We live in an age of numbers. Big data, artificial intelligence, machine learning in investments, passives over actives and black box trading algorithms which move markets at head-spinning speeds.
So it is very appropriate to ask the following question: if you only had access to quantitative data, would it be possible to create a better-than-average portfolio?
“No,” says Celia Benedé Miranda, firmly.
You might be surprised to hear this because not only is she head of fund selection at Caja Ingenieros Gestión in Spain, but she has a degree in financial maths and started out working in the quants department of a bank. Miranda was in the process of programming some investment tools just as the bank started becoming interested in third-party funds and she found herself in demand.
“To begin with I would choose funds within the asset management companies I knew, but after some years I needed a model to look at all the funds in the universe.”
Built to order
So Miranda started building a model to score all the funds in each asset class from scratch. She read the theories about the existing models of fund selection and optimisation and then decided what were the most important elements and used that to build her own system.
And although she thinks quants isn’t enough, she believes it is still important.
“Our first check is to use historical data to identify managers who did well.
“We use one- and three-year statistical data and put more weight on the three year. We look for funds that have a good return but we always look for return at the specified risk and consistency.”
When thinking about risk, she says, there is a danger you simply equate it to volatility.
“You can have good volatility,” Miranda explains. “When we knew we wanted to differentiate between good and bad volatility and not to just measure the return against volatility, we looked at Calmar, which is not as well-known as other ratios.
“It measures your returns against your maximum drawdown and it has been the answer we were looking for.”
Not just quants
But no matter how well a fund scores in all of that analysis, she will not invest unless she knows the company that runs it – and that is where the qualitative analysis starts.
“We look at the philosophy of the fund manager, the objectives of the fund; we also look at the team and how many people work for the fund. Do they have analysts? How many departments are involved in running the fund? How experienced are they?
Another important step is to look at the ESG characteristics of the fund.
“Spain is behind other countries in terms of demanding ESG funds, but in our company, we are focused on this,” she says.
Then she looks at how many years the managers have been working for the company – is there a high turnover or do they tend to stay?
That last one is particularly important. Managers that move a lot don’t have time to settle in. According to Miranda, a stable manager is, on average, a better manager.
Eye contact
And it’s not good enough just to know more information about the fund, it is important to have face-to-face meetings.
“Meeting the manager is very important to us,” she says. “That is why conferences are so important because we get to know them.
With some managers you might only be able to get a phone call but it is very different if you meet them face to face.”
What is she looking for when she does meet the manager? The answer is quite simple: confidence.
“I want to feel confident the manager knows how they invest. I want to be able to ask specific details about how the fund is run. And I want to confirm – or not – that what I thought before the meeting is correct.”
So although it might look like we live in a sterile digital age, you may find it reassuring to note that even in a numbers-heavy area such as investments, human contact and subjective judgement are not just helpful, but essential.
Fund selection in depth
Celia Benedé Miranda’s fund selection process has some basic criteria: the pursuit of profitability is never isolated and can be adjusted by risk, consistency, and capital preservation.
“We have been introducing new parameters to help us better detect what we are looking for,” Miranda says.
The Sharpe ratio is given a lot of credence.
“But within volatility we must keep in mind that we can differentiate between good volatility and bad volatility,” she says.
“Sometimes there is volatility that we want to assume in our portfolios because it provides a reward. The one we want to isolate is bad volatility. In this sense, we have incorporated ratios such as the Calmar ratio that relate the profitability obtained based on the maximum drawdown assumed.”
Caja de Ingenieros Gestión is naturally focused on preserving capital, which encourages Miranda to take a greater account of extent metrics such as the downside capture ratio – which shows whether a fund has outperformed a market benchmark – to ensure it minimises the impact on falls.
“We take special interest in analysing the impact of possible negative market scenarios in the investment funds,” she says.
When creating and optimising the portfolios, once the funds and assets have been chosen, Miranda says it is vital to remember that it is not enough to simply keep the historical data of returns and risk in perspective – it is important to include future expectations and consider them in the final result.
“In the current climate of market intervention, volatilities are at historic lows, and correlations between different assets are high, which has led to complacency in the market. But there are still lots of risks and we have assigned a lot of importance to diversification,” Miranda says.
Therefore, Caja Ingenieros Gestión looks at the contribution to the total risk of the portfolio of each of its positions and has added a calculation that helps it to value the diversification. “[It helps calculate] the benefit of diversification contributed by each position to a specific portfolio,” she says.
Caja Ingenieros Gestión introduced Environmental, Social and Governance (ESG) criteria to its investment philosophy in 2006. Two of its investment funds have an ESG focus: Fonengin ISR and CI Environment.
“We believe in the value of socially responsible investments, aligned with the interests of our partners as a cooperative. This philosophy leads us to manage with extra-financial integration criteria, excluding sectors such as defence and tobacco,” Miranda says.
“In our third-party funds selection process, we have taken two steps in this direction. A first step has been to select third-party funds from various ESG categories that we include in our focus list and investment proposals.
“The second step includes an appreciation of ESG criteria in the qualitative due diligence of our funds. In our qualitative criteria we consider aspects such as conflict of interest, and managers’ remuneration policy or transparency, and we value the inclusion of any socially responsible criteria in the investment process of any investment fund.”
