In conversation with Rademeyer Vermaak: A masterclass on multi-style investing
Style investing means the investment strategy of seeking out stocks with specific fundamental characteristics, e.g. value or growth. It requires active investing, but does so in a disciplined, consistent and systematic way, which eliminates behavioural biases.
STANLIB Systematic Solutions has found that combining three different investment strategies (value, quality and growth) produces superior portfolio performance and removes the need to “call the cycle”.
The optimal time horizon for this blended approach is 12 months, so different segments of the portfolio are rebalanced once a year.
Deploying this strategy, the STANLIB Enhanced Multi Style Equity Fund has outperformed its FTSE/JSE Capped Swix All-Share benchmark over three, five and seven years.
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Since 2016, STANLIB’s Enhanced Multi Style Equity Fund has combined human ingenuity and world-class data analytics to deliver consistent, market-beating returns at low cost. Citywire rates Rademeyer Vermaak, the Head of STANLIB Systematic Solutions, as one of the top equity portfolio managers in SA. We find out how he and his team approach investing.
After graduating with a Masters in Electronic Engineering from the University of Pretoria, Rademeyer worked as an electronic engineer before transitioning to the financial services sector. He worked in quantitative analysis and fund management in London before returning to SA in 2012 to join Fairtree Asset Management as Head of Quantitative Research and portfolio manager of the multi-factor product suite. At Fairtree, Rademeyer successfully developed and managed equity, hedge, and multi-asset funds, and built up a team of quantitative analysts. In 2019 he joined STANLIB. Today he is the portfolio manager responsible for the multi-style equity funds, multi-asset funds within the Systematic Solutions team, index tracking and completion strategies.
How would you explain style investing?
Style investing cuts across this active-passive duality by strategically seeking out stocks with specific fundamental characteristics (value, growth, quality, etc.).
Data shows that investors consistently reward this approach.
The nuances of how a fund invests in a given strategy, or combination of strategies, is down to the manager.
This approach is active, fundamental investing but achieves this in a disciplined, consistent, and systematic way, which eliminates behavioural bias.
I believe style investing is the most rational way to invest in markets. Ben Graham, the grandfather of value investing, observed that markets may behave like voting machines for periods of time (irrational) but perform as weighing machines in the long run (rational). This gives style managers the confidence to persist through periods when their chosen strategy is out of favour.
The world is an uncertain place, of course styles can underperform for years, and not every investor has infinite patience. As John Maynard Keynes famously said, ‘Markets can remain irrational for longer than you can remain solvent’.
There are many ways to ‘do’ style investing. One value fund manager may simply buy the stocks with the lowest price/earnings ratios, while another may trade less frequently or apply other qualitative or quantitative filters to a simple value metric.
Given the abundance of data available from decades of daily stock moves and affordable computing power, perhaps data scientists should have arrived at a single ‘super style’. But there are endless ways to express the concept of style investing.
When did you first become interested in style investing?
After I joined Fairtree, a client sent me a fascinating paper by Haugen and Baker about investing in low-volatility stocks. This introduced me to the idea of simultaneously evaluating multiple stocks based on a specific characteristic. I ran the strategy in Excel as a bit of an experiment, and the results blew my mind.
The alpha that it generated was on a different planet to the macro timing and Commodity Trading Adviser (CTA) strategies that I had been researching until then. That’s when my fascination and obsession with style investing began.
How would you describe your multistyle investing methodology?
Style investing began with single-style strategies. This is intellectually ‘pure’, but our research suggests (and our performance confirms) that combining a number of strategies produces superior portfolio performance. We use three investment strategies: value, quality, and growth. To be clear, we do not put the portfolio into three buckets, each of which separately buys cheap stocks, growth stocks and quality stocks. We invest at the intersection of quality, value and growth, which means that we analyse every stock in our universe and judge its attractiveness based on all three strategies at the same time, so we are effectively looking through three different lenses simultaneously. We then judge the stock’s attractiveness based on its overall score, which is the average of its score for each of the individual styles.
The following chart shows how our multi-style approach has outperformed any single style since 2016, with much lower volatility.
How would you characterise the portfolios that your methodology produces?
The practical result of our approach is that our portfolio is simultaneously cheaper, better quality and higher growth than its benchmark. We achieve this by excluding stocks in the index which we find unattractive. These would include popular stocks which are too expensive for what they offer and unpopular ones which are not cheap enough, given their poor underlying characteristics. This sounds straightforward but it is not – the magic lies in the unlocking of mispriced securities at the intersection of quality, value and growth. The underlying signals we use within each strategy, and the complex way in which we blend them, are the products of deep research. That is part of our secret sauce.
