether or not that company is going to grow its earnings very rapidly. We are trying to make sure we capture the spirit of our model without being misled by pieces of data that are not representative.
Where is the quantitative analysis done?
There are two stages to the process. There is a computer in Boston that sucks in the data, computes the numbers and throws it out in every direction. ThatÆs the operational process.
We need to keep adjusting that model because we need to keep our ideas fresh. People will have new ideas about what will drive stock prices and we have to test those ideas. We have a research department based in a number of locations: staff in Japan, Sydney, Boston, London and we will progressively expand our research resources. We now have 41 people. Their role is to work with active portfolio managers in improving the process. The local insights are important. For example, the Hong Kong team over here, they are living through the process every day. They are seeing whatÆs working and whatÆs not working and their input is critical in making sure that the model we run for Asia-Pacific is very fresh and has got our best thoughts in the sense of the model. ItÆs a longer-term process.
What is the most challenging part of managing a global active equities portfolio?
The challenge is how we deliver the performance. What works well for us is where youÆve got a consensus among investors and analysts about the likely direction of the macroeconomic trends and hence, earnings. It doesnÆt have to be up and it doesnÆt have to be down. But it certainly helps if you have a consensus about whatÆs most likely to happen.
YouÆve got a very rapidly changing environment in which investors are suddenly latching on to an entirely different scenario or trend, that can be very challenging whether you are a subjective manager or a quantitative manager because all of a sudden stock prices will be driven by that new environment.
But particularly for the quants, we rely on a bottom-up evaluation of companies and the outlook for companies on an individual basis as provided by stock analysts. If the stock analysts are able to operate in a reasonably stable consensus environment, then the information they have about individual companies, thatÆs valuable information for us.
If you have a situation where the whole world looks like itÆs changing dramatically and investors basically ignore those bottom-up signals, and you get indiscriminate selling of companies regardless of the fundamentals, thatÆs a challenge for quants and thatÆs a period where we normally suffer in performance.
Can you talk a little bit more about your role in SSgA?
Lacaille: I am the head of the global active equities team, which manages money in various locations around the world. We run, for example, single market strategies here in Hong Kong that are designed to outperform the Hang Seng Index or the MSCI Hong Kong Index. The regional team between Sydney and Hong Kong that run Asia-Pacific active equities are also part of the global active equities team. We have an emerging markets team here as well. We have a team in Japan, in Europe, and in Boston. We run individual country strategies and then we run global strategies that are managed in Boston.
How much in AUM are you responsible for?
About $30 billion. State StreetÆs total AUM is around $2.1 trillion. What my team handles is a small portion of that.
What is the merit of active investing?
Our strategies are designed to outperform markets or to deliver market neutral returns of Libor plus 3% or 4%. We use a quantitative approach by which I mean that we developed some hypothesis about what drives stock prices and then we build models which give us an indication of the attractiveness of all the stocks in the universe. For example, in the global portfolio, we look at 3,000 stocks everyday. We look at many dimensions of each of those securities. We look at things like value (is the company cheap compared to its competitors in the same industry or in the same country), the outlook for the company from an earnings and cash flow perspective (using analysts data that are external to SSgA), investor sentiment (as indicated by price momentum and other measures that give us a idea of what the market itself thinks of that company).
Broadly speaking, we have other factors as well. But when those three factors are positive or when we have a balance of the factors that is positive, then that company will get a high ranking. We rank all the stocks in the universe and then we construct portfolios that are designed to beat the index in a very risk-controlled fashion.
In many ways we are doing a similar job to a traditional manager who would look at the balance sheet and the income statement. They would look at the prospects of the company and they would make an assessment of what they are willing to pay for the growth that the company might deliver. We are doing it in a more structured way. We are trying to cut through all the noise that often gives people a little bit of a bias in their evaluation of the companies.
How do your quantitative models allow you to take advantage of investment themes?
We are looking at a very large number of stocks every single day. We have a large number of value measures that will tell us if a company is cheap and if there has been a long term over reaction in which investors have simply become too pessimistic about that company, and that might be the price-to-book ratio adjusted for return on equity, it might be Ebitda or some other measure that compares the market value of the company to some longer term measure of value. That will be one of the measures we will use.
On growth, we might use measures that we developed that would look at all stock analysts but then weight analysts differently. If you have an analyst for example who is already more optimistic than the average analyst and then he become seven more optimistic, then that would be a very strong signal for us compared for example to an analysts who was less optimistic that the average and simply moved towards the average.
Not every forecast is treated equally. We are not pretending that we understand the individual specificities of the company from a fundamental perspective as we donÆt visit the company. But in some aspects that is an advantage because those measures encompass a lot of other peopleÆs analysis of that company. In particular when we look at earnings changes in a companyÆs outlook, in order for people to make a change, they have to evoke some inertia. The fact that they have already seen the company, or attended a road show, or unearth some information, it doesnÆt really matter to us. What matters to us is that people who have studied the company very deeply have overcome the inertia and have made a change in their forecast.
Do you overlay any qualitative analysis?
ItÆs all quantitative and then we have a process of due diligence that makes sure that we really do make decisions that are consistent with the spirit of them all. The role of the portfolio manager is to really manage the portfolio and the whole process.
The qualitative input is important but itÆs also important to understand what we do. We are not going to try and second guess whether or not that company is going to grow its earnings very rapidly. We are trying to make sure we capture the spirit of our model without being misled by pieces of data that are not representative.
Where is the quantitative analysis done?
There are two stages to the process. There is a computer in Boston that sucks in the data, computes the numbers and throws it out in every direction. ThatÆs the operational process.
We need to keep adjusting that model because we need to keep our ideas fresh. People will have new ideas about what will drive stock prices and we have to test those ideas. We have a research department based in a number of locations: staff in Japan, Sydney, Boston, London and we will progressively expand our research resources. We now have 41 people. Their role is to work with active portfolio managers in improving the process. The local insights are important. For example, the Hong Kong team over here, they are living through the process every day. They are seeing whatÆs working and whatÆs not working and their input is critical in making sure that the model we run for Asia-Pacific is very fresh and has got our best thoughts in the sense of the model. ItÆs a longer-term process.
What is the most challenging part of managing a global active equities portfolio?
The challenge is how we deliver the performance. What works well for us is where youÆve got a consensus among investors and analysts about the likely direction of the macroeconomic trends and hence, earnings. It doesnÆt have to be up and it doesnÆt have to be down. But it certainly helps if you have a consensus about whatÆs most likely to happen.
YouÆve got a very rapidly changing environment in which investors are suddenly latching on to an entirely different scenario or trend, that can be very challenging whether you are a subjective manager or a quantitative manager because all of a sudden stock prices will be driven by that new environment.
But particularly for the quants, we rely on a bottom-up evaluation of companies and the outlook for companies on an individual basis as provided by stock analysts. If the stock analysts are able to operate in a reasonably stable consensus environment, then the information they have about individual companies, thatÆs valuable information for us.
If you have a situation where the whole world looks like itÆs changing dramatically and investors basically ignore those bottom-up signals, and you get indiscriminate selling of companies regardless of the fundamentals, thatÆs a challenge for quants and thatÆs a period where we normally suffer in performance.
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