Europe – a different kind of alpha

03/01/2018

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Adrian Banner, Intech’s Chief Executive Officer and Chief Investment Officer, discusses the advantages of an investment approach not based on fundamentals or asset allocation decisions, but mathematics. By embracing an investment philosophy driven by observations, not expectations, he demonstrates how the approach has historically improved the risk-adjusted returns of a strategy blending European equity funds.

Top-down, bottom-up, value, growth, momentum, quality, size… the choice of factors for investors seeking alpha is seemingly endless, and recently has been complicated further by the number of new offerings from ‘smart beta’ or the ‘factor zoo’. Each investment approach has its merits, although all are dependent on either the skill, or luck, of the fund manager(s) and/or whether the underlying market conditions favour their approach. But what if there was a different way to invest? One that aims to produce long-term alpha, but is not based on forecasting stock returns, or making asset allocation decisions based on fundamentals and/or factor models?

Intech – an independent subsidiary of Janus Henderson Investors – believes that the answer lies in advanced, but well-established, mathematics. It embraces an investment philosophy grounded in observations, not expectations, and therefore does not rely on subjective forecasts of markets, factors or company performance. Intech uses mathematics and systematic portfolio rebalancing in an attempt to harness a historically reliable source of alpha – volatility. Intech’s founder, Dr E. Robert Fernholz, first demonstrated in a 1982 academic paper that maintaining a portfolio’s diversification by regular rebalancing generates a return premium. Buy-and-hold portfolios, such as index trackers or other infrequently reconstituted portfolios do not capture this rebalancing effect efficiently.

Using this academic foundation, Intech’s approach is to estimate relative share price volatility and correlations, optimise a portfolio based on these estimates to determine target weights, and then rebalance regularly in order to capture alpha and control risk. This rebalancing has a ‘buy low, sell high’ character, selling recent winners and reinvesting the proceeds in recent losers.

For investors seeking a broad range of return drivers, Intech’s approach could appeal on two levels:

  • The process has been shown to provide alpha over the long-term, in a wide range of market conditions
  • The pattern of excess returns has historically been lowly correlated to its peers

To demonstrate the diversifying benefit of adding an Intech fund to a portfolio of European funds, the Janus Henderson Intech European Core Fund1 has been included in a simulation with its Morningstar peers.

We performed the following experiment. From a universe of 55 comparable European equity funds in the Morningstar database2, we used a Monte Carlo3 simulation to create portfolios of three randomly selected funds (not including the Intech fund). We measured the performance and risk statistics of each three-fund portfolio, and repeated until we had generated 10,000 three-fund portfolio combinations. For each of these three-fund portfolios, we then randomly replaced one of the funds with the Intech fund, and compared the performance and risk of the new portfolios against the originals.

The results of the experiment can be seen in the following charts:

Excess return: in 69% of cases (that is, c.6,900 of the 10,000 portfolios) the excess return of the three-fund portfolio was increased by including the Intech fund.

Graph 1.png  

Source: as per footnote 2. Past performance is not a guide to future performance.

Tracking error: More importantly, due to the low correlation of Intech’s alpha source to more traditional approaches, the tracking error of the three-fund portfolio was decreased by including the Intech fund in 95% of cases.

Graph 2.png 
Source: as per footnote 2. Past performance is not a guide to future performance.
 
Information Ratio: This increase in excess return and decrease in tracking error resulted in an increase in Information Ratio in 74% of the 10,000 simulated combinations.
Graph 3.png 
Source: as per footnote 2. Past performance is not a guide to future performance.

Downside Capture: And finally, demonstrating that the Intech approach seeks to outperform in a wide range of market conditions (including down markets), the downside capture of the three-fund portfolio was reduced in 71% of cases through inclusion of the Intech fund.

Graph 4.png 

Source: as per footnote 2. Past performance is not a guide to future performance.

This experiment shows the risk-adjusted return enhancement and diversification benefits that the Janus Henderson Intech European Core Fund would have delivered to investors since launch (to 31 October 2017). In our view, the results demonstrate the potential value of the fund as part of a European strategy blending manager styles, but also the attraction of the fund as a standalone ‘core’ European equity holding.

 

[1] Dublin-registered SICAV, MSCI Europe Index benchmark, expected tracking error range of 3-4%.

[2] Defined as; funds stating MSCI Europe Index as primary benchmark, funds with a track record commencing on or pre-dating February 2014 (the inception date of the Janus Henderson Intech European Core Fund), and funds with a zero fee (Z) share class. Period measured as 31 January 2014 to 31 October 2017, total return in euro terms. Janus Henderson Intech European Core Fund performance measured over the same period and on the same terms as the Morningstar database.

[3] A Monte Carlo simulation is a way of calculating or forecasting possible results and risks on outcomes, by running a large number of simulations on a data set. It is also referred to as a ‘probability simulation’.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

For promotional purposes.


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Janus Henderson Intech European Core Fund

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Issued in Europe by Janus Capital International Limited (“JCIL”), authorised and regulated by the U.K. Financial Conduct Authority. Janus Capital International Limited (“JCIL”) is an entity registered and operating under the laws of the United Kingdom and Janus Capital Funds plc. is registered under the legislation of Ireland.

The extract prospectus (edition for Switzerland), the articles of incorporation, the extract annual and semi-annual report, in German, can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd (“FIFS”), Klausstrasse 33, CH-8008 Zurich, Switzerland, tel: +41 44 206 16 40, fax: +41 44 206 16 41, web: http://www.fifs.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For Qualified investors, institutional, wholesale client use only. Outside of Switzerland, this document is for professional use only. Not for onward distribution.

This material is strictly private and confidential and may not be reproduced or used for any purpose other than evaluation of a potential investment in Janus Capital International Limited’s products or the procurement of its services by the recipient of this presentation or provided to any person or entity other than the recipient of this presentation.

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Janus Capital Management LLC serves as investment adviser. Janus, Intech and Perkins are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. For more information or to locate your country’s Janus representative contact information, please visit www.janushenderson.com.

Specific risks

  • This fund is designed to be used only as one component of several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
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  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund uses mathematical formulae to select investments. There is a risk that the processes used to invest in shares with higher volatility and low price-correlation may not achieve positive returns or outperform.

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