Originally published on LinkedIn
Today some of the investment strategies which are most in-demand by investors throughout Asia-Pacific have a thematic approach at their core. Thematic portfolios offer exposure to certain economic, social or technology trends, such as the increasing pressure on potable water supplies, the surging use of robots or the rise of social media.
But choosing the right theme in which to invest is, of course, only part of the equation. Selecting the right stocks too can make a tremendous difference in capturing the value of the global trends that are attractive to invest in. And in this regard, financial institutions in Australia who are looking to build or enhance a robo-advice offering for their clients, can benefit from offering quantitatively managed portfolios.
A quantitative methodology in robo-advice services is a viable and cheaper alternative to traditional human-made portfolios. Investment specialists, such as Quantifeed, develop the rules of a quantitative portfolio. But after the rules have been defined, there’s no room for human misjudgement during the execution.
Here’s how we do it. Every time we construct a thematic index that can be used by our clients, we first conduct thorough research into a specific theme. We look at what defines this theme and what are its economic drivers. Next, we aim to identify stocks that are impacted by the factors central to the theme and, finally, we decide how to weight these stocks.
Let’s look at the theme of social media. To select the components of this theme we consider companies that can be described as social media networks. These are the platforms that individuals use to keep in touch with friends and share content with a global audience. The theme itself is highly attractive to invest in. There are currently over 2 billion people using social media channels in the world today and the number is expected to reach 3 billion by 2020.
To select the potential winners within this theme, we first select stocks from a universe of US-listed companies with a market capitalization of over US$50 million and a daily liquidity greater than US$5 million. Given that a third of global internet users are based in Asia, we include ADRs in this universe of companies as well.
To identify relevant companies within this theme, we look at the general company profile, as well as specific business revenue segments. We then select up to 20 stocks from those relevant companies based on their valuation and the popularity of their platform. In order to select companies with strong financial position, we then screen out any company with no or negative earnings in the remaining selection.
The rules-based system makes the selection of the relevant group of stocks a systematic process. Our methodology in this example picks companies that derive more than 20% of their revenue from at least one business segment relevant to the social media theme.
Integration with technology
Our index design also integrates with the digital capabilities of our technology. Because users trade the individual securities comprising an index, an important aspect of design is the tradability of stocks. The number of index components and their weights are other important variables. To improve diversification, we equally weight our indices or utilise factors such as volatility or dividend yield to determine the weighting of stocks. Interestingly, the application of such weighting methods often leads to outperformance and improved risk/return characteristics relative to a traditional market-cap weighted index.
As a further point of differentiation, our white labelled B2B platform allows financial institutions the flexibility to adapt the index to their own requirements, for example to facilitate a very low investment amount across a reduced number of stocks. Our technology can generate these changes automatically, or enable the user to modify the index composition by eliminating or adjusting the trading order before submission for execution.
If you’re in an Australian financial institution looking to build an engaging robo-advice offering for your customers, let’s meet! You may contact me on firstname.lastname@example.org