To use a rugby analogy: by picking stocks that score well across all our styles we are like a team with a strong kicking backline that can play the whole game in the opposition 22, where we have a greater chance of scoring. The odds are in our favour. Our sensible approach also gives us a good chance of outperforming our benchmark because our methodology produces a portfolio which is “better than the benchmark” across most fundamental metrics, as well as very different from the index.
This table shows our top holdings in the left-hand column. The columns on the right show the top holdings of the benchmark and five leading active equity funds. Our stocks are in purple, and blue stocks are the ones we do not own. Statistically our portfolio averages an ‘active share’ against its benchmark of 54%, which is pretty high in a South African context.
By tradition, styles are defined by historical data. Do critics of this approach say that you are driving in the rear-view mirror?
Our methodology deliberately looks forward, as we take into account a stock’s projected earnings growth and the rate of change in the consensus earnings forecasts, among other things. Of course, it is true that we built our stock-selection strategy based on information contained in the data, but so does every investor. No matter what the strategy, predicting the market’s behaviour in the future depends on an understanding of how it behaves. In the simplest terms, stock-pickers who buy a stock because they think an earnings surprise is coming up, do so because in their experience stocks tend to pop when good fundamental news hits the tape. We put a robust and formal framework around this experience.
You are doing research all the time to improve your methodology. What is a good example of a new insight which you built into your approach?
One of the research insights we have incorporated relates to how frequently we rebalance the portfolio. This is a particularly important aspect of any style strategy. In theory, we could rebalance every day to reflect moves in market prices, but over-trading damages performance through transaction costs. On the other hand, by just buying and holding for years, we could miss opportunities to take profits on stocks that perform and add stocks that have become attractive. We have done a lot of research (and recently published a peer-reviewed paper in the Journal of Portfolio Management) on how long it typically takes for styles to ‘work’. We found that 12 months is the optimal practical time horizon for our selection of investment strategies.
However, if we only rebalanced the portfolio once a year, we would certainly miss opportunities. STANLIB’s unique approach is therefore to rebalance different segments of the portfolio once a year, which enables the managers to constantly capture opportunities and give them time to play out, without incurring excessive transaction costs. It seems to be working well.
What is the best way to understand how your strategy sensibly combines human ingenuity and consistent, systematic principles?
We like to say that we are systematically applying the fundamental principles of active stock investing. This means that
our investors benefit from a deep understanding of how the market works without being exposed to the behavioural flaws which affect all human decision-making.
Every finance professional uses some form of technology, from a simple Excel spreadsheet on a laptop with a Bloomberg screen, to multi-dimensional databases in the cloud. We use our proprietary technology to find and verify the deep but intuitive drivers of the stock market and then sensibly fine-tune our methodology accordingly.
Technology is a force-multiplier for our human thinking.
Our brand of style investing demands technology. The human mind is brilliant but, unassisted, cannot crunch enough data to arrive at the insights that drive systematic investment returns.
A useful analogy would be to think of a classic active equity manager as an old-fashioned treasure hunter armed with a shovel, digging holes on a beach. Our investing methodology is like a team of thousands of treasure-hunters armed with metal detectors who only stop to dig when they hear a ‘beep’ on their headphones. In this metaphor, our portfolio managers direct the treasure-hunting team, seeing where they are having success and then telling the rest of the team where to focus their efforts. I use that metaphor because it paints a picture of how much more ‘ground’ we can cover than traditional operators. Stopping to dig a hole is a good analogy of the time-consuming reality of old-fashioned bottom-up stock selection.
How do you think investors should deploy your fund within their overall portfolio?
Consider a portfolio of equity funds as a soccer team. Each player has a specific task, and the team would fail dismally if it consisted of 11 goalkeepers. A successful team needs strikers who are capable of moments of genius, defenders who are tireless rather than creative, and an agile goalkeeper. Our fund is the dependable midfielder who connects defence with attack and gives the other players the freedom to shine.
We think that our fund provides the perfect core for an investor’s equity exposure. Firstly, because our approach is well-balanced rather than focused on a single style which can fall out of favour for a long time. Secondly, we generate persistent alpha with little if any correlation to most other active strategies. Thirdly, our fees are much lower than most active strategies, despite consistently delivering an exceptional active process.
Finally, our investors know we apply our process consistently. Our goal is to deliver ‘top quartile performance at bottom quartile cost’ and the data is clear. We have outperformed our benchmark over any rolling three-year period since inception – that’s a 100% hit-rate.
At the end of the day investing is about returns. What has the fund historically delivered for investors?
You’re right – as they say, the proof of the pudding is in the eating. We are happy to talk about our numbers. The fund has outperformed its FTSE/JSE Capped SWIX All-Share benchmark over the last three, five and seven years. Since inception it has outperformed by 230 bps per annum, placing us comfortably in the top quartile amongst peers over that time. We think that is a really solid performance, particularly given the various market cycles and volatility we have experienced over the last seven years.