Pure passive plays create potential portfolio imbalance
The trend of investing into equities using passive strategies based on pure valuation metrics will create imbalanced portfolios and over-exposure to a limited set of market sectors according to AllianceBernstein (AB).
AB Global/International Value Equities chief investment officer, Kevin Simms, said the recent trend to passive and smart beta strategies have overlooked the necessity for a hands-on approach to avoid lop-sided portfolios that ignore parts of the market.
Simms said that an examination of performance history shows that valuation metrics require context to be effective and "by studying patterns of the past, investors can gain insight into investing in underappreciated stocks by applying a human touch".
He said managers and investors have used the price/book ratio (P/B) and the price/earnings (P/E) ratio for many years but investment strategies built around these without any analysis or human interaction would be lopsided.
"If we simply took the cheapest 20 per cent of global stocks according to P/B or P/E, we would end up with a portfolio that had more than half of its weight in just two sectors: financials and energy," Simms said.
"The portfolio would be very light on all other sectors, including technology. It wouldn't be able to capture the attractive valuations that can be found in the tech companies that stand out from the crowd."
He said recent efforts to overcome such distortions by style index or smart-beta strategies may work but these are also open to imbalances.
According to Simms the imbalance was evident in that more than 30 per cent of the MSCI World Value Index was in financials at the end of April which was higher than a standard cap-weighted index, however stripping out financials entirely would skip any opportunity to profit from cheap financial stocks that are rebounding.
AUTHOR
Nicholas O'Donoghue
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