SPONSORED CONTENT | With the current cycle showing signs of age, fiduciaries are heeding lessons learned during the global financial crisis and going on the hunt for investment strategies that can perform in different market environments.

In their search for alpha amid expectations for an extended period of low returns and heightened correlations, leading investors have recognised that fundamental and quantitative strategies have complementary strengths. Many are seeking to leverage the benefits of both by allocating two independent managers, one from each camp, within the same portfolio.

Screening for stocks that look attractive through both a fundamental and quantitative lens is a way to improve the active share ratio across the entire portfolio and prevent over-diversification. And owning a single name that is simultaneously well rated by both processes results in a more optimal portfolio than holding two different stocks, one fundamental and one quant driven.

MFS Investment Management, a US$486 billion (AU$640 billion)* Boston-based funds management firm, systematically combines multiple alpha sources in a single strategy designed to be more cost-efficient and deliver better risk-adjusted performance.

The MFS Blended Research Global Equity Strategy has the benefits of an actively managed strategy, with an 84 per cent active share, but also has controls to prevent biases, and can be customised to suit client risk parameters or social objectives. It also has lower fees than a more typical active portfolio.

Learning from history

MFS analysis compared the annual returns of managers of large-cap US core equities from 1994 to 2016 in the eVestment Alliance database, using the median fundamental and quantitative managers as proxies for their investment styles.

With the caveat that past performance is not indicative of future results, the comparison found quantitative strategies were consistently more effective in low to moderate volatility and more challenged amid the high volatility of market inflection points. The reverse was true for fundamental strategies.

MFS portfolio manager Jonathan Sage says combining these two processes into a single, systematic strategy plays to these complementary strengths and potentially generates superior risk-adjusted returns over a full market cycle or even over multiple cycles.

“At their core, fundamental and quantitative research processes look at the world a bit differently,” Sage says. “But they’re quite complementary because they look at things differently.”

Best of both worlds

In similar research covering the same time period, MFS evaluated stocks that were rated ‘buy’ or ‘sell’ by fundamental research, quantitative research or both.

The firm found that when both styles recommended a stock, there was a greater return potential than when the fundamental and quantitative signals did not overlap.

This phenomenon also held true on the short side; stocks not favoured by either approach showed the greatest likelihood of market underperformance.

To put these findings into action, MFS combines both disciplines into a single, blended active-return forecast for each constituent of a benchmark. Sage and his team then build portfolios around these blended return targets, assigning greater weight to names with a higher potential active return.

On the quantitative side, multi-factor stock selection models systematically appraise company financials and market trends; while on the fundamental side, analysts take a deeper dive into companies and industries.

A portfolio optimisation process aims to ensure no sizeable deviations from the respective benchmark’s region, sector, size or style. This allows the portfolio managers to add value with their stock selection skills. The objective is to deliver portfolios with active returns relative to a benchmark, and at the same time a tracking error of about 2 per cent.

MFS senior managing director and head of Australia and New Zealand, Marian Poirier, says that by incorporating a fundamental alpha signal in a more systematic way, the investment team can produce portfolios with moderate active risk but a higher active share – historically above 80 per cent.

“People often assume low tracking error means low active share, and here we’re showing that we can constrain region and sector but have active stock selection within those areas and have delivered a high active share,” Poirier says.

*Disclaimer: Source MFS as at 30 November 2017. This article is directed at investment professionals for general information use only with no consideration given to specific investment objective, financial situation and particular needs of any specific person. Investment involves risk. Past performance is not indicative of future performance.

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