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Tobam: Investing systematically to diversify risk and bias

How quant strategies have accessed risk premia evenly during market volatility


Elena Johansson

Under extreme market stress, 13 of the 14 quant equity strategies from French asset manager Tobam delivered excess gross return in comparison to their benchmarks.

Only one, however, delivered a positive return – the Tobam Anti-Benchmark US Equity (USD).

The table below displays the performance of the strategies from January to May 2020.

Source: Tobam

In terms of the largest outperformance in delta, Tobam’s euro equity strategy returned -9.76% compared to -16.58% for the MSCI Daily Net Total Return EMU Euro – a difference of 6.82%.

Diversification theory

The firm credits this outperformance to a mathematical model, which allows Tobam, with $6.7bn (€5.8bn) in assets under management, to diversify investments beyond traditional means.

Managing director and deputy chief investment officer Tatjana Puhan explained to Expert Investor: “Basically, we are looking at how the different stocks are correlated to each other in this universe, and then we try to maximise the diversification given this investment universe.”

Correlation exists, Puhan said, when, for example, different stocks have exposure to the same risks from the energy or financial sector.

The more uncorrelated stocks are to each other, the more they are diversified and able to compensate for each other’s risk.

Tobam’s approach seeks to create ‘neutral’ portfolios that are diversified as much as possible and don’t have any larger bias. This is one of the advantages compared to market cap indices, Puhan explained.

Biased indices

While people believe that passive investing in market indices would allow unbiased investing in market stocks, this is not the case, she argues.

“You can have 500 stocks in your portfolio and you can have a very large concentration risk,” Puhan said; pointing to the fact that there is a huge single stock risk in the S&P 500, with 20% of allocations weighted towards just five firms.

This bias would also apply to fixed income benchmarks.

When it comes to high-yield indices, the weight of an issuer in the index is determined by its outstanding debt, Puhan said.

This means that issuers with the most leverage are given the biggest weighting, while also carrying the largest risk to default in crisis times, she added (see table below).

Source: Tobam

Crisis performance

Even though volatilities and correlations move up in crisis times, Tobam’s diversification approach can still create excess return, Puhan said, as market sell-offs happen with different intensity.

“In strong periods of market stress asset price dispersion is going up; with dispersion I mean the difference in the strength in price movement.

“And if you are diversified, this means that you can actually capture much better the whole market risk premium,” she said.

This also explains the stronger outperformance of Tobam’s euro equity strategy compared to its other strategies.

The underlying Euro universe had a stronger bias towards financials and industrials than other universes, and when these sectors sold off heavily, Tobam’s unbiased strategy was able to capture the greater difference in risk exposures.

The firm’s strategies, which rely on historical data (return time series), are an antidote to active fund managers seeking to time the market or forecast and participate in trends.

The mantra is that being diversified is the fundamental strategy against any risk.

“And if you don’t know what the future is going to bring, […], we think that one thing that you do know is that being diversified is probably a good idea,” Puhan says.